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 September 30, 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
- ------------------------------------------ --------------------------
(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 November 11, 2003 there were 20,971,317 shares of registrant's common stock
outstanding, excluding 86,300 shares of common stock in treasury.
PFSWEB, INC. AND SUBSIDIARIES
FORM 10-Q
SEPTEMBER 30, 2003
INDEX
<Table>
<Caption>
PAGE
NUMBER
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 2003
(unaudited) and December 31, 2002 ..................................... 3
Unaudited Interim Condensed Consolidated Statements of Operations
for the Three and Nine Months Ended September 30, 2003 and 2002 ....... 4
Unaudited Interim Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2003 and 2002 ................. 5
Notes to Unaudited Interim Condensed Consolidated Financial Statements .. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................................. 17
Item 3. Quantitative and Qualitative Disclosure about Market Risk ............... 27
Item 4. Controls and Procedures ................................................. 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ....................................................... 28
Item 2. Changes in Securities and Use of Proceeds ............................... 28
Item 3. Defaults Upon Senior Securities ......................................... 28
Item 4. Submission of Matters to a Vote of Security Holders ..................... 28
Item 5. Other Information ....................................................... 28
Item 6. Exhibits and Reports on Form 8-K ........................................ 28
SIGNATURES ........................................................................ 29
</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>
September 30, December 31,
2003 2002
------------- ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................................................ $ 11,350 $ 8,595
Restricted cash .......................................................... 1,429 1,016
Accounts receivable, net of allowance for doubtful accounts of $633
and $411 at September 30, 2003 and December 31, 2002, respectively .. 31,616 29,961
Inventories, net ......................................................... 37,877 46,291
Other receivables ........................................................ 4,048 3,417
Prepaid expenses and other current assets ................................ 3,163 2,888
--------- ---------
Total current assets ....................................... 89,483 92,168
--------- ---------
PROPERTY AND EQUIPMENT, net .................................................. 9,732 11,695
RESTRICTED CASH .............................................................. 876 2,878
OTHER ASSETS ................................................................. 171 285
--------- ---------
Total assets ............................................... $ 100,262 $ 107,026
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt and capital lease obligations .......... $ 51,305 $ 60,863
Trade accounts payable ................................................... 11,968 7,317
Accrued expenses ......................................................... 7,799 7,862
--------- ---------
Total current liabilities .................................. 71,072 76,042
--------- ---------
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS, less current
portion ................................................................ 2,544 3,094
OTHER LIABILITIES ............................................................ 1,132 1,420
COMMITMENTS AND CONTINGENCIES
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;
19,178,459 and 18,397,983 shares issued at September 30, 2003 and
December 31, 2002, respectively; and 19,092,159 and 18,311,683
outstanding at September 30, 2003 and December 31, 2002, respectively .. 19 18
Additional paid-in capital ............................................... 52,673 52,094
Accumulated deficit ...................................................... (28,005) (25,557)
Accumulated other comprehensive income ................................... 912 --
Treasury stock at cost, 86,300 shares at September 30, 2003 and
December 31, 2002 .................................................... (85) (85)
--------- ---------
Total shareholders' equity ................................. 25,514 26,470
--------- ---------
Total liabilities and shareholders' equity ................. $ 100,262 $ 107,026
========= =========
</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 Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
REVENUES:
Product revenue, net ........................ $ 60,300 $ -- $ 183,156 $ --
--------- --------- --------- ---------
Gross service fee revenue ................... 8,918 8,583 27,445 26,289
Gross service fee revenue, affiliate ........ -- 1,722 -- 4,862
--------- --------- --------- ---------
Total gross service fee revenue ........... 8,918 10,305 27,445 31,151
Less pass-through charges ................... 858 783 2,296 2,973
--------- --------- --------- ---------
Net service fee revenues .................. 8,060 9,522 25,149 28,178
--------- --------- --------- ---------
Total net revenues ........................ 68,360 9,522 208,305 28,178
--------- --------- --------- ---------
COSTS OF REVENUES:
Cost of product revenue ..................... 56,988 -- 172,980 --
Cost of net service fee revenue ............. 5,691 5,797 17,018 17,552
--------- --------- --------- ---------
Total costs of revenues ................... 62,679 5,797 189,998 17,552
--------- --------- --------- ---------
Gross profit .............................. 5,681 3,725 18,307 10,626
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES ..................................... 6,275 6,669 18,830 20,636
SEVERENCE AND OTHER TERMINATION COSTS ........... -- 1,248 -- 1,248
ASSET IMPAIRMENTS ............................... -- 922 -- 922
--------- --------- --------- ---------
Loss from operations ...................... (594) (5,114) (523) (12,180)
EQUITY IN EARNINGS OF AFFILIATE ................. -- 265 -- 1,163
INTEREST EXPENSE ................................ 489 114 1,685 264
INTEREST INCOME ................................. (14) (269) (96) (952)
--------- --------- --------- ---------
