Annual-Transition Report — [x] Reg. S-K Item 405 — Form 10-K
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Document/Exhibit Description Pages Size
1: 10KT405 Transition Report for Period 4/1/01 to 12/31/01 95 505K
2: EX-10.20 Ninth Amendment to Lease Agreement 8 39K
3: EX-10.21 Stock Option Agreement 8 34K
4: EX-21 Subsidiaries of the Registrant 1 5K
5: EX-23.1 Consent of Kpmg LLP 1 7K
6: EX-23.2 Consent of Arthur Andersen LLP 1 6K
10KT405 — Transition Report for Period 4/1/01 to 12/31/01
Document Table of Contents
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM APRIL 1, 2001 TO DECEMBER 31,
2001
COMMISSION FILE NUMBER 000-28275
[PFSWEB, INC. LOGO]
(Exact name of registrant as specified in its charter)
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DELAWARE 75-2837058
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
500 NORTH CENTRAL EXPRESSWAY, PLANO, TEXAS 75074
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
972-881-2900
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.001 PER SHARE
Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of February 28, 2002 (based on the closing price as reported
by the National Association of Securities Dealers Automated Quotation System)
was $15,429,859.
As of February 28, 2002, there were 18,149,496 shares of the registrant's
Common Stock, $.001 par value, outstanding, excluding 86,300 shares of common
stock in treasury.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this Annual Report, to the extent
not set forth herein, is incorporated herein by reference from the registrant's
definitive proxy statement relating to the annual meeting of stockholders to be
held in June 2002, which definitive proxy statement shall be filed with the
Securities and Exchange Commission within 120 days after the end of the fiscal
year to which this Annual Report relates.
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INDEX
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PAGE
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 27
Item 3. Legal Proceedings........................................... 27
Item 4. Submission of Matters to a Vote of Security Holders......... 27
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 28
Item 6. Selected Consolidated Financial Data........................ 28
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 30
Item 7a. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 43
Item 8. Consolidated Financial Statements and Supplementary Data.... 44
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 87
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 87
Item 11. Executive Compensation...................................... 87
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 87
Item 13. Certain Relationships and Related Transactions.............. 87
PART IV
Item 14. Exhibits, Consolidated Financial Statement Schedules, and
Reports on Form 8-K......................................... 87
Signatures............................................................ 92
Unless otherwise indicated, all references to "PFSweb," "the Company,"
"we," "us" and "our" refer to PFSweb, Inc., a Delaware corporation, and its
subsidiaries. All references to "Daisytek" refer to our former parent
corporation, Daisytek International Corporation, a Delaware corporation, and its
subsidiaries. Reference in this Report to the Company's fiscal year means the 12
month period ending on March 31 of such year. In June 2001, the Company elected
to change its fiscal year end date from March 31 to December 31. Consequently
the Company's most recently completed fiscal period is a nine month period ended
December 31, 2001.
1
PART I
ITEM 1. BUSINESS
GENERAL
PFSweb serves as the "brand behind the brand" for companies seeking to
increase their supply chain efficiencies. As a business process outsourcer,
offering scalable, cost effective, multi-channel infrastructure solutions for
manufacturers, distributors and retailers, we are able to provide our clients
with seamless and transparent solutions to support their business strategies.
Utilizing our technology and infrastructure expertise, we enable our clients to
develop and deploy new products and new business strategies rapidly through our
solutions. Our clients engage us as both a consultant to assist them in the
design of a business solution, as well as the virtual and physical
infrastructure needed to build and operate that solution.
We help our clients define new ways to do business, allowing them the
ability to quickly and dramatically change how they 'go-to-market.' Each client
has unique specifications that require highly customized solutions. Clients turn
to us to help address such business issues as customer satisfaction, production
capacity requirements, vendor integration, supply chain compression, and
international expansion, among others. We also act as an agent of change
providing clients the ability to alter the distribution channel, establish
direct relationships with key clients, and reduce the time and costs associated
with existing distribution channel strategies. Our clients are seeking solutions
that will provide them substantial supply chain and channel marketing
efficiencies, while simultaneously creating a world-class customer service
experience.
Our technology and business infrastructure are adaptable, changeable and
reliable. This flexibility allows us to design custom, variable cost solutions
to fit the business requirements of our client's strategies. Our revenue is
primarily earned from service fees charged to process individual business
transactions on our client's behalf through our technology and infrastructure
capabilities. These business transactions may include the answering of a phone
call or an e-mail, the design and hosting of a client web-site, the processing
of an electronic credit card authorization, the receipt and storage of our
client's inventory, the assembly of a kit of products to meet our customers
specifications, the shipping of products to our client's customer, the
management of a complex set of electronic data transactions designed to keep our
client's suppliers and customers accounting records in balance, or the
processing of a returned package.
Our capabilities are quite expansive. In an ongoing quest to offer the most
necessary and resourceful products to our clients, we are continually developing
capabilities to meet the most pressing business issues in the marketplace. Our
business objective is to focus on "Leading the Evolution of Outsourcing." As our
tagline suggests, we will continue to evolve our service offerings to meet the
needs of the marketplace and the demands of the unique client requirement. We
are most successful when we develop a new capability to enable a client to
pursue a new initiative and we are then able to leverage that revolutionary
development across other client or prospect solutions as it becomes "best
practice" in the marketplace. Our team of experts design and build diverse
solutions for Fortune 1000, Global 2000 and brand name clients around a flexible
core of technology and physical infrastructure that includes:
- Technology collaboration provided by our suite of software products,
called the Entente Suite(SM), that are e-commerce and collaboration tools
that enable buyers and suppliers to fully automate their business
transactions within their supply chain. Entente supports industry
standard collaboration techniques including XML based protocols such as
Biztalk and RosettaNet, real-time application interfaces, text file
exchanges via secured FTP, and traditional electronic data interchange
("EDI");
- Managed Web hosting and Web development, including web site design,
creation, integration and ongoing maintenance, support and enhancement of
web site;
- Order Management, including order processing from any source of entry,
back order processing and future order processing, tracking and tracing,
credit management, all with multiple currency and language options;
2
- Customer Relationship Management ("CRM"), including interactive voice
response ("IVR") technology and web-enabled customer contact services
through world-class call centers utilizing voice, e-mail, voice over
Internet protocol ("VOIP") and Internet chat communications that are
fully integrated with real-time systems and historical data archives to
provide complete customer lifecycle management;
- International fulfillment and distribution services, including warehouse
management, inventory management, product warehousing, order picking and
packing, transportation management and reverse logistics;
- Kitting and assembly services, including light assembly, procurement
services, Supplier Relationship Management, specialized kitting, and
supplier consigned inventory hubbing in PFSweb's distribution facilities
or co-located in other facilities;
- Information management, including real-time data interfaces, data
exchange services and data mining;
- Financial services, including secure on-line credit card processing,
fraud protection, invoicing, credit management and collection, and
working capital solutions; and
- Professional consulting services, including a consultative team of
experts that customize solutions to each client and consistently seek out
ways to increase efficiencies and produce benefits for the client.
We are headquartered in Plano, Texas where our executive and administrative
offices are located as well as our primary technology laboratories and hosting
facilities. We operate state-of-the-art call centers from our U.S. facilities
located in Plano, Texas, and Memphis, Tennessee, and from our international
facilities located in Toronto, Ontario and Liege, Belgium. We have more than one
million square feet of warehouse floor space located across our facilities in
Memphis, Toronto and Liege allowing us to provide global distribution solutions.
These distribution facilities are highly automated and contain state of the art
material handling and communications equipment. We provide solutions to clients
that are often regarded as market leaders in a variety of different industries.
Those industries include technology manufacturing, telecommunications, computer
consumables, direct marketing, apparel, retailing, collectibles, consumer goods,
personal care/cosmetics, pharmaceuticals, housewares and consumer electronics,
among others.
Prior to December 1999, we were a wholly-owned subsidiary of Daisytek
International Corporation ("Daisytek"), one of the world's largest wholesale
distributors of computer supplies, office products, and film and tape media. Our
business unit was formed in 1991 to leverage Daisytek's core competencies in
customer service, order management, product fulfillment and distribution. From
1996 to 1999, the operations of our business unit were primarily focused in
several Daisytek subsidiaries operating collectively as Priority Fulfillment
Services, Inc. ("PFS"). In June 1999, Daisytek created a separate wholly owned
subsidiary named PFSweb, Inc., a Delaware corporation, to become a holding
company for PFS in contemplation of an initial public offering (the "Offering")
of PFSweb. In December 1999, we sold 3,565,000 shares of common stock in the
Offering and Daisytek contributed to us all the assets, liabilities and equity
comprising PFS. PFSweb and Daisytek completed their separation on July 6, 2000
through a pro rata distribution to Daisytek's common stockholders of all of the
shares of our common stock which Daisytek then held (the "spin-off").
Upon completion of the Offering, we entered into a number of agreements
with Daisytek relating to our business and our proposed spin-off from Daisytek.
See "Spin-off of PFSweb from Daisytek." In May 2001, certain of these agreements
were terminated as part of a transaction in which we sold to Daisytek certain
assets used to provide transaction management services to Daisytek. As part of
this sale transaction, we also entered into a short term transition services
agreement with Daisytek which expired in November 2001.
Although we continue to be party to certain agreements with Daisytek
relating to the spin-off, we do not currently generate any revenues or incur any
expenses related to services for Daisytek.
3
INDUSTRY OVERVIEW
Business activities in the public and private sectors operate in an
environment of rapid technological advancement, increasing competition and
continuous pressure to improve operating and supply chain efficiency. In
response to these developments, several significant trends have emerged. For
example:
- Manufacturers are looking to restructure their supply chains to maximize
efficiency and reduce costs in both business-to-business and
business-to-consumer markets and to create a variable-cost supply chain
that is able to support the multiple unique needs of each of their
initiatives, including traditional and electronic commerce.
- Government agencies are focusing on improved citizen usability and
interaction, as well as the need to manage government initiatives from an
efficiency perspective.
- Companies in a variety of industries are using outsourcing as a method to
address one or more business functions that are either not within their
core business competencies, or to improve the speed or cost of
implementation.
SUPPLY CHAIN MANAGEMENT TREND
As companies continue to focus on improving their businesses and balance
sheet financial ratios, significant efforts and investments are being
contemplated and made to identify ways to maximize supply chain efficiency.
Working capital financing, vendor managed inventory, supply chain visibility
software solutions, distribution channel skipping, direct to consumer e-commerce
sales initiatives, and complex upstream supply chain collaborative technology
are products that manufacturers seek to help them achieve greater supply chain
efficiency. AMR Research predicts that the Supply Chain Management Market, which
we believe includes the type of products described above, will increase from
$6.7 billion in 2001 to nearly $21.1 billion by 2005.
A key business challenge facing many manufacturers and retailers as they
evaluate their supply chain efficiency is in determining how the trend for
consumers to shop via the Internet in an electronic commerce fashion will affect
their traditional commerce business model. AMR Research predicts that between
January 2002 and January 2003, companies will continue to increase spending
associated with eBusiness by 7%. While many leading industry experts have
tempered their e-commerce growth trend estimates downward over the past year, we
believe that companies will still need to continue to strategically plan for the
impact that e-commerce and other new technology advancements will have on their
traditional commerce business models and their existing technology and
infrastructure capabilities. eMarketer predicts that by 2004, business-to-
business e-commerce worldwide will reach $2.367 trillion up from $474 billion in
2001. While the majority of online transactions currently occur in the United
States and North America, in the coming years we believe that certain Asian and
European nations will experience significant growth in e-commerce transactions
as well.
Manufacturers, as buyers of materials, are also imposing new business
practices and policies on their supplier partners in order to shift the normal
supply chain costs and risk associated with inventory ownership away from their
own balance sheets. Through techniques like Vendor Managed Inventory ("VMI") or
Consigned Inventory Programs ("CIP") manufacturers are asking their suppliers,
as a part of the supplier selection process, to provide capabilities where the
manufacturer need not own, or even possess, inventory prior to the exact moment
that unit of inventory is required as a raw material component or for shipping
to a customer. In order to be successful for all parties, business models such
as these often require a sophisticated collection of technological capabilities
that allow for complete integration and collaboration of the information
technology environments of both the buyer and supplier. For example, in order
for an inventory unit to arrive at the precise required moment in the
manufacturing facility, it is necessary for the Manufacturing Resource Planning
("MRP") systems of the manufacturer to integrate with the CRM systems of the
supplier. When hundreds of supplier partners are involved, this process can
become quite complex and technologically challenging. Buyers and suppliers are
seeking solutions that utilize XML based protocols like Biztalk, RosettaNet and
other traditional EDI standards in order to insure an open systems platform that
promotes easier technology integration in these collaborative solutions.
4
GOVERNMENT OUTSOURCING TREND
The United States government has increased its focus on streamlining work
efforts and reducing overall governmental costs, which has led to further
evaluation of outsourcing as a possible avenue to achieve these goals. The
federal government has formulated an E-Government strategy, which was created to
support multi-agency projects that improve citizen services and yield
performance gains. Also, recent revisions to government mandate A-76 state that
Government agencies must conduct thorough audits to determine the lowest cost
and most efficient option, and to outsource to the public sector when in-house
operations are unable to compete.
With more than 60% of all Internet users coming into contact with
government websites, the necessity to transform business into a more
citizen-friendly environment is even more prevalent. As stated in the February
2002 E-Government Strategy document developed by the U.S. Office of Management
and Budget (OMB) E-Government task force, the primary goals for this initiative
are to:
- Make it easy for citizens to obtain service and interact with the federal
government;
- Improve government efficiency and effectiveness; and
- Improve the government's responsiveness to citizens.
Based on the U.S. federal budget, federal information technology (IT)
spending in the United States will exceed $48 billion in 2002 and $52 billion in
2003. This level of IT spending provides enormous opportunities for the
government to transform itself into a citizen-centered E-Government and provides
additional opportunities for the government to work with the public sector to
develop more user friendly methods of interaction. A significant portion of
current federal IT spending is devoted to Internet initiatives, yielding more
than 35 million web pages online at more than 22,000 web sites. Past
agency-centered IT approaches have limited the government's productivity gains
and ability to serve citizens. With this initiative, the federal government is
poised to transform the way it does business with citizens through the use of
E-Government.
The 2002 E-Government Strategy document goes on to state, "E-Government
provides many opportunities to improve the quality service to citizens. Citizens
should be able to get service or information in minutes or hours, versus today's
standard of days or weeks. Citizens, businesses and state and local governments
should be able to file required reports without having to hire accountants and
lawyers. Government employees should be able to do their work as easily,
efficiently and effectively as their counterparts in the commercial world.
Effective execution of this strategy are targeted to:
- Simplify delivery of services to citizens;
- Eliminate layers of government management;
- Make it possible for citizens, businesses, other levels of government and
federal employees to easily find information and get service from the
federal government;
- Simplify agencies' business processes and reducing costs through
integrating and eliminating redundant systems;
- Enable achievement of the other elements of the President's Management
Agenda; and
- Streamline government operations to guarantee rapid response to citizen
needs."
E-Government Strategy activities are centered on four citizen-centered
groups, including:
- Individuals/Citizens: Government-to-Citizens(G2C);
- Businesses: Government-to-Business(G2B);
- Intergovernmental: Government-to-Government(G2G);
- Intra-governmental: Internal Efficiency and Effectiveness(IEE);
5
Through the new Government E-Strategy, Government agencies are currently
faced with pressure to upgrade technology capabilities and to better interface
with their audiences. Combined with the A-76 initiative that directs Government
agencies to pursue the most cost-effective method of doing business, current
federal strategy now enforces government's need to better understand public
alternatives, submit to extensive requests for proposals to an array of
government and non-government providers, and to perform complex evaluations of
existing operations and functions. These initiatives will drive government usage
of outside sources.
OUTSOURCING TREND
In response to growing competitive pressures and technological innovations,
we believe many companies, both large and small, are focusing their critical
resources on the core competencies of their business and utilizing business
process outsourcing to accelerate their business plans in a cost-effective
manner and perform non-core business functions. Outsourcing provides many key
benefits, including the ability to:
- Capitalize on skills, expertise and technology infrastructure that would
otherwise be unavailable or expensive given the scale of the business;
- Reduce capital and personnel investments and convert fixed investments to
variable costs;
- Increase flexibility to meet changing business conditions and demand for
products and services;
- Enhance customer satisfaction and gain competitive advantage;
- Improve operating performance and efficiency; and
- Enter new business markets or geographic areas rapidly.
As a result, the market for outsourcing services and external services has
experienced significant growth. Gartner Dataquest predicts that the U.S.
external services market will reach $276 billion in 2002, an 8% increase over
the $254 billion spent in 2001. By 2005, they expect the industry to surpass
$395 million. Gartner Dataquest defines external services to include consulting,
application development and integration, management services and outsourcing,
business process management, transaction processing, hardware and software
support, and education and training. Gartner Dataquest foresees the Business
Process and Transaction Management (BPTM) services to have a strong growth rate
as enterprises attempt to reduce the cost of transaction processing in noncore
areas by turning to external suppliers. Worldwide BPTM services are expected to
total $145.2 billion in 2005, as compared to $74.8 billion in 2000.
Typically, outsourcing service providers are focused on a single function,
such as information technology, call center management, credit card processing,
warehousing or package delivery. This focus creates several challenges for
companies looking to outsource more than one of these functions, including the
need to manage multiple outsourcing service providers, to share information with
service providers and to integrate that information into their internal systems.
Additionally, the delivery of these multiple services must be transparent to the
customer and enable the client to maintain brand recognition and customer
loyalty.
Furthermore, traditional commerce outsourcers are frequently providers of
domestic-only services versus international solutions. As a result, companies
requiring global solutions must establish additional relationships with other
outsourcing parties.
Another vital point for major brand name companies seeking to outsource is
the protection of their brand. When looking for an outsourcing partner to
provide infrastructure solutions, brand name companies must find a company that
can ensure the same quality performance and superior experience that their
customers expect from their brands. Working with an outsourcing partner requires
finding a partner that can maintain the consistency of their brand image, which
is one of the most valuable intangible assets that recognized brand name
companies possess.
6
THE PFSWEB SOLUTION
PFSweb serves as the "brand behind the brand" for companies seeking to
increase the efficiencies of all aspects of their supply chain.
Our value proposition is to become an extension of our clients' businesses
by delivering a superior experience that increases and enhances sales and market
growth, customer satisfaction and customer retention. We act as both a virtual
and a physical infrastructure for our clients' businesses. By utilizing our
services, our clients are able to:
Quickly Capitalize on Market Opportunities. Our solutions empower clients
to rapidly implement their supply chain and e-commerce strategies and to take
advantage of opportunities without lengthy integration and implementation
efforts. We have ready built technology and physical infrastructure that is
flexible in its design, which facilitates quick integration and implementation.
Currently, PFSweb operates with substantial capacity in its call center,
technology and distribution areas further aiding our clients' speed to market.
The PFSweb solution is designed to allow our clients to deliver consistent
quality service as transaction volumes grow and also to handle daily and
seasonal peak periods. Through our international locations, our clients can use
the broad reach of the Internet and e-commerce to sell their products almost
anywhere in the world..
Improve the Customer Experience. We enable our clients to provide their
customers with a positive buying experience thereby maintaining and promoting
brand loyalty. Through our use of advanced technology, we can respond directly
to customer inquiries by e-mail, voice or data communication and assist them
with on-line ordering and product information. We offer our clients a "world
class" level of service, including 24-hour, seven-day-a-week, Web-enabled
customer care service centers, detailed CRM and exceptional order accuracy. We
have significant experience in the development of Internet web sites that allows
us to recommend features and functions that are easily navigated and understood
by our client's customers. Our technology platform is designed to ensure high
levels of reliability and fast response times for our clients' customers.
Because our technology is "world-class" our clients benefit from being able to
offer the latest in customer communication and response conveniences to their
customers.
Minimize Investment and Improve Operating Efficiencies. One of the most
significant benefits that outsourcing to PFSweb provides is the ability to
transform fixed costs into variable costs. By eliminating the need to invest in
a fixed capital infrastructure, our clients' costs typically become directly
correlated with volume increases or declines. Further, as volume increases drive
the demand for greater infrastructure or capacity, PFSweb is able to quickly
deploy additional resources. We provide services to multiple different clients,
which enables us to offer our clients economies of scale, and resulting cost
efficiency, that they may not have been able to obtain on their own.
Additionally, because of the large number of daily transactions we process,
PFSweb has been able to justify investments in levels of automation, security
surveillance, quality control processes and transportation carrier interfaces
that are typically outside the scale of investment that our clients might be
able to cost justify on their own. These additional capabilities can provide our
clients the benefits of enhanced operating efficiency, reduced inventory
shrinkage, and expanded customer service options.
Access a Sophisticated Technology Infrastructure. We provide our clients
with ready access to a sophisticated technology infrastructure through our
Entente Suite, which is designed to interface seamlessly with their systems. We
provide our clients with vital product and customer information which can be
immediately available to them on their own systems or through web based graphic
user interfaces for use in data mining, analyzing sales and marketing trends,
monitoring inventory levels and performing other management functions.
7
THE PFSWEB STRATEGY
Our objective is to grow by being an international provider of integrated
business process outsourcing solutions. As this evolution of our business model
continues, we remain focused today on the following fundamentals:
Focus on quality performance for our existing clients. By providing our
existing clients with superior operating results, we believe we can expand
relationships within these existing client accounts to service additional
product categories and business segments and to provide other additional
services. Our objective is to integrate ourselves to the point that we become
our clients' operations and technology departments. Based upon our clients'
needs, we will continue to introduce new services and products. We also intend
to continue our commitment to invest in state-of-the-art technology, equipment
and systems to provide new, high-quality, innovative solutions to our existing
clients and to attract new clients.
Engaging clients with founded business strategies and financial
stability. We intend to expand our business by targeting major brand name
companies with proven and founded business models that are seeking to adjust
their supply chain strategy or introduce new products or business programs into
their existing business. We believe these companies will be the leaders in the
evolving marketplace, and this focus will provide us with opportunities to grow
along with our clients' strategic initiatives.
Hiring, retaining and training high quality professionals. Our team of
people and their experience are crucial elements in the expansion of our
business because of the uniqueness of analyzing and developing successful
solutions to each individual client's business case. Hiring and retaining high
quality individuals who can design expert business solutions for our prospective
clients will allow PFSweb to continue to extend its expertise, knowledge, and
strategy to potential clients.
Inventing new technology and operational capabilities. We intend to
aggressively expand our market potential by inventing new technology and
operational capabilities that will continue to clearly differentiate PFSweb from
its competitors. We believe that companies are looking for new efficiencies that
they can utilize to reduce costs and save time. Based upon our clients' and
prospective clients' needs we will continue to evolve and develop solutions that
can produce the most positive changes within their organizations.
Controlling overhead costs while focusing on reducing our own excess
infrastructure. We intend to continue our focus on controlling overhead costs
in order to maintain our strong financial position. Our objective is to seek new
business to absorb current excess capacity and to reduce our overhead costs as a
percent of revenue. Through the successful execution of this strategy, it is our
objective to create a strong springboard towards achieving sustainable
profitability.
Seeking strategic opportunities, including acquisitions, that may further
our growth objectives. We intend to examine all possible avenues for business
growth, including acquisitions and strategic alliances. These alliances may
include relationships with consultants, software companies and other providers
of technology related services to assist in developing relationships with major
brand names that are reevaluating their current infrastructure. We may also
consider acquisitions of, or mergers with, synergistic businesses in order to
further expand our solution offering and client base, as well as to enhance
shareholder value.
To execute these strategies we may, among other things, continue to incur
significant operating and marketing expenses, invest in additional technology
infrastructure and continue to maintain certain excess capacity. The successful
balance of the execution of these strategies over the next year, we believe,
should result in the formation of a solid strategic and financial foundation for
PFSweb and provide PFSweb a sustainable and profitable business model for the
future.
See "Risk Factors" for a complete discussion of risk factors related to our
ability to achieve our objectives and fulfill our business strategies.
8
PFSWEB SERVICES
We offer a comprehensive and integrated set of business infrastructure
solutions that are tailored to our clients' specific needs and enable them to
quickly and efficiently implement their supply chain strategies. Our services
include:
Technology Collaboration. Specifically for e-commerce initiatives, PFSweb
has created the Entente Suite(SM), which alludes to the level of electronic
cooperation that is possible when we construct solutions with our clients using
this technology. This set of software solutions enables everything from order
processing and inventory reporting to total e-commerce design and
implementation. The Entente Suite comprises four key
components -- EntenteDirect(SM), EntenteMessage(SM), EntenteWeb(SM) and
EntenteReport(SM).
EntenteDirect provides customers with a real-time, user-friendly interface
between their system and PFSweb order processing and related functions. Using
real-time or batch processes, EntenteMessage is a file delivery solution for
clients using warehousing and distribution facilities. EntenteWeb is a one-stop
shop for the entire e-commerce process, particularly for companies with unusual
needs or specific requests that can't be met by the typical e-commerce
development packages. EntenteWeb is particularly focused to enable global
commerce strategies with its extensive currency and language functionality.
EntenteReport is a real-time, user-friendly data mining tool particularly suited
to companies that need to put key e-commerce data into the hands of business
users, but do not have the IT resources to facilitate the necessary data
extraction, manipulation and presentation. EntenteReport is web browser-based
and simplifies even the most complex data for extraction and analysis.
The Entente Suite operates in an open systems environment and features the
use of industry-standard XML, enabling customized e-commerce solutions with
minimal changes to a client's or our Enterprise Resource Planning ("ERP")
systems, speeding the implementation process. Additionally, by using XML, the
Entente Suite offers companies a more robust electronic information transfer
option than text file FTP or EDI.
Managed Web Hosting and Web Development. We offer a highly available and
secure managed web hosting solution that encompasses complete creation and
maintenance of client web sites. Operating with an in-house creative staff, we
customize commerce enabled client sites to their exact specifications and
requirements. As with all major brand name companies, consistency within the
brand image is vital; therefore, our design engineers create sites that
seamlessly integrate and mirror the exact brand image of our clients. By
operating on IBM enterprise systems and utilizing our state of the art Entente
Suite technology along with Microsoft .Net technologies, we can maintain a
robust hosting environment where client sites reside, maintain and update all
necessary infrastructure.
Specifically through the EntenteWeb package, clients can build an
e-commerce initiative with relatively low investment and in a time efficient
manner. EntenteWeb is a complete front-to-back e-commerce solution which
incorporates components ranging from the look of the user interface to specific
business purchasing, warehousing and shipping needs, enabling companies to
define in exact terms their desired e-commerce site functionality.
Order Management. Our order management solutions provide clients with
interfaces that allow for real-time information retrieval, including information
on product orders, shipment, delivery and customer history. These solutions are
seamlessly integrated with our Web-enabled customer contact centers, allowing
for the processing of orders through shopping cart, phone, fax, mail, email, Web
chat, and other order receipt methods. As the information backbone for our total
supply chain solution, order management services can be used on a stand alone
basis or in conjunction with our other business infrastructure offerings,
including customer contact, financial or distribution services. In addition, for
the business-to-business market, our technology platform provides a variety of
order receipt methods that facilitate commerce within various stages of the
supply chain. Our systems provide the ability for both our clients' and their
customers to track the status of orders at any time. Our services are
transparent to our clients' customers and are seamlessly integrated with
9
our clients' internal systems platforms and Web sites. By synchronizing these
activities, we can capture and provide critical customer information, including:
- Statistical measurements critical to creating a quality customer
experience, containing real-time order status, order exceptions, back
order tracking, soft/hard allocation of product based on timing of online
purchase and business rules, the ratio of customer inquiries to
purchases, average order sizes and order response time;
- Business-to-business supply chain management information critical to
evaluating inventory positioning, for the purpose of reducing inventory
turns, product flow through and end-consumer demand;
- Reverse logistics information including customer response and reason for
the return or rotation of product;
- Detailed marketing information about what was sold and to whom it was
sold, by location and preference; and
- Web traffic reporting showing the number of visits ("hits") received,
areas visited, and products and information requested.
Customer Relationship Management. We offer a completely customized CRM
solution for clients. Our CRM solution encompasses a full-scale customer contact
management service offering, as well as a fully integrated customer analysis
program. All customer contacts are captured and customer purchases are
documented. Full-scale reporting on all customer transactions is available for
evaluation purposes. Through each of our customer touch-points, information can
be analyzed and processed for future use in business evaluation and supply chain
planning.
An important feature of evolving commerce remains the ability for the
customer to speak with a live customer service representative. Our experience
has been that a majority of consumers tell us that they visited the Web location
for information, but only a fraction of those consumers chose to place their
order online. Our customer care services utilize features that integrate voice,
e-mail, data and Internet chat communications to respond to and handle customer
inquiries. Our customer care representatives answer various questions, acting as
virtual representatives of our client's organization, regarding order status,
shipping, billing, returns and product information as well as a variety of other
questions. Our Web-enabled customer care technology identifies each customer
contact automatically and routes it to the available customer care
representative who is individually certified in the client's business and
products. Our web-enabled customer care centers are designed so that our
customer care representatives can handle many different clients and products in
a shared environment, thereby creating economy of scale benefits for our clients
as well as highly customized dedicated support models that provide the ultimate
customer experience and brand reinforcement. Our advanced technology also
enables our representatives to up-sell, cross-sell and inform customers of other
products and sales opportunities. The Web-enabled customer care center is fully
integrated into the data management and order processing system, allowing full
visibility into customer history and customer trends. Through this fully
integrated system we are able to provide a complete CRM solution.
With the need for efficiency and cost optimization for many of our clients,
we have integrated IVR as another option for customer contacts. IVR creates an
"electronic workforce" with virtual agents that can assist customers with vital
information at any time of the day or night. IVR allows for our clients'
customers to deal interactively with our system to handle basic customer
inquiries, such as account balance, order status, shipment status, catalog
requests, product and price inquiries, and routine order entry for established
customers. The inclusion of IVR to our service offering allows us to offer a
cost effective way to handle high volume, low complexity calls.
International Fulfillment and Distribution Services. An integral part of
our business process outsourcing solutions is the warehousing and distribution
of inventory owned by our clients. We currently have more than one million
square feet of warehouse space domestically and internationally to store and
process our clients' inventory. We receive client inventory in our distribution
centers, verify shipment accuracy, unpack, inspect for damage and stock for sale
the same day. On behalf of our clients, we pick, pack and ship their customer
10
orders and can provide customized packaging, inserts and promotional literature
for distribution with customer orders. Based upon our clients' needs, we are
able to take advantage of a variety of shipping and delivery options, including
next day service. Our facility is equipped with multi-carrier functionality,
allowing us to integrate with all major shipping carriers and provide a
comprehensive transportation management offering. In addition, an increasingly
important function that we provide for our clients is reverse logistics
management. We offer a wide array of product return services for our clients,
including issuing return authorizations, receipt of product, crediting customer
accounts, and disposition of returned product.
