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PFSWEB INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our results of operations and financial condition should be read in conjunction with the unaudited interim condensed consolidated financial statements and related notes appearing elsewhere in this Form 10-Q. Forward-Looking Information We have made forward-looking statements in this Report on Form 10-Q. These statements are subject to risks and uncertainties, and there can be no guarantee these statements will prove to be correct. Forward-looking statements include assumptions as to how we may perform in the future. When we use words like "seek," "strive," "believe," "expect," "anticipate," "predict," "potential," "continue," "will," "may," "could," "intend," "plan," "target" and "estimate" or similar expressions, we are making forward-looking statements. You should understand that the following important factors, in addition to those set forth above or elsewhere in this Report on Form 10-Q and our Form 10-K for the year ended December 31, 2011, could cause our results to differ materially from those expressed in our forward-looking statements. These factors include: • our ability to retain and expand relationships with existing clients and attract and implement new clients; • our reliance on the fees generated by the transaction volume or product sales of our clients; • our reliance on our clients' projections or transaction volume or product sales; • our dependence upon our agreements with International Business Machines Corporation ("IBM") and Ricoh Company Limited including Ricoh Production Print Solutions, a strategic business unit within the Ricoh Family Group of Companies (collectively hereafter referred to as "Ricoh"); • our dependence upon our agreements with our major clients; • our client mix, their business volumes and the seasonality of their business; • our ability to finalize pending contracts; • the impact of strategic alliances and acquisitions; • trends in e-commerce, outsourcing, government regulation, both foreign and domestic, and the market for our services; • whether we can continue and manage growth; • increased competition; • our ability to generate more revenue and achieve sustainable profitability; • effects of changes in profit margins; • the customer and supplier concentration of our business; • the reliance on third-party subcontracted services; • the unknown effects of possible system failures and rapid changes in technology; • foreign currency risks and other risks of operating in foreign countries; • potential litigation; • our dependency upon key personnel; • the impact of new accounting standards, and changes in existing accounting rules or the interpretations of those rules; • our ability to raise additional capital or obtain additional financing; • our ability, and the ability of our subsidiaries, to borrow under current financing arrangements and maintain compliance with debt covenants; • relationship with, and our guarantees of, certain of the liabilities and indebtedness of our subsidiaries; and • taxation on the sale of our products and/or service fees. We have based these statements on our current expectations about future events. Although we believe the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee these expectations actually will be achieved. In addition, some forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. Therefore, actual outcomes and results may differ materially from what is expected or forecasted in such forward-looking statements. We undertake no obligation to update publicly any forward-looking statement for any reason, even if new information becomes available or other events occur in the future. 15-------------------------------------------------------------------------------- Table of Contents Overview We are an international business process outsourcing provider of end-to-end eCommerce solutions. We provide these solutions to major brand name companies seeking to optimize their supply chain and to enhance their traditional and online business channels and initiatives. We derive our revenues from providing a broad range of services as we process individual business transactions on our clients' behalf using three different seller services financial models: 1) the Enablement model, 2) the Agent (or Flash) model and 3) the Retail model. We refer to the standard PFS seller services financial model as the Enablement model. In this model, our clients own the inventory and are the merchants of record and engage us to provide various business outsourcing services in support of their business operations. We derive our service fee revenues from a broad range of service offerings that include digital marketing, eCommerce technologies, order management, customer care, logistics and fulfillment, financial management and professional consulting. We offer our services as an integrated