PFSWEB INC - 10-K Annual Report

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

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

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

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
972-881-2900

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE

Indicate by a 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 [ ]

Indicate by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes [X] No [ ]

The aggregate market value of the voting stock held by non-affiliates of
the registrant as of June 30, 2002 (based on the closing price as reported by
the National Association of Securities Dealers Automated Quotation System) was
$9,091,636.

As of February 28, 2003, there were 18,417,077 shares of the registrant's
Common Stock, $.001 par value, outstanding, excluding 86,300 shares of common
stock in treasury.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this Annual Report, to the extent
not set forth herein, is incorporated herein by reference from the registrant's
definitive proxy statement relating to the annual meeting of stockholders to be
held in June 2003, which definitive proxy statement shall be filed with the
Securities and Exchange Commission within 120 days after the end of the fiscal
year to which this Annual Report relates.

INDEX

Unless otherwise indicated, all references to "PFSweb," "the Company,"
"we," "us" and "our" refer to PFSweb, Inc., a Delaware corporation, and its
subsidiaries. All references to "Daisytek" refer to our former parent
corporation, Daisytek International Corporation, a Delaware corporation, and its
subsidiaries. In June 2001, we elected to change our fiscal year end date from
March 31 to December 31.

PART I

ITEM 1. BUSINESS

GENERAL

PFSweb is a leading provider of outsourcing services. These services include
web-site development and hosting, order management, call center, product kitting
and assembly, order fulfillment, warehousing, credit and collections, technology
capabilities and more. Collectively we define this group of services as Business
Process Outsourcing because we offer our clients infrastructure and technology
capabilities that address an entire business transaction cycle, from demand
generation to product delivery.

PFSweb serves as the "brand behind the brand" for companies seeking to
increase their supply chain efficiencies. As a business process outsourcer, we
offer scalable and cost-effective solutions for manufacturers, distributors,
retailers and direct marketing organizations. We provide our clients with
seamless and transparent solutions to support their business strategies,
allowing them to focus on their core competencies while we provide cost
effective capabilities for areas of their business that are not core
competencies. Leveraging PFSweb's technology, expertise and proven methodology,
we enable client organizations to develop and deploy new products quickly and
implement new business strategies or address new distribution channels rapidly
and efficiently through our optimized solutions. Our clients engage us both as a
consulting partner to assist them in the design of a business solution as well
as a virtual and physical infrastructure partner providing the mission critical
operations required to build and manage that business solution. Together, we not
only help our clients define new ways of doing business, but also provide them
the technology and physical infrastructure necessary to quickly implement this
new business model. We allow our clients to quickly and dramatically change how
they 'go-to-market.'

Each client has a unique business model and unique strategic objectives that
require highly customized solutions. Clients in a wide array of industries, from
computer products to cosmetics to consumer goods to collectibles, turn to PFSweb
for help in addressing a variety of business issues, such as customer
satisfaction, production capacity requirements, vendor integration, supply chain
compression, cost model realignment and international expansion, among others.
We also act as an agent of change, providing clients the ability to alter their
current distribution model, establish direct relationships with end-customers,
and reduce the overall time and costs associated with existing distribution
channel strategies. Our clients are seeking solutions that will provide them
with dynamic supply chain and channel marketing efficiencies, while ultimately
delivering a world-class customer service experience.

Our technology and business infrastructures are adaptable, changeable and
reliable. This flexibility allows us to design custom, variable cost solutions
to fit the business requirements of our client's strategies. Our revenue is
primarily earned from product revenue earned through our master distribution
relationship with certain clients and service fees charged to process individual
business transactions on our client's behalf through our technology and
infrastructure capabilities. These business transactions may include the
answering of a phone call or an e-mail, the design and hosting of a client
web-site, the processing of an electronic credit card authorization, the receipt
and storage of our client's inventory, the assembly of a kit of products to meet
our customers specifications, the shipping of products to our client's customer,
the management of a complex set of electronic data transactions designed to keep
our client's suppliers and customers accounting records in balance, or the
processing of a returned package.

Our capabilities are expansive. In an ongoing quest to offer the most
necessary and resourceful products to our clients, we are continually developing
capabilities to meet the most pressing business issues in the marketplace. Our
business objective is to focus on "Leading the Evolution of Outsourcing." As our
tagline suggests, we will continue to evolve our master distributor
relationships and service offerings to meet the needs of the marketplace and the
demands of unique client requirements. We are most successful when we develop a
new capability to enable a client to pursue a new initiative and we are then
able to leverage that revolutionary development across other client or prospect
solutions as it becomes "best practice" in the marketplace. Our team of experts
design and build diverse solutions for Fortune 1000, Global 2000 and brand name
clients around a flexible core of technology and physical infrastructure that
includes:

o Technology collaboration provided by our suite of technology services,
called the Entente Suite(SM), that are e-commerce and collaboration
services that enable buyers and suppliers to fully automate their
business

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transactions within their supply chain. Entente supports industry
standard collaboration techniques including XML based protocols such as
Biztalk and RosettaNet, real-time application interfaces, text file
exchanges via secured FTP, and traditional electronic data interchange
("EDI");

o Managed hosting and internet application development services, including
web site design, creation, integration and ongoing maintenance, support
and enhancement of web site;

o Order management, including order processing from any source of entry,
back order processing and future order processing, tracking and tracing,
credit management, electronic payment processing, calculation and
collection of sales tax and VAT comprehensive freight calculation and
email notification, all with multiple currency and language options;

o Customer Relationship Management ("CRM"), including interactive voice
response ("IVR") technology and web-enabled customer contact services
through world-class call centers utilizing voice, e-mail, voice over
internet protocol ("VOIP") and internet chat communications that are
fully integrated with real-time systems and historical data archives to
provide complete customer lifecycle management;

o International fulfillment and distribution services, including warehouse
management, inventory management, inventory postponement, product
warehousing, order picking and packing, transportation management and
reverse logistics;

o Kitting and assembly services, including light assembly, procurement
services, Supplier Relationship Management, specialized kitting, and
supplier consigned inventory hubbing in PFSweb's distribution facilities
or co-located in other facilities;

o Information management, including real-time data interfaces, data
exchange services and data mining;

o Financial services, including secure on-line credit card processing,
fraud protection, invoicing, credit management and collection, and
working capital solutions; and

o Professional consulting services, including a consultative team of
experts that customize solutions to each client and continuously seeks
out ways to increase efficiencies and produce benefits for the client.

We are headquartered in Plano, Texas where our executive and administrative
offices are located as well as our primary technology laboratories and hosting
facilities. We operate state-of-the-art call centers from our U.S. facilities
located in Plano, Texas, and Memphis, Tennessee, and from our international
facility located in Liege, Belgium. We have approximately one million square
feet of warehouse floor space located across our facilities in Memphis, Toronto
and Liege allowing us to provide global distribution solutions. These
distribution facilities are highly automated and contain state of the art
material handling and communications equipment. We provide solutions to clients
that are often regarded as market leaders in a variety of different industries.
Those industries include technology manufacturing, telecommunications, computer
consumables, direct marketing, apparel, retailing, collectibles, consumer goods,
personal care/cosmetics, pharmaceuticals, housewares and consumer electronics,
among others.

Prior to December 1999, we were a wholly-owned subsidiary of Daisytek
International Corporation ("Daisytek"), one of the world's largest wholesale
distributors of computer supplies, office products, and film and tape media. Our
business unit was formed in 1991 to leverage Daisytek's core competencies in
customer service, order management, product fulfillment and distribution. From
1996 to 1999, the operations of our business unit were primarily focused in
several Daisytek subsidiaries operating collectively as Priority Fulfillment
Services, Inc. ("PFS"). In June 1999, Daisytek created a separate wholly owned
subsidiary named PFSweb, Inc., a Delaware corporation, to become a holding
company for PFS in contemplation of an initial public offering (the "Offering")
of PFSweb. In December 1999, we sold 3,565,000 shares of common stock in the
Offering and Daisytek contributed to us all the assets, liabilities and equity
comprising PFS. PFSweb and Daisytek completed their separation on July 6, 2000
through a pro rata distribution to Daisytek's common stockholders of all of the
shares of our common stock that Daisytek then held (the "spin-off").

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Upon completion of the Offering, we entered into a number of agreements with
Daisytek relating to our business and our proposed spin-off from Daisytek. See
"Spin-off of PFSweb from Daisytek." In May 2001, certain of these agreements
were terminated as part of a transaction in which we sold to Daisytek certain
assets used to provide transaction management services to Daisytek. As part of
this sale transaction, we also entered into a short term transition services
agreement with Daisytek which expired in November 2001.

Although we continue to be party to certain agreements with Daisytek
relating to the spin-off, we do not currently generate any service fee revenues
or incur any expenses related to services for Daisytek. However, through our
master distributor relationship operated by our subsidiary, Supplies
Distributors, we sell certain products to Daisytek and also purchase certain
products from them.

INDUSTRY OVERVIEW

Business activities in the public and private sectors continue to operate in
an environment of rapid technological advancement, increasing competition and
continuous pressure to improve operating and supply chain efficiency while
decreasing costs. We continue to see the following trends within the industry:

o Manufacturers look to restructure their supply chains to maximize
efficiency and reduce costs in both business-to-business and
business-to-consumer markets and to create a variable-cost supply chain
that is able to support the multiple unique needs of each of their
initiatives, including traditional and electronic commerce.

o Government agencies are increasingly focused on improved citizen
usability and interaction, as well as the need to manage government
initiatives from an efficiency perspective.

o Companies in a variety of industries seek outsourcing as a method to
address one or more business functions that are either not within their
core business competencies, to reduce operating costs or to improve the
speed or cost of implementation.

SUPPLY CHAIN MANAGEMENT TREND

As companies maintain focus on improving their businesses and balance sheet
financial ratios, significant efforts and investments continue to be made
identifying ways to maximize supply chain efficiency and extend supply chain
processes. Working capital financing, vendor managed inventory, supply chain
visibility software solutions, distribution channel skipping, direct to consumer
e-commerce sales initiatives, and complex upstream supply chain collaborative
technology are products that manufacturers seek to help them achieve greater
supply chain efficiency. Forrester Research predicts that U.S. firms will spend
a total of $35 billion over the next five years to improve business processes,
which we believe includes the type of products described above, that monitor,
manage, and optimize their extended supply chains.

A key business challenge facing many manufacturers and retailers as they
evaluate their supply chain efficiency is in determining how the trend for
consumers to shop via the Internet in an electronic commerce fashion will affect
their traditional commerce business model. According to the International Data
Corporation's ("IDC") eWorld survey, eBusiness grew more than 20% in 2001 and
they predict this growth will continue as companies make ebusiness one of their
top priorities. IDC further reports that companies will continue to invest in
eBusiness initiatives to reduce costs, improve customer service and enhance
coordination with customers and suppliers. We believe that companies will
continue to strategically plan for the impact that e-commerce and other new
technology advancements will have on their traditional commerce business models
and their existing technology and infrastructure capabilities. eMarketer
predicts that by 2004, business to business e-commerce worldwide will reach $2.8
trillion up from $448 billion in 2001. While the majority of online transactions
currently occur in the United States and North America, in the coming years we
believe that certain Asian and European nations will experience significant
growth in e-commerce transactions as well.

Manufacturers, as buyers of materials, are also imposing new business
practices and policies on their supplier partners in order to shift the normal
supply chain costs and risks associated with inventory ownership away from their
own balance sheets. Through techniques like Vendor Managed Inventory ("VMI") or
Consigned Inventory

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Programs ("CIP"), manufacturers are asking their suppliers, as a part of the
supplier selection process, to provide capabilities where the manufacturer need
not own, or even possess, inventory prior to the exact moment that unit of
inventory is required as a raw material component or for shipping to a customer.
To be successful for all parties, business models such as these often require a
sophisticated collection of technological capabilities that allow for complete
integration and collaboration of the information technology environments of both
the buyer and supplier. For example, in order for an inventory unit to arrive at
the precise required moment in the manufacturing facility, it is necessary for
the Manufacturing Resource Planning ("MRP") systems of the manufacturer to
integrate with the CRM systems of the supplier. When hundreds of supplier
partners are involved, this process can become quite complex and technologically
challenging. Buyers and suppliers are seeking solutions that utilize XML based
protocols like Biztalk, RosettaNet and other traditional EDI standards in order
to ensure an open systems platform that promotes easier technology integration
in these collaborative solutions.

GOVERNMENT OUTSOURCING TREND

The United States government has increased its focus on streamlining work
efforts and reducing overall governmental costs, which has led to further
evaluation of outsourcing as a possible avenue to achieve these goals. The
federal government formulated an E-Government strategy in 2002, which was
created to support multi-agency projects that improve citizen services and yield
performance gains. Also, recent revisions to government mandate A-76 state that
Government agencies must conduct thorough audits to determine the lowest cost
and most efficient method of doing business, and to outsource to the public
sector when in-house operations are unable to compete.

As stated in the February 2002 E-Government Strategy document developed by
the U.S. Office of Management and Budget (OMB) E-Government task force, the
primary goals for this initiative are to:

o Make it easy for citizens to obtain service and interact with the
federal government;

o Improve government efficiency and effectiveness; and

o Improve the government's responsiveness to citizens.

According to the Budget of the United States Government, fiscal year 2004,
the federal government's investment in information technology (IT) is estimated
to be increased to $59 billion for 2004 versus the 2003 budget request of $53
billion. This increased level of IT spending provides enormous opportunities for
the government to transform itself into a citizen-centered E-Government and
provides additional opportunities for the government to work with the public
sector to develop more user friendly methods of interaction. Past
agency-centered IT approaches have limited the government's productivity gains
and ability to serve citizens. With this initiative, the federal government is
poised to transform the way it does business with citizens through the use of
E-Government.

The 2002 E-Government strategy document goes on to state, "E-Government
provides many opportunities to improve the quality of service to citizens.
Citizens should be able to get service or information in minutes or hours,
versus today's standard of days or weeks. Citizens, businesses and state and
local governments should be able to file required reports without having to hire
accountants and lawyers. Government employees should be able to do their work as
easily, efficiently and effectively as their counterparts in the commercial
world. Effective execution of this strategy are targeted to:

o Simplify delivery of services to citizens;

o Eliminate layers of government management;

o Make it possible for citizens, businesses, other levels of government
and federal employees to easily find information and get service from
the federal government;

o Simplify agencies' business processes and reduce costs through
integrating and eliminating redundant systems;

o Enable achievement of the other elements of the President's Management
Agenda; and

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o Streamline government operations to guarantee rapid response to citizen
needs."

E-Government Strategy activities are centered on four citizen-centered
groups, including:

o Individuals/Citizens: Government-to-Citizens (G2C);

o Businesses: Government-to-Business (G2B);

o Intergovernmental: Government-to-Government (G2G);

o Intra-governmental: Internal Efficiency and Effectiveness (IEE);

Through the E-Government Strategy, Government agencies are currently faced
with pressure to upgrade technology capabilities and to better interface with
their audiences. Combined with the A-76 initiative that directs Government
agencies to pursue the most cost-effective method of doing business, current
federal strategy now enforces government's need to better understand public
alternatives, submit to extensive requests for proposals to an array of
government and non-government providers, and to perform complex evaluations of
existing operations and functions. These initiatives will continue to drive
government usage of outside sources.

OUTSOURCING TREND

In response to the current economic situation, growing competitive pressures
and technological innovations, we believe many companies, both large and small,
are focusing their critical resources on the core competencies of their business
and utilizing business process outsourcing to accelerate their business plans in
a cost-effective manner and perform non-core business functions. Outsourcing
provides many key benefits, including the ability to:

o Capitalize on skills, expertise and technology infrastructure that would
otherwise be unavailable or expensive given the scale of the business;

o Reduce capital and personnel investments and convert fixed investments
to variable costs;

o Increase flexibility to meet changing business conditions and demand for
products and services;

o Enhance customer satisfaction and gain competitive advantage;

o Improve operating performance and efficiency; and

o Enter new business markets or geographic areas rapidly.

As a result, the market for business process outsourcing services continues
to grow. IDC predicts that worldwide logistics business process outsourcing
trends will continue to evolve and grow to reach $308.7 billion in 2006.

Typically, outsourcing service providers are focused on a single function,
such as information technology, call center management, credit card processing,
warehousing or package delivery. This focus creates several challenges for
companies looking to outsource more than one of these functions, including the
need to manage multiple outsourcing service providers, to share information with
service providers and to integrate that information into their internal systems.
Additionally, the delivery of these multiple services must be transparent to the
customer and enable the client to maintain brand recognition and customer
loyalty.

Furthermore, traditional commerce outsourcers are frequently providers of
domestic-only services versus international solutions. As a result, companies
requiring global solutions must establish additional relationships with other
outsourcing parties.

Another vital point for major brand name companies seeking to outsource is
the protection of their brand. When looking for an outsourcing partner to
provide infrastructure solutions, brand name companies must find a company that
can ensure the same quality performance and superior experience that their
customers expect from their brands.

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Working with an outsourcing partner requires finding a partner that can maintain
the consistency of their brand image, which is one of the most valuable
intangible assets that recognized brand name companies possess.

THE PFSWEB SOLUTION

PFSweb serves as the "brand behind the brand" for companies seeking to
increase the efficiencies of all aspects of their supply chain.

Our value proposition is to become an extension of our clients' businesses
by delivering a superior experience that increases and enhances sales and market
growth, customer satisfaction and customer retention. We act as both a virtual
and a physical infrastructure for our clients' businesses. By utilizing our
services, our clients are able to:

Quickly Capitalize on Market Opportunities. Our solutions empower clients to
rapidly implement their supply chain and e-commerce strategies and to take
advantage of opportunities without lengthy integration and implementation
efforts. We have ready built technology and physical infrastructure that is
flexible in its design, which facilitates quick integration and implementation.
Currently, PFSweb operates with substantial capacity in its call center,
technology and distribution areas further aiding our clients' speed to market.
The PFSweb solution is designed to allow our clients to deliver consistent
quality service as transaction volumes grow and also to handle daily and
seasonal peak periods. Through our international locations, our clients can use
the broad reach of the internet and e-commerce to sell their products almost
anywhere in the world.

Improve the Customer Experience. We enable our clients to provide their
customers with a positive buying experience thereby maintaining and promoting
brand loyalty. Through our use of advanced technology, we can respond directly
to customer inquiries by e-mail, voice or data communication and assist them
with on-line ordering and product information. We offer our clients a "world-
class" level of service, including 24-hour, seven-day-a-week, Web-enabled
customer care service centers, detailed CRM reporting and exceptional order
accuracy. We have significant experience in the development of Internet web
sites that allows us to recommend features and functions that are easily
navigated and understood by our client's customers. Our technology platform is
designed to ensure high levels of reliability and fast response times for our
clients' customers. Because our technology is "world-class," our clients benefit
from being able to offer the latest in customer communication and response
conveniences to their customers.

Minimize Investment and Improve Operating Efficiencies. One of the most
significant benefits that outsourcing to PFSweb provides is the ability to
transform fixed costs into variable costs. By eliminating the need to invest in
a fixed capital infrastructure, our clients' costs typically become directly
correlated with volume increases or declines. Further, as volume increases drive
the demand for greater infrastructure or capacity, PFSweb is able to quickly
deploy additional resources. We provide services to multiple clients, which
enables us to offer our clients economies of scale, and resulting cost
efficiency, that they may not have been able to obtain on their own.
Additionally, because of the large number of daily transactions we process,
PFSweb has been able to justify investments in levels of automation, security
surveillance, quality control processes and transportation carrier interfaces
that are typically outside the scale of investment that our clients might be
able to cost justify on their own. These additional capabilities can provide our
clients the benefits of enhanced operating efficiency, reduced inventory
shrinkage, and expanded customer service options.

Access a Sophisticated Technology Infrastructure. We provide our clients
with ready access to a sophisticated technology infrastructure through our
Entente Suite, which is designed to interface seamlessly with their systems. We
provide our clients with vital product and customer information that can be
immediately available to them on their own systems or through web based graphic
user interfaces for use in data mining, analyzing sales and marketing trends,
monitoring inventory levels and performing other management functions.

THE PFSWEB STRATEGY

As we look to 2003, we have adopted a simple but effective strategy
statement to drive our actions for the year, QGP. This acronym stands for
Quality, Growth and Profit. We believe that if we can achieve outstanding
performance on these three basic elements, they will provide for a stable
foundation for the future of PFSweb. As this evolution of our business model
continues, we will remain focused on these three fundamentals:

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Quality: To meet our client's service level requirements and enhance the
value of their "brand" while providing their customers a positive, memorable and
efficient experience.

Growth: To increase our company's revenue and gross profit from its current
levels. To expand our product offering and to add new clients that drive revenue
and profit growth. To become a larger company in order to create career and
additional employment opportunities.

Profit: To increase the value of our company for all of its stake holders
while rewarding our team members with challenging, fun and memorable life
experiences.

The successful balance of the execution of these fundamental strategies over
the next year is targeted to result in the formation of a solid strategic and
financial foundation for PFSweb and provide PFSweb a sustainable and profitable
business model for the future.

See "Risk Factors" for a complete discussion of risk factors related to our
ability to achieve our objectives and fulfill our business strategies.

PFSWEB SERVICES

We offer a comprehensive and integrated set of business infrastructure
solutions that are tailored to our clients' specific needs and enable them to
quickly and efficiently implement their supply chain strategies. Our services
include:

Technology Collaboration. Specifically for e-commerce initiatives, PFSweb
has created the Entente Suite, which illustrates the level of electronic
cooperation that is possible when we construct solutions with our clients using
this technology service offering. This set of technology services enables
everything from order processing and inventory reporting to total e-commerce
design and implementation. The Entente Suite comprises four key services--
EntenteDirect(SM), EntenteMessage(SM), EntenteWeb(SM) and EntenteReport(SM).

EntenteDirect provides clients with a real-time, user-friendly interface
between their system and PFSweb order processing, warehouse management and
related functions. Using real-time or batch processes, EntenteMessage is a file
exchange service for clients using our warehousing and distribution facilities.
EntenteWeb is a one-stop shop for the entire e-commerce process, particularly
for companies with unusual needs or specific requests that are not easily met by
the typical e-commerce development packages. EntenteWeb is a service
particularly focused to enable global commerce strategies with its extensive
currency and language functionality. EntenteReport is a real-time, user-friendly
data mining service particularly suited to companies that need to put key
e-commerce information into the hands of business users, but do not have the IT
resources to facilitate the necessary data extraction, manipulation and
presentation. EntenteReport is web browser-based and simplifies even the most
complex data for extraction and analysis.

The Entente Suite operates in an open systems environment and features the
use of industry-standard XML, enabling customized e-commerce solutions with
minimal changes to a clients' systems or our Enterprise Resource Planning
("ERP") systems. The result is a faster implementation process. Additionally, by
using XML, the Entente Suite offers companies a more robust electronic
information transfer option than text file FTP or EDI.

Managed Hosting and Internet Application Development. We offer a highly
available and secure managed hosting solution that encompasses complete creation
and maintenance of client web sites. Operating with an in-house creative staff,
we customize commerce enabled client sites to their exact specifications and
requirements. As with all major brand name companies, consistency within the
brand image is vital; therefore, our design engineers create sites that
seamlessly integrate and mirror the exact brand image of our clients. By
operating on IBM enterprise systems and utilizing our state of the art Entente
Suite technology along with Microsoft.Net technologies, we can maintain a robust
hosting environment for client sites to reside.

Specifically through the EntenteWeb package, clients can build an e-commerce
offering with relatively low investment and in a time efficient manner.
EntenteWeb is a complete front-to-back e-commerce solution that

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incorporates components ranging from the look of the user interface to specific
business purchasing, warehousing and shipping needs, enabling companies to
define in exact terms their desired e-commerce site functionality.

Order Management. Our order management solutions provide clients with
interfaces that allow for real-time information retrieval, including information
on inventory, product orders, shipment, delivery and customer history. These
solutions are seamlessly integrated with our web-enabled customer contact
centers, allowing for the processing of orders through shopping cart, phone,
fax, mail, email, web chat, and other order receipt methods. As the information
backbone for our total supply chain solution, order management services can be
used on a stand alone basis or in conjunction with our other business
infrastructure offerings, including customer contact, financial or distribution
services. In addition, for the business-to-business market, our technology
platform provides a variety of order receipt methods that facilitate commerce
within various stages of the supply chain. Our systems provide the ability for
both our clients' and their customers to track the status of orders at any time.
Our services are transparent to our clients' customers and are seamlessly
integrated with our clients' internal systems platforms and web sites. By
synchronizing these activities, we can capture and provide critical customer
information, including:

o Statistical measurements critical to creating a quality customer
experience, containing real-time order status, order exceptions, back
order tracking, allocation of product based on timing of online purchase
and business rules, the ratio of customer inquiries to purchases,
average order sizes and order response time;

o Business-to-business supply chain management information critical to
evaluating inventory positioning, for the purpose of reducing inventory
turns, product flow through and end-consumer demand;

o Reverse logistics information including customer response and reason for
the return or rotation of product and desired customer action;

o Detailed marketing information about what was sold and to whom it was
sold, by location and preference; and

o Web traffic reporting showing the number of visits ("hits") received,
areas visited, and products and information requested.

Customer Relationship Management. We offer a completely customized CRM
solution for clients. Our CRM solution encompasses a full-scale customer contact
management service offering, as well as a fully integrated customer analysis
program. All customer contacts are captured and customer purchases are
documented. Full-scale reporting on all customer transactions is available for
evaluation purposes. Through each of our customer touch-points, information can
be analyzed and processed for current or future use in business evaluation,
product effectiveness and positioning, and supply chain planning.

An important feature of evolving commerce remains the ability for the
customer to speak with a live customer service representative. Our experience
has been that a majority of consumers tell us they visited the web location for
information, but only a fraction of those consumers chose to place their order
online. Our customer care services utilize features that integrate voice,
e-mail, standard mail, data and internet chat communications to respond to and
handle customer inquiries. Our customer care representatives answer various
questions, acting as virtual representatives of our client's organization,
regarding order status, shipping, billing, returns and product information and
availability as well as a variety of other questions. Our web-enabled customer
care technology identifies each customer contact automatically and routes it to
the available customer care representative who is individually certified in the
client's business and products. Our web-enabled customer care centers are
designed so that our customer care representatives can handle several different
clients and products in a shared environment, thereby creating economy of scale
benefits for our clients as well as highly customized dedicated support models
that provide the ultimate customer experience and brand reinforcement. Our
advanced technology also enables our representatives to up-sell, cross-sell and
inform customers of other products and sales opportunities. The web-enabled
customer care center is fully integrated into the data management and order
processing system, allowing full visibility into customer history and customer
trends. Through this fully integrated system, we are able to provide a complete
CRM solution.

8

With the need for efficiency and cost optimization for many of our clients,
we have integrated IVR as another option for customer contacts. IVR creates an
"electronic workforce" with virtual agents that can assist customers with vital
information at any time of the day or night. IVR allows for our clients'
customers to deal interactively with our system to handle basic customer
inquiries, such as account balance, order status, shipment status, catalog
requests, product and price inquiries, and routine order entry for established
customers. The inclusion of IVR to our service offering allows us to offer a
cost effective way to handle high volume, low complexity calls.

International Fulfillment and Distribution Services. An integral part of our
business process outsourcing solutions is the warehousing and distribution of
inventory either owned by our clients or owned by us through our master
distributor relationships. We currently have approximately one million square
feet of warehouse space domestically and internationally to store and process
our clients' inventory. We receive client inventory in our distribution centers,
verify shipment accuracy, unpack, audit (a process that includes spot-checking a
small percentage of the clients inventory to validate piece counts and check for
damages that may have occurred during loading and unloading), inspect for other
damages (which may include checking fabric, stitching and zippers, for soft
goods, or 'testing' power-up capabilities for electronic items) and stock for
sale the same day. On behalf of our clients, we pick, pack and ship their
customer orders and can provide customized packaging, inserts and promotional
literature for distribution with customer orders.

We will also work with clients to re-sequence certain supply to aid in an
inventory postponement strategy. We can build clients assembly flow lines and
create thousands of units daily to stock in a JIT environment. This service, for
example, can entail the procurement of packaging materials including retail
boxes, foam inserts and anti-static bags. These raw material components would be
shipped to PFSweb from overseas manufacturers, and PFSweb will build the
finished SKU units to stock for the client. This strategy allows manufacturers
to make a smaller investment in inventory while meeting changing customer
demand.

Based upon our clients' needs, we are able to take advantage of a variety of
shipping and delivery options, including next day service. Our facilities are
equipped with multi-carrier functionality, allowing us to integrate with all
major shipping carriers and provide a comprehensive transportation management
offering. In addition, an increasingly important function that we provide for
our clients is reverse logistics management. We offer a wide array of product
return services for our clients, including issuing return authorizations,
receipt of product, crediting customer accounts, and disposition of returned
product.