Our distribution facilities contain computerized sorting equipment, powered
material handling equipment, scanning and bar-coding systems and automated
conveyors, in-line scales, x-ray equipment and digital cameras to photograph
shipment contents for automatic accuracy checking. Our international
distribution complexes include several advanced technology enhancements, such as
radio frequency technology in product receiving processing to ensure accuracy,
an automated package routing system and a "pick to light" paperless order
picking system. Our advanced distribution systems provide us with the capability
to currently warehouse an extensive number of stock keeping units (SKUs) for our
clients ranging from high-end laser printers to cosmetic compacts. Our
facilities are flexibly configured to process business-to-business and single
pick business-to-consumer orders from the same central location.
During 2001, we warehoused, managed and fulfilled approximately $1 billion
in client merchandise and transactions. This does not represent our revenue, but
rather the revenue of our clients' transactions for whom we provided e-business
infrastructure solutions. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Kitting and Assembly Services. Our expanded kitting and assembly services
reduce the time and costs associated with managing multiple suppliers,
warehousing hubs, and light manufacturing partners. As a single source provider,
we provide clients with the advantage of convenience, accountability and speed.
Our comprehensive kitting and assembly services provide a quality one-stop
resource for any international channel. PFSweb's kitting and assembly service
includes light assembly, specialized kitting and supplier-consigned inventory
hubbing either in our distribution facilities or co-located elsewhere. We also
offer customized light manufacturing and Supplier Relationship Management
("SRM") for Fortune 1000 and Global 2000 manufacturers.
Combining our assembly services with our supplier-owned inventory hub
services allows our clients to reduce cycle times, to compress their supply
chains and to consolidate their operations and supplier management functions. We
have supplier inventory management, assembly and fulfillment services all in one
place, providing greater flexibility in product line utilization, as well as
rapid response to change orders or packaging development. Our standard
capabilities include: build-to-order, build-to-stock, expedited orders, passive
and active electrostatic discharge ("ESD") controls, product labeling, serial
number generation, marking and/or capture, lot number generation, marking, and
capture, asset tagging, bill of materials ("BOM") or computer automated design
("CAD") engineering change processing, SKU-level pricing and billing,
manufacturing and metrics reporting, first article approval processes, and
comprehensive quality controls.
Our kitting and assembly service also includes procurement. We work
directly with client suppliers to make Just-in-Time ("JIT") inventory orders for
each component in client packages, thereby ensuring the appropriate inventory
quantities at just the right time to PFSweb then turned around JIT to customers.
Kitting and inventory hubbing services enable clients to collapse supply
chains into the minimal steps necessary to prepare product for distribution to
any channel, including wholesale, mass merchant retail, or direct to consumer.
Clients no longer have to employ multiple providers or require suppliers to
consign multiple inventory caches for each channel. We offer our clients the
opportunity to consolidate operations from a channel standpoint, as well as from
a geographic perspective. Our integrated, global information systems and
international locations support client business needs worldwide.
Information Management. We have the ability to communicate with and
transfer information to and from our clients through a wide variety of
technologies, including real-time data interfaces, file transferring
11
and electronic data interchange. Our systems are designed to capture, store and
electronically forward to our clients critical information regarding customer
inquiries and orders, product shipments, inventory levels, product returns and
other information. We maintain for our clients detailed product master files
that can be seamlessly integrated with their Web sites. Our systems are capable
of providing our clients with customer and order information for use in
analyzing sales and marketing trends and introducing new products. We also offer
customized reports or data analyses based upon specific client needs to assist
them in their budgeting and business decision process.
Financial Services. Our financial services are divided into two major
areas: 1) billing and collection services for business-to-business and
business-to-consumer clients and 2) working capital solutions. Through our
client financial services, we act as a virtual and physical financial management
department for all potential client needs.
We offer secure credit and collections services for both
business-to-business and business-to-consumer business. Specifically, for
business-to-consumer clients, we offer secure, real-time credit card processing
for orders made via a client Web site or through our customer contact center.
Additionally, we calculate sales tax, if applicable, for numerous taxing
authorities and on a variety of products. Using third-party leading-edge fraud
protection services and risk management systems, we can assure the highest level
of security and the lowest level of risk for client transactions.
For business-to-business clients, we offer full-service accounts receivable
management and collection capabilities, including the ability to generate
customized computer-generated invoices in our clients' names. We assist clients
in reducing accounts receivable and days sales outstanding, while minimizing
costs associated with maintaining an in-house collections staff. In addition, we
offer electronic credit services in the format of EDI X.12 and XML
communications direct from our clients to their vendors, suppliers and
retailers.
PFSweb's affiliate, Supplies Distributors, Inc. provides working capital
solutions, which enables manufacturers to remove inventory and receivables from
their balance sheets through the use of third party financing. This service
offering is available to clients operating in North America and Europe.
While the majority of our clients maintain ownership of their own
inventory, we work with Supplies Distributors to create and implement client
inventory solutions as well. PFSweb has years of experience in dealing with the
issues related to inventory ownership, secure inventory management,
replenishment and product distribution. PFSweb and Supplies Distributors can
offer prospective clients a management solution for the entire customer
relationship, including ownership of inventory and receivables. Through CIP, we
utilize technology resources to time the replenishment purchase of inventory
with the simultaneous sale of product to the end user. All interfaces are done
electronically and all processes regarding the financial transactions are
automated, creating significant supply chain advantages.
PFSweb is experienced in the complex legal, accounting and governmental
control issues that can be hurdles in the successful implementation of working
capital financing programs. Our knowledge and experience help clients achieve
supply chain benefits while reducing inventory carrying costs. Substantial
benefits and improvement to a company's balance sheet can be achieved through
these working capital solutions.
Professional Consulting Services. As part of the tailored solution for our
clients, we offer a full team of experts specifically designated to focus on our
clients' businesses. Team members play a consultative role, providing
evaluation, analysis and recommendations for the client's business. This team
creates customized solutions and devises plans that will increase efficiencies
and produce benefits for the client when implemented.
Comprised of industry experts from top-tier consulting firms and industry
market leaders, our team of professional consultants provides client service
focus and logistics and distribution expertise. They have built solutions for
Fortune 1000 and Global 2000 market leaders in a wide range of industries,
including apparel, computer-related products, telecommunications, cosmetics,
housewares, high-value collectibles, sporting goods, pharmaceuticals and several
more. Focusing on the evolving infrastructure needs of major corporations
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and their business initiatives, our team has a solid track record providing
consulting services in the areas of supply chain management, distribution and
fulfillment, technology interfacing, logistics and customer support.
CLIENTS AND MARKETING
Our target clients include brand name manufacturers looking to quickly and
efficiently implement business initiatives, to adapt their go-to-market
strategies, or to introduce new products or programs, without the burden of
modifying or expanding their order processing and distribution infrastructure.
We also target retailers and direct marketers seeking to expand their sales
through new channels as well as government agencies trying to reduce costs
and/or increase efficiency, expectations and responsiveness. Our services are
available for a multitude of industries and company types, including such
clients as:
International Business Machines ("IBM") (printer supplies in several
geographic areas), Adaptec (computer accessories), a U.S. Federal Government
Unit (as a sub-contractor to IBM Global Services), Avaya Communication, Dell (a
computer manufacturer), Emtec Magnetics (a manufacturer of BASF-branded data
media and audio visual products), Lancome (a cosmetics division of L'Oreal
International), Xerox (printers and printer supplies), Thomson multimedia (RCA
branded televisions and consumer electronics), Mary Kay Cosmetics (cosmetics),
Pharmacia/Upjohn (pharmaceuticals), Nokia USA.com (cell phone accessories),
Roots Canada (apparel), and Hewlett-Packard (printers and computer networking
equipment).
We target clients through a direct sales force dedicated to acquiring new
business to fuel our growth; through direct marketing to key vertical industry
segments where we feel that we are able to provide significant service
differentiation; trade shows and industry conferences, trade journal
advertising, and our Web site. We also pursue strategic marketing alliances with
consultants and other professional firms to generate referrals and customer
leads.
Our direct sales force is comprised of dedicated sales professionals whose
compensation is tied to their ability to expand our relationships with existing
clients and attract new clients. We also employ highly trained implementation
managers whose responsibilities include the oversight and supervision of client
projects and maintaining high levels of client satisfaction.
TECHNOLOGY
We maintain advanced management information systems and have automated key
business functions using on-line, real-time systems. These systems enable us to
provide our clients information concerning sales, inventory levels, customer
payments and other operations that are essential for our clients to efficiently
manage their electronic commerce and supply chain business programs. Our systems
are designed to scale rapidly in order to handle the transaction processing
demands of our clients.
We employ technology from a selected group of partners, many of which are
also our clients. For example, we deploy IBM e-servers and network printers in
appropriate models to run Web site functions as well as order management and
distribution functions. We utilize Avaya Communication for telephone switch and
call center management functions. We also employ Avaya Communication for our
Web-enabled customer care center to interact with customers via voice, e-mail or
chat. Avaya Communication technology also allows us to share Web pages between
customers and our service representatives. We have the ability to transmit and
receive voice, data and video simultaneously on a single network connection to a
customer to more effectively serve that customer for our client. Clients'
interest in using this technology stems from its ability to allow shoppers to
consult with known experts in a way that the customer chooses prior to
purchasing. Our sophisticated computer-telephony integration has been
accomplished by combining systems software from IBM and Avaya Communication
together with our own application development. We use AT&T for our private
enterprise network and long distance carrier. We use J.D. Edwards as the
software provider for the primary ERP applications that we use in our
operational areas and financial areas. We use Siemens Dematic/ Rapistan
Materials Handling Automation for our automated order selection, automated
conveyor and "pick-to-light" (inventory retrieval) systems, and Symbol
Technologies/Telxon for our warehouse radio
13
frequency applications. Our Warehouse Management System ("WMS") is a highly
customized J.D. Edwards' system.
Many internal infrastructures are not sufficient to support the explosive
growth in e-business, e-marketplaces, supply chain compression, distribution
channel realignment and the corresponding demand for real-time information
necessary for strategic decision-making and product fulfillment. To address this
need, we have created the Entente Suite which is a comprehensive software
solution, with supporting services and hardware, that enables companies with
little or no e-commerce infrastructure to speed their time to market and
minimize resource investment and risk, and allows all companies involved to
improve the efficiency of their supply chain. The Entente Suite is comprised of
four distinct offerings -- EntenteDirect, EntenteMessage, EntenteWeb, and
EntenteReport -- which can stand alone or be combined for a fully customized
e-commerce solution depending on the level of direct involvement a company wants
to maintain in their e-commerce initiative.
The components of the Entente Suite provide the open platform
infrastructure that allows us to create complete e-commerce solutions with our
customers. Using the various components of the Entente Suite, we can assist our
clients in easily integrating their Web sites or ERP systems to our systems for
real-time transaction processing without regard for their hardware platform or
operating system. This high-level of systems integration allows our clients to
automatically process orders, customer data and other e-commerce information. We
also can track information sent to us by the client as it moves through our
systems in the same manner a carrier would track a package throughout the
delivery process. Our systems enable us to track, at a detailed level,
information received, transmission timing, any errors or special processing
required and information sent back to the client. The transactional and
management information contained within our systems is made available to the
client quickly and easily through the Entente Suite.
The Entente Suite serves as a transparent interface to our back-office
productivity suite which is a customized JD Edwards order management and
fulfillment application that runs on IBM e-Servers. It also is designed to
integrate with marketplace technologies offered by major marketplace software
companies.
To enhance our service offerings, we have invested in advanced
telecommunications, computer telephony, electronic mail and messaging, automated
fax technology, IVR technology, barcode scanning, wireless technology, fiber
optic network communications and automated inventory management systems. We have
also developed and utilize telecommunications technology that provides for
automatic customer call recognition and customer profile recall for inbound
customer service representatives.
The primary responsibility of our systems development team of IT
professionals is directed at implementing custom solutions for new clients and
maintaining existing client relationships. Our development team can also produce
proprietary systems infrastructure to expand our capabilities in circumstances
where we cannot purchase standard solutions from commercial providers. We also
utilize temporary resources when needed for additional capacity.
Our information technology operations and infrastructure are built on the
premise of reliability and scalability. We maintain diesel generators and
uninterruptible power supply equipment to provide constant availability to
computer rooms, call centers and warehouses. Multiple Internet service providers
and redundant Web servers provide for a high degree of availability to Web sites
that interface with our systems. Capacity planning and upgrading is performed
regularly to allow for quick implementation of new clients and avoid
time-consuming infrastructure upgrades that could slow growth rates. We also
have a disaster recovery plan for our information systems and maintain a "hot
site" under contract with a major provider.
COMPETITION
Many companies offer, on an individual basis, one or more of the same
services we do, and we face competition from many different sources depending
upon the type and range of services requested by a potential client. Our
competitors include vertical outsourcers, which are companies that offer a
single function, such as call centers, public warehouses or credit card
processors. Many of these companies have greater capabilities than we do for the
function they provide. We also compete against transportation logistics
14
providers who offer product management functions as an ancillary service to
their primary transportation services. In many instances, our competition is the
in-house operations of our potential clients themselves. The in-house operations
departments of potential clients often believe that they can perform the same
services we do, while others are reluctant to outsource business functions which
involve direct customer contact. We cannot be certain that we will be able to
compete successfully against these or other competitors in the future.
Although many of our competitors can offer one or more of our services, we
believe our primary competitive advantage is our ability to offer a wide array
of services that cover a broad spectrum of business processes, including web
site design and hosting, kitting and assembly, order processing and shipment,
credit card payment and customer service, thereby eliminating any need for our
clients to coordinate these services from many different providers. We believe
we are unique in offering our clients a very broad range of business process
services that addresses, in many cases, the entire business transaction, from
demand to delivery.
We also compete on the basis of many other important additional factors,
including:
- operating performance and reliability;
- ease of implementation and integration;
- experience of the people required to successfully and efficiently design
and implement solutions;
- leading edge technology capabilities;
- global reach; and
- price.
We believe that we presently compete favorably with respect to each of
these factors. However, the market for our services is becoming more competitive
and still evolving, and we may not be able to compete successfully against
current and future competitors.
EMPLOYEES
As of December 31, 2001, we had 575 full-time employees and 45 part-time
employees, of which 498 were located in the United States. We are not a party to
any collective bargaining agreements, and we have never suffered an interruption
of business as a result of a labor dispute. We consider our relationship with
our employees to be good.
Our success in recruiting, hiring and training large numbers of skilled
employees and obtaining large numbers of hourly employees during peak periods
for distribution and call center operations is critical to our ability to
provide high quality distribution and support services. Call center
representatives and distribution personnel receive feedback on their performance
on a regular basis and, as appropriate, are recognized for superior performance
or given additional training. Generally, our clients provide specific product
training for our customer service representatives and, in certain instances,
on-site client personnel to provide specific technical support. To maintain good
employee relations and to minimize employee turnover, we offer competitive pay,
hire primarily full-time employees who are eligible to receive a full range of
employee benefits, and provide employees with clear, visible career paths.
REGULATION
Our business may be affected by current and future governmental regulation,
both foreign and domestic. For example, the Internet Tax Freedom Act bars state
and local governments from imposing taxes on Internet access or that would
subject buyers and sellers of electronic commerce to taxation in multiple
states. This act is in effect through November 1, 2003. If legislation to extend
this act or similar legislation is not enacted, Internet access and sales across
the Internet may be subject to additional taxation by state and local
governments, thereby discouraging purchases over the Internet and adversely
affecting the market for our services.
15
SPIN-OFF OF PFSWEB FROM DAISYTEK
HISTORY
The PFSweb business unit was formed in 1991 as a subsidiary of Daisytek
named "Working Capital of America" whose purpose was to provide inventory
management, direct shipping to end-users, and accounts receivable collections
for Daisytek customers and other third parties. Until 1996, this business unit
was comprised of operations both at Working Capital of America and at Daisytek.
As the business gradually developed, this business unit recognized an
opportunity to expand its business and capitalize on Daisytek's strengths in
customer service, order management, product fulfillment and distribution, and
provide these services on an outsourcing basis. Since 1996, the operations of
this business unit have been primarily focused in PFS. PFSweb was formed in 1999
to be a holding company for PFS and to facilitate the Offering and spin-off from
Daisytek. In December 1999, we completed the Offering and entered into various
agreements with Daisytek relating to the spin-off. Under these agreements, the
spin-off was conditioned upon, among other things, the receipt of a ruling by
the Internal Revenue Service ("IRS") that, among certain other tax consequences
of the transaction, the spin-off qualify as a tax-free distribution for U.S.
federal income tax purposes and not result in the recognition of taxable gain or
loss for U.S. federal income tax purposes to Daisytek or its shareholders (the
"IRS Ruling"). On June 8, 2000, Daisytek received the IRS Ruling and the
Daisytek board of directors approved the spin-off and authorized the
distribution of 14,305,000 shares of PFSweb common stock to the holders of
Daisytek common stock. The distribution was made at the close of business on
July 6, 2000 to Daisytek stockholders of record as of June 19, 2000.
PFSWEB'S RELATIONSHIP WITH DAISYTEK
At the time of the Offering, PFSweb and Daisytek entered into various
agreements providing for the separation of their respective business operations.
These agreements governed various interim and ongoing relationships between the
companies, including the transaction management services that PFSweb provided
for Daisytek, the transitional services that Daisytek provided to PFSweb and a
tax indemnification and allocation agreement which governs the allocation of tax
liabilities and sets forth provisions with respect to other tax matters.
All of the agreements between PFSweb and Daisytek were made in the context
of a parent-subsidiary relationship and were negotiated in the overall context
of the spin-off. Although we generally believe that the terms of these
agreements are consistent with fair market values, there can be no assurance
that the prices charged to or by each company under these agreements are not
higher or lower than the prices that may be charged by, or to, unaffiliated
third parties for similar services.
Although we continue to be party to certain agreements with Daisytek, such
as the Master Separation Agreement, the Tax Indemnification and Allocation
Agreement and the Initial Public Offering and Distribution Agreement, we do not
currently generate any revenues or incur any expenses related to services for
Daisytek.
MASTER SEPARATION AGREEMENT
The Master Separation Agreement sets forth the agreements between PFSweb
and Daisytek with respect to the principal corporate transactions required to
effect the transfers of assets and assumptions of liabilities necessary to
separate the PFSweb business unit from Daisytek and certain other agreements
governing this relationship thereafter.
Transfer of Assets and Liabilities. Following completion of the Offering,
Daisytek transferred to PFSweb all of the fixed assets in Daisytek's Memphis
distribution facility as well as certain assets associated with providing
information technology services and the stock of several subsidiaries of
Daisytek representing the business operations of PFSweb, and PFSweb transferred
to Daisytek approximately $5 million in cash and assumed approximately $0.3
million of capital lease obligations, as well as the operating lease obligations
related to these assets. PFSweb also repaid to Daisytek, from the net proceeds
of the Offering, the aggregate
16
sum of approximately $27 million, representing the outstanding balance of
PFSweb's intercompany payable to Daisytek.
Indemnification. PFSweb agreed to indemnify Daisytek against any losses,
claims, damages or liabilities arising from the liabilities transferred to
PFSweb and the conduct of the PFSweb business after the completion of the
Offering. Daisytek agreed to retain, and indemnify PFSweb against, any losses,
claims, damages or liabilities arising from the conduct of the PFSweb business
prior to the completion of the Offering.
INITIAL PUBLIC OFFERING AND DISTRIBUTION AGREEMENT
General. PFSweb and Daisytek entered into an Initial Public Offering and
Distribution Agreement which governs their respective rights and duties with
respect to the Offering and the spin-off, and sets forth certain covenants to
which they are bound for various periods following the Offering and the
spin-off.
Preservation of the Tax-free Status of the Spin-off. Daisytek has received
a private letter ruling from the Internal Revenue Service to the effect that the
spin-off qualifies as a tax-free distribution under Section 355 of the Internal
Revenue Code to Daisytek and its stockholders. In connection with obtaining such
ruling, certain representations and warranties were made regarding Daisytek,
PFSweb and their respective businesses. PFSweb has also agreed to certain
covenants that are intended to preserve the tax-free status of the spin-off.
These covenants include:
Certain Acquisition Transactions. Until two years after the
completion of the spin-off, PFSweb has agreed not to enter into or permit
any transaction or series of transactions that would result in a person or
persons acquiring or having the right to acquire shares of its capital
stock that would comprise 50% or more of either the value of all
outstanding shares of its capital stock or the total combined voting power
of its outstanding voting stock.
Continuation of Active Trade or Business. Until two years after the
completion of the spin-off, PFSweb has agreed to continue to conduct its
active trade or business (within the meaning of Section 355 of the Code) as
it was conducted immediately prior to the completion of the spin-off.
During such time, PFSweb has agreed not to:
- liquidate, dispose of or otherwise discontinue the conduct of any
substantial portion of its active trade or business; or
- dispose of any business or assets that would cause it to be operated
in a manner inconsistent in any material respect with the business
purposes for the spin-off as described in the representations made in
connection with Daisytek's request for the IRS Ruling.
Continuity of Business. Until two years after the completion of the
spin-off, PFSweb has agreed that it will not voluntarily dissolve or liquidate;
and, except in the ordinary course of business, neither it nor any of its direct
or indirect subsidiaries will sell, transfer, or otherwise dispose of or agree
to dispose of assets (including any shares of capital stock of its subsidiaries)
that, in the aggregate, constitute more than 60% of its assets.
Intracompany Debt. Until two years after the completion of the spin-off,
PFSweb will not be able to have any indebtedness to Daisytek, other than
payables arising in the ordinary course of business.
These covenants will not prohibit PFSweb from implementing or complying
with any transaction permitted by an IRS ruling or a tax opinion.
Other Covenants Regarding Tax Treatment of the Transactions. The transfer
of assets and liabilities from Daisytek to PFSweb as provided by the master
separation agreement (the "Contribution") were intended to qualify as a
reorganization under Section 368(a)(1)(D) of the Code (a "D Reorganization").
Until two years after the completion of the spin-off, PFSweb has agreed not to
take, or permit any of our subsidiaries to take, any actions or enter into any
transaction or series of transactions that would be reasonably likely to
jeopardize the tax-free status of the spin-off or the qualification of the
Contribution as a D Reorganization, including any action or transaction that
would be reasonably likely to be inconsistent with
17
any representation made in connection with Daisytek's request for the IRS
Ruling. PFSweb has also agreed to take any reasonable actions necessary for the
Contribution and the spin-off to qualify as a D Reorganization.
Cooperation on Tax Matters. PFSweb and Daisytek have agreed to various
procedures with respect to the tax-related covenants described above, and PFSweb
is required to notify Daisytek if it desires to take any action prohibited by
these covenants. Upon such notification, if Daisytek determines that such action
might jeopardize the tax-free status of the spin-off or the qualification of the
Contribution as a D Reorganization, Daisytek will either use all commercially
reasonable efforts to obtain a private letter ruling from the IRS or a tax
opinion that would permit PFSweb to take the desired action or provide all
reasonable cooperation to PFSweb in connection with PFSweb obtaining such an IRS
ruling or tax opinion. In either case, Daisytek has agreed to bear the
reasonable costs and expenses of obtaining the IRS ruling or tax opinion, unless
it is determined that PFSweb's proposed action will jeopardize the tax-free
status of the spin-off or the qualification of the Contribution as a D
Reorganization, in which event PFSweb will be responsible for such costs and
expenses.
Indemnification for Tax Liabilities. PFSweb has generally agreed to
indemnify Daisytek and its affiliates against any and all tax-related losses
incurred by Daisytek in connection with any proposed tax assessment or tax
controversy with respect to the spin-off or the Contribution to the extent
caused by any breach by it of any of its representations, warranties or
covenants. If PFSweb causes the spin-off to not qualify as a tax-free
distribution, Daisytek would incur federal income tax (which currently would be
imposed at a 35% rate) and possibly state income taxes on the gain inherent in
the shares distributed, which would be based upon the market value of the shares
of PFSweb at the time of the spin-off. This indemnification does not apply to
actions that Daisytek permits PFSweb to take as a result of a determination
under the tax-related covenants as described above. Similarly, Daisytek has
agreed to indemnify PFSweb and its affiliates against any and all tax-related
losses incurred by it in connection with any proposed tax assessment or tax
controversy with respect to the spin-off or the Contribution to the extent
caused by any breach by Daisytek of any of its representations, warranties or
covenants.
Other Indemnification. PFSweb has generally agreed to indemnify Daisytek
and its affiliates against all liabilities arising out of any material untrue
statements and omissions in PFSweb's prospectus and the registration statement
of which it is a part and in any and all registration statements, information
statements and/or other documents filed with the SEC in connection with the
spin-off or otherwise. However, PFSweb's indemnification of Daisytek does not
apply to information relating to Daisytek. Daisytek has agreed to indemnify
PFSweb for this information.
Expenses. In general, PFSweb agreed to pay substantially all costs and
expenses relating to the Offering, including the underwriting discounts and
commissions, and Daisytek agreed to pay substantially all costs and expenses
relating to the spin-off.
TAX MATTERS
Daisytek and PFSweb have entered into a Tax Indemnification and Allocation
Agreement to govern the allocation of tax liabilities and to set forth
agreements with respect to certain other tax matters.
Under the Code, PFSweb ceased to be a member of the Daisytek consolidated
group upon the completion of the spin-off.
Daisytek generally will pay all taxes attributable to PFSweb and its
subsidiaries for tax periods or portions thereof ending on or before the
effective date of the Offering, except to the extent of any accruals thereof on
the books and records of PFSweb or its subsidiaries for such taxes under
generally accepted accounting principles. Thereafter, for tax periods or
portions thereof during which PFSweb was a member of the Daisytek consolidated,
combined or unitary group, PFSweb was apportioned its share of the group's
income tax liability based on its taxable income determined separately from
Daisytek's taxable income, and PFSweb paid its calculated taxes to Daisytek,
which will then file a consolidated, combined or unitary return with the
appropriate tax authorities. There may be certain U.S. state or local
jurisdictions in which PFSweb will file separate income tax returns, not
combined or consolidated with Daisytek, for such tax periods. In that
18
circumstance, PFSweb would file a tax return with the appropriate tax
authorities, and pay all taxes directly to the tax authority. PFSweb will be
compensated for tax benefits generated by it before tax deconsolidation and used
by the Daisytek consolidated group. PFSweb will prepare and file all tax
returns, and pay all income taxes due with respect to all tax returns required
to be filed by it for all tax periods after it ceased to be a member of the
Daisytek consolidated, combined or unitary group.
Daisytek is responsible for most U.S. tax adjustments related to PFSweb for
all periods or portions thereof ending on or before the effective date of the
Offering. In addition, PFSweb and Daisytek have agreed to cooperate in any tax
audits, litigation or appeals that involve, directly or indirectly, periods
prior to the time that PFSweb ceased to be a member of the Daisytek consolidated
group. PFSweb and Daisytek have agreed to indemnify each other for tax
liabilities resulting from the failure to cooperate in such audits, litigation
or appeals, and for any tax liability resulting from the failure to maintain
adequate records.
Notwithstanding the tax allocation agreement, for all periods in which
Daisytek owned 80% or more of PFSweb's capital stock, PFSweb will be included in
Daisytek's consolidated group for federal income tax purposes. If Daisytek or
other members of the consolidated group fail to make any federal income tax
payments, PFSweb will be liable for the shortfall since each member of a
consolidated group is liable for the group's entire tax obligation.
Under the Tax Indemnification and Allocation Agreement, Daisytek has agreed
to indemnify PFSweb against any taxes resulting from the failure of the spin-off
to qualify for tax-free treatment, except that PFSweb will be liable for, and
will indemnify Daisytek against, any taxes resulting from the failure of the
spin-off to qualify for tax-free treatment if it is the result of PFSweb
engaging in a "Prohibited Action" or the occurrence of a "Disqualifying Event."
Neither PFSweb nor Daisytek have the option to rescind the spin-off if a tax
liability results.
A "Prohibited Action" is defined as:
- if PFSweb takes any action which is inconsistent with the tax treatment
of the spin-off as contemplated in the IRS Ruling; or
- if, prior to the spin-off, PFSweb issued shares of stock or took any
other action that would result in it not being controlled by Daisytek
within the meaning of Section 368(c) of the Code.
A "Disqualifying Event" includes any event involving the direct or indirect
acquisition of the shares of PFSweb's capital stock after the spin-off which has
the effect of disqualifying the spin-off from tax-free treatment, whether or not
the event is the result of our direct action or within PFSweb's control.
TRANSACTION MANAGEMENT SERVICES AGREEMENT
PFSweb and Daisytek entered into a transaction management services
agreement which set forth the transaction management services that PFSweb
provided for Daisytek. Under this agreement, PFSweb provided a wide range of
transaction management services, including information management, order
fulfillment and distribution, product warehousing, inbound call center services,
product return administration and other services.
As described in "Sale of Assets to Daisytek," effective May 2001, Daisytek
and PFSweb terminated the transaction management services agreement.
TRANSITION SERVICES AGREEMENT
Upon completion of the Offering, Daisytek and PFSweb entered into a
transition services agreement. Under this agreement, Daisytek provided PFSweb
with various services relating to employee payroll and benefits, use of
facilities, and other administrative services. Daisytek is no longer providing
services to PFSweb under this transition services agreement.
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SUBSTITUTE STOCK OPTIONS
In connection with the completion of the spin-off, all outstanding Daisytek
stock options were replaced with substitute stock options as described below:
Options held by Daisytek employees who were transferred to PFSweb were
replaced (at the option holder's election) with either options to acquire shares
of PFSweb common stock or options to acquire shares of both Daisytek common
stock and PFSweb common stock (which may be exercised separately) (the
"Unstapled Options"). Options held by Daisytek employees who remained with
Daisytek were replaced (at the option holder's election) with either options to
acquire shares of Daisytek common stock or Unstapled Options.
In general, the adjustments to the outstanding Daisytek options were
established pursuant to a formula designed to ensure that: (1) the aggregate
"intrinsic value" (i.e. the difference between the exercise price of the option
and the market price of the common stock underlying the option) of the
substitute options did not exceed the aggregate intrinsic value of the
outstanding Daisytek stock option which was replaced by such substitute option
immediately prior to the spin-off, and (2) the ratio of the exercise price of
each option to the market value of the underlying stock immediately before and
after the spin-off was preserved.
Substantially all of the other terms and conditions of each substitute
stock option, including the time or times when, and the manner in which, each
option will be exercisable, the duration of the exercise period, the permitted
method of exercise, settlement and payment, the rules that will apply in the
event of the termination of employment of the employee, the events, if any, that
may give rise to an employee's right to accelerate the vesting or the time or
exercise thereof and the vesting provisions, are the same as those of the
replaced Daisytek stock option, except that option holders who are employed by
one company will be permitted to exercise, and will be subject to all of the
terms and provisions of, options to acquire shares in the other company as if
such holder was an employee of such other company.
No adjustment or replacement was made to outstanding PFSweb stock options
as a result of the spin-off.