solution, which enables our clients to outsource their complete infrastructure needs to a single source and to focus on their core competencies. Our distribution services are conducted at warehouses we lease or manage. We currently provide infrastructure and distribution solutions to clients that operate in a range of vertical markets, including technology manufacturing, computer products, cosmetics, fragile goods, contemporary home furnishings, apparel, aviation, telecommunications, consumer electronics and consumer packaged goods, among others. In this model, we typically charge for our services on a cost-plus basis, a percent of shipped revenue basis or a per-transaction basis, such as a per-minute basis for web-enabled customer contact center services and a per-item basis for fulfillment services. Additional fees are billed for other services. We price our services based on a variety of factors, including the depth and complexity of the services provided, the amount of capital expenditures or systems customization required, the length of contract and other factors. Many of our service fee contracts involve third-party vendors who provide additional services such as package delivery. The costs we are charged by these third-party vendors for these services are often passed on to our clients. Our billings for reimbursements of these costs and other 'out-of-pocket' expenses include travel, shipping and handling costs and telecommunication charges and are included in pass-through revenue. As an additional service, we offer our second model, the Agent (or Flash) financial model, in which our clients maintain ownership of the product inventory stored at our locations as in the Enablement model. When a customer orders the product from our clients, a "flash" sale transaction passes product ownership to us for each order and we in turn immediately re-sell the product to the customer. The "flash" ownership exchange establishes us as the merchant of record, which enables us to use our existing merchant infrastructure to process sales to end customers, removing the need for the clients to establish these business processes internally, but permitting them to control the sales process to end customers. In this model, based on the terms of our current client arrangements, we record product revenue net of cost of product revenue. Finally, our Retail model allows us to purchase inventory from the client just as any other client reseller partner. In this model, we place the initial and replenishment purchase orders with the client and take ownership of the product upon delivery to our facility. Consequently, in this model, we generate product revenue as we own the inventory and the accounts receivable arising from our product sales. Under the Retail model, depending upon the product category and sales characteristics, we may require the client to provide product price protection as well as product purchase payment terms, right of return, and obsolescence protection appropriate to the product sales profile. In this model we recognize product revenue for customer sales. Freight costs billed to customers are reflected as components of product revenue. This business model generally requires significant working capital requirements, for which we have credit available either through credit terms provided by our client or under senior credit facilities. In general, we provide the Enablement and Agent (or Flash) models through our PFS and Supplies Distributors subsidiaries and the Retail model through our Supplies Distributors and PFSweb Retail Connect subsidiaries. 16 -------------------------------------------------------------------------------- Table of Contents Growth is a key element to achieving our future goals, including achieving and maintaining sustainable profitability. Growth in our Enablement and Agent models is driven by two main elements: new client relationships and organic growth from existing clients. We focus our sales efforts on larger contracts with brand-name companies within two primary target markets, online brands and retailers and technology manufacturers, which, by nature, require a longer duration to close but also have the potential to be higher-quality and longer duration engagements. Currently, any growth within our Retail model would primarily be driven by our ability to attract new distributor arrangements with Ricoh, or other manufacturers and the sales and marketing efforts of the manufacturers and third party sales partners. Ricoh has advised us that it is restructuring its business, which will include certain realignment and operational changes in the sale and distribution of its products. The changes have and are expected to continue to result in reduced revenues and profitability under our Retail model in 2012 and 2013. We continue to monitor and control our costs to focus on profitability. While we are targeting our new service