Loss before income taxes .................. (1,069) (4,694) (2,112) (10,329)
INCOME TAX PROVISION ............................ 72 -- 336 --
--------- --------- --------- ---------
NET LOSS .................................. $ (1,141) $ (4,694) $ (2,448) $ (10,329)
========= ========= ========= =========
NET LOSS PER SHARE:
Basic and diluted ........................... $ (0.06) $ (0.26) $ (0.13) $ (0.57)
========= ========= ========= =========
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic and diluted ........................... 18,761 18,268 18,537 18,201
========= ========= ========= =========
</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>
Nine Months Ended
September 30,
--------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................ $ (2,448) $(10,329)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization ........................................ 3,497 4,607
Asset impairments .................................................... -- 922
Provision for doubtful accounts ...................................... 387 (29)
Provision for excess and obsolete inventory .......................... 1,412 --
Deferred income taxes ................................................ (78) --
Equity in earnings of affiliate ...................................... -- (1,163)
Non-cash compensation expense ........................................ 6 28
Changes in operating assets and liabilities:
Accounts receivables ............................................. (1,094) 26
Inventories, net ................................................. 8,528 --
Prepaid expenses, other receivables and other current assets ..... (459) 1,227
Accounts payable, accrued expenses and deferred income ........... 3,948 1,720
-------- --------
Net cash provided by (used in) operating activities ......... 13,699 (2,991)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ..................................... (1,002) (1,485)
Decrease (increase) in restricted cash .................................. 1,700 (154)
Proceeds from loans to affiliate, net ................................... -- 2,855
-------- --------
Net cash provided by investing activities ................... 698 1,216
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations ................................... (672) (845)
Decrease in restricted cash ............................................. (29) --
Proceeds from issuance of common stock .................................. 573 113
Proceeds from (payments on) debt, net ................................... (11,352) 325
-------- --------
Net cash used in financing activities ....................... (11,480) (407)
-------- --------
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS ....................... (162) 124
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........................ 2,755 (2,058)
CASH AND CASH EQUIVALENTS, beginning of period .............................. 8,595 10,669
-------- --------
CASH AND CASH EQUIVALENTS, end of period .................................... $ 11,350 $ 8,611
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Non-cash investing and financing activities:
Fixed assets acquired under capital leases .............................. $ 204 $ 779
======== ========
</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 OVERVIEW
PFSweb, Inc. and its subsidiaries are collectively referred to as the
"Company," while the term "PFSweb" refers to PFSweb, Inc. and its subsidiaries
excluding Business Supplies Distributors Holdings, LLC and its subsidiaries.
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. PFSweb 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 agreements between PFSweb and
Supplies Distributors, PFSweb 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 to Global Marketing Services, Inc. ("GMS") the product demand
generation function for the IBM products distributed by Supplies Distributors.
Supplies Distributors, via its arrangements with GMS and PFSweb, sells its
products in the United States, Canada and Europe.
All of the agreements between PFSweb and Supplies Distributors were made in
the context of a related party relationship and were negotiated in the overall
context of PFSweb'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, PFSweb 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 and nine months ended
September 30, 2002. Effective October 1, 2002, PFSweb 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 of the Company, for
comparative purposes, assuming the acquisition had occurred on January 1, 2002:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
------------------ ------------------
Net revenues ....... $ 65,443 $ 187,098
============= =============
Net loss ........... $ (4,489) $ (9,684)
============= =============
Loss per share ..... $ (0.25) $ (0.53)
============= =============
</Table>
6
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The pro forma data for the nine months ended September 30, 2002 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 Supplies Distributors been
consolidated during the period noted.
The unaudited interim condensed consolidated financial statements as of
September 30, 2003, and for the three and nine months ended September 30, 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 September 30, 2003, its results of operations for the
three and nine months ended September 30, 2003 and 2002 and its results of cash
flows for the nine months ended September 30, 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 (loss) or shareholders' equity.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
All intercompany accounts and transactions have been eliminated in
consolidation. Accounts and transactions between PFSweb and Supplies
Distributors have been eliminated as of September 30, 2003 and December 31, 2002
and for the three and nine months ended September 30, 2003.
INVESTMENT IN AFFILIATE
In July 2001, PFSweb purchased a 49% equity interest in Supplies
Distributors. Effective October 1, 2002, PFSweb purchased the remaining 51%
equity interest of Supplies Distributors. Prior to consolidating Supplies
Distributors' financial position and results of operations, PFSweb 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 PFSweb
recording its allocated earnings of Supplies Distributors or 100% of Supplies
Distributors' losses.
