PFSWEB INC - 10-Q Quarterly Report

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

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2003

OR

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

For the Transition Period from _______ to _______

Commission File Number 000-28275

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

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes [X] No [ ]

At May 7, 2003 there were 18,428,871 shares of registrant's common stock
outstanding, excluding 86,300 shares of common stock in treasury.

PFSWEB, INC. AND SUBSIDIARIES
FORM 10-Q
MARCH 31, 2003

INDEX

2

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

PFSWEB, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

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

3

PFSWEB, INC. AND SUBSIDIARIES

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

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

4

PFSWEB, INC. AND SUBSIDIARIES

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

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

5

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. OVERVIEW AND BASIS OF PRESENTATION

PFSWEB OVERVIEW

PFSweb, Inc. and its subsidiaries (the "Company" or "PFSweb") is an
international provider of integrated business process outsourcing services to
major brand name companies seeking to maximize their supply chain efficiencies
and to extend their traditional and e-commerce initiatives in the United States,
Canada, and Europe. The Company offers such services as professional consulting,
technology collaboration, managed hosting and 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

Business Supplies Distributors Holdings, LLC ("Holdings") and its
subsidiaries (collectively "Supplies Distributors") are master distributors of
various products, primarily International Business Machines ("IBM") products.
Pursuant to transaction management services agreement between the Company and
Supplies Distributors, the Company provides to Supplies Distributors 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
Supplies Distributors have outsourced the product demand generation to Global
Marketing Services, Inc. ("GMS"). Supplies Distributors, 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 Supplies Distributors were
made in the context of a related party relationship and were negotiated in the
overall context of the Company's and Supplies Distributors' 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 the period from July 2001 to September 2002, the Company owned 49% of
Supplies Distributors and as such the results of Supplies Distributors were not
consolidated into the Company's results. The Company's equity interest in
Supplies Distributors was presented in the consolidated balance sheet as
investment in affiliate prior to October 2002 and the Company's allocation of
Supplies Distributors' net income was presented in the consolidated statement of
operations as equity in earnings of affiliate for the period from inception
(July 2001) to September 2002, including the three months ended March 31, 2002.
Effective October 1, 2002, the Company purchased the remaining 51% interest in
Supplies Distributors from Inventory Financing Partners, LLC ("IFP"). As a
result of the purchase, effective October 1, 2002, the Company began
consolidating 100% of Supplies Distributors' financial position and results of
operations into the Company's consolidated financial statements. The following
table presents selected pro forma information, for comparative purposes,
assuming the acquisition had occurred on January 1, 2002, for the three months
ended March 31, 2002:

Net revenues...................... $ 59,879
========
Net loss.......................... $ 2,927
========
Loss per share.................... $ 0.16
========

The pro forma data includes a $0.2 million extraordinary gain on the purchase
from IFP, primarily as a result of the purchase price being less than IFP's
capital account. The unaudited pro forma net revenue and pro forma net loss are
not necessarily indicative of the consolidated results of operations for future
periods

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PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

or the results of operations that would have been realized had we consolidated
Supplies Distributors during the period noted.

The unaudited interim condensed consolidated financial statements as of
March 31, 2003, and for the three months ended March 31, 2003 and 2002, have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") and are unaudited. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to the rules and regulations promulgated
by the SEC. In the opinion of management and subject to the foregoing, the
unaudited interim condensed consolidated financial statements of the Company
include all adjustments, consisting of only normal recurring adjustments,
necessary for a fair presentation of the Company's financial position as of
March 31, 2003, its results of operations for the three months ended March 31,
2003 and 2002 and its results of cash flows for the three months ended March 31,
2003 and 2002. Results of the Company's operations for interim periods may not
be indicative of results for the full fiscal year.

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

2. SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

All intercompany accounts and transactions have been eliminated in
consolidation. Accounts and transactions between the Company and Supplies
Distributors have been eliminated as of December 31, 2002 and as of and for the
three months ended March 31, 2003.