fee contracts to yield incremental gross profit, we also expect to incur incremental investments in technology development, operational and support management and sales and marketing expenses. Our expenses comprise primarily four categories: 1) cost of product revenue, 2) cost of service fee revenue, 3) cost of pass-through revenue and 4) selling, general and administrative expenses. Cost of product revenue - consists of the purchase price of product sold and freight costs, which are reduced by certain reimbursable expenses. These reimbursable expenses include pass-through customer marketing programs, direct costs incurred in passing on any price decreases offered by vendors to cover price protection and certain special bids, the cost of products provided to replace defective product returned by customers and certain other expenses as defined under the distributor agreements. Cost of service fee revenue - consists primarily of compensation and related expenses for our web-enabled customer contact center services, international fulfillment and distribution services and professional consulting services, and other fixed and variable expenses directly related to providing services under the terms of fee based contracts, including certain occupancy and information technology costs and depreciation and amortization expenses. Cost of pass-through revenue - the related reimbursable costs for pass-through expenditures are reflected as cost of pass-through revenue. Selling, General and Administrative expenses - consist of expenses such as compensation and related expenses for sales and marketing staff, distribution costs (excluding freight) applicable to the Supplies Distributors business and the Retail model, executive, management and administrative personnel and other overhead costs, including certain occupancy and information technology costs and depreciation and amortization expenses. Monitoring and controlling our available cash balances and our expenses continues to be a primary focus. Our cash and liquidity positions are important components of our financing of both current operations and our targeted growth. 17 -------------------------------------------------------------------------------- Table of Contents Results of Operations For the Interim Periods Ended September 30, 2012 and 2011 The results of operations related to the eCOST business unit that was sold in February 2011 have been reported as discontinued operations for the 2011 three and nine-month periods presented below. The following table discloses certain financial information for the periods presented, expressed in terms of dollars, dollar change, percentage change and as a percentage of total revenue (in millions): Three Months Ended September 30, Nine Months Ended September 30, % of Net Revenues % of Net Revenues 2012 2011 Change 2012 2011 2012 2011 Change 2012 2011 Revenues: Product revenue, net $ 27.6 $ 37.9 $ (10.3 ) 41.5 % 53.5 % $ 91.9 $ 122.0 $ (30.1 ) 43.8 % 57.8 % Service fee revenue 28.3 23.0 5.3 42.5 % 32.4 % 85.0 62.8 22.2 40.5 % 29.7 % Pass-through revenue 10.6 10.0 0.6 16.0 % 14.1 % 32.9 26.4 6.5 15.7 % 12.5 % Total net revenues 66.5 70.9 (4.4 ) 100.0 % 100.0 % 209.8 211.2 (1.4 ) 100.0 % 100.0 % Cost of Revenues Cost of product revenue (1) 25.7 35.3 (9.6 ) 93.0 % 93.1 % 84.9 113.2 (28.3 ) 92.4 % 92.8 % Cost of service fee revenue (2) 20.4 17.7 2.7 72.2 % 77.0 % 62.0 47.2 14.8 72.9 % 75.2 % Pass-through cost of revenue (3) 10.6 10.0 0.6 100.0 % 100.0 % 32.9 26.4 6.5 100.0 % 100.0 % Total cost of revenues 56.7 63.0 (6.3 ) 85.3 % 88.8 % 179.8 186.8 (7.0 ) 85.7 % 88.5 % Product revenue gross profit 1.9 2.6 (0.7 ) 7.0 % 6.9 % 7.0 8.8 (1.8 ) 7.6 % 7.2 % Service fee gross profit 7.9 5.3 2.6 27.8 % 23.0 % 23.0 15.6 7.4 27.1 % 24.8 % Pass-through gross profit - - - - % - % - - - - % - % Total gross profit 9.8 7.9 1.9 14.7 % 11.2 % 30.0 24.4 5.6 14.3 % 11.4 % Selling, General and Administrative expenses 9.8 9.4 0.4 14.7 % 13.2 % 30.9 28.1 2.8 14.7 % 13.3 % Loss from operations - (1.5 ) 1.5 (0.0 )% (2.0 )% (0.9 ) (3.7 ) 2.8 (0.4 )% (1.9 )% Interest expense, net 0.2 0.3 (0.1 ) 0.4 % 0.4 % 0.8 0.8 - 0.4 % 0.4 % Loss from continuing operations before income taxes (0.2 ) (1.8 ) 1.6 (0.4 )% (2.4 )% (1.7 ) (4.5 ) 2.8 (0.8 )% (2.3 )% Income tax expense, net 0.2 - 0.2 0.2 % 0.2 % 0.5 0.3 0.2 0.2 % 0.1 % Loss from continuing operations (0.4 ) (1.8 ) 1.4 (0.6 )% (2.6 )% (2.2 ) (4.8 ) 2.6 (1.0 )% (2.2 )% Income (loss) from discontinued operations, net of tax - - - - % 0.1 % - (0.5 ) 0.5 - % (0.3 )% Net loss $ (0.4 ) $ (1.8 ) $ 1.4 (0.6 )% (2.5 )% $ (2.2 ) $ (5.3 ) $ 3.1 (1.0 )% (2.5 )% (1) % of net revenues represents the percent of Product revenue, net. (2) % of net revenues represents the percent of Service fee revenue. (3) % of net revenues represents the percent of Pass-through revenue. Product Revenue, net. Product revenue was $27.6 million for the three months ended September 30, 2012, which