In addition to the equity investment, PFSweb loaned Supplies Distributors
funds 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 September 30,
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. These estimates include allowances for the
collectibility of accounts and other receivables, the recoverability of
inventory and liabilities for incurred but not reported healthcare claims. 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 accrued expenses 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 10% of the Company's total
product revenues for the nine months ended September 30, 2003. Service fee
revenue from two clients accounted for approximately 40% and 16% of net service
fee revenue for the nine months ended September 30, 2003. On a consolidated
basis, two customers/clients accounted for approximately 16% and 10% of the
Company's total revenues for the nine months ended September 30, 2003. As of
September 30, 2003, three customers/clients accounted for approximately 51% of
accounts receivable. As of December 31, 2002, three customers/clients accounted
for approximately 39% of accounts receivable.
In conjunction with Supplies Distributors' financing, PFSweb 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 certain
master distributor agreements, subject to certain termination rights, but has
the right to return product rendered obsolete by engineering changes, as
defined. 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. During the three months ended September 30, 2003, the Company agreed
to certain modifications to a selected master distributor agreement. As a result
of these modifications, the Company reevaluated its inventory for impairment as
of September 30, 2003. Based on such review, the Company increased its allowance
for slow moving inventory from $0.2 million as of June 30, 2003, ($0.1 million
at December 31, 2002) to $1.6 million as of September 30, 2003.
In the event the Company, Supplies Distributors and IBM do not renew their
Master Distributor Agreements, the parties shall mutually agree on a plan of
disposition of Supplies Distributors' then existing inventory.
9
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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
$3.5 million and $4.3 million, net of accumulated amortization of approximately
$4.8 million and $3.5 million, at September 30, 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 and nine months ended
September 30, 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 periods may not be representative of the pro forma
effect for future periods due to the impact of vesting and potential future
awards.
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2003 2002 2003 2002
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net loss as reported ...................................... $ (1,141) $ (4,694) $ (2,448) $(10,329)
Add: Stock-based non-employee compensation expense
included in reported net loss ......................... -- -- 6 28
Deduct: Total stock-based employee and non-employee
compensation expense determined under fair value
based method .......................................... (107) (262) (418) (1,578)
-------- -------- -------- --------
Pro forma net loss, applicable to common stock for basic
and diluted computations .............................. $ (1,248) $ (4,956) $ (2,860) $(11,879)
======== ======== ======== ========
Loss per common share - as reported
Basic and diluted ..................................... $ (0.06) $ (0.26) $ (0.13) $ (0.57)
======== ======== ======== ========
Loss per common share - pro forma
Basic and diluted ..................................... $ (0.07) $ (0.27) $ (0.15) $ (0.65)
======== ======== ======== ========
</Table>
During the nine months ended September 30, 2003, the Company issued an
aggregate of 831,000 options to purchase shares of common stock to officers,
directors, employees and consultants of PFSweb.
10
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3. RECENTLY ISSUED ACCOUNTING PRINCIPLES
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
adoption of EITF 00-21 did not have a material impact on the consolidated
financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150
establishes standards for how an issuer measures certain financial instruments
with characteristics of both liabilities and equity and classifies them in its
statements of financial position. It requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances) when that financial instrument embodies an obligation of the
issuer. This Statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003, and the adoption of SFAS 150
did not have a material impact on the consolidated financial statements.
11
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4. COMPREHENSIVE LOSS (IN THOUSANDS)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net loss ............................ $ (1,141) $ (4,694) $ (2,448) $(10,329)
Other comprehensive income (loss):
Foreign currency translation
adjustment .................. 104 (186) 912 680
-------- -------- -------- --------
Comprehensive loss .................. $ (1,037) $ (4,880) $ (1,536) $ (9,649)
======== ======== ======== ========
</Table>
5. NET LOSS PER COMMON SHARE AND COMMON SHARE EQUIVALENT
Basic and diluted net loss per common share attributable to the Company's
common stock were determined based on dividing the net loss available to common
stockholders by the weighted-average number of common shares outstanding. For
the three and nine months ended September 30, 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 September 30, 2003 and
2002 there were 4,668,292 and 4,953,814 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):
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Term master lease agreement .......................... $ 3,847 $ 4,627
Inventory and working capital financing agreements:
United States ................................... 22,170 28,147
Europe .......................................... 10,386 15,219
Loan and security agreements:
Supplies Distributors ........................... 12,804 12,552
PFSweb .......................................... 1,289 --
Factoring agreement, Europe .......................... 3,123 3,202
Other ................................................ 230 210
------- -------
Total ........................................... 53,849 63,957
Less current portion of long-term debt ............... 51,305 60,863
------- -------
Long-term debt, less current portion ............ $ 2,544 $ 3,094
======= =======
</Table>
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
eligible 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 Demand Note receivable balance from
Supplies Distributors of $8.0 million and a minimum shareholders' equity, as
defined, 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.
