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, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _______ to _______
Commission File Number 000-28275
PFSWEB, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2837058
------------------------------------ --------------------------
(State of Incorporation) (I.R.S. Employer I.D. No.)
500 NORTH CENTRAL EXPRESSWAY, PLANO, TEXAS 75074
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 881-2900
-----------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
At May 3, 2002 there were 18,183,272 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, 2002
INDEX
<Table>
<Caption>
PAGE NUMBER
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 2002 (unaudited) and
December 31, 2001....................................................... 3
Unaudited Interim Condensed Consolidated Statements of Operations for the Three
Months Ended March 31, 2002 and 2001.................................... 4
Unaudited Interim Condensed Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2002 and 2001................................... 5
Notes to Unaudited Interim Condensed Consolidated Financial Statements...... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ......................................... 14
Item 3. Quantitative and Qualitative Disclosure about Market Risk ....................... 23
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.............................. 24
Item 6. Exhibits and Reports on Form 8-K ................................................ 24
SIGNATURES ............................................................................. 25
</Table>
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PFSWEB, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<Table>
<Caption>
ASSETS March 31, December 31,
2002 2001
------------ ------------
(unaudited)
CURRENT ASSETS:
Cash and cash equivalents ............................................................ $ 9,322 $ 10,786
Accounts receivable, net of allowance for doubtful accounts of $248 and $254
at March 31, 2002 and December 31, 2001, respectively ............................ 7,882 6,915
Other receivables .................................................................... -- 92
Prepaid expenses and other current assets ............................................ 2,068 2,646
------------ ------------
Total current assets ................................................... 19,272 20,439
------------ ------------
PROPERTY AND EQUIPMENT, net .............................................................. 14,079 15,329
NOTE RECEIVABLE FROM AFFILIATE ........................................................... 11,800 11,655
OTHER ASSETS (including $2,876 and $2,722 of restricted cash at March 31, 2002 and
December 31, 2001, respectively) ................................................. 4,547 4,305
------------ ------------
Total assets ........................................................... $ 49,698 $ 51,728
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt and capital lease obligations ...................... $ 1,128 $ 995
Trade accounts payable ............................................................... 4,345 2,995
Accrued expenses ..................................................................... 5,526 5,300
------------ ------------
Total current liabilities .............................................. 10,999 9,250
------------ ------------
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS, less current
portion ................................................................ 3,629 3,663
------------ ------------
DEFERRED INCOME .......................................................................... 2,061 2,210
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 8 and 9)
SHAREHOLDERS' EQUITY:
Preferred stock, $1.00 par value; 1,000,000 shares authorized; none issued and
outstanding ...................................................................... -- --
Common stock, $0.001 par value; 40,000,000 shares authorized;
18,235,796 and 18,143,409 shares issued at March 31, 2002 and December 31,
2001, respectively; and 18,149,496 and 18,057,109 outstanding at March 31,
2002 and December 31, 2001, respectively ......................................... 18 18
Additional paid-in capital ........................................................... 52,020 51,942
Accumulated deficit .................................................................. (17,384) (14,157)
Accumulated other comprehensive loss ................................................. (1,560) (1,113)
Treasury stock at cost, 86,300 shares at March 31, 2002 and December 31, 2001 ........ (85) (85)
------------ ------------
Total shareholders' equity ............................................. 33,009 36,605
------------ ------------
Total liabilities and shareholders' equity ............................. $ 49,698 $ 51,728
============ ============
</Table>
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)
<Table>
<Caption>
Three Months Ended
March 31,
------------------------------
2002 2001
------------ ------------
REVENUES:
Gross service fee revenue ...................... $ 7,826 $ 12,638
Gross service fee revenue, affiliate (Note 8) .. 1,565 --
------------ ------------
Total gross service fee revenue .............. 9,391 12,638
Less pass through charges ...................... 1,073 1,397
------------ ------------
Net service fee revenue ...................... 8,318 11,241
Other net revenue .............................. -- 397
------------ ------------
Total net revenues ........................ 8,318 11,638
------------ ------------
COSTS OF REVENUES:
Cost of net service fee revenue ................ 5,229 7,591
Cost of other revenue .......................... -- 59
------------ ------------
Total costs of net revenues ............... 5,229 7,650
------------ ------------
Gross profit ............................... 3,089 3,988
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES .................................... 7,093 6,402
------------ ------------
Loss from operations ....................... (4,004) (2,414)
EQUITY IN EARNINGS OF AFFILIATE .................... 512 --
INTEREST INCOME .................................... 265 211
------------ ------------
Loss before income taxes ................... (3,227) (2,203)
INCOME TAX BENEFIT ................................. -- 11
------------ ------------
NET LOSS ........................................... $ (3,227) $ (2,192)
============ ============
NET LOSS PER SHARE:
Basic and diluted ............................. $ (0.18) $ (0.12)
============ ============
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic and diluted ............................. 18,149 17,907
============ ============
</Table>
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)
<Table>
<Caption>
Three Months Ended
March 31,
------------------------------
2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ........................................................................ $ (3,227) $ (2,192)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ................................................ 1,648 1,635
Deferred income taxes ........................................................ -- 109
Provision for doubtful accounts .............................................. 21 211
Equity in earnings of affiliate .............................................. (512) --
Non-cash compensation expense ................................................ 24 --
Changes in operating assets and liabilities:
Accounts receivables ..................................................... (1,008) 1,575
Prepaid expenses and other current assets ................................ 713 1,546
Accounts payable, accrued expenses and deferred income ................... 1,555 2,493
------------ ------------
Net cash provided by (used in) operating activities ................. (786) 5,377
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ............................................. (338) (1,249)
Increase in restricted cash ..................................................... (154) --
Loan to affiliate ............................................................... (145) --
------------ ------------
Net cash used in investing activities ............................... (637) (1,249)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment on long-term debt and capital lease obligations ......................... (259) (35)
Proceeds from issuance of common stock .......................................... 54 25
Proceeds from debt .............................................................. 172 --
------------ ------------
Net cash used in financing activities ............................... (33) (10)
------------ ------------
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS ............................... (8) 5
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS ........................................... (1,464) 4,123
CASH AND CASH EQUIVALENTS, beginning of period ...................................... 10,786 18,143
------------ ------------
CASH AND CASH EQUIVALENTS, end of period ............................................ $ 9,322 $ 22,266
============ ============
SUPPLEMENTAL CASH FLOW INFORMATION Non-cash investing and financing activities:
Fixed assets acquired under capital leases ...................................... $ 186 $ --
============ ============
Increase in equity investment in affiliate ...................................... $ 149 $ --
============ ============
</Table>
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, Inc. (the "Company" or "PFSweb") is an international provider
of integrated business process outsourcing services to major brand name
companies seeking to maximize their supply chain efficiencies and to extend
their traditional and e-commerce initiatives in the United States, Canada, and
Europe. The Company offers such services as professional consulting, technology
collaboration, managed hosting and creative web development, order management,
web-enabled customer contact centers, customer relationship management,
financial services including billing and collection services, information
management, option kitting and assembly services, and international fulfillment
and distribution services.
The unaudited interim condensed consolidated financial statements as of
March 31, 2002, and for the three months ended March 31, 2002 and 2001, have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") and are unaudited. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted pursuant to the rules and regulations promulgated
by the SEC. In the opinion of management and subject to the foregoing, the
unaudited interim condensed consolidated financial statements of the Company
include all adjustments, consisting of only normal recurring adjustments,
necessary for a fair presentation of the Company's financial position as of
March 31, 2002, its results of operations for the three months ended March 31,
2002 and 2001 and its results of cash flows for the three months ended March 31,
2002 and 2001. Results of the Company's operations for interim periods may not
be indicative of results for the full fiscal year.