represents a decrease of $10.3 million, or 27.2%, as compared to the same quarter of the prior year. Product revenue was $91.9 million for the nine months ended September 30, 2012, which represents a decrease of $30.1 million, or 24.7%, as compared to the same period of the prior year. Ricoh has advised Supplies Distributors that it is restructuring its business, which includes certain operational changes in the sale and distribution of Ricoh products, which has and is expected to continue to result in reduced revenue for Supplies Distributors in 2012 and 2013. We currently expect product revenue to be approximately $115 million to $120 million for the full calendar year of 2012 and to decrease further in calendar year 2013. Service Fee Revenue. Service Fee revenue of $28.3 million increased $5.4 million, or 23.1%, in the three months ended September 30, 2012 as compared to the same quarter of the prior year. Service Fee revenue of $85.0 million increased $22.2 million, or 35.5% in the nine months ended September 30, 2012 18 -------------------------------------------------------------------------------- Table of Contents compared to the nine months in the prior year period. The increase in service fee revenue for the three and nine months ended September 30, 2012 was primarily due to increased service fees from both existing client relationships and new client relationships that began in late 2011 and early 2012 partially offset by the impact of terminated clients. The change in service fee revenue is shown below ($ millions): Three Nine Months Months Period ended September 30, 2011 $ 23.0 $ 62.8 New service contract relationships 3.3 9.9 Change in existing client service fees 2.3 13.8 Terminated clients not included in 2012 revenue (0.3 ) (1.5 ) Period ended September 30, 2012 $ 28.3 $ 85.0 We currently expect our service fee revenue to be negatively impacted in 2013 by the conclusion or anticipated reduction of operations of several client programs. While we continue to win new client relationships and generate many new and exciting opportunities in our sales pipeline, based on the client information and timing estimates we currently have, we believe it is unlikely that projected new client revenue will offset the impact of these expected reductions in 2013. Cost of Product Revenue. The cost of product revenue decreased by $9.6 million, or 27.3%, to $25.7 million in the three months ended September 30, 2012. The resulting gross profit margin was $1.9 million, or 7.0% of product revenue, for the three months ended September 30, 2012 and $2.6 million, or 6.9% of product revenue, for the comparable 2011 period. The cost of product revenue decreased by $28.3 million, or 25.0%, to $84.9 million in the nine months ended September 30, 2012. The resulting gross profit margin was $7.0 million, or 7.6% of product revenue, for the nine months ended September 30, 2012 and $8.8 million, or 7.2% of product revenue, for the comparable 2011 period. The gross profit for both the three and nine months ended September 30, 2012, was negatively impacted by the reduced product revenue primarily applicable to the Ricoh restructuring activities, and we expect this to continue in 2013. The three and nine month periods ended September 30, 2012 and 2011 include the impact of incremental gross margin earned on product sales resulting from product price increases and the impact of certain incremental inventory cost reductions. Cost of Service Fee Revenue. Gross profit as a percentage of service fees was 27.8% in three month period ended September 30, 2012 and 23.0% in the same period of 2011. Gross profit as a percentage of service fees was 27.1% in nine month period ended September 30, 2012 and 24.8% in the same period of 2011. The gross profit percentage increase is primarily due to a change in the client mix, improved operating efficiencies, including benefits of leveraging our infrastructure across increased service fee revenues, and an increased level of higher margin client project activity. We target to earn an overall average gross profit of 25-30% on existing and new service fee contracts, but we have accepted, and may continue to accept, lower gross margin percentages on certain contracts depending on contract scope and other factors, including projected volumes. We expect that our gross profit for our service fee business will be negatively impacted in 2013 by the conclusion or anticipated reduction of operations of several client programs. Selling, General and Administrative Expenses. Selling, General and Administrative expenses for the three months ended September 30, 2012 and 2011 were $9.8 million and $9.4 million, respectively. As a percentage of total net revenue, selling, general and administrative expenses were 14.7% in the three months ended September 30, 2012 and 13.2% in the prior year period. Selling, General and Administrative expenses for the nine