12
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 $14.1 million) (19.0
million euros, or approximately $21.4 million at December 31, 2002) in financing
for eligible 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 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 Demand Note receivable balance from
Supplies Distributors of $8.0 million and a minimum shareholders' equity 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 Demand Note 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 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, of $19.0
million 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. On September 11, 2003, the Borrowers and Comerica amended
this agreement to provide for up to $5.0 million of eligible accounts receivable
financing and up to
13
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
$2.5 million of eligible equipment purchases ("Equipment Advances"). Outstanding
Equipment Advances under the amended Comerica facility accrue interest at prime
rate plus 1.5% and have a final maturity date of September 10, 2006. The
amendment requires the Borrowers to maintain a minimum cash balance of $1.25
million at Comerica.
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 $8.4 million) (originally 10 million euros, amended
in October 2002) of eligible accounts receivables, which has subsequently been
amended. Borrowings under this agreement can be either cash advances or straight
loans, as defined. Cash advances accrue interest at 7.9%, 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.
DEBT COVENANTS
To the extent PFSweb or Supplies Distributors fail to comply with their
covenants, including the monthly financial covenant requirements and required
minimum level of consolidated shareholders' equity ($19.0 million), as defined,
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 September 30, 2003, PFSweb 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, PFSweb 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 PFSweb owned, individually, a 9.8% non-voting
interest, and, collectively, a 49% non-voting interest, in IFP. Effective
October 1, 2002, PFSweb purchased the remaining 51% interest in Supplies
Distributors from IFP for $0.3 million.
Pursuant to the terms of PFSweb's transaction management services agreement
with Supplies Distributors, PFSweb 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 $1.7 million and $4.7 million for the three and nine months,
respectively, ended September 30, 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. PFSweb recorded $0.3
million and $1.2 million of equity in the earnings of Supplies Distributors,
14
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
prior to the October 1, 2002 acquisition, for the three and nine months ended
September 30, 2002, respectively. As a result of PFSweb's 100% ownership of
Supplies Distributors, future earnings and dividends will be allocated and paid
100% to PFSweb. 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 $600,000, which was paid in
September 2003.
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.
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 $0.1 million and $0.3 million were paid during the three and nine
months ended September 30, 2003, respectively. The remaining $0.1 million at
September 30, 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 next twelve months.
9. COMMITMENTS AND CONTINGENCIES
On August 12, 2003, we received a NASDAQ Listing Qualifications Panel
Notification that PFSweb has evidenced compliance with all NASDAQ SmallCap
Market listing requirements. Accordingly, our stock will continue to be traded
on The NASDAQ SmallCap Market. The Panel has closed our hearing file, and
PFSweb's common stock will not be subject to delisting.
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.
15
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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.
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues (in thousands):
PFS ....................... $ 10,079 $ 9,522 $ 31,137 $ 28,178
Supplies Distributors ..... 60,300 -- 183,156 --
Eliminations .............. (2,019) -- (5,988) --
--------- --------- --------- ---------
$ 68,360 $ 9,522 $ 208,305 $ 28,178
========= ========= ========= =========
</Table>
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Long-lived assets (in thousands):
PFS ............................... $ 9,732 $11,710
Supplies Distributors ............. 14 35
------- -------
$ 9,746 $11,745
======= =======
</Table>
11. SUBSEQUENT EVENT
On November 7, 2003, the Company entered into a Securities Purchase
Agreement (the "Agreement") with certain institutional investors in a private
placement transaction pursuant to which the Company issued and sold an aggregate
of 1,581,944 shares of its common stock, par value $.001 per share (the "Common
Stock"), at $2.16 per share, resulting in gross proceeds of $3.4 million. After
deducting expenses, the net proceeds are approximately $3.2 million. In addition
to the Common Stock, the investors received one-year warrants to purchase an
aggregate 525,692 shares of Common Stock at an exercise price of $3.25 per share
and four-year warrants to purchase an aggregate of 395,486 shares of Common
Stock at an exercise price of $3.30 per share (collectively with the one year
warrants, the "Warrants").
The securities issued in the private placement have not been registered
under the Securities Act of 1933 or any state securities laws and unless so
registered may not be offered or sold except pursuant to an exemption from, or
in a transaction not subject to, the registration requirements of the Securities
Act of 1933 and applicable state securities laws. The Company has agreed to file
a registration statement within 30 days for the resale of the shares of the
Common Stock, including all shares of Common Stock underlying the Warrants, and
to use its reasonable efforts to have the registration statement declared
effective by the Securities and Exchange Commission within 90 days of the
closing. The Company will be required to pay a monthly penalty to the investors
equal to 1% of the aggregate proceeds paid by the investors to the Company, pro
rated for each day after the 90th day that the registration statement has not
been declared effective and under certain other circumstances described in the
Agreement.