On May 29, 2001, PFSweb repriced and fully vested all PFSweb options then
held by Daisytek officers, directors and employees.
BUSINESS SUPPLIES DISTRIBUTORS
PFSweb, Business Supplies Distributors, (a Daisytek subsidiary -- "BSD"),
Daisytek and IBM were parties to various Master Distributor Agreements which
expired on various dates through September 2001. Under these agreements, BSD
acted as a master distributor of various IBM products, Daisytek provided
financing and credit support to BSD and PFSweb provided transaction management
and fulfillment services to BSD. In July 2001, PFSweb and Inventory Financing
Partners, LLC ("IFP") formed Business Supplies Distributors Holdings, LLC
("Holdings"), and Holdings formed a wholly-owned subsidiary, Supplies
Distributors. Supplies Distributors, PFSweb and IBM entered into new Master
Distributor Agreements to replace the prior agreements. Under these new
agreements, Supplies Distributors and its subsidiaries act as master
distributors of various IBM products and, pursuant to a transaction management
services agreement between PFSweb and Supplies Distributors, PFSweb provides
transaction management and fulfillment services to Supplies Distributors. See
"Supplies Distributors".
SALE OF ASSETS TO DAISYTEK
In May 2001, we sold to Daisytek certain of our assets used to provide
transaction management services to Daisytek and its subsidiaries for a purchase
price of $11 million ($10 million of which was paid at closing and $1 million
was paid over a six month period ending in November 2001). As part of this
transaction, Daisytek and PFSweb terminated the transaction management services
agreement described above. As part of this transaction, we entered into a
six-month transition services agreement with Daisytek under which we provided
certain information technology transition services for a monthly service fee
through November 2001.
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RISK FACTORS
Our business, financial condition and operating results could be adversely
affected by any of the following factors, in which event the trading price of
our common stock could decline, and you could lose part or all of your
investment. The risks and uncertainties described below are not the only ones
that we face. Additional risks and uncertainties not presently known to us, or
that we currently think are immaterial, may also impair our business operations.
RISKS RELATED TO OUR BUSINESS
OUR FINANCIAL INFORMATION FOR PERIODS PRIOR TO FISCAL YEAR 2001 MAY NOT BE
REPRESENTATIVE OF OUR RESULTS AS A SEPARATE COMPANY.
The financial information for periods prior to fiscal year 2001 included in
this Form 10-K may not reflect what our results of operations, financial
position and cash flows would have been had we been a separate, stand-alone
entity during the periods presented or what our results of operations, financial
position and cash flows will be in the future. This is because:
- we made certain adjustments and allocations since Daisytek did not
account for us as, and we were not operated as, a single stand-alone
business for the periods presented; and
- the information does not reflect many significant changes that occurred
in our funding and operations as a result of our new agreements with IBM
and our separation from Daisytek.
We cannot assure you that the adjustments and allocations we made in
preparing our historical consolidated financial statements appropriately reflect
our operations during such periods as if we had, in fact, operated as a
stand-alone entity or what the actual effect of our separation from Daisytek
would have been. Accordingly, we cannot assure you that our historical results
of operations are indicative of our future operating or financial performance.
WE HAVE EXCESS CAPACITY AND NEED MORE REVENUE TO ACHIEVE SUSTAINABLE
PROFITABILITY.
We currently have unused space in our call centers and distribution centers
and excess capacity in our systems infrastructure. As a result, we are currently
incurring losses from operations. In order to properly service our existing
clients and attract new clients, it may be difficult or impractical to
substantially reduce many of the fixed costs associated with our unused space
and excess capacity. Consequently, we may continue to incur losses from
operations until we have sufficiently increased our revenue to cover our fixed
and variable costs. While we believe that as we add revenue we will be able to
cover our existing infrastructure costs, there can be no assurance that we will
increase our revenue or achieve sustainable profitability.
OUR REVENUE IS DEPENDENT UPON OUR CLIENTS' BUSINESS AND TRANSACTION VOLUMES;
ALL OF OUR CLIENT AGREEMENTS ARE TERMINABLE BY THE CLIENT AT WILL.
Our revenue is primarily transaction based and will fluctuate with the
volume of transactions or level of sales of the products by our clients for
which we provide transaction management services. If we are unable to retain
existing clients or attract new clients or if we dedicate significant resources
to clients whose business does not generate substantial transactions or whose
products do not generate substantial customer sales, our business may be
materially adversely affected. In addition, generally all of our agreements with
our clients are terminable by the client at will. Therefore, we cannot assure
you that any of our clients will continue to use our services for any period of
time.
WE ANTICIPATE INCURRING SIGNIFICANT EXPENSES IN THE FORESEEABLE FUTURE, WHICH
MAY REDUCE OUR ABILITY TO ACHIEVE PROFITABILITY.
In order to reach our business growth objectives, we expect to incur
significant operating and marketing expenses, as well as capital expenditures,
during the next several years. In order to offset these expenses, we will need
to generate significant additional profitable business. If our revenue grows
more slowly than either we
21
anticipate or our clients' projections indicate, or if our operating and
marketing expenses exceed our expectations, we may not generate sufficient
revenue to be profitable or be able to sustain or increase profitability on a
quarterly or an annual basis in the future. Additionally, if our revenue grows
more slowly than either we anticipate or our clients' projections indicate, we
may incur unnecessary or redundant costs and our operating results could be
adversely affected.
OUR OPERATING RESULTS COULD BE MATERIALLY IMPACTED BY OUR CLIENT MIX AND THE
SEASONALITY OF THEIR BUSINESS.
Our business could be materially impacted by our client mix and the
seasonality of their business. Based upon our current client mix, we anticipate
our revenue to be most affected by seasonality during the first and second
quarters of the fiscal year. We are unable to predict how the seasonality of
future clients' business may affect our quarterly revenue.
OUR SYSTEMS MAY NOT ACCOMMODATE SIGNIFICANT GROWTH IN OUR NUMBER OF CLIENTS.
Our success depends on our ability to handle a large number of transactions
for many different clients in various product categories. We expect that the
volume of transactions will increase significantly as we expand our operations.
If this occurs, additional stress will be placed upon the network hardware and
software that manages our operations. We cannot assure you of our ability to
efficiently manage a large number of transactions. If we are not able to
maintain an appropriate level of operating performance, we may develop a
negative reputation and our business would be materially adversely affected.
WE MAY NOT BE ABLE TO RECOVER ALL OR A PORTION OF OUR START-UP COSTS
ASSOCIATED WITH ONE OR MORE OF OUR CLIENTS.
We generally incur start-up costs in connection with the planning and
implementation of business process solutions for our clients. Although we
generally recover these costs from the client in the early stages of the client
relationship, there is a risk that the client contract may not fully cover the
start-up costs. To the extent start-up costs exceed the start-up fees received,
excess costs will be expensed as incurred. Additionally, in connection with new
client contracts we generally incur capital expenditures associated with assets
whose primary use is related to the client solution. There is a risk that the
contract may end before expected and we may not recover the full amount of our
capital costs.
OUR MARGINS MAY BE MATERIALLY IMPACTED BY CLIENT TRANSACTION VOLUMES WHICH
DIFFER FROM CLIENT PROJECTIONS AND BUSINESS ASSUMPTIONS.
Our pricing for client transaction services, such as call center and
fulfillment, is often based upon volume projections and business assumptions
provided by the client. In the event the actual level of activity is
substantially different from the projections or assumptions, we may have
insufficient or excess staffing or other assets dedicated for such client which
may impact our margins and business relationship with such client. In the event
we are unable to meet the service levels expected by the client, our
relationship with the client will suffer and may result in the termination of
the client contract.
OUR BUSINESS IS SUBJECT TO THE RISK OF CUSTOMER CONCENTRATION.
For the nine month period ended December 31, 2001, excluding Daisytek, a
U.S. Federal Government Unit, via a subcontract agreement with IBM, and Xerox
Corporation represented approximately 29% and 14%, respectively, of our total
revenue for such period. The loss of any one or more of such clients would have
a material adverse effect upon our business.
22
WE HAVE GUARANTEED ALL OF THE INDEBTEDNESS OF OUR AFFILIATE, SUPPLIES
DISTRIBUTORS, WHICH AS OF MARCH 2002 WAS APPROXIMATELY $48.5 MILLION; WE ARE
REQUIRED TO MAINTAIN A MINIMUM LEVEL OF SUBORDINATED LOANS TO SUPPLIES
DISTRIBUTORS; AND WE ARE OBLIGATED TO REPAY ANY OVER-ADVANCE MADE TO SUPPLIES
DISTRIBUTORS BY ITS LENDERS.
We have guaranteed all of the indebtedness of our affiliate, Supplies
Distributors, which as of March 2002 was approximately $48.5 million, which
guaranty is secured by a pledge of substantially all of our assets. We currently
have $11.7 million of indebtedness owed to us from Supplies Distributors which
is subordinated to the approximately $48.5 million of Supplies Distributors'
senior indebtedness. We are required to maintain $6.5 million of subordinated
loans to Supplies Distributors. Any default by Supplies Distributors under any
such indebtedness would have a material adverse impact upon our business and
financial condition. Furthermore, we are obligated to repay any over-advance
made to Supplies Distributors by its lenders.
WE FACE COMPETITION FROM MANY SOURCES THAT COULD ADVERSELY AFFECT OUR
BUSINESS.
Many companies offer, on an individual basis, one or more of the same
services we do, and we face competition from many different sources depending
upon the type and range of services requested by a potential client. Our
competitors include vertical outsourcers, which are companies that offer a
single function, such as call centers, public warehouses or credit card
processors, and many of these companies have greater capabilities than we do for
the function they provide. We also compete against transportation logistics
providers who offer product management functions as an ancillary service to
their primary transportation services. In many instances, our competition is the
in-house operations of our potential clients themselves. The in-house operations
departments of potential clients often believe that they can perform the same
services we do, while others are reluctant to outsource business functions which
involve direct customer contact. We cannot be certain that we will be able to
compete successfully against these or other competitors in the future.
OUR SALES AND IMPLEMENTATION CYCLES ARE HIGHLY VARIABLE AND OUR ABILITY TO
FINALIZE PENDING CONTRACTS MAY CAUSE OUR OPERATING RESULTS TO VARY WIDELY.
The sales cycle for our services is variable, typically ranging between a
few weeks to six months from initial contact with the potential client to the
signing of a contract. Occasionally the sales cycle requires substantially more
time. Delays in signing and executing client contracts may affect our revenue
and cause our operating results to vary widely. We believe that a potential
client's decision to purchase our services is discretionary, involves a
significant commitment of its resources and is influenced by intense internal
and external pricing and operating comparisons. To successfully sell our
services, we generally must educate our potential clients regarding the use and
benefit of our services, which can require significant time and resources.
Consequently, the period between initial contact and the purchase of our
services is often long and subject to delays associated with the lengthy
approval and competitive evaluation processes that typically accompany
significant operational decisions. Additionally, the time required to finalize
pending contracts and to implement our systems and integrate a new client can
range from several weeks to many months. Delays in signing and integrating new
clients may affect our revenue and cause our operating results to vary widely.
WE ARE DEPENDENT ON OUR KEY PERSONNEL, AND WE NEED TO HIRE AND RETAIN SKILLED
PERSONNEL TO SUSTAIN OUR BUSINESS.
Our performance is highly dependent on the continued services of our
executive officers and other key personnel, the loss of any of whom could
materially adversely affect our business. In addition, we need to attract and
retain other highly-skilled technical and managerial personnel for whom there is
intense competition. We cannot assure you that we will be able to attract and
retain the personnel necessary for the continuing growth of our business. Our
inability to attract and retain qualified technical and managerial personnel
would materially adversely affect our ability to maintain and grow our business.
23
WE ARE SUBJECT TO RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS.
A significant component of our business strategy is to continue to operate
and expand internationally. We currently operate a 150,000 square foot
distribution center in Liege, Belgium and a 33,000 square foot distribution
center in Richmond Hill, Canada, near Toronto. We cannot assure you that we will
be successful in expanding into additional international markets. In addition to
the uncertainty regarding our ability to generate revenue from foreign
operations and expand our international presence, there are risks inherent in
doing business internationally, including:
- changing regulatory requirements;
- legal uncertainty regarding foreign laws, tariffs and other trade
barriers;
- political instability;
- potentially adverse tax consequences;
- foreign currency fluctuations; and
- cultural differences.
Any one or more of these factors may materially adversely affect our
business in a number of ways, such as increased costs, operational difficulties
and reductions in revenue.
WE ARE UNCERTAIN ABOUT OUR NEED FOR AND THE AVAILABILITY OF ADDITIONAL FUNDS.
Our future capital needs are difficult to predict. We may require
additional capital in order to take advantage of unanticipated opportunities,
including strategic alliances and acquisitions, or to respond to changing
business conditions and unanticipated competitive pressures. In addition, we may
require additional funds to finance our operating losses. Should these
circumstances arise, we may need to raise additional funds either by borrowing
money or issuing additional equity. We cannot assure you that we will be able to
raise such funds on favorable terms or at all. If we were successful in
completing an equity financing, this could result in dilution to our
stockholders. We currently do not have any credit facility in place under which
we can borrow funds when needed. If we are unable to obtain additional funds, we
may be unable to take advantage of new opportunities or take other actions that
otherwise might be important to our business.
WE MAY ENGAGE IN FUTURE STRATEGIC ALLIANCES OR ACQUISITIONS THAT COULD DILUTE
OUR EXISTING STOCKHOLDERS, CAUSE US TO INCUR SIGNIFICANT EXPENSES OR HARM OUR
BUSINESS.
We may review strategic alliance or acquisition opportunities that would
complement our current business or enhance our technological capabilities.
Integrating any newly acquired businesses, technologies or services may be
expensive and time-consuming. To finance any acquisitions, it may be necessary
for us to raise additional funds through public or private financings.
Additional funds may not be available on terms that are favorable to us and, in
the case of equity financings, may result in dilution to our stockholders. In
addition, we have limited ability to issue capital stock during the two-year
period following the spin-off. We may not be able to operate any acquired
businesses profitably or otherwise implement our growth strategy successfully.
If we are unable to integrate any newly acquired entities or technologies
effectively, our operating results could suffer. Future acquisitions by us could
also result in incremental expenses and the incurrence of debt and contingent
liabilities, or amortization of expenses related to goodwill and other
intangibles, any of which could harm our operating results.
OUR BUSINESS COULD BE ADVERSELY AFFECTED BY A SYSTEMS OR EQUIPMENT FAILURE,
WHETHER OUR OWN OR OF OUR CLIENTS.
Our operations are dependent upon our ability to protect our distribution
facilities, customer service centers, computer and telecommunications equipment
and software systems against damage and failures. Damage or failures could
result from fire, power loss, equipment malfunctions, system failures, natural
disasters and other causes. Although we believe we have sufficient property and
business interruption
24
insurance, if our business is interrupted either from accidents or the
intentional acts of others, our business could be materially adversely affected.
In addition, in the event of widespread damage or failures at our facilities,
our short-term disaster recovery and contingency plans and insurance coverage
may not be sufficient.
Our clients' businesses may also be harmed from any system or equipment
failures we experience. In that event, our relationship with these clients may
be adversely affected, we may lose these clients, our ability to attract new
clients may be adversely affected and we could be exposed to liability.
Interruptions could also result from the intentional acts of others, like
"hackers." If our systems are penetrated by computer hackers, or if computer
viruses infect our systems, our computers could fail or proprietary information
could be misappropriated.
If our clients suffer similar interruptions in their operations, for any of
the reasons discussed above or for others, our business could also be adversely
affected. Many of our clients' computer systems interface with our own. If they
suffer interruptions in their systems, the link to our systems could be severed
and sales of their products could be slowed or stopped.
A BREACH OF OUR E-COMMERCE SECURITY MEASURES COULD REDUCE DEMAND FOR OUR
SERVICES.
A requirement of the continued growth of e-commerce is the secure
transmission of confidential information over public networks. A party who is
able to circumvent our security measures could misappropriate proprietary
information or interrupt our operations. Any compromise or elimination of our
security could reduce demand for our services.
We may be required to expend significant capital and other resources to
protect against security breaches or to address any problem they may cause.
Because our activities involve the storage and transmission of proprietary
information, such as credit card numbers, security breaches could damage our
reputation, cause us to lose clients, impact our ability to attract new clients
and we could be exposed to litigation and possible liability. Our security
measures may not prevent security breaches, and failure to prevent security
breaches may disrupt our operations.
WE MAY BE A PARTY TO LITIGATION INVOLVING OUR E-COMMERCE INTELLECTUAL PROPERTY
RIGHTS.
In recent years, there has been significant litigation in the United States
involving patent and other intellectual property rights. We may be a party to
intellectual property litigation in the future to protect our trade secrets or
know-how. United States patent applications are confidential until a patent is
issued and most technologies are developed in secret. Accordingly, we are not,
and cannot be, aware of all patents or other intellectual property rights of
which our services may pose a risk of infringement. Others asserting rights
against us could force us to defend ourselves or our customers against alleged
infringement of intellectual property rights. We could incur substantial costs
to prosecute or defend any such litigation.
RISKS RELATED TO DAISYTEK
WE HAVE POTENTIAL LIABILITY TO DAISYTEK FOR TAX INDEMNIFICATION OBLIGATIONS.
Under the terms of our tax indemnification and allocation agreement with
Daisytek, we will indemnify Daisytek for any tax liability it suffers arising
out of our actions, or certain actions to which we are a party that may exist,
before or after the spin-off that would cause the spin-off to lose its
qualification as a tax-free distribution for federal income tax purposes. These
actions include any event involving the acquisition of the shares of our capital
stock after the spin-off which has the effect of disqualifying the spin-off from
tax-free treatment, whether or not the event is the result of our direct action
or within our control. If we cause the spin-off to not qualify as a tax-free
distribution, Daisytek would incur federal income tax (which currently would be
imposed at a 35% rate), and possibly state income taxes on the gain inherent in
the shares distributed, which would be based upon the market value of the PFSweb
shares at the time of the spin-off. In the event that we are required to
indemnify Daisytek in respect of this liability, it would have a material
adverse effect on our cash flow and business operations.
25
WE HAVE POTENTIAL LIABILITY FOR DAISYTEK'S TAX OBLIGATIONS.
For all periods in which Daisytek owned 80% or more of our capital stock,
we are included in Daisytek's consolidated group for federal income tax
purposes. If Daisytek or other members of the consolidated group fail to make
any federal income tax payments, we would be liable for the shortfall since each
member of a consolidated group is liable for the group's entire tax obligation.
WE HAVE LIMITED ABILITY TO ISSUE COMMON STOCK AFTER THE SPIN-OFF.
In order for the spin-off to be tax-free to Daisytek and Daisytek's
stockholders, we agreed to certain limitations upon our issuance of capital
stock during the two-year period after the spin-off, such as issuing an
additional amount of our capital stock in a single transaction or series of
transactions related to the spin-off which, when combined with the common stock
issued in the Offering, could cause a 50% or greater change in the vote or value
of our outstanding capital stock. These restrictions may impede our ability to
complete transactions using our capital stock or to attract qualified persons to
become officers or directors.
RISKS RELATED TO OUR INDUSTRY
IF THE TREND TOWARD OUTSOURCING DOES NOT CONTINUE, OUR BUSINESS WILL BE
ADVERSELY AFFECTED.
Our business could be materially adversely affected if the trend toward
outsourcing declines or reverses, or if corporations bring previously outsourced
functions back in-house. Particularly during general economic downturns,
businesses may bring in-house previously outsourced functions in order to avoid
or delay layoffs. The continued threat of terrorism within the United States and
abroad and the potential for sustained military action may cause disruption to
commerce and economic conditions, both domestic and foreign, which could have a
material adverse effect upon our business and new client prospects.
OUR MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND TO COMPETE WE MUST
CONTINUALLY ENHANCE OUR SYSTEMS TO COMPLY WITH EVOLVING STANDARDS.
To remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of our services and the underlying
network infrastructure. If we are unable to adapt to changing market conditions,
client requirements or emerging industry standards, our business could be
adversely affected. The Internet and e-commerce are characterized by rapid
technological change, changes in user requirements and preferences, frequent new
product and service introductions embodying new technologies and the emergence
of new industry standards and practices that could render our technology and
systems obsolete. Our success will depend, in part, on our ability to both
internally develop and license leading technologies to enhance our existing
services and develop new services. We must continue to address the increasingly
sophisticated and varied needs of our clients and respond to technological
advances and emerging industry standards and practices on a cost-effective and
timely basis. The development of proprietary technology involves significant
technical and business risks. We may fail to develop new technologies
effectively or to adapt our proprietary technology and systems to client
requirements or emerging industry standards.
RISKS RELATED TO OUR STOCK
OUR COMMON STOCK IS SUBJECT TO POSSIBLE DELISTING FROM THE NASDAQ NATIONAL
MARKET SYSTEM.
Under current NASDAQ National Market System ("NMS") listing rules, listed
companies are required to maintain a $1.00 minimum share price. As of February
14, 2002, our common stock share price had closed under $1.00 for 30 consecutive
trading days. As a result, and in accordance with NASDAQ NMS regulations, we
have until May 15, 2002 to regain compliance with this rule. If the bid price of
our common stock closes at $1.00 or more for a minimum of ten days prior to May
15, 2002, under current NASDAQ NMS rules, we would be in compliance with the
minimum share price requirement. Conversely, if the share price does not meet
this ten day requirement, our common stock would then be subject to a delisting
determination from NASDAQ. Upon receipt of such determination, we may either (1)
appeal the determination to the
26
NASDAQ Listing Qualifications Panel (which appeal would postpone the delisting
until the appeal is decided) or (2) transfer our listing to the NASDAQ SmallCap
Market. The delisting of our common stock could have a material adverse effect
on the market price of, and the efficiency of the trading market for, our common
stock.
OUR CERTIFICATE OF INCORPORATION, OUR BYLAWS, OUR SHAREHOLDER RIGHTS PLAN AND
DELAWARE LAW MAKE IT DIFFICULT FOR A THIRD PARTY TO ACQUIRE US, DESPITE THE
POSSIBLE BENEFIT TO OUR STOCKHOLDERS.
Provisions of our certificate of incorporation, our bylaws, our shareholder
rights plan and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders. For
example, our certificate of incorporation provides for a classified board of
directors, meaning that only approximately one-third of our directors will be
subject to re-election at each annual stockholder meeting. Our certificate of
incorporation also permits our Board of Directors to issue one or more series of
preferred stock which may have rights and preferences superior to those of the
common stock. The ability to issue preferred stock could have the effect of
delaying or preventing a third party from acquiring us. We have also adopted a
shareholder rights plan. These provisions could discourage takeover attempts and
could materially adversely affect the price of our stock.
ITEM 2. PROPERTIES
Our PFSweb business is headquartered in a central office facility located
in Plano, Texas, a Dallas suburb.
In the U.S., we operate an approximately eight hundred thousand square foot
central distribution complex in Memphis, Tennessee. This complex is located
approximately four miles from the Memphis International Airport, where both
Federal Express and United Parcel Service operate large hub facilities.
We also operate a 150,000 square foot distribution center in Liege,
Belgium, which contains advanced distribution systems and equipment. We also
operate a 33,000 square foot distribution center in Richmond Hill, Canada, near
Toronto. We operate customer service centers in Memphis, Tennessee; Plano,
Texas; Richmond Hill, Canada; and Liege, Belgium. Our call center technology
permits the automatic routing of calls to available customer service
representatives in several of our call centers.
All of our facilities are leased and the material lease agreements contain
one or more renewal options.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
27
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is listed and currently trades on the Nasdaq Stock Market
under the symbol "PFSW." The following table sets forth for the period indicated
the high and low sale price for the common stock as reported by the Nasdaq
National Market:
[Download Table]
PRICE
--------------
HIGH LOW
------ -----
Fiscal Year 2001
First Quarter............................................. $17.13 $3.88
Second Quarter............................................ $ 5.00 $1.92
Third Quarter............................................. $ 2.69 $0.53
Fourth Quarter............................................ $ 1.59 $0.66
Nine Months Ended December 31, 2001
First Quarter............................................. $ 1.45 $0.69
Second Quarter............................................ $ 1.06 $0.35
Third Quarter............................................. $ 1.00 $0.67
As of March 15, 2002, there were approximately 7,100 shareholders of which
119 were record holders of the common stock.
We have never declared or paid cash dividends on our common stock and do
not anticipate the payment of cash dividends on our common stock in the
foreseeable future. We currently intend to retain all earnings to finance the
further development of our business. The payment of any future cash dividends
will be at the discretion of our Board of Directors and will depend upon, among
other things, future earnings, operations, capital requirements, the general
financial condition of the Company and general business conditions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
HISTORICAL PRESENTATION
In June 2001, we announced a change in our fiscal year end from March 31 to
December 31. Consequently, our most recent fiscal period is a nine month
transition period ended December 31, 2001.
The selected consolidated historical statement of operations data for each
of the fiscal years ended March 31, 2000 and 2001 and the nine months ended
December 31, 2001, and the selected consolidated balance sheet data as of March
31, 2001 and December 31, 2001 have been derived from our audited consolidated
financial statements, and should be read in conjunction with those statements
and notes, which are included in this Form 10-K. The selected consolidated
statement of operations data for the fiscal years ended March 31, 1998 and 1999
and the selected consolidated balance sheet data as of March 31, 1998, 1999 and
2000 have been derived from our audited consolidated financial statements, and
should be read in conjunction with those statements, which are not included in
this Form 10-K. The selected consolidated statement of operations data for the
nine months ended December 31, 2000, and the selected consolidated balance sheet
data as of December 31, 2000 have been derived from our unaudited interim
condensed consolidated financial statements, and should be read in conjunction
with these statements, which are not included in this Form 10-K. The financial
information for periods prior to fiscal year 2001 herein may not necessarily
reflect our results of operations, financial position and cash flows in the
future or what our results of operations, financial position and cash flows
would have been had we been a separate, stand-alone entity during the periods
presented. The selected consolidated financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and notes
thereto which are included elsewhere in this Form 10-K.
28
HISTORICAL SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
[Enlarge/Download Table]
NINE MONTHS ENDED
FISCAL YEARS ENDED MARCH 31, DECEMBER 31,
--------------------------------------- ---------------------
1998 1999 2000 2001 2000 2001(B)
------- -------- ------- -------- ----------- -------
(UNAUDITED)
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Revenues:
Product revenue................ $46,404 $ 94,768 $57,044 $ -- $ -- $ --
Service fee revenue............ 3,539 7,547 30,829 48,258 37,017 26,569
Service fee
revenue-affiliate............ -- -- -- -- -- 1,384
Other revenue.................. -- -- -- 2,097 1,700 100
------- -------- ------- -------- ------- -------
Total revenues............... 49,943 102,315 87,873 50,355 38,717 28,053
------- -------- ------- -------- ------- -------
Costs of revenues:
Cost of product revenue........ 43,992 89,401 53,905 -- -- --
Cost of service fee revenue.... 2,208 5,323 23,475 34,261 26,670 17,984
Cost of other revenue.......... -- -- -- 2,470 2,411 (627)
------- -------- ------- -------- ------- -------
Total costs of revenues...... 46,200 94,724 77,380 36,731 29,081 17,357
------- -------- ------- -------- ------- -------
Gross profit...................... 3,743 7,591 10,493 13,624 9,636 10,696
Percent of revenues............... 7.5% 7.4% 11.9% 27.1% 24.9% 38.1%
Selling, general and
administrative expenses........ 3,705 6,711 17,764 25,446 19,044 17,117
Other............................. -- -- -- -- -- (5,141)
------- -------- ------- -------- ------- -------
Income (loss) from operations..... 38 880 (7,271) (11,822) (9,408) (1,280)
Percent of revenues............... 0.1% 0.9% (8.3)% (23.5)% (24.3)% (4.6)%
Interest expense (income), net.... 143 374 459 (1,091) (880) (496)
------- -------- ------- -------- ------- -------
Income (loss) before income
taxes.......................... (105) 506 (7,730) (10,731) (8,528) (784)
Income tax expense (benefit)...... (30) 214 (1,791) 25 36 (219)
------- -------- ------- -------- ------- -------
Net income (loss)................. $ (75) $ 292 $(5,939) $(10,756) $(8,564) $ (565)
======= ======== ======= ======== ======= =======
PER SHARE DATA:
Net income (loss) per share:
Basic and diluted(a)........... $ (0.01) $ 0.02 $ (0.38) $ (0.60) $ (0.48) $ (0.03)
======= ======== ======= ======== ======= =======
Weighted average number of shares
outstanding:
Basic and diluted(a)........... 14,305 14,305 15,479 17,879 17,870 18,036
[Enlarge/Download Table]
AS OF MARCH 31, AS OF DECEMBER 31,
------------------------------------- ---------------------
1998 1999 2000 2001 2000 2001(B)
------- ------- ------- ------- ----------- -------
(UNAUDITED)
CONSOLIDATED BALANCE SHEET DATA:
Working capital...................... $ 1,344 $14,636 $27,974 $19,941 $21,055 $11,154
Total assets......................... 20,911 69,057 60,405 59,089 58,789 51,593
Long-term obligations................ 1,827 29,029 2,407 4,353 4,100 5,873
Shareholders' equity (deficit)....... (155) 581 47,650 37,001 39,010 36,605
---------------
(a) Prior to the Offering, which was consummated in fiscal year 2000, basic and
diluted net income (loss) per share was determined based on net income
(loss) divided by the 14,305,000 shares outstanding. There
29
were no potentially dilutive securities outstanding prior to the Offering.
For fiscal year 2000 and 2001, and the nine month periods ended December
31, 2000 and 2001, outstanding options to purchase common shares of PFSweb
were anti-dilutive and have been excluded from the weighted average share
computation.
(b) In June 2001, the Company elected to change its fiscal year end from March
31 to December 31. Consequently the Company's most recently completed
fiscal period is a nine month period ended December 31, 2001.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our results of operations and
financial condition should be read in conjunction with the consolidated
financial statements and related notes thereto appearing elsewhere in this Form
10-K.
FORWARD-LOOKING INFORMATION
We have made forward-looking statements in this Report on Form 10-K. These
statements are subject to risks and uncertainties, and there can be no guarantee
that these statements will prove to be correct. Forward-looking statements
include assumptions as to how we may perform in the future. When we use words
like "seek," "strive," "believe," "expect," "anticipate," "predict,"
"potential," "continue," "will," "may," "could," "intend," "plan," "target" and
"estimate" or similar expressions, we are making forward-looking statements. You
should understand that the following important factors, in addition to those set
forth above or elsewhere in this Report on Form 10-K, could cause our results to
differ materially from those expressed in our forward-looking statements. These
factors include:
- Our ability to retain and expand relationships with existing clients and
attract new clients;
- our reliance on the fees generated by the transaction volume or product
sales of our clients;
- our reliance on our clients' projections or transaction volume or product
sales;
- our client mix and the seasonality of their business;
- our ability to finalize pending contracts;
- the impact of strategic alliances and acquisitions;
- trends in the market for our services;
- trends in e-commerce;
- whether we can continue and manage growth;
- changes in the trend toward outsourcing;
- increased competition;
- our ability to generate more revenue and achieve sustainable
profitability;
- effects of changes in profit margins;
- the customer concentration of our business;
- the unknown effects of possible system failures and rapid changes in
technology;
- trends in government regulation both foreign and domestic;
- foreign currency risks and other risks of operating in foreign countries;
- potential litigation involving our e-commerce intellectual property
rights;
- our dependency on key personnel;
30
- our ability to raise additional capital;
- our relationship with and our guarantees of the working capital
indebtedness of our affiliate, Supplies Distributors;
- the continued listing of our common stock on the NASDAQ; and
- our relationship with and separation from Daisytek, our former parent
corporation.