months ended September 30, 2012 and 2011 were $30.9 million and $28.1 million, respectively. As a percentage of total net revenue, selling, general and administrative expenses were 14.7% in the nine months ended September 30, 2012 and 13.2% in the prior year period. The increase in expenses is primarily attributable to approximately $0.5 million of lease termination costs incurred in the nine months ended September 30, 2012 and approximately $0.9 million of relocation related costs relating to our planned facility relocations and expansions in the nine months ended September 30, 2012 and due to investments to support growth in our service fee business. During the three and nine months ended September 30, 2011, we incurred approximately $0.3 million of incremental relocation related costs necessary to support our growth. Income Taxes. We recorded a tax provision associated primarily with state income taxes, our subsidiary Supplies Distributors' Canadian and European operations and our Philippines operations. A valuation allowance has been provided for the majority of our net deferred tax assets, which are primarily related to our net operating loss carryforwards and certain foreign deferred tax assets. We expect we will continue to record an income tax provision associated with state income taxes, Supplies Distributors' Canadian and European results of operations and our Philippines operations. 19 -------------------------------------------------------------------------------- Table of Contents Income (Loss) from Discontinued Operations, Net of Tax. Discontinued operations generated income of $20,000 and a loss of $0.6 million in the three and nine months ended September 30, 2011, respectively. In February 2011, we sold substantially all of the inventory and certain intangible assets applicable to our eCOST business unit for a total aggregate cash purchase price of approximately $2.3 million. For the three and nine month periods ending September 30, 2011, we classified the operating results of this business unit, excluding costs expected to continue to occur in the future, as discontinued operations. Liquidity and Capital Resources During the nine months ended September 30, 2012, we generated $19.7 million of cash from operating activities primarily due to a $14.8 million decrease in accounts receivable related to cash collected from our clients and customers following the December 31 seasonal peak period of our services business, a $5.4 million increase in deferred rent related to tenant improvement allowances at certain new facilities, a $3.7 million decrease in prepaid expenses, other receivables and other assets primarily related to a timing of receipts and a reduction of value-added tax receivable at our European subsidiary and a $4.8 million reduction in inventories related to reduced product revenue. These inflows were partially offset by a $14.8 million decrease in accounts payable, deferred revenue, accrued expenses and other liabilities following the timing of payments we make for products and services, payment processing and related transactions costs. Included in our cash flows from operating activities is also $5.8 million of cash income from continuing operations before working capital changes. During the nine months ended September 30, 2011, we generated $2.3 million in proceeds from the February 2011 sale of our eCOST business plus $1.3 million applicable to a reduction of eCOST inventory prior to the sale. In addition, we generated $2.6 million applicable to a decrease in accounts receivable related to cash collected from our clients and customers following the December 31 seasonal peak period of our services business, received proceeds from issuance of common stock of $2.0 million, primarily through the exercise of stock options, and a $3.7 million decrease in prepaid expenses, other receivables and other assets primarily related to a timing of receipts. Additional proceeds of $3.0 million were generated from an increase in accounts payable, deferred revenue, accrued expenses and other liabilities following the timing of payments we make for products and services, payment processing and related transactions costs. These proceeds were partially offset by a $7.1 million increase in inventories related to timing of product receipts. In the nine months ended September 30, 2012, we incurred capital expenditures of $11.0 million, exclusive of $6.3 million of property and equipment acquired under debt and capital lease financing. This includes capital expenditures related to our new corporate headquarters and call center facility, which are being primarily financed by the landlords through tenant allowances. Cash used for payments on debt and capital leases, net of any proceeds from debt and a decrease in restricted cash, was $8.5 million in the nine months ended September 30, 2012. In the nine months ended September 30, 2011, we incurred