INVESTMENT IN AFFILIATE

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

In addition to the equity investment, the Company loaned Supplies
Distributors monies in the form of a Subordinated Demand Note (the "Subordinated
Demand Note"). Under certain new and amended terms of its senior debt
facilities, the outstanding balance of the Subordinated Demand Note cannot be
increased or decreased without prior approval of the Company's lenders. As of
March 31, 2003 and December 31, 2002, the outstanding balance of the
Subordinated Demand Note was $8.0 million.

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
and the determination of costs applicable to client terminations in these
consolidated financial statements also required management estimates and
assumptions.

7

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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, the Company bills IBM for
reimbursements of certain expenses, including: pass through customer marketing
programs, including rebates and coop funds; certain freight costs; direct costs
incurred in passing on any price decreases offered by IBM to Supplies
Distributors or its 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.

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.

8

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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.

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, excluding certain technology infrastructure and
development costs, exceed the fees received, excess costs are expensed as
incurred.

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. Current and non-current deferred implementation revenues are a
component of deferred revenue and other liabilities, respectively.

CONCENTRATION OF BUSINESS AND CREDIT RISK

The Company's product revenue was primarily generated by sales of product
purchased under master distributor agreements with one supplier. Sales to three
customers accounted for approximately 13% 11% and 11% of the Company's total
product revenues for the three months ended March 31, 2003. Service fee revenue
from two clients accounted for approximately 30% and 22% of net service fee
revenue for the three months ended March 31, 2003. On a consolidated basis,
three clients accounted for approximately 15%, 10% and 10% of the Company's
total revenues for the three months ended March 31, 2003. As of March 31, 2003,
three customers/clients accounted for approximately 41% of accounts receivable.
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 collaterized guarantees on behalf of Supplies Distributors.
Supplies Distributors' ability to obtain financing on similar terms would be
significantly impacted without these guarantees. Additionally, since Supplies
Distributors has limited personnel and physical resources, its ability to
conduct business could be materially impacted by contract terminations by GMS.

The Company has multiple arrangements with IBM and is dependent upon the
continuation of such arrangements. These arrangements, which are critical to the
Company's ongoing operations, include Supplies Distributors' master distributor
agreements, Supplies Distributors' working capital financing agreements, product
sales to IBM business units, a general contractor relationship through the
Company's largest client, and a term master lease agreement.

CASH AND CASH EQUIVALENTS

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

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. 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 March 31, 2003 and December

9

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

31, 2002, the Company's allowance for slow-moving inventory was approximately
$0.2 million and $0.1 million, respectively. 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 Company's property held under capital leases amounted to approximately
$4.1 million and $4.3 million, net of accumulated amortization of approximately
$3.8 million and $3.5 million, at March 31, 2003 and December 31, 2002,
respectively.

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. 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 three months ended March 31,
2003 and 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
periods for stock options granted to employees. 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.

On April 14, 2003, the Company issued an aggregate of 750,000 options to
purchase shares of common stock at $0.44 to officers and employees of PFSweb.

3. RECENTLY ISSUED ACCOUNTING PRINCIPLES

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 adoption of this standard did not have a
material impact on the consolidated financial statements.

10

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 adoption of
this standard did not have a material impact on the consolidated financial
statements.

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.

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 the measurement provisions of this statement during the
three months ended March 31, 2003. The adoption of this statement did not have a
material effect on the consolidated financial statements.

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
adopted the provisions of FIN No. 46 during the three months ended March 31,
2003. The adoption of the statement did not have a material effect on the
consolidated 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.