Certain prior period data has been reclassified to conform to the
current period presentation. Included in selling, general and administrative
expenses in the three months ended March 31, 2002, are approximately $0.8
million of technology infrastructure costs that were incurred in both periods
but that were recorded a component of cost of net service fee revenue in the
three months ended March 31, 2001. These technology costs were principally
dedicated to the activities that generated service fee revenue under the
transaction management services contract with Daisytek International Corporation
("Daisytek"), the Company's former parent corporation, which was terminated in
November 2001 (see Note 6). These reclassifications had no effect on previously
reported net income or shareholders' equity.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
Subsequent to the Offering and for all periods presented herein, the
financial position, results of operations and cash flows of the Company are
referred to as the consolidated financial statements of PFSweb, Inc. and
subsidiaries. All intercompany accounts and transactions have been eliminated in
consolidation.
INVESTMENT IN AFFILIATE
In 2001 the Company paid $750,000 in cash for a 49% ownership interest
in Business Supplies Distributors Holdings, LLC, ("Holdings") (see Note 8). The
Company records its interest in Holdings' net income, which is allocated and
distributed to the owners pursuant to the terms of Holdings' operating
agreement, under the modified equity method, which results in the Company
recording its allocated earnings of Holdings or 100% of Holdings' losses.
In addition to the equity investment, the Company has loaned a
subsidiary of this affiliate $11.8 million in the form of a Subordinated Demand
Note (the "Note"). The Note can be decreased to $6.5 million subject to
Holdings' compliance with the covenants of its senior loan facilities, as
amended. Management believes that the Note, which is due on demand, will not be
repaid in its entirety within the upcoming year and has therefore classified the
entire balance as long-term.
6
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
REVENUE AND COST RECOGNITION
The Company's service fee revenues primarily relate to its (1)
distribution services, (2) order management/customer care services and (3) the
reimbursement of out-of-pocket and third-party vendor expenses.
Distribution services relate primarily to inventory management, product
receiving, warehousing and fulfillment (i.e., picking, packing and shipping).
Revenue for these activities are either (i) earned on a per transaction basis or
(ii) earned at the time of product fulfillment which occurs at the completion of
the distribution services.
Order management/customer care services relate primarily to taking
customer orders for our client's products via various channels such as telephone
call-center, electronic or facsimile. These services also entail addressing
customer questions related to orders, as well as cross-selling/up-selling
activities. Revenue is recognized as the services are rendered. Fees charged to
the client are on a per transaction basis based on either (i) a pre-determined
fee per order or fee per telephone minutes incurred, or (ii) are included in the
product fulfillment service fees which are recognized on product shipment. The
Company's cost of service fee revenue, representing the cost to provide the
services described above, is recognized as incurred. Cost of service fee revenue
also includes certain costs associated with technology collaboration and ongoing
technology support which consist of creative website development and
maintenance, web hosting, technology interfacing, and other ongoing programming
activities. These activities are primarily performed to support the distribution
and order management/customer cares services and are recognized as incurred.
The Company also performs billing services and information management
services for its clients. Billing services and information management services
are typically not billed separately to clients because the activities are
continually performed, and the costs are insignificant and are generally covered
by other fees described above. Therefore, any revenue attributable to these
services is often included in the distribution or order management fees which
are recognized as services are performed. The service fee revenue associated
with these activities is currently not significant and is incidental to the
above-mentioned services.
The Company's billings for reimbursement of out-of-pocket expenses,
such as travel, and certain third-party vendor expenses such as shipping and
handling costs and telecommunication charges are included in gross service fee
revenue. The related reimbursable costs are reflected as pass-through charges
and reduce total gross service fee revenue in computing net service fee revenue.
The Company recognizes revenue, and records trade accounts receivables,
pursuant to the methods described above when collectibility is reasonably
assured. Collectibility is evaluated on an individual customer basis taking into
consideration historical payment trends, current financial position, results of
independent credit evaluations and payment terms.
Other revenue of $0.4 million for the three months ended March 31, 2001
represents the fees charged to a client in conjunction with the early
termination of its contract. Cost of other revenue for the three months ended
March 31, 2001 includes approximately $0.1 million of certain uncollectible
amounts receivable from, and liabilities applicable to, clients who terminated
contracts.
The Company primarily performs its services under two to three year
contracts that can be terminated by either party. In conjunction with these
long-term contracts the Company generally receives start-up fees to 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):
7
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<Table>
<Caption>
MARCH 31, 2002 DECEMBER 31, 2001
-------------- -----------------
Deferred implementation costs
Current .............................. $ 761 $ 845
Non-current .......................... 607 655
------------ ------------
$ 1,368 $ 1,500
============ ============
Deferred implementation revenues
Current .............................. 1,254 1,434
Non-current .......................... 913 988
------------ ------------
$ 2,167 $ 2,422
============ ============
</Table>
Current and non-current deferred implementation costs are a component
of prepaid expenses and other assets, respectively. Current and non-current
deferred implementation revenues are a component of accrued expenses and
deferred income, respectively.
CONCENTRATION OF BUSINESS AND CREDIT RISK
The Company had four clients which accounted for approximately 67% of
the Company's revenue for the three months ended March 31, 2002, of which 19%
was from Holdings or its wholly-owned subsidiaries. Service fee revenue from
Daisytek accounted for approximately 63% of the Company's total revenues for the
three months ended March 31, 2001, of which 20% was from the Daisytek
subsidiaries that were the predecessors to Supplies Distributors. As of March
31, 2002, three customers accounted for approximately 40% of accounts
receivable, of which 14% is due from Holdings or its wholly-owned subsidiaries.
as of December 31, 2001, two customers accounted for approximately 36% of
accounts receivable, of which 12% was due from Holdings or its wholly-owned
subsidiaries.
RESTRICTED CASH
In conjunction with certain long-term debt and leases, as of March 31,
2002 and December 31, 2001, the Company had approximately $2.9 million and $2.7
million of cash restricted, respectively, as collateral for letters of credit
that secure these debt and lease obligations. The letters of credit expire at
various dates through July, 2004.
3. RECENTLY ISSUED ACCOUNTING PRINCIPLES
On January 1, 2002, the Company adopted the provisions of EITF D-103
"Income Characterization of Reimbursements Received for `Out-of-Pocket' Expenses
Incurred." The Company's billings for out-of-pocket expenses, such as travel,
and certain third-party vendor expenses such as shipping and handling costs and
telecommunication charges are included in gross service fee revenue. The related
reimbursable costs are reflected as pass-through charges and reduce total gross
service fee revenue in computing net service fee revenues.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses the accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The Company is currently assessing the impact
on the consolidated financial statements and will adopt the provisions of this
standard in the first quarter of 2003.
8
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4. COMPREHENSIVE LOSS (IN THOUSANDS)
<Table>
<Caption>
Three Months Ended
March 31,
----------------------------
2002 2001
----------- -----------
Net loss ............................... $ (3,227) $ (2,192)
Other comprehensive income:
Foreign currency translation
adjustment ..................... (447) 10
----------- -----------
Comprehensive loss ..................... $ (3,674) $ (2,182)
=========== ===========
</Table>
Effective April 1, 2001, in response to a change to the Euro for
transaction activity previously conducted in the U.S. dollar by the Company's
largest European client, the Company adopted the Euro as its functional currency
for its European operations. As a result, beginning April 1, 2001, all assets
and liabilities are translated at exchange rates in effect at the end of the
period, and income and expense items are translated at the average exchange
rates for the period. Translation adjustments are reported as a separate
component of shareholders' equity. Gains and losses from foreign currency
transactions are included in net loss.
