PFSWEB INC - 10-K Annual Report

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

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

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

COMMISSION FILE NUMBER 000-28275

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

DELAWARE 75-2837058
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

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

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

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

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

Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

INDEX

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

PART I

ITEM 1. BUSINESS

GENERAL

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

INDUSTRY OVERVIEW

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

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

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

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

SUPPLY CHAIN MANAGEMENT TREND

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

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

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

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

GOVERNMENT OUTSOURCING TREND

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

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

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

o Improve government efficiency and effectiveness; and

o Improve the government's responsiveness to citizens.

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

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

o Simplify delivery of services to citizens;

o Eliminate layers of government management;

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

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

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

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

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

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

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

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

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

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

OUTSOURCING TREND

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

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

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

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

o Enhance customer satisfaction and gain competitive advantage;

o Improve operating performance and efficiency; and

o Enter new business markets or geographic areas rapidly.

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

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

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

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

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

THE PFSWEB SOLUTION

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

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

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

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

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

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

THE PFSWEB STRATEGY

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

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

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

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

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

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

PFSWEB SERVICES

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

8

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

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

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

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

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

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

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

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

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

- Regular reviews of security processes and procedures ,

- Performing ongoing risk assessment,

- Identifying hazard severity and probability,

- Resolution of identified risks and hazards,

- Using available surveillance and detection capabilities,

- Coordination with Law Enforcement Agencies, and

- Alert levels with predetermined security measures.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CLIENTS AND MARKETING

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

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

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

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

TECHNOLOGY

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

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

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

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

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

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

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

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

COMPETITION

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

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

13

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

o operating performance and reliability;

o ease of implementation and integration;

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

o leading edge technology capabilities;

o global reach; and

o price.

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

EMPLOYEES

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

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

INTERNET ACCESS TO REPORTS

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

REGULATION

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

14

SPIN-OFF OF PFSWEB FROM DAISYTEK

HISTORY

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

PFSWEB'S RELATIONSHIP WITH DAISYTEK

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

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

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

MASTER SEPARATION AGREEMENT

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

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

15

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

INITIAL PUBLIC OFFERING AND DISTRIBUTION AGREEMENT

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

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

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

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

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

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

16

TAX MATTERS

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

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

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

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

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

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

A "Prohibited Action" is defined as:

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

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

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

17

TRANSACTION MANAGEMENT SERVICES AGREEMENT

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

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

TRANSITION SERVICES AGREEMENT

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

SUBSTITUTE STOCK OPTIONS

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

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

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

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

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

BUSINESS SUPPLIES DISTRIBUTORS

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

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SALE OF ASSETS TO DAISYTEK

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

RISK FACTORS

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

RISKS RELATED TO OUR BUSINESS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

20

and at its highest in the second quarter of the fiscal year and that our product
revenue business activity will be at its highest in the fourth quarter of our
fiscal year. We believe that results of operations for a quarterly period may
not be indicative of the results for any other quarter or for the full year. We
are unable to predict how the seasonality of future clients' business may affect
our quarterly revenue.

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

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

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

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

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

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

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

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

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

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

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

21

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

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

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

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

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

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

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

WE ARE SUBJECT TO RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS.

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

o changing regulatory requirements;

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

22

o political instability;

o potentially adverse tax consequences;

o foreign currency fluctuations; and

o cultural differences.

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

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

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

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

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

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

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

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

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

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

23

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

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

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

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

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

RISKS RELATED TO DAISYTEK

WE HAVE POTENTIAL LIABILITY TO DAISYTEK FOR TAX INDEMNIFICATION OBLIGATIONS.

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

WE HAVE POTENTIAL LIABILITY FOR DAISYTEK'S TAX OBLIGATIONS.

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

RISKS RELATED TO OUR INDUSTRY

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

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

24

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

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

RISKS RELATED TO OUR STOCK

OUR COMMON STOCK IS SUBJECT TO POSSIBLE DELISTING FROM THE NASDAQ SMALLCAP
MARKET.

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

This transition occurred in response to NASDAQ Marketplace Rule 4450(a)(5),
which requires a minimum bid price of $1.00 for continued listing on the NASDAQ
National Market. The SmallCap Market also has a minimum bid price of $1.00 per
share. However, as compared to the 90-day grace period provided by the NASDAQ
National Market, the SmallCap Market currently has a longer minimum bid price
grace period of 180 days from receipt of NASDAQ Delisting Notification (February
14, 2002 for the Company). This grace period extended us through August 13,
2002.

Due to our compliance with the initial listing requirements for the NASDAQ
SmallCap Market, on August 14, 2002 we were provided an additional 180 day grace
period, or until February 10, 2003 to regain compliance. In March 2003, we were
provided an additional 90 day grace period, or until May 12, 2003, to regain
compliance. We can, however, provide no assurance as to our ability to maintain
compliance with the core listing standards and our continued listing in the
NASDAQ SmallCap Market. If we are unable to regain compliance with the minimum
bid price requirement, our common stock would then be subject to a delisting
determination from NASDAQ. Upon receipt of such determination, we plan to appeal
the determination to the NASDAQ Listing Qualifications Panel. The appeal would
postpone the delisting until the appeal is decided. The delisting of our common
stock could have a material adverse effect on the market price of, and the
efficiency of