4. COMPREHENSIVE LOSS (IN THOUSANDS)

11

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

5. NET LOSS PER COMMON SHARE AND COMMON SHARE EQUIVALENT

Basic and diluted net loss per common share attributable to PFSweb common
stock were determined based on dividing the net loss available to common
stockholders by the weighted-average number of common shares outstanding. During
the three months ended March 31, 2003 and 2002, all outstanding options to
purchase common shares were anti-dilutive and have been excluded from the
weighted diluted average share computation. As of March 31, 2003 and 2002 there
were 4,724,835 and 5,982,391 options outstanding, respectively. There are no
other potentially dilutive securities outstanding.

6. DEBT AND CAPITAL LEASE OBLIGATIONS:

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

INVENTORY AND WORKING CAPITAL FINANCING AGREEMENT, UNITED STATES - SUPPLIES
DISTRIBUTORS

On September 27, 2001, Supplies Distributors entered into a short-term
credit facility with IBM Credit LLC (formerly IBM Credit Corporation) to finance
its distribution of IBM products in the United States, which has subsequently
been amended. The amended asset based credit facility provides financing for
purchasing IBM inventory and for certain other receivables up to $27.5 million
($30.5 million at December 31, 2002) through its expiration on March 29, 2004.
The credit facility contains cross default provisions, various restrictions upon
the ability of 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,
cash flow from operations, 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 $18.0 million. Borrowings under the credit facility accrue
interest, after a defined free financing period, at prime rate plus 1%. The
facility accrues a quarterly commitment fee of 0.375% on the unused portion of
the commitment, and a monthly service fee.

INVENTORY AND WORKING CAPITAL FINANCING AGREEMENT, EUROPE - SUPPLIES
DISTRIBUTORS

On September 27, 2001, Supplies Distributors S.A. ("SDSA"), a Belgium
corporation and wholly-owned subsidiary of Supplies Distributors, 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, which has
subsequently been amended. The amended asset based credit facility with IBM
Belgium provides up to 12.5 million Euros (approximately $13.5 million) (19.0
million euros, or approximately $20.5 million at December 31, 2002) 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, 2004. The credit facility contains cross
default provisions, various restrictions upon the ability of Supplies
Distributors to, among others, merge, consolidate, sell assets, incur
indebtedness, make loans and

12

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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, cash flow from operations 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 $18.0 million. Borrowings
under the credit facility accrue interest, after a defined free financing
period, at Euribor plus 4%. SDSA pays a monthly service fee on the commitment.

LOAN AND SECURITY AGREEMENT - SUPPLIES DISTRIBUTORS

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 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. This agreement contains cross default provisions,
various restrictions upon the ability of 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 entered into
Blocked Account Agreements with its banks and Congress whereby a security
interest was granted to Congress for all customer remittances received in
specified bank accounts.

LOAN AND SECURITY AGREEMENT - PFSWEB

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 restricts the amount of the
Subordinated Demand 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. There
were no amounts outstanding under this facility as of March 31, 2003.

FACTORING AGREEMENT - SUPPLIES DISTRIBUTORS

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 $8.1 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 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.

13

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DEBT COVENANTS

To the extent the Company or Supplies Distributors fail to comply with its
covenants, including the monthly financial covenant requirements and required
level of consolidated stockholders' equity ($18.0 million), and the lenders
accelerate the repayment of the credit facility obligations, the Company would
be required to repay all amounts outstanding thereunder. Any acceleration of the
repayment of the credit facilities 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 March 31, 2003, the Company and Supplies Distributors were in
compliance with all debt covenants.

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.

7. SUPPLIES DISTRIBUTORS AND OTHER RELATED PARTIES

SUPPLIES DISTRIBUTORS

In September 2001, the Company made an equity investment of $0.75 million
in Supplies Distributors, for a 49% voting interest, and IFP made an equity
investment of $0.25 million in Supplies Distributors 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
Supplies Distributors from IFP for $0.3 million.

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 $1.5 million for the three months ended March 31, 2002.