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 loss available to common
stockholders by the weighted-average number of common shares outstanding. During
the three months ended March 31, 2002 and 2001, all outstanding options to
purchase common shares were anti-dilutive and have been excluded from the
weighted diluted average share computation. As of March 31, 2002 and 2001 there
were 5,982,391 and 5,756,195 options outstanding. There are no other potentially
dilutive securities outstanding.
6. TRANSACTIONS WITH DAISYTEK
As of March 31, 2002, the Company had no receivables from Daisytek. As
of December 31, 2001 the Company had receivables from Daisytek of approximately
$0.1 million.
In conjunction with the successful completion of the Offering, PFSweb
entered into agreements with Daisytek, including a tax sharing agreement, a
transaction management services agreement, a transition services agreement and a
master separation agreement. In addition, on a going forward basis, Daisytek
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.
For the three months ended March 31, 2001, the unaudited interim
condensed consolidated financial statements include service fee revenues and
cost of service fee revenues for certain services subcontracted to PFSweb by
Daisytek under Daisytek's contractual agreements.
Service fee revenues charged to Daisytek under (i) the IBM Master
Distributor Agreements (See Note 8), entered into during the quarter ended
September 30, 1999, (ii) terms of the transaction management services agreement
with Daisytek, and (iii) for certain subcontracted services, were $7.4 million,
for the three months ended March 31, 2001.
9
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Effective November 2001, the Company is not a party to any agreement to
provide services for Daisytek.
7. DISPOSITION OF ASSETS
On May 25, 2001, the Company completed the sale of certain assets to
Daisytek pursuant to the Purchase Agreement. Under the Purchase Agreement, the
Company transferred and sold to Daisytek certain distribution and fulfillment
assets, including equipment and fixtures, that were previously used by the
Company to provide outsourcing services to Daisytek. Daisytek also assumed
certain related equipment leases and a warehouse lease and hired certain
employees who were associated with the warehouse facility. The consideration
payable under the Purchase Agreement of $11.0 million included a termination by
the Company and Daisytek of certain transaction management services agreements
previously entered into between the Company 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 net revenues and pro forma loss from operations for the three
months ended March 31, 2001, assuming the transaction had occurred in January
2001, would have been $6.6 million and ($4.3) million, respectively. The pro
forma data do not give effect to any fees earned by PFSweb for services provided
to Daisytek under a six-month transition services agreement entered into on May
25, 2001 or the effect of the $5.8 million gain on the sale of the assets.
Additionally, these pro forma adjustments do not consider certain infrastructure
costs, such as operating costs associated with the information technology
function, salaries of certain management and personnel, telephone and lease
costs, and depreciation expense which supported this business but that will
continue in the future. Because these ongoing costs were not considered, the pro
forma adjustments to the loss from operations are not indicative of the overall
margin earned under these transaction management services agreements.
8. SUPPLIES DISTRIBUTORS
The Company, Business Supplies Distributors (a Daisytek subsidiary --
"BSD"), Daisytek and IBM were parties to various Master Distributor Agreements
which had various scheduled expiration dates through September 2001. Under these
agreements, BSD and its affiliates Business Supplies Distributors Europe B.V.
("BSD Europe"), a Daisytek subsidiary, and BSD (Canada) Inc., a Daisytek
subsidiary ("BSD Canada" and together with BSD and BSD Europe, the "BSD
Companies"), acted as master distributors of various IBM products, Daisytek
provided financing and credit support to the BSD Companies and the Company
provided transaction management and fulfillment services to the BSD Companies.
On June 8, 2001, Daisytek notified the Company and IBM that it did not
intend to renew these agreements upon their scheduled expiration dates. In July
2001, the Company and Inventory Financing Partners, LLC ("IFP") formed Holdings,
and Holdings formed a wholly-owned subsidiary, Supplies Distributors ("Supplies
Distributors"). Concurrently, Supplies Distributors formed its
wholly-owned subsidiaries Supplies Distributors of Canada, Inc. ("SDC") and
Supplies Distributors S.A. ("SDSA"), a Belgium corporation. Supplies
Distributors, SDSA, the Company and IBM entered into new Master Distributor
Agreements to replace the prior agreements. Under these agreements, Supplies
Distributors and SDSA act as master distributors of various IBM products and,
pursuant to a transaction management services agreement between the Company and
Supplies Distributors, the Company provides transaction management and
fulfillment services to Supplies Distributors.
The Company made an equity investment of $0.75 million in Holdings,
which is included in other assets in the accompanying consolidated financial
statements, for a 49% voting interest, and IFP made an equity investment of
$0.25 million in Holdings for a 51% voting interest. Certain officers and a
director of the
10
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Company collectively own a 49% non-voting interest in IFP. In addition to its
equity investment in Holdings, the Company has also provided Supplies
Distributors with a subordinated loan, evidenced by the Note, which, as of March
31, 2002, had an outstanding balance of $11.8 million. The Note, which is
classified as a note receivable from affiliate, accrues interest at a
fluctuating rate per annum equal to the Company's cost of funds, as determined
by the Company. For the three months ended March 31, 2002, the Company charged
interest at 10% and earned $0.3 million associated with the Note.
On September 26, 2001, Supplies Distributors purchased all of the stock
of the BSD Companies for a purchase price of $923,000. In conjunction with the
purchase, BSD and Supplies Distributors were merged with Supplies Distributors
being the surviving corporation. Effective December 31, 2001, BSD Canada and SDC
were amalgamated, with SDC being the surviving corporation. On September 27,
2001, Supplies Distributors entered into short-term credit facilities with IBM
Credit Corporation ("IBM Credit") and IBM Belgium Financial Services S.A. ("IBM
Belgium") for the purpose of financing its distribution of IBM products. The
facilities, which at inception included $40 million for the U.S. operations and
20 million Euros (approximately $18 million) for the European operations, were
subsequently increased to $45 million and 27 million Euros (approximately $24
million), respectively, and extended through March 25, 2002.
On March 29, 2002, Supplies Distributors entered into amended credit
facilities with IBM Credit and SDSA and BSD Europe entered into amended credit
facilities with IBM Belgium. The asset based credit facility with IBM Credit
provides financing for purchasing IBM inventory up to $32.5 million through June
30, 2002 and $27.5 million from July 1, 2002 through its expiration on March 29,
2003. The asset based credit facility with IBM Belgium provides up to 27 million
Euros (approximately $23.5 million) in financing for purchasing IBM inventory
through June 30, 2002 and 22 million Euros (approximately $19.1 million)
thereafter. The IBM Belgium facility remains in force until not less than 60
days written notice by any party, but no sooner than March 29, 2003. These
credit facilities contain cross default provisions, various restrictions upon
the ability of Holdings, Supplies Distributors, SDSA and BSD Europe to, among
other things, merge, consolidate, sell assets, incur indebtedness, make loans
and payments to related parties, provide guarantees, make investments and loans,
pledge assets, make changes to capital stock ownership structure and pay
dividends, as well as financial covenants, such as annualized revenue to working
capital, net profit after tax to revenue, and total liabilities to tangible net
worth, as defined, and are secured by all of the assets of Supplies
Distributors, as well as collateralized guaranties of Holdings and PFSweb (See
Note 9). Additionally, the Company is required to maintain a subordinated loan
to Supplies Distributors of no less than $6.5 million and shareholders' equity
of at least $25.0 million.
Concurrent with these amended agreements, Supplies Distributors entered
into a loan and security agreement with Congress Financial Corporation
(Southwest) ("Congress") to provide financing for up to $25 million of eligible
accounts receivables in the U.S. and Canada. The Congress facility expires on
the earlier of three years or the date on which the parties to the IBM Master
Distributor Agreement shall no longer operate under the terms of such agreement
and/or IBM no longer supplies products pursuant to such agreement. Borrowings
under the Congress facility accrue interest at prime rate plus 0.25% or
Eurodollar rate plus 3.0% or on an adjusted basis, as defined. In Europe, SDSA
entered into a two year factoring agreement with Fortis Commercial Finance N.V.