We have based these statements on our current expectations about future
events. Although we believe that the expectations reflected in our
forward-looking statements are reasonable, we cannot guarantee you that these
expectations actually will be achieved. In addition, some forward-looking
statements are based upon assumptions as to future events that may not prove to
be accurate. Therefore, actual outcomes and results may differ materially from
what is expected or forecasted in such forward-looking statements. We undertake
no obligation to update publicly any forward-looking statement for any reason,
even if new information becomes available or other events occur in the future.
There may be additional risks that we do not currently view as material or that
are not presently known. In evaluating these statements, you should consider
various factors, including the risks set forth in the section entitled "Risk
Factors".
OVERVIEW
We are an international outsourcing provider of integrated business process
outsourcing solutions to major brand name companies seeking to maximize their
supply chain efficiencies and to extend their e-commerce initiatives. We derive
our revenues from a broad range of services, including professional consulting,
technology collaboration, order management, managed web hosting and web
development, customer relationship management, financial services including
billing and collection services, options kitting and assembly services,
information management and international fulfillment and distribution services.
We offer our services as an integrated solution, which enables our clients to
outsource their complete infrastructure needs to a single source and to focus on
their core competencies. Our distribution services are conducted at our
warehouses and include real-time inventory management and customized picking,
packing and shipping of our clients' customer orders. We currently provide
infrastructure and distribution solutions to clients that operate in a range of
vertical markets, including technology manufacturing, computer products,
printers, cosmetics, fragile goods, high security collectibles, pharmaceuticals,
housewares, apparel, telecommunications and consumer electronics, among others.
Our service fee revenue is typically charged on a percent of shipped
revenue basis or 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) and are not reflected in our revenue or expense.
Historically, our services have also included purchasing and reselling client
product inventory. In these arrangements, our product revenue was recognized at
the time product was shipped. During the quarter ended September 30, 1999, our
primary client agreement under which we previously purchased and sold inventory
was restructured to provide transaction management services only on a service
fee basis.
Our expenses are comprised of:
- prior to September 30, 1999, cost of product revenue, which consisted of
the price of product sold and freight costs;
- 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
31
technology costs and depreciation and amortization expenses; and selling,
general and administrative expenses, which consist primarily of
compensation and related expenses for sales and marketing staff,
executive, management and administrative personnel and other overhead
costs, including certain occupancy and information technology costs and
depreciation and amortization expenses. In addition, for the periods
prior to September 30, 1999, certain direct contract costs related to our
IBM master distributor agreements were reflected as selling and
administrative expenses.
HISTORICAL FINANCIAL PRESENTATION
We believe our historical financial statements for the periods prior to
fiscal year 2001 may not provide a meaningful comparison to our current and
future financial performance for the reasons described below.
In 1996, we entered into an agreement with the printer supplies division of
IBM. Under this agreement, we provided IBM with various transaction management
services, such as call center services and order fulfillment and distribution.
We also served as an IBM master distributor of printer supply products. Under
this master distributor arrangement, we purchased the printer supply products
from IBM and resold them to IBM customers. Following our initial agreement with
the printer supplies division, we entered into several similar agreements with
other divisions of IBM, both in the U.S. and Europe, and expanded our then
existing agreements to include more product lines.
During the quarter ended September 30, 1999, we, Daisytek and IBM entered
into new agreements to conform to our current business model. Under these new
agreements, Daisytek acted as the master distributor of the IBM products and we
provided various transaction management services. As part of this restructuring,
we transferred to Daisytek the IBM product inventory, which we held as the
master distributor, together with our customer accounts receivable and our
accounts payable owing to IBM in respect of the product inventory. The purpose
of the restructuring was to separate the master distributor and transaction
management responsibilities between ourselves and Daisytek so that each could
focus on its core competencies.
As a result of the restructuring of the IBM agreements, our historical
financial statements for the periods prior to fiscal year 2001 may not provide a
meaningful comparison to our current and future financial statements. This is
because, as a master distributor under our prior agreements, we recorded revenue
as product revenue as we sold the product to IBM customers. Similarly, our gross
profit was based upon the difference between our revenue from product sales and
the cost of purchasing the product from IBM.
As a result of this restructuring of our IBM agreements, our total revenues
arising under our new IBM agreements have been reduced, as compared to the total
revenues arising under the prior IBM agreements. However, our gross profit
margin as a percent of service fee revenue under the new IBM agreements is
higher as compared to our gross profit margin as a percent of product revenue
under the prior IBM agreements.
In September 2001, Daisytek sold its subsidiaries that had been conducting
the IBM business to a subsidiary of our affiliate, Business Supplies
Distributors Holdings, LLC. In conjunction with this transaction, we entered
into a new service fee contract with this affiliate. See "Supplies
Distributors."
In addition, upon completion of the Offering on December 2, 1999, we
entered into a transaction management services agreement with Daisytek. Under
this agreement, we received service fee revenue based upon a percentage of
Daisytek's shipped product revenue. Consequently, our historical financial
statements reflect the service fee revenue we received from Daisytek under this
new agreement for the twelve months ended March 31, 2001, but for only four
months in the fiscal year ended March 31, 2000. Effective May 2001, our
transaction management services agreement with Daisytek was terminated.
Concurrently, we also entered into a six-month transitional and information
technology services agreement with Daisytek, which terminated in November 2001.
32
RESULTS OF OPERATIONS
The following table sets forth certain historical financial information
from our consolidated statements of operations expressed as a percent of
revenues.
[Enlarge/Download Table]
FISCAL YEARS ENDED NINE MONTHS ENDED
MARCH 31, DECEMBER 31,
------------------- -------------------
2000 2001 2000 2001
------- ------- ----------- -----
(UNAUDITED)
Product revenue................................... 64.9% --% --% --%
Service fee revenue............................... 35.1 95.8 95.6 94.7
Service fee revenue -- affiliate.................. -- -- -- 4.9
Other revenue..................................... -- 4.2 4.4 0.4
----- ----- ----- -----
Total revenues.......................... 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of product revenue (as % of product
revenue)........................................ 94.5 -- -- --
Cost of service fee revenue (as % of service fee
revenue)........................................ 76.1 71.0 72.0 64.3
Cost of other revenue (as % of total revenues).... -- 4.9 6.2 (2.2)
----- ----- ----- -----
Total costs of revenues................. 88.1 72.9 75.1 61.9
----- ----- ----- -----
Gross profit...................................... 11.9 27.1 24.9 38.1
Selling, general and administrative expenses...... 20.2 50.5 49.2 61.0
Other............................................. -- -- -- (18.3)
----- ----- ----- -----
Loss from operations.............................. (8.3) (23.4) (24.3) (4.6)
Interest expense (income), net.................... 0.5 (2.0) (2.3) (1.8)
----- ----- ----- -----
Loss before income taxes.......................... (8.8) (21.4) (22.0) (2.8)
Income tax expense (benefit)...................... (2.0) -- 0.1 (0.8)
----- ----- ----- -----
Net loss.......................................... (6.8)% (21.4)% (22.1)% (2.0)%
===== ===== ===== =====
NINE MONTHS ENDED DECEMBER 31, 2001 COMPARED TO NINE MONTHS ENDED DECEMBER 31,
2000
Service Fee Revenue (including service fee revenue -- affiliate). Service
fee revenue was $28.0 million for the nine months ended December 31, 2001 as
compared to $37.0 million for the nine months ended December 31, 2000, a
decrease of $9.0 million or 24.5%. The decrease in service fee revenue over the
prior period was due to the impact of certain contract terminations, primarily
the Daisytek contract, as well as certain other lower margin producing
contracts. This reduction was partially offset by the impact of new service
contract relationships and growth in existing client relationships. In
conjunction with the $10.9 million sale of a distribution facility to Daisytek
in May 2001 (discussed below in "Liquidity and Capital Resources"), we
terminated certain of our transaction management services agreements entered
into between us and Daisytek and a Daisytek subsidiary. Concurrently with the
closing of the facility sale, we entered into a six-month transition services
agreement to provide Daisytek with certain transitional and information
technology services, under which we earned $2.6 million. The net impact of the
changes in our services provided to Daisytek was a reduction in revenue of $10.6
million for the nine months ended December 31, 2001. The reduction in revenue
attributed to the termination of lower margin producing contracts was $8.2
million for the nine months ended December 31, 2001. For the nine months ended
December 31, 2001, the increase in revenue attributed to new client contract
relationships was $7.2 million. For the nine months ended December 31, 2001, the
increase in revenue from existing contracts was $2.6 million. We believe this
increase was negatively impacted by the recent slowdown in the U.S. economy.
Pursuant to the terms of the Company's transaction management services
agreement with Supplies Distributors, the Company earned service fees, which are
reported as service fee revenue -- affiliate in the accompanying consolidated
financial statements, of approximately $1.4 million for the nine months ended
33
December 31, 2001. For the nine months ended December 31, 2001, PFSweb fees
earned from BSD (the Daisytek subsidiary and predecessor to Supplies
Distributors) were $3.6 million. For the nine months ended December 31, 2000,
prior to becoming a related party, service fees earned by PFSweb from BSD,
associated with the same business activities, were $4.6 million. For the nine
months ended December 31, 2001, our revenue was negatively impacted by lower
than anticipated IBM related activity due to the transition to Supplies
Distributors from Daisytek but was benefited by approximately $0.8 million of
service fee adjustments resulting from the termination of the Daisytek
transaction management service agreements. Service fee revenue earned from the
IBM business for the nine months ended December 31, 2000 were reduced by $1.3
million foreign currency transaction losses applicable to the devaluation of the
Euro that were required, under the terms of the arrangements between us and BSD,
to be included as part of the service fee billings.
Other Revenue. Other revenue of $0.1 million for the nine months ended
December 31, 2001 and $1.7 million for the nine months December 31, 2000,
respectively, represents the fees charged to clients in conjunction with early
contract terminations.
Cost of Service Fee Revenue. Cost of service fee revenue was $18.0 million
for the nine months ended December 31, 2001, as compared to $26.7 million during
the nine months ended December 31, 2000, a decrease of $8.7 million or 32.6%.
The resulting service fee gross profit was $10.0 million or 35.7% of service fee
revenue, during the nine months ended December 31, 2001 as compared to $10.3
million, or 28.0% of service fee revenue for the nine months ended December 31,
2000. For the nine months ended December 31, 2000, the service fee gross profit
was negatively impacted by a $1.3 million reduction in revenue applicable to
foreign currency transaction losses discussed above, for which there was no
reduction in costs. In addition, the gross profit earned on certain contracts
terminated during the nine months ended December 31, 2000 was lower than other
contracts we continue to operate. Additionally, by leveraging our existing
infrastructure and by reducing the direct operating costs associated with the
terminated contracts, such as personnel costs, warehousing and distribution
costs, lower depreciation costs resulting from the sale of assets, and other
expenses, we were able to reduce our operating costs and increase our gross
profit percentage. For the nine months ended December 31, 2001, our gross profit
margin was negatively impacted by lower than anticipated IBM related activity
due to the transition to Supplies Distributors from Daisytek but was benefited
by approximately $0.8 million of service fees adjustments resulting from the
termination of the Daisytek transaction management services agreements for which
the related service activities were performed in earlier periods. Furthermore,
the revenue generated by our transition services agreement with Daisytek, under
which we provided certain transitional and information technology services,
primarily utilized infrastructure, which existed in the prior periods and will
continue to exist in future periods.
Cost of Other Revenue. Cost of other revenue for the nine months ended
December 31, 2001 reflect the reversal of $0.6 million of accruals made in the
prior year for estimated client termination costs that were determined this
period to be in excess of the actual costs. Cost of other revenue for the nine
months ended December 31, 2000 includes costs from certain terminated contracts
and are primarily comprised of approximately $0.4 million of employee severance
costs, approximately $0.5 million of asset impairments from fixed assets which
were specific to terminated contracts and produced no further value to PFSweb,
and approximately $1.6 million of certain uncollectible amounts receivable from,
and accrued expenses applicable to, clients who terminated contracts.
Selling, General and Administrative Expenses. SG&A expenses were $17.1
million for the nine months ended December 31, 2001, or 61.0% of revenues, as
compared to $19.0 million, or 49.2% of revenues, for the nine months ended
December 31, 2000. The decrease in SG&A expenses are due to costs incurred in
the prior nine month periods for which there are no or lower comparable costs
incurred in the current year periods. These relate to approximately $1.4 million
of incremental costs primarily applicable to provisions for doubtful accounts, a
$0.5 million foreign currency transaction loss, due to a devaluation of the
Euro, and the $0.3 million favorable resolution of accounts and Value Added Tax
("VAT") receivables in the quarter ended September 30, 2001, offset by an
increase in stand alone public company expenses, consisting primarily of taxes
and insurance, incremental professional services fees for audit and tax services
associated with the change in our fiscal year end and increases in personnel
compensation and sales and marketing costs.
34
Other. Other primarily reflects the sale of a distribution facility
previously used by PFSweb to provide outsourcing services to Daisytek. For the
nine months ended December 31, 2001, cash proceeds of $10.9 million, net of
approximately $0.6 million of closing costs, were received for assets with an
approximately $4.5 million net book value with a resulting $5.8 million gain.
The net gain was offset by a $0.7 million non-cash stock compensation charge
associated with our modification of certain PFSweb stock options held by
employees of our former parent company Daisytek.
Interest Income. Interest income was $0.5 million for the nine months
ended December 31, 2001 as compared to interest income of $0.9 million for the
nine months ended December 31, 2000. The reduction in interest income is
attributable to lower interest rates earned by our cash and cash equivalents and
higher interest expense due to an increase in our long-term debt and capital
lease obligations partially offset by the impact of higher interest rates
charged on our subordinated loan to Supplies Distributors.
Income Taxes. For the nine months ended December 31, 2001, we recorded an
income tax benefit of $0.2 million which primarily relates to a pre-tax loss
from our Canadian operations that can be carried back to prior tax years. For
the nine months ended December 31, 2001, we did not record an income tax benefit
associated with our net loss in our U.S. or European operations. Since we have
not established a sufficient history of earnings for our U.S. and European
operations, a valuation allowance has been provided for our net deferred tax
assets as of December 31, 2001, which are primarily related to our net operating
loss carryforwards. Although we had a pre-tax loss for the nine months ended
December 31, 2000, we recorded an income tax provision associated with a pre-tax
income from our Canadian operations.
FISCAL YEAR ENDED MARCH 31, 2001 COMPARED TO FISCAL YEAR ENDED MARCH 31, 2000
We believe our historical financial statements for the periods prior to
fiscal 2001 may not provide a meaningful comparison to our current and future
financial performance for the reasons described above in "Historical Financial
Presentation."
Product Revenue. Product revenue was zero for fiscal 2001 as compared to
$57.0 million for fiscal 2000. As stated above, during the quarter ended
September 30, 1999, we, Daisytek and IBM entered into new agreements applicable
to all of our IBM relationships. As a result of these new agreements, the
activities performed under these contracts since that date were accounted for as
service fee revenue as opposed to product revenue.
Service Fee Revenue. Service fee revenue was $48.3 million for fiscal 2001
as compared to $30.8 million during fiscal 2000, an increase of $17.5 million or
56.5%. Changes in service fee revenues over prior periods were due to the
further expansion of existing contracts, the restructuring of all the IBM
contracts, new service contract relationships, our transaction management
services agreement with Daisytek which commenced on the completion of the
Offering in December 1999 and the impact of certain contract terminations.
Service fee revenue from existing contracts increased $13.3 million and new
service contract relationships added $4.2 million for fiscal 2001. Service fee
revenue for fiscal 2001 also includes approximately $0.5 million of previously
deferred revenue associated with terminated contracts. For fiscal 2001, service
fee revenue totaling $27.6 million included fees earned from Daisytek under our
new transaction management services agreement, effective as of the Offering, our
new IBM contracts that, prior to the September 1999 quarter, would have been
reported as product revenue, and for certain subcontracted services. During
fiscal 2001, we effected certain contract terminations with service fee revenues
of approximately $8 million and experienced a longer implementation cycle
associated with new larger contracts.
Other Revenue. Other revenue of $2.1 million for fiscal 2001 represents
the fees charged to clients in conjunction with the early termination of certain
contracts.
Cost of Product Revenue. Cost of product revenue was zero for fiscal 2001,
as compared to $53.9 million during fiscal 2000. Cost of product revenue as a
percent of product revenue was zero during fiscal 2001 and 94.5% during fiscal
2000. The resulting gross profit margin was 5.5% for fiscal 2000.
Cost of Service Fee Revenue. Cost of service fee revenue was $34.3 million
for fiscal 2001, as compared to $23.5 million during fiscal 2000, an increase of
$10.8 million or 45.9%. The resulting service fee gross profit
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was $14.0, million or 29.0% of service fee revenue, during fiscal 2001 as
compared to $7.4 million, or 23.9% of service fee revenue during fiscal 2000.
The increase in gross profit margin for fiscal 2001 resulted primarily from the
further expansion of existing contracts and new service contract relationships,
including our transaction management services agreement with Daisytek, which
commenced on the completion of the Offering in December 1999, and the
termination of certain lower margin producing contracts. The gross profit margin
also increased because cost of service fee revenue for fiscal 2000 included
incremental costs related to a large number of new client implementations during
that year. Fiscal 2001 gross profit increases were offset by approximately $0.5
million of previously deferred costs associated with terminated contracts. In
addition, certain excess infrastructure costs, incremental operating costs
related to terminated contracts and costs associated with improving service
quality had a negative impact on fiscal 2001 gross margin. As a percentage of
total revenues, the gross profit margin for fiscal 2001 of 27.1% increased when
compared to the 11.9% gross profit margin for fiscal 2000 due to the factors
discussed above as well as the restructuring of all of the IBM contracts into
service fee contracts, which typically have a higher gross profit margin as a
percent of revenue as compared to the gross profit margin as a percent of
revenue earned under the IBM master distributor agreements.
Cost of Other Revenue. Cost of other revenue for fiscal 2001 includes
costs from certain terminated contracts and are primarily comprised of
approximately $0.4 million of employee severance costs, approximately $0.5
million of asset impairments from fixed assets which were specific to terminated
contracts and provided no further value to PFSweb, and approximately $1.6
million of certain uncollectible amounts receivable from, and liabilities
applicable to, clients who terminated contracts.
Selling, General and Administrative Expenses. SG&A expenses were $25.4
million for fiscal 2001, or 50.5% of revenues, as compared to $17.8 million, or
20.2% of revenues, for fiscal 2000. As a result of incremental costs, the
restructuring of the IBM agreements and the related reduction in product
revenue, SG&A expenses as a percentage of total revenue were higher in fiscal
2001 than in fiscal 2000. SG&A expenses increased as a result of costs incurred
to support the higher sales volumes under both new and existing contracts,
certain excess infrastructure costs, incremental investments in resources and
technology to support our continued growth and public company costs.
Interest Expense (Income), Net. Interest income was $1.1 million for
fiscal 2001 as compared to interest expense of $0.5 million for fiscal 2000. The
weighted average interest rate was 6.7% during fiscal 2000. Our intercompany
payable to Daisytek, on which we incurred interest expense during fiscal 2000,
was repaid with a portion of the proceeds from our Offering. Subsequent to the
Offering, the remaining proceeds have been utilized to fund working capital
needs and capital expenditures and generate interest income.
Income Taxes. For fiscal 2001, we recorded income tax expense associated
with our Canadian operations. Because of our limited operating history in
Europe, it is uncertain whether it is "more likely than not" that we will be
able to utilize our European losses in future periods and therefore we did not
record an income tax benefit for the pre-tax losses. During fiscal 2001, we
recorded an income tax benefit of $0.1 million related to our ability to utilize
our net operating losses to offset future taxes related to deferred tax
liabilities. However, since we ceased to be included in Daisytek's consolidated
return due to the completion of the spin-off and we have not established a
sufficient history of earnings from our U.S. operations, on a stand-alone basis,
a valuation allowance has been provided for the remaining net deferred tax asset
as of March 31, 2001. For fiscal 2000, although we did not benefit our European
losses, as a result of the inclusion of our U.S. operations in Daisytek's
consolidated return prior to the spin-off, our income tax benefit as a
percentage of pre-tax loss was 23.2%.
SUPPLIES DISTRIBUTORS
Business Supplies Distributors (a Daisytek subsidiary -- "BSD"), Daisytek
and IBM and us were parties to various Master Distributor Agreements which had
various scheduled expiration dates through September 2001. Under these
agreements, BSD and its affiliates Business Supplies Distributors Europe B.V.
("BSD Europe"), a Daisytek subsidiary, and BSD (Canada) Inc., a Daisytek
subsidiary ("BSD Canada" and together with BSD and BSD Europe, the "BSD
Companies"), acted as master distributors of various IBM
36
products, Daisytek provided financing and credit support to the BSD Companies
and we provided transaction management and fulfillment services to the BSD
Companies. On June 8, 2001, Daisytek notified us and IBM that it did not intend
to renew these agreements upon their scheduled expiration dates. In July 2001,
we and Inventory Financing Partners, LLC ("IFP") formed Business Supplies
Distributors Holdings, LLC ("Holdings"), and Holdings formed a wholly-owned
subsidiary, Supplies Distributors ("Supplies Distributors"). Concurrently,
Supplies Distributors formed its wholly-owned subsidiaries Supplies Distributors
of Canada, Inc. ("SDC") and Supplies Distributors S.A. ("SDSA"), a Belgium
corporation. Supplies Distributors, SDSA, IBM and PFSweb entered into new Master
Distributor Agreements to replace the prior agreements. Under the new
agreements, Supplies Distributors and SDSA act as master distributors of various
IBM products and, pursuant to a transaction management services agreement
between us and Supplies Distributors, we provide transaction management and
fulfillment services to Supplies Distributors. We made an equity investment of
$0.75 million in Holdings for a 49% voting interest, and IFP made an equity
investment of $0.25 million in Holdings for a 51% voting interest. Certain
officers and directors of PFSweb own, individually, a 9.8% non-voting interest,
and, collectively, a 49% non-voting interest, in IFP. In addition to its equity
investment in Holdings, we have also provided Supplies Distributors with a
subordinated loan which, as of December 31, 2001, had an outstanding balance of
$11.7 million and accrued interest at approximately 10%. The balance can be
decreased to $6.5 million subject to Supplies Distributors' compliance with the
covenants of its senior loan facilities, as amended.
On September 26, 2001, Supplies Distributors purchased all of the stock of
the BSD Companies for a purchase price of $923,000. In conjunction with the
purchase, BSD and Supplies Distributors were merged with Supplies Distributors
being the surviving corporation. Effective December 31, 2001, BSD Canada and SDC
were amalgamated, with SDC being the surviving corporation. On September 27,
2001, Supplies Distributors entered into short-term credit facilities with IBM
Credit Corporation ("IBM Credit") and IBM Belgium Financial Services S.A. ("IBM
Belgium") for the purpose of financing its distribution of IBM products. The
facilities, which at inception included $40 million for the U.S. operations and
20 million Euros (approximately $18 million) for the European operations, were
subsequently increased to $45 million and 27 million Euros (approximately $24
million), respectively, and extended through March 25, 2002. The Company has
provided a collateralized guaranty to secure the repayment of these credit
facilities.
On March 29, 2002, Supplies Distributors entered into amended credit
facilities with IBM Credit and SDSA and BSD Europe entered into amended credit
facilities with IBM Belgium. The asset based credit facility with IBM Credit
provides financing for purchasing IBM inventory up to $32.5 million through June
30, 2002 and $27.5 million from July 1, 2002 through its expiration on March 29,
2003. The asset based credit facility with IBM Belgium provides up to 27 million
Euros (approximately $24.3 million) in financing for purchasing IBM inventory
through June 30, 2002 and 22 million Euros (approximately $19.8 million)
thereafter. The IBM Belgium facility remains in force until not less than 60
days written notice by any party, but no sooner than March 29, 2003. These
credit facilities contain cross default provisions, various restrictions upon
the ability of Holdings, Supplies Distributors, SDSA and BSD Europe to, among
other things, merge, consolidate, sell assets, incur indebtedness, make loans
and payments to related parties, provide guarantees, make investments and loans,
pledge assets, make changes to capital stock ownership structure and pay
dividends, as well as financial covenants, such as annualized revenue to working
capital, net profit after tax to revenue, and total liabilities to tangible net
worth, as defined, and are secured by all of the assets of Supplies
Distributors, as well as collateralized guaranties of Holdings and PFSweb.
Additionally, we are required to maintain a subordinated loan to Supplies
Distributors of no less than $6.5 million, and shareholders' equity of at least
$25.0 million. Furthermore, we are obligated to repay any over-advance made to
Supplies Distributors or SDSA under these facilities. An over-advance would
arise in the event borrowings exceeded the maximum amount available under the
eligible borrowing base, as defined.
Concurrent with these amended agreements, Supplies Distributors entered
into a loan and security agreement with Congress Financial Corporation
(Southwest) ("Congress") to provide financing for up to $25 million of eligible
accounts receivables in the U.S. and Canada. The Congress facility expires on
the earlier of three years or the date on which the parties to the IBM Master
Distributor Agreement shall no longer operate under the terms of such agreement
and/or IBM no longer supplies products pursuant to such
37
agreement. Borrowings under the Congress facility accrue interest at prime rate
plus 0.25% or Eurodollar rate plus 3.0% or on an adjusted basis, as defined. In
Europe, SDSA entered into a two year factoring agreement with Fortis Commercial
Finance N.V. ("Fortis") to provide factoring for up to 10 million Euros
(approximately $9 million) of eligible accounts receivables. Borrowings under
this agreement accrue interest at 8.5%, or on an adjusted basis as defined.
These credit facilities contain cross default provisions, various restrictions
upon the ability of Holdings, Supplies Distributors and SDSA to, among other
things, merge, consolidate, sell assets, incur indebtedness, make loans and
payments to related parties, provide guarantees, make investments and loans,
pledge assets, make changes to capital stock ownership structure and pay
dividends, as well as financial covenants, such as minimum net worth, as
defined, and are secured by all of the assets of Supplies Distributors, as well
as collateralized guaranties of Holdings and PFSweb. Additionally, we are
required to maintain a subordinated loan of no less than $6.5 million to
Supplies Distributors and restricted cash of less than $5.0 million, and are
restricted with regard to transactions with related parties, indebtedness and
changes to capital stock ownership structure. Furthermore, we are obligated to
repay any over-advance made to Supplies Distributors under the Congress
facility. An over-advance would arise in the event borrowings exceeded the
maximum amount available under the eligible borrowing base, as defined. PFS has
also provided a guarantee of the obligations of Supplies Distributors and SDSA
to IBM, excluding the trade payables that are financed by IBM credit.
Pursuant to the terms of our transaction management services agreement with
Supplies Distributors, we earned service fees, which are reported as service fee
revenue -- affiliate in the accompanying consolidated financial statements, of
approximately $1.4 million for the nine months ended December 31, 2001. For the
nine months ended December 31, 2001, our fees earned from services provided
under the IBM Master Distributor Agreements, including related party revenue,
were $5.0 million. For the nine months ended December 31, 2000, prior to
becoming a related party, service fees earned by PFSweb from BSD, associated
with the Master Distributor Agreements, were $4.6 million. As of December 31,
2001, we had trade accounts receivables of $0.9 million due from Supplies
Distributors.
We record our interest in Holdings' net income, which is allocated and
distributed to the owners pursuant to the terms of Holdings' operating
agreement, under the modified equity method, which results in us recording our
allocated earnings of Holdings or 100% of Holdings' losses. Pursuant to
Holdings' operating agreement, Holdings allocates its earning and distributes
its cash flow, as defined, in the following order of priority: first, to IFP
until it has received a one-time amount equal to its capital contribution of
$0.25 million; second, to IFP until it has received an amount equal to a 35%
cumulative annual return on its capital contribution; third, to PFSweb until it
has received a one-time amount equal to its capital contribution of $0.75
million; fourth, to PFSweb until it has received an amount equal to a 35%
cumulative annual return on its capital contribution; and fifth, to PFSweb and
IFP, pro rata, in accordance with their respective capital accounts.
Notwithstanding the foregoing, no distribution may be made if, after giving
effect thereto, the net worth of Holdings shall be less than $1.0 million. Under
terms of the credit agreements described above, Holdings is currently limited to
annual cash dividends of $0.6 million. We did not record any equity in the
earnings of Holdings for the nine months ended December 31, 2001.
Summarized financial information for Holdings as of December 31, 2001 is as
follows (in thousands):
[Download Table]
Current assets.............................................. $80,247
Total assets................................................ $81,554
Current liabilities......................................... $ 9,651
Credit facilities (guaranteed by PFSweb).................... $59,038
Subordinated debt due to PFSweb............................. $11,655
Members' capital............................................ $ 1,210
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Summarized operating information for Holdings for the period from July 3,
2001 (Inception) through December 31, 2001 is as follows (in thousands):
[Download Table]
Net revenues................................................ $75,444
Cost of goods sold.......................................... $71,870
Income before taxes......................................... $ 673
Net income.................................................. $ 401
LIQUIDITY AND CAPITAL RESOURCES
On May 25, 2001, we completed the sale of certain assets to Daisytek
pursuant to an Asset Purchase Agreement (the "Purchase Agreement"). Under the
Purchase Agreement, we transferred and sold to Daisytek certain distribution and
fulfillment assets, including equipment and fixtures, that were previously used
by us to provide outsourcing services to Daisytek. Daisytek also assumed certain
related equipment leases and a warehouse lease and hired certain employees who
were associated with the warehouse facility. The consideration payable under the
Purchase Agreement of $11.0 million included a termination by us and Daisytek of
certain transaction management services agreements previously entered into
between us and Daisytek and a Daisytek subsidiary. Proceeds of $10.9 million
were received for assets with an approximately $4.5 million net book value with
a resulting $5.8 million gain, after closing costs of $0.6 million. Concurrently
with the closing of the asset sale, we and Daisytek also entered into a
six-month transition services agreement, which terminated in November 2001,
under which we provided Daisytek with certain transitional and information
technology services.