Our distribution facilities contain computerized sorting equipment, highly
mobile pick-to-light carts, powered material handling equipment, scanning and
bar-coding systems and automated conveyors, in-line scales, x-ray equipment and
digital cameras to photograph shipment contents for automatic accuracy checking.
Our international distribution complexes include several advanced technology
enhancements, such as radio frequency technology in product receiving processing
to ensure accuracy, an automated package routing system and a pick-to-light
paperless order picking system. Our advanced distribution systems provide us
with the capability to currently warehouse an extensive number of stock keeping
units (SKUs) for our clients ranging from high-end laser printers to cosmetic
compacts. Our facilities are flexibly configured to process business-to-business
and single pick business-to-consumer orders from the same central location.

During 2002, we warehoused, managed and fulfilled approximately $1 billion
in client merchandise and transactions. Much of this does not represent our
revenue, but rather the revenue of our clients' transactions for whom we
provided e-business infrastructure solutions. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

Domestic clients of PFSweb enjoy the benefits of having their inventory
assets secured by a network of trained law enforcement professionals who have
developed and continue to operate a world-class security network from our
security headquarters in Memphis, TN. Because of our strong relationship with
the US Government pursuant to our US Mint contract, our security plans and
procedures are under constant evaluation and evolution to ensure that we employ
the latest in security processes and procedures as either new threats are
uncovered, or as new technology is announced that further enhances our
surveillance and detection capabilities.

Some of the security actions that PFSweb has recently implemented for our U.S.
operations include;

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- A continuous and thorough review of local and regional threats and
incidents that might affect the flow of product to/from our PFSweb
facilities,

- Regular reviews of security processes and procedures ,

- Performing ongoing risk assessment,

- Identifying hazard severity and probability,

- Resolution of identified risks and hazards,

- Using available surveillance and detection capabilities,

- Coordination with Law Enforcement Agencies, and

- Alert levels with predetermined security measures.

Kitting and Assembly Services. Our expanded kitting and assembly services
reduce the time and costs associated with managing multiple suppliers,
warehousing hubs, and light manufacturing partners. As a single source provider,
we provide clients with the advantage of convenience, accountability and speed.
Our comprehensive kitting and assembly services provide a quality one-stop
resource for any international channel. PFSweb's kitting and assembly service
includes light assembly, specialized kitting and supplier-consigned inventory
hubbing either in our distribution facilities or co-located elsewhere. We also
offer customized light manufacturing and Supplier Relationship Management
("SRM") for Fortune 1000 and Global 2000 manufacturers.

Combining our assembly services with our supplier-owned inventory hub
services allows our clients to reduce cycle times, to compress their supply
chains and to consolidate their operations and supplier management functions. We
have supplier inventory management, assembly and fulfillment services all in one
place, providing greater flexibility in product line utilization, as well as
rapid response to change orders or packaging development. Our standard
capabilities include: build-to-order, build-to-stock, expedited orders, passive
and active electrostatic discharge ("ESD") controls, product labeling, serial
number generation, marking and/or capture, lot number generation, asset tagging,
bill of materials ("BOM") or computer automated design ("CAD") engineering
change processing, SKU-level pricing and billing, manufacturing and metrics
reporting, first article approval processes, and comprehensive quality controls.

Our kitting and assembly services also include procurement. We work directly
with client suppliers to make Just-in-Time ("JIT") inventory orders for each
component in client packages, thereby ensuring the appropriate inventory
quantities arrive at just the right time to PFSweb and then turned around JIT to
customers.

Kitting and inventory hubbing services enable clients to collapse supply
chains into the minimal steps necessary to prepare product for distribution to
any channel, including wholesale, mass merchant retail, or direct to consumer.
Clients no longer have to employ multiple providers or require suppliers to
consign multiple inventory caches for each channel. We offer our clients the
opportunity to consolidate operations from a channel standpoint, as well as from
a geographic perspective. Our integrated, global information systems and
international locations support client business needs worldwide.

Information Management. We have the ability to communicate with and transfer
information to and from our clients through a wide variety of technology
services, including real-time data interfaces, file transferring and electronic
data interchange. Our systems are designed to capture, store and electronically
forward to our clients critical information regarding customer inquiries and
orders, product shipments, inventory status (for example, levels of inventory on
hand, on backorder, on purchase order and inventory due dates to our warehouse),
product returns and other information. We maintain for our clients detailed
product databases that can be seamlessly integrated with their web sites. Our
systems are capable of providing our clients with customer inventory and order
information for use in analyzing sales and marketing trends and introducing new
products. We also offer customized reports and data analyses based upon specific
client needs to assist them in their budgeting and business decision process.

Financial Services. Our financial services are divided into two major areas:
1) billing and collection services for business-to-business and
business-to-consumer clients and 2) working capital solutions. Through our
client financial services, we act as a virtual and physical financial management
department for all potential client needs.

We offer secure credit and collections services for both
business-to-business and business-to-consumer business. Specifically, for
business-to-consumer clients, we offer secure, real-time credit card processing
for orders made via

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a client web site or through our customer contact center. Additionally, we
calculate sales or VAT tax, if applicable, for numerous taxing authorities and
on a variety of products. Using third-party leading-edge fraud protection
services and risk management systems, we can assure the highest level of
security and the lowest level of risk for client transactions.

For business-to-business clients, we offer full-service accounts receivable
management and collection capabilities, including the ability to generate
customized computer-generated invoices in our clients' names. We assist clients
in reducing accounts receivable and days sales outstanding, while minimizing
costs associated with maintaining an in-house collections staff. In addition, we
offer electronic credit services in the format of EDI X.12 and XML
communications direct from our clients to their vendors, suppliers and
retailers.

PFSweb's subsidiary, Supplies Distributors, Inc. provides working capital
solutions, which enables manufacturers to remove inventory and receivables from
their balance sheets through the use of third party financing. This service
offering is available to clients operating in North America and Europe.

While the majority of our clients maintain ownership of their own inventory,
through Supplies Distributors we can create and implement client inventory
solutions as well. PFSweb has years of experience in dealing with the issues
related to inventory ownership, secure inventory management, replenishment and
product distribution. PFSweb and Supplies Distributors can offer prospective
clients a management solution for the entire customer relationship, including
ownership of inventory and receivables. Through CIP, we utilize technology
resources to time the replenishment purchase of inventory with the simultaneous
sale of product to the end user. All interfaces are done electronically and all
processes regarding the financial transactions are automated, creating
significant supply chain advantages.

PFSweb is experienced in the complex legal, accounting and governmental
control issues that can be hurdles in the successful implementation of working
capital financing programs. Our knowledge and experience help clients achieve
supply chain benefits while reducing inventory carrying costs. Substantial
benefits and improvement to a company's balance sheet can be achieved through
these working capital solutions.

Professional Consulting Services. As part of the tailored solution for our
clients, we offer a full team of experts specifically designated to focus on our
clients' businesses. Team members play a consultative role, providing
evaluation, analysis and recommendations for the client's business. This team
creates customized solutions and devises plans that will increase efficiencies
and produce benefits for the client when implemented.

Comprised of industry experts from top-tier consulting firms and industry
market leaders, our team of professional consultants provides client service
focus and logistics and distribution expertise. They have built solutions for
Fortune 1000 and Global 2000 market leaders in a wide range of industries,
including apparel, computer-related products, telecommunications, cosmetics,
housewares, high-value collectibles, sporting goods, pharmaceuticals and several
more. Focusing on the evolving infrastructure needs of major corporations and
their business initiatives, our team has a solid track record providing
consulting services in the areas of supply chain management, distribution and
fulfillment, technology interfacing, logistics and customer support.

CLIENTS AND MARKETING

Our target clients include brand name manufacturers looking to quickly and
efficiently implement business initiatives, to adapt their go-to-market
strategies, or to introduce new products or programs, without the burden of
modifying or expanding their order processing, customer service and distribution
infrastructure. We also target retailers and direct marketers seeking to expand
their sales through new channels as well as government agencies trying to reduce
costs and/or increase efficiency, meet customer expectations and responsiveness.
Our solutions are applicable to a multitude of industries and company types and
we have provided solutions for such companies as:

International Business Machines ("IBM") (printer supplies in several
geographic areas), Adaptec (computer accessories), the U.S. Mint (as a
sub-contractor to IBM Global Services), Avaya Communication, Dell (a computer
manufacturer), Emtec Magnetics (a manufacturer of BASF-branded data media and
audio visual products), Lancome (a cosmetics division of L'Oreal International),
Xerox (printers and printer supplies), Thomson Multimedia (RCA branded
televisions and consumer electronics), Mary Kay Cosmetics (cosmetics),
Pharmacia/Upjohn

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(pharmaceuticals), Nokia USA.com (cell phone accessories), Roots Canada
(apparel), Hewlett-Packard (printers and computer networking equipment) and The
Smithsonian Business Ventures (a collectibles cataloger). We target potential
clients through an extensive integrated marketing program that comprises a
variety of direct marketing techniques, high impact direct print advertising and
a sophisticated tele-sales model. We target our direct marketing efforts to
selected key vertical industry segments where we feel that we are able to
provide significant service differentiation and value. We also utilize trade
shows, industry conferences, trade journal advertising, internet search engines,
and our web site www.pfsweb.com. We also pursue strategic marketing alliances
with consulting firms, software manufacturers and other logistics providers to
generate referrals and customer leads.

Because of the highly complex nature of the solutions we provide, our
clients demand significant competence and experience from a variety of different
business disciplines during the sales cycle. As such, we utilize a selected
member of our senior executive team to lead the design and proposal development
of each potential new client we choose to pursue. The senior executive is
supported by a select group of highly experienced individuals from our
professional services group with specific industry knowledge or experience to
the solutions development process. We employ a team of highly trained
implementation managers whose responsibilities include the oversight and
supervision of client projects and maintaining high levels of client
satisfaction during the transition process between the sales cycle and steady
state operations.

TECHNOLOGY

We maintain advanced management information systems and have automated key
business functions using on-line, real-time systems. These systems enable us to
provide our clients information concerning sales, inventory status, customer
payments and other operations that are essential for our clients to efficiently
manage their electronic commerce and supply chain business programs. Our systems
are designed to scale rapidly in order to handle the transaction processing
demands of our clients.

We employ technology from a selected group of partners, many of whom are
also our clients. For example, we deploy IBM e-servers and network printers in
appropriate models to run web site functions as well as order management and
distribution functions. We utilize Avaya Communication for telephone switch and
call center management functions. We employ Avaya Communication for our
web-enabled customer care center to interact with customers via voice, e-mail or
chat. Avaya Communication technology also allows us to share web pages between
customers and our service representatives. We have the ability to transmit and
receive voice, data and video simultaneously on a single network connection to a
customer to more effectively serve that customer for our client. Clients'
interest in using this technology stems from its ability to allow shoppers to
consult with known experts in a way that the customer chooses prior to
purchasing. Our sophisticated computer-telephony integration has been
accomplished by combining systems software from IBM and Avaya Communication
together with our own application development. We use AT&T for our private
enterprise network and long distance carrier. We use J.D. Edwards as the
software provider for the primary ERP applications that we use in our
operational areas and financial areas. We use Ecometry as the software provider
for the primary multi-channel direct marketing application we deploy for our
catalog and direct marketing clients. We use Siemens Dematic/Rapistan Materials
Handling Automation for our automated order selection, automated conveyor and
"pick-to-light" (inventory retrieval) systems, and Symbol Technologies/Telxon
for our warehouse radio frequency applications. Our Warehouse Management System
("WMS") and Distribution Requirements Planning ("DRP") system have been
developed in-house to meet the varied unique requirements of our vertical
markets. Both the WMS and DRP are tightly integrated to both the North American
and European deployments of our J.D. Edwards' system.

Many internal infrastructures are not sufficient to support the explosive
growth in e-business, e-marketplaces, supply chain compression, distribution
channel realignment and the corresponding demand for real-time information
necessary for strategic decision-making and product fulfillment. To address this
need, we have created the Entente Suite, which is a comprehensive suite of
technology services, with supporting software and hardware infrastructure, that
enables companies with little or no e-commerce infrastructure to speed their
time to market and minimize resource investment and risk, and allows all
companies involved to improve the efficiency of their supply chain. The Entente
Suite is comprised of four distinct service offerings -- EntenteDirect,
EntenteMessage, EntenteWeb, and EntenteReport -- which can stand alone or be
combined for a fully customized e-commerce solution depending on the level of
direct involvement a company wants to maintain in their e-commerce initiative.

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The components of the Entente Suite provide the open platform service
infrastructure that allows us to create complete e-commerce solutions with our
customers. Using the various services of the Entente Suite, we can assist our
clients in easily integrating their web sites or ERP systems to our systems for
real-time transaction processing without regard for their hardware platform or
operating system. This high-level of systems integration allows our clients to
automatically process orders, customer data and other e-commerce information. We
also can track information sent to us by the client as it moves through our
systems in the same manner a carrier would track a package throughout the
delivery process. Our systems enable us to track, at a detailed level,
information received, transmission timing, any errors or special processing
required and information sent back to the client. The transactional and
management information contained within our systems is made available to the
client quickly and easily through the Entente Suite.

The Entente Suite serves as a transparent interface to our back-office
productivity applications including our customized J.D. Edwards order management
and fulfillment application and our Ecometry multi-channel direct marketing
application that runs on IBM e-Servers. It also is designed to integrate with
marketplace technologies offered by major marketplace software companies.

To enhance our service offerings, we have invested in advanced
telecommunications, computer telephony, electronic mail and messaging, automated
fax technology, IVR technology, barcode scanning, wireless technology, fiber
optic network communications and automated inventory management systems. We have
also developed and utilize telecommunications technology that provides for
automatic customer call recognition and customer profile recall for inbound
customer service representatives.

The primary responsibility of our systems development team of IT
professionals is directed at implementing custom solutions for new clients and
maintaining existing client relationships. Our development team can also produce
proprietary systems infrastructure to expand our capabilities in circumstances
where we cannot purchase standard solutions from commercial providers. We also
utilize temporary resources when needed for additional capacity.

Our information technology operations and infrastructure are built on the
premise of reliability and scalability. We maintain diesel generators and
un-interruptible power supply equipment to provide constant availability to
computer rooms, call centers and warehouses. Multiple internet service providers
and redundant web servers provide for a high degree of availability to web sites
that interface with our systems. Capacity planning and upgrading is performed
regularly to allow for quick implementation of new clients and avoid
time-consuming infrastructure upgrades that could slow growth rates. We also
have a disaster recovery plan for our information systems and maintain a "hot
site" under contract with a major provider.

COMPETITION

Many companies offer, on an individual basis, one or more of the same
services we do, and we face competition from many different sources depending
upon the type and range of services requested by a potential client. Our
competitors include vertical outsourcers, which are companies that offer a
single function, such as call centers, public warehouses or credit card
processors. Many of these companies have greater capabilities than we do for the
single function they provide. We also compete against transportation logistics
providers who offer product management functions as an ancillary service to
their primary transportation services. In many instances, our competition is the
in-house operations of our potential clients themselves. The in-house operations
departments of potential clients often believe that they can perform the same
services we do, while others are reluctant to outsource business functions that
involve direct customer contact. We cannot be certain that we will be able to
compete successfully against these or other competitors in the future.

Although many of our competitors can offer one or more of our services, we
believe our primary competitive advantage is our ability to offer a wide array
of services that cover a broad spectrum of business processes, including web
site design and hosting, kitting and assembly, order processing and shipment,
credit card payment and customer service, thereby eliminating any need for our
clients to coordinate these services from many different providers. We believe
we are unique in offering our clients a very broad range of business process
services that addresses, in many cases, the entire business transaction, from
demand to delivery.

13

We also compete on the basis of many other important additional factors,
including:

o operating performance and reliability;

o ease of implementation and integration;

o experience of the people required to successfully and efficiently design
and implement solutions;

o leading edge technology capabilities;

o global reach; and

o price.

We believe that we compete favorably with respect to each of these factors.
However, the market for our services is becoming more competitive and still
evolving, and we may not be able to compete successfully against current and
future competitors.

EMPLOYEES

As of December 31, 2002, we had 437 full-time employees and 113 part-time
employees, of which 503 were located in the United States. We are not a party to
any collective bargaining agreements, and we have never suffered an interruption
of business as a result of a labor dispute. We consider our relationship with
our employees to be good.

Our success in recruiting, hiring and training large numbers of skilled
employees and obtaining large numbers of hourly employees during peak periods
for distribution and call center operations is critical to our ability to
provide high quality distribution and support services. Call center
representatives and distribution personnel receive feedback on their performance
on a regular basis and, as appropriate, are recognized for superior performance
or given additional training. Generally, our clients provide specific product
training for our customer service representatives and, in certain instances,
on-site client personnel to provide specific technical support. To maintain good
employee relations and to minimize employee turnover, we offer competitive pay,
hire primarily full-time employees who are eligible to receive a full range of
employee benefits, and provide employees with clear, visible career paths.

INTERNET ACCESS TO REPORTS

We maintain an internet website, www.pfsweb.com. Our annual reports on Form
10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K (and
amendments, if any, to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934) are made available, free
of charge, through the investor relations section of this website as soon as
reasonably practicable after we electronically file such material, or furnish it
to the Securities and Exchange Commission.

REGULATION

Our business may be affected by current and future governmental regulation,
both foreign and domestic. For example, the internet Tax Freedom Act bars state
and local governments from imposing taxes on internet access or that would
subject buyers and sellers of electronic commerce to taxation in multiple
states. This act is in effect through November 1, 2003. If legislation to extend
this act or similar legislation is not enacted, internet access and sales across
the Internet may be subject to additional taxation by state and local
governments, thereby discouraging purchases over the Internet and adversely
affecting the market for our services.

14

SPIN-OFF OF PFSWEB FROM DAISYTEK

HISTORY

The PFSweb business unit was formed in 1991 as a subsidiary of Daisytek
named "Working Capital of America" whose purpose was to provide inventory
management, direct shipping to end-users, and accounts receivable collections
for Daisytek customers and other third parties. Until 1996, this business unit
was comprised of operations both at Working Capital of America and at Daisytek.
As the business gradually developed, this business unit recognized an
opportunity to expand its business and capitalize on Daisytek's strengths in
customer service, order management, product fulfillment and distribution, and
technology and provide these services on an outsourcing basis. Since 1996, the
operations of this business unit have been primarily focused in PFS. PFSweb was
formed in 1999 to be a holding company for PFS and to facilitate the Offering
and spin-off from Daisytek. In December 1999, we completed the Offering and
entered into various agreements with Daisytek relating to the spin-off. Under
these agreements, the spin-off was conditioned upon, among other things, the
receipt of a ruling by the Internal Revenue Service ("IRS") that, among certain
other tax consequences of the transaction, the spin-off qualify as a tax-free
distribution for U.S. federal income tax purposes and not result in the
recognition of taxable gain or loss for U.S. federal income tax purposes to
Daisytek or its shareholders (the "IRS Ruling"). On June 8, 2000, Daisytek
received the IRS Ruling and the Daisytek board of directors approved the
spin-off and authorized the distribution of 14,305,000 shares of PFSweb common
stock to the holders of Daisytek common stock. The distribution was made at the
close of business on July 6, 2000 to Daisytek stockholders of record as of June
19, 2000.

PFSWEB'S RELATIONSHIP WITH DAISYTEK

At the time of the Offering, PFSweb and Daisytek entered into various
agreements providing for the separation of their respective business operations.
These agreements governed various interim and ongoing relationships between the
companies, including the transaction management services that PFSweb provided
for Daisytek, the transitional services that Daisytek provided to PFSweb and a
tax indemnification and allocation agreement that governed the allocation of tax
liabilities and set forth provisions with respect to other tax matters.

All of the agreements between PFSweb and Daisytek were made in the context
of a parent-subsidiary relationship and were negotiated in the overall context
of the spin-off. Although we generally believe that the terms of these
agreements were consistent with fair market values, there can be no assurance
that the prices charged to or by each company under these agreements were not
higher or lower than the prices that may have been charged by, or to,
unaffiliated third parties for similar services.

Although we continue to be party to certain agreements with Daisytek, such
as the Master Separation Agreement, the Tax Indemnification and Allocation
Agreement and the Initial Public Offering and Distribution Agreement, we do not
currently generate any service revenues or incur any related expenses related to
services for Daisytek. However, through our master distributor relationships
operated by our subsidiary, Supplies Distributors, we sell certain products to
Daisytek and also purchase certain products from them (see "Supplies
Distributors").

MASTER SEPARATION AGREEMENT

The Master Separation Agreement sets forth the agreements between PFSweb and
Daisytek with respect to the principal corporate transactions required to effect
the transfers of assets and assumptions of liabilities necessary to separate the
PFSweb business unit from Daisytek and certain other agreements governing this
relationship thereafter.

Transfer of Assets and Liabilities. Following completion of the Offering,
Daisytek transferred to PFSweb all of the fixed assets in Daisytek's Memphis
distribution facility as well as certain assets associated with providing
information technology services and the stock of several subsidiaries of
Daisytek representing the business operations of PFSweb, and PFSweb transferred
to Daisytek approximately $5 million in cash and assumed approximately $0.3
million of capital lease obligations, as well as the operating lease obligations
related to these assets. PFSweb also repaid to Daisytek, from the net proceeds
of the Offering, the aggregate sum of approximately $27 million, representing
the outstanding balance of PFSweb's intercompany payable to Daisytek.

15

Indemnification. PFSweb agreed to indemnify Daisytek against any losses,
claims, damages or liabilities arising from the liabilities transferred to
PFSweb and the conduct of the PFSweb business after the completion of the
Offering. Daisytek agreed to retain, and indemnify PFSweb against, any losses,
claims, damages or liabilities arising from the conduct of the PFSweb business
prior to the completion of the Offering.

INITIAL PUBLIC OFFERING AND DISTRIBUTION AGREEMENT

General. PFSweb and Daisytek entered into an Initial Public Offering and
Distribution Agreement that governs their respective rights and duties with
respect to the Offering and the spin-off, and sets forth certain covenants to
which they are bound for various periods following the Offering and the
spin-off.

Preservation of the Tax-free Status of the Spin-off. Daisytek received a
private letter ruling from the Internal Revenue Service to the effect that the
spin-off qualified as a tax-free distribution under Section 355 of the Internal
Revenue Code to Daisytek and its stockholders. In connection with obtaining such
ruling, certain representations and warranties were made regarding Daisytek,
PFSweb and their respective businesses. PFSweb has also agreed to certain
covenants that were intended to preserve the tax-free status of the spin-off.
These included covenants whereby PFSweb agreed to restrictions on certain
acquisition transactions, to continue as an active trade or business and to not
have indebtedness to Daisytek, other than in the ordinary course of business
from the date of spin-off through July 2002. These covenants did not prohibit
PFSweb from implementing or complying with any transaction permitted by an IRS
ruling or a tax opinion.

Other Covenants Regarding Tax Treatment of the Transactions. The transfer of
assets and liabilities from Daisytek to PFSweb as provided by the Master
Separation Agreement (the "Contribution") was intended to qualify as a
reorganization under Section 368(a)(1)(D) of the Code (a "D Reorganization").
PFSweb agreed not to take, or permit any of our subsidiaries to take, any
actions or enter into any transaction or series of transactions that would have
been reasonably likely to jeopardize the tax-free status of the spin-off or the
qualification of the Contribution as a D Reorganization, including any action or
transaction that would have been reasonably likely to be inconsistent with any
representation made in connection with Daisytek's request for the IRS Ruling
prior to July 2002. PFSweb also agreed to take any reasonable actions necessary
for the Contribution and the spin-off to qualify as a D Reorganization.

Indemnification for Tax Liabilities. PFSweb has generally agreed to
indemnify Daisytek and its affiliates against any and all tax-related losses
incurred by Daisytek in connection with any proposed tax assessment or tax
controversy with respect to the spin-off or the Contribution to the extent
caused by any breach by it of any of its representations, warranties or
covenants. If PFSweb causes the spin-off to not qualify as a tax-free
distribution, Daisytek would incur federal income tax (which currently would be
imposed at a 35% rate) and possibly state income taxes on the gain inherent in
the shares distributed, which would be based upon the market value of the shares
of PFSweb at the time of the spin-off. This indemnification does not apply to
actions that Daisytek permits PFSweb to take as a result of a determination
under the tax-related covenants as described above. Similarly, Daisytek has
agreed to indemnify PFSweb and its affiliates against any and all tax-related
losses incurred by it in connection with any proposed tax assessment or tax
controversy with respect to the spin-off or the Contribution to the extent
caused by any breach by Daisytek of any of its representations, warranties or
covenants.

Other Indemnification. PFSweb has generally agreed to indemnify Daisytek and
its affiliates against all liabilities arising out of any material untrue
statements and omissions in PFSweb's prospectus and the registration statement
of which it was a part and in any and all registration statements, information
statements and/or other documents filed with the SEC in connection with the
spin-off or otherwise. However, PFSweb's indemnification of Daisytek does not
apply to information relating to Daisytek. Daisytek agreed to indemnify PFSweb
for this information.

Expenses. In general, PFSweb agreed to pay substantially all costs and
expenses relating to the Offering, including the underwriting discounts and
commissions, and Daisytek agreed to pay substantially all costs and expenses
relating to the spin-off.

16

TAX MATTERS

Daisytek and PFSweb entered into a Tax Indemnification and Allocation
Agreement to govern the allocation of tax liabilities and to set forth
agreements with respect to certain other tax matters.

Under the Code, PFSweb ceased to be a member of the Daisytek consolidated
group upon the completion of the spin-off.

Under these agreements, Daisytek has the responsibility to pay all taxes
attributable to PFSweb and its subsidiaries for tax periods or portions thereof
ending on or before the effective date of the Offering, except to the extent of
any accruals thereof on the books and records of PFSweb or its subsidiaries for
such taxes under generally accepted accounting principles. Thereafter, for tax
periods or portions thereof during which PFSweb was a member of the Daisytek
consolidated, combined or unitary group, PFSweb was apportioned its share of the
group's income tax liability based on its taxable income determined separately
from Daisytek's taxable income, and PFSweb paid its calculated taxes to
Daisytek, which then filed a consolidated, combined or unitary return with the
appropriate tax authorities. There were certain U.S. state or local
jurisdictions in which PFSweb filed separate income tax returns, not combined or
consolidated with Daisytek, for such tax periods. In that circumstance, PFSweb
filed a tax return with the appropriate tax authorities, and paid all taxes
directly to the tax authority. PFSweb was compensated for tax benefits generated
by it before tax deconsolidation and used by the Daisytek consolidated group.
PFSweb prepared and filed all tax returns, and paid all income taxes due with
respect to all tax returns required to be filed by it for all tax periods after
it ceased to be a member of the Daisytek consolidated, combined or unitary
group.

Daisytek was responsible for most U.S. tax adjustments related to PFSweb for
all periods or portions thereof ending on or before the effective date of the
Offering. In addition, PFSweb and Daisytek have agreed to cooperate in any tax
audits, litigation or appeals that involve, directly or indirectly, periods
prior to the time that PFSweb ceased to be a member of the Daisytek consolidated
group. PFSweb and Daisytek have agreed to indemnify each other for tax
liabilities resulting from the failure to cooperate in such audits, litigation
or appeals, and for any tax liability resulting from the failure to maintain
adequate records.

Notwithstanding the tax allocation agreement, for all periods in which
Daisytek owned 80% or more of PFSweb's capital stock, PFSweb was included in
Daisytek's consolidated group for federal income tax purposes. If Daisytek or
other members of the consolidated group failed to make any federal income tax
payments, PFSweb would be liable for the shortfall since each member of a
consolidated group is liable for the group's entire tax obligation.

Under the Tax Indemnification and Allocation Agreement, Daisytek has agreed
to indemnify PFSweb against any taxes resulting from the failure of the spin-off
to qualify for tax-free treatment, except that PFSweb will be liable for, and
will indemnify Daisytek against, any taxes resulting from the failure of the
spin-off to qualify for tax-free treatment if it is the result of PFSweb
engaging in a "Prohibited Action" or the occurrence of a "Disqualifying Event."
Neither PFSweb nor Daisytek have the option to rescind the spin-off if a tax
liability results.

A "Prohibited Action" is defined as:

o if PFSweb takes any action that is inconsistent with the tax treatment
of the spin-off as contemplated in the IRS Ruling; or

o if, prior to the spin-off, PFSweb issued shares of stock or took any
other action that would result in it not being controlled by Daisytek
within the meaning of Section 368(c) of the Code.