("Fortis") to provide factoring for up to 10 million Euros (approximately $8.7
million) of eligible accounts receivables. Borrowings under this agreement
accrue interest at 8.5%, or on an adjusted basis as defined. These credit
facilities contain cross default provisions, various restrictions upon the
ability of Holdings, Supplies Distributors and SDSA to, among other things,
merge, consolidate, sell assets, incur indebtedness, make loans and payments to
related parties, provide guarantees, make investments and loans, pledge assets,
make changes to capital stock ownership structure and pay dividends, as well as
financial covenants, such as minimum net worth, as defined, and are secured by
all of the assets of Supplies Distributors, as well as collateralized guaranties
of Holdings and PFSweb (See Note 9). Additionally, the Company is required to
maintain a subordinated loan to Supplies Distributors of no less than $6.5
million and may not maintain restricted cash of more than $5.0 million as
security for capital leases, and is restricted with regard to transactions with
related parties, indebtedness and changes to capital stock ownership structure.
11
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Pursuant to the terms of the Company's transaction management services
agreement with Supplies Distributors, the Company earned service fees, which are
reported as service fee revenue, affiliate in the accompanying unaudited interim
condensed consolidated financial statements, of approximately $1.6 million for
the three months ended March 31, 2002. For the three months ended March 31,
2001, prior to becoming a related party, service fees earned by PFSweb from BSD
(the Daisytek subsidiary and predecessor to Supplies Distributors), associated
with the same business activities, were $2.3 million, net of $0.2 million of
pass-through charges. As of March 31, 2002 and December 31, 2001, the Company
has trade accounts receivables of $1.1 million and $0.9 million due from
Supplies Distributors, respectively.
Pursuant to Holdings' operating agreement, Holdings allocates its
earning and distributes its cash flow, as defined, in the following order of
priority: first, to IFP until it has received a one-time amount equal to its
capital contribution of $0.25 million; second, to IFP until it has received an
amount equal to a 35% cumulative annual return on its capital contribution;
third, to PFSweb until it has received a one-time amount equal to its capital
contribution of $0.75 million; fourth, to PFSweb until it has received an amount
equal to a 35% cumulative annual return on its capital contribution; and fifth,
to PFSweb and IFP, pro rata, in accordance with their respective capital
accounts. Notwithstanding the foregoing, no distribution may be made if, after
giving effect thereto, the net worth of Holdings may be less than $1.0 million.
Under the terms of its credit agreements, Holdings is currently limited to
annual cash dividends of $0.6 million. The Company recorded $0.5 million of
equity in the earnings of Holdings for the three months ended March 31, 2002.
Summarized financial information for Holdings as of March 31, 2002 is
as follows (in thousands):
<Table>
Cash and cash equivalents ............................. $ 2,583
Accounts receivable, net of allowance for
doubtful accounts of $673 ........................ 31,264
Inventories, net ...................................... 41,971
Prepaid expenses and other current assets ............. 4,388
Other assets, net (including restricted cash of
$608) ............................................ 851
------------
Total assets ................................... $ 81,057
============
Trade accounts payable ................................ $ 11,639
Accrued expenses ...................................... 2,213
Debt (guaranteed by PFSweb) ........................... 53,779
Other debt ............................................ 169
Note payable to affiliate ............................. 11,800
Members' capital:
Capital contributions ............................. 1,000
Retained earnings ................................. 820
Unrealized loss on investment ..................... (207)
Accumulated other comprehensive loss .............. (156)
------------
Total members' capital ......................... 1,457
------------
Total liabilities and members' capital ......... $ 81,057
============
</Table>
Summarized operating information for Holdings for the three months
ending March 31, 2002 is as follows (in thousands):
<Table>
Net revenues ..................................... $ 53,103
Cost of goods sold ............................... 50,080
------------
Gross profit ..................................... 3,023
Selling, general and administrative expenses ..... 1,875
------------
Income from operations ........................... 1,148
Interest expense ................................. 433
------------
Income before income taxes ....................... 715
Income tax expense ............................... 296
------------
Net income ....................................... $ 419
============
</Table>
12
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
9. COMMITMENTS AND CONTINGENCIES
The Company has provided collateralized guarantees to secure the
repayment of Supplies Distributors' credit facilities. As of March 31, 2002 the
outstanding balance of the credit facilities guaranteed by the Company was
approximately $54.0 million. These guarantees expire concurrently with the
expiration of the underlying credit agreements. To the extent Supplies
Distributors or its subsidiaries fails to comply with its covenants, including
its monthly financial covenant requirements, and the lenders accelerate the
repayment of the credit facility obligations, Supplies Distributors or its
subsidiaries would be required to repay all amounts outstanding thereunder. In
such event, the Company would be obligated to perform under those guarantees and
repay, to the extent Supplies Distributors or its subsidiaries was unable to,
Supplies Distributors' or its subsidiaries credit facility obligations.
Additionally, if the Company was unable to maintain the Company's required level
of stockholders' equity of $25.0 million or if the Company was to violate any of
the restricted transactions pursuant to the IBM Credit, IBM Belgium, or Congress
agreements (see Note 8), the Company could also be obligated to perform under
these guarantees. Any requirement to perform under the Company's guarantees
would have a material adverse impact on the Company's financial condition and
results of operations and no assurance can be given that the Company will have
the financial ability to repay all of such guaranteed obligations. In addition,
in the event Supplies Distributors or its subsidiaries is, or would be, in
default of its obligations under its credit facilities, the Company is
restricted from receiving any payment of its Note and such event would also have
a material adverse impact upon the Company's financial condition and results of
operations. Furthermore, the Company is obligated to repay any over-advance made
to Supplies Distributors or its subsidiaries by its lenders. An over-advance
would arise in the event borrowings exceeded the maximum amount available under
the eligible borrowing base, as defined. The Company has also provided a
guarantee of the obligations of Supplies Distributors and its subsidiaries to
IBM, excluding the trade payables that are financed by IBM Credit. No
liabilities have been recorded in the accompanying financial statements for
these guarantee obligations.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our results of operations and
financial condition should be read in conjunction with the unaudited interim
condensed consolidated financial statements and related notes appearing
elsewhere in this Form 10-Q.
FORWARD-LOOKING INFORMATION
We have made forward-looking statements in this Report on Form 10-Q.
These statements are subject to risks and uncertainties, and there can be no
guarantee that these statements will prove to be correct. Forward-looking
statements include assumptions as to how we may perform in the future. When we
use words like "seek," "strive," "believe," "expect," "anticipate," "predict,"
"potential," "continue," "will," "may," "could," "intend," "plan," "target" and
"estimate" or similar expressions, we are making forward-looking statements. You
should understand that the following important factors, in addition to those set
forth above or elsewhere in this Report on Form 10-Q and our Form 10-K for the
nine-month transition period ended December 31, 2001, could cause our results to
differ materially from those expressed in our forward-looking statements. These
factors include:
o our ability to retain and expand relationships with existing
clients and attract new clients;
o our reliance on the fees generated by the transaction volume
or product sales of our clients;
o our reliance on our clients' projections or transaction volume
or product sales;
o our client mix and the seasonality of their business;
o our ability to finalize pending contracts;
o the impact of strategic alliances and acquisitions;
o trends in the market for our services;
o trends in e-commerce;
o whether we can continue and manage growth;
o changes in the trend toward outsourcing;
o increased competition;
o our ability to generate more revenue and achieve sustainable
profitability;
o effects of changes in profit margins;
o the customer concentration of our business;
o the unknown effects of possible system failures and rapid
changes in technology;
o trends in government regulation both foreign and domestic;
o foreign currency risks and other risks of operating in foreign
countries;
o potential litigation involving our e-commerce intellectual
property rights;
o our dependency on key personnel;
14
o our ability to raise additional capital;
o our relationship with and our guarantees of the working
capital indebtedness of our affiliate, Supplies Distributors;
o the continued listing of our common stock on the NASDAQ; and
o our relationship with and separation from Daisytek, our former
parent corporation.