Pursuant to Supplies Distributors' operating agreement, prior to the
October 1, 2002 acquisition date, Supplies Distributors 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 respective capital accounts. The Company recorded
$0.5 million of equity in the earnings of Supplies Distributors, prior to the
October 1, 2002 acquisition, for the three months ended March 31, 2002. As a
result of the Company's 100% ownership of Supplies Distributors, future earnings
and dividends will be allocated and paid 100% to the Company. Under the terms of
its amended credit agreements, Supplies Distributors is currently restricted
from paying annual cash dividends without the prior approval of its lenders. In
March 2003, Supplies Distributors received lender approval for a distribution to
PFSweb of up to $600,000, none of which has been declared.

OTHER RELATED PARTIES

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 required under the ASFS for an amount equal to the fees received by
Supplies Distributors from IBM under the ASFS. The principal officer of GMS
owned 46% of IFP, prior to PFSweb's purchase of IFP's interest in Supplies
Distributors.

14

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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, and $0.2 million was paid during the three months ended March 31,
2003. The remaining $0.2 million at March 31, 2003 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. COMMITMENTS AND CONTINGENCIES

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 the Company's compliance with the initial listing requirements for
the NASDAQ SmallCap Market, on August 14, 2002 PFSweb was provided an additional
180 day grace period, or until February 10, 2003 to regain compliance. In March
2003, the Company was provided an additional 90 day grace period, or until May
12, 2003, to regain compliance. On May 14, 2003, we received a NASDAQ Staff
Determination letter, indicating that the Company no longer complies with the $1
minimum bid price requirement for continued listing and that the Company's
common stock is, therefore, subject to delisting from the NASDAQ SmallCap Market
at the opening of business on May 23, 2003. The Company will request a hearing
to appeal this notice. The Company's hearing request will defer delisting until
the NASDAQ Listing Qualifications Panel reaches a decision. Until then, the
Company's common stock will remain listed and will continue to trade on the
NASDAQ SmallCap Market. There can be no assurance as to when the Panel will
reach a decision or that such a decision will be favorable to the Company. If
the Company subsequently decides not to appeal the delisting notice, or if the
Panel denies the appeal, the Company's securities may be immediately eligible
for quotation on the OTC Bulletin Board. The delisting of the Company's common
stock could have a material adverse effect on the market price of, and the
efficiency of the trading market for, PFSweb's 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.

10. SEGMENT INFORMATION

The Company is organized into two operating segments: PFSweb 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.

15

PFSWEB, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

16

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

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

FORWARD-LOOKING INFORMATION

We have made forward-looking statements in this Report on Form 10-Q. These
statements are subject to risks and uncertainties, and there can be no guarantee
that these statements will prove to be correct. Forward-looking statements
include assumptions as to how we may perform in the future. When we use words
like "seek," "strive," "believe," "expect," "anticipate," "predict,"
"potential," "continue," "will," "may," "could," "intend," "plan," "target" and
"estimate" or similar expressions, we are making forward-looking statements. You
should understand that the following important factors, in addition to those set
forth above or elsewhere in this Report on Form 10-Q and our Form 10-K for the
year ended December 31, 2002, 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 dependence upon our agreements with IBM;

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.

17

OVERVIEW

We are an international outsourcing provider of integrated business process
outsourcing solutions to major brand name companies seeking to maximize their
supply chain efficiencies and to extend their e-commerce initiatives. We derive
our revenues from a broad range of services, including professional consulting,
technology collaboration, order management, managed web hosting and web
development, customer relationship management, financial services including
billing and collection services 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 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.
Product revenue includes freight costs billed to customers and is reduced for
pass through customer marketing programs. For the period from January 1, 2002,
to September 30, 2002, these IBM and other agreements were structured to provide
transaction management services only on a service fee basis based on a
percentage of shipped revenue.

Our expenses are comprised of:

o 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 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.