Net cash used in operating activities was $4.5 million for the nine months
ended December 31, 2001, and primarily resulted from cash used to fund operating
losses and the net impact of decreases in accounts payable and accrued expenses
of $9.1 million, partially offset by a decrease in prepaid expenses and other
current assets of $5.1 million. The decrease in accounts payable and accrued
expenses is primarily attributable to the remittance of the VAT monies due to
one of our clients and the reversal of client termination reserves, recorded as
expense in prior year, and the reversal of deferrals applicable to the
termination of the Daisytek transaction management services agreements, for
which the related activities occurred in earlier periods. The decrease in other
current assets primarily relates to the collection of a note receivable, a
governmental grant and VAT receivables associated with our European operations.
Net cash provided by operating activities was $0.6 million for fiscal 2001, and
primarily resulted from an increase in accounts payable and accrued expenses of
$8.2 million partially offset by cash used to fund operating losses and an
increase to prepaid expenses and other current assets of $5.4 million. The
increase in other current assets primarily relates to receivables associated
with our European operations including a $1.1 million note receivable from a
terminated client, a $1.6 million receivable related to an asset based
governmental grant and VAT receivables of $2.3 million. The increase in accounts
payable was primarily attributable to $7.2 million of VAT collections that was
due one of our clients. Cash flows provided by operating activities totaled
$10.6 million for fiscal 2000 and primarily relate to a reduction in accounts
receivable of $8.3 million and inventory of $29.9 million, net of a reduction in
accounts payable and accrued expenses of $25.0 million. These reductions
primarily related to the transfer of the IBM related working capital assets from
us to Daisytek in conjunction with the new IBM agreements. The cash flow impact
of these reductions was partially offset by cash used to fund operating losses.
Net cash used by investing activities for the nine months ended December
31, 2001 totaled $8.1 million. The net proceeds of $10.3 million from the sale
of one of our distribution facilities to Daisytek were offset by capital
expenditures of $3.2 million, the establishment of a restricted cash balance of
$2.8 million to support our long-term debt and lease financing, and a
subordinated loan of approximately $11.7 million to Supplies Distributors and an
equity investment of $0.8 million in Holdings. Cash used in investing activities
for fiscal 2001 totaled $2.9 million. Capital expenditures were $6.3 million for
fiscal 2001. Partially offsetting the cash usage associated with these capital
expenditures was the full collection of other receivables. Cash used in
investing activities was $10.2 million for fiscal 2000. During fiscal 2000, our
capital expenditures totaled $18.5 million and included the asset purchase from
Daisytek at the completion of the Offering, our new Belgium distribution
facility, and the expansion of U.S. sales and distribution facilities. Partially
offsetting the
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cash usage associated with these capital expenditures was the $8.4 million
collection of other receivables. Capital expenditures have historically
consisted primarily of additions to upgrade our management information systems,
including our Internet-based customer tools, other methods of e-commerce and
general expansion of our facilities, both domestic and foreign. We expect to
incur capital expenditures in order to support new contracts and anticipated
future growth opportunities. We anticipate that our total investment in upgrades
and additions to facilities and information technology services for the upcoming
twelve months will be approximately $2 to $4 million, although additional
capital expenditures may be necessary to support the infrastructure requirements
of new clients. Some of these expenditures may be financed through operating or
capital leases.
Net cash provided by financing activities was $1.0 million for the nine
months ended December 31, 2001, representing the proceeds from debt and from the
issuance of common stock pursuant to our employee stock purchase plan offset by
payments on our capital lease obligations and payments to acquire treasury
stock. Net cash used in financing activities was $0.2 million in fiscal 2001,
representing payments on our capital lease obligations partially offset by the
proceeds from issuance of common stock. Net cash provided by financing
activities was $24.0 million for fiscal 2000. In December 1999, we successfully
completed our Offering and sold 3,565,000 shares of common stock, including the
underwriters over-allotment, at $17 per share. Net proceeds from the Offering
aggregated approximately $53.0 million. Proceeds were used to repay an
intercompany payable to Daisytek of approximately $27 million and to acquire
from Daisytek all fixed assets in its Memphis distribution facility, as well as
certain assets providing information technology services for approximately $5
million, and we received the stock of several subsidiaries of Daisytek
representing the business operations of PFSweb.
During the nine months ended December 31, 2001, our working capital
decreased to $11.2 million from $19.9 million at March 31, 2001, primarily due
to the establishment and capitalization of an affiliate, Supplies Distributors,
and the funding of operations and capital expenditures offset by the proceeds
from the sale of a distribution facility. In order to obtain additional
financing in the future, in addition to our current cash position, we plan to
evaluate alternatives including utilizing capital or operating leases,
establishing our own credit facility, entering into asset based lending or
factoring programs, or transferring a portion of our subordinated loan balances,
due from Supplies Distributors, to third-parties. In conjunction with these
alternatives we may be required to provide certain letters of credit to secure
these arrangements. No assurances can be given that we will be successful in
obtaining any additional financing or the terms thereof. We currently believe
that our cash position and funds generated from operations will satisfy our
presently known operating cash needs, our working capital and capital
expenditure requirements and our lease obligations, and additional subordinated
loans to Supplies Distributors, if necessary, through April 2003.
The following is a schedule of our total contractual cash obligations,
which is comprised of operating leases and long-term debt and capital leases
(including interest), as of December 31, 2001 (in millions):
[Enlarge/Download Table]
LONG-TERM
DEBT AND CONTRACTUAL
OPERATING CAPITAL TOTAL CASH
LEASES LEASES OBLIGATIONS
--------- ----------- -----------
Fiscal Year Ended December 31,
2002............................................... $ 6,060 $1,238 $ 7,298
2003............................................... 5,985 1,248 7,233
2004............................................... 4,198 943 5,141
2005............................................... 2,782 786 3,568
2006............................................... 2,751 620 3,371
Thereafter......................................... 2,696 602 3,298
------- ------ -------
Total contractual cash obligations......... $24,472 $5,437 $29,909
======= ====== =======
In support of certain debt instruments and leases, as of December 31, 2001,
we had $2.8 million of cash restricted in the form of a letter of credit. The
letter of credit expires at the termination of the underlying long-
40
term debt and lease obligations in July 2004. As described above, we have
provided collateralized guarantees to secure the repayment of Supplies
Distributors' credit facilities. As of December 31, 2001, the outstanding
balance of the credit facilities guaranteed by PFSweb was approximately $59.0
million. In association with the new credit facilities entered into in March
2002, the outstanding balance of the credit facilities guaranteed by PFSweb was
approximately $48.5 million. These guarantees expire concurrently with the
expiration of the underlying credit agreements. To the extent Supplies
Distributors or its subsidiaries fails to comply with its covenants, including
its monthly financial covenant requirements, and the lenders accelerate the
repayment of the credit facility obligations, Supplies Distributors or its
subsidiaries would be required to repay all amounts outstanding thereunder. In
such event, we would be obligated to perform under those guarantees and repay,
to the extent Supplies Distributors or its subsidiaries was unable to, Supplies
Distributors' or its subsidiaries credit facility obligations. Additionally, if
we were unable to maintain our required level of stockholders' equity of $25.0
million, we could also be obligated to perform under these guarantees. Any
requirement to perform under our guarantees would have a material adverse impact
on our financial condition and results of operations and no assurance can be
given that we will have the financial ability to repay all of such guaranteed
obligations. In addition, in the event Supplies Distributors or its subsidiaries
is, or would be, in default of its obligations under its credit facilities, we
are restricted from receiving any payment of our subordinated loans and such
event would also have a material adverse impact upon our financial condition and
results of operations. Furthermore, we are obligated to repay any over-advance
made to Supplies Distributors or its subsidiaries by its lenders. An
over-advance would arise in the event borrowings exceeded the maximum amount
available under the eligible borrowing base, as defined. The Company does not
have any other material commercial commitments.
Currently, we believe that we are operating with and incurring costs
applicable to excess capacity in both our North American and European
operations. We believe that as we add revenue, we will be able to cover our
existing infrastructure and public company costs and reach profitability. We
currently estimate that the revenue needed to leverage our infrastructure and
reach profitability is approximately $14 million per quarter. No assurance can
be given that we can achieve such operating levels, or that, if achieved, we
will be profitable in any particular fiscal period.
In the future, we may attempt to acquire other businesses to expand our
services or capabilities in connection with our efforts to grow our business. We
currently have no binding agreements to acquire any such businesses. Should we
be successful in acquiring other businesses, we may require additional
financing. Acquisitions involve certain risks and uncertainties. Therefore, we
can give no assurance with respect to whether we will be successful in
identifying businesses to acquire, whether we will be able to obtain financing
to complete an acquisition, or whether we will be successful in operating the
acquired business.
INVENTORY MANAGEMENT
Prior to September 30, 1999, our agreements with IBM were structured as
master distributor agreements. The transaction management services we provided
for IBM under these agreements included purchasing and reselling IBM product
inventory to IBM customers. During the quarter ended September 30, 1999, we
restructured our agreements with IBM so that we no longer purchased or resold
the IBM product inventory. In addition, we transferred to Daisytek the
IBM-related customer accounts receivables, inventory and accounts payable. We do
not currently own any product inventory.
SEASONALITY
The seasonality of our business is dependent upon the seasonality of our
clients' business and the sale of their products. Accordingly, our management
must rely upon the projections of our clients in assessing quarterly
variability. We believe that with our current client mix our business activity
will be at its lowest in the quarter ended March 31 and at its highest in the
quarter ended June 30.
We believe that results of operations for a quarterly period may not be
indicative of the results for any other quarter or for the full year.
41
INFLATION
Management believes that inflation has not had a material effect on our
operations.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No.'s 141 and 142, "Business
Combinations" and "Goodwill and Other Intangibles." SFAS 141 requires all
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method. SFAS 142 requires that ratable amortization of goodwill be
replaced with annual fair-value based tests of the goodwill's impairment, and
that intangible assets other than goodwill be amortized over their useful lives.
Additionally, under the provision of the new accounting standard, an acquired
intangible asset should be separately recognized if the benefit of the
intangible asset is obtained through contractual other legal rights, or if the
intangible asset can be sold, transferred, licensed, rented, or exchanged,
regardless of the acquirer's intent to do so. SFAS 141 is effective for all
business combinations initiated after June 30, 2001 and for all business
combinations accounted for by the purchase method for which the date of
acquisition is after June 30, 2001. The adoption of SFAS 141 as of July 1, 2001
did not have a material impact on the Company's financial statements and related
disclosures. The provisions of SFAS 142 will be effective for fiscal years
beginning after December 15, 2001. The Company's adoption SFAS 142 on January 1,
2002 did not have a material impact on the Company's consolidated financial
statements and related disclosures.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses the accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The Company is currently assessing the impact
on the consolidated financial statements and will adopt the provisions of this
standard by the first quarter of 2003.
In October, 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which establishes a universal
accounting model based on the framework established in SFAS 121 for the
long-lived assets to be disposed of by sale. The Company's adoption of SFAS 144
on January 1, 2002 did not have a material impact on the Company's consolidated
financial statements and related disclosures.
CRITICAL ACCOUNTING POLICIES
Our service fee revenues primarily relate to our (1) distribution services
and (2) order management/customer care services.
Distribution services relate primarily to inventory management, product
receiving, warehousing and fulfillment (i.e., picking, packing and shipping).
Revenue for these activities are either (i) earned on a per transaction basis or
(ii) earned at the time of product fulfillment which occurs at the completion of
the distribution services.
Order management/customer care services relate primarily to taking customer
orders for our client's products via various channels such as telephone
call-center, electronic or facsimile. These services also entail addressing
customer questions related to orders, as well as cross-selling/up-selling
activities. Revenue is recognized as the services are rendered. Fees charged to
the client are on a per transaction basis based on either (i) a pre-determined
fee per order or fee per telephone minutes incurred, or (ii) are included in the
product fulfillment service fees which are recognized on product shipment. Our
cost of service fee revenue, representing the cost to provide the services
described above, is recognized as incurred. Cost of service fee revenue also
includes costs associated with technology collaboration and ongoing technology
support which consist of creative website development and maintenance, web
hosting, technology interfacing, and other ongoing programming activities. These
activities are primarily performed to support the distribution and order
management/customer cares services and are recognized as incurred.
We also perform billing services and information management services for
its clients. Billing services and information management services are typically
not billed separately to clients because the activities are continually
performed, and the costs are insignificant and are generally covered by other
fees described above.
42
Therefore, any revenue attributable to these services is often included in the
distribution or order management fees which are recognized as services are
performed. The service fee revenue associated with these activities are
currently not significant and are incidental to the above-mentioned services.
We recognize revenue, and record trade accounts receivables, pursuant to
the methods described above when collectibility is reasonably assured.
Collectibility is evaluated on an individual customer basis taking into
consideration historical payment trends, current financial position, results of
independent credit evaluations and payment terms.
We primarily perform our services under two to three year contracts that
can be terminated by either party. In conjunction with these long-term contracts
we generally receive start-up fees to cover our implementation costs, including
certain technology infrastructure and development costs. We defer the fees
received, and the related costs, and amortize them over the life of the
contract. The amortization of deferred revenue is included as a component of
service fee revenue. The amortization of deferred implementation costs is
included as a cost of service fee revenue. To the extent implementation costs
exceed the fees received, excess costs are expensed as incurred.
A description of other significant accounting policies is included in
footnote 2 to the accompanying consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to various market risks including interest rates on its
financial instruments and foreign exchange rates.
INTEREST RATE RISK
The carrying value of our financial instruments, which include cash and
cash equivalents, accounts receivable, note receivable, accounts payable,
long-term debt and capital lease obligations, approximate their fair values
based on short terms to maturity or current market prices and rates. The impact
of a 100 basis point change in interest rates would not have a material impact
on the Company's results of operations or financial position.
FOREIGN EXCHANGE RISK
Currently, our foreign currency exchange rate risk is primarily limited to
the Canadian Dollar and the Euro. In the future, we believe 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 long-term intercompany payable or receivable
balances in foreign operations, we may enter into forward currency exchange
contracts. We do not hold or issue derivative financial instruments for trading
purposes or for speculative purposes.
Effective April 1, 2001, in response to a change to the Euro for
transaction activity previously conducted in the U.S. dollar by our largest
European client, we adopted the Euro as our functional currency for our European
operations.
43
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE
[Download Table]
PAGE
----
PFSWEB, INC. AND SUBSIDIARIES
Independent Auditors' Report................................ 45
Report of Independent Public Accountants.................... 46
Consolidated Balance Sheets................................. 47
Consolidated Statements of Operations....................... 48
Consolidated Statements of Shareholders' Equity and
Comprehensive Loss........................................ 49
Consolidated Statements of Cash Flows....................... 50
Notes to Consolidated Financial Statements.................. 51
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND
SUBSIDIARIES
Independent Auditors' Report................................ 72
Consolidated Balance Sheet.................................. 73
Consolidated Statement of Operations........................ 74
Consolidated Statement of Members' Capital and Comprehensive
Income.................................................... 75
Consolidated Statement of Cash Flows........................ 76
Notes to Consolidated Financial Statements.................. 77
SUPPLEMENTARY DATA
Schedule II -- Valuation and Qualifying Accounts............ 91
44
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and
Shareholders of PFSweb, Inc.:
We have audited the accompanying consolidated balance sheets of PFSweb,
Inc. and subsidiaries as of March 31, 2001 and December 31, 2001, and the
related consolidated statements of operations, shareholders' equity and
comprehensive loss and cash flows for the year ended March 31, 2001 and the
nine-month period ended December 31, 2001. In connection with our audits of the
consolidated financial statements, we also have audited the accompanying
financial statement schedule as of March 31, 2001 and December 31, 2001 and for
the year ended March 31, 2001 and the nine-month period ended December 31, 2001.
These consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PFSweb, Inc.
and subsidiaries as of March 31, 2001 and December 31, 2001, and the results of
their operations and their cash flows for the year ended March 31, 2001 and the
nine-month period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedule as of March 31, 2001 and
December 31, 2001 and for the year ended March 31, 2001 and the nine-month
period ended December 31, 2001, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
KPMG LLP
Dallas, Texas
February 15, 2002, except for Note 7 and 9 to which the date is as of March 29,
2002
45
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of PFSweb, Inc.:
We have audited the accompanying consolidated statements of operations,
shareholders' equity and cash flows of PFSweb, Inc. (a Delaware corporation) and
subsidiaries (see Note 1) for the year ended March 31, 2000. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of PFSweb, Inc. and
subsidiaries as of March 31, 2000, and the results of their operations and their
cash flows for the year then ended, in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Dallas, Texas,
May 4, 2000
46
PFSWEB, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
[Enlarge/Download Table]
MARCH 31, DECEMBER 31,
2001 2001
--------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 22,266 $ 10,751
Accounts receivable, net of allowance for doubtful
accounts of $279 and $254 at March 31, 2001 and
December 31, 2001, respectively (Note 7)............... 7,294 6,780
Other receivables......................................... 4,972 92
Prepaid expenses and other current assets................. 3,144 2,646
-------- --------
Total current assets.............................. 37,676 20,269
-------- --------
PROPERTY AND EQUIPMENT, net................................. 20,875 15,329
NOTE RECEIVABLE FROM AFFILIATE (Note 7)..................... -- 11,655
OTHER ASSETS (including $2,757 of restricted cash as of
December 31, 2001)........................................ 538 4,340
-------- --------
Total assets...................................... $ 59,089 $ 51,593
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt and capital lease
obligations............................................ $ 300 $ 995
Trade accounts payable.................................... 11,403 2,820
Accrued compensation payable.............................. 734 608
Accrued expenses.......................................... 5,298 4,692
-------- --------
Total current liabilities......................... 17,735 9,115
-------- --------
LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS, less current
portion................................................... 2,139 3,663
-------- --------
OTHER LIABILITIES........................................... 2,214 2,210
-------- --------
COMMITMENTS AND CONTINGENCIES (Notes 7 and 9)
SHAREHOLDERS' EQUITY:
Preferred stock, $1.00 par value; 1,000,000 shares
authorized; none issued and outstanding at March 31,
2001 and December 31, 2001............................. -- --
Common stock, $0.001 par value; 40,000,000 shares
authorized; 17,907,378 and 18,143,409 shares issued at
March 31, 2001 and December 31, 2001, respectively;
17,907,378 and 18,057,109 outstanding at March 31 and
December 31, 2001, respectively........................ 18 18
Additional paid-in capital................................ 50,884 51,942
Accumulated deficit....................................... (13,592) (14,157)
Accumulated other comprehensive loss...................... (309) (1,113)
Treasury stock at cost, 86,300 shares at December 31,
2001................................................... -- (85)
-------- --------
Total shareholders' equity........................ 37,001 36,605
-------- --------
Total liabilities and shareholders' equity........ $ 59,089 $ 51,593
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
47
PFSWEB, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
[Enlarge/Download Table]
FISCAL YEARS ENDED
MARCH 31,
------------------ NINE MONTHS ENDED
2000 2001 DECEMBER 31, 2001
------- -------- -----------------
REVENUES (Note 5):
Product revenue....................................... $57,044 $ -- $ --
Service fee revenue................................... 30,829 48,258 26,569
Service fee revenue, affiliate (Note 7)............... -- -- 1,384
Other revenue......................................... -- 2,097 100
------- -------- -------
Total revenues................................ 87,873 50,355 28,053
------- -------- -------
COSTS OF REVENUES:
Cost of product revenue............................... 53,905 -- --
Cost of service fee revenue........................... 23,475 34,261 17,984
Cost of other revenue................................. -- 2,470 (627)
------- -------- -------
Total costs of revenues....................... 77,380 36,731 17,357
------- -------- -------
Gross profit.................................. 10,493 13,624 10,696
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES............ 17,764 25,446 17,117
OTHER (Note 5).......................................... -- -- (5,141)
------- -------- -------
Loss from operations.......................... (7,271) (11,822) (1,280)
INTEREST EXPENSE (INCOME), net.......................... 459 (1,091) (496)
------- -------- -------
Loss before income taxes...................... (7,730) (10,731) (784)
INCOME TAX EXPENSE (BENEFIT)............................ (1,791) 25 (219)
------- -------- -------
NET LOSS................................................ $(5,939) $(10,756) $ (565)
======= ======== =======
NET LOSS PER SHARE:
Basic and diluted..................................... $ (0.38) $ (0.60) $ (0.03)
======= ======== =======
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic and diluted..................................... 15,479 17,879 18,036
======= ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
48
PFSWEB, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT SHARE DATA)
[Enlarge/Download Table]
ACCUMULATED
COMMON STOCK ADDITIONAL DAISYTEK'S OTHER
------------------- PAID-IN ACCUMULATED NET EQUITY COMPREHENSIVE
SHARES AMOUNT CAPITAL DEFICIT INVESTMENT LOSS
---------- ------ ---------- ----------- ---------- -------------
Balance, March 31, 1999............. -- $-- $ -- $ -- $ 712 $ (131)
Net loss prior to initial public
offering......................... -- -- -- -- (3,103) --
Contribution of Daisytek's net
equity investment................ -- -- (2,391) -- 2,391 --
Net loss subsequent to initial
public offering.................. -- -- -- (2,836) -- --
Issuance of common stock to
Daisytek......................... 14,305,000 14 6 -- -- --
Initial public offering, net of
issuance costs................... 3,565,000 4 53,010 -- -- --
Stock based compensation expense... -- -- 48 -- -- --
Other comprehensive loss -- foreign
currency translation
adjustment....................... -- -- -- -- -- (74)
---------- --- ------- -------- ------- -------
Comprehensive loss.................
Balance, March 31, 2000............. 17,870,000 $18 $50,673 $ (2,836) $ -- $ (205)
Net loss........................... -- -- -- (10,756) -- --
Reduction in costs of initial
public offering.................. -- -- 148 -- -- --
Stock based compensation expense... -- -- 38 -- -- --
Employee stock purchase plan....... 37,378 -- 25 -- -- --
Other comprehensive loss -- foreign
currency translation
adjustment....................... -- -- -- -- -- (104)
---------- --- ------- -------- ------- -------
Comprehensive loss.................
Balance, March 31, 2001............. 17,907,378 $18 $50,884 $(13,592) $ -- $ (309)
Net loss........................... -- -- -- (565) -- --
Reduction in costs of initial
public offering.................. -- -- 175 -- -- --
Purchases of treasury stock........ -- -- -- -- -- --
Stock based compensation expense... -- -- 704 -- -- --
Tax benefit from exercise of
Daisytek stock options........... -- -- 26 -- -- --
Employee stock purchase plan....... 236,031 -- 153 -- -- --
Other comprehensive loss -- foreign
currency translation
adjustment....................... -- -- -- -- -- (804)
---------- --- ------- -------- ------- -------
Comprehensive loss.................
Balance, December 31, 2001.......... 18,143,409 $18 $51,942 $(14,157) $ -- $(1,113)
========== === ======= ======== ======= =======
TREASURE STOCK TOTAL
---------------- SHAREHOLDERS' COMPREHENSIVE
SHARES AMOUNT EQUITY LOSS
------- ------ ------------- -------------
Balance, March 31, 1999............. -- $ -- $ 581
Net loss prior to initial public
offering......................... -- -- (3,103) $ (3,103)
Contribution of Daisytek's net
equity investment................ -- -- --
Net loss subsequent to initial
public offering.................. -- -- (2,836) (2,836)
Issuance of common stock to
Daisytek......................... -- -- 20
Initial public offering, net of
issuance costs................... -- -- 53,014
Stock based compensation expense... -- -- 48
Other comprehensive loss -- foreign
currency translation
adjustment....................... -- -- (74) (74)
------- ---- -------- --------
Comprehensive loss................. $ (6,013)
========
Balance, March 31, 2000............. -- $ -- $ 47,650
Net loss........................... -- -- (10,756) $(10,756)
Reduction in costs of initial
public offering.................. -- -- 148
Stock based compensation expense... -- -- 38
Employee stock purchase plan....... -- -- 25
Other comprehensive loss -- foreign
currency translation
adjustment....................... -- -- (104) (104)
------- ---- -------- --------
Comprehensive loss................. $(10,860)
========
Balance, March 31, 2001............. -- $ -- $ 37,001
Net loss........................... -- -- (565) $ (565)
Reduction in costs of initial
public offering.................. -- -- 175
Purchases of treasury stock........ 86,300 (85) (85)
Stock based compensation expense... -- -- 704
Tax benefit from exercise of
Daisytek stock options........... -- -- 26
Employee stock purchase plan....... -- -- 153
Other comprehensive loss -- foreign
currency translation
adjustment....................... -- -- (804) (804)
------- ---- -------- --------
Comprehensive loss................. $ (1,369)
========
Balance, December 31, 2001.......... 86,300 $(85) $ 36,605
======= ==== ========
The accompanying notes are an integral part of these consolidated financial
statements.
49
PFSWEB, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
[Enlarge/Download Table]
FISCAL YEARS NINE MONTHS
ENDED MARCH 31, ENDED
------------------- DECEMBER 31,
2000 2001 2001
-------- -------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss................................................. $ (5,939) $(10,756) $ (565)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization......................... 2,373 6,803 4,605
Provision for doubtful accounts....................... 458 2,203 17
Deferred income taxes................................. 453 109 --
Non-cash compensation expense......................... 48 38 704
Gain on sale of distribution facility................. -- -- (5,837)
Changes in operating assets and liabilities:
Accounts receivables................................ 8,324 (607) 524
Inventories, net.................................... 29,856 -- --
Prepaid expenses and other current assets........... (55) (5,423) 5,152
Accounts payable and accrued expenses............... (24,954) 8,223 (9,061)
-------- -------- --------
Net cash provided by (used in) operating activities... 10,564 590 (4,461)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment...................... (18,521) (6,309) (3,237)
(Increase) decrease in other assets...................... 8,358 3,417 (2,757)
Equity investment in affiliate........................... -- -- (750)
Proceeds from sale of distribution facility, net......... -- -- 10,298
Loan to affiliate........................................ -- -- (11,655)
-------- -------- --------
Net cash used in investing activities................. (10,163) (2,892) (8,101)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock to Daisytek..................... 20 -- --
Net proceeds from initial public offering of common
stock................................................. 53,014 -- --
Net proceeds from issuance of common stock............... -- 25 153
Payment on capital lease obligations..................... (15) (242) (558)
Proceeds from debt....................................... -- -- 1,529
Purchases of treasury stock.............................. -- -- (85)
Decrease in payable to Daisytek.......................... (29,029) -- --
-------- -------- --------
Net cash provided by (used in) financing activities... 23,990 (217) 1,039
-------- -------- --------
EFFECT OF EXCHANGE RATES ON CASH........................... (82) (111) 8
-------- -------- --------
NET INCREASE (DECREASE) IN CASH............................ 24,309 (2,630) (11,515)
CASH AND CASH EQUIVALENTS, beginning of period............. 587 24,896 22,266
-------- -------- --------
CASH AND CASH EQUIVALENTS, end of period................... $ 24,896 $ 22,266 $ 10,751
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Non-cash investing and financing activities:
Fixed assets acquired under capital leases............... $ 2,696 $ -- $ 2,777
======== ======== ========
Governmental grant receivable for capital expenditures
(Note 2).............................................. $ -- $ 1,564 $ --
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
50
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. OVERVIEW AND BASIS OF PRESENTATION
In June 1999, Daisytek International Corporation ("Daisytek") created a
separate wholly-owned subsidiary named PFSweb, Inc. (the "Company" or "PFSweb"),
a Delaware corporation, to become a holding company for certain of Daisytek's
wholly-owned subsidiaries ("PFS") in contemplation of an initial public offering
of PFSweb. Daisytek contributed $20,000 for 14,305,000 shares of common stock of
PFSweb. In December 1999, PFSweb sold 3,565,000 shares of common stock at a
price of $17 per share (the "Offering"). Net proceeds from the Offering
aggregated approximately $53.0 million and were used to repay the Company's
payable to Daisytek and to acquire from Daisytek all fixed assets in its Memphis
distribution facility as well as certain assets providing information technology
services for approximately $5 million (see Note 5). Simultaneous with the
completion of the Offering, Daisytek contributed to PFSweb all the assets,
liabilities and equity comprising PFS.
On June 8, 2000, the Daisytek Board of Directors approved the separation of
PFSweb from Daisytek by means of a tax-free dividend of Daisytek's remaining
ownership of PFSweb after receiving a favorable ruling from the IRS to the
effect that the distribution by Daisytek of its shares of PFSweb stock would be
tax-free to Daisytek and to Daisytek's shareholders for U.S. federal income tax
purposes. The distribution of Daisytek's 14,305,000 shares of PFSweb (the
"Spin-off") occurred at the close of business on July 6, 2000, to Daisytek
shareholders of record as of June 19, 2000.
PFSweb is an international provider of integrated business process
outsourcing services to major brand name companies seeking to maximize their
supply chain efficiencies and to extend their traditional and e-commerce
initiatives in the United States, Canada, and Europe. The Company offers such
services as professional consulting, technology collaboration, managed hosting
and creative web development, order management, web-enabled customer contact
centers, customer relationship management, financial services including billing
and collection services, information management, option kitting and assembly
services, and international fulfillment and distribution services.
For all periods prior to the Spin-off, the accompanying consolidated
financial statements are presented on a carve-out basis and reflect the
consolidated historical results of operations, financial position and cash flows
of the Company. For all periods prior to the nine month period ended December
31, 2001, certain expenses reflected in the consolidated financial statements
include an allocation of certain Daisytek corporate expenses and infrastructure
costs (see Note 5). Management believes that the methods used to allocate
expenses are reasonable, although the cost of services could be higher if
obtained from other sources. In addition, certain service fee revenue and cost
of service fee revenue have been reflected by PFSweb for services subcontracted
to PFSweb by Daisytek. The service fee revenue, cost of service fee revenue and
allocated expenses have been reflected on bases that Daisytek and PFSweb
consider to be a reasonable reflection of the services provided and revenue
earned by PFSweb and the utilization of services provided by Daisytek and the
benefit received by PFSweb. The financial information included herein may not
reflect the consolidated financial position, operating results, shareholders'
equity and cash flows of PFSweb in the future or what it would have been had
PFSweb been a separate, stand-alone entity during the periods presented.
In June 2001, the Company changed its fiscal year from March 31 to December
31. Consequently, the most recent fiscal period is a nine month transition
period ended December 31, 2001.
2. SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
Prior to the Offering, the financial position, results of operations and
cash flows of PFS were referred to as the combined financial statements of
PFSweb. Subsequent to the Offering and for all periods presented herein, the
financial position, results of operations and cash flows of the Company are
referred to as the consolidated
51
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
financial statements of PFSweb, Inc. and subsidiaries. All intercompany accounts
and transactions have been eliminated in consolidation.
INVESTMENT IN AFFILIATE
During the nine month period ended December 31, 2001, the Company made a
49% investment in Business Supplies Distributors Holdings, LLC, ("Holdings") an
affiliate (see Note 7). The Company records its interest in Holdings' net
income, which is allocated and distributed to the owners pursuant to the terms
of Holdings' operating agreement, under the modified equity method, which
results in the Company recording its allocated earnings of Holdings or 100% of
Holdings' losses.