We have based these statements on our current expectations about future
events. Although we believe that the expectations reflected in our
forward-looking statements are reasonable, we cannot guarantee you that these
expectations actually will be achieved. In addition, some forward-looking
statements are based upon assumptions as to future events that may not prove to
be accurate. Therefore, actual outcomes and results may differ materially from
what is expected or forecasted in such forward-looking statements. We undertake
no obligation to update publicly any forward-looking statement for any reason,
even if new information becomes available or other events occur in the future.
There may be additional risks that we do not currently view as material or that
are not presently known.
OVERVIEW
We are an international outsourcing provider of integrated business
process outsourcing solutions to major brand name companies seeking to maximize
their supply chain efficiencies and to extend their e-commerce initiatives. We
derive our revenues from a broad range of services, including professional
consulting, technology collaboration, order management, managed web hosting and
web development, customer relationship management, financial services including
billing and collection services, options kitting and assembly services,
information management and international fulfillment and distribution services.
We offer our services as an integrated solution, which enables our clients to
outsource their complete infrastructure needs to a single source and to focus on
their core competencies. Our distribution services are conducted at our
warehouses and include real-time inventory management and customized picking,
packing and shipping of our clients' customer orders. We currently provide
infrastructure and distribution solutions to clients that operate in a range of
vertical markets, including technology manufacturing, computer products,
printers, cosmetics, fragile goods, high security collectibles, pharmaceuticals,
housewares, apparel, telecommunications and consumer electronics, among others.
Our service fee revenue is typically charged on a percent of shipped
revenue basis or on a per-transaction basis, such as a per-minute basis for
Web-enabled customer contact center services and a per-item basis for
fulfillment services. Additional fees are billed for other services. We price
our services based on a variety of factors, including the depth and complexity
of the services provided, the amount of capital expenditures or systems
customization required, the length of contract and other factors. Our billings
for reimbursements of out-of-pocket expenses, such as travel and certain
third-party vendor expenses such as shipping and handling costs and
telecommunication charges are included in gross service fee revenue. The related
reimbursable costs are reflected as pass-through charges and reduce total gross
service fee revenue in computing net service fee revenue.
Our expenses are comprised of (i) cost of service fee revenue, which
consists primarily of compensation and related expenses for our Web-enabled
customer contact center services, international fulfillment and distribution
services and professional consulting services, and other fixed and variable
expenses directly related to providing services under the terms of fee based
contracts, including certain occupancy and information technology costs and
depreciation and amortization expenses; and (ii) selling, general and
administrative expenses, which consist primarily of compensation and related
expenses for sales and marketing staff, executive, management and administrative
personnel and other overhead costs, including certain occupancy and information
technology costs and depreciation and amortization expenses.
15
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.
<Table>
<Caption>
Three Months Ended
March 31,
-------------------------------
2002 2001
------------ ------------
Gross service fee revenue ........................ 94.1% 108.6%
Gross service fee revenue, affiliate ............. 18.8 --
------------ ------------
Total gross service fee revenue .................. 112.9 108.6
Pass-through charges ............................. (12,9) (12.0)
------------ ------------
Net service fee revenue .......................... 100.0 96.6
Other net revenue ................................ -- 3.4
------------ ------------
Total net revenues ........................ 100.0 100.0
Cost of net service fee revenue (as % of net
service fee revenue) ......................... 62.9 67.5
Cost of other net revenue (as % of total net
revenue) ..................................... -- 0.5
------------ ------------
Total costs of net revenues ............... 62.9 65.7
------------ ------------
Gross profit ..................................... 37.1 34.3
Selling, general and administrative expenses ..... 85.3 55.0
------------ ------------
Loss from operations ............................. (48.2) (20.7)
Equity in earnings of affiliate .................. 6.2 --
Interest income .................................. 3.2 1.8
------------ ------------
Loss before income taxes ......................... (38.8) (18.9)
Income tax benefit ............................... -- 0.1
------------ ------------
Net loss ......................................... (38.8)% (18.8)%
============ ============
</Table>
RESULTS OF OPERATIONS FOR THE INTERIM PERIODS ENDED MARCH 31, 2002 AND 2001
Net Service Fee Revenue (including service fee revenue, affiliate).
Service fee revenue was $8.3 million for the three months ended March 31, 2002
as compared to $11.2 million for the three months ended March 31, 2001, a
decrease of $2.9 million or 26.0%. 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. The net impact of the changes in our services provided to
Daisytek was a reduction in revenue of $7.4 million for the three months ended
March 31, 2002. The reduction in net service fee revenue attributed to the
termination of lower margin producing contracts was $0.7 million for the three
months ended March 31, 2002. For the three months ended March 31, 2002, the
increase in net service fee revenue attributed to new client contract
relationships was $3.3 million. For the three months ended March 31, 2002, the
increase in net service fee revenue from existing contracts was $1.9 million. We
believe our revenue was negatively impacted by the recent slowdown in the U.S.
economy and the seasonality of our largest client, which has a low first quarter
of business activity followed by a higher second quarter.
Pursuant to the terms of the Company's transaction management services
agreement with Supplies Distributors, the Company earned service fees, which are
reported as service fee revenue, affiliate in the accompanying unaudited interim
condensed consolidated financial statements, of approximately $1.6 million for
the three months ended March 31, 2002. For the three months ended March 31,
2001, prior to becoming a related party, service fees earned by PFSweb from BSD
(the Daisytek subsidiary and predecessor to Supplies Distributors), associated
with the same business activities, were $2.3 million, net of $0.2 million of
pass-through charges.
16
Other Revenue. Other revenue of $0.4 million for the three months ended
March 31, 2001 represents the fees charged to a client in conjunction with the
early termination of its contract.
Cost of Net Service Fee Revenue. Cost of net service fee revenue was
$5.2 million for the three months ended March 31, 2002, as compared to $7.6
million during the three months ended March 31, 2001, a decrease of $2.4 million
or 31.1%. The resulting service fee gross profit was $3.1, million or 37.1% of
net service fee revenue, during the three months ended March 31, 2002 as
compared to $3.6 million, or 32.5% of net service fee revenue for the three
months ended March 31, 2001. The reduction in gross profit is primarily a result
of the decrease in service fee revenue. However, our gross profit as a percent
of net service fee revenue increased in the current period because the gross
profit percentage earned on certain contracts terminated during or since the
three months ended March 31, 2001 was lower than the contracts we continue to
operate.
Cost of Other Net Revenue. Cost of other revenue for the three months
ended March 31, 2001 reflect approximately $0.1 million of certain uncollectible
amounts receivable from, and accrued expenses applicable to, clients who
terminated contracts.
Selling, General and Administrative Expenses. SG&A expenses were $7.1
million for the three months ended March 31, 2002, or 85.3% of revenues, as
compared to $6.4 million, or 55.0% of revenues, for the three months ended March
31, 2001. SG&A expenses increased over the prior year due to approximately $0.8
million of technology infrastructure costs that were incurred in both periods
but that were recorded as a component of cost of service fee revenue in the
prior year. These technology costs were principally dedicated to the activities
that generated service fee revenue under the transaction management services
contract with Daisytek, which was terminated in November 2001. Increases in
sales and marketing costs in the current period were offset by a net decrease in
personnel compensation costs due to head count reductions.
Equity in Earnings of Affiliate. For the three months ended March 31,
2002, we recorded $0.5 million of equity in earnings of affiliate which
represents our allocation of Holdings earnings.