18

RESULTS OF OPERATIONS

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

RESULTS OF OPERATIONS FOR THE INTERIM PERIODS ENDED MARCH 31, 2003 AND 2002

Product Revenue. Product revenue was $59.7 million for the three months
ended March 31, 2003, which reflects product sales for Supplies Distributors
subsequent to its consolidation effective October 1, 2002 (see "Supplies
Distributors"). Supplies Distributors had $53.1 million of product revenue for
the three months ended March 31, 2002 prior to consolidation. Based on Supplies
Distributors' current business plan, we expect to report future product revenue
of approximately $60 million per quarter in calendar year 2003.

Net Service Fee Revenue (including service fee revenue, affiliate). Net
service fee revenue was $6.6 million for the three months ended March 31, 2003
as compared to $8.3 million for the three months ended March 31, 2002, a
decrease of $1.7 million or 20.6%. We earned $1.2 million of service fee
revenues in the three months ended March 31, 2003, applicable to new service
contract relationships. However, this increase was more than offset primarily by
(i) $1.5 million applicable to the elimination of service fee revenue, affiliate
earned from our arrangements with Supplies Distributors, subsequent to its
consolidation effective October 1, 2002, (ii) the prior year period including
service fees of $0.9 million applicable to an incremental project for a certain
client which did not recur this year, and (iii) the impact of certain client
terminations in calendar year 2002, which had generated $0.5 million of net
service fee revenue in the prior year period. Net service fee revenue during the
March quarter is seasonably lower than other quarters due to the seasonality of
our largest client, which is expected to be followed by a higher second quarter.

Cost of Product Revenue. Cost of product revenue was $56.4 million for the
three months ended March 31, 2003, which reflects cost of product sales for
Supplies Distributors subsequent to its consolidation effective October 1, 2002.
Cost of product revenue as a percent of product revenue was 94.5% during the
three months ended March 31, 2003. The resulting gross profit margin was 5.5%
for the three months ended March 31, 2003. Supplies Distributors had $50.1
million of cost of product revenue, prior to

19

consolidation, for the three months ended March 31, 2002. Based on Supplies
Distributors' current business plan, we expect to report future cost of product
revenue of approximately $57 million per quarter in calendar year 2003.

Cost of Net Service Fee Revenue. Cost of net service fee revenue was $4.9
million for the three months ended March 31, 2003, as compared to $5.3 million
during the three months ended March 31, 2002, a decrease of $0.4 million or
7.4%. The resulting service fee gross profit was $1.7 million or 25.7% of net
service fee revenue, during the three months ended March 31, 2003 as compared to
$3.0 million, or 36.2% of net service fee revenue for the three months ended
March 31, 2002. Our gross profit as a percent of net service fee revenue
decreased in the current period primarily as a result of the elimination of the
service fee revenue affiliate and resulting gross profit, from services provided
under our arrangements with Supplies Distributors and due to the seasonality of
our largest client. As we add new service fee revenue in the future, we
currently intend to target the underlying contracts to earn an average gross
profit percentage of 35-40%.

Selling, General and Administrative Expenses. SG&A expenses were $6.1
million for the three months ended March 31, 2003, or 9.2% of total net
revenues, as compared to $7.0 million, or 84.4% of total net revenues, for the
three months ended March 31, 2002. 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 Supplies Distributors effective October 1, 2002. SG&A expenses
decreased from the prior year due to the restructuring actions, including
personnel reductions, which occurred in September 2002. In addition, the prior
year SG&A expense included certain incremental sales and marketing costs. These
items were partially offset as due to the consolidation of Supplies
Distributors, we reclassify certain costs previously characterized as cost of
service fee revenue to SG&A. We are targeting our future consolidated SG&A
expenses to be between approximately $6.0 million to $7.0 million on a quarterly
basis for calendar year 2003.

Equity in Earnings of Affiliate. For the three months ended March 31, 2002,
we recorded $0.5 million of equity in earnings of affiliate that represents our
allocation of Supplies Distributors' earnings prior to October 1, 2002. Due to
the consolidation of Supplies Distributors, effective October 1, 2002, we no
longer report equity in earnings of affiliate, on a consolidated basis, for our
ownership of Supplies Distributors in the future.