capital expenditures of $7.0 million, exclusive of $1.6 million of property and equipment acquired under debt and capital lease financing. Proceeds from debt and a decrease in restricted cash, net of payments on debt and capital leases, was $1.3 million in the nine months ended September 30, 2011. Capital expenditures in both periods primarily consist of payments for internally developed software, technology, call center and distribution equipment, leasehold improvements, and furniture and fixtures. Capital expenditures have historically consisted of additions to upgrade our management information systems, development of customized technology solutions to support and integrate with our service fee clients and general expansion and upgrades to our facilities, both domestic and foreign. We expect to incur capital expenditures to support new contracts and anticipated future growth opportunities. Based on our current client business activity and our targeted growth plans, we anticipate our total investment in upgrades and additions to facilities and information technology services for the upcoming twelve months, 20 -------------------------------------------------------------------------------- Table of Contents including costs to implement new clients, will be approximately $10 million to $12 million, although additional capital expenditures may be necessary to support the infrastructure requirements of new clients. To maintain our current operating cash position, a portion of these expenditures may be financed through client reimbursements, debt, operating or capital leases or additional equity. We may elect to modify or defer a portion of such anticipated investments in the event we do not obtain the financing or achieve the financial results necessary to support such investments. During the nine months ended September 30, 2012, our working capital decreased to $15.1 million from $20.4 million at December 31, 2011 primarily due to the funding of capital expenditures as well as net operating losses incurred. To obtain additional financing in the future, in addition to our current cash position, we plan to evaluate various financing alternatives including the sale of equity, utilizing capital or operating leases, borrowing under our credit facilities, expanding our current credit facilities or entering into new debt agreements. No assurances can be given we will be successful in obtaining any additional financing or the terms thereof. We currently believe our cash position, financing available under our credit facilities and funds generated from operations will satisfy our presently known operating cash needs, our working capital and capital expenditure requirements, our current debt and lease obligations, and additional loans to our subsidiaries, if necessary, for at least the next twelve months. In support of certain debt instruments and leases, as of September 30, 2012, we had $0.5 million of cash restricted for repayment to lenders. In addition, as described above, we have provided collateralized guarantees to secure the repayment of certain of our subsidiaries' credit facilities. Many of these facilities include both financial and non-financial covenants, and also include cross default provisions applicable to other credit facilities and agreements. These covenants include, among others, minimum levels of net worth, profitability and cash flow (as defined) and restrictions on the ability of the borrower subsidiaries to advance funds to other borrower subsidiaries. As a result, it is possible for one or more of these borrower subsidiaries to fail to meet their respective covenants even if another borrower subsidiary otherwise has available excess funds, which, if not restricted, could be used to cure the default. To the extent we fail to comply with our debt covenants, including the monthly financial covenant requirements and our required level of shareholders' equity, and we are not able to obtain a waiver, the lenders would be entitled to accelerate the repayment of any outstanding credit facility obligations, and exercise all other rights and remedies, including sale of collateral and enforcement of payment under our parent guarantee. A requirement to accelerate the repayment of the credit facility obligations may have a material adverse impact on our financial condition and results of operations. We can provide no assurance we will have the financial ability to repay all such obligations. As of September 30, 2012, we were in compliance with all debt covenants. Further, non-renewal of any of our credit facilities may have a material adverse impact on our business and financial condition. We do not have any other material financial commitments, although future client contracts may require capital expenditures and lease commitments to support the services provided to such clients. In the future, we may attempt to acquire other businesses or seek an