inventory cost reductions from a vendor. The resulting gross profit margin was 5.8% and 5.6%
for the year ended December 31, 2004 and 2003, respectively.
Cost of Service Fee Revenue. Cost of service fee revenue was $28.1 million for the year ended
December 31, 2004, as compared to $23.2 million during the year ended December 31, 2003, an
increase of $4.9 million or 21.2%. The resulting service fee gross profit was $14.0 million or
33.3% of service fee revenue, during the year ended December 31, 2004 as compared to $10.6 million,
or 31.4% of service fee revenue for the year ended December 31, 2003. Our gross profit as a percent
of service fee revenue increased in the current period primarily due to incremental projects with
certain client relationships partially offset by lower gross margins on certain new contracts,
including certain start up costs. As we add new service fee revenue in the future, we currently
intend to target the underlying contracts to earn an average gross profit percentage of 25-35%, but
we have and may continue to accept lower gross margin percentages on certain contracts depending on
contract scope and other factors.
Selling, General and Administrative Expenses. SG&A expenses were $27.1 million for the year
ended December 31, 2004 or 8.4% of total net revenues, as compared to $25.4 million, or 8.9% of
total revenues, for the year ended December 31, 2003. SG&A expenses increased from the prior year
primarily due to additional expenses incurred in preparation of complying with the Sarbanes-Oxley
Act of 2002 and incremental sales and marketing expenses. We expect SG&A expense to increase in
calendar year 2005 due primarily to investments in infrastructure and sales and marketing expenses
to support our targeted growth and professional fees primarily related to compliance with the
requirements of the Sarbanes-Oxley Act.
Interest Expense. Interest expense was $1.6 million for the year ended December 31, 2004 as
compared to $2.1 million for the year ended December 31, 2003. The decrease in interest expense is
primarily due to lower average loan balances as a result of reduced inventory levels.
Income Taxes. For the years ended December 31, 2004 and 2003, we recorded a tax provision of
$0.7 million and $0.6 million, respectively, primarily associated with Supplies Distributors
Canadian and European operations. We did not record an income tax benefit associated with our
consolidated net loss in our U.S. operations. A valuation allowance has been provided for certain
of our net deferred tax assets as of December 30, 2004, which are primarily related to our net
operating loss carryforwards. We did not record an income tax benefit for our PFSweb European
pre-tax losses in the current or prior periods. Due to the consolidation of Supplies Distributors,
in the future we anticipate that we will continue to record an income tax provision associated with
Supplies Distributors Canadian and European results of operations.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Product Revenue. Product revenue was $249.2 million for the year ended December 31, 2003, as
compared to $57.5 million for the year ended December 31, 2002, which reflects product sales for
Supplies Distributors subsequent to its consolidation effective October 1, 2002 (see Supplies
Distributors). Supplies Distributors had $163.6 million of product revenue for the nine months
ended September 30, 2002 prior to consolidation, or a total of $221.1 million of product revenue
for the year ended December 31, 2002. The increase in annual product revenue resulted primarily
from the favorable impact of exchange rates on our European and Canadian operations and increased
sales volumes of many existing products. In addition, product revenue was favorably impacted by the
addition of certain new products and increased sales prices for certain products.
Service Fee Revenue (including service fee revenue, affiliate). Service fee revenue was $33.8
million for the year ended December 31, 2003 as compared to $35.8 million for the year ended
December 31, 2002, a decrease of $2.0 million or 5.7%. The change in service fee revenue is shown
below ($ millions):