PFSWEB, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

hosting and maintenance, procurement support, web-enabled customer contact center services, customer relationship management, financial services including billing and collection services, information management, and international distribution services. Additionally, IBM and Supplies Distributors and its subsidiaries have outsourced the product demand generation to Global Marketing Services, Inc. (“GMS”). Supplies Distributors and its subsidiaries, via arrangements with GMS and PFSweb, sell products in the United States, Canada and Europe.

     All of the agreements between PFSweb, Holdings and Supplies Distributors and its subsidiaries were made in the context of a related party relationship and were negotiated in the overall context of PFSweb’s and Holdings’ prior arrangement with IBM. Although management generally believes that the terms of these agreements are consistent with fair market values, there can be no assurance that the prices charged to or by each company under these arrangements are not higher or lower than the prices that may be charged by, or to, unaffiliated third parties for similar services.

Basis of Presentation

     For the period from July 2001 to September 2002, PFSweb owned 49% of Holdings and as such the results of Holdings were not consolidated into the Company’s results. The Company’s allocation of Holdings’ net income (see Note 9) was presented in the consolidated statements of operations as equity in earnings of affiliate for year ended December 31, 2002 (through September 30, 2002) and the nine months ended December 31, 2001. Effective October 1, 2002, PFSweb purchased the remaining 51% interest in Holdings from IFP for $0.3 million. As a result of the purchase, effective October 1, 2002, the Company began consolidating 100% of Holdings’ financial position and results of operations into the Company’s consolidated financial statements.

     In June 2001, the Company changed its fiscal year from March 31 to December 31.

2. Significant Accounting Policies

Principles of Consolidation

     All intercompany accounts and transactions have been eliminated in consolidation. Accounts and transactions between PFSweb and Holdings have been eliminated as of December 31, 2003 and 2002 and for the year ended December 31, 2003, and the three-month period ended December 31, 2002 (see Note 1).

Investment in Affiliate

     In July 2001, PFSweb purchased a 49% investment in Holdings (see Note 9). Effective October 1, 2002, PFSweb purchased the remaining 51% ownership interest of Holdings. Prior to consolidating Holdings’ financial position and results of operations, PFSweb recorded its interest in Holdings’ net income, which was allocated and distributed to the owners pursuant to the terms of Holdings’ operating agreement, under the modified equity method, which resulted in PFSweb recording its allocated earnings of Holdings or 100% of Holdings’ losses.

     In addition to the equity investment, PFSweb loaned Supplies Distributors monies in the form of a Subordinated Demand Note (the “Subordinated Note”). Under certain new and amended terms of certain of the Company’s debt facilities, the outstanding balance of the Subordinated Note cannot be increased or decreased without prior approval of the Company’s lenders (see Note 3). As of December 31, 2003 and 2002, the outstanding balance of the Subordinated Note, which is eliminated upon the consolidation of Holdings’ financial position, was $8.0 million.

Use of Estimates

     The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses, including allowances for the collectibility of accounts and other receivables and the recoverability of inventory. The recognition and allocation of certain operating expenses, restructuring costs (see Note 8) and the determination of costs applicable to client terminations (see Note 6) in these consolidated financial statements also required management estimates and assumptions. The Company’s estimates and assumptions are continually evaluated

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