The Company intends to use the net proceeds from the private placement for
general working capital purposes.
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 our ability to comply with our obligations under our recently completed
private placement transaction and whether warrants sold in the private
placement will be exercised in the future.
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.
<Table>
<Caption>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Product revenue, net .......................... 88.2% --% 87.9% --%
------ ------ ------ ------
Gross service fee revenue ..................... 13.0 90.1 13.2 93.3
Gross service fee revenue, affiliate .......... -- 18.1 -- 17.3
------ ------ ------ ------
Total gross service fee revenue ..... 13.0 108.2 13.2 110.6
Pass-through charges .......................... (1.2) (8.2) (1.1) (10.6)
------ ------ ------ ------
Net service fee revenues ...................... 11.8 100.0 12.1 100.0
------ ------ ------ ------
Total net revenues .................. 100.0 100.0 100.0 100.0
------ ------ ------ ------
Cost of product revenue (as % of product
revenue) ............................... 94.5 -- 94.4 --
Cost of service fee revenue (as % of net
service fee revenue) ................... 70.6 60.9 67.7 62.3
------ ------ ------ ------
Total costs of revenues ............. 91.7 60.9 91.2 62.3
------ ------ ------ ------
Gross profit ........................ 8.3 39.1 8.8 37.7
Selling, general and administrative expenses .. 9.2 70.0 9.0 73.2
Severance and other termination costs ......... -- 13.1 -- 4.4
Asset impairments ............................. -- 9.7 -- 3.3
------ ------ ------ ------
Loss from operations ................ (0.9) (53.7) (0.2) (43.2)
Equity in earnings of affiliate ............... -- 2.8 -- 4.1
Interest expense .............................. 0.7 1.2 0.8 0.9
Interest income ............................... -- (2.8) -- (3.3)
------ ------ ------ ------
Loss before income taxes ............ (1.6) (49.3) (1.0) (36.7)
Income tax expense ............................ 0.1 -- 0.2 --
------ ------ ------ ------
Net loss ............................ (1.7)% (49.3)% (1.2)% (36.7)%
====== ====== ====== ======
</Table>
RESULTS OF OPERATIONS FOR THE INTERIM PERIODS ENDED SEPTEMBER 30, 2003 AND 2002
Product Revenue. Product revenue was $60.3 million and $183.2 million for
the three and nine months ended September 30, 2003, respectively, which reflects
product sales for Supplies Distributors subsequent to its consolidation
effective October 1, 2002 (see "Supplies Distributors"). Supplies Distributors
had $57.6 and $163.7 million of product revenue for the three and nine months,
respectively, ended September 30, 2002 prior to consolidation. Based on Supplies
Distributors' current business plan, we expect to report future product revenue
of approximately $60 million to $70 million in the fourth quarter of 2003.
Net Service Fee Revenue (including service fee revenue, affiliate). Net
service fee revenue was $8.1 million for the three months ended September 30,
2003 as compared to $9.5 million for the three months ended September 30, 2002,
a decrease of $1.4 million or 14.9%. We earned $0.2 million of service fee
revenues in the three months ended September 30, 2003, applicable to new service
contract relationships. For the three months ended September 30, 2003, service
fee revenues from existing clients increased $0.2 million from the prior period,
including the impact of organic client growth and certain incremental projects.
However, service fee revenues also decreased by (i) $2.0 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, and (ii) the impact of certain client terminations in calendar year 2002,
which had generated $0.1 million of net service fee revenue in the prior year
period. Net service fee revenue was $25.1 million for the nine months ended
September 30, 2003 as compared to $28.2 million for the nine months ended
September 30, 2002, a decrease of $3.1 million or 11.0%. We earned $1.1 million
of service fee revenues in the nine months ended September 30, 2003, applicable
to new service contract relationships. For the nine months ended September 30,
2003, service fee revenues from existing clients increased $1.8 million from the
prior period. However, these increases were more than offset primarily by (i)
$6.0 million applicable to the elimination of service fee revenue, affiliate
earned from our arrangements
19
with Supplies Distributors, subsequent to its consolidation effective October 1,
2002, and (ii) the impact of certain client terminations in calendar year 2002,
which had generated $1.2 million of net service fee revenue in the prior year
period.
Cost of Product Revenue. Cost of product revenue was $57.0 million and
$173.0 million for the three and nine months ended September 30, 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% and 94.4% during the three and nine months ended
September 30, 2003, respectively. Cost of product revenue includes additional
reserves for inventory impairment of $1.4 million and $1.5 million for the three
and nine months ended September 30, 2003, respectively. These additional
reserves were partially offset by other inventory cost reductions from a vendor.