A "Disqualifying Event" includes any event involving the direct or indirect
acquisition of the shares of PFSweb's capital stock after the spin-off that has
the effect of disqualifying the spin-off from tax-free treatment, whether or not
the event was the result of our direct action or within PFSweb's control.

17

TRANSACTION MANAGEMENT SERVICES AGREEMENT

PFSweb and Daisytek entered into a Transaction Management Services Agreement
that set forth the transaction management services that PFSweb provided for
Daisytek. Under this agreement, PFSweb provided a wide range of transaction
management services, including information management, order fulfillment and
distribution, product warehousing, inbound call center services, product return
administration and other services.

As described in "Sale of Assets to Daisytek," effective May 2001, Daisytek
and PFSweb terminated the transaction management services agreement.

TRANSITION SERVICES AGREEMENT

Upon completion of the Offering, Daisytek and PFSweb entered into a
Transition Services Agreement. Under this agreement, Daisytek provided PFSweb
with various services relating to employee payroll and benefits, use of
facilities, and other administrative services. Daisytek is no longer providing
services to PFSweb under this transition services agreement.

SUBSTITUTE STOCK OPTIONS

In connection with the completion of the spin-off, all outstanding Daisytek
stock options were replaced with substitute stock options as described below:

Options held by Daisytek employees who were transferred to PFSweb were
replaced (at the option holder's election) with either options to acquire shares
of PFSweb common stock or options to acquire shares of both Daisytek common
stock and PFSweb common stock, which may be exercised separately (the "Unstapled
Options"). Options held by Daisytek employees who remained with Daisytek were
replaced (at the option holder's election) with either options to acquire shares
of Daisytek common stock or Unstapled Options.

In general, the adjustments to the outstanding Daisytek options were
established pursuant to a formula designed to ensure that: (1) the aggregate
"intrinsic value" (i.e. the difference between the exercise price of the option
and the market price of the common stock underlying the option) of the
substitute options did not exceed the aggregate intrinsic value of the
outstanding Daisytek stock option that was replaced by such substitute option
immediately prior to the spin-off, and (2) the ratio of the exercise price of
each option to the market value of the underlying stock immediately before and
after the spin-off was preserved.

Substantially all of the other terms and conditions of each substitute stock
option, including the time or times when, and the manner in which, each option
will be exercisable, the duration of the exercise period, the permitted method
of exercise, settlement and payment, the rules that will apply in the event of
the termination of employment of the employee, the events, if any, that may give
rise to an employee's right to accelerate the vesting or the time or exercise
thereof and the vesting provisions, are the same as those of the replaced
Daisytek stock option, except that option holders who are employed by one
company will be permitted to exercise, and will be subject to all of the terms
and provisions of, options to acquire shares in the other company as if such
holder was an employee of such other company.

No adjustment or replacement was made to outstanding PFSweb stock options as
a result of the spin-off.

BUSINESS SUPPLIES DISTRIBUTORS

PFSweb, Business Supplies Distributors, (a Daisytek subsidiary -- "BSD"),
Daisytek and IBM were parties to various Master Distributor Agreements that
expired on various dates through September 2001. Under these agreements, BSD
acted as a master distributor of various IBM products, Daisytek provided
financing and credit support to BSD and PFSweb provided transaction management
and fulfillment services to BSD. In July 2001, PFSweb and Inventory Financing
Partners, LLC ("IFP") formed Business Supplies Distributors Holdings, LLC
("Holdings"), and Holdings formed a wholly-owned subsidiary, Supplies
Distributors. Supplies Distributors, PFSweb and IBM entered into new Master
Distributor Agreements to replace the prior agreements. Under these new
agreements, Supplies Distributors and its subsidiaries act as master
distributors of various IBM products and, pursuant to a transaction management
services agreement between PFSweb and Supplies Distributors, PFSweb provides
transaction management and fulfillment services to Supplies Distributors. In
October 2002, PFSweb acquired the remaining ownership interest in Holdings from
IFP and as a result now owns 100% of Holdings.
See "Supplies Distributors."

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SALE OF ASSETS TO DAISYTEK

In May 2001, PFSweb sold to Daisytek certain of our assets used to provide
transaction management services to Daisytek and its subsidiaries for a purchase
price of $11 million. As part of this transaction, Daisytek and PFSweb
terminated the transaction management services agreement described above. As
part of this transaction, PFSweb entered into a six-month transition services
agreement with Daisytek under which we provided certain information technology
transition services for a monthly service fee through November 2001. Effective
November 2001, we are no longer a party to any agreement to provide services for
Daisytek. Although we continue to be party to certain agreements with Daisytek,
such as the Master Separation Agreement, the Tax Indemnification and Allocation
Agreement and the Initial Public Offering and Distribution Agreement, we do not
currently generate any service revenues or incur any related expenses related to
services for Daisytek. However, through our master distributor relationships
operated by our subsidiary, Supplies Distributors, we sell certain products to
Daisytek and also purchase certain products from them (see "Supplies
Distributors").

RISK FACTORS

Our business, financial condition and operating results could be adversely
affected by any of the following factors, in which event the trading price of
our common stock could decline, and you could lose part or all of your
investment. The risks and uncertainties described below are not the only ones
that we face. Additional risks and uncertainties not presently known to us, or
that we currently think are immaterial, may also impair our business operations.

RISKS RELATED TO OUR BUSINESS

OUR HISTORICAL FINANCIAL INFORMATION MAY NOT BE REPRESENTATIVE OF OUR FUTURE
RESULTS.

The financial information for periods prior to the year ended March 31, 2001
included in this Form 10-K may not reflect what our results of operations,
financial position and cash flows would have been had we been a separate,
stand-alone entity during the periods presented. This is because we made certain
adjustments and allocations since Daisytek did not account for us as, and we
were not operated as, a single stand-alone business for the periods presented.

We cannot assure you that the adjustments and allocations we made in
preparing our historical consolidated financial statements appropriately reflect
our operations during such periods as if we had, in fact, operated as a
stand-alone entity or what the actual effect of our separation from Daisytek
would have been. Accordingly, we cannot assure you that our historical results
of operations are indicative of our future operating or financial performance.

The financial information for periods prior to September 30, 1999,
subsequent to October 1, 2002 and currently, reflect product revenue earned from
the master distributor agreements with IBM. In 1996 we entered into an agreement
with the printer supplies division of IBM. Under this agreement, we served as an
IBM master distributor of printer supply products and purchased product from IBM
and resold them to IBM customers. We subsequently entered into a similar
agreement in Europe and expanded our existing agreements to include more product
lines. During the quarter ended September 30, 1999, we, BSD and IBM entered into
new agreements to conform to a service fee revenue business model. Under these
agreements, BSD acted as a master distributor of various IBM products, Daisytek
provided financing and credit support to BSD and PFSweb provided transaction
management and fulfillment services to BSD. As part of this restructuring, we
transferred to BSD the IBM product inventory we held as the master distributor,
together with our customer accounts receivable and our accounts payable owing to
IBM in respect to the product inventory. As a master distributor under the
original agreements, we recorded product revenue as we sold the product to IBM
customers. Similarly, our gross profit was based upon the difference between our
revenue from product sales and the cost of purchasing the product from IBM.
Under the new agreements, whereby BSD acted as the master distributor, our
revenue was service fee revenue based on a percentage of IBM product sales.

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In July 2001, PFSweb and Inventory Financing Partners, LLC ("IFP") formed
Business Supplies Distributors Holdings, LLC ("Holdings"), and Holdings formed a
wholly-owned subsidiary, Supplies Distributors. PFSweb originally had a 49%
voting interest and IFP had a 51% voting interest in Holdings. Supplies
Distributors, PFSweb and IBM entered into new Master Distributor Agreements to
replace the prior agreements. Under these new agreements, Supplies Distributors
and its subsidiaries act as master distributors of various IBM products and,
pursuant to a transaction management services agreement between PFSweb and
Supplies Distributors, PFSweb provides transaction management and fulfillment
services to Supplies Distributors. Under the agreements with Supplies
Distributors, PFSweb continued to recognize service fee revenue.

In October 2002, we acquired the remaining 51% ownership interest in
Holdings from IFP and thus now own 100% of Holdings. As a result of the
purchase, we will now consolidate 100% of Holdings financial position and
results of operations into our consolidated financial statements. Upon
consolidation, effective October 1, 2002, we will eliminate the service fee
revenue earned from our subsidiary, Supplies Distributors.

As a result of reflecting revenue earned under the IBM agreements as product
revenue in certain historical periods and as service fee revenue in others, our
historical results of operations may not be indicative of our future operating
or financial performance.

WE HAVE EXCESS CAPACITY, ARE INCURRING LOSSES FROM OPERATIONS AND NEED MORE
REVENUE TO ACHIEVE SUSTAINABLE PROFITABILITY.

We currently have unused space in our call centers and distribution centers
and excess capacity in our systems infrastructure. As a result, we are currently
incurring losses from operations. To properly service our existing clients and
attract new clients, it may be difficult or impractical to substantially reduce
many of the fixed costs associated with our unused space and excess capacity.
Consequently, we may continue to incur losses from operations until we have
sufficiently increased our revenue to cover our fixed and variable costs.
Alternatively, we may incur restructuring charges to reduce portions of the
fixed costs associated with the unused space and fixed capacity. While we
believe that as we add revenue we will be able to cover our existing
infrastructure costs, there can be no assurance that we will increase our
revenue or achieve sustainable profitability.

OUR SERVICE FEE REVENUE IS DEPENDENT UPON OUR CLIENTS' BUSINESS AND TRANSACTION
VOLUMES; ALL OF OUR CLIENT SERVICE AGREEMENTS ARE TERMINABLE BY THE CLIENT AT
WILL.

Our service fee revenue is primarily transaction based and fluctuates with
the volume of transactions or level of sales of the products by our clients for
which we provide transaction management services. If we are unable to retain
existing clients or attract new clients or if we dedicate significant resources
to clients whose business does not generate substantial transactions or whose
products do not generate substantial customer sales, our business may be
materially adversely affected. In addition, generally all of our service
agreements with our clients are terminable by the client at will. Therefore, we
cannot assure you that any of our clients will continue to use our services for
any period of time.

WE ANTICIPATE INCURRING SIGNIFICANT EXPENSES IN THE FORESEEABLE FUTURE, WHICH
MAY REDUCE OUR ABILITY TO ACHIEVE PROFITABILITY.

In order to reach our business growth objectives, we expect to incur
significant operating and marketing expenses, as well as capital expenditures,
during the next several years. In order to offset these expenses, we will need
to generate significant additional profitable business. If our revenue grows
slower than either we anticipate or our clients' projections indicate, or if our
operating and marketing expenses exceed our expectations, we may not generate
sufficient revenue to be profitable or be able to sustain or increase
profitability on a quarterly or an annual basis in the future. Additionally, if
our revenue grows slower than either we anticipate or our clients' projections
indicate, we may incur unnecessary or redundant costs and our operating results
could be adversely affected.

OUR OPERATING RESULTS COULD BE MATERIALLY IMPACTED BY OUR CLIENT MIX AND THE
SEASONALITY OF THEIR BUSINESS.

Our business could be materially impacted by our client mix and the
seasonality of their business. Based upon our current client mix, we anticipate
our service fee revenue business activity will be at its lowest in the first
quarter

20

and at its highest in the second quarter of the fiscal year and that our product
revenue business activity will be at its highest in the fourth quarter of our
fiscal year. 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. We
are unable to predict how the seasonality of future clients' business may affect
our quarterly revenue.

OUR SYSTEMS MAY NOT ACCOMMODATE SIGNIFICANT GROWTH IN OUR NUMBER OF CLIENTS.

Our success depends on our ability to handle a large number of transactions
for many different clients in various product categories. We expect that the
volume of transactions will increase significantly as we expand our operations.
If this occurs, additional stress will be placed upon the network hardware and
software that manages our operations. We cannot assure you of our ability to
efficiently manage a large number of transactions. If we are not able to
maintain an appropriate level of operating performance, we may develop a
negative reputation, and impair existing and prospective client relationships
and our business would be materially adversely affected.

WE MAY NOT BE ABLE TO RECOVER ALL OR A PORTION OF OUR START-UP COSTS ASSOCIATED
WITH ONE OR MORE OF OUR CLIENTS.

We generally incur start-up costs in connection with the planning and
implementation of business process solutions for our clients. Although we
generally recover these costs from the client in the early stages of the client
relationship, there is a risk that the client contract may not fully cover the
start-up costs. To the extent start-up costs exceed the start-up fees received,
excess costs will be expensed as incurred. Additionally, in connection with new
client contracts we generally incur capital expenditures associated with assets
whose primary use is related to the client solution. There is a risk that the
contract may end before expected and we may not recover the full amount of our
capital costs.

OUR MARGINS MAY BE MATERIALLY IMPACTED BY CLIENT TRANSACTION VOLUMES THAT DIFFER
FROM CLIENT PROJECTIONS AND BUSINESS ASSUMPTIONS.

Our pricing for client transaction services, such as call center and
fulfillment, is often based upon volume projections and business assumptions
provided by the client. In the event the actual level of activity is
substantially different from the projections or assumptions, we may have
insufficient or excess staffing or other assets dedicated for such client that
may impact our margins and business relationship with such client. In the event
we are unable to meet the service levels expected by the client, our
relationship with the client will suffer and may result in the termination of
the client contract.

OUR BUSINESS IS SUBJECT TO THE RISK OF CUSTOMER AND SUPPLIER CONCENTRATION.

For the year ended December 31, 2002, the U.S. Mint, via a subcontract
agreement with IBM, Supplies Distributors (prior to consolidation effective
October 1, 2002) and Xerox Corporation represented approximately 35%, 13% and
14%, respectively, of our total service fee revenue for such period. The loss of
either, or both, the U.S. Mint or Xerox Corporation as clients would have a
material adverse effect upon our business.

Substantially all of our product revenue was generated by sales of product
purchased under master distributor agreements with IBM and is dependent on IBM's
business. Sales to two customers accounted for approximately 13% and 12% of our
total product revenues for the year ended December 31, 2002. The loss of any one
or more of such customers would have a material adverse effect upon our
business.

WE OPERATE WITH SIGNIFICANT LEVELS OF INDEBTEDNESS AND ARE REQUIRED TO COMPLY
WITH CERTAIN FINANCIAL AND NON FINANCIAL COVENANTS; WE ARE REQUIRED TO MAINTAIN
A MINIMUM LEVEL OF SUBORDINATED LOANS TO OUR SUBSIDIARY SUPPLIES DISTRIBUTORS;
AND WE ARE OBLIGATED TO REPAY ANY OVER-ADVANCE MADE TO SUPPLIES DISTRIBUTORS BY
ITS LENDERS.

As of February 28, 2003, our senior indebtedness totaled $54.3 million. In
addition we have provided $8.0 million of subordinated indebtedness to Supplies
Distributors, the minimum level required under certain senior indebtedness
facilities and the maximum level that may be provided without approval from our
lenders. The restrictions on increasing this amount without lender approval may
limit our ability to comply with certain loan covenants or further grow and
develop Supplies Distributors' business. We have guaranteed most of the

21

indebtedness of Supplies Distributors. These guarantees are secured by a pledge
of substantially all of our assets. The senior indebtedness have maturity dates
in calendar year 2004 and 2005, but are classified as current debt in the
accompanying financial statements. We cannot provide assurance that such
indebtedness will be renewed by the senior lending parties. Additionally, these
senior indebtedness facilities include both financial and non-financial
covenants. We can not provide assurance that we will be able to maintain
compliance with these covenants. Any non-renewal of these senior indebtedness
facilities or any default under any of our senior indebtedness would have a
material adverse impact upon our business and financial condition. Furthermore,
we are obligated to repay any over-advance made to Supplies Distributors by its
lenders to the extent Supplies Distributors is unable to do so.

WE FACE COMPETITION FROM MANY SOURCES THAT COULD ADVERSELY AFFECT OUR BUSINESS.

Many companies offer, on an individual basis, one or more of the same
services we do, and we face competition from many different sources depending
upon the type and range of services requested by a potential client. Our
competitors include vertical outsourcers, which are companies that offer a
single function, such as call centers, public warehouses or credit card
processors. Many of these companies have greater capabilities than we do for the
single function they provide. We also compete against transportation logistics
providers who offer product management functions as an ancillary service to
their primary transportation services. In many instances, our competition is the
in-house operations of our potential clients themselves. The in-house operations
departments of potential clients often believe that they can perform the same
services we do, while others are reluctant to outsource business functions that
involve direct customer contact. We cannot be certain that we will be able to
compete successfully against these or other competitors in the future.

OUR SALES AND IMPLEMENTATION CYCLES ARE HIGHLY VARIABLE AND OUR ABILITY TO
FINALIZE PENDING CONTRACTS MAY CAUSE OUR OPERATING RESULTS TO VARY WIDELY.

The sales cycle for our services is variable, typically ranging between
several months to up to a year from initial contact with the potential client to
the signing of a contract. Occasionally the sales cycle requires substantially
more time. Delays in signing and executing client contracts may affect our
revenue and cause our operating results to vary widely. We believe that a
potential client's decision to purchase our services is discretionary, involves
a significant commitment of its resources and is influenced by intense internal
and external pricing and operating comparisons. To successfully sell our
services, we generally must educate our potential clients regarding the use and
benefit of our services, which can require significant time and resources.
Consequently, the period between initial contact and the purchase of our
services is often long and subject to delays associated with the lengthy
approval and competitive evaluation processes that typically accompany
significant operational decisions. Additionally, the time required to finalize
pending contracts and to implement our systems and integrate a new client can
range from several weeks to many months. Delays in signing and integrating new
clients may affect our revenue and cause our operating results to vary widely.

WE ARE DEPENDENT ON OUR KEY PERSONNEL, AND WE NEED TO HIRE AND RETAIN SKILLED
PERSONNEL TO SUSTAIN OUR BUSINESS.

Our performance is highly dependent on the continued services of our
executive officers and other key personnel, the loss of any of whom could
materially adversely affect our business. In addition, we need to attract and
retain other highly-skilled technical and managerial personnel for whom there is
intense competition. We cannot assure you that we will be able to attract and
retain the personnel necessary for the continuing growth of our business. Our
inability to attract and retain qualified technical and managerial personnel
would materially adversely affect our ability to maintain and grow our business.

WE ARE SUBJECT TO RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS.

We currently operate a 150,000 square foot distribution center in Liege,
Belgium and a 33,000 square foot distribution center in Richmond Hill, Canada,
near Toronto, both of which currently have excess capacity. We cannot assure you
that we will be successful in expanding in these or any additional international
markets. In addition to the uncertainty regarding our ability to generate
revenue from foreign operations and expand our international presence, there are
risks inherent in doing business internationally, including:

o changing regulatory requirements;

o legal uncertainty regarding foreign laws, tariffs and other trade
barriers;

22

o political instability;

o potentially adverse tax consequences;

o foreign currency fluctuations; and

o cultural differences.

Any one or more of these factors could materially adversely affect our
business in a number of ways, such as increased costs, operational difficulties
and reductions in revenue.

WE ARE UNCERTAIN ABOUT OUR NEED FOR AND THE AVAILABILITY OF ADDITIONAL FUNDS.

Our future capital needs are difficult to predict. We may require
additional capital in order to take advantage of unanticipated opportunities,
including strategic alliances and acquisitions and to fund capital expenditures,
or to respond to changing business conditions and unanticipated competitive
pressures. In addition, we may require additional funds to finance our operating
losses. Should these circumstances arise, we may need to raise additional funds
either by borrowing money or issuing additional equity. Although we recently
entered into a $7.5 million accounts receivable line of credit, we cannot assure
you that such financings will be adequate or available for all of our future
financing needs. If we were successful in completing an equity financing, this
could result in dilution to our stockholders.

WE MAY ENGAGE IN FUTURE STRATEGIC ALLIANCES OR ACQUISITIONS THAT COULD DILUTE
OUR EXISTING STOCKHOLDERS, CAUSE US TO INCUR SIGNIFICANT EXPENSES OR HARM OUR
BUSINESS.

We may review strategic alliance or acquisition opportunities that would
complement our current business or enhance our technological capabilities.
Integrating any newly acquired businesses, technologies or services may be
expensive and time-consuming. To finance any acquisitions, it may be necessary
for us to raise additional funds through public or private financings.
Additional funds may not be available on terms that are favorable to us and, in
the case of equity financings, may result in dilution to our stockholders. We
may not be able to operate any acquired businesses profitably or otherwise
implement our growth strategy successfully. If we are unable to integrate any
newly acquired entities or technologies effectively, our operating results could
suffer. Future acquisitions by us could also result in incremental expenses and
the incurrence of debt and contingent liabilities, or amortization of expenses
related to goodwill and other intangibles, any of which could harm our operating
results.

OUR BUSINESS COULD BE ADVERSELY AFFECTED BY A SYSTEMS OR EQUIPMENT FAILURE,
WHETHER OUR OWN OR OF OUR CLIENTS.

Our operations are dependent upon our ability to protect our distribution
facilities, customer service centers, computer and telecommunications equipment
and software systems against damage and failures. Damage or failures could
result from fire, power loss, equipment malfunctions, system failures, natural
disasters and other causes. Although we believe we have sufficient property and
business interruption insurance, if our business is interrupted either from
accidents or the intentional acts of others, our business could be materially
adversely affected. In addition, in the event of widespread damage or failures
at our facilities, our short-term disaster recovery and contingency plans and
insurance coverage may not be sufficient.

Our clients' businesses may also be harmed from any system or equipment
failures we experience. In that event, our relationship with these clients may
be adversely affected, we may lose these clients, our ability to attract new
clients may be adversely affected and we could be exposed to liability.

Interruptions could also result from the intentional acts of others, like
"hackers." If our systems are penetrated by computer hackers, or if computer
viruses infect our systems, our computers could fail or proprietary information
could be misappropriated.

If our clients suffer similar interruptions in their operations, for any of
the reasons discussed above or for others, our business could also be adversely
affected. Many of our clients' computer systems interface with our own. If they
suffer interruptions in their systems, the link to our systems could be severed
and sales of their products could be slowed or stopped.

23

A BREACH OF OUR E-COMMERCE SECURITY MEASURES COULD REDUCE DEMAND FOR OUR
SERVICES.

A requirement of the continued growth of e-commerce is the secure
transmission of confidential information over public networks. A party who is
able to circumvent our security measures could misappropriate proprietary
information or interrupt our operations. Any compromise or elimination of our
security could reduce demand for our services.

We may be required to expend significant capital and other resources to
protect against security breaches or to address any problem they may cause.
Because our activities involve the storage and transmission of proprietary
information, such as credit card numbers, security breaches could damage our
reputation, cause us to lose clients, impact our ability to attract new clients
and we could be exposed to litigation and possible liability. Our security
measures may not prevent security breaches, and failure to prevent security
breaches may disrupt our operations.

WE MAY BE A PARTY TO LITIGATION INVOLVING OUR E-COMMERCE INTELLECTUAL PROPERTY
RIGHTS.

In recent years, there has been significant litigation in the United States
involving patent and other intellectual property rights. We may be a party to
intellectual property litigation in the future to protect our trade secrets or
know-how. United States patent applications are confidential until a patent is
issued and most technologies are developed in secret. Accordingly, we are not,
and cannot be, aware of all patents or other intellectual property rights of
which our services may pose a risk of infringement. Others asserting rights
against us could force us to defend ourselves or our customers against alleged
infringement of intellectual property rights. We could incur substantial costs
to prosecute or defend any such litigation.

RISKS RELATED TO DAISYTEK

WE HAVE POTENTIAL LIABILITY TO DAISYTEK FOR TAX INDEMNIFICATION OBLIGATIONS.

Under the terms of our tax indemnification and allocation agreement with
Daisytek, we will indemnify Daisytek for any tax liability it suffers arising
out of our actions, or certain actions to which we are a party that may exist,
before or after the spin-off that would cause the spin-off to lose its
qualification as a tax-free distribution for federal income tax purposes. These
actions include any event involving the acquisition of the shares of our capital
stock after the spin-off that has the effect of disqualifying the spin-off from
tax-free treatment, whether or not the event is the result of our direct action
or within our control. If we cause the spin-off to not qualify as a tax-free
distribution, Daisytek would incur federal income tax (that currently would be
imposed at a 35% rate), and possibly state income taxes on the gain inherent in
the shares distributed, which would be based upon the market value of the PFSweb
shares at the time of the spin-off. In the event that we are required to
indemnify Daisytek in respect of this liability, it would have a material
adverse effect on our cash flow and business operations.

WE HAVE POTENTIAL LIABILITY FOR DAISYTEK'S TAX OBLIGATIONS.

For all periods in which Daisytek owned 80% or more of our capital stock, we
were included in Daisytek's consolidated group for federal income tax purposes.
If Daisytek or other members of the consolidated group fail to make any federal
income tax payments, we would be liable for the shortfall since each member of a
consolidated group is liable for the group's entire tax obligation.

RISKS RELATED TO OUR INDUSTRY

IF THE TREND TOWARD OUTSOURCING DOES NOT CONTINUE, OUR BUSINESS WILL BE
ADVERSELY AFFECTED.

Our business could be materially adversely affected if the trend toward
outsourcing declines or reverses, or if corporations bring previously outsourced
functions back in-house. Particularly during general economic downturns,
businesses may bring in-house previously outsourced functions to avoid or delay
layoffs. The continued threat of terrorism within the United States and abroad
and the potential for sustained military action may cause disruption to commerce
and economic conditions, both domestic and foreign, which could have a material
adverse effect upon our business and new client prospects.

24

OUR MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND TO COMPETE WE MUST
CONTINUALLY ENHANCE OUR SYSTEMS TO COMPLY WITH EVOLVING STANDARDS.

To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of our services and the underlying
network infrastructure. If we are unable to adapt to changing market conditions,
client requirements or emerging industry standards, our business could be
adversely affected. The internet and e-commerce are characterized by rapid
technological change, changes in user requirements and preferences, frequent new
product and service introductions embodying new technologies and the emergence
of new industry standards and practices that could render our technology and
systems obsolete. Our success will depend, in part, on our ability to both
internally develop and license leading technologies to enhance our existing
services and develop new services. We must continue to address the increasingly
sophisticated and varied needs of our clients and respond to technological
advances and emerging industry standards and practices on a cost-effective and
timely basis. The development of proprietary technology involves significant
technical and business risks. We may fail to develop new technologies
effectively or to adapt our proprietary technology and systems to client
requirements or emerging industry standards.

RISKS RELATED TO OUR STOCK

OUR COMMON STOCK IS SUBJECT TO POSSIBLE DELISTING FROM THE 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 minimum bid price
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 were provided an additional 180 day grace
period, or until February 10, 2003 to regain compliance. In March 2003, we were
provided an additional 90 day grace period, or until May 12, 2003, to regain
compliance. We can, however, provide no assurance as to our ability to maintain
compliance with the core listing standards and our continued listing in the
NASDAQ SmallCap Market. If we are unable to regain compliance with the minimum
bid price requirement, our common stock would then be subject to a delisting
determination from NASDAQ. Upon receipt of such determination, we plan to appeal
the determination to the NASDAQ Listing Qualifications Panel. The appeal would
postpone the delisting until the appeal is decided. The delisting of our common
stock could have a material adverse effect on the market price of, and the
efficiency of the trading market for, our common stock.

OUR CERTIFICATE OF INCORPORATION, OUR BYLAWS, OUR SHAREHOLDER RIGHTS PLAN AND
DELAWARE LAW MAKE IT DIFFICULT FOR A THIRD PARTY TO ACQUIRE US, DESPITE THE
POSSIBLE BENEFIT TO OUR STOCKHOLDERS.

Provisions of our certificate of incorporation, our bylaws, our shareholder
rights plan and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. For
example, our certificate of incorporation provides for a classified board of
directors, meaning that only approximately one-third of our directors will be
subject to re-election at each annual stockholder meeting. Our certificate of
incorporation also permits our Board of Directors to issue one or more series of
preferred stock which may have rights and preferences superior to those of the
common stock. The ability to issue preferred stock could have the effect of
delaying or preventing a third party from acquiring us. We have also adopted a
shareholder rights plan. These provisions could discourage takeover attempts and
could materially adversely affect the price of our stock.

25

ITEM 2. PROPERTIES

Our PFSweb business is headquartered in a central office facility located in
Plano, Texas, a Dallas suburb.

In the U.S., we operate an approximately 800,000 square foot central
distribution complex in Memphis, Tennessee. This complex is located
approximately four miles from the Memphis International Airport, where both
Federal Express and United Parcel Service operate large hub facilities.