Interest Expense. Interest expense was $0.6 million for the three months
ended March 31, 2003 as compared to $0.1 million for the three months ended
March 31, 2002. The increase in interest expense is due to the consolidation of
Supplies Distributors. Based on current estimates of interest rates and
borrowing levels, we expect interest expense to be approximately $0.6 million to
$0.8 million on a quarterly basis for calendar year 2003.

Interest Income. Interest income was $0.03 million and $0.3 million for the
three months ended March 31, 2003 and 2002, respectively. Effective October 1,
2002 we now report lower consolidated interest income resulting from the
elimination of interest income from the Subordinated Note due to PFS from
Supplies Distributors upon consolidating Supplies Distributors. Interest income,
prior to the consolidation of Supplies Distributors, would have been $0.2
million for the three months ended March 31, 2003. Interest income decreased as
compared to the three months ended March 31, 2003, attributable to lower
interest rates earned by our cash and cash equivalents and lower balances of
cash and cash equivalents.

Income Taxes. For the three months ended March 31, 2003, we recorded a tax
provision of $0.1 million primarily associated with Supplies Distributors'
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 three months ended March 31, 2002, we did not record an income tax benefit.
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 Supplies Distributors, in
the future we anticipate that we will continue to record an income tax provision
associated with Supplies Distributors' Canadian and European results of
operations.

20

SUPPLIES DISTRIBUTORS

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 ("SD"). Concurrently, SD formed
its wholly-owned subsidiaries Supplies Distributors of Canada, Inc. ("SDC") and
Supplies Distributors S.A. ("SDSA"), a Belgium corporation (collectively with
Holdings, SD, SDC and SDSA, "Supplies Distributors"). Supplies Distributors acts
as master distributors of various IBM and other 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 in Holdings for a 49% voting
interest, and IFP made an equity investment 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. In addition to
our equity investment in Holdings, we have also provided Supplies Distributors
with a subordinated loan that, as of March 31, 2003, had an outstanding balance
of $8.0 million and accrued interest at a rate of approximately 10%.

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") to finance its distribution of IBM products. We
provided a collateralized guaranty to secure the repayment of these credit
facilities. As of March 31, 2003, the subsequently amended asset-based credit
facilities provided financing for up to $27.5 million and up to 12.5 million
Euros (approximately $13.5 million) with IBM Credit and IBM Belgium,
respectively. These agreements expire in March 2004

In March 2002, Supplies Distributors also 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. In March 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 $8.1 million) of eligible
accounts receivables. Borrowings under this agreement can be either cash
advances or straight loans, as defined.

These credit facilities contain cross default provisions, various
restrictions upon the ability of Holdings, SD 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 cash flow from operations, annualized revenue to
working capital, net profit after tax to revenue, minimum net worth 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, maintain restricted
cash of less than $5.0 million, are restricted with regard to transactions with
related parties, indebtedness and changes to capital stock ownership structure
and a minimum shareholders' equity of at least $18.0 million. Furthermore, we
are obligated to repay any over-advance made to Supplies Distributors or SDSA
under these facilities if SD, SDC or SDSA is unable to do so. We have also
provided a guarantee of the obligations of SD 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.

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 unaudited interim condensed consolidated
financial statements (prior to the consolidation of Supplies Distributors'
results of operations effective October 1, 2002), of approximately $1.5 million
for the three months ended March 31, 2002.