The resulting gross profit margin was 5.5% and 5.6% for the three and nine
months ended September 30, 2003, respectively, and includes the effect of the
additional inventory impairment reserves and cost reductions along with certain
increases in the sales prices for certain related product. Supplies Distributors
had $54.4 million and $154.3 million of cost of product revenue, prior to
consolidation, for the three and nine months ended September 30, 2002,
respectively. The resulting gross profit margin was 5.6% and 5.7% for the three
and nine months ended September 30, 2002, respectively. Based on Supplies
Distributors' current business plan, we expect to report future cost of product
revenue of approximately $57 million to $67 million in the fourth quarter of
2003.
Cost of Net Service Fee Revenue. Cost of net service fee revenue was $5.7
million for the three months ended September 30, 2003, as compared to $5.8
million during the three months ended September 30, 2002, a decrease of $0.1
million or 1.7%. The resulting service fee gross profit was $2.4 million or
29.4% of net service fee revenue, during the three months ended September 30,
2003 as compared to $3.7 million, or 39.1% of net service fee revenue for the
three months ended September 30, 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 due to our
consolidation in October 2002. Cost of net service fee revenue was $17.0 million
for the nine months ended September 30, 2003, as compared to $17.5 million
during the nine months ended September 30, 2002, a decrease of $0.5 million or
2.9%. The resulting service fee gross profit was $8.1 million or 32.3% of net
service fee revenue, during the nine months ended September 30, 2003 as compared
to $10.6 million, or 37.7% of net service fee revenue for the nine months ended
September 30, 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. 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 30-40%.
Selling, General and Administrative Expenses. SG&A expenses were $6.3
million for the three months ended September 30, 2003, or 9.2% of total net
revenues, as compared to $6.7 million, or 70.0% of total net revenues, for the
three months ended September 30, 2002. SG&A expenses were $18.8 million for the
nine months ended September 30, 2003, or 9.0% of total net revenues, as compared
to $20.6 million, or 73.2% of total net revenues, for the nine months ended
September 30, 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 in the fourth quarter of 2003.
Asset Impairments. For the three and nine months ended September 30, 2002,
we recorded $0.9 million of expense for asset impairment and abandonment
charges. This charge relates to an older warehouse management system that was
upgraded to a new system during the quarter, as well as the disposition of
certain other assets no longer used in the business.
Severance and Other Terminations Costs. For the three and nine months ended
September 30, 2002, we recorded $1.2 million of severance and other termination
charges associated with a restructuring plan to reduce costs.
Equity in Earnings of Affiliate. For the three and nine months ended
September 30, 2002, we recorded $0.3 million and $1.2 million, respectively, of
equity in earnings of affiliate that represents our allocation of
20
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.
Interest Expense. Interest expense was $0.5 million for the three months
ended September 30, 2003 as compared to $0.1 million for the three months ended
September 30, 2002. Interest expense was $1.7 million for the nine months ended
September 30, 2003 as compared to $0.3 million for the nine months ended
September 30, 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 $0.4 million to
$0.7 million in the fourth quarter of 2003.
Interest Income. Interest income was $0.01 million and $0.3 million for the
three months ended September 30, 2003 and 2002, respectively. Interest income
was $0.1 million and $1.0 million for the nine months ended September 30, 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 and $0.7 million for the
three and nine months ended September 30, 2003 respectively. Interest income
decreased as compared to the three and nine months ended September 30, 2002,
respectively, 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 and nine months ended September 30, 2003, we
recorded a tax provision of $0.1 million and $0.3 million, respectively,
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 September 30, 2003, which are
primarily related to our net operating loss carryforwards. For the three and
nine months ended September 30, 2002, we did not record an income tax benefit.
We did not record an income tax benefit for our PFSweb 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.
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 September 30, 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 September 30, 2003, the subsequently amended asset-based
credit facilities provided financing for up to $27.5 million and up to 12.5
million Euros (approximately $14.1 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
21
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 $8.4 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, as defined, 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 $1.7 million
and $4.7 million for the three and nine months ended September 30, 2002,
respectively.
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 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 $0.3 million and $1.2 million of equity in the earnings of
Supplies Distributors for the three and nine months ended September 30, 2002,
respectively. 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
March 2003, Supplies Distributors received lender approval for a distribution to
us of $600,000, which was paid in September 2003.
Beginning October 1, 2002, as a result of the purchase, we now 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 September 30, 2002, assuming our purchase of the
remaining 51% interest in Supplies Distributors from IFP had occurred in January
2002, would have been $65.4 million and $4.5 million, respectively. Pro forma
net revenues and pro forma net loss for the nine months ended September 30,
2002, assuming our purchase of the remaining 51% interest in Supplies
Distributors from IFP had occurred in January 2002, would have been $187.1
million and $9.7 million, respectively. The pro forma data for the nine months
ended September 30, 2002 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.