Interest Income. Interest income was $0.3 million for the three months
ended March 31, 2002 as compared to interest income of $0.2 million for the
three months ended March 31, 2001. The increase in interest income is
attributable to the impact of higher interest rates charged on our subordinated
loan to Supplies Distributors partially offset by lower interest rates earned by
our cash and cash equivalents and higher interest expense due to an increase in
our long-term debt and capital lease obligations.
Income Taxes. For the three months ended March 31, 2002, we did not
record any tax benefits associated with our net loss since we have not
established a sufficient history of earnings for our operations. A valuation
allowance has been provided for our net deferred tax assets as of March 31,
2002, which are primarily related to our net operating loss carryforwards. For
the three months ended March 31, 2001, we recorded an income tax benefit
associated with the true-up of previously estimated tax attributes for fiscal
2000, which were due to us since our prior results were included in Daisytek's
consolidated tax return, offset by an income tax provision associated with a
pre-tax income from our Canadian operations. We did not record an income tax
benefit for our European pre-tax losses in the current or prior period.
SUPPLIES DISTRIBUTORS
Business Supplies Distributors (a Daisytek subsidiary -- "BSD"),
Daisytek and IBM and us were parties to various Master Distributor Agreements
which had various scheduled expiration dates through September 2001. Under these
agreements, BSD and its affiliates Business Supplies Distributors Europe B.V.
("BSD Europe"), a Daisytek subsidiary, and BSD (Canada) Inc., a Daisytek
subsidiary ("BSD Canada" and together with BSD and BSD Europe, the "BSD
Companies"), acted as master distributors of various IBM products, Daisytek
provided financing and credit support to the BSD Companies and we provided
transaction management and fulfillment services to the BSD Companies. On June 8,
2001, Daisytek notified us and IBM that it did not intend to renew these
agreements upon their scheduled expiration dates. In July 2001, we and Inventory
Financing Partners, LLC ("IFP") formed Business Supplies Distributors Holdings,
17
LLC ("Holdings"), and Holdings formed a wholly-owned subsidiary, Supplies
Distributors ("Supplies Distributors"). Concurrently, Supplies Distributors
formed its wholly-owned subsidiaries Supplies Distributors of Canada, Inc.
("SDC") and Supplies Distributors S.A. ("SDSA"), a Belgium corporation. Supplies
Distributors, SDSA, IBM and PFSweb entered into new Master Distributor
Agreements to replace the prior agreements. Under the new agreements, Supplies
Distributors and SDSA act as master distributors of various IBM products and,
pursuant to a transaction management services agreement between us and Supplies
Distributors, we provide transaction management and fulfillment services to
Supplies Distributors. We made an equity investment of $0.75 million in Holdings
for a 49% voting interest, and IFP made an equity investment of $0.25 million in
Holdings for a 51% voting interest. Certain officers and a director of PFSweb
own a 49% non-voting interest in IFP. In addition to its equity investment in
Holdings, we have also provided Supplies Distributors with a subordinated loan,
which, as of March 31, 2002, had an outstanding balance of $11.8 million and
accrued interest at approximately 10%. The balance can be decreased to $6.5
million subject to Supplies Distributors' compliance with the covenants of its
senior loan facilities, as amended.
On September 26, 2001, Supplies Distributors purchased all of the stock
of the BSD Companies for a purchase price of $923,000. In conjunction with the
purchase, BSD and Supplies Distributors were merged with Supplies Distributors
being the surviving corporation. Effective December 31, 2001, BSD Canada and SDC
were amalgamated, with SDC being the surviving corporation. On September 27,
2001, Supplies Distributors entered into short-term credit facilities with IBM
Credit Corporation ("IBM Credit") and IBM Belgium Financial Services S.A. ("IBM
Belgium") for the purpose of financing its distribution of IBM products. The
facilities, which at inception included $40 million for the U.S. operations and
20 million Euros (approximately $18 million) for the European operations, were
subsequently increased to $45 million and 27 million Euros (approximately $24
million), respectively, and extended through March 25, 2002. The Company has
provided a collateralized guaranty to secure the repayment of these credit
facilities.
On March 29, 2002, Supplies Distributors entered into amended credit
facilities with IBM Credit and SDSA and BSD Europe entered into amended credit
facilities with IBM Belgium. The asset based credit facility with IBM Credit
provides financing for purchasing IBM inventory up to $32.5 million through June
30, 2002 and $27.5 million from July 1, 2002 through its expiration on March 29,
2003. The asset based credit facility with IBM Belgium provides up to 27 million
Euros (approximately $23.5 million) in financing for purchasing IBM inventory
through June 30, 2002 and 22 million Euros (approximately $19.1 million)
thereafter. The IBM Belgium facility remains in force until not less than 60
days written notice by any party, but no sooner than March 29, 2003. These
credit facilities contain cross default provisions, various restrictions upon
the ability of Holdings, Supplies Distributors, SDSA and BSD Europe to, among
other things, merge, consolidate, sell assets, incur indebtedness, make loans
and payments to related parties, provide guarantees, make investments and loans,
pledge assets, make changes to capital stock ownership structure and pay
dividends, as well as financial covenants, such as annualized revenue to working
capital, net profit after tax to revenue, and total liabilities to tangible net
worth, as defined, and are secured by all of the assets of Supplies
Distributors, as well as collateralized guaranties of Holdings and PFSweb.
Additionally, we are required to maintain a subordinated loan to Supplies
Distributors of no less than $6.5 million, and shareholders' equity of at least
$25.0 million. Furthermore, we are obligated to repay any over-advance made to
Supplies Distributors or SDSA under these facilities. An over-advance would
arise in the event borrowings exceeded the maximum amount available under the
eligible borrowing base, as defined.
Concurrent with these amended agreements, Supplies Distributors entered
into a loan and security agreement with Congress Financial Corporation
(Southwest) ("Congress") to provide financing for up to $25 million of eligible
accounts receivables in the U.S. and Canada. The Congress facility expires on
the earlier of three years or the date on which the parties to the IBM Master
Distributor Agreement shall no longer operate under the terms of such agreement
and/or IBM no longer supplies products pursuant to such agreement. Borrowings
under the Congress facility accrue interest at prime rate plus 0.25% or
Eurodollar rate plus 3.0% or on an adjusted basis, as defined. In Europe, SDSA
entered into a two year factoring agreement with Fortis Commercial Finance N.V.
("Fortis") to provide factoring for up to 10 million Euros (approximately $8.7
million) of eligible accounts receivables. Borrowings under this agreement
accrue interest at 8.5%, or on an adjusted basis as defined. These credit
facilities contain cross default provisions, various restrictions upon the
ability of Holdings, Supplies Distributors and SDSA to, among other things,
merge, consolidate, sell assets, incur indebtedness, make loans and payments to
related parties, provide guarantees, make investments and loans, pledge assets,
make changes to capital stock ownership structure
18
and pay dividends, as well as financial covenants, such as minimum net worth, as
defined, and are secured by all of the assets of Supplies Distributors, as well
as collateralized guaranties of Holdings and PFSweb. Additionally, we are
required to maintain a subordinated loan of no less than $6.5 million to
Supplies Distributors and may not maintain restricted cash of more than $5.0
million as security for capital leases, and are restricted with regard to
transactions with related parties, indebtedness and changes to capital stock
ownership structure. Furthermore, we are obligated to repay any over-advance
made to Supplies Distributors under the Congress facility. An over-advance would
arise in the event borrowings exceeded the maximum amount available under the
eligible borrowing base, as defined. PFS has also provided a guarantee of the
obligations of Supplies Distributors and SDSA to IBM, excluding the trade
payables that are financed by IBM credit.