In addition to the equity investment, the Company loaned a subsidiary of
this affiliate $11.7 million in the form of a Subordinated Demand Note (the
"Note"). The Note can be decreased to $6.5 million subject to Holdings'
compliance with the covenants of its senior loan facilities, as amended.
Management believes that the Note, which is due on demand, will not be repaid in
its entirety within the upcoming year and has therefore classified the entire
balance as long-term.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
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. The allocation
of certain expenses and the determination of costs applicable to client
terminations (see Notes 1 and 5) in these consolidated financial statements also
required management estimates and assumptions. Actual results could differ from
those estimates.
REVENUE AND COST RECOGNITION
For fiscal 2000, the Company recognized product revenue and cost of product
revenue upon shipment of product to customers and provided for estimated returns
and allowances. The Company's service fee revenues primarily relate to its (1)
distribution services and (2) order management/customer care services.
Distribution services relate primarily to inventory management, product
receiving, warehousing and fulfillment (i.e., picking, packing and shipping).
Revenue for these activities are either (i) earned on a per transaction basis or
(ii) earned at the time of product fulfillment which occurs at the completion of
the distribution services.
Order management/customer care services relate primarily to taking customer
orders for our client's products via various channels such as telephone
call-center, electronic or facsimile. These services also entail addressing
customer questions related to orders, as well as cross-selling/up-selling
activities. Revenue is recognized as the services are rendered. Fees charged to
the client are on a per transaction basis based on either (i) a pre-determined
fee per order or fee per telephone minutes incurred, or (ii) are included in the
product fulfillment service fees which are recognized on product shipment. The
Company's cost of service fee revenue, representing the cost to provide the
services described above, is recognized as incurred. Cost of service fee revenue
also includes costs associated with technology collaboration and ongoing
technology support which consist of creative website development and
maintenance, web hosting, technology interfacing, and other ongoing programming
activities. These activities are primarily performed to support the distribution
and order management/customer cares services and are recognized as incurred.
The Company also performs billing services and information management
services for its clients. Billing services and information management services
are typically not billed separately to clients because the activities are
continually performed, and the costs are insignificant and are generally covered
by other fees described above. Therefore, any revenue attributable to these
services is often included in the distribution or
52
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
order management fees which are recognized as services are performed. The
service fee revenue associated with these activities are currently not
significant and are incidental to the above-mentioned services.
The Company recognizes revenue, and records trade accounts receivables,
pursuant to the methods described above when collectibility is reasonably
assured. Collectibility is evaluated on an individual customer basis taking into
consideration historical payment trends, current financial position, results of
independent credit evaluations and payment terms.
Other revenue of $2.1 million and $0.1 million for fiscal 2001 and the nine
months ended December 31, 2001, respectively, represents the fees charged to
clients in conjunction with the early termination of certain contracts. Cost of
other revenue for fiscal 2001 includes approximately $0.4 million of employee
severance costs, approximately $0.5 million of asset impairments from fixed
assets which were specific to terminated contracts and provided no further value
to PFSweb, and approximately $1.6 million of certain uncollectible amounts
receivable from, and liabilities applicable to, clients who terminated
contracts. Cost of other revenue for the nine months ended December 31, 2001 of
$0.6 million reflects the benefit associated with the reversal of accruals made
in the prior year for estimated client terminations costs that were determined
this period to be in excess of actual costs incurred.
The Company primarily performs its services under two to three year
contracts that can be terminated by either party. In conjunction with these
long-term contracts the Company generally receives start-up fees to cover its
implementation costs, including certain technology infrastructure and
development costs. The Company defers the fees received, and the related costs,
and amortizes them over the life of the contract. The amortization of deferred
revenue is included as a component of service fee revenue. The amortization of
deferred implementation costs is included as a cost of service fee revenue. To
the extent implementation costs exceed the fees received, excess costs are
expensed as incurred. The following summarizes the deferred implementation costs
and revenues (in thousands):
[Enlarge/Download Table]
MARCH 31, 2001 DECEMBER 31, 2001
-------------- -----------------
Deferred implementation costs
Current.............................................. $ 518 $ 845
Non-current.......................................... 434 655
------ ------
$ 952 $1,500
====== ======
Deferred implementation revenues
Current.............................................. 1,283 1,434
Non-current.......................................... 974 988
------ ------
$2,257 $2,422
====== ======
Current and non-current deferred implementation costs are a component of
prepaid expenses and other assets, respectively. Current and non-current
deferred implementation revenues are a component of accrued expenses and other
liabilities, respectively.
Certain contracts involve third-party vendors who provide services such as
package delivery. The costs incurred by the Company related to such third-party
services are reimbursed at cost by its clients and are not reflected in revenue
or expense.
CONCENTRATION OF BUSINESS AND CREDIT RISK
All of the Company's product revenue for fiscal 2000 was generated by sales
of product purchased under master distributor agreements with one supplier.
Product and service fee revenue from Daisytek accounted for approximately 22%,
55% and 34% of the Company's total revenues for fiscal years 2000 and 2001, and
the nine
53
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
month period ended December 31, 2001, respectively. The Company had one other
client which accounted for approximately 19% of the Company's revenue for the
nine-month period ended December 31, 2001. For the nine month period ended
December 31, 2001, excluding Daisytek, two clients accounted for approximately
43% of the Company's revenue. As of March 31, 2001, Daisytek and one other
customer accounted for approximately 55% of accounts receivable. As of December
31, 2001, two customers accounted for approximately 34% of accounts receivable,
of which 12% is due from an affiliate (see Note 7).
RECLASSIFICATIONS
Certain prior year data have been reclassified to conform to the current
period presentation. These reclassifications had no effect on previously
reported net income or shareholders' equity.
CASH AND CASH EQUIVALENTS
Cash equivalents are defined as short-term highly liquid investments with
original maturities of three months or less.
RESTRICTED CASH
In conjunction with certain long-term debt and leases, as of December 31,
2001, the Company had approximately $2.8 million of cash restricted as
collateral for of a letter of credit that secures these debt and lease
obligations. The letter of credit expires in July, 2004.
OTHER RECEIVABLES AND LIABILITIES
As of March 31, 2001, other receivables includes the following items
applicable to the Company's European operations (in thousands):
[Download Table]
MARCH 31,
2001
---------
Note........................................................ $1,132
Value added tax............................................. 2,276
Governmental grant.......................................... 1,564
------
$4,972
======
The note receivable amount represented the remaining balance of a $1.7
million contract termination fee which was collected in full during the nine
months ended December 31, 2001. Value Added Tax ("VAT") receivables represent
amounts due from European governments for refundable VAT payments made in the
ordinary course of business. The Company received approximately $2.2 million,
net, associated with VAT in the nine months ended December 31, 2001. The
governmental grant relates to investments made by the Company in fixed assets in
its Belgium operation. The grant was fully collected as of December 31, 2001.
At establishment, the total grant of approximately $1.6 million was
deferred and is being recognized as a reduction in depreciation expense over the
same period over which the related fixed assets are being depreciated. A
deferred credit of $1.1 million and $1.0 million as of March 31, 2001 and
December 31, 2001, respectively, is included in other liabilities in the
accompanying consolidated balance sheets and represents the unamortized portion
of the grant. For fiscal 2001 and the nine months ended December 31, 2001,
approximately $0.2 million and $0.1 million, respectively, was recognized as a
reduction of depreciation expense. The grant was earned by the Company upon the
achievement of certain minimum capital expenditure requirements. Realization of
the entire gain requires the Company to maintain a certain minimum workforce
through December 2004. The Company's management believes that the likelihood
that it would be required to refund this grant is remote.
54
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
The components of property and equipment as of March 31, 2001 and December
31, 2001 are as follows (in thousands):
[Enlarge/Download Table]
MARCH 31, DEC. 31,
2001 2001 DEPRECIABLE LIFE
--------- -------- ----------------
Furniture and fixtures............................ $13,882 $ 7,725 5-9 years
Computer equipment................................ 4,714 5,638 3-7 years
Leasehold improvements............................ 3,554 3,761 2-9 years
Purchased and Capitalized software costs.......... 6,968 8,482 1-3 years
Other............................................. 251 206 3-7 years
------- --------
29,369 25,812
Less-accumulated depreciation and
amortization................................. (8,494) (10,483)
------- --------
Property and equipment, net.................. $20,875 $ 15,329
======= ========
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the respective assets.
Leasehold improvements are amortized over the shorter of the useful life of the
related asset or the remaining lease term.
The Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured as the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Fair value would be
determined using appraisals, discounted cash flow analysis or similar valuation
techniques. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
For the Company's Canadian operations, the local currency is the functional
currency. All assets and liabilities are translated at exchange rates in effect
at the end of the period, and income and expense items are translated at the
average exchange rates for the period. Translation adjustments are reported as a
separate component of shareholders' equity.
For the Company's European operations, the U.S. dollar was the functional
currency through March 31, 2001. Through this date, monetary assets and
liabilities were translated at the rates of exchange on the balance sheet date
and certain assets (notably property and equipment) were translated at
historical rates. Income and expense items were translated at average rates of
exchange for the period except for those items of expense, which related to
asset amortization, which were translated at historical rates. The gains and
losses from translation related to this subsidiary were included in net income
through March 31, 2001.
Effective April 1, 2001, in response to a change to the Euro for
transaction activity previously conducted in the U.S. dollar by the Company's
largest European client, the Company adopted the Euro as its functional currency
for its European operations. As a result, beginning April 1, 2001, all assets
and liabilities are translated at exchange rates in effect at the end of the
period, and income and expense items are translated at the average exchange
rates for the period. Translation adjustments are reported as a separate
component of shareholders' equity.
Gains and losses from foreign currency transactions are included in net
income.
55
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, to account
for its fixed plan stock options. 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. Statement of Financial Standards
("SFAS") No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"),
established accounting and disclosure requirements using a fair-value based
method of accounting for stock-based employee compensation plans. As allowed by
SFAS No. 123, the Company has elected to continue to apply the intrinsic value-
based method of accounting described above, and has adopted the disclosure
requirements of SFAS No. 123.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of our financial instruments, which include cash and
cash equivalents, accounts receivable, note receivable, accounts payable,
long-term debt and capital lease obligations, approximate their fair values
based on short terms to maturity or current market prices and interest rates.
COMPREHENSIVE LOSS
Comprehensive loss is defined as the change in equity (net assets) of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources. Comprehensive loss consists of net loss
and foreign currency translation adjustments.
NET LOSS PER COMMON SHARE
Prior to the Offering, which was consummated in fiscal 2000, basic and
diluted net loss per share attributable to PFSweb was determined based on net
loss divided by the 14,305,000 shares of PFSweb, Inc. (see Note 1) outstanding.
There were no potentially dilutive securities outstanding during the periods
presented prior to the Offering. For fiscal years 2000 and 2001 and the
nine-month period ended December 31, 2001 outstanding options to purchase common
shares of PFSweb were anti-dilutive and have been excluded from the weighted
average share computation. There are no other potentially dilutive securities
outstanding.
CASH PAID DURING YEAR
The Company made payments for interest of approximately $3,514,000,
$194,000 and $238,000 and income taxes of approximately $6,000, $164,000 and
$94,000 during fiscal 2000 and 2001 and the nine-month period ended December 31,
2001, respectively (see Notes 5 and 8).
3. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
During the nine months ended December 31, 2001, the Company entered into a
Term Lease Master Agreement with IBM Credit Corporation ("Master Agreement")
which provides for leasing or financing
56
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
transactions of equipment with terms of 3 to 5 years. The leasing transactions
are secured by the related equipment. The leasing and financing transactions are
secured by a letter of credit (see Note 2). Financing transactions under the
Master Agreement during the nine months ended December 31, 2001 totaled $1.5
million and carried interest rates ranging from 6.2% to 7.0%. The aggregate
maturities of long-term debt subsequent to December 31, 2001 are as follows.
[Download Table]
Fiscal year ended December 31,
2002........................................................ $ 293
2003........................................................ 306
2004........................................................ 324
2005........................................................ 320
2006........................................................ 177
Thereafter.................................................. --
------
Total long-term debt payments............................... $1,420
======
The Company has certain non-cancelable capital lease agreements including
those under the Master Agreement, primarily involving warehouse and computer
equipment.
The Company's property held under capital leases, included in furniture and
fixtures amounted to approximately $2.3 million and $2.9 million, net of
accumulated amortization of approximately $0.4 million and $1.0 million at March
31, 2001 and December 31, 2001, respectively.
The following is a schedule of future minimum lease payments under the
capital leases together with the present value of the net minimum lease payments
as of December 31, 2001 (in thousands):
[Download Table]
Fiscal year ended December 31,
2002........................................................ $ 945
2003........................................................ 942
2004........................................................ 619
2005........................................................ 466
2006........................................................ 443
Thereafter.................................................. 602
------
Total minimum lease payments................................ $4,017
Less: Amount representing interest at rates ranging from
6.5% to 9.2%.............................................. (779)
------
Present value of net minimum lease payments................. 3,238
Less: Current portion....................................... (702)
------
Long-term capital lease obligations......................... $2,536
======
4. STOCK AND STOCK OPTIONS
TREASURY STOCK
On August 13, 2001, the Company announced that its Board of Directors had
authorized the repurchase of up to two million shares of the Company's common
stock. As of December 31, 2001, the Company had purchased 86,300 shares of
common stock.
57
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PREFERRED STOCK PURCHASE RIGHTS
On June 8, 2000 the Company's Board of Directors declared a dividend
distribution of one preferred stock purchase right (a "Right") for each share of
the Company's common stock outstanding on July 6, 2000. Each Right entitles the
registered shareholders to purchase from the Company one one-thousandth of a
share of preferred stock at an exercise price of $67, subject to adjustment. The
Rights are not currently exercisable, but would become exercisable if certain
events occurred relating to a person or group acquiring or attempting to acquire
15 percent or more of the Company's outstanding shares of common stock. The
Rights expire on July 6, 2010, unless redeemed or exchanged by the Company
earlier.
EMPLOYEE STOCK PURCHASE PLAN
On September 15, 2000, PFSweb shareholders adopted the PFSweb Employee
Stock Purchase Plan (the "Stock Purchase Plan") which is qualified under Section
423 of the Internal Revenue Code of 1986, to provide employees of PFSweb an
opportunity to acquire a proprietary interest in the Company. The Stock Purchase
Plan provides for acquisition of PFSweb common stock at a 15% discount to the
market value. The Stock Purchase Plan permits each U.S. employee who has
completed ninety days of service to elect to participate in the plan. Eligible
employees may elect to contribute up to 10 percent of their compensation with
after-tax dollars up to a maximum annual contribution of $21,250. The Company
has reserved 2,000,000 shares of its common stock under the Stock Purchase Plan,
as amended. The Stock Purchase Plan became effective for eligible employees in
September 2000. During fiscal 2001 and the nine-month period ended December 31,
2001, 37,378 and 236,031 shares were issued under the Stock Purchase Plan,
respectively.
STOCK OPTIONS AND STOCK OPTION PLANS
Spin-off
Prior to the Offering and Spin-off transaction described in Note 1, certain
of the Company's employees were granted Daisytek stock options under Daisytek's
stock option compensation plans (the "Daisytek Plans"). The stock options
generally vest over a three to five-year period from the date of grant and
expire 10 years after the date of grant.
In connection with the completion of the Spin-off, all outstanding Daisytek
stock options were replaced with substitute stock options as described below:
Options held by PFSweb employees were replaced (at the option holder's
election made prior to the Spin-off) with either options to acquire shares of
PFSweb common stock or options to acquire shares of both Daisytek common stock
and PFSweb common stock (which may be exercised separately) (the "Unstapled
Options"). Options held by Daisytek employees were replaced (at the option
holder's election made prior to the Spin-off) with either options to acquire
shares of Daisytek common stock or Unstapled Options.
In general, the adjustments to the outstanding Daisytek options were
established pursuant to a formula designed to ensure that: (1) the aggregate
"intrinsic value" (i.e. the difference between the exercise price of the option
and the market price of the common stock underlying the option) of the
substitute options did not exceed the aggregate intrinsic value of the
outstanding Daisytek stock options which were replaced by such substitute
options immediately prior to the Spin-off, and (2) the ratio of the exercise
price of the options to the market value of the underlying stock immediately
before and after the Spin-off was preserved.
Substantially all of the other terms and conditions of each substitute
stock option, including the time or times when, and the manner in which, each
option is exercisable, the duration of the exercise period, the permitted method
of exercise, settlement and payment, the rules that will apply in the event of
the termination of employment of the employee, the events, if any, that may give
rise to an employee's right to accelerate the
58
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
vesting or the time or exercise thereof and the vesting provisions, are the same
as those of the replaced Daisytek stock option, except that option holders who
are employed by one company will be permitted to exercise, and will be subject
to all of the terms and provisions of, options to acquire shares in the other
company as if such holder was an employee of such other company.
As a result of the stock option replacement process described above, in
conjunction with the Spin-off on July 6, 2000, 3,479,697 non-plan PFSweb stock
options (the "PFSweb Non-plan") were issued to PFSweb and Daisytek officers,
directors and employees.
Offer to Exchange
On April 30, 2001, the Company filed a Tender Offer Statement on Schedule
TO (the "Schedule TO") relating to the Company's offer to exchange certain
PFSweb Plan and Non-plan options to purchase shares of its common stock held by
certain PFSweb officers, directors and employees for new options to purchase
shares of its common stock at a per share price equal to the fair market value
of one share of its common stock on the date of issuance, which occurred on
December 5, 2001, upon the terms and subject to the conditions in the Offer to
Exchange (the "Offer") dated April 30, 2001. On May 29, 2001, the Offer expired
and the Company accepted for exchange options to purchase 3,753,044 shares of
common stock, 2,663,544 of which were PFSweb Non-plan options and 1,089,500 were
PFSweb Plan options. On May 29, 2001, the Company also repriced and fully vested
105,000 options issued under the PFSweb Plans and 698,860 PFSweb Non-plan
options held by Daisytek officers, directors and employees and non-employees
which resulted in a non-cash stock compensation charge of approximately $0.7
million.
Pursuant to the terms of the Offer, on December 5, 2001, the Company
granted 3,184,963 options to officers, directors and employees of PFSweb,
2,462,614 of which were issued as PFSweb Plan options and 722,349 were issued as
Non-plan options. At issuance, pursuant to terms of the Offer, 658,000 of the
PFSweb Plan options and 293,000 of the Non-plan options were 75% vested on the
date of issuance with the remaining 25% vesting quarterly over one year and
1,804,614 of the PFSweb Plan options and 429,349 of the Non-plan options vest
quarterly over one year.
PFSweb Plan Options
PFSweb has authorized 6,000,000 shares of common stock for issuance under
two 1999 stock option plans and 35,000 shares for issuance under a stock option
agreement (the "PFSweb Plans"). The PFSweb Plans provide for the granting of
incentive awards in the form of stock options to directors, executive
management, key employees, and outside consultants of PFSweb. The right to
purchase shares under the employee stock option agreements typically vest over a
three-year period. Stock options must be exercised within 10 years from the date
of grant. Stock options are generally issued at fair market value. The Company
recorded stock based compensation expense of $48,000, $38,000 and $7,000 in
fiscal 2000 and 2001, and the nine month period ended December 31, 2001,
respectively, in connection with stock options to purchase an aggregate of
72,500 shares issued under the PFSweb Plans to non-employees. At December 31,
2001 there is no unamortized stock based compensation expense.
As of December 31, 2001 there were 2,438,631 shares available for future
options under the PFSweb Plans.
59
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes stock option activity under the PFSweb
Plans:
[Enlarge/Download Table]
WEIGHTED AVERAGE
SHARES PRICE PER SHARE EXERCISE PRICE
---------- --------------- ----------------
Outstanding, March 31, 1999................ -- $ -- $ --
Granted.................................. 1,425,000 $10.45-$17.00 $10.69
Exercised................................ -- $ -- $ --
Canceled................................. (63,500) $10.45-$13.00 $10.77
----------
Outstanding, March 31, 2000................ 1,361,500 $10.45-$17.00 $10.69
Granted.................................. 1,238,700 $ 1.16-$11.75 $ 2.01
Exercised................................ -- $ -- $ --
Canceled................................. (240,850) $ 1.44-$17.00 $ 6.73
----------
Outstanding, March 31, 2001................ 2,359,350 $ 1.16-$17.00 $ 6.54
Granted.................................. 2,507,819 $ 0.60-$ 1.20 $ 0.91
Exercised................................ -- $ -- $ --
Canceled................................. (1,270,800) $ 1.92-$17.00 $ 9.84
----------
Outstanding, December 31, 2001............. 3,596,369 $ 0.60-$16.00 $ 1.27
==========
PFSweb Plan options granted prior to the Spin-off and not included in the
Offer, referred to above, vest one-third on the anniversary of the date of grant
and one-twelfth each quarter thereafter. PFSweb Plan options granted after the
Spin-off, excluding those issued pursuant to the Offer, vest one-twelfth each
quarter. As of March 31, 2001 and December 31, 2001, 963,520 and 1,092,419
options were exercisable. The weighted average fair value of options granted
during fiscal 2000 and 2001 and the nine month period ended December 31, 2001
were $5.50, $1.67, and $0.76 respectively.
The following table summarizes information concerning currently outstanding
and exercisable PFSweb stock options issued under the PFSweb Plans to PFSweb
officers, directors and employees as of December 31, 2001:
[Enlarge/Download Table]
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------------------------- ----------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF OUTSTANDING AS OF REMAINING AVERAGE EXERCISABLE AS OF AVERAGE
EXERCISE PRICES DECEMBER 31, 2001 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 2001 EXERCISE PRICE
--------------- ----------------- ---------------- -------------- ----------------- --------------
$ 0.60-$ 2.69 3,571,369 9.5 $ 1.20 1,073,834 $ 1.41
$10.45-$16.00 25,000 7.5 $10.67 18,585 $10.62
--------- ---------
3,596,369 9.5 $ 1.27 1,092,419 $ 1.57
========= =========
PFSweb Non-plan Options
As of December 31, 2001, 1,431,503 PFSweb Non-plan options were
outstanding, of which 747,172 were held by PFSweb officers, directors and
employees and 684,331 were held by Daisytek officers, directors and employees.
60
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes stock option activity under the PFSweb
Non-plan:
[Enlarge/Download Table]
WEIGHTED AVERAGE
SHARES PRICE PER SHARE EXERCISE PRICE
---------- --------------- ----------------
Outstanding, March 31, 2000.................. -- $ -- $ --
Granted.................................... 3,479,697 $ 4.22-$10.58 $7.26
Exercised.................................. -- $ -- $ --
Canceled................................... (82,852) $ 4.51-$10.58 $7.91
----------
Outstanding, March 31, 2001.................. 3,396,845 $ 4.22-$10.58 $7.25
Granted.................................... 757,349 $ 0.91-$1.17 $0.92
Exercised.................................. -- $ -- $ --
Canceled................................... (2,722,691) $ 1.17-$10.58 $6.87
----------
Outstanding, December 31, 2001............... 1,431,503 $ 0.91-$10.58 $1.15
==========
The weighted average fair values of options granted during fiscal 2001 and
nine months ended December 31, 2001 were $5.95 and $0.77, respectively. As of
March 31, 2001 and December 31, 2001, 1,895,773 and 918,106 of options
outstanding were exercisable, respectively. The remaining options will become
exercisable over the next year.
The following table summarizes information concerning PFSweb Non-plan
options outstanding and exercisable as of December 31, 2001:
[Enlarge/Download Table]
OPTIONS OUTSTANDING
---------------------------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED ----------------------------------
OUTSTANDING AS OF AVERAGE WEIGHTED EXERCISABLE AS OF WEIGHTED
RANGE OF DECEMBER 31, REMAINING AVERAGE DECEMBER 31, AVERAGE
EXERCISE PRICES 2001 CONTRACTUAL LIFE EXERCISE PRICE 2001 EXERCISE PRICE
--------------- ----------------- ---------------- -------------- ----------------- --------------
$0.91-$ 1.17 1,406,680 8.3 $ 1.04 904,092 $ 1.11
$5.78-$10.58 24,823 7.1 $ 7.36 14,014 $ 7.51
--------- ---------
1,431,503 8.3 $ 1.15 918,106 $ 1.20
========= =========
Had compensation expense for the PFSweb Plans and Non-plan and the Daisytek
Plans applicable to the Company's employees been determined based upon the fair
value at the grant date for awards consistent with the methodology prescribed by
SFAS 123, the Company's consolidated pretax loss would have increased by
approximately $5,352,000 and $3,766,000 in fiscal 2000 and 2001, respectively,
and would have resulted in a net loss per share of ($0.73) and ($0.81) in fiscal
2000 and 2001, respectively. For the nine months ended December 31, 2001, the
Company's pretax loss would have decreased by $2,650,000 and would have resulted
in a net income per share of $0.12. These pro forma effects may not be
representative of expense in future periods since the estimated fair value of
stock options on the date of grant is amortized to expense over the vesting
period. Options issued under the Daisytek Plans prior to April 1, 1995, were
excluded from the computation.
61
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants of PFSweb options to PFSweb officers, directors, and employees under the
PFSweb Plans:
[Download Table]
FISCAL YEARS ENDED MARCH 31, NINE MONTH PERIOD
------------------------------ ENDED DECEMBER 31,
2000 2001 2001
------------- -------------- ------------------
Expected dividend yield........ -- -- --
Expected stock price
volatility................... 45.00%-84.23% 98.37%-128.38% 117.27%-126.08%
Risk-free interest rate........ 5.5%-6.2% 5.8%-6.3% 4.6%-5.3%
Expected life of options
(years)...................... 6 5 5
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants of PFSweb options to PFSweb and Daisytek officers, directors, and
employees under the PFSweb Non-Plans during fiscal 2001: no dividends; expected
volatility of 112.08%, risk-free interest rate of 6.1%, and expected life of 5
years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants of PFSweb options to PFSweb officers, directors, and employees and a
Daisytek director under the PFSweb Non-Plan during fiscal the nine months ended
December 31, 2001: no dividends; expected volatility between 117.27% and
124.12%, risk-free interest rate ranging between 4.9% and 5.5%, and expected
life of 5 years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants of Daisytek options to PFSweb employees under the Daisytek Plans during
fiscal 2000: no dividends; expected volatility between 49.37% and 50.02%;
risk-free interest rate ranging between 5.7% and 6.0%; and expected life of 6
years. No options were granted to PFSweb officers, directors or employees under
the Daisytek Plans during fiscal 2001 or the nine-month period ended December
31, 2001.
On January 25, 2002, the Company issued 970,000 options to purchase shares
of common stock at $0.84, from the PFSweb Plans to officers, directors and
employees of PFSweb and certain non-employees, recording a non-cash stock
compensation charge of approximately $24,000.
5. TRANSACTIONS WITH DAISYTEK
Prior to the Offering, monies advanced by Daisytek were used to fund the
Company's operations, working capital requirements and certain investment
activities. Interest expense charged by Daisytek was based on its weighted
average interest rates of 6.7% for fiscal 2000 and approximated $1.7 million.
During fiscal 2000, PFSweb used a portion of the proceeds from the Offering
to repay its payable to Daisytek. Following the completion of the Offering,
Daisytek is prohibited from advancing funds to PFSweb, except in the normal
course of business, and PFSweb is restricted from borrowing from Daisytek.
As of March 31, 2001 the Company had payables to Daisytek of approximately
$7.2 million and receivables from Daisytek of $3.1 million. As of December 31,
2001, the Company had receivables from Daisytek of $0.1 million.
The Company's product revenue from sales to Daisytek was $7.2 million in
fiscal year 2000.
In fiscal years 2000 and 2001, the Company's costs and expenses include
allocations from Daisytek for certain general administrative services including
information technology, financial, treasury, legal, insurance and other
corporate functions as well as certain costs of operations including facility
charges. These allocations were estimated on bases that Daisytek and the Company
consider to be a reasonable reflection of the
62
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
utilization of services provided or the benefit received by the Company. The
methods used for allocation of expenses from Daisytek were either (i) percentage
of: revenue, shipped orders, or number of employees, or (ii) management's best
estimate. However, these allocations of costs and expenses do not necessarily
indicate the costs and expenses that would have been or will be incurred by the
Company on a stand-alone basis. Management estimates that incremental selling,
general and administrative expenses associated with PFSweb operating as a
stand-alone publicly traded company, including executive management, overhead
and public company costs, insurance and risk management costs, and other costs
would have been approximately $2.0 million for fiscal year 2000, $0.2 million
for fiscal year 2001 and zero for the nine month period ended December 31, 2001.
During the quarter ended September 30, 1999, and in connection with the
restructuring of certain IBM master distribution agreements under which both
Daisytek and PFSweb are parties, the Company transferred to Daisytek certain
related product inventory, accounts receivable and accounts payable that it held
under its prior agreements. In consideration of this transfer, the Company
received the net book value of these assets and liabilities of approximately $20
million and reduced its payable to Daisytek by a corresponding amount.
In conjunction with the successful completion of the Offering, PFSweb
entered into agreements with Daisytek, including a tax sharing agreement, a
transaction management services agreement, transition services agreement and a
master separation agreement. In addition, on a going forward basis, Daisytek
will continue to be an obligor and guarantor for certain of the Company's
facility and equipment leases.
On May 25, 2001, the Company completed the sale of certain assets to
Daisytek pursuant to an Asset Purchase Agreement (the "Purchase Agreement") (See
Notes 6 and 7). The Purchase Agreement included a termination by the Company and
Daisytek of certain transaction management services agreements previously
entered into between the Company and Daisytek and a Daisytek subsidiary.
Concurrently with the closing of the asset sale, the Company and Daisytek also
entered into a six-month transition services agreement under which the Company
provided Daisytek with certain transitional and information technology services
that expired in November 2001.
Through September 2001, the consolidated financial statements include
service fee revenues and cost of service fee revenues for certain services
subcontracted to PFSweb by Daisytek under Daisytek's contractual agreements.
Service fee revenues charged to Daisytek under (i) the IBM Master
Distributor Agreements, entered into during the quarter ended September 30,
1999, (ii) terms of the transaction management services agreement with Daisytek,
(iii) for certain subcontracted services, and (iv) for certain transaction and
information technology services, were $12.1 million, $27.6 million and $9.6
million for fiscal 2000 and 2001, and the nine-month period ended December 31,
2001, respectively.
As of December 31, 2001, the Company is not party to any agreement to
provide services for Daisytek.