22
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $13.7 million for the nine
months ended September 30, 2003, and primarily resulted from a $8.5 million
decrease in inventory and an increase in accounts payable and accrued expenses
of $3.9 million, partially offset by an increase in accounts receivable of $1.1
million. The September 30, 2003, accounts payable balance was higher than normal
primarily due to the timing of invoice processing by our large master
distributor vendor and due to the timing of certain client remittances. We
expect accounts payable to decrease during the December 31, 2003 quarter. Net
cash used in operating activities was $3.0 million for the nine months ended
September 30, 2002, and primarily resulted from cash used to fund operating
losses, partially offset by an increase in accounts payable and accrued expenses
of $1.7 million and a decrease in prepaid expenses, other receivables and other
current assets of $1.2 million.
Net cash provided by investing activities for the nine months ended
September 30, 2003 totaled $0.7 million, resulting primarily from a decrease in
restricted cash offset by capital expenditures. Net cash provided by investing
activities totaled $1.2 million for the nine months ended September 30, 2002,
representing the net repayment of $2.9 million by Supplies Distributors of the
subordinated loan, offset by capital expenditures of $1.5 million and a $0.2
million increase in our restricted cash balance. 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 $11.5 million for
the nine months ended September 30, 2003, primarily representing $0.7 million of
payments on our capital lease obligations and $11.4 million of payments on debt,
offset by $0.6 million of proceeds from the issuance of common stock pursuant to
our employee stock purchase and stock option programs. As a result of
anticipated reductions in our accounts payable balance during the December 31,
2003 quarter, we expect to have corresponding increases in our outstanding debt
levels. Net cash used in financing activities was approximately $0.4 million for
the nine months ended September 30, 2002, representing $0.8 million of payments
on our long-term debt and capital lease obligations offset by the proceeds from
debt and from the issuance of common stock pursuant to our employee stock
purchase program.
During the nine months ended September 30, 2003, our working capital
increased slightly to $18.4 million from $16.1 million at December 31, 2002
resulting primarily from a reduction in our restricted cash balance, which
resulted in a reclassification of a portion of our restricted cash from a
long-term asset to a current asset. To obtain additional financing in the
future, in addition to our current cash position, we plan to evaluate various
financing alternatives including the sale of equity (including a November 2003
private placement transaction discussed below), 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 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.
23
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):
<Table>
<Caption>
TOTAL
CONTRACTUAL
DEBT AND CONTRACTUAL CASH AND
OPERATING CAPITAL OTHER
LEASES LEASES OBLIGATIONS
--------- ----------- -----------
Twelve Months Ended September 30,
2004....................................... $ 55,713 $ 921 $ 56,634
2005....................................... 3,568 575 4,143
2006....................................... 3,291 429 3,720
2007....................................... 1,907 425 2,332
2008....................................... 894 283 1,177
Thereafter................................. 326 -- 326
--------- -------- ---------
Total contractual cash obligations... $ 65,699 $ 2,633 $ 68,332
========= ======== =========
</Table>
In support of certain debt instruments and leases, as of June 30, 2003, we
had $2.8 million of cash restricted as collateral for letters of credit. In
September 2003, in connection with the amendment to our credit facility with
Comerica, we refinanced certain debt instruments and leases. This refinancing
allowed us to reduce the amount of letters of credit, and resulting restricted
cash collateral to $1.1 million. The remaining letters of credit currently
expire at various dates through April 2006, 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 September 30, 2003, the outstanding
balance of our senior credit facilities was approximately $50.0 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 September 30, 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
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, including
service fees earned from our subsidiary Supplies Distributors, which are
eliminated in consolidation. No assurance can be given that we can achieve such
operating levels, or that, if achieved, we will be profitable in any particular
fiscal period. We will reevaluate the carrying value of certain of the excess
long-lived warehouse operation and information technology infrastructure assets
for impairment in 2003, in conjunction with our future operating plans, and
determine if additional asset impairment costs should be recognized.
24
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 accrue interest at prime rate plus 1%. On September 11, 2003, the
Borrowers and Comerica amended this agreement to provide financing for up to
$5.0 million of eligible accounts receivable and financing for up to $2.5
million of eligible equipment purchases (Equipment Advances). Outstanding
Equipment Advances under the amended Comerica facility accrue interest at prime
rate plus 1.5% and have a final maturity date of September 10, 2006. 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. At September 30, 2003, we had $1.3 million
outstanding under this facility that was subsequently repaid in October 2003.