We operate a 150,000 square foot distribution center in Liege, Belgium,
which contains advanced distribution systems and equipment. We also operate a
33,000 square foot distribution center in Richmond Hill, Canada, near Toronto.
We operate customer service centers in Memphis, Tennessee; Plano, Texas; and
Liege, Belgium. Our call center technology permits the automatic routing of
calls to available customer service representatives in several of our call
centers.

All of our facilities are leased and the material lease agreements contain
one or more renewal options.

ITEM 3. LEGAL PROCEEDINGS

None.

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

None.

26

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock is listed and currently trades on the NASDAQ SmallCap Stock
Market under the symbol "PFSW." The following table sets forth for the period
indicated the high and low sale price for the common stock as reported by
NASDAQ:

As of March 15, 2003, there were approximately 5,855 shareholders of which
127 were record holders of the common stock.

We have never declared or paid cash dividends on our common stock and do not
anticipate the payment of cash dividends on our common stock in the foreseeable
future. We currently intend to retain all earnings to finance the further
development of our business. The payment of any future cash dividends will be at
the discretion of our Board of Directors and will depend upon, among other
things, future earnings, operations, capital requirements, the general financial
condition of the Company and general business conditions. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

HISTORICAL PRESENTATION

In June 2001, we announced a change in our fiscal year end from March 31 to
December 31.

The selected consolidated historical statement of operations data for the
year ended March 31, 2001, the nine months ended December 31, 2001, and the year
ended December 31, 2002, and the selected consolidated balance sheet data as of
December 31, 2001 and 2002 have been derived from our audited consolidated
financial statements, and should be read in conjunction with those statements
and notes, which are included in this Form 10-K. The selected consolidated
statement of operations data for the years ended March 31, 1999 and 2000 and the
selected consolidated balance sheet data as of March 31, 1999, 2000 and 2001
have been derived from our audited consolidated financial statements, and should
be read in conjunction with those statements, which are not included in this
Form 10-K. The selected consolidated statement of operations data for the nine
months ended December 31, 2000 and twelve months ended December 31, 2001, and
the selected consolidated balance sheet data as of December 31, 2000 have been
derived from our unaudited interim condensed consolidated financial statements,
and should be read in conjunction with those statements, which are not included
in this Form 10-K.

The financial information for periods prior to the year ended March 31, 2001
herein may not necessarily reflect what our results of operations, financial
position and cash flows would have been had we been a separate, stand-alone
entity during the periods presented. This is because we made certain adjustments
and allocations since Daisytek did not account for us as, and we were not
operated as, a single stand-alone business for the periods presented.

The selected consolidated financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Risks Related to Our Business - Our historical

27

Operations," "Risks Related to Our Business - Our historical financial
information may not be representative of our future results," and the
consolidated financial statements and notes thereto that are included elsewhere
in this Form 10-K.

HISTORICAL SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

(a) Prior to the Offering, which was consummated in the year ended March 31,
2000, basic and diluted net income (loss) per share was determined based on
net income (loss) divided by the 14,305,000 shares outstanding. There were
no potentially dilutive securities outstanding prior to the Offering. For
the years ended March, 31, 2000 and 2001, the nine month periods ended
December 31, 2000 and 2001, and the years ended December 31, 2001 and 2002,
outstanding options to purchase common shares of PFSweb were anti-dilutive
and have been excluded from the weighted average share computation.

(b) In June 2001, the Company elected to change its fiscal year end from March
31 to December 31.

28

ITEM 7. 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 consolidated
financial statements and related notes thereto appearing elsewhere in this Form
10-K.

FORWARD-LOOKING INFORMATION

We have made forward-looking statements in this Report on Form 10-K. 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-K, 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;
o our ability to raise additional capital or obtain additional financing;
o our relationship with and our guarantees of the working capital
indebtedness of our subsidiary, Supplies Distributors;
o our ability or the ability of our subsidiaries to borrow under current
financing arrangements and maintain compliance with debt covenants; and
o the continued listing of our common stock on the NASDAQ SmallCap Market.

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. In evaluating these statements, you should consider
various factors, including the risks set forth in the section entitled "Risk
Factors."

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,

29

order management, managed web hosting and web development, customer relationship
management, financial services including billing and collection services and
working capital solutions, 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 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. Many of our contracts with our clients involve
third-party vendors who provide additional services such as package delivery.
The costs we are charged by these third-party vendors for these services are
passed on to our clients (and, in many cases, our clients' customers). Our
billings for reimbursements of these and other 'out-of-pocket' expenses, such as
travel, 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.

For the periods prior to September 30, 1999, subsequent to October 1, 2002
and currently, our services include purchasing and reselling client product
inventory under our master distributor agreements with IBM and certain other
clients. In these arrangements, our product revenue is recognized at the time
product is shipped. During this time, product revenue includes freight costs
billed to customers and is reduced for pass through customer marketing programs.
For the period from October 1, 1999, to September 30, 2002, these IBM and other
agreements were restructured to provide transaction management services only on
a service fee basis based on a percentage of shipped revenue. See "Historical
Financial Presentation."

Our expenses are comprised of:

o prior to September 30, 1999, subsequent to October 1, 2002 and
currently, cost of product revenue, which consists of the price of
product sold and freight costs and is reduced by certain reimbursable
expenses such as pass through customer marketing programs, direct costs
incurred in passing on any price decreases offered by IBM to Supplies
Distributors customers to cover price protection and certain special
bids, the cost of products provided to replace defective product
returned by customers and certain other expenses as defined under the
master distributor agreements;

o 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

o 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. In addition, for the periods
prior to September 30, 1999, subsequent to October 1, 2002 and
currently, certain direct contract costs related to our IBM and other
master distributor agreements are reflected as selling and
administrative expenses.

HISTORICAL FINANCIAL PRESENTATION

We believe our historical financial statements may not provide a meaningful
comparison to our current and future financial performance for the reasons
described below.

30

In 1996, we entered into an agreement with the printer supplies division of
IBM. Under this agreement, we provided IBM with various transaction management
services, such as call center services and order fulfillment and distribution.
We also served as an IBM master distributor of printer supply products. Under
this master distributor arrangement, we purchased the printer supply products
from IBM and resold them to IBM customers. Following our initial agreement with
the printer supplies division, we expanded our agreements to include more
product lines.

During the quarter ended September 30, 1999, we, Daisytek and IBM entered
into new agreements to conform this IBM business to our service fee business
model. Under these new agreements, Daisytek acted as the master distributor of
the IBM products and we provided various transaction management services. As
part of this restructuring, we transferred to Daisytek the IBM product
inventory, which we held as the master distributor, together with our customer
accounts receivable and our accounts payable owing to IBM in respect of the
product inventory. The purpose of the restructuring was to separate the master
distributor and transaction management responsibilities between ourselves and
Daisytek so that each could focus on its core competencies.

As a master distributor under our prior agreements, we recorded revenue as
product revenue as we sold the product to IBM customers. Similarly, our gross
profit was based upon the difference between our revenue from product sales and
the cost of purchasing the product from IBM. Under the revised agreements,
whereby Daisytek acted as the master distributor, our revenue was service fee
revenue based on a percentage of IBM product sales.

In July 2001, PFSweb and Inventory Financing Partners, LLC ("IFP") formed
Business Supplies Distributors Holdings, LLC ("Holdings"), and Holdings formed a
wholly-owned subsidiary, Supplies Distributors, Inc. ("Supplies Distributors").
PFSweb originally had a 49% voting interest and IFP had a 51% voting interest in
Holdings. In September 2001, Daisytek sold its subsidiaries that had been
conducting the IBM master distributor business to Holdings. Supplies
Distributors, PFSweb and IBM entered into new Master Distributor Agreements to
replace the prior agreements. Under these new agreements, Supplies Distributors
and its subsidiaries act as master distributors of various IBM products and,
pursuant to a transaction management services agreement between PFSweb and
Supplies Distributors, PFSweb provides transaction management and fulfillment
services to Supplies Distributors. Under the agreements with Supplies
Distributors, we continued to recognize service fee revenue.

In October 2002, we acquired the remaining 51% ownership interest in
Holdings from IFP and, as a result, we now own 100% of Holdings. As the Company
initially owned 49% of Holdings, the results of Holdings were not previously
consolidated into our results. Instead, our equity interest was presented in the
consolidated balance sheet as investment in affiliate and our allocation of
Holdings' net income were presented in the consolidated statement of operations
as equity in earnings of affiliate. As a result of the purchase, effective
October 1, 2002, we began consolidating 100% of Holdings' financial position and
results of operations into our consolidated financial statements. Upon
consolidation, we eliminate the service fee revenue earned from our subsidiary,
Supplies Distributors, as well as the corresponding expense recorded by Supplies
Distributors in its selling, general and administrative expense. In addition,
our costs previously reflected as cost of service fee revenues under the service
fee arrangement are now recorded on a consolidated basis as selling, general and
administrative expense. Subsequent to October 1, 2002, and currently our
consolidated revenue earned under the IBM agreements is reflected as product
revenue. See "Supplies Distributors."

As a result of this purchase, our total revenues arising under our new IBM
agreements will increase, as compared to the total revenues arising under the
prior IBM agreements. This is because we will now recognize product revenue for
this arrangement as compared to our previous recognition of service fees, which
equaled a percentage of the associated product revenue. However, our gross
profit margin as a percent of product revenue under the new IBM agreements is
lower as compared to our gross profit margin as a percent of net service fee
revenue under the prior IBM service fee agreements.

In addition, upon completion of the Offering on December 2, 1999, we entered
into a transaction management services agreement with Daisytek. Under this
agreement, we received service fee revenue based upon a percentage of Daisytek's
shipped product revenue. Consequently, our historical financial statements
reflect the service fee revenue we received from Daisytek under this new
agreement for the twelve months ended March 31, 2001, but for only four months
in the fiscal year ended March 31, 2000. Effective May 2001, our transaction
management services agreement with Daisytek was terminated. Concurrently, we
also entered into a six-month transitional and information technology services
agreement with Daisytek, which terminated in November 2001. Effective November
2001, we are no longer party to any agreement to provide services for Daisytek,
however, through our

31

master distributor relationships operated by our subsidiary Supplies
Distributors, we sell and purchase certain products to and from Daisytek.

RESULTS OF OPERATIONS

The following table sets forth certain historical financial information from
our consolidated statements of operations expressed as a percent of net
revenues.

YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001

Product Revenue. Product revenue was $57.5 million for the year ended
December 31, 2002, which reflects product sales for Supplies Distributors
subsequent to its consolidation effective October 1, 2002 (see "Supplies
Distributors"). Supplies Distributors had $163.6 million of product revenue for
the nine months ended September 30, 2002 prior to consolidation, or a total of
$221.1 million of product revenue for the year ended December 31, 2002. Based on
Supplies Distributors' current business plan, we expect to report future product
revenue of approximately $240 million in calendar year 2003.

Net Service Fee Revenue (including service fee revenue, affiliate). Net
service fee revenue was $35.8 million for the year ended December 31, 2002 as
compared to $39.2 million for the year ended December 31, 2001, a decrease of
$3.4 million or 8.6%. 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 $12.6 million, primarily the Daisytek contracts discussed below,
partially offset by an increase in net service fee revenue from existing clients
of $4.7 million and the impact of new service contract relationships of $4.5
million. The increase in net service fee revenue from existing clients would
have been $6.5 million had we not consolidated Supplies Distributors, and thus
eliminated service fee revenue, affiliate for the three months ended December
31, 2002. Net service fee revenue for the year ended December 31, 2002, included

32

$1.3 million of client relationships terminated in the current fiscal year. For
the year ended December 31, 2002, net service fee revenue from existing clients
increased from the prior periods, primarily related to increased service fee
revenue from of our largest client offset by 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 reduction in net service fee revenue of $11.0 million
for the year ended December 31, 2002 as compared to the year ended December 31,
2001.

Pursuant to the terms of our transaction management services agreement with
Supplies Distributors, we earned service fees, which are reported as service fee
revenue, affiliate in the accompanying consolidated financial statements (prior
to the consolidation of Holdings' results of operations effective October 1,
2002), of approximately $4.7 million, net of $0.2 million of pass-through
charges, for the year ended December 31, 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 $6.0 million, net of $0.5 million of pass-through charges, for
the year ended December 31, 2001. For the year ended December 31, 2001, our
revenue was negatively impacted by lower than anticipated IBM related activity
due to the transition to Supplies Distributors from Daisytek but was benefited
by approximately $0.8 million of service fee adjustments resulting from the
finalization of the Daisytek contract.

Other Revenue. Other revenue of $0.5 million for the year ended December 31,
2001 represents the fees charged to clients in conjunction with early contract
terminations.

Cost of Product Revenue. Cost of product revenue was $54.3 million for the
year ended December 31, 2002, which reflects cost of product sales for Supplies
Distributors subsequent to its consolidation effective October 1, 2002 ("see
Supplies Distributors"). Cost of product revenue as a percent of product revenue
was 94.5% during the year ended December 31, 2002 and zero during the year ended
December 31, 2001. The resulting gross profit margin was 5.5% for the year ended
December 31, 2002. Supplies Distributors had $154.3 million of cost of product
revenue, prior to consolidation, or a total of $208.6 million of cost of product
revenue for the year ended December 31, 2002. Based on Supplies Distributors'
current business plan, we expect to report future cost of product revenue of
approximately $228 million in calendar year 2003.

Cost of Net Service Fee Revenue. Cost of net service fee revenue was $22.7
million for the year ended December 31, 2002, as compared to $25.8 million
during the year ended December 31, 2001, a decrease of $3.1 million or 12.3%.
The resulting service fee gross profit was $13.2 million or 36.7% of net service
fee revenue, during the year ended December 31, 2002 as compared to $13.4
million, or 34.1% of net service fee revenue for the year ended December 31,
2001. 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 $0.4 million of costs in excess of start
up fees incurred for a new client implementation during the year ended December
31, 2002. For the year ended December 31, 2001, our gross profit margin was
negatively impacted by lower than anticipated IBM related activity due to the
transition to Supplies Distributors from Daisytek but was benefited by
approximately $0.8 million of service fee adjustments resulting from the
finalization of the Daisytek contract for which the related service activities
were performed in earlier periods. As we add new service fee revenue in the
future, we will target the underlying contracts to earn a gross profit of
35-40%.

Cost of Other Net Revenue. Cost of other revenue for the year ended December
31, 2001 of ($0.6) million primarily reflects the benefit associated with the
reversal of accruals made in the previous years for estimated client termination
costs that were determined to be in excess of actual costs incurred.

Selling, General and Administrative Expenses. SG&A expenses were $27.0
million for the year ended December 31, 2002, or 28.9% of total net revenues, as
compared to $23.3 million, or 58.6% of total revenues, for the year

33

ended December 31, 2001. SG&A expenses increased over the prior year due to
approximately $2.8 million for the year ended December 31, 2002, 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. In addition, SG&A expenses for
the year ended December 31, 2001, were benefited by the favorable resolution of
certain accounts and VAT receivables. SG&A expenses as a percentage of total net
revenues decreased from the prior year due to the increase in total net
revenues, resulting from the inclusion of product sales subsequent to the
consolidation of Holdings effective October 1, 2002. In future periods, as a
result of personnel reductions and certain asset write-offs recorded during the
year ended December 31, 2002, we believe our SG&A expenses will decline by
approximately $1.2 million quarterly as compared to the $7.0 million expense
level incurred in the March and June quarters of calendar year 2002. However
this benefit will be partially offset, as due to the consolidation of Holdings
(see "Supplies Distributors"), we reclassify certain costs previously
characterized as cost of service fee revenue to SG&A. We believe that the
percentage of SG&A expenses to total net revenues will further decrease in
calendar year 2003 as total net revenues for calendar year 2003 will include a
full twelve months of Supplies Distributors' product revenue as compared to one
quarter in calendar year 2002.

Severance and Other Terminations Costs. For the year ended December 31,
2002, we recorded $1.2 million of severance and other termination charges
associated with a restructuring plan to reduce costs.

Asset Impairments. For the year ended December 31, 2002, we recorded $0.9
million of expense for asset impairment and abandonment charges. This charge
relates to an older warehouse management system that was upgraded to a new
system during the year, as well as the disposition of certain other assets no
longer used in the business. We did not finalize all restructuring activities as
of December 31, 2002, and thus expect to incur an additional amount totaling
$0.5 million to $1.0 million of restructuring charges during calendar year 2003.

Equity in Earnings of Affiliate. For the year ended December 31, 2002, we
recorded $1.2 million of equity in earnings of affiliate that represents our
allocation of Holdings earnings prior to October 1, 2002. Due to the
consolidation of Holdings (see "Supplies Distributors"), effective October 1,
2002, we will not report equity in earnings of affiliate for our ownership of
Holdings in the future.

Interest Expense. Interest expense was $0.8 million for the year ended
December 31, 2002 as compared to $0.3 million for the year ended December 31,
2001. The increase in interest expense is due to the consolidation of Holdings
(see "Supplies Distributors"). In the future we will report a higher
consolidated interest expense resulting from interest paid under Holdings'
credit facilities and higher interest expense due to an increase in our
long-term debt and capital lease obligations. Interest expense, without the
consolidation of Holdings, would have been $0.4 million for the year ended
December 31, 2002, an increase compared to the year ended December 31, 2001, due
to an increase in our long-term debt and capital lease obligations.

Interest Income. Interest income was $1.0 million and $1.0 million for the
year ended December 31, 2002 and 2001, respectively. In the future we will
report lower consolidated interest income resulting from the elimination of
interest income from the Subordinated Note due to PFS from Holdings upon
consolidating Holdings (see "Supplies Distributors"). Interest income, without
the consolidation of Holdings, would have been $1.2 million for the year ended
December 31, 2002. Interest income increased as compared to the year ended
December 31, 2001, attributable to the interest charged on our subordinated loan
to Supplies Distributors, which was reflected in our consolidated results for
nine months during the year ended December 31, 2002 (through the October 1, 2002
acquisition date) as compared to approximately four months during the prior
year, offset by lower interest rates earned by our cash and cash equivalents and
lower balances of cash and cash equivalents.

Income Taxes. For the year ended December 31, 2002, we recorded a tax
provision of $0.1 million primarily associated with Holdings' Canadian and
European operations. We did not record an income tax benefit associated with our
consolidated net loss in our U.S. operations. A valuation allowance has been
provided for our net deferred tax assets as of December 31, 2002, which are
primarily related to our net operating loss carryforwards. For the year ended
December 31, 2001, we recorded an income tax benefit of $0.2 million, which
primarily related to a pre-tax loss from our Canadian operations that can be
carried back to prior tax years. We did not record an income tax benefit for our
European pre-tax losses in the current or prior period. Due to the consolidation
of Holdings (see

34

"Supplies Distributors"), in the future we anticipate that we will record an
income tax provision associated with Holdings' Canadian and European results of
operations.

NINE MONTHS ENDED DECEMBER 31, 2001 COMPARED TO NINE MONTHS ENDED DECEMBER 31,
2000

Service Fee Revenue (including service fee revenue, affiliate). Service
fee revenue was $28.0 million for the nine months ended December 31, 2001 as
compared to $37.0 million for the nine months ended December 31, 2000, a
decrease of $9.0 million or 24.5%. The decrease in service fee revenue over the
prior period was due to the impact of certain contract terminations, primarily
the Daisytek contract, as well as certain other lower margin producing
contracts. This reduction was partially offset by the impact of new service
contract relationships and growth in existing client relationships. 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 and 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, under which we earned $2.6 million. The net impact of the
changes in our services provided to Daisytek was a reduction in revenue of $10.6
million for the nine months ended December 31, 2001. The reduction in revenue
attributed to the termination of lower margin producing contracts was $8.2
million for the nine months ended December 31, 2001. For the nine months ended
December 31, 2001, the increase in revenue attributed to new client contract
relationships was $7.2 million. For the nine months ended December 31, 2001, the
increase in revenue from existing contracts was $2.6 million. We believe this
increase was negatively impacted by a slowdown in the U.S. economy.

Pursuant to the terms of our transaction management services agreement with
Supplies Distributors, we earned service fees, which are reported as service fee
revenue -- affiliate in the accompanying consolidated financial statements, of
approximately $1.4 million, net of $0.3 million of pass-through charges, for the
nine months ended December 31, 2001. For the nine months ended December 31,
2001, the fees we earned from BSD (the Daisytek subsidiary and predecessor to
Supplies Distributors) were $3.6 million. For the nine months ended December 31,
2000, prior to becoming a related party, service fees earned by PFSweb from BSD,
associated with the same business activities, were $4.6 million. For the nine
months ended December 31, 2001, our revenue was negatively impacted by lower
than anticipated IBM related activity due to the transition to Supplies
Distributors from Daisytek but was benefited by approximately $0.8 million of
service fee adjustments resulting from the termination of the Daisytek
transaction management service agreements. Service fee revenue earned from the
IBM business for the nine months ended December 31, 2000 were reduced by $1.3
million foreign currency transaction losses applicable to the devaluation of the
Euro that were required, under the terms of the arrangements between us and BSD,
to be included as part of the service fee billings.

Other Revenue. Other revenue of $0.1 million for the nine months ended
December 31, 2001 and $1.7 million for the nine months December 31, 2000,
respectively, represents the fees charged to clients in conjunction with early
contract terminations.

Cost of Service Fee Revenue. Cost of service fee revenue was $18.2 million
for the nine months ended December 31, 2001, as compared to $26.8 million during
the nine months ended December 31, 2000, a decrease of $8.6 million or 32.0%.
The resulting service fee gross profit was $9.8 million or 34.9% of service fee
revenue, during the nine months ended December 31, 2001 as compared to $10.2
million, or 27.6% of service fee revenue for the nine months ended December 31,
2000. For the nine months ended December 31, 2000, the service fee gross profit
was negatively impacted by a $1.3 million reduction in revenue applicable to
foreign currency transaction losses discussed above, for which there was no
reduction in costs. In addition, the gross profit earned on certain contracts
terminated during the nine months ended December 31, 2000 was lower than other
contracts we continue to operate. Additionally, by leveraging our existing
infrastructure and by reducing the direct operating costs associated with the
terminated contracts, such as personnel costs, warehousing and distribution
costs, lower depreciation costs resulting from the sale of assets, and other
expenses, we were able to reduce our operating costs and increase our gross
profit percentage. For the nine months ended December 31, 2001, our gross profit
margin was negatively impacted by lower than anticipated IBM related activity
due to the transition to Supplies Distributors from Daisytek but was benefited
by approximately $0.8 million of service fees adjustments resulting from the
termination of the Daisytek transaction management services agreements for which
the related service activities were performed in earlier periods. Furthermore,
the revenue generated by our transition services agreement with Daisytek, under
which we provided certain transitional and information technology services,
primarily utilized infrastructure, which existed in the prior periods and will
continue to exist in future periods.

35

Cost of Other Revenue. Cost of other revenue for the nine months ended
December 31, 2001 reflect the reversal of $0.6 million of accruals made in the
prior year for estimated client termination costs that were determined this
period to be in excess of the actual costs. Cost of other revenue for the nine
months ended December 31, 2000 includes costs from certain terminated contracts
and are primarily comprised of approximately $0.4 million of employee severance
costs, approximately $0.5 million of asset impairments from fixed assets which
were specific to terminated contracts and produced no further value to PFSweb,
and approximately $1.6 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 $16.9
million for the nine months ended December 31, 2001, or 60.2% of revenues, as
compared to $18.9 million, or 48.9% of revenues, for the nine months ended
December 31, 2000. The decrease in SG&A expenses are due to costs incurred in
the prior nine month periods for which there are no or lower comparable costs
incurred in the current year periods. These relate to approximately $1.4 million
of incremental costs primarily applicable to provisions for doubtful accounts, a
$0.5 million foreign currency transaction loss, due to a devaluation of the
Euro, and the $0.3 million favorable resolution of accounts and Value Added Tax
("VAT") receivables in the quarter ended September 30, 2001, offset by an
increase in stand alone public company expenses, consisting primarily of taxes
and insurance, incremental professional services fees for audit and tax services
associated with the change in our fiscal year end and increases in personnel
compensation and sales and marketing costs.

Other. Other primarily reflects the sale of a distribution facility
previously used by PFSweb to provide outsourcing services to Daisytek. For the
nine months ended December 31, 2001, cash proceeds of $10.9 million, net of
approximately $0.6 million of closing costs, were received for assets with an
approximately $4.5 million net book value with a resulting $5.8 million gain.
The net gain was offset by a $0.7 million non-cash stock compensation charge
associated with our modification of certain PFSweb stock options held by
employees of our former parent company Daisytek.

Interest Expense. Interest expense was $0.2 million for the nine months
ended December 31, 2001 as compared to interest expense of $0.1 million for the
nine months ended December 31, 2000. The increase is due to an increase in our
long-term debt and capital lease obligations.

Interest Income. Interest income was $0.7 million for the nine months ended
December 31, 2001 as compared to interest income of $1.1 million for the nine
months ended December 31, 2000. The reduction in interest income is attributable
to lower interest rates earned by our cash and cash equivalents partially offset
by the impact of higher interest rates charged on our subordinated loan to
Supplies Distributors established in September 2001.

Income Taxes. For the nine months ended December 31, 2001, we recorded an
income tax benefit of $0.2 million which primarily relates to a pre-tax loss
from our Canadian operations that can be carried back to prior tax years. For
the nine months ended December 31, 2001, we did not record an income tax benefit
associated with our net loss in our U.S. or European operations. Since we have
not established a sufficient history of earnings for our U.S. and European
operations, a valuation allowance has been provided for our net deferred tax
assets as of December 31, 2001, which are primarily related to our net operating
loss carryforwards. Although we had a pre-tax loss for the nine months ended
December 31, 2000, we recorded an income tax provision associated with a pre-tax
income from our Canadian operations.

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. Also under
these agreements, Daisytek provided financing and credit support to the BSD
Companies and we provided transaction management and fulfillment services to the
BSD Companies. In June 2001, Daisytek notified us and IBM that it did not intend
to renew these agreements upon their scheduled expiration dates.

36

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 us 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 initial
equity investment of $0.75 million in Holdings for a 49% voting interest, and
IFP made an initial equity investment of $0.25 million in Holdings for a 51%
voting interest. Certain officers and directors of PFSweb owned, individually, a
9.8% non-voting interest, and, collectively, a 49% non-voting interest, in IFP.

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 $21 million) for the European operations, were
subsequently increased to $45 million and 27 million Euros (approximately $28
million), respectively, and extended through March 25, 2002. The Company
provided a collaterialized 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 and certain other receivables up
to $30.5 million through its expiration on March 29, 2003. The asset based
credit facility with IBM Belgium provides up to 19 million Euros (approximately
$19.9 million) in financing for purchasing IBM inventory and certain other
receivables. 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 $8.0 million, and shareholders' equity of at least
$20.0 million as of December 31, 2002 and $18.0 million thereafter. Furthermore,
we are obligated to repay any over-advance made to Supplies Distributors or SDSA
under these facilities to the extent Supplies Distributors or SDSA are unable to
do so. 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 7.5 million Euros (approximately $7.9 million)
(originally 10 million euros, amended in October 2002) of eligible accounts
receivables. Borrowings under this agreement can be either cash advances or
straight loans, as defined. Cash advances accrue interest at 8.5%, or on an
adjusted basis as defined, and straight loans accrue interest at Euribor plus
1.4% for the agreement's first year (4.45% as of December 31, 2002) and Euribor
plus 1.3% for the agreement's second year. 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 restricted cash of less than $5.0
million,

37

and are restricted with regard to transactions with related parties,
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 if Supplies Distributors is unable to do so. An over-advance
would arise in the event borrowings exceeded the maximum amount available under
the eligible borrowing base, as defined. We have also provided a guarantee of
the obligations of Supplies Distributors and SDSA to IBM, excluding the trade
payables that are financed by IBM credit.

Effective October 1, 2002, we purchased the remaining 51% interest in
Holdings from IFP for $0.3 million. In addition to our equity investment in
Holdings, we have also provided Supplies Distributors with a subordinated loan
that, as of December 31, 2002, had an outstanding balance of $8.0 million and
accrued interest at a rate of approximately 10%. The balance must be maintained
at a minimum of $8.0 million to ensure Supplies Distributors' compliance with
the covenants of its senior loan facilities, as amended.

On March 28, 2003, Supplies Distributors and SDSA entered into amended
credit facilities with IBM Credit and IBM Belgium, respectively. The amendments
extend the termination dates through March 29, 2004, reduce Supplies
Distributors' and SDSA's maximum financing amounts to $27.5 million and 12.5
million Euros (approximately $13.1 million), respectively, restrict Holdings'
ability to declare and pay a dividend without the prior approval of IBM Credit
and IBM Belgium and expand and modify certain financial covenants.