6. DISPOSITION OF ASSETS
On May 25, 2001, the Company completed the sale of certain assets to
Daisytek pursuant to the Purchase Agreement. Under the Purchase Agreement, the
Company transferred and sold to Daisytek certain distribution and fulfillment
assets, including equipment and fixtures, that were previously used by the
Company to provide outsourcing services to Daisytek. Daisytek also assumed
certain related equipment leases and a warehouse lease and hired certain
employees who were associated with the warehouse facility. The consideration
payable under the Purchase Agreement of $11.0 million included a termination by
the Company and Daisytek of certain transaction management services agreements
previously entered into between the Company and Daisytek and a Daisytek
subsidiary. Proceeds of $10.9 million were received for assets with an
approximately $4.5 million net book value with a resulting $5.8 million gain,
after closing costs of $0.6 million. Concurrently with the closing of the asset
sale, the Company and Daisytek also entered into a six-month
63
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
transition services agreement under which the Company provided Daisytek with
certain transitional and information technology services.
Pro forma revenues and pro forma loss from operations for fiscal 2001,
assuming the transaction had occurred in April 2000, would have been $29.5
million and ($18.9) million, respectively. Pro forma revenues and pro forma loss
from operations for the nine months ended December 31, 2001, had the transaction
occurred on April 2000, would have been $22.0 million and ($10.4) million,
respectively. The pro forma data do not give effect to any fees earned by PFSweb
for services provided to Daisytek under a six-month transition services
agreement entered into on May 25, 2001 or the effect of the $5.8 million gain on
the sale of the assets. Additionally, these pro forma adjustments do not
consider certain infrastructure costs, such as operating costs associated with
the information technology function, salaries of certain management and
personnel, telephone and lease costs, and depreciation expense which supported
this business but that will continue in the future. Because these ongoing costs
were not considered, the pro forma adjustments to the loss from operations are
not indicative of the overall margin earned under these transaction management
services agreements.
7. SUPPLIES DISTRIBUTORS AND OTHER RELATED PARTIES
SUPPLIES DISTRIBUTORS
The Company, Business Supplies Distributors (a Daisytek
subsidiary -- "BSD"), Daisytek and IBM were parties to various Master
Distributor Agreements which had various scheduled expiration dates through
September 2001. Under these agreements, BSD and its affiliates Business Supplies
Distributors Europe B.V. ("BSD Europe"), a Daisytek subsidiary, and BSD (Canada)
Inc., a Daisytek subsidiary ("BSD Canada" and together with BSD and BSD Europe,
the "BSD Companies"), acted as master distributors of various IBM products,
Daisytek provided financing and credit support to the BSD Companies and the
Company provided transaction management and fulfillment services to the BSD
Companies.
On June 8, 2001, Daisytek notified the Company and IBM that it did not
intend to renew these agreements upon their scheduled expiration dates. In July
2001, the Company and Inventory Financing Partners, LLC ("IFP") formed Holdings,
and Holdings formed a wholly-owned subsidiary, Supplies Distributors ("Supplies
Distributors"). Concurrently, Supplies Distributors formed its wholly-owned
subsidiaries Supplies Distributors of Canada, Inc. ("SDC") and Supplies
Distributors S.A. ("SDSA"), a Belgium corporation. Supplies Distributors, SDSA,
the Company and IBM entered into new Master Distributor Agreements to replace
the prior agreements. Under these agreements, Supplies Distributors and SDSA act
as master distributors of various IBM products and, pursuant to a transaction
management services agreement between the Company and Supplies Distributors, the
Company provides transaction management and fulfillment services to Supplies
Distributors.
The Company made an equity investment of $0.75 million in Holdings, which
is included in other assets in the accompanying consolidated financial
statements, for a 49% voting interest, and IFP made an equity investment of
$0.25 million in Holdings for a 51% voting interest. Certain officers and
directors of the Company own, individually, a 9.8% non-voting interest, and,
collectively, a 49% non-voting interest, in IFP. In addition to its equity
investment in Holdings, the Company has also provided Supplies Distributors with
a subordinated loan, evidenced by the Note which, as of December 31, 2001, had
an outstanding balance of $11.7 million. The Note, which is classified as a note
receivable from affiliate, accrues interest at a fluctuating rate per annum
equal to the Company's cost of funds, as determined by the Company. For the
period ended December 31, 2001, the Company charged interest at 10% and earned
$0.3 million associated with the Note.
On September 26, 2001, Supplies Distributors purchased all of the stock of
the BSD Companies for a purchase price of $923,000. On September 27, 2001,
Supplies Distributors entered into short-term credit facilities with IBM Credit
Corporation ("IBM Credit") and IBM Belgium Financial Services S.A. ("IBM
Belgium") for the purpose of financing its distribution of IBM products. The
facilities, which at inception
64
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
included $40 million for the U.S. operations and 20 million Euros (approximately
$18 million) for the European operations, were subsequently increased to $45
million and 27 million Euros (approximately $24 million), respectively, and
extended through March 25, 2002.
On March 29, 2002, Supplies Distributors entered into amended credit
facilities with IBM Credit and SDSA and BSD Europe entered into amended credit
facilities with IBM Belgium. The asset based credit facility with IBM Credit
provides financing for purchasing IBM inventory up to $32.5 million through June
30, 2002 and $27.5 million from July 1, 2002 through its expiration on March 29,
2003. The asset based credit facility with IBM Belgium provides up to 27 million
Euros (approximately $24.3 million) in financing for purchasing IBM inventory
through June 30, 2002 and 22 million Euros (approximately $19.8 million)
thereafter. The IBM Belgium facility remains in force until not less than 60
days written notice by any party, but no sooner than March 29, 2003. These
credit facilities contain cross default provisions and various restrictions upon
the ability of Holdings, Supplies Distributors, SDSA and BSD Europe to, among
other things, merge, consolidate, sell assets, incur indebtedness, make loans
and payments to related parties, provide guarantees, make investments and loans,
pledge assets, make changes to capital stock ownership structure and pay
dividends, as well as financial covenants, such as annualized revenue to working
capital, net profit after tax to revenue, and total liabilities to tangible net
worth, as defined, and are secured by all of the assets of Supplies
Distributors, as well as collateralized guaranties of Holdings and PFSweb.
Additionally, the Company is required to maintain a subordinated loan to
Supplies Distributors of no less than $6.5 million and shareholders' equity of
at least $25.0 million.
Concurrent with these amended agreements, Supplies Distributors entered
into a loan and security agreement with Congress Financial Corporation
(Southwest) ("Congress") to provide financing for up to $25 million of eligible
accounts receivables in the U.S. and Canada. The Congress facility expires on
the earlier of three years or the date on which the parties to the IBM Master
Distributor Agreement shall no longer operate under the terms of such agreement
and/or IBM no longer supplies products pursuant to such agreement. Borrowings
under the Congress facility accrue interest at prime rate plus 0.25% or
Eurodollar rate plus 3.0% or on an adjusted basis, as defined. In Europe, SDSA
entered into a two year factoring agreement with Fortis Commercial Finance N.V.
("Fortis") to provide factoring for up to 10 million Euros (approximately $9
million) of eligible accounts receivables. Borrowings under this agreement
accrue interest at 8.5%, or on an adjusted basis as defined. These credit
facilities contain cross default provisions and various restrictions upon the
ability of Holdings, Supplies Distributors and SDSA to, among other things,
merge, consolidate, sell assets, incur indebtedness, make loans and payments to
related parties, provide guarantees, make investments and loans, pledge assets,
make changes to capital stock ownership structure and pay dividends, as well as
financial covenants, such as minimum net worth, as defined, and are secured by
all of the assets of Supplies Distributors, as well as collateralized guaranties
of Holdings and PFSweb. Additionally, the Company is required to maintain a
subordinated loan to Supplies Distributors of no less than $6.5 million and
restricted cash of less than $5.0 million, and is restricted with regard to
transactions with related parties, indebtedness and changes to capital stock
ownership structure.
The Company has provided a collateralized guaranty to secure the repayment
of these credit facilities (see Note 9).
Pursuant to the terms of the Company's transaction management services
agreement with Supplies Distributors, the Company earned service fees, which are
reported as service fee revenue -- affiliate in the accompanying consolidated
financial statements, of approximately $1.4 million for the nine months ended
December 31, 2001. For the nine months ended December 31, 2001, PFSweb fees
earned from BSD (the Daisytek subsidiary and predecessor to Supplies
Distributors) were $3.6 million. For the nine months ended December 31, 2000,
prior to becoming a related party, service fees earned by PFSweb from BSD,
associated with the same business activities, were $4.6 million. As of December
31, 2001, the Company has trade accounts receivables of $0.9 million due from
Supplies Distributors.
65
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pursuant to Holdings' operating agreement, Holdings allocates its earning
and distributes its cash flow, as defined, in the following order of priority:
first, to IFP until it has received a one-time amount equal to its capital
contribution of $0.25 million; second, to IFP until it has received an amount
equal to a 35% cumulative annual return on its capital contribution; third, to
PFSweb until it has received a one-time amount equal to its capital contribution
of $0.75 million; fourth, to PFSweb until it has received an amount equal to a
35% cumulative annual return on its capital contribution; and fifth, to PFSweb
and IFP, pro rata, in accordance with their respective capital accounts.
Notwithstanding the foregoing, no distribution may be made if, after giving
effect thereto, the net worth of Holdings may be less than $1.0 million. Under
the terms of its credit agreements, Holdings is currently limited to annual cash
dividends of $0.6 million. The Company did not record any equity in the earnings
of Holdings for the nine months ended December 31, 2001.
Summarized financial information for Holdings as of December 31, 2001 is as
follows (in thousands):
[Download Table]
Current assets.............................................. $80,247
Total assets................................................ $81,554
Current liabilities......................................... $ 9,651
Credit facilities (guaranteed by PFSweb).................... $59,038
Subordinated note due to PFSweb............................. $11,655
Members' capital............................................ $ 1,210
Summarized operating information for Holdings for the period from July 3,
2001 (Inception) through December 31, 2001 is as follows (in thousands):
[Download Table]
Net revenues................................................ $75,444
Cost of goods sold.......................................... $71,870
Income before taxes......................................... $ 673
Net income.................................................. $ 401
OTHER RELATED PARTIES
In May 1999, the Company entered into an agreement to provide services to a
certain company. During fiscal 2000, an executive officer and a director of
PFSweb both served on the Board of Directors of this company. During fiscal 2001
an executive officer of PFSweb served on the Board of Directors of this company.
PFSweb no longer provides services to this company. Service fee revenue earned
from this company was approximately $1.8 million and $2.0 million for fiscal
2000 and 2001, respectively, and other revenue was $1.7 million for fiscal 2001.
PFS had previously guaranteed an unsecured revolving line of credit with
commercial banks of Daisytek. In December 1999, PFS was released from its
guarantee.
A non-employee director of PFSweb was a Managing Director of Hambrecht and
Quist LLP, one of the lead managing underwriters on the Offering.
8. INCOME TAXES
Prior to the Spin-off, the Company's operations were included in
consolidated income tax returns filed by Daisytek. The provision for income
taxes reflected in the consolidated statements of operations and the deferred
tax assets reflected in the consolidated balance sheets have been prepared as
computed on a separate return basis. Effective with the completion of the
Spin-off, PFSweb ceased to be included in Daisytek's consolidated tax return.
66
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the difference between the expected income tax expense
at the U.S. federal statutory corporate tax rate of 34%, and the Company's
effective tax rate is as follows (in thousands):
[Enlarge/Download Table]
FISCAL YEARS ENDED
MARCH 31, NINE MONTHS ENDED
------------------- DECEMBER 31,
2000 2001 2001
-------- -------- -----------------
Income tax expense (benefit) computed at
statutory rate................................. $(2,628) $(3,649) $(267)
Impact of foreign taxation at different rate..... (24) (28) (35)
State income taxes, net of federal tax impact.... 51 -- --
Expenses not deductible for tax purposes......... 84 9 54
Net operating loss carryback..................... (171) -- --
Change in valuation reserve...................... 915 3,567 125
Other............................................ (18) 126 (96)
------- ------- -----
Provision (benefit) for income taxes........... $(1,791) $ 25 $(219)
======= ======= =====
The consolidated income (loss) before income taxes, by domestic and foreign
entities, is as follows (in thousands):
[Enlarge/Download Table]
FISCAL YEARS ENDED
MARCH 31, NINE MONTHS ENDED
------------------ DECEMBER 31,
2000 2001 2001
------- -------- -----------------
Domestic........................................ $(5,331) $ (6,188) $ 988
Foreign......................................... (2,399) (4,543) (1,772)
------- -------- -------
Total................................. $(7,730) $(10,731) $ (784)
======= ======== =======
Current and deferred income tax expense (benefit) is summarized as follows
(in thousands):
[Enlarge/Download Table]
FISCAL YEARS ENDED
MARCH 31, NINE MONTHS ENDED
------------------- DECEMBER 31,
2000 2001 2001
--------- ------- -----------------
Current
Domestic........................................ $(2,150) $ 57 $ (68)
State........................................... 77 -- --
Foreign......................................... (171) 77 (151)
------- ----- -----
Total current........................... (2,244) 134 (219)
Deferred
Domestic........................................ 453 (109) --
State........................................... -- -- --
------- ----- -----
Total deferred............................... 453 (109) --
------- ----- -----
Total................................... $(1,791) $ 25 $(219)
======= ===== =====
67
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the deferred tax asset (liability) are as follows (in
thousands):
[Download Table]
MARCH 31, DECEMBER 31,
2001 2001
--------- ------------
Deferred tax asset:
Allowance for doubtful accounts........................... $ 95 $ 63
Net operating loss carryforwards.......................... 4,639 5,411
Other..................................................... 30 127
------ ------
4,764 5,601
Less -- Valuation reserve................................. 4,482 5,429
------ ------
Total deferred tax asset.......................... 282 172
------ ------
Deferred tax liability:
Property and equipment.................................... (470) (360)
------ ------
Total deferred liability.......................... (470) (360)
------ ------
Deferred tax liability, net................................. $ (188) $ (188)
====== ======
Management believes a sufficient history of earnings has not been
established by PFSweb, on a stand-alone basis, to support the more likely than
not realization of deferred tax assets in excess of existing taxable temporary
differences. A valuation allowance has been provided for the net deferred income
tax asset as of March 31, 2001 and December 31, 2001. At December 31, 2001, net
operating loss carryforwards relate to taxable losses of the Company's Europe
subsidiary totaling approximately $8.0 million and the Company's U.S.
subsidiary, totaling approximately $5.4 million that expire in 2017.
Approximately $0.8 million of the valuation allowance recorded against deferred
tax assets relates to $0.8 million of tax benefits of stock option exercises and
will be recorded against additional paid-in-capital upon utilization rather that
as an adjustment to income tax expense from continuing operations.
9. COMMITMENTS AND CONTINGENCIES
The Company leases facilities, warehouse, office, transportation and other
equipment under operating leases expiring in various years through fiscal 2009.
In most cases, management expects that, in the normal course of business, leases
will be renewed or replaced by other leases. Minimum future annual rental
payments under non-cancelable operating leases having original terms in excess
of one year are as follows (in thousands):
[Download Table]
Fiscal year ended December 31,
2002........................................................ $ 6,060
2003........................................................ 5,985
2004........................................................ 4,198
2005........................................................ 2,782
2006........................................................ 2,751
Thereafter.................................................. 2,696
-------
Total....................................................... $24,472
=======
Total rental expense under operating leases, net of sublease rental income,
approximated $3.7 million, $7.7 million and $4.4 million for fiscal 2000 and
2001, and the nine-month period ended December 31, 2001, respectively.
68
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For all periods prior to the Spin-off, Daisytek owned 80% of more of our
capital stock, the Company was included in Daisytek's consolidated group for
federal income tax purposes. If Daisytek or other members of the consolidated
group fail to make any federal income tax payments, the Company would be liable
for the shortfall since each member of a consolidated group is liable for the
group's entire tax obligation.
In December 2001, the Company contracted with a marketing and lead
generation firm to assist in new business development. In addition to a monthly
retainer payment the Company is obligated to make a $320,000 payment to this
firm if it performs the requirements of the contract, as defined.
The Company has provided collateralized guarantees to secure the repayment
of Supplies Distributors' credit facilities. As of December 31, 2001 the
outstanding balance of the credit facilities guaranteed by the Company was
approximately $59.0 million. In association with the new credit facilities
entered into in March 2002, the outstanding balance of the credit facilities
guaranteed by the Company was approximately $48.5 million. These guarantees
expire concurrently with the expiration of the underlying credit agreements. To
the extent Supplies Distributors or its subsidiaries fails to comply with its
covenants, including its monthly financial covenant requirements, and the
lenders accelerate the repayment of the credit facility obligations, Supplies
Distributors or its subsidiaries would be required to repay all amounts
outstanding thereunder. In such event, the Company would be obligated to perform
under those guarantees and repay, to the extent Supplies Distributors or its
subsidiaries was unable to, Supplies Distributors' or its subsidiaries credit
facility obligations. Additionally, if the Company was unable to maintain the
Company's required level of stockholders' equity of $25.0 million, the Company
could also be obligated to perform under these guarantees. Any requirement to
perform under the Company's guarantees would have a material adverse impact on
the Company's financial condition and results of operations and no assurance can
be given that the Company will have the financial ability to repay all of such
guaranteed obligations. In addition, in the event Supplies Distributors or its
subsidiaries is, or would be, in default of its obligations under its credit
facilities, the Company is restricted from receiving any payment of its Note and
such event would also have a material adverse impact upon the Company's
financial condition and results of operations. Furthermore, the Company is
obligated to repay any over-advance made to Supplies Distributors or its
subsidiaries by its lenders. An over-advance would arise in the event borrowings
exceeded the maximum amount available under the eligible borrowing base, as
defined. The Company has also provided a guarantee of the obligations or
Supplies Distributors and its subsidiaries to IBM, excluding the trade payables
that are financed by IBM Credit.
10. SEGMENT AND GEOGRAPHIC INFORMATION
The Company is organized as a single operating segment, which is an
international provider of integrated business process outsourcing solutions.
Geographic areas in which the Company operates include the United States, Europe
(primarily Belgium), and Canada.
69
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is geographic information by area. Transfers between
geographic areas were immaterial. Revenues are attributed based on the Company's
domicile.
[Enlarge/Download Table]
NINE MONTHS
YEAR ENDED OR AT ENDED OR AT
MARCH 31, DECEMBER 31,
----------------- ------------
2000 2001 2001
------- ------- ----
Revenues:
(in thousands)
United States...................................... $65,278 $43,352 $25,325
Europe............................................. 18,796 5,863 2,274
Canada............................................. 3,799 1,140 454
------- ------- -------
$87,873 $50,355 $28,053
======= ======= =======
Long-lived assets:
(in thousands)
United States...................................... $14,465 $14,397 $10,233
Europe............................................. 7,358 6,448 4,961
Canada............................................. 260 134 190
------- ------- -------
$22,083 $20,979 $15,384
======= ======= =======
11. EMPLOYEE SAVINGS PLAN
The Company has a defined contribution employee savings plan under Section
401(k) of the Internal Revenue Code. Substantially all full-time and part-time
U.S. employees are eligible to participate in the plan. The Company, at is
discretion, may match employee contributions to the plan and also make an
additional matching contribution in the form of profit sharing in recognition of
the Company performance. During fiscal year 2001, the Company matched 10% of
employee contributions totaling approximately $41,000, and provided an
additional discretionary match of approximately $38,000. During the nine months
ended December 31, 2001, the Company matched 10% of employee contributions
totaling approximately $34,000.
12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Unaudited quarterly results of operations for fiscal 2001 and the
nine-month period ended December 31, 2001 were as follows (amounts in thousands
except per share data):
[Enlarge/Download Table]
FISCAL 2001
-----------------------------------------
1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR.
-------- -------- -------- --------
Total revenues................................. $13,370 $12,963 $12,384 $11,638
Total cost of revenues......................... 8,645 11,869 8,567 7,650
Gross profit................................... 4,725 1,094 3,817 3,988
Selling, general and administrative expenses... 5,230 7,858 5,956 6,402
Loss from operations........................... (505) (6,764) (2,139) (2,414)
Net loss....................................... (238) (6,465) (1,861) (2,192)
Basic and diluted loss per share............... (0.01) (0.36) (0.10) (0.12)
Shares used in computation of basic and diluted
loss per share:.............................. 17,870 17,870 17,870 17,907
70
PFSWEB, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
[Enlarge/Download Table]
NINE-MONTH PERIOD ENDED
DECEMBER 31, 2001
------------------------------
1ST QTR. 2ND QTR. 3RD QTR.
-------- -------- --------
Total revenues.......................................... $ 9,517 $ 9,289 $ 9,247
Total cost of revenues.................................. 6,087 5,053 6,217
Gross profit............................................ 3,430 4,236 3,030
Selling, general and administrative expenses............ 5,978 5,301 5,838
Other................................................... (4,280) (500) (361)
Income (loss) from operations........................... 1,732 (565) (2,447)
Net income (loss)....................................... 1,903 (453) (2,015)
Basic and diluted income (loss) per share............... 0.11 (0.03) (0.11)
Shares used in computation of basic and diluted loss per
share:................................................ 17,970 18,079 18,057
The seasonality of the Company's business is dependent upon the seasonality
of its clients' business and their sale of products. Management believes that
with the Company's current client mix, the Company's business activity is
expected to be at its lowest in the quarter ended March 31 and at its highest in
the quarter ended June 30.
71
INDEPENDENT AUDITORS' REPORT
To the Members of
Business Supplies Distributors Holdings, LLC:
We have audited the accompanying consolidated balance sheet of Business
Supplies Distributors Holdings, LLC and subsidiaries as of December 31, 2001,
and the related consolidated statements of operations, members' capital and
comprehensive income, and cash flows for the period from July 3, 2001
(inception) to December 31, 2001. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Business
Supplies Distributors Holdings, LLC and subsidiaries as of December 31, 2001,
and the results of their operations and their cash flows for the period from
July 3, 2001 (inception) to December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America.
KPMG LLP
Dallas, Texas
March 29, 2002
72
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 2001
(IN THOUSANDS)
[Download Table]
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 578
Accounts receivable, net of allowance for doubtful
accounts of $616....................................... 23,231
Inventories, net.......................................... 32,847
Inventories in-transit.................................... 10,544
Other receivables......................................... 12,364
Prepaid expenses and other current assets................. 683
-------
Total current assets.............................. 80,247
-------
OTHER ASSETS, net (including restricted cash of $982)....... 1,307
-------
Total assets...................................... $81,554
=======
LIABILITIES AND MEMBERS' CAPITAL
CURRENT LIABILITIES:
Trade accounts payable.................................... $ 4,205
Trade accounts payable -- related parties (Note 7)........ 2,403
Value added tax payable................................... 1,424
Marketing funds payable................................... 493
Accrued expenses.......................................... 717
Income taxes payable...................................... 409
-------
Total current liabilities......................... 9,651
-------
LONG-TERM DEBT (Note 6)..................................... 59,038
-------
NOTE PAYABLE TO AFFILIATE................................... 11,655
-------
COMMITMENTS AND CONTINGENCIES
MEMBERS' CAPITAL:
Capital contributions..................................... 1,000
Retained earnings......................................... 401
Unrealized loss on investment............................. (85)
Accumulated other comprehensive loss...................... (106)
-------
Total members' capital............................ 1,210
-------
Total liabilities and members' capital............ $81,554
=======
The accompanying notes are an integral part of these consolidated financial
statements.
73
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE PERIOD FROM JULY 3, 2001 (INCEPTION) THROUGH DECEMBER 31, 2001
(IN THOUSANDS)
[Download Table]
NET REVENUES................................................ $75,444
COST OF GOODS SOLD.......................................... 71,870
-------
Gross profit.............................................. 3,574
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
(including affiliate expenses of $1,384, Note 7)............ 2,098
-------
Income from operations.................................... 1,476
INTEREST EXPENSE, net....................................... 803
-------
Income before income taxes................................ 673
INCOME TAX EXPENSE.......................................... 272
-------
NET INCOME.................................................. $ 401
=======
The accompanying notes are an integral part of these consolidated financial
statements.
74
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF MEMBERS' CAPITAL AND COMPREHENSIVE INCOME
FOR THE PERIOD FROM JULY 3, 2001 (INCEPTION) THROUGH DECEMBER 31, 2001
(IN THOUSANDS)
[Enlarge/Download Table]
ACCUMULATED
MEMBERS' UNREALIZED OTHER TOTAL
CAPITAL RETAINED LOSS ON COMPREHENSIVE MEMBERS' COMPREHENSIVE
CONTRIBUTIONS EARNINGS INVESTMENT LOSS CAPITAL INCOME
------------- -------- ---------- ------------- -------- -------------
Balance, at inception........ $ -- $ -- $ -- $ -- $ --
Net income................. -- 401 -- 401 $ 401
Capital contributions...... 1,000 -- -- 1,000 --
Unrealized loss on
investment.............. -- -- (85) -- (85) (85)
Other comprehensive loss --
foreign currency
translation
adjustment.............. -- -- -- (106) (106) (106)
------ ---- ---- ----- ------ -----
Comprehensive income......... $ 210
=====
Balance, December 31, 2001... $1,000 $401 $(85) $(106) $1,210
====== ==== ==== ===== ======
The accompanying notes are an integral part of these consolidated financial
statements.
75
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM JULY 3, 2001 (INCEPTION) THROUGH DECEMBER 31, 2001
(IN THOUSANDS)
[Download Table]
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 401
Adjustments to reconcile net income to net cash used in
operating activities:
Amortization........................................... 51
Provision for doubtful accounts........................ 353
Provision for inventory obsolescence................... 13
Deferred income taxes.................................. (300)
Changes in operating assets and liabilities, net of
effect of acquisition:
Accounts receivables................................. (20,480)
Inventories, net..................................... (30,154)
Prepaid expenses and other current assets............ (7,229)
Accounts payable and accrued expenses................ (20,625)
--------
Net cash provided by (used in) operating
activities........................................ (77,970)
--------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash acquired in acquisition of BSD Companies, net (Note
3)..................................................... 7,555
--------
Net cash provided by investing activities......... 7,555
--------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contributions..................................... 1,000
Proceeds from debt........................................ 59,352
Proceeds from affiliate loan.............................. 11,655
Restricted cash........................................... (982)
--------
Net cash provided by financing activities......... 71,025
--------
EFFECT OF EXCHANGE RATES ON CASH............................ (32)
--------
NET INCREASE IN CASH........................................ 578
CASH AND CASH EQUIVALENTS, beginning of period.............. --
--------
CASH AND CASH EQUIVALENTS, end of period.................... $ 578
========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest.................................... $ 463
========
Cash paid for taxes....................................... $ --
========
The accompanying notes are an integral part of these consolidated financial
statements.
76
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. OVERVIEW AND BASIS OF PRESENTATION:
PFSweb, Inc. ("PFS"), Daisytek International, Inc. ("Daisytek"), Business
Supplies Distributors, Inc., (a Daisytek subsidiary -- "BSD"), and International
Business Machines Corporation ("IBM") were parties to various Master Distributor
Agreements that had various scheduled expiration dates through September 2001.
Under these agreements, BSD and its affiliates Business Supplies Distributors
Europe B.V. ("BSD Europe"), a Daisytek subsidiary, and BSD (Canada) Inc., a
Daisytek subsidiary ("BSD Canada" and together with BSD and BSD Europe, the "BSD
Companies"), acted as master distributors of various IBM products. Daisytek
provided financing and credit support to the BSD Companies and PFS provided
transaction management and fulfillment services to the BSD Companies. On June 8,
2001, Daisytek notified PFS and IBM that it did not intend to renew these
agreements upon their scheduled expiration dates.
On July 3, 2001, PFS and Inventory Financing Partners, LLC ("IFP") formed
Business Supplies Distributors Holdings, LLC ("Holdings"), and Holdings formed a
wholly-owned subsidiary, Supplies Distributors, Inc. ("Supplies Distributors").
Concurrently, Supplies Distributors formed its wholly-owned subsidiaries
Supplies Distributors of Canada, Inc. ("SDC") and Supplies Distributors S.A.
("SDSA"), a Belgium corporation. Supplies Distributors, SDSA, PFS and IBM
entered into new Master Distributor Agreements to replace the prior agreements
(see Note 4). Under the new agreements, Supplies Distributors and SDSA act as
master distributors of various IBM products and, pursuant to a transaction
management services agreement between PFS and Supplies Distributors, PFS
provides transaction management and fulfillment services to Supplies
Distributors. On September 26, 2001, Supplies Distributors purchased all of the
stock of the BSD Companies for a purchase price of $923,000 and incurred $60,000
of acquisition costs (see Note 3). In conjunction with the purchase, BSD and
Supplies Distributors were merged with Supplies Distributors being the surviving
corporation. Effective December 31, 2001, BSD Canada and SDC were amalgamated,
with SDC being the surviving corporation.
All references to the "Company" include Holdings and Supplies Distributors
and its subsidiaries.
The Company, through its subsidiaries, is primarily a master distributor of
various IBM products. Supplies Distributors and SDSA have obtained certain
financing (see Note 6 and 7) that allows them to fund the working capital
requirements for the sale of IBM products. Pursuant to the transaction
management services agreement between PFS and Supplies Distributors, PFS
provides to Supplies Distributors and SDSA such services as managed website
hosting and maintenance, procurement support, web-enabled customer contact
center services, customer relationship management, financial services including
billing and collection services, information management, selected financial
services and international distribution services. Additionally, IBM and Holdings
have outsourced its product demand generation to Global Marketing Services, Inc.
("GMS"). The Company, via its arrangements with GMS and PFS, sells its products
in the United States, Canada and Europe.
All of the agreements between PFS and Holdings were made in the context of
a related party relationship and were negotiated in the overall context of PFS'
and Holdings' prior arrangement with IBM. Although management generally believes
that the terms of these agreements are consistent with fair market values, there
can be no assurance that the prices charged to or by each company under these
arrangements are not higher or lower than the prices that may be charged by, or
to, unaffiliated third parties for similar services.
2. SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
77
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
REVENUE AND COST RECOGNITION
The Company recognizes revenue upon shipment of product to customers and
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 permits its customers to return defective products
(which are then returned by the Company to the manufacturer) and incorrect
shipments for credit against other purchases and provides for estimated returns
and allowances. The Company offers terms to its customers that it believes are
standard for its industry.
Freight costs billed to customers are reflected as components of net
revenues. Freight costs incurred by the Company are recorded as a component of
cost of good sold. The Company records its costs as they are incurred by the
Company or its service providers.
CONCENTRATION OF BUSINESS AND CREDIT RISK
In conjunction with Supplies Distributors' financing, PFS 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 Holdings
has limited personnel and physical resources, its ability to conduct business
could be materially impacted by contract terminations by either PFS or GMS.
All of the Company's revenue was generated by sales of product purchased
under master distributor agreements with one supplier. Sales to two customers
accounted for approximately 25% of the Company's total revenues. No other client
accounted for 10% or more of the Company's revenue. As of December 31, 2001, two
customers accounted for over 37% of trade accounts receivable on an aggregate
basis.
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. As of December 31,
2001, the Company's allowance for obsolete inventory is approximately $13,000.
INVENTORIES IN-TRANSIT
Inventories in-transit represents merchandise that has not been received by
the Company but that has been shipped and invoiced by the Company's vendors. The
corresponding payable for inventories in-transit is included in long-term debt
in the accompanying consolidated financial statement.