equity or strategic partner to generate capital or expand our services or capabilities in connection with our efforts to grow our business. Acquisitions involve certain risks and uncertainties and may require additional financing. Therefore, we can give no assurance with respect to whether we will be successful in identifying businesses to acquire or an equity or strategic partner, whether we or they will be able to obtain financing to complete a transaction, or whether we or they will be successful in operating the acquired business. We receive municipal tax abatements in certain locations. In prior years we received notice from a municipality that we did not satisfy certain criteria necessary to maintain the abatements and that the municipal authority planned to make an adjustment to our tax abatement. We disputed the adjustment and such dispute has been settled with the municipality. However, the amount of additional property taxes to be assessed against us and the timing of the related payments has not been finalized. As of September 30, 2012, we believe we have adequately accrued for the expected assessment. In April 2010, a sales employee of our former subsidiary eCOST.com was charged with violating various federal criminal statutes in connection with the sales of eCOST products to certain customers, and approximately $620,000 held in an eCOST deposit account was seized and turned over to the Office of the U.S. Attorney in connection with such activity. We received subpoenas from the Office of the U.S. 21 -------------------------------------------------------------------------------- Table of Contents Attorney requesting information regarding the employee and other matters, and have responded to such subpoenas and are fully cooperating with the Office of the U.S. Attorney. In August 2012, the employee pleaded guilty to a misdemeanor. Neither the Company nor eCOST have been charged with any criminal activity, and we intend to seek the recovery or reimbursement of such funds, that are currently classified as other receivables in the September 30, 2012 financial statements. Based on the information available to date, we are unable to determine the amount of the loss, if any, relating to the seizure of such funds. No assurance can be given, however, that the seizure of such funds, or our inability to recover such funds or any significant portion thereof, or any costs and expenses we may incur in connection with such matter will not have a material adverse effect upon our financial condition or results of operations. On December 16, 2011, we announced a board approved stock repurchase program of up to $1 million of the outstanding shares of our common stock. As of September 30, 2012, and through November 9, 2012, we have purchased 13,800 and 15,106 shares, respectively, under this program, respectively. In considering whether to purchase additional shares under this program, we will consider, among other factors, the market price of the shares, our available cash balance and our anticipated cash needs. Supplies Distributors Financing To finance its distribution of Ricoh products in the U.S., Supplies Distributors has a short-term credit facility with IBM Credit LLC ("IBM Credit"), which provides financing for up to $20.0 million. We have provided a collateralized guarantee to secure the repayment of this credit facility. This facility does not have a stated maturity and both parties have the ability to exit the facility following a 90-day notice. The Company has direct vendor credit terms with Ricoh to finance Supplies Distributors' European subsidiary's inventory purchases. Supplies Distributors also has a loan and security agreement with Wells Fargo Bank, National Association ("Wells Fargo") to provide financing for up to $25 million of eligible accounts receivable in the United States and Canada. The Wells Fargo facility expires on the earlier of March 2014 or the date on which the parties to the Ricoh distributor agreement no longer operate under the terms of such agreement and/or Ricoh no longer supplies products pursuant to such agreement. Supplies Distributors' European subsidiary has a factoring agreement with BNP Paribas Fortis Factor to provide factoring for up to 7.5 million euros (approximately $9.7 million as of September 30, 2012) of eligible accounts receivables through March 2014. These credit facilities contain cross default provisions, various restrictions upon the ability of Supplies Distributors and its subsidiaries to, among other things, merge, consolidate, sell assets, incur indebtedness, make loans, investments and payments to related parties (including other direct or indirect Company subsidiaries), provide guarantees, make investments and loans, pledge assets, make changes to capital stock ownership structure and pay dividends, as well as financial covenants, such as cash flow from operations, annualized revenue to working