Pursuant to the terms of our transaction management services agreement with
Supplies Distributors, we earned service fees, which are reported as service fee
revenue, affiliate in the accompanying consolidated financial statements (prior
to the consolidation of Holdings' results of operations effective October 1,
2002), of approximately $1.4 million, net of $0.3 million of pass-through
charges, for the nine months ended December 31, 2001 and $4.7 million, net of
$0.2 million of pass-through charges, for the year ended December 31, 2002. For
the nine months ended December 31, 2001, our fees earned from BSD (the Daisytek
subsidiary and predecessor to Supplies Distributors) were $3.7 million, net of
$0.3 million of pass-through charges. For the year ended March 31, 2001, prior
to becoming a related party, we earned service fees from BSD, associated with
the same business activities, of $7.1 million, net of $0.7 million of
pass-through charges.

Prior to the consolidation of Holdings' operating results effective October
1, 2002, we recorded our interest in Holdings' net income, which was allocated
and distributed to the owners pursuant to the terms of Holdings' operating
agreement, under the modified equity method, which resulted in us recording our
allocated earnings of Holdings or 100% of Holdings' losses. Pursuant to
Holdings' operating agreement, Holdings allocated its earning and distributed
its cash flow, as defined, in the following order of priority: first, to IFP
until it received a one-time amount equal to its capital contribution of $0.25
million; second, to IFP until it received an amount equal to a 35% cumulative
annual return on its capital contribution; third, to us until we received a
one-time amount equal to our capital contribution of $0.75 million; fourth, to
us until we received an amount equal to a 35% cumulative annual return on
our capital contribution; and fifth, to us and IFP, pro rata, in accordance
with our respective capital accounts. As a result of our 100% ownership of
Holdings, future earnings and dividends will be allocated and paid 100% to
PFSweb. In May 2002, Holdings paid a $0.2 million dividend to IFP. In December
2002, Holdings paid us a $0.4 million dividend. Pursuant to the terms of its
amended credit agreements, Holdings is currently restricted from paying cash
dividends without the prior approval of its lenders. Notwithstanding the
foregoing, no distribution may be made if, after giving effect thereto, the net
worth of Holdings could be less than $1.0 million.

Summarized financial information for Holdings as of December 31, 2002 is as
follows (in thousands):

Current assets ................................. $ 76,730
Total assets ................................... $ 77,018
Current liabilities (including $56.1 million
guaranteed by PFSweb ....................... $ 66,094
Subordinated debt due to PFSweb ................ $ 8,005
Members' capital ............................... $ 2,919

38

Summarized operating results for Holdings for the year ended December 31,
2002 is as follows (in thousands):

Net revenues ............ $ 221,145
Gross profit ............ $ 12,528
Income before taxes ..... $ 2,421
Net income .............. $ 1,492

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 $9.9 million for the year ended
December 31, 2002, and primarily resulted from cash used to fund operating
losses and the net impact of increases in Holdings' inventories of $8.1 million
from October 1, 2002 to December 31, 2002, partially offset by decreases in
accounts receivable of $2.1 million and prepaid expenses and other current
assets of $1.8 million. Net cash used in operating activities was $4.6 million
for the nine months ended December 31, 2001, and primarily resulted from cash
used to fund operating losses and the net impact of decreases in accounts
payable and accrued expenses of $9.0 million, partially offset by a decrease in
prepaid expenses and other current assets of $5.2 million. The decrease in
accounts payable and accrued expenses is primarily attributable to the
remittance of the VAT monies due to the predecessor of Supplies Distributors and
the reversal of client termination reserves, recorded as expense in prior year,
and the reversal of deferrals applicable to the termination of the Daisytek
transaction management services agreements, for which the related activities
occurred in earlier periods. The decrease in other current assets primarily
relates to the collection of a note receivable, a governmental grant and VAT
receivables associated with our European operations. Net cash provided by
operating activities was $0.6 million for the year ended March 31, 2001, and
primarily resulted from an increase in accounts payable and accrued expenses of
$8.2 million partially offset by cash used to fund operating losses and an
increase to prepaid expenses and other current assets of $5.4 million. The
increase in other current assets primarily relates to receivables associated
with our European operations including a $1.1 million note receivable from a
terminated client, a $1.6 million receivable related to an asset based
governmental grant and VAT receivables of $2.3 million. The increase in accounts
payable was primarily attributable to $7.2 million of VAT collections that was
due to the predecessor of Supplies Distributors.

Net cash provided by investing activities for the year ended December 31,
2002 totaled $1.5 million, representing the net repayment of $2.9 million by
Supplies Distributors of our subordinated loan, which totaled $8.8 million at
September 30, 2002, but which is now eliminated due to the consolidation of
Holdings, (see "Supplies Distributors") and net cash acquired in our acquisition
of the remaining 51% interest of Holdings from IFP, offset by capital
expenditures of $1.8 million. Net cash used by investing activities for the nine
months ended December 31, 2001 totaled $8.1 million. The net proceeds of $10.3
million from the sale of one of our distribution facilities to Daisytek were
offset by capital expenditures of $3.2 million, the establishment of a
restricted cash balance of $2.7 million to support our long-term debt and lease
financing, and a subordinated loan of approximately $11.7 million to Supplies
Distributors and an equity investment of $0.8 million in Holdings. Cash used in
investing activities during the year ended March 31, 2001 totaled $2.9 million,
representing capital expenditures of $6.3 million partially offset by the full
collection of other receivables. 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

39

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 provided by financing activities was $6.3 million for the year
ended December 31, 2002, primarily representing $6.3 million of proceeds from
debt. Net cash provided by financing activities was $1.0 million for the nine
months ended December 31, 2001, representing the proceeds from debt and from the
issuance of common stock pursuant to our employee stock purchase plan offset by
payments on our capital lease obligations and payments to acquire treasury
stock. Net cash used in financing activities was $0.2 million during the year
ended March 31, 2001, representing payments on our capital lease obligations
partially offset by the proceeds from issuance of common stock.

During the year ended December 31, 2002, our working capital increased to
$15.9 million from $11.2 million at December 31, 2001, primarily due to the
consolidation of Holdings (see "Supplies Distributors") offset by the funding of
operations and capital expenditures. To enhance our financing of future working
capital needs, in March 2003, we entered into a two year credit facility with a
bank. This credit facility provides financing for up to $7.5 million of eligible
accounts. In addition to our current cash position and this new credit facility,
we will continue to evaluate alternatives including utilizing capital or
operating leases, or transferring a portion of our subordinated loan balances,
due from Supplies Distributors, to third-parties. In conjunction with 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, the new credit facility and funds generated from
operations 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, through at
least April 2004.

The following is a schedule of our total contractual cash obligations, which
is comprised of operating leases, other obligations, which represents $0.1
million of contingent obligations we believe will be paid in the next twelve
months, long-term debt and capital leases (including interest), as of December
31, 2002 (in millions):

In support of certain debt instruments and leases, as of December 31, 2002,
we had $2.9 million of cash restricted as collateral for letters of credit. The
letters of credit currently expire at various dates through July 2004, but
require renewal through the related debt and lease obligations termination
dates. In addition, as described above, we have provided collateralized
guarantees to secure the repayment of certain Supplies Distributors' credit
facilities. As of December 31, 2002, the outstanding balance of our senior
credit facilities was approximately $60.7 million. As of February 28, 2003, the
outstanding balance of our senior credit facilities was approximately $54.3
million. To the extent we fail to comply with our debt covenants, including the
monthly financial covenant requirements and our required level of stockholders'
equity, and the lenders accelerate the repayment of the credit facility
obligations, we would be required to repay all amounts outstanding thereunder,
either through Supplies Distributors or under our related guarantees, to the
extent Supplies Distributors or its subsidiaries was unable to do so. Any
requirement to accelerate the repayment of the credit facility obligations would
have a material adverse impact on our financial condition and results of
operations. We can provide no assurance that we will have the financial ability
to repay all of such obligations. As of December 31, 2002, we were in compliance
with all debt covenants and we believe that we will maintain such compliance
throughout calendar year 2003. Furthermore, we are obligated to repay any
over-advance made to Supplies

40

Distributors or its subsidiaries by its lenders, in the event that Supplies
Distributors or its subsidiaries are unable to do so. An over-advance would
arise in the event borrowings exceeded the maximum amount available under the
eligible borrowing base, as defined. We are also required to maintain a minimum
subordinated loan to Supplies Distributors of $8.0 million. We have to seek
lender approval to increase or decrease this amount. We do not have any other
material commercial commitments.

In September 2002, we implemented a restructuring plan and terminated
approximately 10% of our workforce. In conjunction with the terminations and
certain asset write-offs recorded during the year ended December 31, 2002, we
believe we reduced our annual operating expenses by approximately $5.0 to $6.0
million, as compared to our annual run-rate incurred in the first six months of
the year ended December 31, 2002. We did not finalize all restructuring
activities as of December 31, 2002, and thus expect to incur an additional
amount aggregating $0.5 million to $1.0 million of restructuring charges during
calendar year 2003. We also continue to seek out other non-payroll related
operating expense reductions that could impact this amount further.

We currently believe that we are still operating with and incurring costs
applicable to excess capacity in our North American and European warehouse
operations and our information technology infrastructure. We believe that based
on our current cost structure, as we add revenue, we will be able to cover our
reduced infrastructure costs and reach profitability. We currently estimate that
the net service fee revenue needed to leverage our infrastructure and cost
structure and reach profitability is approximately between $12 million to $13
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. We will reevaluate the carrying value of certain of the excess
long-lived warehouse operation and information technology infrastructure assets
for impairment in 2003, in conjunction with our future operating plans, and
determine if additional asset impairment costs should be recognized.

In the future, we may attempt to acquire other businesses to expand our
services or capabilities in connection with our efforts to grow our business. We
currently have no binding agreements to acquire any such businesses. Should we
be successful in acquiring other businesses, we may require additional
financing. Acquisitions involve certain risks and uncertainties. Therefore, we
can give no assurance with respect to whether we will be successful in
identifying businesses to acquire, whether we will be able to obtain financing
to complete an acquisition, or whether we will be successful in operating the
acquired business.

On March 28, 2003, Priority Fulfillment Services, Inc. and Priority
Fulfillment Services of Canada, Inc., (both wholly-owned subsidiaries of PFSweb
and collectively the "Borrowers") entered into a two year Loan and Security
Agreement with Comerica Bank ("Comerica") to provide financing for up to $7.5
million of eligible accounts receivable in the U.S. and Canada. Borrowings under
the Comerica facility will accrue interest at prime rate plus 1%. The agreement
contains cross default provisions, various restrictions upon the Borrowers'
ability to, among other things, merge, consolidate, sell assets, incur
indebtedness, make loans and payments to related parties, make investments and
loans, pledge assets, make changes to capital stock ownership structure, as well
as financial covenants of a minimum tangible net worth, as defined, and a
minimum liquidity ratio, as defined. The agreement also limits our ability to
increase the subordinated loan to Supplies Distributors without the lender's
approval. The agreement is secured by all of the assets of the Borrowers, as
well as a guarantee of PFSweb.

INVENTORY MANAGEMENT

Prior to September 30, 1999, our agreements with IBM and certain other
clients were structured as master distributor agreements. The transaction
management services we provided for IBM under these agreements included
purchasing and reselling IBM product inventory to IBM customers. During the
quarter ended September 30, 1999, we restructured our agreements with IBM so
that we no longer purchased or resold the IBM product inventory. In addition, we
transferred to Daisytek the IBM-related customer accounts receivables, inventory
and accounts payable. As such, we did not own product inventory while Daisytek,
through its subsidiary BSD, purchased and resold the product inventory and we
provided transaction management services and fulfillment services to BSD. In
September 2001, us, our then affiliate Supplies Distributors and IBM entered
into new agreements whereby Supplies Distributors became the master distributor
of IBM product inventory. Effective October 1, 2002, we purchased the remaining
ownership interest in Supplies Distributors and as such now consolidate their
financial position with our own.

We manage our inventories held for sale by maintaining sufficient quantities
of product to achieve high order fill rates while at the same time maximizing
inventory turnover rates. Inventory balances will fluctuate as we add new
product lines. To reduce the risk of loss due to supplier price reductions, our
master distributor agreement provides for price protection under which we
receive credits if the supplier lowers prices on previously purchased inventory.

41

SEASONALITY

The seasonality of our business is dependent upon the seasonality of our
clients' business and the 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 service fee
business activity will be at its lowest in the quarter ended March 31 and at its
highest in the quarter ended June 30. We anticipate that our product revenue
will be highest during the quarter ended December 31.

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

In 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No.'s 141 and 142, "Business
Combinations" and "Goodwill and Other Intangibles." SFAS 141 requires all
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. SFAS 142 requires that ratable amortization of goodwill be
replaced with annual fair-value based tests of the goodwill's impairment, and
that intangible assets other than goodwill be amortized over their useful lives.
Additionally, under the provision of the new accounting standard, an acquired
intangible asset should be separately recognized if the benefit of the
intangible asset is obtained through contractual or other legal rights, or if
the intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so. SFAS 141 is effective for all
business combinations initiated after June 30, 2001 and for all business
combinations accounted for by the purchase method for which the date of
acquisition is after June 30, 2001. The adoption of SFAS 141 as of July 1, 2001
did not have a material impact on our financial statements and related
disclosures. The provisions of SFAS 142 were effective for fiscal years
beginning after December 15, 2001. Our adoption of SFAS 142 on January 1, 2002
did not have a material impact on our consolidated financial statements and
related disclosures.

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 do not believe the adoption of this standard will
have a material impact on the consolidated financial statements and we 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 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 do not believe the
early adoption of SFAS No. 146 would have had a material impact on our
consolidated financial statements for the year ended December 31, 2002 and we
will adopt the provisions of this standard in the first quarter of 2003.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS 148 amends SFAS 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of transition for
a voluntary change to the fair value method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the provisions of SFAS 123
to require more prominent disclosure in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results of operations. We adopted
the disclosure requirements of SFAS 148 as of December 31, 2002.

On January 1, 2002, we adopted the provisions of EITF D-103 "Income
Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses
Incurred." Our billings for reimbursements of 'out-of-pocket' expenses,

42

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 January 2003, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of
Others." FIN No. 45 requires a company to recognize a liability for the
obligations it has undertaken in issuing a guarantee. This liability would be
recorded at the inception of a guarantee and would be measured at fair value.
The measurement provisions of this statement apply prospectively to guarantees
issued or modified after December 31, 2002. The disclosure provisions of the
statement apply to financial statements for periods ending after December 15,
2002. We adopted the disclosure provisions of the statement as of December 31,
2002 and will adopt the measurement provisions of this statement in the first
quarter of 2003 and do not expect the measurement adoption to have a material
effect on the consolidated financial statements when adopted.

In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN 46 requires a company to consolidate a variable interest
entity if it is designated as the primary beneficiary of that entity even if the
company does not have a majority of voting interests. A variable interest entity
is generally defined as an entity where its equity is unable to finance its
activities or where the owners of the entity lack the risk and rewards of
ownership. The provisions of this statement apply at inception for any entity
created after January 31, 2003. For an entity created before February 1, 2003,
the provisions of this interpretation must be applied at the beginning of the
first interim or annual period beginning after June 15, 2003. We will adopt the
provisions of FIN No. 46 in the first quarter of 2003 and do not expect the
adoption to have a material effect on the financial statements.

The FASB Emerging Issues Task Force issued EITF 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables," to address certain revenue
recognition issues. The guidance provided from EITF 00-21 addresses both the
timing and classification in accounting for different earnings processes. We do
not expect that the adoption of EITF 00-21 will have a material impact on our
consolidated financial condition or operations.

CRITICAL ACCOUNTING POLICIES

REVENUE AND COST RECOGNITION

We recognize product revenue upon shipment of product to customers. We
permit our customers to return defective products (that we then return to the
manufacturer) and incorrect shipments for credit against other purchases and
provide for estimated returns and allowances. We offer terms to our customers
that we believe are standard for our industry.

We reflect freight costs billed to customers as components of product
revenues. We record freight costs as a component of cost of goods sold. We
record our product costs as they are incurred.

Under the Master Distributor Agreements, we bill IBM for reimbursements of
certain expenses, including: pass through customer marketing programs; certain
freight costs; direct costs incurred in passing on any price decreases offered
by IBM to Supplies Distributors customers to cover price protection and certain
special bids; the cost of products provided to replace defective product
returned by customers; and certain other expenses as defined. We record a
receivable for these reimbursable amounts as they are incurred with a
corresponding reduction in either inventory or cost of product revenue. We also
reflect pass through customer marketing programs as a reduction of product
revenue.

Our service fee revenues primarily relate to our (1) distribution services,
(2) order management/customer care services and (3) the reimbursement of
out-of-pocket and third party expenses.

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

43

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. The service fee 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.

Our 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.

Our 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 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.

We also perform 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 that we recognize as
services are performed. The service fee revenue associated with these activities
are currently not significant and are incidental to the above-mentioned
services.

We primarily perform our services under two to three year contracts that can
be terminated by either party. In conjunction with these long-term contracts we
generally receive start-up fees to cover our implementation costs, including
certain technology infrastructure and development costs. We defer the fees
received, and the related costs, and amortize 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.

We recognize revenue, and record 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.

INVENTORIES

Inventories (merchandise, held for resale, all of which are finished goods)
are stated at the lower of weighted average cost or market. Supplies
Distributors assumes responsibility for slow-moving inventory under the Master
Distributor Agreements. We review inventory for impairment on a periodic basis,
but at a minimum, annually. Recoverability of the inventory on hand is measured
by comparison of the carrying value of the inventory to the fair value of the
inventory. Supplies Distributors is able to return product rendered obsolete by
IBM engineering changes after customer demand for the product ceases. In the
event we, Supplies Distributors and IBM do not renew the Master Distributor
Agreements, the parties shall mutually agree on a plan of disposition of
Supplies Distributors' then existing inventory.

FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS

For our Canadian operations, the local currency is the functional currency.
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.

For our European operations, the U.S. dollar was the functional currency
through March 31, 2001. Through that date, monetary assets and liabilities were
translated at the rates of exchange on the balance sheet date and certain

44

assets (notably property and equipment) were translated at historical rates.
Income and expense items were translated at average rates of exchange for the
period except for those items of expense, which related to asset amortization,
which were translated at historical rates. The gains and losses from translation
related to these operations were included in net income through March 31, 2001.

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. 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.

Historically, we deemed intercompany transactions with our foreign
subsidiaries as long-term investments part of our net investment. Accordingly,
we recorded transaction gains or losses on these intercompany transactions in
other comprehensive income (loss). Effective September 30, 2002, due to changes
in the operations of the subsidiaries whereby we no longer believe certain of
these transactions to be long-term in nature, we will include certain future
intercompany transaction gains and losses in the determination of net income. We
will continue to report gains or losses on intercompany foreign currency
transactions that are of a long-term investment nature as a separate component
of members' capital.

A description of other significant accounting policies is included in
footnote 2 to the accompanying consolidated financial statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

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

INTEREST RATE RISK

Our interest rate risk is limited to our outstanding balances on our
inventory and working capital financing agreements, loan and security agreement
and factoring agreement for the financing of inventory, accounts receivable and
certain other receivables, which amounted to $59.3 million at December 31, 2002.
A 100 basis point movement in interest rates would result in approximately $0.3
million annualized increase or decrease in interest expense based on the
outstanding balance of these agreements at December 31, 2002.

FOREIGN EXCHANGE RISK

Currently, our foreign currency exchange rate risk is primarily limited to
the Canadian Dollar and the Euro. In the future, our foreign currency exchange
risk may also include other currencies applicable to certain of our
international operations. We may, from time to time, employ derivative financial
instruments to manage our exposure to fluctuations in foreign currency rates. To
hedge our net investment and intercompany payable or receivable balances in
foreign operations, we may enter into forward currency exchange contracts. We do
not hold or issue derivative financial instruments for trading purposes or 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.

Historically, we deemed intercompany transactions with our foreign
subsidiaries as long-term investments and thus part of our net investment.
Accordingly, we recorded transaction gains or losses on these intercompany
transactions in other comprehensive income (loss). Effective September 30, 2002,
due to changes in the operations of our subsidiaries whereby we no longer
believe certain of these transactions to be long-term in nature, we will include
certain future intercompany transaction gains and losses in the determination of
net income or loss.

45

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE

46

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholders of PFSweb, Inc.:

We have audited the accompanying consolidated balance sheets of PFSweb, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of operations, shareholders' equity and comprehensive loss and cash
flows for the year ended December 31, 2002, the nine-month period ended December
31, 2001 and the year ended March 31, 2001. In connection with our audits of the
consolidated financial statements, we also have audited the accompanying
financial statement schedule as of December 31, 2002 and 2001 and for the year
ended December 31, 2002, the nine-month period ended December 31, 2001 and the
year ended March 31, 2001. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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 PFSweb, Inc. and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for the year ended December 31, 2002, the
nine-month period ended December 31, 2001 and the year ended March 31, 2001 in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the related financial statement schedule as of
December 31, 2002 and 2001 and for the year ended December 31, 2002, the
nine-month period ended December 31, 2001 and the year ended March 31, 2001 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.

KPMG LLP

Dallas, Texas
February 14, 2003, except for Notes 3 and 15 as to which the date is March 28,
2003

47

PFSWEB, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

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

48

PFSWEB, INC. AND SUBSIDIARIES

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

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

49

PFSWEB, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT SHARE DATA)

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

50

PFSWEB, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

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

51

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. OVERVIEW AND BASIS OF PRESENTATION

PFSWEB, INC. OVERVIEW

In June 1999, Daisytek International Corporation ("Daisytek") created a
separate wholly-owned subsidiary named PFSweb, Inc. (the "Company" or "PFSweb"),
a Delaware corporation, to become a holding company for certain of Daisytek's
wholly-owned subsidiaries ("PFS") in contemplation of an initial public offering
of PFSweb. Daisytek contributed $20,000 for 14,305,000 shares of common stock of
PFSweb. In December 1999, PFSweb sold 3,565,000 shares of common stock at a
price of $17 per share in an initial public offering (the "Offering"). Net
proceeds from the Offering aggregated approximately $53.0 million and were used
to repay the Company's payable to Daisytek and to acquire from Daisytek all
fixed assets in its Memphis distribution facility as well as certain assets
providing information technology services for approximately $5 million (see Note
6). Simultaneous with the completion of the Offering, Daisytek contributed to
PFSweb all the assets, liabilities and equity comprising PFS.

On June 8, 2000, the Daisytek Board of Directors approved the separation of
PFSweb from Daisytek by means of a tax-free dividend of Daisytek's remaining
ownership of PFSweb after receiving a favorable ruling from the IRS to the
effect that the distribution by Daisytek of its shares of PFSweb stock would be
tax-free to Daisytek and to Daisytek's shareholders for U.S. federal income tax
purposes. The distribution of Daisytek's 14,305,000 shares of PFSweb (the
"Spin-off") occurred at the close of business on July 6, 2000, to Daisytek
shareholders of record as of June 19, 2000.

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 internet application development, order management, web-enabled customer
contact centers, customer relationship management, financial services including
billing and collection services and working capital solutions, information
management, option kitting and assembly services, and international fulfillment
and distribution services.

SUPPLIES DISTRIBUTORS OVERVIEW

The Company, Daisytek, Business Supplies Distributors, Inc., (a Daisytek
subsidiary -- "BSD"), and International Business Machines Corporation ("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 and other products. Daisytek provided financing and
credit support to the BSD Companies and PFSweb provided transaction management
and fulfillment services to the BSD Companies. On June 8, 2001, Daisytek
notified PFSweb and IBM that it did not intend to renew these agreements upon
their scheduled expiration dates.

On July 3, 2001, the Company and Inventory Financing Partners, LLC ("IFP")
formed Business Supplies Distributors Holdings, LLC ("Holdings"), and Holdings
formed a wholly-owned subsidiary, Supplies Distributors, Inc. ("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 the new agreements, Supplies Distributors and SDSA
act as master distributors of various products, primarily IBM product, 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. On September 26, 2001, Supplies
Distributors purchased all of the stock of the BSD Companies for a purchase
price of $923,000 and incurred $140,000 of acquisition costs. 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.

52

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

Supplies Distributors and SDSA have obtained certain financing (see Note 3)
that allows them to fund the working capital requirements for the sale of
primarily IBM products. Pursuant to the transaction management services
agreements, the Company provides to Supplies Distributors, SDC and SDSA such
services as managed web hosting and maintenance, procurement support,
web-enabled customer contact center services, customer relationship management,
financial services including billing and collection services, information
management, and international distribution services. Additionally, IBM and
Holdings have outsourced the product demand generation to Global Marketing
Services, Inc. ("GMS"). Holdings, via its arrangements with GMS and the Company,
sells its products in the United States, Canada and Europe.

All of the agreements between the Company and Holdings were made in the
context of a related party relationship and were negotiated in the overall
context of the Company's and Holdings' prior arrangement with IBM. Although
management generally believes that the terms of these agreements are consistent
with fair market values, there can be no assurance that the prices charged to or
by each company under these arrangements are not higher or lower than the prices
that may be charged by, or to, unaffiliated third parties for similar services.

BASIS OF PRESENTATION

For all periods prior to the Spin-off, the accompanying consolidated
financial statements are presented on a carve-out basis and reflect the
consolidated historical results of operations, financial position and cash flows
of the Company. For the year ended March 31, 2001, certain expenses reflected in
the consolidated financial statements include an allocation of certain Daisytek
corporate expenses and infrastructure costs (see Note 6). Management believes
that the methods used to allocate expenses were reasonable, although the cost of
services could have been higher if obtained from other sources. In addition,
PFSweb has reflected certain service fee revenue and cost of service fee revenue
for services subcontracted to PFSweb by Daisytek. The service fee revenue, cost
of service fee revenue and allocated expenses have been reflected on the basis
that Daisytek and PFSweb consider to be a reasonable reflection of the services
provided and revenue earned by PFSweb and the utilization of services provided
by Daisytek and the benefit received by PFSweb. The financial information
included herein may not reflect what the consolidated financial position,
operating results, shareholders' equity and cash flows would have been had
PFSweb been a separate, stand-alone entity during the year ended March 31, 2001.

For the period from July 2001 to September 2002, the Company owned 49% of
Holdings and as such the results of Holdings were not consolidated into the
Company's results. The Company's equity interest in Holdings was presented in
the consolidated balance sheet as investment in affiliate at December 31, 2001
and the Company's allocation of Holdings' net income (see Note 9) was presented
in the consolidated statement of operations as equity in earnings of affiliate
for the nine months ended December 31, 2001 and the year ended December 31, 2002
(through September 30, 2002). Effective October 1, 2002, the Company purchased
the remaining 51% interest in Holdings from IFP for $0.3 million. As a result of
the purchase, effective October 1, 2002, the Company began consolidating 100% of
Holdings' financial position and results of operations into the Company's
consolidated financial statements.

In June 2001, the Company changed its fiscal year from March 31 to December
31.

2. SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

All intercompany accounts and transactions have been eliminated in
consolidation. Accounts and transactions between the Company and its now
consolidated subsidiary, Holdings, have been eliminated as of and for the three
months ended December 31, 2002 (see Note 1).

53

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

INVESTMENT IN AFFILIATE

In July 2001, the Company made a 49% investment in Holdings (see Note 9).
Effective October 1, 2002, the Company purchased the remaining 51% ownership
interest of Holdings. Prior to consolidating Holdings' financial position and
results of operations, the Company recorded its interest in Holdings' net
income, which was allocated and distributed to the owners pursuant to the terms
of Holdings' operating agreement, under the modified equity method, which
resulted in the Company recording its allocated earnings of Holdings or 100% of
Holdings' losses.

In addition to the equity investment, the Company loaned Supplies
Distributors monies in the form of a Subordinated Demand Note (the "Note").
Under certain new and amended terms of its senior debt facilities, the
outstanding balance of the Note cannot be increased or decreased without prior
approval of the Company's lenders (see Notes 3 and 15). As of December 31, 2001
and 2002, the outstanding balance of the Note was $11.7 million and $8.0
million, respectively.

USE OF ESTIMATES

The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the U.S. requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities, and the reported
amounts of revenues and expenses, including allowances for the collectibility of
accounts and other receivable and the recoverability of inventory. The
recognition and allocation of certain operating expenses, restructuring costs
(see Note 8) and the determination of costs applicable to client terminations
(see Notes 1 and 6) in these consolidated financial statements also required
management estimates and assumptions.

REVENUE AND COST RECOGNITION

The Company recognizes product revenue and product cost upon shipment of
product to customers. The Company permits its customers to return defective
products (that the Company then returns to the manufacturer) and incorrect
shipments for credit against other purchases and provides a reserve for
estimated returns and allowances. The Company offers terms to its customers that
it believes are standard for its industry.