78
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER RECEIVABLES
Other receivables represent $7.1 million of Value Added Tax ("VAT") amounts
due from European governments for refundable VAT payments made in the ordinary
course of business and $5.2 million of amounts due from IBM under the Master
Distributor Agreements (see Note 4).
OTHER ASSETS
Other assets includes restricted cash of $1.0 million, which represents
customer remittances received in Holdings' bank accounts that are payable to
certain of the Company's lenders, and the value attributable to the Master
Distributor Agreements of $0.4 million. This indentifiable intangible asset is
being amortized on a straight-line basis over the terms of the Master
Distributor Agreements which are two years. The Company assesses the
recoverability of this intangible asset by determining whether the amortization
of the remaining balance over its remaining life can be recovered through
undiscounted future operating cash flows of the associated contracts.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
For the Company's Canadian and European operations, the local currency is
the functional currency. All assets and liabilities are translated at exchange
rates in effect at the end of the period, and income and expense items are
translated at the average exchange rates for the period. Translation adjustments
are reported as a separate component of members' equity.
Gains or losses on intercompany foreign currency transactions that are of a
long-term investment nature are also reported as a separate component of
members' capital.
INCOME TAXES
Although Holdings is an LLC, it has elected to be taxed, for federal income
tax purposes, as a C corporation. Accordingly, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of financial instruments, which include cash and cash
equivalents, accounts receivable, accounts payable and debt, approximate their
fair values based on short terms to maturity or current market prices and rates.
COMPREHENSIVE INCOME
Comprehensive income represents the change in members' capital available
for distribution to the partners pursuant to the Operating Agreements (see Note
5). Comprehensive income consists of net income, foreign currency translation
adjustments and the loss associated with long-term intercompany foreign currency
transactions.
79
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. ACQUISITION OF THE BSD COMPANIES:
The following table summarizes the estimated fair value of the assets
acquired and liabilities assumed as of September 26, 2001, the acquisition date
of the BSD Companies (unaudited, in thousands):
[Download Table]
Cash........................................................ $ 8,538
Accounts receivable, net.................................... 3,230
Receivable from Daisytek.................................... 5,715
Receivable from Supplies Distributors....................... 5,877
Other receivables........................................... 6,022
Inventories, net............................................ 13,516
Other assets -- identifiable intangible (see Note 2)........ 378
-------
Total assets acquired....................................... 43,276
-------
Trade accounts payable...................................... 40,557
Accrued expenses............................................ 1,679
Other current liabilities................................... 57
-------
Total liabilities assumed................................... 42,293
-------
Net assets acquired......................................... $ 983
=======
The receivable from Daisytek was repaid concurrently with the acquisition.
The results of the BSD Companies' operations have been included in the
consolidated financial statements since the acquisition date. For the period
from inception through December 31, 2001, the Company recorded approximately
$51,000 of amortization expense associated with the identifiable intangible.
Pro forma revenues and pro forma income from operations for the period from
inception through December 31, 2001, assuming the transaction had occurred on
July 3, 2001, would have been $90.6 million and $2.1 million, respectively.
Because of the negative impact to revenue as a result of the transition of the
master distributor agreements from Daisytek to Supplies Distributors, the pro
forma adjustments to the operating results of the business may not be indicative
of future results.
4. MASTER DISTRIBUTOR AGREEMENTS:
In August 2001, Supplies Distributors, SDSA, PFS and IBM entered into
Master Distributor Agreements whereby Supplies Distributors and SDSA act as
master distributors of various IBM products and PFS provides transaction
management and fulfillment services to Supplies Distributors. The Master
Distributor Agreements expire in August 2003 and can be extended for additional
one year terms upon mutual agreement by all parties. Under the Master
Distributor Agreements, IBM reimburses Supplies Distributors for certain freight
costs, direct costs incurred in passing on any price decreases offered by IBM to
Supplies Distributors customers to cover price protection and certain special
bids, the cost of products provided to replace defective product returned by
customers and other certain expenses as defined. Supplies Distributors can
return to IBM product rendered obsolete by IBM engineering changes after
customer demand ends. IBM determines when a product is obsolete. IBM and SDSA
also have verbal agreements under which IBM reimburses or collects from SDSA
amounts calculated in certain inventory cost adjustments, amounts applicable to
currency related inventory cost variances, and amounts applicable to favorable
or unfavorable gross margin performance versus targeted objectives.
Supplies Distributors and SDSA pass through to customers marketing programs
specified by IBM and administer, along with GMS, such programs according to IBM
guidelines.
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BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. MEMBERS' CAPITAL:
PFS made an equity investment of $0.75 million in Holdings for a 49% voting
interest, and IFP made an equity investment of $0.25 million in Holdings for a
51% voting interest. Certain officers and directors of PFS own, individually, a
9.8% non-voting interest, and, collectively, a 49% non-voting interest, in IFP.
The contributions do not accrue interest. No member, solely by reason of being a
member, has any obligation to make any additional capital contribution or loan
to Holdings or guaranty any indebtedness or obligation of Holdings. (See Note 6)
Holdings' comprehensive income is allocated and distributed to the members
pursuant to the terms of the operating agreement, which expires on December 31,
2050. Pursuant to the operating agreement, Holdings allocates its earning and
distributes its cash flow, as defined, in the following order of priority:
- to IFP until it has received a one-time amount equal to its capital
contribution of $0.25 million;
- to IFP until it has received an amount equal to a 35% cumulative annual
return on its capital contribution;
- to PFS until it has received a one-time amount equal to its capital
contribution of $0.75 million;
- to PFS until it has received an amount equal to a 35% cumulative annual
return on its capital contribution; and
- to PFS and IFP, pro rata, in accordance with their respective capital
accounts.
Notwithstanding the foregoing, no distribution may be made if, after giving
effect thereto, the net worth of Holdings shall be less than $1.0 million.
Pursuant to the terms of its credit agreements, Holdings is currently limited to
annual cash dividends of $0.6 million.
Following the earnings allocation priority, the members' capital accounts
as of December 31, 2001 are as follows:
[Download Table]
PFS......................................................... $ 750
IFP......................................................... 460
------
Total members' capital...................................... $1,210
======
In the event of liquidations, distributions will be made in accordance with
the operating agreement. The distribution will be made based upon members'
capital as determined on a basis in a manner similar to the comprehensive income
and cash flow distributions described above.
6. LONG-TERM DEBT:
As of December 31, 2001, debt consists of the following (in thousands):
[Download Table]
Inventory and working capital financing agreement, United
States.................................................... $39,292
Inventory and working capital financing agreement, Europe... 19,746
-------
Total debt.................................................. $59,038
=======
INVENTORY AND WORKING CAPITAL FINANCING AGREEMENT, UNITED STATES
On September 27, 2001, Supplies Distributors entered into a short-term
credit facility with IBM Credit Corporation ("IBM Credit") to finance its
distribution of IBM products in the United States. At inception, the facility
provided for a $40 million credit line and expired on January 25, 2002. Prior to
expiration, the credit line was increased to $45 million and extended through
March 25, 2002. Availability under the credit
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BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
facility was subject to certain borrowing base limitations, including eligible
receivables and inventory, as defined. Borrowings under the credit facility
accrued interest, after a defined free financing period, at prime rate plus 1%,
which was 6.0% as of December 31, 2001. Supplies Distributors paid a quarterly
commitment fee of 0.375% on the unused portion of the commitment, and a monthly
service fee. The credit facility contained cross default provisions and various
monthly financial covenant compliance requirements for Supplies Distributors and
Holdings based on (i) annualized revenue to working capital, (ii) net profit
after tax to revenue, and (iii) total liabilities to tangible net worth, as
defined. In general, these covenants required minimum levels of net income and
capitalization. Additionally, PFS was required to maintain shareholders' equity
of at least $30 million. The credit facility also contained restrictions on
certain activities, including loans and payments to related parties, incurring
additional debt, acquisitions, investments, dividends and asset sales. The
credit facility was secured by a security interest in Supplies Distributors'
assets, including accounts receivable and inventory and 65% of the stock of SDC,
and was guaranteed by PFS and Holdings. Supplies Distributors entered into a
Blocked Account Agreement with its bank and IBM Credit whereby a security
interest was granted to IBM Credit for all customer remittances received in
specified bank accounts. At December 31, 2001, these bank accounts held $1.0
million, which was restricted for payment to IBM Credit.
INVENTORY AND WORKING CAPITAL FINANCING AGREEMENT, EUROPE
On September 27, 2001, SDSA entered into a short-term credit facility with
IBM Belgium Financial Services S.A. ("IBM Belgium") to finance its distribution
of IBM products in Europe. At inception, the facility provided for a 20 million
euro credit line (approximately $18 million) and expired on January 25, 2002.
Prior to expiration, the credit line was increased to 27 million euros
(approximately $24.3 million) and extended through March 25, 2002. Availability
under the credit facility was subject to certain borrowing base limitations,
including eligible receivables and inventory, as defined. Borrowings under the
credit facility accrued interest, after a defined free financing period, at
euribor plus 4%, which was 7.425% as of December 31, 2001. SDSA paid a monthly
service fee on the commitment. The credit facility contained cross default
provisions and various monthly financial covenant compliance requirements for
SDSA based on (i) annualized revenue to working capital, (ii) net profit after
tax to revenue, and (iii) total liabilities to tangible net worth, as defined.
In general, these covenants required minimum levels of net income and
capitalization. Additionally, PFS was required to have shareholders' equity of
at least $30 million. The credit facility also contained restrictions on certain
activities, including acquisitions, liquidations, dividends, asset sales and
payments on SDSA's intercompany debt with Supplies Distributors. The credit
facility was secured by a security interest in all of SDSA's assets, including
accounts receivable, bank accounts, inventory and 65% of the stock of SDSA and
BSD Europe and was guaranteed by Holdings, Supplies Distributors and PFS. SDSA
entered into a Blocked Account Agreement with its bank and IBM Belgium whereby a
security interest was granted to IBM Belgium for all customer remittances
received in specified bank accounts.
AMENDED AGREEMENTS
On March 29, 2002, Supplies Distributors entered into amended credit
facilities with IBM Credit and SDSA and BSD Europe entered into amended credit
facilities with IBM Belgium. The asset based credit facility with IBM Credit
provides financing for purchasing IBM inventory up to $32.5 million through June
30, 2002 and $27.5 million from July 1, 2002 through its expiration on March 29,
2003. The asset based credit facility with IBM Belgium provides up to 27 million
Euros (approximately $24.3 million) in financing for purchasing IBM inventory
through June 30, 2002 and 22 million Euros (approximately $19.8 million)
thereafter. The IBM Belgium facility remains in force until not less than 60
days written notice by any party, but no sooner than March 29, 2003. These
credit facilities contain cross default provisions, various restrictions upon
the ability of Holdings, Supplies Distributors, SDSA and BSD Europe to, among
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
82
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
dividends, as well as financial covenants, such as annualized revenue to working
capital, net profit after tax to revenue, and total liabilities to tangible net
worth, as defined, and are secured by all of the assets of Supplies
Distributors, as well as collateralized guaranties of Holdings and PFS.
Additionally, PFS is required to maintain a subordinated receivable balance of
no less than $6.5 million from Supplies Distributors, and shareholders' equity
of at least $25.0 million.
LOAN AND SECURITY AND FACTORING AGREEMENT
Concurrent with these amended agreements, Supplies Distributors entered
into a loan and security agreement with Congress Financial Corporation
(Southwest) ("Congress") to provide financing for up to $25 million of eligible
accounts receivables in the U.S. and Canada. The Congress facility expires on
the earlier of three years or the date on which the parties to the IBM Master
Distributor Agreement shall no longer operate under the terms of such agreement
and/or IBM no longer supplies products pursuant to such agreement. Borrowings
under the Congress facility accrue interest at prime rate plus 0.25% or
Eurodollar rate plus 3.0% or on an adjusted basis, as defined. In Europe, SDSA
entered into a two year factoring agreement with Fortis Commercial Finance N.V.
("Fortis") to provide factoring for up to 10 million Euros (approximately $9
million) of eligible accounts receivables. Borrowings under this agreement
accrue interest at 8.5%, or on an adjusted basis as defined. These credit
facilities contain cross default provisions, various restrictions upon the
ability of Holdings, Supplies Distributors and SDSA to, among other things,
merge, consolidate, sell assets, incur indebtedness, make loans and payments to
related parties, provide guarantees, make investments and loans, pledge assets,
make changes to capital stock ownership structure and pay dividends, as well as
financial covenants, such as minimum net worth, as defined, and are secured by
all of the assets of Supplies Distributors, as well as collateralized guaranties
of Holdings and PFS. Additionally, PFS is required to maintain a subordinated
loan to Supplies Distributors of no less than $6.5 million and restricted cash
of less than $5.0 million, and is restricted with regard to transactions with
related parties, indebtedness and changes to capital stock ownership structure.
GUARANTEES
PFS has provided collateralized guarantees to secure the repayment of all
of the Company's credit facilities. As of December 31, 2001 the outstanding
balance of the credit facilities guaranteed by PFS was approximately $59.0
million. In association with the new credit facilities entered into on March 29,
2002, the outstanding balance of the credit facilities guaranteed by PFS was
approximately $48.5 million. These guarantees expire concurrently with the
expiration of the underlying credit agreements. To the extent Supplies
Distributors fails to comply with its covenants, including its monthly financial
covenant requirements, and the lenders accelerate the repayment of the credit
facility obligations, Supplies Distributors would be required to repay all
amounts outstanding thereunder. In such event, PFS would be obligated to perform
under those guarantees and repay, to the extent Supplies Distributors was unable
to, Supplies Distributors' credit facility obligations. Additionally, if PFS was
unable to maintain PFS' required level of stockholders' equity of $25.0 million,
PFS could also be obligated to perform under these guarantees. Any requirement
to perform under PFS' guarantees would have a material adverse impact on PFS'
financial condition and results of operations and no assurance can be given that
PFS will have the financial ability to repay all of such guaranteed obligations.
Furthermore, PFS is obligated to repay any over-advance made to Supplies
Distributors by its lenders. An over-advance would arise in the event borrowings
exceeded the maximum amount available under the eligible borrowing base, as
defined.
PFS has also provided a guarantee of the obligations of Supplies
Distributors and SDSA to IBM, excluding the trade payables that are financed by
IBM credit.
83
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. TRANSACTIONS WITH 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 for an amount equal to the fees received by Supplies Distributors.
The principal officer of GMS owns 46% of IFP. As of December 31, 2001, Supplies
Distributors has $1.1 million due from IBM under the terms of the ASFS included
in accounts receivable and approximately $1.5 million of unpaid service fees due
to GMS.
In August 2001, PFS and Supplies Distributors entered into Transaction
Management Services Agreements ("TMSA") whereby PFS provides transaction
management and fulfillment services to Supplies Distributors (see Note 1). Under
terms of the TMSA, PFS is required to conduct its services within certain
performance levels, as defined, and is liable to indemnify Supplies Distributors
for inventory losses, as defined. The TMSA has terms corresponding with the
Master Distributor Agreements (see Note 4).
Under the terms of the TMSA, PFS charges Supplies Distributors for its
services based on a percentage of Supplies Distributors' shipped revenue.
Percentages vary by geographic location and by the amount of shipped revenue.
Dependent on changes in the type and levels of transactions, percentages charged
by PFS can be amended by mutual consent of PFS and Supplies Distributors.
Pursuant to the TMSA, Supplies Distributors incurred service expenses, reported
as selling, general and administrative expenses in the accompanying consolidated
financial statement, of approximately $1.4 million to PFS. As of December 31,
2001, the Company owes PFS $0.9 million.
In September 2001, Supplies Distributors issued a Subordinated Demand Note
(the "Note") to PFS in exchange for proceeds of $8.8 million. The balance of the
Note can be increased by PFS, at its discretion or as required to meet the
senior financial obligations of the Company, as needed, and as of December 31,
2001, had an outstanding balance of $11.7 million, which is classified as note
payable to affiliate. The Note can be decreased to $6.5 million subject to
Supplies Distributors' compliance with the covenants of its senior loan
facilities, as amended. The Note accrues interest at a fluctuating rate per
annum equal to PFS' cost of funds as determined by PFS, approximately 10% as of
December 31, 2001. During the period from inception through December 31, 2001,
Supplies Distributors recorded $0.3 million of interest associated with the
amount due to PFS.
In December 2001, PFS issued 12,500 stock options to Supplies Distributors'
President. The options were immediately vested and have an exercise price of
$0.91.
8. INCOME TAXES:
The Company has elected to be taxed as a C corporation. A reconciliation of
the difference between the expected income tax expense at the U.S. federal
statutory corporate tax rate of 34%, and the Company's effective tax rate, for
the period from inception through December 31, 2001, is as follows (in
thousands):
[Download Table]
Income tax expense (benefit) computed at statutory rate..... $228
Impact of foreign taxation at different rate................ 27
Expenses not deductible for tax purposes.................... 17
----
Provision for income taxes................................ $272
====
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BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The consolidated income before income taxes, by domestic and foreign
entities, for the period from inception through December 31, 2001, is as follows
(in thousands):
[Download Table]
Domestic.................................................... $243
Foreign..................................................... 429
----
Total............................................. $672
====
Current and deferred income tax expense for the period from inception
through December 31, 2001, is summarized as follows (in thousands):
[Download Table]
Current
Domestic.................................................. $ 156
Foreign................................................... 416
-----
Total current..................................... 572
-----
Deferred
Domestic.................................................. (55)
Foreign................................................... (245)
-----
Total deferred.................................... (300)
-----
Total............................................. $ 272
=====
The components of the deferred tax asset (liability) as of December 31,
2001 are as follows (in thousands):
[Download Table]
Deferred tax asset:
Allowance for doubtful accounts........................... $300
Other..................................................... 31
----
Total deferred tax asset.......................... 331
----
Deferred tax liability:
Total deferred liability.......................... 89
----
Deferred tax asset, net..................................... $242
====
9. SEGMENT AND GEOGRAPHIC INFORMATION:
The Company is organized as a single operating segment, which is
international distribution of computer supplies. Geographic areas in which the
Company operates include the United States, Europe (primarily Belgium), and
Canada.
85
BUSINESS SUPPLIES DISTRIBUTORS HOLDINGS, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is geographic information by area. Revenues are attributed
based on the Company's domicile. Amounts shown are for the period from inception
through December 31, 2001 (in thousands):
[Download Table]
Revenues:
United States............................................. $ 53,077
Europe.................................................... 42,116
Canada.................................................... 4,073
Eliminations.............................................. (23,822)
--------
$ 75,444
========
The eliminations amount above primarily relates to intercompany sales in
Europe from BSD Europe to SDSA.
The company has $0.3 million of long-lived assets in the United States
associated with the acquisition of the BSD companies.
86
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to the information to be set forth in the section
entitled "Election of Directors" in the definitive proxy statement involving the
election of directors in connection with the Annual Meeting of Stockholders of
the Company to be held in June 2002 (the "Proxy Statement") which section is
incorporated herein by reference. The Proxy Statement (or an amendment to this
Form 10-K containing the relevant information) will be filed with the Securities
and Exchange Commission not later than 120 days after the last day of the
Company's transition period ended December 31, 2001.
ITEM 11. EXECUTIVE COMPENSATION
Information required by Part III, Item 11, will be included in the section
entitled "Election of Directors" of the Company's Proxy Statement relating to
the Company's annual meeting of stockholders to be held in June 2002, and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by Part III, Item 12, will be included in the Sections
entitled "Election of Directors" and "Security Ownership of Certain Beneficial
Owners and Management" of the Company's Proxy Statement relating to the
Company's annual meeting of stockholders to be held in June 2002, and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS
Information regarding certain of the Company's relationships and related
transactions will be included in the section entitled "Certain Relationship and
Related Transactions" of the Company's Proxy Statement relating to the Company's
annual meeting of stockholders to be held in June 2002, and is incorporated
herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements
PFSweb, Inc. and Subsidiaries
Independent Auditors' Report
Report of Independent Public Accountants
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Shareholders' Equity and Comprehensive Loss
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Business Supplies Distributors Holdings, LLC
Independent Auditors' Report
Consolidated Balance Sheet
87
Consolidated Statement of Operations
Consolidated Statement of Members' Capital and Comprehensive Income
Consolidated Statement of Cash Flows
Notes to Consolidated Financial Statements
Financial Statements Schedules
Report of Independent Public Accountants
Schedule II -- Valuation and Qualifying Accounts
All other schedules are omitted because the required information is
not present in amounts sufficient to require submission of the schedule
or because the information required is included in the financial
statements or notes thereto.
2. Exhibits
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EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
2.1* Master Separation Agreement by and among Daisytek
International Corporation, Daisytek, Incorporated, Priority
Fulfillment Services, Inc. and PFSweb, Inc.
2.2* Initial Public Offering and Distribution Agreement by and
among Daisytek International Corporation, Daisytek,
Incorporated, and PFSweb, Inc.
2.3* Registration Rights Agreement by and among Daisytek
International Corporation, Daisytek, Incorporated and
PFSweb, Inc.
2.4* Tax Indemnification and Allocation Agreement between
Daisytek, International Corporation and PFSweb, Inc.
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1* Non-Employee Director Stock Option and Retainer Plan
10.2* Employee Stock Option Plan
10.3* Employee Annual Incentive Plan
10.4* Industrial Lease Agreement between Shelby Drive Corporation
and Priority Fulfillment Services, Inc.
10.5* Lease Contract between Transports Weerts and Priority
Fulfillment Services Europe B.V.
10.6** Asset Purchase Agreement by and among PFSweb, Inc., Priority
Fulfillment Services, Inc., Daisytek, Inc. and Daisytek
International Corporation
10.7** Transition Services Agreement by and between PFSweb, Inc.
and Daisytek International Corporation
10.8** Form of Change of Control Agreement between the Company and
each of its executive officers
10.9*** Offer to Exchange dated April 30, 2001
10.10**** Inventory and Working Capital Financing Agreement by and
among Business Supplies Distributors Holdings, LLC, BSD
Acquisition Corp., Priority Fulfillment Services, Inc.,
PFSweb, Inc., Inventory Financing Partners, LLC and IBM
Credit Corporation
10.11**** Collateralized Guaranty by and between Priority Fulfillment
Services, Inc. and IBM Credit Corporation
10.12**** Guaranty to IBM Credit Corporation by PFSweb, Inc.
10.13**** Notes Payable Subordination Agreement by and between
Priority Fulfillment Services, Inc., BSD Acquisition Corp.
and IBM Credit Corporation
10.14**** Stock Purchase Agreement by and among Daisytek,
Incorporated, BSD Acquisition Corp., Priority Fulfillment
Services, Inc., PFSweb, Inc. and Priority Fulfillment
Services Europe B.V.
10.15**** Operating Agreement of Business Supplies Distributors
Holdings, LLC
88
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EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
10.16**** IBM Global Financing Platinum Plan Agreement (with Invoice
Discounting) by and among Supplies Distributors, S.A.,
Business Supplies Distributors Europe, B.V., PFSweb B.V.,
and IBM Belgium Financial Services S.A.
10.17**** Collateralized Guaranty between Priority Fulfillment
Services, Inc. and IBM Belgium Financial Services S.A.
10.18**** Guaranty to IBM Belgium Financial Services S.A. by PFSweb,
Inc.
10.19**** Subordinated Demand Note by and among BSD Acquisition Corp.
and Priority Fulfillment Services, Inc.
10.20***** Ninth Amendment to Lease Agreement by and between AGBRI
ATRIUM, L.P., and Priority Fulfillment Services, Inc.
10.21***** Stock Option Agreement
21***** Subsidiaries of the Registrant
23.1***** Consent of KPMG LLP
23.2***** Consent of Arthur Andersen LLP
---------------
* Incorporated by reference from PFSweb, Inc. Registration Statement on
Form S-1 (Commission File No. 333-87657).
** Incorporated by reference from PFSweb, Inc. Form 10-K for the fiscal year
ended March 31, 2001
*** Incorporated by reference from PFSweb, Inc. Schedule TO filed on April 30,
2001
**** Incorporated by reference from PFSweb, Inc. Form 10-Q/A for the quarterly
period ended September 30, 2001
***** Filed herewith.
(b) Reports on Form 8-K:
None.
89
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Shareholders of PFSweb, Inc.:
We have audited, in accordance with auditing standards generally accepted
in the United States, the consolidated statement of operations, shareholders'
equity and cash flows of PFSweb, Inc. (a Delaware corporation) and subsidiaries
(see Note 1) for the year ended March 31, 2000 included in this report on Form
10-K and have issued our report thereon dated May 4, 2000. Our audit was made
for the purpose of forming an opinion on the basic consolidated financial
statements taken as a whole. Schedule II of this report on Form 10-K is the
responsibility of the Company's management and is presented for the purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic consolidated financial statements. This schedule has been subjected to
the auditing procedures applied in the audits of the basic consolidated
financial statements and, in our opinion, fairly states in all material
respects, the financial data required to be set forth therein in relation to the
basic consolidated financial statements as of March 31, 2000 and for the year
then ended taken as a whole.
ARTHUR ANDERSEN LLP
Dallas, Texas
May 4, 2000
90
SCHEDULE II
PFSWEB, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE FISCAL YEARS ENDED MARCH 31, 2000 AND 2001,
AND THE NINE MONTH PERIOD ENDED DECEMBER 31, 2001
(AMOUNTS IN THOUSANDS)
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ADDITIONS
-----------------------
BALANCE AT CHARGES TO CHARGES TO BALANCE AT
BEGINNING COST AND OTHER END OF
OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
---------- ---------- ---------- ---------- ----------
Fiscal Year Ended March 31, 2000:
Allowance for doubtful accounts........ $ 635 458 -- (403) $ 690
Income tax valuation allowance......... $ -- 915 -- -- $ 915
Fiscal Year Ended March 31, 2001:
Allowance for doubtful accounts........ $ 690 2,203 -- (2,614) $ 279
Income tax valuation allowance......... $ 915 3,567 -- -- $4,482
Nine Months Ended December 31, 2001:
Allowance for doubtful accounts........ $ 279 17 -- (42) $ 254
Income tax valuation allowance......... $4,482 125 822 -- $5,429
91
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
By: /s/ THOMAS J. MADDEN
------------------------------------
Thomas J. Madden,
Executive Vice President and
Chief Financial and Accounting
Officer
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
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SIGNATURE TITLE DATE
--------- ----- ----
/s/ MARK C. LAYTON Chairman of the Board, President and April 2, 2002
------------------------------------------------ Chief Executive Officer (Principal
Mark C. Layton Executive Officer)
/s/ THOMAS J. MADDEN Executive Vice President and Chief April 2, 2002
------------------------------------------------ Financial and Accounting Officer
Thomas J. Madden (Principal Financial and Accounting
Officer)
/s/ DR. NEIL JACOBS Director April 2, 2002
------------------------------------------------
Dr. Neil Jacobs
/s/ TIMOTHY M. MURRAY Director April 2, 2002
------------------------------------------------
Timothy M. Murray
/s/ JAMES F. REILLY Director April 2, 2002
------------------------------------------------
James F. Reilly
/s/ DAVID I. BEATSON Director April 2, 2002
------------------------------------------------
David I. Beatson
92
EXHIBIT INDEX
[Download Table]
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------- -----------------------
2.1* Master Separation Agreement by and among Daisytek
International Corporation, Daisytek, Incorporated, Priority
Fulfillment Services, Inc. and PFSweb, Inc.
2.2* Initial Public Offering and Distribution Agreement by and
among Daisytek International Corporation, Daisytek,
Incorporated, and PFSweb, Inc.
2.3* Registration Rights Agreement by and among Daisytek
International Corporation, Daisytek, Incorporated and
PFSweb, Inc.
2.4* Tax Indemnification and Allocation Agreement between
Daisytek, International Corporation and PFSweb, Inc.
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
10.1* Non-Employee Director Stock Option and Retainer Plan
10.2* Employee Stock Option Plan
10.3* Employee Annual Incentive Plan
10.4* Industrial Lease Agreement between Shelby Drive Corporation
and Priority Fulfillment Services, Inc.
10.5* Lease Contract between Transports Weerts and Priority
Fulfillment Services Europe B.V.
10.6** Asset Purchase Agreement by and among PFSweb, Inc., Priority
Fulfillment Services, Inc., Daisytek, Inc. and Daisytek
International Corporation
10.7** Transition Services Agreement by and between PFSweb, Inc.
and Daisytek International Corporation
10.8** Form of Change of Control Agreement between the Company and
each of its executive officers
10.9*** Offer to Exchange dated April 30, 2001
10.10**** Inventory and Working Capital Financing Agreement by and
among Business Supplies Distributors Holdings, LLC, BSD
Acquisition Corp., Priority Fulfillment Services, Inc.,
PFSweb, Inc., Inventory Financing Partners, LLC and IBM
Credit Corporation
10.11**** Collateralized Guaranty by and between Priority Fulfillment
Services, Inc. and IBM Credit Corporation
10.12**** Guaranty to IBM Credit Corporation by PFSweb, Inc.
10.13**** Notes Payable Subordination Agreement by and between
Priority Fulfillment Services, Inc., BSD Acquisition Corp.
and IBM Credit Corporation
10.14**** Stock Purchase Agreement by and among Daisytek,
Incorporated, BSD Acquisition Corp., Priority Fulfillment
Services, Inc., PFSweb, Inc. and Priority Fulfillment
Services Europe B.V.
10.15**** Operating Agreement of Business Supplies Distributors
Holdings, LLC
10.16**** IBM Global Financing Platinum Plan Agreement (with Invoice
Discounting) by and among Supplies Distributors, S.A.,
Business Supplies Distributors Europe, B.V., PFSweb B.V.,
and IBM Belgium Financial Services S.A.
10.17**** Collateralized Guaranty between Priority Fulfillment
Services, Inc. and IBM Belgium Financial Services S.A.
10.18**** Guaranty to IBM Belgium Financial Services S.A. by PFSweb,
Inc.
10.19**** Subordinated Demand Note by and among BSD Acquisition Corp.
and Priority Fulfillment Services, Inc.
10.20***** Ninth Amendment to Lease Agreement by and between AGBRI
ATRIUM, L.P., and Priority Fulfillment Services, Inc.
10.21***** Stock Option Agreement
21***** Subsidiaries of the Registrant
23.1***** Consent of KPMG LLP
23.2***** Consent of Arthur Andersen LLP
---------------
* Incorporated by reference from PFSweb, Inc. Registration Statement on
Form S-1 (Commission File No. 333-87657).
** Incorporated by reference from PFSweb, Inc. Form 10-K for the fiscal year
ended March 31, 2001
*** Incorporated by reference from PFSweb, Inc. Schedule TO filed on April 30,
2001
**** Incorporated by reference from PFSweb, Inc. Form 10-Q/A for the quarterly
period ended September 30, 2001
***** Filed herewith.
Dates Referenced Herein and Documents Incorporated by Reference
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