capital, net profit after tax to revenue, minimum net worth and total liabilities to tangible net worth, as defined, and are secured by all of the assets of Supplies Distributors, as well as a collateralized guarantees by their respective parent companies including Supplies Distributors and/or PFS and a Company parent guarantee. Additionally, we are required to maintain a subordinated loan to Supplies Distributors of no less than $3.5 million, not maintain restricted cash of more than $5.0 million, are restricted with regard to transactions with related parties, indebtedness and changes to capital stock ownership structure and a minimum shareholders' equity of at least $18.0 million. Furthermore, we are obligated to repay any over-advance made to Supplies Distributors or its subsidiaries under these facilities if they are unable to do so. We have also provided a guarantee of substantially all of the obligations of Supplies Distributors and its subsidiaries to IBM and Ricoh. PFS Financing PFS has a Loan and Security Agreement ("Comerica Agreement") with Comerica Bank, which provides for up to $12.5 million ($10.0 million during certain non-seasonal peak-months) of eligible accounts receivable financing through March 2014. The Comerica Agreement also allows for up to $3.0 million of eligible equipment financing ("Equipment Advances"). Outstanding Equipment Advances have a final maturity date of April 15, 2015. We entered into this Comerica Agreement to supplement our 22-------------------------------------------------------------------------------- Table of Contents existing cash position and provide funding for our current and future operations, including our targeted growth. The Comerica Agreement contains cross default provisions, various restrictions upon our ability to, among other things, merge, consolidate, sell assets, incur indebtedness, make loans and payments to subsidiaries, affiliates and related parties (including other direct or indirect Company subsidiaries), make capital expenditures, make investments and loans, pledge assets, make changes to capital stock ownership structure, as well as financial covenants of a minimum tangible net worth of $20.0 million, as defined, a minimum earnings before interest and taxes, plus depreciation, amortization and non-cash compensation accruals, if any, as defined, and a minimum liquidity ratio, as defined. The Comerica Agreement also limits PFS' ability to increase the subordinated loan to Supplies Distributors to more than $5.0 million and permits PFS to advance incremental amounts to certain of its subsidiaries and/or affiliates subject to certain financial covenants, as defined. The Comerica Agreement is secured by all of the assets of PFS, as well as a Company parent guarantee. Retail Connect Financing Retail Connect has an asset-based line of credit facility for up to $3.0 million of eligible financing with Wells Fargo, which is collateralized by substantially all of Retail Connect's assets and expires in May 2013. Borrowings under the facility and letter of credit availability are limited to a percentage of accounts receivable and inventory, up to specified amounts. The credit facility restricts Retail Connect's ability to, among other things, merge, consolidate, sell assets, incur indebtedness, make loans, investments and payments to subsidiaries, affiliates and related parties, make investments and loans, pledge assets, make changes to capital stock ownership structure, as well as a minimum tangible net worth for Retail Connect of $0 million, as defined. The Company has guaranteed all current and future obligations of Retail Connect under this line of credit. Seasonality The seasonality of our service fee business is dependent upon the seasonality of our clients' business and sales of their products. Accordingly, we must rely upon the projections of our clients in assessing quarterly variability. We believe that with our current client mix and their current business volumes, our run rate service fee business activity, which is dependent upon the business volume of our clients, will generally be highest in the quarter ended December 31. We anticipate our product revenue will be generally highest during the quarter ended December 31. We believe our historical revenue pattern makes it difficult to predict the effect of seasonality on our future revenues and results of operations. 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. Inflation Management believes that inflation has not had a material effect on our operations. Critical Accounting Policies A description of our critical accounting policies is included in Note 2 of the consolidated financial statements in our December 31, 2011 Annual Report on Form 10-K. There have been no changes to our critical accounting policies since that report. 23 -------------------------------------------------------------------------------- Table of Contents |