Freight costs billed to customers are reflected as components of product
revenues. Freight costs incurred by the Company are recorded as a component of
cost of goods sold.

Under the Master Distributor Agreements (see Note 5), the Company bills IBM
for reimbursements of certain expenses, including: pass through customer
marketing programs; certain freight costs; direct costs incurred in passing on
any price decreases offered by IBM to Supplies Distributors customers to cover
price protection and certain special bids; the cost of products provided to
replace defective product returned by customers; and certain other expenses as
defined. The Company records a receivable for these reimbursable amounts as they
are incurred with a corresponding reduction in either inventory or cost of
product revenue. The Company also reflects pass through customer marketing
programs as a reduction of product revenue.

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 expenses.

Distribution services relate primarily to inventory management, product
receiving, warehousing and fulfillment (i.e., picking, packing and shipping).
Service fee revenue for these activities is recognized as earned, which is
either (i) on a per transaction basis or (ii) 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 the Company's 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. Service fee revenue for this activity 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 that are recognized on product shipment.

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.

54

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

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 costs associated with technology collaboration and ongoing
technology support that consist of creative internet application 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 certain of 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
that are recognized as services are performed. The service fee revenue
associated with these activities are currently not significant and are
incidental to the above-mentioned services.

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 $2.1 million and $0.1 million for the year ended March 31,
2001 and the nine months ended December 31, 2001, respectively, represents the
fees charged to clients in conjunction with the early termination of certain
contracts. Cost of other revenue for the year ended March 31, 2001 includes
approximately $0.4 million of employee severance costs, approximately $0.5
million of asset impairments from fixed assets that were specific to terminated
contracts and provided no further value to PFSweb, and approximately $1.6
million of certain uncollectible amounts receivable from, and liabilities
applicable to, clients who terminated contracts. Cost of other revenue for the
nine months ended December 31, 2001 of $0.6 million reflects the benefit
associated with the reversal of accruals made in the previous year for estimated
client terminations costs that were determined to be in excess of actual costs
incurred.

The Company primarily performs its services under one 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 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. Implementation costs associated
with technology infrastructure and development costs are a component of property
and equipment and are not included in the above analysis. Current and
non-current deferred implementation revenues are a component of deferred revenue
and other liabilities, respectively.

CONCENTRATION OF BUSINESS AND CREDIT RISK

Service fee revenue from Daisytek accounted for approximately 55% and 34% of
the Company's total net revenues for the year ended March 31, 2001 and the nine
months ended December 31, 2001, respectively.

55

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

For the nine months ended December 31, 2001, excluding Daisytek, two clients
accounted for approximately 43% of the Company's revenue. As of December 31,
2001, two clients accounted for approximately 34% of accounts receivable, of
which 12% was due from Supplies Distributors (see Note 9).

The Company's product revenue was primarily generated by sales of product
purchased under master distributor agreements with one supplier. Sales to two
customers accounted for approximately 13% and 12% of the Company's total product
revenues for the year ended December 31, 2002. Service fee revenue from two
clients accounted for approximately 35% and 14% of net service fee revenue for
the year ended December 31, 2002. In addition, service fee revenue earned from
Supplies Distributors prior to the October 1, 2002 acquisition date
approximated 13% of net service fee revenue for the year ended December 31,
2002. On a consolidated basis, one client accounted for
approximately 22% of the Company's total revenues for the year ended December
31, 2002. As of December 31, 2002, three customers/clients accounted for
approximately 39% of accounts receivable.

In conjunction with Supplies Distributors' financing, the Company has
provided certain collateralized guarantees on behalf of Supplies Distributors.
Supplies Distributors' ability to obtain financing on similar terms would be
significantly impacted without these guarantees. Additionally, since Holdings
has limited personnel and physical resources, its ability to conduct business
could be materially impacted by contract terminations by GMS.

CASH AND CASH EQUIVALENTS

Cash equivalents are defined as short-term highly liquid investments with
original maturities of three months or less.

RESTRICTED CASH

Restricted cash includes the following items (in thousands):

The Company has cash restricted as collateral for letters of credit that
secure certain debt and lease obligations (see Note 3). The letters of credit
currently expire at various dates through July 2004, but require renewal through
the related debt and lease obligations termination dates.

In conjunction with certain of its financing agreements, Supplies
Distributors has entered into agreements with its banks and lenders whereby
a security interest was granted to the lender for all customer remittances
received in specified bank accounts (see Note 3). At December 31, 2002, these
bank accounts held $0.2 million, which was restricted for payment to the lender
against the outstanding long term debt.

To facilitate Value Added Tax ("VAT") processing on its inventory
transactions, BSD Europe provided a bank guarantee to the Belgium government. To
secure the guarantee, the bank required BSD Europe to maintain cash balances as
collateral for the guarantee. The Company's maximum exposure under this
guarantee was $0.8 million at December 31, 2002. The Company expects this
collateral to be released in 2003.

OTHER RECEIVABLES AND LIABILITIES

Other receivables include the following items (in thousands):

56

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The amounts due from IBM represent billings under the Master Distributor
Agreements (see Note 5).

During 2001, the Company received a governmental grant for investments made
in fixed assets in its Belgium operations. At establishment, the total grant of
approximately $1.6 million was deferred and is being recognized as a reduction
in depreciation expense over the same period over which the related fixed assets
are being depreciated. As of December 31, 2001 and 2002, a deferred credit of
$0.2 million at each year end and $1.0 million at each year end is included in
accrued expenses and other liabilities, respectively, in the accompanying
consolidated balance sheets and represents the unamortized portion of the grant.
For the year ended March 31, 2001, the nine months ended December 31, 2001, and
the year ended December 31, 2002, approximately $0.2 million, $0.1 million, and
$0.2 million, respectively, was recognized as a reduction of depreciation
expense. The grant was earned by the Company upon the achievement of certain
minimum capital expenditure requirements. Realization of the entire gain
requires the Company to maintain a certain minimum workforce through December
2004. The Company's management believes that the likelihood that it would be
required to refund this grant is remote.

INVENTORIES

Inventories (merchandise, held for resale, all of which are finished goods)
are stated at the lower of weighted average cost or market. Supplies
Distributors assumes responsibility for slow-moving inventory under the Master
Distributor Agreements (see Note 5). The Company reviews inventory for
impairment on a periodic basis, but at a minimum, annually. Recoverability of
the inventory on hand is measured by comparison of the carrying value of the
inventory to the fair value of the inventory. As of December 31, 2002, the
Company's allowance for slow-moving inventory was approximately $0.1 million.
Supplies Distributors is able to return product rendered obsolete by IBM
engineering changes after customer demand for the product ceases. In the event
the Company, Supplies Distributors and IBM do not renew the Master Distributor
Agreements, the parties shall mutually agree on a plan of disposition of
Supplies Distributors' then existing inventory.

Inventories include merchandise in-transit that has not been received by the
Company but that has been shipped and invoiced by Supplies Distributors'
vendors. The corresponding payable for inventories in-transit is included in
debt in the accompanying consolidated financial statements.

PROPERTY AND EQUIPMENT

The components of property and equipment as of December 31, 2001 and 2002
are as follows (in thousands):

Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the respective assets.
Leasehold improvements are amortized over the shorter of the useful life of the
related asset or the remaining lease term.

The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that 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 future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured as the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Fair value would be
determined using appraisals, discounted cash flow analysis or similar valuation
techniques. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.

57

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The Company's property held under capital leases amount to approximately
$5.5 million and $4.3 million, net of accumulated amortization of approximately
$2.4 million and $3.5 million, at December 31, 2001 and 2002, respectively.

FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS

For the Company's Canadian operations, the local currency is the functional
currency. 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.

For the Company's European operations, the U.S. dollar was the functional
currency through March 31, 2001. Through that date, monetary assets and
liabilities were translated at the rates of exchange on the balance sheet date
and certain assets (notably property and equipment) were translated at
historical rates. Income and expense items were translated at average rates of
exchange for the period except for those items of expense, which related to
asset amortization, which were translated at historical rates. The gains and
losses from translation related to this subsidiary were included in net income
through March 31, 2001.

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.

Historically, the Company deemed intercompany transactions with its foreign
subsidiaries as long-term investments and part of its net investment.
Accordingly, the Company recorded currency gains or losses on these intercompany
transactions in other comprehensive income (loss). Effective September 30, 2002,
due to changes in the operations of the subsidiaries whereby the Company no
longer believes certain of these transactions to be long-term in nature, the
Company will include certain future intercompany currency gains and losses in
the determination of net income. Intercompany transaction gains and losses
included in net loss were not material for the year ended December 31, 2002. The
Company will continue to report gains or losses on intercompany foreign currency
transactions that are of a long-term investment nature as a separate component
of members' capital.

STOCK BASED COMPENSATION

The Company accounts for stock options using the intrinsic-value method as
outlined under Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees ("APB No. 25") and related interpretations, including FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation and Interpretation of APB No. 25, issued in March 2000 (see Note
4). Under this method, compensation expense is recorded on the date of the grant
only if the current market price of the underlying stock exceeds the exercise
price. The exercise prices of all options granted during the year ended March
31, 2001, the nine months ended December 31, 2001 and the year ended December
31, 2002 were equal to the market price of the Company's common stock at the
date of grant. As such, no compensation cost was recognized during those years
for stock options granted to employees (see Note 4). The following table shows
the pro forma effect on the Company's net loss and loss per share as if
compensation cost had been recognized for stock options based on their fair
value at the date of the grant. The pro forma effect of stock options on the
Company's net loss for those years may not be representative of the pro forma
effect for future years due to the impact of vesting and potential future
awards. Options issued under the Daisytek Plans (see Note 4) prior to April 1,
1995, were excluded from the computation.

58

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

INCOME TAXES

Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. 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. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying value of our financial instruments, which include cash and cash
equivalents, accounts receivable, accounts payable and debt and capital lease
obligations, approximate their fair values based on short terms to maturity or
current market prices and interest rates.

COMPREHENSIVE LOSS

Comprehensive loss is defined as the change in equity (net assets) of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources. Comprehensive loss consists of net losses
and foreign currency translation adjustments.

NET LOSS PER COMMON SHARE

For the year ended March 31, 2001, the nine-month period ended December 31,
2001, and the year ended December 31, 2002, outstanding options to purchase
common shares of PFSweb were anti-dilutive and have been excluded from the
weighted average share computation (see Note 4). There are no other potentially
dilutive securities outstanding.

CASH PAID DURING YEAR

The Company made payments for interest of approximately $0.2 million, $0.2
million and $0.8 million and income taxes of approximately $0.2 million, $0.1
million and $0.8 million during the year ended March 31, 2001, the nine-month
period ended December 31, 2001, and the year ended December 31, 2002,
respectively (see Notes 3 and 10).

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No.'s 141 and 142, "Business
Combinations" and "Goodwill and Other Intangibles." SFAS 141 requires all
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. SFAS 142 requires that ratable amortization of goodwill be
replaced with annual fair-value based tests of the

59

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

goodwill's impairment, and that intangible assets other than goodwill be
amortized over their useful lives. Additionally, under the provision of the new
accounting standard, an acquired intangible asset should be separately
recognized if the benefit of the intangible asset is obtained through
contractual or other legal rights, or if the intangible asset can be sold,
transferred, licensed, rented, or exchanged, regardless of the acquirer's intent
to do so. SFAS 141 is effective for all business combinations initiated after
June 30, 2001 and for all business combinations accounted for by the purchase
method for which the date of acquisition is after June 30, 2001. The adoption of
SFAS 141 as of July 1, 2001 did not have a material impact on the Company's
financial statements and related disclosures. The provisions of SFAS 142 was
effective for fiscal years beginning after December 15, 2001. The Company's
adoption of SFAS 142 on January 1, 2002 did not have a material impact on its
consolidated financial statements and related disclosures.

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 does not believe the adoption of this
standard will have a material 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 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 does not
believe the early adoption of SFAS No. 146 would have had a material impact on
our consolidated financial statements for the year ended December 31, 2002 and
will adopt the provisions of this standard in the first quarter of 2003.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS 148 amends SFAS 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of transition for
a voluntary change to the fair value method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the provisions of SFAS 123
to require more prominent disclosure in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results of operations. The Company
adopted the disclosure requirements of SFAS 148 as of December 31, 2002.

On January 1, 2002, the Company adopted the provisions of EITF D-103 "Income
Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses
Incurred." For all periods presented, 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 January 2003, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of
Others." FIN No. 45 requires a company to recognize a liability for the
obligations it has undertaken in issuing a guarantee. This liability would be
recorded at the inception of a guarantee and would be measured at fair value.
The measurement provisions of this statement apply prospectively to guarantees
issued or modified after December 31, 2002. The disclosure provisions of the
statement apply to financial statements for periods ending after December 15,
2002. The Company adopted the disclosure provisions of the statement as of
December 31, 2002 and will adopt the measurement provisions of this statement in
the first quarter of 2003. The Company does not expect the adoption to have a
material effect on the financial statements when adopted.

In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN 46 requires a company to consolidate a variable interest
entity if it is designated as the primary beneficiary of that entity even if the
company does not have a majority of voting interests. A variable interest entity
is generally defined as an entity where its equity is unable to finance its
activities or where the owners of the entity lack the risk and rewards of
ownership. The provisions of this statement apply at inception for any entity
created after January 31, 2003. For an entity created before February 1, 2003,
the provisions of this interpretation must be applied at the beginning of the

60

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

first interim or annual period beginning after June 15, 2003. The Company will
adopt the provisions of FIN No. 46 in the first quarter of 2003 and does not
expect the adoption of the statement to have a material effect on the financial
statements.

The FASB Emerging Issues Task Force issued EITF 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables," to address certain revenue
recognition issues. The guidance provided from EITF 00-21 addresses both the
timing and classification in accounting for different earnings processes. The
Company does not expect that the adoption of EITF 00-21 will have a material
impact on our consolidated financial condition or operations.

RECLASSIFICATIONS

Certain prior year data have been reclassified to conform to the current
period presentation. These reclassifications had no effect on previously
reported net income or shareholders' equity.

3. DEBT AND CAPITAL LEASE OBLIGATIONS:

Debt and capital lease obligations consist of the following (in thousands):

TERM MASTER LEASE AGREEMENT

During the nine months ended December 31, 2001, the Company entered into a
Term Lease Master Agreement with IBM Credit Corporation ("Master Lease
Agreement") that provides for leasing or financing transactions of equipment
with terms of 3 to 5 years. The leasing transactions are secured by the related
equipment and letters of credit (see Note 2). The financing transactions are
secured by a letter of credit (see Note 2). Leasing and financing transactions
under the Master Lease Agreement during the nine months ended December 31, 2001,
and the year ended December 31, 2002, totaled $1.5 million and $0.3 million,
respectively.

The Company has certain non-cancelable capital lease agreements including
those under the Master Lease Agreement, primarily involving warehouse and
computer equipment.

The following is a schedule of future minimum lease payments under the
capital leases together with the present value of the net minimum lease payments
as of December 31, 2002 (in thousands):

Fiscal year ended December 31,
2003.............................................................. $ 1,373
2004.............................................................. 918
2005.............................................................. 507
2006.............................................................. 451
2007.............................................................. 425
Thereafter........................................................ 177
--------
Total minimum lease payments................................. $ 3,851
Less amount representing interest at rates ranging from 5.75%
to 16.29%..................................................... (622)
---------
Present value of net minimum lease payments....................... 3,229
Less: Current portion............................................. (1,119)
--------
Long-term capital lease obligations.......................... $ 2,110
========

61

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

INVENTORY AND WORKING CAPITAL FINANCING AGREEMENT, UNITED STATES

On September 27, 2001, Supplies Distributors entered into a short-term
credit facility with IBM Credit Corporation ("IBM Credit") to finance its
distribution of IBM products in the United States. On March 29, 2002, Supplies
Distributors entered into an amended credit facility with IBM Credit that was
subsequently further amended. The asset based credit facility provides financing
for purchasing IBM inventory and for certain other receivables up to $30.5
million through its expiration on March 29, 2003. The credit facility contains
cross default provisions, various restrictions upon the ability of Holdings and
Supplies Distributors to, among others, 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, PFSweb is required to maintain a minimum
subordinated note receivable balance from Supplies Distributors of $8.0 million
and a minimum shareholders' equity, as modified, of $20.0 million as of December
31, 2002 and $18.0 million thereafter. Borrowings under the credit facility
accrue interest, after a defined free financing period, at prime rate plus 1%,
which was 5.25% as of December 31, 2002. The facility accrues a quarterly
commitment fee of 0.375% on the unused portion of the commitment, and a monthly
service fee.

On March 28, 2003, Supplies Distributors entered into an amended credit
facility with IBM Credit LLC (formerly IBM Credit Corporation). The amendment
extends the termination date through March 29, 2004, reduces the maximum
financing amount to $27.5 million, restricts Holdings' ability to declare and
pay a dividend without the prior approval of IBM Credit and expands and modifies
certain financial covenants. The Company has classified the outstanding amount
under this facility as current at December 31, 2002.

INVENTORY AND WORKING CAPITAL FINANCING AGREEMENT, EUROPE

On September 27, 2001, SDSA entered into a short-term credit facility with
IBM Belgium Financial Services S.A. ("IBM Belgium") to finance its distribution
of IBM products in Europe. On March 29, 2002, SDSA and BSD Europe entered into
an amended credit facility with IBM Belgium that was subsequently further
amended. The asset based credit facility with IBM Belgium provides up to 19
million Euros (approximately $19.9 million) in financing for purchasing IBM
inventory and for certain other receivables. 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. The credit facility contains cross default provisions,
various restrictions upon the ability of Holdings and Supplies Distributors to,
among others, 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, PFSweb is required to maintain a minimum subordinated note
receivable balance from Supplies Distributors of $8.0 million and a minimum
shareholders' equity, as modified, of $20.0 million as of December 31, 2002, and
$18.0 million thereafter. Borrowings under the credit facility accrue interest,
after a defined free financing period, at euribor plus 4%, which was 6.93% as of
December 31, 2002. SDSA pays a monthly service fee on the commitment.

On March 28, 2003, SDSA entered into an amended credit facility with IBM
Belgium. The amendment extends the termination date through March 29, 2004,
reduces the maximum financing amount to 12.5 million Euros (approximately $13.1
million), restricts SDSA's ability to declare and pay a dividend without the
prior approval of IBM Belgium and modifies certain financial covenants. The
Company has classified the outstanding amount under this facility as current at
December 31, 2002.

LOAN AND SECURITY AGREEMENT

On March 29, 2002, 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 receivable 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

62

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

longer supplies products pursuant to such agreement (see Note 5). Borrowings
under the Congress facility accrue interest at prime rate plus 0.25% (4.5% at
December 31, 2002) or Eurodollar rate plus 3.0% or on an adjusted basis, as
defined. This agreement contains cross default provisions, various restrictions
upon the ability of Holdings and Supplies Distributors 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 is secured by
all of the assets of Supplies Distributors, as well as collateralized guaranties
of Holdings and PFSweb. Additionally, PFSweb is required to maintain a
subordinated loan to Supplies Distributors of no less than $6.5 million and
restricted cash of less than $5.0 million, and is restricted with regard to
transactions with related parties, indebtedness and changes to capital stock
ownership structure. Supplies Distributors and SDC entered into Blocked Account
Agreements with their banks and Congress whereby a security interest was granted
to Congress for all customer remittances received in specified bank accounts. At
December 31, 2002, these bank accounts held $0.2 million, which was restricted
for payment to Congress. The Company has classified the outstanding amount under
this facility as current at December 31, 2002.

FACTORING AGREEMENT

On March 29, 2002, SDSA entered into a two year factoring agreement with
Fortis Commercial Finance N.V. ("Fortis") to provide factoring for up to 7.5
million euros (approximately $7.9 million) (originally 10 million euros, amended
in October 2002) of eligible accounts receivables. Borrowings under this
agreement can be either cash advances or straight loans, as defined. Cash
advances accrue interest at 8.5%, or on an adjusted basis as defined, and
straight loans accrue interest at Euribor plus 1.4% for the agreement's first
year (4.45% as of December 31, 2002) and Euribor plus 1.3% for the agreement's
second year. This agreement contains various restrictions upon the ability of
SDSA to, among other things, merge, consolidate, incur indebtedness, as well as
financial covenants, such as minimum net worth. This agreement is secured by a
guarantee of Supplies Distributors, up to a maximum of 200,000 euros. The
Company has classified the outstanding amount under this facility as current at
December 31, 2002.

DEBT COVENANTS

To the extent the Company fails to comply with its covenants, including the
monthly financial covenant requirements and required level of stockholders'
equity ($20.0 million as of December 31, 2002 and $18.0 million thereafter), and
the lenders accelerate the repayment of the credit facility obligations, the
Company would be required to repay all amounts outstanding thereunder, either
through Supplies Distributors or under PFSweb's related guarantees, to the
extent Supplies Distributors or its subsidiaries was unable to do so. Any
requirement to accelerate the repayment of the credit facilities obligations
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 would have
the financial ability to repay all of such obligations. At December 31, 2002,
the Company was in compliance with all debt covenants. Furthermore, PFSweb is
obligated to repay any over-advance made to Supplies Distributors by its
lenders, if Supplies Distributors is unable to do so. An over-advance would
arise in the event borrowings exceeded the maximum amount available under the
eligible borrowing base, as defined.

PFSweb 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.

The Company's aggregate maturities of long-term debt subsequent to December
31, 2002 are as follows:

Fiscal year ended December 31,
2003........................................... $ 59,744
2004........................................... 438
2005........................................... 369
2006........................................... 177
2007........................................... --
Thereafter..................................... --
------------
Total long-term debt payments.................. $ 60,728
============

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PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

4. STOCK AND STOCK OPTIONS

TREASURY STOCK

On August 13, 2001, the Company announced that its Board of Directors had
authorized the repurchase of up to two million shares of the Company's common
stock. As of December 31, 2001 and 2002, the Company had repurchased 86,300
shares of common stock.

PREFERRED STOCK PURCHASE RIGHTS

On June 8, 2000 the Company's Board of Directors declared a dividend
distribution of one preferred stock purchase right (a "Right") for each share of
the Company's common stock outstanding on July 6, 2000. Each Right entitles the
registered shareholders to purchase from the Company one one-thousandth of a
share of preferred stock at an exercise price of $67, subject to adjustment. The
Rights are not currently exercisable, but would become exercisable if certain
events occurred relating to a person or group acquiring or attempting to acquire
15 percent or more of the Company's outstanding shares of common stock. The
Rights expire on July 6, 2010, unless redeemed or exchanged by the Company
earlier.

EMPLOYEE STOCK PURCHASE PLAN

On September 15, 2000, PFSweb shareholders adopted the PFSweb Employee Stock
Purchase Plan (the "Stock Purchase Plan") that is qualified under Section 423 of
the Internal Revenue Code of 1986, to provide employees of PFSweb an opportunity
to acquire a proprietary interest in the Company. The Stock Purchase Plan
provides for acquisition of PFSweb common stock at a 15% discount to the market
value. The Stock Purchase Plan permits each U.S. employee who has completed
ninety days of service to elect to participate in the plan. Eligible employees
may elect to contribute up to 10 percent of their compensation with after-tax
dollars up to a maximum annual contribution of $21,250. The Company has reserved
2,000,000 shares of its common stock under the Stock Purchase Plan, as amended.
The Stock Purchase Plan became effective for eligible employees in September
2000. During the year ended March 31, 2001, the nine months ended December 31,
2001, and the year ended December 31, 2002, 37,378, 236,031 and 254,574 shares
were issued under the Stock Purchase Plan, respectively.

STOCK OPTIONS AND STOCK OPTION PLANS

Spin-off

Prior to the Offering and Spin-off transaction described in Note 1, certain
of the Company's employees were granted Daisytek stock options under Daisytek's
stock option compensation plans (the "Daisytek Plans"). The stock options
generally vest over a three to five-year period from the date of grant and
expire 10 years after the date of grant.

In connection with the completion of the Spin-off, all outstanding Daisytek
stock options were replaced with substitute stock options as described below:

Options held by PFSweb employees were replaced (at the option holder's
election made prior to the Spin-off) with either options to acquire shares of
PFSweb common stock or options to acquire shares of both Daisytek common stock
and PFSweb common stock (which may be exercised separately) (the "Unstapled
Options"). Options held by Daisytek employees were replaced (at the option
holder's election made prior to the Spin-off) with either options to acquire
shares of Daisytek common stock or Unstapled Options.

In general, the adjustments to the outstanding Daisytek options were
established pursuant to a formula designed to ensure that: (1) the aggregate
"intrinsic value" (i.e. the difference between the exercise price of the option
and the market price of the common stock underlying the option) of the
substitute options did not exceed the aggregate intrinsic value of the
outstanding Daisytek stock options which were replaced by such substitute
options immediately prior to the Spin-off, and (2) the ratio of the exercise
price of the options to the market value of the underlying stock immediately
before and after the Spin-off was preserved.

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Substantially all of the other terms and conditions of each substitute stock
option, including the time or times when, and the manner in which, each option
is exercisable, the duration of the exercise period, the permitted method of
exercise, settlement and payment, the rules that will apply in the event of the
termination of employment of the employee, the events, if any, that may give
rise to an employee's right to accelerate the vesting or the time or exercise
thereof and the vesting provisions, are the same as those of the replaced
Daisytek stock option, except that option holders who are employed by one
company will be permitted to exercise, and will be subject to all of the terms
and provisions of, options to acquire shares in the other company as if such
holder was an employee of such other company.

As a result of the stock option replacement process described above, in
conjunction with the Spin-off on July 6, 2000, 3,479,697 non-plan PFSweb stock
options (the "PFSweb Non-plan") were issued to PFSweb and Daisytek officers,
directors and employees.

Offer to Exchange

On April 30, 2001, the Company filed a Tender Offer Statement on Schedule TO
(the "Schedule TO") relating to the Company's offer to exchange certain PFSweb
Plan and Non-plan options to purchase shares of its common stock held by certain
PFSweb officers, directors and employees for new options to purchase shares of
its common stock at a per share price equal to the fair market value of one
share of its common stock on the date of issuance, which occurred on December 5,
2001, upon the terms and subject to the conditions in the Offer to Exchange (the
"Offer") dated April 30, 2001. On May 29, 2001, the Offer expired and the
Company accepted for exchange options to purchase 3,753,044 shares of common
stock, 2,663,544 of which were PFSweb Non-plan options and 1,089,500 were PFSweb
Plan options. On May 29, 2001, the Company also repriced and fully vested
105,000 options issued under the PFSweb Plans and 698,860 PFSweb Non-plan
options held by Daisytek officers, directors and employees and non-employees
which resulted in a non-cash stock compensation charge of approximately $0.7
million.

Pursuant to the terms of the Offer, on December 5, 2001, the Company granted
3,184,963 options to officers, directors and employees of PFSweb, 2,462,614 of
which were issued as PFSweb Plan options and 722,349 were issued as Non-plan
options. At issuance, pursuant to terms of the Offer, 658,000 of the PFSweb Plan
options and 293,000 of the Non-plan options were 75% vested on the date of
issuance with the remaining 25% vesting quarterly over one year and 1,804,614 of
the PFSweb Plan options and 429,349 of the Non-plan options vest quarterly over
one year.

PFSweb Plan Options

PFSweb has authorized 6,000,000 shares of common stock for issuance under
two 1999 stock option plans and 35,000 shares for issuance under a stock option
agreement (the "PFSweb Plans"). The PFSweb Plans provide for the granting of
incentive awards in the form of stock options to directors, executive
management, key employees, and outside consultants of PFSweb. The right to
purchase shares under the employee stock option agreements typically vest over a
three-year period. Stock options must be exercised within 10 years from the date
of grant. Stock options are generally issued at fair market value. The Company
recorded stock based compensation expense of $38,000, $7,000 and $28,000 in the
year ended March 31, 2001, the nine month period ended December 31, 2001, and
the year ended December 31, 2002 respectively, in connection with stock options
to purchase an aggregate of 124,200 shares issued under the PFSweb Plans to
non-employees.

As of December 31, 2002, there were 2,429,331 shares available for future
options under the PFSweb Plans.

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The following table summarizes stock option activity under the PFSweb Plans:

PFSweb Plan options granted prior to the Spin-off and not included in the
Offer, referred to above, vest one-third on the anniversary of the date of grant
and one-twelfth each quarter thereafter. PFSweb Plan options granted after the
Spin-off, excluding those issued pursuant to the Offer, vest one-twelfth each
quarter. As of December 31, 2001 and 2002, 1,092,419 and 2,797,077 options were
exercisable, respectively. The weighted average fair value of options granted
during the year ended March 31, 2001, the nine month period ended December 31,
2001 and the year ended December 31, 2002 were $1.67, $0.76 and $0.67,
respectively.