Pursuant to the terms of our transaction management services agreement
with Supplies Distributors, we earned service fees, which are reported as gross
service fee revenue, affiliate in the accompanying unaudited interim condensed
consolidated financial statements, of approximately $1.6 million for the three
months ended March 31, 2002. For the three months ended March 31, 2001, prior to
becoming a related party, service fees earned by PFSweb from BSD, associated
with the Master Distributor Agreements, were $2.3 million, net of $0.2 million
of pass-through charges. As of March 31, 2002 and December 31, 2001 we had trade
accounts receivables of $1.1 million and $0.9 million due from Supplies
Distributors, respectively.
We record our interest in Holdings' net income, which is allocated and
distributed to the owners pursuant to the terms of Holdings' operating
agreement, under the modified equity method, which results in us recording our
allocated earnings of Holdings or 100% of Holdings' losses. Pursuant to
Holdings' operating agreement, Holdings allocates its earning and distributes
its cash flow, as defined, in the following order of priority: first, to IFP
until it has received a one-time amount equal to its capital contribution of
$0.25 million; second, to IFP until it has received an amount equal to a 35%
cumulative annual return on its capital contribution; third, to PFSweb until it
has received a one-time amount equal to its capital contribution of $0.75
million; fourth, to PFSweb until it has received an amount equal to a 35%
cumulative annual return on its capital contribution; and fifth, to PFSweb and
IFP, pro rata, in accordance with their respective capital accounts.
Notwithstanding the foregoing, no distribution may be made if, after giving
effect thereto, the net worth of Holdings shall be less than $1.0 million. Under
terms of the credit agreements described above, Holdings is currently limited to
annual cash dividends of $0.6 million. We recorded $0.5 million of equity in the
earnings of Holdings for the three months ended March 31, 2002.
Summarized financial information for Holdings as of March 31, 2002 is
as follows (in thousands):
<Table>
Cash and cash equivalents ........................... $ 2,583
Accounts receivable, net of allowance for
doubtful accounts of $673 ........................ 31,264
Inventories, net .................................... 41,971
Prepaid expenses and other current assets ........... 4,388
Other assets, net (including restricted cash of
$608) ............................................. 851
------------
Total assets ................................ $ 81,057
============
Trade accounts payable .............................. $ 11,639
Accrued expenses .................................... 2,213
Debt (guaranteed by PFSweb) ......................... 53,779
Other debt .......................................... 169
Note payable to affiliate ........................... 11,800
Members' capital:
Capital contributions ........................... 1,000
Retained earnings ............................... 820
Unrealized loss on investment ................... (207)
Accumulated other comprehensive loss ............ (156)
------------
Total members' capital ....................... 1,457
------------
Total liabilities and members' capital ....... $ 81,057
============
</Table>
19
Summarized operating information for Holdings for the three months
ended March 31, 2002 is as follows (in thousands):
<Table>
Net revenues ..................................... $ 53,103
Cost of goods sold ............................... 50,080
------------
Gross profit ..................................... 3,023
Selling, general and administrative expenses ..... 1,875
------------
Income from operations ........................... 1,148
Interest expense ................................. 433
------------
Income before income taxes ....................... 715
Income tax expense ............................... 296
------------
Net income ....................................... $ 419
============
</Table>
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 $0.8 million for the three
months ended March 31, 2002, and primarily resulted from cash used to fund
operating losses and the net impact of an increase in accounts receivables of
$1.0 million, partially offset by an increase in accounts payable and accrued
expenses of $1.6 million and a decrease in prepaid expenses and other current
assets of $0.7 million. The increase in accounts receivable is primarily due to
a $1.2 million increase in credit card charges owed to us as part of the billing
and collection services we perform on behalf of our clients. Once collected,
these funds are remitted to our clients. The increase in accounts payable and
accrued expenses is primarily due to a $2.0 million increase in credit card
charges collected or to be collected that are owed to our clients and were
remitted in April. The decrease in other current assets primarily relates to the
collection of VAT receivables associated with our European operations. Net cash
provided by operating activities was $5.4 million for the three months ended
March 31, 2001, and primarily resulted from an increase in accounts payable and
accrued expenses of $2.5 million, decreases in accounts receivable of $1.6
million and prepaid expenses and other current assets of $1.5 million, partially
offset by cash used to fund operating losses.
Net cash used by investing activities for the three months ended March
31, 2002 totaled $0.6 million, representing capital expenditures of $0.3
million, a $0.2 million increase in our restricted cash balance to $2.9 million,
which is to secure our long-term debt and lease financing, and an increase of
$0.1 million in our subordinated loan to Supplies Distributors, which totaled
$11.8 million at March 31, 2002. Cash used in investing activities for capital
expenditures totaled $1.2 million for the three months ended March 31, 2001.
Capital expenditures have historically consisted primarily of additions to
upgrade our management information systems, including our Internet-based
customer tools, other methods of e-commerce and general expansion of our
facilities, both domestic and foreign. We expect to incur capital expenditures
in order to support new contracts and anticipated future growth opportunities.
We anticipate that our total investment in upgrades and additions to facilities
and information technology services for the upcoming twelve months will be
approximately $2 to $4 million, although additional capital expenditures may be
necessary to support the infrastructure requirements of new clients. A portion
of these expenditures may be financed through operating or capital leases.
20
Net cash used in financing activities was approximately $33,000 for the
three months ended March 31, 2002, representing the proceeds from debt and from
the issuance of common stock pursuant to our employee stock purchase plan offset
by payments on our long-term debt and capital lease obligations. Net cash used
in financing activities was approximately $10,000 for the three months ended
March 31, 2001, representing payments on our capital lease obligations offset by
the proceeds from issuance of common stock.
During the three months ended March 31, 2002, our working capital
decreased to $8.3 million from $11.2 million at December 31, 2001, primarily due
to the funding of operations and capital expenditures. In order to obtain
additional financing in the future, in addition to our current cash position, we
plan to evaluate various financing alternatives including utilizing capital or
operating leases, establishing our own credit facility, entering into asset
based lending or factoring programs, or transferring a portion of our
subordinated loan balances, due from Supplies Distributors, to third-parties. In
conjunction with 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. Additionally, in conjunction with Supplies Distributors finalizing its
long-term financing objectives, we anticipate that up to several million of
PFSweb's subordinated debt will be repaid in the June quarter. We currently
believe that our cash position 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, 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 $0.2 million of contingent obligations that we believe will be paid
in the next twelve months, long-term debt and capital leases, including interest
(in millions):
<Table>
<Caption>
TOTAL
OPERATING LONG-TERM CONTRACTUAL
LEASES DEBT AND CASH AND
AND OTHER CAPITAL OTHER
OBLIGATIONS LEASES OBLIGATIONS
------------- ------------- -------------
Twelve Months Ended March 31,
2003 ................................................ $ 6,254 $ 1,367 $ 7,621
2004 ................................................ 5,948 1,359 7,307
2005 ................................................ 3,371 950 4,321
2006 ................................................ 2,787 786 3,573
2007 ................................................ 2,606 531 3,137
Thereafter .......................................... 1,904 496 2,400
------------- ------------- -------------
Total contractual cash obligations .......... $ 22,870 $ 5,489 $ 28,359
============= ============= =============
</Table>
In support of certain debt instruments and leases, as of March 31,
2002, we had $2.9 million of cash restricted in the form of letters of credit.