Prior to the consolidation of Supplies Distributors' operating results
effective October 1, 2002, we recorded our interest in Supplies Distributors'
net income, which was allocated and distributed to the owners pursuant to the
terms of Supplies Distributors' operating agreement, under the modified equity
method, which resulted in us recording our allocated earnings of Supplies
Distributors or 100% of Supplies Distributors' losses and our proportionate
share of Supplies Distributors' cumulative foreign currency

21

translation adjustments. Pursuant to Supplies Distributors' operating agreement,
Supplies Distributors 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
respective capital accounts. We recorded $0.5 million of equity in the earnings
of Supplies Distributors for the three months ended March 31, 2002. As a result
of our 100% ownership of Supplies Distributors, future earnings and dividends
will be allocated and paid 100% to PFSweb. Notwithstanding the foregoing, no
distribution could be made if, after giving effect thereto, the net worth of
Supplies Distributors would be less than $1.0 million. Under terms of the credit
agreements described above, Supplies Distributors is currently limited to annual
cash dividends of $0.6 million.

In the future, as a result of the purchase, we will consolidate 100% of
Supplies Distributors financial position and results of operations into our
consolidated financial statements. Pro forma net revenues and pro forma net loss
for the three months ended March 31, 2002, assuming our purchase of the
remaining 51% interest in Supplies Distributors from IFP had occurred in January
2002, would have been $59.9 million and $2.9 million, respectively. The pro
forma data includes a $0.2 million extraordinary gain on the purchase from IFP,
primarily as a result of the purchase price being less than IFP's capital
account. The unaudited pro forma net revenue and pro forma net loss are not
necessarily indicative of the consolidated results of operations for future
periods or the results of operations that would have been realized had we
consolidated Supplies Distributors during the period noted.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operating activities was $4.0 million for the three
months ended March 31, 3003, and primarily resulted from a $7.2 million decrease
in inventory, partially offset by cash used to fund operating losses and an
increase in accounts receivable of $2.0 million and decrease in accounts payable
and accrued expenses of $0.9 million. Net cash used in operating activities was
$0.8 million for the three months ended March 31, 2002, and primarily resulted
from cash used to fund operating losses and an increase in accounts receivable,
partially offset by a decrease in prepaid expenses and other current assets and
a decrease in accounts payable, accrued expenses, and deferred income.

Net cash used in investing activities for the three months ended March 31,
2003 totaled $0.3 million, representing capital expenditures. Net cash used by
investing activities totaled $0.6 million for the three months ended March 31,
2002, which primarily included $0.3 million of capital expenditures. Capital
expenditures have historically consisted primarily of additions to upgrade our
management information systems, including our Internet-based customer tools,
other methods of e-commerce and general expansion of and upgrades to our
facilities, both domestic and foreign. We expect to incur capital expenditures
in order to support new contracts and anticipated future growth opportunities.
We anticipate that our total investment in upgrades and additions to facilities
and information technology services for the upcoming twelve months will be
approximately $2 to $4 million, although additional capital expenditures may be
necessary to support the infrastructure requirements of new clients. A portion
of these expenditures may be financed through operating or capital leases. We
may elect to modify or defer a portion of such anticipated investments in the
event that we do not achieve the revenue necessary to support such investments.

Net cash used in financing activities was approximately $3.4 million for
the three months ended March 31, 2003, primarily representing $0.3 million of
payments on our long-term debt and capital lease obligations and $2.8 million of
payments on debt.

During the three months ended March 31, 2003, our working capital decreased
to $15.0 million from $16.1 million at December 31, 2002 primarily as a result
of our operating losses. To obtain additional financing in the future, in
addition to our current cash position, we plan to evaluate various financing
alternatives including utilizing capital or operating leases, borrowing under
our own credit facility, or transferring a portion of our subordinated loan
balances, due from Supplies Distributors, to third-parties. In conjunction with
certain of these alternatives, we may be required to provide certain letters of
credit to secure these arrangements. No assurances can be given that we will be
successful in obtaining any

22

additional financing or the terms thereof. We currently believe that our cash
position, financing available under our credit facilities and funds generated
from operations (including our anticipated revenue growth and/or cost reductions
to offset lower than anticipated revenue growth) will satisfy our presently
known operating cash needs, our working capital and capital expenditure
requirements, our lease obligations, and additional subordinated loans to
Supplies Distributors, if necessary, for at least the next twelve months.