The following table summarizes information concerning currently outstanding
and exercisable PFSweb stock options issued under the PFSweb Plans to PFSweb
officers, directors and employees as of December 31, 2002:

PFSweb Non-plan Options

As of December 31, 2002, 1,184,807 PFSweb Non-plan options were outstanding,
of which 610,624 were held by PFSweb officers, directors and employees and
574,183 were held by Daisytek officers, directors and employees.

The following table summarizes stock option activity under the PFSweb
Non-plan:

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The weighted average fair values of options granted during the year ended
March 31, 2001 and nine months ended December 31, 2001 were $5.95 and $0.77,
respectively. As of December 31, 2001 and 2002, 918,106 and 1,184,807 of options
outstanding were exercisable, respectively.

The following table summarizes information concerning PFSweb Non-plan
options outstanding and exercisable as of December 31, 2002:

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants of PFSweb options to PFSweb and Daisytek officers, directors, and
employees under the PFSweb Non-Plans during the year ended March 31, 2001: no
dividends; expected volatility of 112%, risk-free interest rate of 6.1% and
expected life of 5 years.

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants of PFSweb options to PFSweb officers, directors, and employees and a
Daisytek director under the PFSweb Non-Plan during the nine months ended
December 31, 2001: no dividends; expected volatility between 117% and 124%,
risk-free interest rate ranging between 4.9% and 5.5% and expected life of 5
years.

No options were granted to PFSweb officers, directors or employees under the
Daisytek Plans during the nine-month period ended December 31, 2001 or the year
ended December 31, 2002. No options were granted to PFSweb officers, directors,
or employees under the PFSweb Non-Plan during the year ended December 31, 2002.

5. MASTER DISTRIBUTOR AGREEMENTS:

In August 2001, Supplies Distributors, SDSA, the Company and IBM entered
into Master Distributor Agreements whereby Supplies Distributors and SDSA act as
master distributors of various IBM products and PFSweb provides transaction
management and fulfillment services to Supplies Distributors. The Master
Distributor Agreements expire in March 2004 and can be extended for additional
one-year terms upon mutual agreement by all parties. Under the Master
Distributor Agreements, IBM sells product to Supplies Distributors and
reimburses Supplies Distributors for certain freight costs, direct costs
incurred in passing on any price decreases offered by IBM to Supplies
Distributors customers to cover price protection and certain special bids, the
cost of products provided to replace defective product returned by customers and
other certain expenses as defined. Supplies Distributors can return to IBM
product rendered obsolete by IBM engineering changes after customer demand ends.
IBM determines when a product is obsolete. IBM, Supplies Distributors and SDSA
also have verbal agreements under which IBM reimburses or collects from Supplies
Distributors or SDSA amounts calculated in certain inventory cost adjustments
and amounts applicable to certain favorable or unfavorable gross margin
performance versus targeted objectives.

Supplies Distributors, SDC and SDSA pass through to customers marketing
programs specified by IBM and administer, along with GMS, such programs
according to IBM guidelines.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

6. TRANSACTIONS WITH DAISYTEK

During the year ended March 31, 2001, the Company's costs and expenses
include allocations from Daisytek for certain general administrative services
including information technology, financial, treasury, legal, insurance and
other corporate functions as well as certain costs of operations including
facility charges. These allocations were estimated on the basis that Daisytek
and the Company consider to be a reasonable reflection of the utilization of
services provided or the benefit received by the Company. The methods used for
allocation of expenses from Daisytek were either (i) percentage of: revenue,
shipped orders, or number of employees, or (ii) management's best estimate.
However, these allocations of costs and expenses do not necessarily indicate the
costs and expenses that would have been incurred by the Company on a stand-alone
basis. Management estimates that incremental selling, general and administrative
expenses associated with PFSweb operating as a stand-alone publicly traded
company, including executive management, overhead and public company costs,
insurance and risk management costs, and other costs would have been
approximately $0.2 million for the year ended March 31, 2001.

In conjunction with the successful completion of the Offering, PFSweb
entered into agreements with Daisytek, including a tax sharing agreement, a
transaction management services agreement, transition services agreement and a
master separation agreement. In addition, on a going forward basis, Daisytek
will continue 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 technology services
that expired in November 2001.

Through September 2001, the 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.

Service fee revenues charged to Daisytek under (i) certain IBM master
distributor agreements, (ii) terms of the transaction management services
agreement with Daisytek, (iii) for certain subcontracted services, and (iv) for
certain transaction and information technology services, were $27.6 million and
$9.6 million for the year ended March 31, 2001, and the nine months ended
December 31, 2001, respectively.

As of December 31, 2001, the Company was no longer party to any agreement to
provide services for Daisytek, however, through its master distributor
relationships operated by Supplies Distributors, the Company continues to buy
and sell certain product from Daisytek.

7. DISPOSITION AND IMPAIRMENT 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 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, 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 revenues and pro forma loss from operations for the year ended
March 31, 2001, assuming the transaction had occurred in April 2000, would have
been $29.5 million and ($18.9) million, respectively. Pro forma revenues and pro
forma loss from operations for the nine months ended December 31, 2001, had the
transaction occurred in April 2000, would have been $22.0 million and ($10.4)
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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

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.

In September 2002, the Company changed the manner in which certain warehouse
and order management transactions are processed. These changes eliminated the
future service potential of selected software applications to the Company.
Accordingly, the Company recorded a $0.7 million asset impairment charge during
the year ended December 31, 2002. The Company also abandoned certain
distribution center assets and recorded a $0.2 million asset impairment charge
during the year ended December 31, 2002. The Company continues to operate with
excess physical infrastructure in its warehouse operations and information
technology systems. The Company reviewed the carrying amount of certain of these
excess long-lived assets for impairment and determined no further impairment
charges were required at December 31, 2002. The Company will reevaluate such
assets in calendar year 2003, in conjunction with its future operating plans, to
determine if any additional asset impairment charges should be recognized.

8. RESTRUCTURING

In September 2002, the Company implemented a restructuring plan that
resulted in the termination of approximately 60 employees, of which 20 were
hourly employees. The Company recorded $1.2 million for severance and other
termination costs, of which $0.8 million was paid during the year ended December
31, 2002. The remaining $0.4 million is included in accrued expenses and is
expected to be paid by March 2004. The Company did not finalize all
restructuring activities as of December 31, 2002, and expects to incur an
additional amount totaling $0.5 million to $1.0 million of restructuring charges
during calendar year 2003.

9. SUPPLIES DISTRIBUTORS AND OTHER RELATED PARTIES

SUPPLIES DISTRIBUTORS

In September 2001, the Company 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 directors of
the Company owned, individually, a 9.8% non-voting interest, and, collectively,
a 49% non-voting interest, in IFP. Effective October 1, 2002, the Company
purchased the remaining 51% interest in Holdings from IFP for $0.3 million. As
the acquired proportionate share of the fair value of Holdings' net assets was
greater than the purchase price, the Company recognized an extraordinary gain on
the purchase of $0.2 million in accordance with SFAS No. 141.

Pursuant to the terms of the Company's transaction management services
agreement with Supplies Distributors, the Company earned service fees, which,
prior to the consolidation effective October 1, 2002 are reported as service fee
revenue, affiliate in the accompanying consolidated financial statements, of
approximately $1.4 million, net of $0.3 million of pass-through charges, and
$4.7 million, net of $0.2 million of pass-through charges, for the nine months
ended December 31, 2001, and the year ended December 31, 2002, respectively. For
the nine months ended December 31, 2001, PFSweb fees earned from BSD (the
Daisytek subsidiary and predecessor to Supplies Distributors) were $3.7 million,
net of $0.3 million of pass-through charges. For the year ended March 31, 2001,
prior to becoming a related party, service fees earned by PFSweb from BSD,
associated with the same business activities, were $7.1 million, net of $0.7
million of pass-through charges. As of December 31, 2001, the Company had trade
accounts receivables of $0.9 million due from Supplies Distributors.

Pursuant to Holdings' operating agreement, prior to the October 1, 2002
acquisition date, Holdings allocated its earning and distributed its cash flow,
as defined, in the following order of priority: first, to IFP until it received
a one-time amount equal to its capital contribution of $0.25 million; second, to
IFP until it received an amount equal to a 35% cumulative annual return on its
capital contribution; third, to PFSweb until it received a one-time amount equal
to its capital contribution of $0.75 million; fourth, to PFSweb until it
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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

respective capital accounts. As a result of the Company's 100% ownership of
Holdings, future earnings and dividends will be allocated and paid 100% to the
Company. Notwithstanding the foregoing, no distribution could be made if, after
giving effect thereto, the net worth of Holdings would be less than $1.0
million. At December 31, 2002, Holdings' net worth was $2.9 million. Under the
terms of its amended credit agreements, Holdings is currently restricted from
paying annual cash dividends without the prior approval of its lenders (see Note
3). In May 2002, Holdings paid a $0.2 million dividend to IFP. In December 2002,
Holdings paid a $0.4 million dividend to the Company. The Company recorded $1.2
million of equity in the earnings of Holdings, prior to the October 1, 2002
acquisition, for the year ended December 31, 2002.

The following summarizes the purchase price allocation of the Company's
purchase of the remaining 51% interest in Holdings from IFP (in thousands):

Cash and cash equivalents (including
restricted cash of $1,745) ............ $ 2,578
Accounts receivable ........................ 28,110
Inventories ................................ 37,193
Prepaid expenses ........................... 684
Other assets, net .......................... 284
--------------
Total assets acquired ............... $ 68,849
--------------

Trade accounts payable ..................... $ 3,611
Accrued expenses ........................... 1,901
Debt (guaranteed by the Company) ........... 48,823
Other debt ................................. 3,070
Note payable to affiliate .................. 8,800
--------------
Total liabilities assumed ........... 66,205
--------------
Net assets .......................... 2,644
Less PFS' prior investment ................. 2,109
--------------
Net assets acquired ................. 535
Less cash purchase price ................... 332
--------------
Extraordinary gain on purchase ...... $ 203
==============

As a result of the Company's purchase of the remaining 51% interest in
Holdings from IFP, effective October 1, 2002, the Company began consolidating
100% of Holdings' financial position and results of operations into the
Company's consolidated financial statements. Following is (1) an unaudited, pro
forma, condensed consolidating income statement for the full calendar year 2002,
as if the acquisition had occurred as of January 1, 2002, and (2) an unaudited,
pro forma, condensed consolidated income statement for the nine months ended
December 31, 2001

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

(including Supplies Distributors' results of operations for the period from July
3, 2001, inception, to December 31, 2001), as if the acquisition had occurred as
of April 1, 2001, (in thousands):

The unaudited pro forma data are not necessarily indicative of the consolidated
results of operations for future periods or the results of operations that would
have been realized had the Company consolidated Holdings during the periods
presented.

In September 2001, Supplies Distributors issued the Note to PFSweb in
exchange for proceeds of $8.8 million. As of December 31, 2001 and 2002, the
Note had an outstanding balance of $11.7 million and $8.0 million, respectively.
Under certain new and amended terms of its senior debt facilities, the Note
cannot be increased or decreased without the prior approval of the Company's
lenders (see Notes 3 and 15). The Note accrues interest at a fluctuating rate
per annum equal to PFSweb's cost of funds as determined by PFSweb, approximately
10% as of December 31, 2001 and 2002. During the period from July 3, 2001
(inception) through December 31, 2001, and the year ended December 31, 2002,
excluding the period from October 1, 2002 through December 31, 2002, the Company
earned $0.3 million and $0.8 million, respectively, of interest associated with
the Note.

OTHER RELATED PARTIES

In May 1999, the Company entered into an agreement to provide services to a
certain company. During the year ended March 31, 2001, an executive officer of
PFSweb served on the Board of Directors of this company. PFSweb no longer
provides services to this company. Service fee revenue earned from this company
was approximately $2.0 million for the year ended March 31, 2001, and other
revenue was $1.7 million for the year ended March 31, 2001.

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In August 2001, Supplies Distributors entered into an Agreement for Sales
Forces Services ("ASFS") with IBM, whereby Supplies Distributors is to actively
generate demand for and promote brand loyalty for IBM products. The ASFS expires
on the earlier of December 31, 2003 or the termination of the Master Distributor
Agreements. The ASFS automatically renews for successive one-year periods unless
either party provides prior written notice. Pursuant to the ASFS, IBM pays to
Supplies Distributors a quarterly service fee as agreed to by both parties.
Supplies Distributors has subcontracted with GMS to provide the sales force
activities for an amount equal to the fees received by Supplies Distributors.
The principal officer of GMS owned 46% of IFP, prior to PFSweb's purchase of
IFP's interest in Holdings. As of December 31, 2002, the Company had no amounts
due from IBM under the terms of the ASFS included in accounts receivable and
approximately $1.7 million of unpaid service fees due to GMS.

10. INCOME TAXES

Prior to the Spin-off, the Company's operations were included in
consolidated income tax returns filed by Daisytek. The provision for income
taxes reflected in the consolidated statements of operations and the deferred
tax assets reflected in the consolidated balance sheets were prepared as
computed on a separate return basis. Effective with the completion of the
Spin-off, PFSweb ceased to be included in Daisytek's consolidated tax return.

A reconciliation of the difference between the expected income tax expense
at the U.S. federal statutory corporate tax rate of 34%, and the Company's
effective tax rate is as follows (in thousands):

The consolidated income (loss) before income taxes, by domestic and foreign
entities, is as follows (in thousands):

Current and deferred income tax expense (benefit) is summarized as follows
(in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The components of the deferred tax asset (liability) are as follows (in
thousands):

Management believes a sufficient history of earnings has not been
established by PFSweb, on a stand-alone basis, to support the more likely than
not realization of deferred tax assets in excess of existing taxable temporary
differences. A valuation allowance has been provided for the net deferred income
tax asset as of December 31, 2001 and 2002. At December 31, 2002, net operating
loss carryforwards relate to taxable losses of the Company's Europe subsidiary
totaling approximately $9.8 million and the Company's U.S. subsidiary, totaling
approximately $12.9 million that expire through 2018. Approximately $1.4 million
of the valuation allowance recorded against deferred tax assets relates to tax
benefits of stock option exercises and, if utilized, will be recorded against
additional paid-in-capital upon utilization rather that as an adjustment to
income tax expense from continuing operations.

11. COMMITMENTS AND CONTINGENCIES

The Company leases facilities, warehouse, office, transportation and other
equipment under operating leases expiring in various years through the year
ended December 31, 2009. In most cases, management expects that, in the normal
course of business, leases will be renewed or replaced by other leases. Minimum
future annual rental payments under non-cancelable operating leases having
original terms in excess of one year are as follows (in thousands):

Total rental expense under operating leases, net of sublease rental income,
approximated $7.7 million, $4.4 million and $5.8 million for the year ended
March 31, 2001, the nine months ended December 31, 2001, and the year ended
December 31, 2002, respectively.

For all periods prior to the Spin-off, Daisytek owned 80% of more of our
capital stock, the Company was included in Daisytek's consolidated group for
federal income tax purposes. If Daisytek or other members of the consolidated
group fail to make any federal income tax payments, the Company would be liable
for the shortfall since each member of a consolidated group is liable for the
group's entire tax obligation.

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

Market, the SmallCap Market currently has a longer minimum bid price 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 were provided an additional 180 day grace
period, or until February 10, 2003 to regain compliance. In March 2003, we were
provided an additional 90 day grace period, or until May 12, 2003, to regain
compliance. We can, however, provide no assurance as to our ability to maintain
compliance with the core listing standards and our continued listing in the
NASDAQ SmallCap Market. If we are unable to regain compliance with the minimum
bid price requirement, our common stock would then be subject to a delisting
determination from NASDAQ. Upon receipt of such determination, we plan to appeal
the determination to the NASDAQ Listing Qualifications Panel. The appeal would
postpone the delisting until the appeal is decided. The delisting of our common
stock could have a material adverse effect on the market price of, and the
efficiency of the trading market for, our common stock.

The Company is involved in certain litigation arising in the ordinary course
of business. Management believes that such litigation will be resolved without
material effect on the Company's financial position or results of operations.

12. SEGMENT AND GEOGRAPHIC INFORMATION

The Company is organized into two operating segments: PFS, is an
international provider of integrated business process outsourcing solutions and
operates as a service fee business; Supplies Distributors is a master
distributor of primarily IBM products, and recognizes revenues and costs when
product is shipped.

Geographic areas in which the Company operates include the United States,
Europe (primarily Belgium), and Canada.

The following is geographic information by area. Revenues are attributed
based on the Company's domicile.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

13. EMPLOYEE SAVINGS PLAN

The Company has a defined contribution employee savings plan under Section
401(k) of the Internal Revenue Code. Substantially all full-time and part-time
U.S. employees are eligible to participate in the plan. The Company, at is
discretion, may match employee contributions to the plan and also make an
additional matching contribution in the form of profit sharing in recognition of
the Company performance. During the year ended March 31, 2001, the Company
matched 10% of employee contributions totaling approximately $41,000, and
provided an additional discretionary match of approximately $38,000. During the
nine months ended December 31, 2001, and the year ended December 31, 2002, the
Company matched 10% of employee contributions totaling approximately $34,000
each period.

14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Unaudited quarterly results of operations for nine-month period ended
December 31, 2001 and the year ended December 31, 2002 were as follows (amounts
in thousands except per share data):

The seasonality of the Company's business is dependent upon the seasonality
of its clients' business and their sale of products. Management believes that
with the Company's current client mix, the Company's service fee revenue
business activity is expected to be at its lowest in the quarter ended March 31
and at its highest in the quarter ended June 30. The Company's product revenue
business activity is expected to be at its highest in the quarter ended December
31.

15. SUBSEQUENT EVENTS

On March 28, 2003, Priority Fulfillment Services, Inc. and Priority
Fulfillment Services of Canada, Inc., (both wholly-owned subsidiaries of PFSweb
and collectively the "Borrowers") entered into a two year Loan and Security
Agreement with Comerica Bank ("Comerica") to provide financing for up to $7.5
million of eligible accounts receivable in the U.S. and Canada. Borrowings under
the Comerica facility will accrue interest at prime rate plus 1%. The agreement
contains cross default provisions, various restrictions upon the Borrowers'
ability to, among other things, merge, consolidate, sell assets, incur
indebtedness, make loans and payments to related parties, make

75

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

investments and loans, pledge assets, make changes to capital stock ownership
structure, as well as financial covenants of a minimum tangible net worth, as
defined, and a minimum liquidity ratio, as defined. The agreement restricts the
amount of the Note to a maximum of $8.0 million. The agreement is secured by all
of the assets of the Borrowers, as well as a guarantee of PFSweb.

76

INDEPENDENT AUDITORS' REPORT

To the Members of
Business Supplies Distributors Holdings, LLC:

We have audited the accompanying consolidated balance sheets of Business
Supplies Distributors Holdings, LLC and subsidiaries as of December 31, 2002 and
2001, and the related consolidated statements of operations, members' capital
and comprehensive income, and cash flows for the year ended December 31, 2002
and the period from July 3, 2001 (inception) to December 31, 2001. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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 Business Supplies
Distributors Holdings, LLC and subsidiaries as of December 31, 2002 and 2001,
and the results of their operations and their cash flows for the year ended
December 31, 2002 and the period from July 3, 2001 (inception) to December 31,
2001, in conformity with accounting principles generally accepted in the United
States of America.

KPMG LLP

Dallas, Texas
February 14, 2003, except for Note 6 as to which the date is March 28, 2003

77

BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

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

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BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)

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

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BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF MEMBERS' CAPITAL AND COMPREHENSIVE INCOME
(IN THOUSANDS)

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

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BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

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

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BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. OVERVIEW AND BASIS OF PRESENTATION:

PFSweb, Inc. ("PFSweb"), Daisytek International, Inc. ("Daisytek"),
Business Supplies Distributors, Inc., (a Daisytek subsidiary -- "BSD"), and
International Business Machines Corporation ("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 and
other products. Daisytek provided financing and credit support to the BSD
Companies and PFSweb provided transaction management and fulfillment services to
the BSD Companies. On June 8, 2001, Daisytek notified PFSweb and IBM that it did
not intend to renew these agreements upon their scheduled expiration dates.

On July 3, 2001, PFSweb and Inventory Financing Partners, LLC ("IFP")
formed Business Supplies Distributors Holdings, LLC ("Holdings"), and Holdings
formed a wholly-owned subsidiary, Supplies Distributors, Inc. ("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,
PFSweb and IBM 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 and other products and, pursuant to a
transaction management services agreement between PFSweb and Supplies
Distributors, PFSweb provides transaction management and fulfillment services to
Supplies Distributors. On September 26, 2001, Supplies Distributors purchased
all of the stock of the BSD Companies for a purchase price of $923,000 and
incurred $140,000 of acquisition costs. 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.

PFSweb 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 (see Note 5). Effective October 1, 2002, PFSweb
purchased the remaining 51% interest in Holdings from IFP for $0.3 million. The
consolidated financial statements presented herein do not reflect any purchase
price adjustments related to the acquisition of the Holdings by PFSweb.

All references to the "Company" include Holdings and Supplies Distributors
and its subsidiaries.

The Company, through its subsidiaries, is primarily a master distributor of
various IBM products. Supplies Distributors and SDSA have obtained certain
financing (see Notes 6 and 7) that allows them to fund the working capital
requirements for the sale of IBM products. Pursuant to the transaction
management services agreement between PFSweb and Supplies Distributors, PFSweb
provides to Supplies Distributors, SDC and SDSA such services as managed web
hosting and maintenance, procurement support, web-enabled customer contact
center services, customer relationship management, financial services including
billing and collection services, information management, selected financial
services and international distribution services. Additionally, IBM and Holdings
have outsourced the product demand generation to Global Marketing Services, Inc.
("GMS"). The Company, via its arrangements with GMS and PFSweb, sells its
products in the United States, Canada and Europe.

All of the agreements between PFSweb and the Company were made in the
context of a related party relationship and were negotiated in the overall
context of PFSweb's and the Company's prior arrangement with IBM. Although
management generally believes that the terms of these agreements are consistent
with fair market values, there can be no assurance that the prices charged to or
by each company under these arrangements are not higher or lower than the prices
that may be charged by, or to, unaffiliated third parties for similar services.

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 members' capital.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

2. SIGNIFICANT ACCOUNTING POLICIES:

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

USE OF ESTIMATES

The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the U.S. requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes, primarily related to the
collectibility of accounts receivable and the recoverability of inventory.
Actual results could differ from those estimates.

REVENUE AND COST RECOGNITION

The Company recognizes revenue upon shipment of product to customers. The
Company permits its customers to return defective products (that the Company
then returns to the manufacturer) and incorrect shipments for credit against
other purchases and provides for estimated returns and allowances. The Company
offers terms to its customers that it believes are standard for its industry.

The Company records trade accounts receivables, pursuant to 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.

Freight costs billed to customers are reflected as components of net
revenues. Freight costs incurred by the Company are recorded as a component of
cost of goods sold. The Company records its costs as they are incurred by the
Company or its service providers.

Under the Master Distributor Agreements (see Note 4), the Company bills IBM
for reimbursements of certain expenses, including: pass through customer
marketing programs; certain freight costs; direct costs incurred in passing on
any price decreases offered by IBM to Supplies Distributors customers to cover
price protection and certain special bids; the cost of products provided to
replace defective product returned by customers; and certain other expenses as
defined. The Company records a receivable for these reimbursable amounts as they
are incurred. The Company reflects pass through customer marketing programs as a
reduction of both product revenue and cost of product revenue.

CONCENTRATION OF BUSINESS AND CREDIT RISK

In conjunction with the Company's financing, PFSweb provided certain
collateralized guarantees on behalf of the Company. Supplies Distributors'
ability to obtain financing on similar terms would be significantly impacted
without these guarantees. Additionally, since Holdings has limited personnel and
physical resources, its ability to conduct business could be materially impacted
by contract terminations by either PFSweb or GMS.

The Company's revenue was primarily generated by sales of product purchased
under master distributor agreements with one supplier. Sales to two customers
accounted for approximately 14% and 11% of the Company's total revenues for the
period from July 3, 2001 (inception) through December 31, 2001. No other client
accounted for 10% or more of the Company's revenue for the period ended July 3,
2001 (inception) through December 31, 2001. As of December 31, 2001, two
customers accounted for over 37% of trade accounts receivable on an aggregate
basis. Sales to two customers accounted for approximately 12% and 10% of the
Company's total revenues for the year ended December 31, 2002. No other client
accounted for 10% or more of the Company's revenue for the year ended December
31, 2002. As of December 31, 2002, three customers accounted for over 42% of
trade accounts receivable on an aggregate basis.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

CASH AND CASH EQUIVALENTS

Cash equivalents are defined as short-term highly liquid investments with
original maturities of three months or less.

RESTRICTED CASH

Restricted cash includes the following items (in thousands):

In conjunction with certain of its financing agreements, Supplies
Distributors has entered into agreements with its banks and the lenders whereby
a security interest was granted to the lender for all customer remittances
received in specified bank accounts (see Note 6). At December 31, 2001 and 2002,
these bank accounts held $1.0 and $0.2 million, respectively, which was
restricted for payment to the lenders against the outstanding long-term debt and
is reflected as a component of other assets.

To facilitate Value Added Tax ("VAT") processing on its inventory
transactions, BSD Europe provided a bank guarantee to the Belgium government. To
secure the guarantee, the bank required BSD Europe to maintain cash balances as
collateral for the guarantee. The Company's maximum exposure under this
guarantee was $0.8 million at December 31, 2002. The Company expects this
collateral to be released in 2003.

INVENTORIES

Inventories (merchandise, held for resale, all of which are finished goods)
are stated at the lower of weighted average cost or market. The Company assumes
responsibility for slow-moving inventory under the Master Distributor Agreements
(see Note 4). The Company reviews inventory for impairment on a periodic basis,
but at a minimum, annually. Recoverability of the inventory on hand is measured
by comparison of the carrying value of the inventory to the fair value of the
inventory. As of December 31, 2001 and 2002, the Company's allowance for
slow-moving inventory was approximately $0.01 million and $0.1 million,
respectively. The Company is able to return product rendered obsolete by IBM
engineering changes after customer demand for the product ceases. In the event
the Company, PFSweb and IBM do not renew the Master Distributor Agreements, the
parties shall mutually agree on a plan of disposition of Supplies Distributors'
then existing inventory.

INVENTORIES IN-TRANSIT

Inventories in-transit represents merchandise that has not been received by
the Company but that has been shipped and invoiced by the Company's vendors. The
corresponding payable for inventories in-transit is included in debt in the
accompanying consolidated financial statements.

OTHER RECEIVABLES

Other receivables include the following items (in thousands):

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BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

VAT represents amounts due from European governments for refundable VAT
payments made in the ordinary course of business. The amounts due from IBM
represent billings under the Master Distributor Agreements (see Note 4).

OTHER ASSETS

Other assets includes restricted cash (see "Restricted Cash") and an
identifiable intangible asset of $0.3 million and $0.1 million as of December
31, 2001 and 2002, respectively. The identifiable intangible asset represents
the value attributable to the Master Distributor Agreements and is being
amortized on a straight-line basis over the length of the Master Distributor
Agreements. The Company assesses the recoverability of this intangible asset by
determining whether the amortization of the remaining balance over its remaining
life can be recovered through undiscounted future operating cash flows of the
associated contracts.

FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS

For the Company's Canadian and European operations, the local currency is
the functional currency. 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.

Historically, the Company deemed intercompany transactions with its foreign
subsidiaries as long-term investments and part of its net investment.
Accordingly, the Company recorded currency gains or losses on these intercompany
transactions in other comprehensive income (loss). Effective September 30, 2002,
due to changes in the operations of the subsidiaries whereby the Company no
longer believes certain of these transactions to be long-term in nature, the
Company will include certain future intercompany currency gains and losses in
the determination of net income. Intercompany transaction gains and losses
included in the determination of net income for the year ended December 31, 2002
were $0.1 million. The Company will continue to report gains or losses on
intercompany foreign currency transactions that are of a long-term investment
nature as a separate component of members' capital.

INCOME TAXES

Although Holdings is an LLC, it historically elected to be taxed, for
federal income tax purposes, as a C corporation. Accordingly, deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. 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. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. Beginning October 1, 2002, the Company's domestic operations
will be included in the U.S. federal income tax return filed by PFSweb.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying value of financial instruments, which include cash and cash
equivalents, accounts receivable, accounts payable and debt, approximate their
fair values based on short terms to maturity or current market prices and rates.