The letters of credit expire at various dates through July 2004. As described
above, we have provided collateralized guarantees to secure the repayment of
Supplies Distributors' credit facilities. As of March 31, 2002, the outstanding
balance of the credit facilities guaranteed by PFSweb was approximately $54.0
million. These guarantees expire concurrently with the expiration of the
underlying credit agreements. To the extent Supplies Distributors or its
subsidiaries fails to comply with its covenants, including its monthly financial
covenant requirements, and the lenders accelerate the repayment of the credit
facility obligations, Supplies Distributors or its subsidiaries would be
required to repay all amounts outstanding thereunder. In such event, we would be
obligated to perform under those guarantees and repay, to the extent Supplies
Distributors or its subsidiaries was unable to, Supplies Distributors' or its
subsidiaries credit facility obligations. Additionally, if we were unable to
maintain our required level of stockholders' equity of $25.0 million or if we
were to violate any of the restricted transactions pursuant to the IBM Credit,
IBM Belgium, or Congress agreements, we could also be obligated to perform under
these guarantees. Any requirement to perform under our guarantees would have a
material adverse impact on our financial condition and results of operations and
no assurance can be given that we will have the financial ability to repay all
of such guaranteed obligations. In addition, in the event Supplies Distributors
or its subsidiaries is, or would be, in default of its obligations under its
credit facilities, we are
21
restricted from receiving any payment of our subordinated loans and such event
would also have a material adverse impact upon our financial condition and
results of operations. Furthermore, we are obligated to repay any over-advance
made to Supplies Distributors or its subsidiaries by its lenders. An
over-advance would arise in the event borrowings exceeded the maximum amount
available under the eligible borrowing base, as defined. No liabilities have
been recorded in the accompanying financial statements for these guarantee
obligations. The Company does not have any other material commercial
commitments.
Currently, we believe that we are operating with and incurring costs
applicable to excess capacity in both our North American and European
operations. We believe that as we add revenue, we will be able to cover our
existing infrastructure and public company costs and reach profitability. We
currently estimate that the net service fee revenue needed to leverage our
infrastructure and reach profitability is approximately $14 million per quarter.
No assurance can be given that we can achieve such operating levels, or that, if
achieved, we will be profitable in any particular fiscal period.
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.
SEASONALITY
The seasonality of our business is dependent upon the seasonality of
our clients' business and their sale of their products. Accordingly, our
management must rely upon the projections of our clients in assessing quarterly
variability. We believe that with our current client mix, our business activity
will be at it lowest in the quarter ended March 31 and at its highest in the
quarter ended June 30.
We believe that results of operations for a quarterly period may not be
indicative of the results for any other quarter or for the full year.
INFLATION
Management believes that inflation has not had a material effect on our
operations.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
On January 1, 2002, the Company adopted the provisions of EITF D-103
"Income Characterization of Reimbursements Received for `Out-of -Pocket'
Expenses Incurred." For the periods presented above, our billings for
reimbursements of `out-of-pocket' expenses, such as travel, and certain
third-party vendor expenses such as shipping and handling costs and
telecommunication charges are included in gross service fee revenue. The related
reimbursable costs are reflected as pass-through charges and reduce total gross
service fee revenue in computing net service fee revenue.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses the accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The Company is currently assessing the impact
on the consolidated financial statements and will adopt the provisions of this
standard by the first quarter of 2003.
CRITICAL ACCOUNTING POLICIES
A description of critical accounting policies is included in footnote 2
to the accompanying unaudited interim condensed consolidated financial
statements. For other significant accounting policies, see Note 2 to the
consolidated financial statements in the Company's December 31, 2001 Annual
Report on Form 10-K.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to various market risks including interest rates on its
financial instruments and foreign exchange rates.
Interest Rate Risk
The carrying value of our financial instruments, which include cash and
cash equivalents, accounts receivable, note receivable, accounts payable and
capital lease obligations, approximate their fair values based on short terms to
maturity or current market prices and rates. The impact of a 100 basis point
change in interest rates would not have a material impact on the Company's
results of operations or financial position.
Foreign Exchange Risk
Currently, our foreign currency exchange rate risk is primarily limited
to Canadian dollars and the Euro. In the future, we believe our foreign currency
exchange risk will also include other currencies applicable to certain of our
international operations. We may, from time to time, employ a small number of
derivative financial instruments to manage our exposure to fluctuations in
foreign currency rate risk. To hedge our net investment and long-term
intercompany payable balance we might enter into forward currency exchange
contracts. We do not hold or issue derivative financial instruments for trading
purposes or enter into foreign currency transactions for speculative purposes.
Effective April 1, 2001, in response to a change to the Euro for
transaction activity previously conducted in the U.S. dollar by the Company's
largest European client, the Company adopted the Euro as its functional currency
for its European operations.
23
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
------- -----------------------
3.1*
Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1** 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
10.2** Amended and Restated Collateralized Guaranty by and
between Priority Fulfillment Services, Inc. and IBM
Credit Corporation
10.3** Amended and Restated Guaranty to IBM Credit
Corporation by PFSweb, Inc.
10.4** Amended and Restated Notes Payable Subordination
Agreement by and between Priority Fulfillment
Services, Inc., Supplies Distributors, Inc. and IBM
Credit Corporation
10.5** 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.
10.6** Amended and Restated Collateralized Guaranty between
Priority Fulfillment Services, Inc. and IBM Belgium
Financial Services S.A.
10.7** Amended and Restated Guaranty to IBM Belgium
Financial Services S.A. by PFSweb, Inc.
10.8** Subordinated Demand Note by and between Supplies
Distributors, Inc. and Priority Fulfillment
Services, Inc.
10.9** Notes Payable Subordination Agreement between
Congress Financial Corporation (Southwest) and
Priority Fulfillment Services, Inc.
10.10** Guarantee in favor of Congress Financial Corporation
(Southwest) by Business Supplies Distributors
Holdings, LLC, Priority Fulfillment Services, Inc.
and PFSweb, Inc.
10.11** General Security Agreement by Priority Fulfillment
Services, Inc. in favor of Congress Financial
Corporation (Southwest).
10.12** Inducement Letter by Priority Fulfillment Services,
Inc. and PFSweb, Inc. in favor of Congress Financial
Corporation (Southwest).
- ----------
* 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:
None.
24
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, 2002
PFSweb, Inc.
By: /s/ Thomas J. Madden
---------------------------
Thomas J. Madden
Chief Financial Officer,
Chief Accounting Officer,
Executive Vice President
25
INDEX TO EXHIBITS
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1** 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
10.2** Amended and Restated Collateralized Guaranty by and
between Priority Fulfillment Services, Inc. and IBM
Credit Corporation
10.3** Amended and Restated Guaranty to IBM Credit
Corporation by PFSweb, Inc.
10.4** Amended and Restated Notes Payable Subordination
Agreement by and between Priority Fulfillment
Services, Inc., Supplies Distributors, Inc. and IBM
Credit Corporation
10.5** 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.
10.6** Amended and Restated Collateralized Guaranty between
Priority Fulfillment Services, Inc. and IBM Belgium
Financial Services S.A.
10.7** Amended and Restated Guaranty to IBM Belgium
Financial Services S.A. by PFSweb, Inc.
10.8** Subordinated Demand Note by and between Supplies
Distributors, Inc. and Priority Fulfillment
Services, Inc.
10.9** Notes Payable Subordination Agreement between
Congress Financial Corporation (Southwest) and
Priority Fulfillment Services, Inc.
10.10** Guarantee in favor of Congress Financial Corporation
(Southwest) by Business Supplies Distributors
Holdings, LLC, Priority Fulfillment Services, Inc.
and PFSweb, Inc.
10.11** General Security Agreement by Priority Fulfillment
Services, Inc. in favor of Congress Financial
Corporation (Southwest).
10.12** Inducement Letter by Priority Fulfillment Services,
Inc. and PFSweb, Inc. in favor of Congress Financial
Corporation (Southwest).
</Table>
- ----------
* Incorporated by reference from PFSweb, Inc. Registration Statement on
Form S-1 (Commission File No. 333-87657).
** Filed herewith.