The following is a schedule of our total contractual cash and other
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 (in
millions):

In support of certain debt instruments and leases, as of March 31, 2003, 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 March 31, 2003, the outstanding balance of our senior credit
facilities was approximately $58.4 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. 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 March
31, 2003, 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 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 financial
commitments.

In September 2002, we implemented a restructuring plan and terminated
approximately 10% of our workforce. As a result of the terminations and certain
asset write-offs recorded during the three months ended September 30, 2002, we
believe we have reduced our annual operating expenses by approximately $5
million to $6 million. 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 physical capacity in our North American and European
operations. 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 existing 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

23

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

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. We entered this
agreement to supplement our existing cash position, and provide funding for our
future operations, including our targeted growth. 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.

CONTINUED LISTING ON NASDAQ SMALLCAP MARKET

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

This transition occurred in response to NASDAQ Marketplace Rule 4450(a)(5),
which requires a minimum bid price of $1.00 for continued listing on the NASDAQ
National Market. The SmallCap Market also has a minimum bid price of $1.00 per
share. However, as compared to the 90 day grace period provided by the NASDAQ
National Market, the SmallCap Market currently has a longer 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. On May 14, 2003, we received a NASDAQ Staff Determination letter,
indicating that we no longer comply with the $1 minimum bid price requirement
for continued listing and that our common stock is, therefore, subject to
delisting from the NASDAQ SmallCap Market at the opening of business on May 23,
2003. We will request a hearing to appeal this notice. Our hearing request will
defer delisting until the NASDAQ Listing Qualifications Panel reaches a
decision. Until then, our common stock will remain listed and will continue to
trade on the NASDAQ SmallCap Market. There can be no assurance as to when the
Panel will reach a decision or that such a decision will be favorable to us. If
we subsequently decide not to appeal the delisting notice, or if the Panel
denies the appeal, our securities may be immediately eligible for quotation on
the OTC Bulletin Board. 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.

SEASONALITY

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

24

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 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 adoption of this standard did not have a
material impact on the consolidated financial statements.

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 adoption of
this standard did not have a material impact on the consolidated financial
statements.

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.

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 the measurement provisions of this statement during the three months
ended March 31, 2003. The adoption of this statement did not have a material
effect on the consolidated financial statements.

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 adopted the
provisions of FIN No. 46 during the three months ended March 31, 2003. The
adoption of the statement did not have a material effect on the consolidated
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.

25

CRITICAL ACCOUNTING POLICIES

A description of critical accounting policies is included in Note 2 to the
accompanying unaudited interim condensed consolidated financial statements. For
other significant accounting policies, see Note 2 to the consolidated financial
statements in our December 31, 2002 Annual Report on Form 10-K.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

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

Interest Rate Risk

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 $57.1 million at March 31, 2003. A
100 basis point movement in interest rates would result in approximately $0.2
million annualized increase or decrease in interest expense based on the
outstanding balance of these agreements at March 31, 2003.

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.

ITEM 4. 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 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.

26

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

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

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a) Exhibits:

27

- ----------

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

** Filed herewith

b) Reports on Form 8-K:

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.

28

SIGNATURES

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

Date: May 15, 2003

PFSweb, Inc.

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

29

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

I, Mark Layton, certify that:

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

2. Based on my knowledge, this quarterly 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 quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly 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 officers and I have indicated in this
quarterly 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: May 15, 2003
-----------------------

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

30

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

I, Tom Madden, certify that:

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

2. Based on my knowledge, this quarterly 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 quarterly
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly 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 officers and I have indicated in this
quarterly 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: May 15, 2003
---------------------------

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

31

INDEX TO EXHIBITS

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

** Filed herewith

32