Service fee revenue for the year ended December 31, 2005 included approximately $2.4 million
of fees earned from client contracts terminated during 2005.
Cost of Product Revenue. Cost of product revenue was $235.6 million for the year ended
December 31, 2005, as compared to $252.0 million for the year ended December 31, 2004, a decrease
of $16.4 million or 6.5%. Cost of product revenue as a percent of product revenue was 93.2% during
the year ended December 31, 2005 and 94.2% during the year ended December 31, 2004. The resulting gross profit margin was 6.8% and 5.8%
for the year ended December 31, 2005 and 2004, respectively. The decrease in annual cost of product
revenue from the prior year resulted primarily from certain incremental inventory cost reductions
and the result of decreased sales volumes of certain products. In addition, 2004 included higher
provisions for excess and obsolete inventory of $1.2 million compared to 2005.
Cost of Service Fee Revenue. Cost of service fee revenue was $45.6 million for the year ended
December 31, 2005, as compared to $28.1 million during the year ended December 31, 2004, an
increase of $17.5 million or 62.5%. The resulting service fee gross profit was $15.2 million or
25.0% of service fee revenue, during the year ended December 31, 2005 as compared to $14.0 million,
or 33.3% of service fee revenue for the year ended December 31, 2004. Our gross profit as a percent
of service fee revenue decreased in the current period primarily due to lower gross margins on
certain new contracts partially due to higher costs incurred during the implementation and initial
operating periods of these new contracts. The 2004 results also reflects the higher gross margin
benefit related to certain project revenue that did not occur at a similar level in 2005.
Operating Expenses. Operating expenses were $30.5 million for the year ended December 31, 2005
or 9.2% of total net revenues, as compared to $27.1 million, or 8.4% of total revenues, for the
year ended December 31, 2004. SG&A expenses increased from the prior year primarily due to
approximately $1.4 million of incremental costs incurred in 2005 to relocate certain of our
operations from Memphis, Tennessee to a new facility in Southaven, Mississippi, the legal fees
related to the Daisytek lawsuit filed in May 2005 (see Part I. Item 3. Legal Proceedings),
incremental sales and marketing expenses and certain personnel related costs.
Income Taxes. For the years ended December 31, 2005 and 2004, we recorded a tax provision of
$1.0 million and $0.7 million, respectively, primarily associated with Supplies Distributors
Canadian and European operations. We did not record an income tax benefit for our PFSweb Canadian
pre-tax losses in the current or prior periods.
Supplies Distributors and its Subsidiaries
Supplies Distributors and its subsidiaries act as master distributors of various IBM and other
products and, pursuant to a transaction management services agreement between us and Supplies
Distributors, we provide transaction management and fulfillment services to Supplies Distributors
and its subsidiaries. In addition to our equity investment in Supplies Distributors, we have also
provided Supplies Distributors with a subordinated loan that, as of December 31, 2006, had an
outstanding balance of $6.5 million.
Supplies Distributors has paid us dividends of $3.9 million, $1.0 million, and $0.8 million in
2006, 2005 and 2004, respectively. Pursuant to the terms of its amended credit agreements,
Supplies Distributors is currently restricted from paying further cash dividends without the prior
approval of its lenders. In addition, no distribution may be made if, after giving effect thereto,
the net worth of Supplies Distributors would be less than $1.0 million.
eCOST and its Subsidiaries
eCOST is a multi-category online discount retailer of new, close-out and recertified
brand-name merchandise, selling products primarily to customers in the United States. As of
December 31, 2006, we have advanced $10.6 million to eCOST to support their operations.