COMPREHENSIVE INCOME

Comprehensive income represents the change in members' capital available for
distribution to the partners pursuant to the Operating Agreements (see Note 5).
Comprehensive income consists of net income and foreign currency translation
adjustments.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

RECENTLY ISSUED ACCOUNTING PRINCIPLES

In 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No.'s 141 and 142, "Business
Combinations" and "Goodwill and Other Intangibles." SFAS 141 requires all
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. SFAS 142 requires that ratable amortization of goodwill be
replaced with annual fair-value based tests of the goodwill's impairment, and
that intangible assets other than goodwill be amortized over their useful lives.
Additionally, under the provision of the new accounting standard, an acquired
intangible asset should be separately recognized if the benefit of the
intangible asset is obtained through contractual other legal rights, or if the
intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so. SFAS 141 is effective for all
business combinations initiated after June 30, 2001 and for all business
combinations accounted for by the purchase method for which the date of
acquisition is after June 30, 2001. The adoption of SFAS 141 did not have a
material impact on the Company's financial statements and related disclosures.
The provisions of SFAS 142 was effective for fiscal years beginning after
December 15, 2001. The Company's adoption of SFAS 142 on January 1, 2002 did not
have a material impact on its consolidated financial statements and related
disclosures.

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 certain reimbursable expenses, such as
customer marketing programs, are deducted from cost of goods sold under the
EITF. Prior period amounts reclassified as a result of the adoption of the EITF
were not material to the Company's consolidated financial statements.

In January 2003, the FASB issued FIN No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of
Others." FIN No. 45 requires a company to recognize a liability for the
obligations it has undertaken in issuing a guarantee. This liability would be
recorded at the inception of a guarantee and would be measured at fair value.
The measurement provisions of this statement apply prospectively to guarantees
issued or modified after December 31, 2002. The disclosure provisions of the
statement apply to financial statements for periods ending after December 15,
2002. The Company adopted the disclosure provisions of the statement as of
December 31, 2002 and will adopt the measurement provisions of this statement in
the first quarter of 2003. The Company does not expect the adoption to have a
material effect on the financial statements when adopted.

In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable
Interest Entities." FIN 46 requires a company to consolidate a variable interest
entity if it is designated as the primary beneficiary of that entity even if the
company does not have a majority of voting interests. A variable interest entity
is generally defined as an entity where its equity is unable to finance its
activities or where the owners of the entity lack the risk and rewards of
ownership. The provisions of this statement apply at inception for any entity
created after January 31, 2003. For an entity created before February 1, 2003,
the provisions of this interpretation must be applied at the beginning of the
first interim or annual period beginning after June 15, 2003. The Company will
adopt the provisions of FIN No. 46 in the first quarter of 2003 and does not
expect the adoption of the statement to have a material effect on the financial
statements.

The FASB Emerging Issues Task Force issued EITF 00-21, "Accounting for
Revenue Arrangements with Multiple Deliverables," to address certain revenue
recognition issues. The guidance provided from EITF 00-21 addresses both the
timing and classification in accounting for different earnings processes. The
Company does not expect that the adoption of EITF 00-21 will have a material
impact on our consolidated financial condition or operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

3. ACQUISITION OF THE BSD COMPANIES:

The following table summarizes the fair value of the assets acquired and
liabilities assumed as of September 26, 2001, the acquisition date of the BSD
Companies (unaudited, in thousands):

Cash .................................................... $ 8,529
Accounts receivable, net ................................ 3,271
Receivable from Daisytek ................................ 5,715
Receivable from Supplies Distributors ................... 5,877
Other receivables ....................................... 6,022
Inventories, net ........................................ 13,547
Other assets -- identifiable intangible (see Note 2) .... 243
------------
Total assets acquired ................................... 43,204
------------
Trade accounts payable .................................. 40,557
Accrued expenses ........................................ 1,527
Other current liabilities ............................... 57
------------
Total liabilities assumed ............................... 42,141
------------
Net assets acquired ..................................... $ 1,063
============

The receivable from Daisytek was repaid concurrently with the acquisition.
The results of the BSD Companies' operations have been included in the
consolidated financial statements since the acquisition date. The purchase price
adjustment was finalized during the year ended December 31, 2002 for additional
acquisition expenses and certain adjustments to other receivables and payables
resulting in a decrease to the identifiable intangible of $0.1 million. For the
period from inception through December 31, 2001, and the year ended December 31,
2002, the Company recorded approximately $0.1 million each period of
amortization expense associated with the identifiable intangible.

Pro forma revenues and pro forma income from operations for the period from
inception through December 31, 2001, assuming the transaction had occurred on
July 3, 2001, would have been $90.6 million and $2.1 million, respectively.
Because of the negative impact to revenue as a result of the transition of the
master distributor agreements from Daisytek to the Company, the pro forma
adjustments to the operating results of the business may not be indicative of
future results.

4. MASTER DISTRIBUTOR AGREEMENTS:

In August 2001, Supplies Distributors, SDSA, PFSweb and IBM entered into
Master Distributor Agreements whereby Supplies Distributors and SDSA act as
master distributors of various IBM products and PFSweb provides transaction
management and fulfillment services to Supplies Distributors. The Master
Distributor Agreements expire in March 2004 and can be extended for additional
one-year terms upon mutual agreement by all parties. Under the Master
Distributor Agreements, IBM reimburses the Company for certain freight costs,
direct costs incurred in passing on any price decreases offered by IBM to the
Company's customers to cover price protection and certain special bids, the cost
of products provided to replace defective product returned by customers and
other certain expenses as defined. The Company can return to IBM product
rendered obsolete by IBM engineering changes after customer demand ends. IBM
determines when a product is obsolete. IBM, Supplies Distributors and SDSA also
have verbal agreements under which IBM reimburses or collects from Supplies
Distributors or SDSA amounts calculated in certain inventory cost adjustments
and amounts applicable to certain favorable or unfavorable gross margin
performance versus targeted objectives.

Supplies Distributors, SDC and SDSA pass through to customers marketing
programs specified by IBM and administer, along with GMS, such programs
according to IBM guidelines.

5. MEMBERS' CAPITAL:

PFSweb 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 directors of PFSweb owned,
individually, a 9.8% non-voting interest, and, collectively, a 49% non-voting
interest, in IFP. The contributions do not accrue interest. No member, solely by
reason of being a member, has any obligation to make

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

any additional capital contribution or loan to Holdings or guaranty any
indebtedness or obligation of Holdings. Effective October 1, 2002, PFSweb
purchased the remaining 51% interest in Holdings from IFP for $0.3 million.

Prior to October 1, 2002, Holdings' comprehensive income was allocated and
distributed to the members pursuant to the terms of its operating agreement,
which expires on December 31, 2050. Pursuant to the operating agreement,
Holdings allocated its earning and distributed its cash flow, as defined, in the
following order of priority:

o to IFP until it had received a one-time amount equal to its capital
contribution of $0.25 million;

o to IFP until it had received an amount equal to a 35% cumulative annual
return on its capital contribution;

o to PFSweb until it had received a one-time amount equal to its capital
contribution of $0.75 million;

o to PFSweb until it had received an amount equal to a 35% cumulative annual
return on its capital contribution; and

o to PFSweb and IFP, pro rata, in accordance with their respective capital
accounts.

In May 2002, the Company paid a $0.2 million dividend to IFP. In December
2002, the Company paid a $0.4 million dividend to PFSweb. Pursuant to the terms
of its amended credit agreements, Holdings is currently restricted from paying
annual cash dividends without the prior approval of its lenders (see Note 6).
Notwithstanding the foregoing, no distribution could be made if, after giving
effect thereto, the net worth of Holdings would be less than $1.0 million. As a
result of PFSweb's ownership of 100% of Holdings following PFSweb's purchase of
the remaining 51% ownership interest from IFP, future earnings and dividends
will be allocated 100% to PFSweb.

Following the earnings allocation priority, the members' capital accounts
were as follows (in thousands):

6. DEBT:

Debt consists of the following (in thousands):

INVENTORY AND WORKING CAPITAL FINANCING AGREEMENT, UNITED STATES

On September 27, 2001, Supplies Distributors entered into a short-term
credit facility with IBM Credit Corporation ("IBM Credit"), to finance its
distribution of IBM products in the United States. At inception, the facility
provided for a $40 million credit line and expired on January 25, 2002. Prior to
expiration, the credit line was increased to $45 million and extended through
March 25, 2002. Availability under the credit facility was subject to certain
borrowing base limitations, including eligible receivables and inventory, as
defined. Supplies Distributors entered into a Blocked Account Agreement with its
bank and IBM Credit whereby a security interest was granted to IBM Credit for
all customer remittances received in specified bank accounts. At December 31,
2001, these bank accounts held $1.0 million, which was restricted for payment to
IBM Credit. Borrowings under the credit facility accrued interest, after a
defined free financing period, at prime rate plus 1%, which was 6.0% as of
December 31, 2001. The facility accrued a quarterly commitment fee of 0.375% on
the unused portion of the commitment, and a monthly service fee.

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On March 29, 2002, Supplies Distributors entered into an amended credit
facility with IBM Credit that was subsequently amended. The asset based credit
facility provides financing for purchasing IBM inventory and certain other
receivables up to $30.5 million through its expiration on March 29, 2003. The
credit facility contains cross default provisions, various restrictions upon the
ability of Holdings and Supplies Distributors to, among others, 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, PFSweb is
required to maintain a minimum subordinated receivable balance from Supplies
Distributors of $8.0 million and a minimum shareholders' equity, as modified, of
$20.0 million as of December 31, 2002 and $18.0 million thereafter. Borrowings
under the credit facility accrue interest, after a defined free financing
period, at prime rate plus 1%, which was 5.25% as of December 31, 2002. The
facility accrues a quarterly commitment fee of 0.375% on the unused portion of
the commitment and a monthly service fee.

On March 28, 2003, Supplies Distributors entered into an amended credit
facility with IBM Credit LLC, formerly IBM Credit Corporation. The amendment
extends the termination date through March 29, 2004, reduces the maximum
financing amount to $27.5 million, restricts Holdings' ability to declare and
pay a dividend without the prior approval of IBM Credit and modifies certain
financial covenants. The Company has classified the outstanding amount under
this facility as current at December 31, 2002.

INVENTORY AND WORKING CAPITAL FINANCING AGREEMENT, EUROPE

On September 27, 2001, SDSA and BSD Europe entered into a short-term credit
facility with IBM Belgium Financial Services S.A. ("IBM Belgium") to finance its
distribution of IBM products in Europe. At inception, the facility provided for
a 20 million euro credit line (approximately $21.0 million) and expired on
January 25, 2002. Prior to expiration, the credit line was increased to 27
million euros (approximately $28.3 million) and extended through March 25, 2002.
Availability under the credit facility was subject to certain borrowing base
limitations, including eligible receivables and inventory, as defined. SDSA
entered into a Blocked Account Agreement with its bank and IBM Belgium whereby a
security interest was granted to IBM Belgium for all customer remittances
received in specified bank accounts. Borrowings under the credit facility
accrued interest, after a defined free financing period, at euribor plus 4%,
which was 7.43% as of December 31, 2001. SDSA paid a monthly service fee on the
commitment.

On March 29, 2002, SDSA and BSD Europe entered into an amended credit
facility with IBM Belgium that was subsequently amended. The asset based credit
facility with IBM Belgium provides up to 19 million Euros (approximately $19.9
million) in financing for purchasing IBM inventory and certain other
receivables. 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. The credit
facility contains cross default provisions, various restrictions upon the
ability of the Company to, among others, 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 SDSA and BSD Europe, as well as collateralized guaranties of
Holdings, Supplies Distributors and PFSweb. Additionally, PFSweb is required to
maintain a minimum subordinated receivable balance from the Company of $8.0
million and a minimum shareholders' equity, as modified, of $20.0 million as of
December 31, 2002 and $18.0 million thereafter. Borrowings under the credit
facility accrue interest, after a defined free financing period, at euribor plus
4%, which was 6.93% as of December 31, 2002. SDSA paid a monthly service fee on
the commitment.

On March 28, 2003, SDSA entered into an amended credit facility with IBM
Belgium. The amendment extends the termination date through March 29, 2004,
reduces the maximum financing amount to 12.5 million Euros (approximately $13.1
million), restricts SDSA's ability to declare and pay a dividend without the
prior approval of IBM Belgium and modifies certain financial covenants. The
Company has classified the outstanding amount under this facility as current at
December 31, 2002.

89

BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

LOAN AND SECURITY AGREEMENT

On March 29, 2002, 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 (see Note 4). Borrowings under the Congress
facility accrue interest at prime rate plus 0.25% (4.5% at December 31, 2002) or
Eurodollar rate plus 3.0% or on an adjusted basis as defined. This agreement
contains cross default provisions, various restrictions upon the ability of the
Company 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, PFSweb is required to maintain a subordinated loan to the Company
of no less than $6.5 million and restricted cash of less than $5.0 million, and
is restricted with regard to transactions with related parties, indebtedness and
changes to capital stock ownership structure. Supplies Distributors and SDC
entered into Blocked Account Agreements with their banks and Congress whereby a
security interest was granted to Congress for all customer remittances received
in specified bank accounts. At December 31, 2002, these bank accounts held $0.2
million, which was restricted for payment to Congress. The Company has
classified the outstanding amount under this facility as current at December 31,
2002.

FACTORING AGREEMENT

On March 29, 2002, SDSA entered into a two year factoring agreement with
Fortis Commercial Finance N.V. ("Fortis") to provide factoring for up to 7.5
million euros (approximately $7.9 million) (originally 10 million euros, amended
in October 2002) of eligible accounts receivables. Borrowings under this
agreement can be either cash advances or straight loans, as defined. Cash
advances accrue interest at 8.5%, or on an adjusted basis as defined, and
straight loans accrue interest at Euribor plus 1.4% for the agreement's first
year (4.45% as of December 31, 2002) and Euribor plus 1.3% for the agreement's
second year. This agreement contains various restrictions upon the ability of
SDSA to, among other things, merge, consolidate, incur indebtedness, as well as
financial covenants, such as minimum net worth. This agreement is secured by a
guarantee of Supplies Distributors, up to a maximum of 200,000 euros. The
Company has classified the outstanding amount under this facility as current at
December 31, 2002.

DEBT COVENANTS AND GUARANTEES

PFSweb has provided collateralized guarantees to secure the repayment of
certain of the Company's credit facilities. As of December 31, 2002 the
outstanding balance of the credit facilities guaranteed by PFSweb was
approximately $56.1 million. These guarantees expire concurrently with the
expiration of the underlying credit agreements. To the extent the Company and
PFSweb fail to comply with its covenants, including its monthly financial
covenant requirements, and the lenders accelerate the repayment of the credit
facility obligations, the Company would be required to repay all amounts
outstanding thereunder which would have a material adverse impact on the
Company's financial condition. In such event, PFSweb would be obligated to
perform under those guarantees and repay, to the extent Supplies Distributors
was unable to, Supplies Distributors' credit facility obligations. Any
requirement to perform under PFSweb's guarantees would have a material adverse
impact on PFSweb's financial condition and results of operations and no
assurance can be given that PFSweb will have the financial ability to repay all
of such guaranteed obligations. At December 31, 2002, the Company and PFSweb
were in compliance with all of the Company's debt covenants. Furthermore, PFSweb
is obligated to repay any over-advance made to Supplies Distributors by its
lenders, in the event Supplies Distributors is unable to do so. An over-advance
would arise in the event borrowings exceeded the maximum amount available under
the eligible borrowing base, as defined.

PFSweb 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.

90

BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

7. TRANSACTIONS WITH RELATED PARTIES:

In August 2001, the Company entered into an Agreement for Sales Forces
Services ("ASFS") with IBM, whereby the Company is to actively generate demand
for and promote brand loyalty for IBM products. The ASFS expires on the earlier
of December 31, 2003 or the termination of the Master Distributor Agreements.
The ASFS automatically renews for successive one-year periods unless either
party provides prior written notice. Pursuant to the ASFS, IBM pays to Supplies
Distributors a quarterly service fee as agreed to by both parties. Supplies
Distributors has subcontracted with GMS to provide the sales force activities
for an amount equal to the fees received by the Company. The principal officer
of GMS owned 46% of IFP, prior to its sale to PFSweb (see Note 5). As of
December 31, 2002 and 2001, the Company had zero and $1.1 million, respectively,
due from IBM under the terms of the ASFS included in accounts receivable and
approximately $1.7 million and $1.5 million, respectively, of unpaid service
fees due to GMS.

In August 2001, PFSweb and the Company entered into Transaction Management
Services Agreements ("TMSA") whereby PFSweb provides transaction management and
fulfillment services to the Company. Under terms of the TMSA, PFSweb is required
to conduct its services within certain performance levels, as defined, and is
liable to indemnify Supplies Distributors for inventory losses, as defined. The
TMSA has terms corresponding with the Master Distributor Agreements among
Supplies Distributors, SDSA, PFSweb, and IBM, whereby Supplies Distributors and
SDSA act as master distributors of various IBM products. The Master Distributor
Agreements expire in March 2004 and can be extended for additional one year
terms upon mutual agreement by all parties (see Note 4).

Under the terms of the TMSA, PFSweb charges the Company for its services
based on a percentage of Supplies Distributors' shipped revenue. Percentages
vary by geographic location and by the amount of shipped revenue. Dependent on
changes in the type and levels of transactions, percentages charged by PFSweb
can be amended by mutual consent of PFSweb and Supplies Distributors. Pursuant
to the TMSA, the Company incurred service expenses, reported as selling, general
and administrative expenses in the accompanying consolidated financial
statement, of approximately $6.4 million and $1.4 million to PFSweb for the year
ended December 31, 2002 and the period from July 3, 2001 (inception) to December
31, 2001, respectively. As of December 31, 2002 and 2001, the Company owes
PFSweb $0.6 million and $0.9 million, respectively.

In September 2001, the Company issued a Subordinated Demand Note (the
"Note") to PFSweb in exchange for proceeds of $8.8 million. As of December 31,
2002 and 2001, the Note had an outstanding balance of $8.0 million and $11.7
million, respectively, which is classified as note payable to affiliate. The
Note cannot be increased or decreased without the prior approval of the
Company's and PFSweb's lenders (see Note 6). The Note accrues interest at a
fluctuating rate per annum equal to PFSweb's cost of funds as determined by
PFSweb, approximately 10% as of December 31, 2002 and 2001. During the year
ended December 31, 2002 and the period from July 3, 2001 (inception) through
December 31, 2001, the Company recorded $1.0 million and $0.3 million,
respectively, of interest associated with the amount due to PFSweb.

PFSweb issued 12,500 and 21,000 stock options to the Company's President in
December 2001 and January 2002, respectively. These options were immediately
vested and have an exercise price of $0.91 and $0.84, respectively.

8. INCOME TAXES:

The Company has elected to be taxed as a C corporation for U.S. tax
reporting. Beginning October 1, 2002, the Company's domestic operations will be
included in the domestic income tax return filed by PFSweb. A reconciliation of
the difference between the expected income tax expense at the U.S. federal
statutory corporate tax rate of 34%, and the Company's effective tax rate, is as
follows (in thousands):

91

BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The consolidated income before income taxes, by domestic and foreign
entities, is as follows (in thousands):

Current and deferred income tax expense is summarized as follows (in
thousands):

The components of the deferred tax asset (liability) are as follows (in
thousands):

9. SEGMENT AND GEOGRAPHIC INFORMATION:

The Company is organized as a single operating segment, which is
international distribution of computer supplies. Geographic areas in which the
Company operates include the United States, Europe (primarily Belgium), and
Canada.

The following is geographic information by area. Revenues are attributed
based on the Company's domicile (in thousands):

92

BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The eliminations amount for the period July 3, 2001 (inception) through
December 31, 2001 above primarily relates to intercompany sales in Europe from
BSD Europe to SDSA. The eliminations for the year ended December 31, 2002
primarily relate to intercompany sales from Supplies Distributors to SDC, from
SDSA to Supplies Distributors and in Europe from BSD Europe to SDSA.

The Company has $0.3 million and $0.1 million as of December 31, 2001 and
2002, respectively, of long-lived assets in the United States associated with
the acquisition of the BSD companies.

10. COMMITMENTS AND CONTINGENCIES

The Company is involved in certain litigation arising in the ordinary course
of business. Management believes that such litigation will be resolved without
material effect on the Company's financial position or results of operations.

93

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

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Reference is made to the information to be set forth in the section entitled
"Election of Directors" in the definitive proxy statement involving the election
of directors in connection with the Annual Meeting of Stockholders of the
Company to be held in June 2003 (the "Proxy Statement"), which section is
incorporated herein by reference. The Proxy Statement (or an amendment to this
Form 10-K containing the relevant information) will be filed with the Securities
and Exchange Commission not later than 120 days after the last day of the
Company's fiscal year ended December 31, 2002.

ITEM 11. EXECUTIVE COMPENSATION

Information required by Part III, Item 11, will be included in the section
entitled "Election of Directors" of the Company's Proxy Statement relating to
the Company's annual meeting of stockholders to be held in June 2003, and is
incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required by Part III, Item 12, will be included in the Sections
entitled "Election of Directors" and "Security Ownership of Certain Beneficial
Owners and Management" of the Company's Proxy Statement relating to the
Company's annual meeting of stockholders to be held in June 2003, and is
incorporated herein by reference.

The following table summarizes information with respect to equity
compensation plans under which equity securities of the registrant are
authorized for issuance as of December 31, 2002:

(1) See Note 4 to the Consolidated Financial Statements for more detailed
information regarding the registrant's equity compensation plans.

ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS

Information regarding certain of the Company's relationships and related
transactions will be included in the section entitled "Certain Relationship and
Related Transactions" of the Company's Proxy Statement relating to the Company's
annual meeting of stockholders to be held in June 2003, and is incorporated
herein by reference.

ITEM 14. CONTROLS AND PROCEDURES

We maintain a system of controls and procedures designed to provide
reasonable assurance as to the reliability of the financial statements and other
disclosures included in this report, as well as to safeguard assets from
unauthorized use or disposition. We evaluated the effectiveness of the design
and operation of our disclosure controls and procedures under the supervision
and with the participation of management, including our Chief Executive Officer
and Principal Financial and Accounting Officer, within 90 days prior to the
filing date of this report. Based upon the evaluation, our Chief Executive
Officer and Principal Financial and Accounting Officer

94

concluded that our disclosure controls and procedures are effective in timely
alerting them to material information required to be included in our periodic
Securities and Exchange Commission filings. No significant changes were made to
our internal controls or other factors that could significantly affect these
controls subsequent to the date of their evaluation.

PART IV

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

(a) The following documents are filed as part of this report:

1. Financial Statements

PFSweb, Inc. and Subsidiaries

Independent Auditors' Report
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Shareholders' Equity and Comprehensive Loss
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements

Financial Statement Schedules

Schedule II -- Valuation and Qualifying Accounts

All other schedules are omitted because the required information is not
present in amounts sufficient to require submission of the schedule or
because the information required is included in the financial statements
or notes thereto.

2. Exhibits

95

10.12 (5) Amended and Restated Guaranty to IBM Credit Corporation by
PFSweb, Inc.

10.13 (5) Amended and Restated Notes Payable Subordination Agreement
by and between Priority Fulfillment Services, Inc., Supplies
Distributors, Inc. and IBM Credit Corporation

10.14 (5) Amended and Restated Platinum Plan Agreement (with Invoice
Discounting) by and among Supplies Distributors, S.A.,
Business Supplies Distributors Europe B.V., PFSweb B.V., and
IBM Belgium Financial Services S.A.

10.15 (5) Amended and Restated Collateralized Guaranty between
Priority Fulfillment Services, Inc. and IBM Belgium
Financial Services S.A.

10.16 (5) Amended and Restated Guaranty to IBM Belgium Financial
Services S.A. by PFSweb, Inc.

10.17 (5) Subordinated Demand Note by and between Supplies
Distributors, Inc. and Priority Fulfillment Services, Inc.

10.18 (5) Notes Payable Subordination Agreement between Congress
Financial Corporation (Southwest) and Priority Fulfillment
Services, Inc.

10.19 (5) Guarantee in favor of Congress Financial Corporation
(Southwest) by Business Supplies Distributors Holdings, LLC,
Priority Fulfillment Services, Inc. and PFSweb, Inc.

10.20 (5) General Security Agreement by Priority Fulfillment Services,
Inc. in favor of Congress Financial Corporation (Southwest).

10.21 (5) Inducement Letter by Priority Fulfillment Services, Inc. and
PFSweb, Inc. in favor of Congress Financial Corporation
(Southwest).

10.22 (6) Form of Executive Severance Agreement between the Company
and each of its executive officers

10.23 (7) Option Purchase Agreement between the Company and C. Cliff
Defee

10.24 (7) Form of Severance Agreement between the Company and Lindsley
Medlin, Martin Anderson and Valarie Remmers

10.25 (8) Assignment of Membership Interest Agreement between the
Company and Inventory Financing Partners, LLC

10.26 (9) Amendment to Agreement for Inventory Financing by and among
Business Supplies Distributors Holdings, LLC, Supplies
Distributors, Inc., Priority Fulfillment Services, Inc.,
PFSweb, Inc., Inventory Financing Partners, LLC and IBM
Credit Corporation

10.27 (9) Amendment to Amended and Restated Platinum Plan Agreement
(with Invoice Discounting) by and among Supplies
Distributors, S.A., Business Supplies Distributors Europe
B.V., PFSweb B.V., and IBM Belgium Financial Services S.A.

10.28 (9) Amended and Restated Notes Payable Subordination Agreement
by and between Priority Fulfillment Services, Inc., Supplies
Distributors, Inc. and IBM Credit Corporation

10.29 (9) Amendment to Factoring agreement dated March 29, 2002
between Supplies Distributors S.A. and Fortis Commercial
Finance N.V.

23.1 (9) Consent of KPMG LLP

99.1 (9) 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 (9) 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

96

- ----------

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

(2) Incorporated by reference from PFSweb, Inc. Form 10-K for the fiscal
year ended March 31, 2001

(3) Incorporated by reference from PFSweb, Inc. Form 10-Q/A for the
quarterly period ended September 30, 2001

(4) Incorporated by reference from PFSweb, Inc. Form 10-K for the
transition period ended December 31, 2001

(5) Incorporated by reference from PFSweb, Inc. Form 10-Q for the
quarterly period ended March 31, 2002

(6) Incorporated by reference from PFSweb, Inc. Form 10-Q for the
quarterly period ended June 30, 2002

(7) Incorporated by reference from PFSweb, Inc. Form 10-Q for the
quarterly period ended September 30, 2002

(8) Incorporated by reference from PFSweb, Inc. Report on Form 8-K filed
on November 12, 2002

(9) Filed herewith

(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.

Form 8-K filed on November 11, 2002 reporting Item 2, Acquisition or
Disposition of Assets, that on October 25, 2002, Priority Fulfillment
Services, Inc. (the "Company") acquired the remaining 51% ownership
interest in Business Supplies Distributors Holdings, LLC ("Holdings") for
$331,758. Also reporting Item 7, Financial Statements, Pro Forma Financial
Information and Exhibits, that the financial statements of Holdings and Pro
forma financial statements of the Company would be filed by amendment
within 60 days as required.

Form 8-K/A filed on January 8, 2003 reporting Item 2, Acquisition or
Disposition of Assets, that on October 25, 2002, Priority Fulfillment
Services, Inc. (the "Company") acquired the remaining 51% ownership
interest in Business Supplies Distributors Holdings, LLC ("Holdings") for
$331,758. Also reporting Item 7, Financial Statements of Holdings and the
Pro Forma Financial Information of the Company.

97

SCHEDULE II

PFSWEB, INC. AND SUBSIDIARIES

VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED MARCH 31, 2001, THE
NINE MONTH PERIOD ENDED DECEMBER 31, 2001 AND THE YEAR ENDED DECEMBER 31, 2002
(AMOUNTS IN THOUSANDS)

98

SIGNATURES

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

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

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

99

CERTIFICATIONS OF PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350

I, Mark Layton, certify that:

1. I have reviewed this annual report on Form 10-K of PFSweb, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operation and cash
flows of the registrant as of, and for, the periods presented in this
annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize, and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: March 31, 2003
--------------------------

By: /s/ Mark C. Layton
--------------------------
Chief Executive Officer

100

CERTIFICATIONS OF PRINCIPAL FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350

I, Tom Madden, certify that:

1. I have reviewed this annual report on Form 10-K of PFSweb, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered by
this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operation and cash
flows of the registrant as of, and for, the periods presented in this
annual report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize, and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: March 31, 2003
----------------------------------------------------

By: /s/ Thomas J. Madden
----------------------------------------------------
Chief Financial Officer and Chief Accounting Officer

101