The amendment in September 2003 allowed us to reduce certain of our existing
letters of credit, and thus remove restrictions on the related cash security.
On November 7, 2003, We entered into a Securities Purchase Agreement (the
"Agreement") with certain institutional investors in a private placement
transaction pursuant to which we issued and sold an aggregate of 1,581,944
shares of our common stock, par value $.001 per share (the "Common Stock"), at
$2.16 per share, resulting in gross proceeds of $3.4 million. After deducting
expenses, the net proceeds are approximately $3.2 million. In addition to the
Common Stock, the investors received one-year warrants to purchase an aggregate
525,692 shares of Common Stock at an exercise price of $3.25 per share and
four-year warrants to purchase an aggregate of 395,486 shares of Common Stock at
an exercise price of $3.30 per share (collectively with the one year warrants,
the "Warrants").
The securities issued in the private placement have not been registered
under the Securities Act of 1933 or any state securities laws and unless so
registered may not be offered or sold except pursuant to an exemption from, or
in a transaction not subject to, the registration requirements of the Securities
Act of 1933 and applicable state securities laws. We have agreed to file a
registration statement within 30 days for the resale of the shares of the Common
Stock, including all shares of Common Stock underlying the Warrants, and to use
our reasonable efforts to have the registration statement declared effective by
the Securities and Exchange Commission within 90 days of the closing. We will be
required to pay a monthly penalty to the investors equal to 1% of the aggregate
proceeds paid by the investors to the Company, pro rated for each day after the
90th day that the registration statement has not been declared effective and
under certain other circumstances described in the Agreement.
We intend to use the net proceeds from the private placement for general
working capital purposes.
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 the Company's liability to meet
NASDAQ Marketplace Rule 4450(a), which requires a minimum bid price of $1.00 for
continued listing on the NASDAQ National
25
Market. The SmallCap Market also has a minimum bid price of $1.00 per share. On
August 12, 2003, we received a NASDAQ Listing Qualifications Panel Notification
that PFSweb has evidenced compliance with all NASDAQ SmallCap Market listing
requirements. Accordingly, our stock will continue to be traded on the NASDAQ
SmallCap Market. The Panel has closed our hearing file, and PFSweb's common
stock will not be subject to delisting.
SEASONALITY
The seasonality of our business is dependent upon the seasonality of our
clients' business and sales 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 PFSweb 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.
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 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 our 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 our 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 our consolidated
financial statements.
26
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
adoption of EITF 00-21 did not have a material impact on our consolidated
financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150
establishes standards for how an issuer measures certain financial instruments
with characteristics of both liabilities and equity and classifies them in its
statements of financial position. It requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances) when that financial instrument embodies an obligation of the
issuer. This Statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003, and the adoption of SFAS 150
did not have a material impact on our consolidated financial statements.
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 agreements and
factoring agreement for the financing of inventory, accounts receivable and
certain other receivables, which amounted to $49.8 million at September 30,
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 September 30, 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
As required by Rule 13a-15(b), Company management, including the Chief Executive
Officer and Chief Financial Officer, conducted an evaluation as of the end of
the period covered by this report, of the effectiveness of the Company's
disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
effective as of the end of the period covered by this report. As required by
Rule 13a-15(d), Company management, including the Chief Executive Officer and
Chief Financial Officer, also conducted an evaluation of the Company's internal
control over financial reporting to determine whether any changes occurred
during the quarter covered by this report that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting. Based on that evaluation, there has been no such change
during the quarter covered by this report.
27
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:
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
------- -----------------------
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1** First Amendment to Loan and Security Agreement made as of
September 11, 2003 by and between Priority Fulfillment
Services, Inc., Priority Fulfillment Services of Canada,
Inc. and Comerica Bank.
31.1** Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350
31.2** Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350
32.1** Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32.2** Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
</Table>
- ----------
* 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 furnished on August 13, 2003 reporting Item 12, Results of
Operations and Financial Condition, that on August 13, 2003, PFSweb,
Inc. issued a press release announcing its financial results for the
quarter ended June 30, 2003.
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: November 14, 2003
PFSweb, Inc.
By: /s/ Thomas J. Madden
-------------------------------------
Thomas J. Madden
Chief Financial Officer,
Chief Accounting Officer,
Executive Vice President
29
INDEX TO EXHIBITS
<Table>
<Caption>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
------- -----------------------
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1** First Amendment to Loan and Security Agreement made as of
September 11, 2003 by and between Priority Fulfillment
Services, Inc., Priority Fulfillment Services of Canada,
Inc. and Comerica Bank.
31.1** Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350
31.2** Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350
32.1** Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32.2** Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
</Table>
* Incorporated by reference from PFSweb, Inc. Registration Statement on Form
S-1 (Commission File No. 333-87657).
** Filed herewith