• 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 InfoPrint Solutions Company ("IPS"), a joint venture company owned by Ricoh and IBM;

• 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 unknown effects of possible system failures and rapid changes in technology;

• foreign currency risks and other risks of operating in foreign countries;

• potential litigation;

• impact of reverse stock split;

• our dependency on 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;

• whether outstanding warrants issued in a prior private placement will be exercised in the future;

• our ability to successfully achieve the anticipated benefits of our merger with eCOST;

• taxation on the sale of our products;

• eCOST's potential indemnification obligations to its former parent;

• eCOST's ability to maintain existing and build new relationships with manufacturers and vendors and the success of its advertising and marketing efforts;

• eCOST's ability to increase its sales revenue and sales margin and improve operating efficiencies; and

• eCOST's ability to generate projected cash flows sufficient to cover the values of its intangible assets.

We have based these statements on our current expectations about future events. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that 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. Overview
We are an international provider of integrated business process outsourcing solutions to major brand name companies seeking to maximize their supply chain efficiencies and to extend their traditional business and e-commerce initiatives as well as a leading multi-category online discount retailer of new, "close-out" and recertified brand-name merchandise. We derive our revenues from three business segments: business process outsourcing, a master distributor and a discount online retailer.
First, in our business process outsourcing segment we derive our revenues from a broad range of services, including professional consulting, technology collaboration, order management, managed web hosting and web development, customer relationship management, financial services including billing and collection services and working capital solutions, kitting and assembly services, information management and international fulfillment and distribution services. 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 that we lease or manage and include real-time inventory management and customized picking, packing and shipping of our clients' customer orders. We currently offer the ability to provide infrastructure and distribution solutions to clients that operate in a range of vertical markets, including technology manufacturing, computer products, printers, cosmetics, fragile goods, high security collectibles, pharmaceuticals, contemporary home furnishings, apparel, aviation, telecommunications and consumer electronics, among others.
In this business process outsourcing segment, we do not own the underlying inventory or the resulting accounts receivable, but provide management services for these client-owned assets. We typically charge our service fee revenue 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 and other 'out-of-pocket' expenses include travel, shipping and handling costs and telecommunication charges are included in pass-through revenue.
Our second business segment is a product revenue model. In this segment, we are a master distributor of product for IPS and certain other clients. In this capacity, we purchase, and thus own, inventory and recognize the corresponding product revenue. As a result, upon the sale of inventory, we own the accounts receivable. Freight costs billed to customers are reflected as components of product revenue. This business segment requires significant working capital requirements, for which we have senior credit facilities to provide for approximately $90 million of available financing.
Our third business segment is a web-commerce product revenue model focused on the sale of products to a broad range of consumer and small business customers. In this segment we operate as a multi-category online discount retailer of new, "close-out" and recertified brand-name merchandise. Our product line currently offers approximately 200,000 products in several primary merchandise categories, primarily including computer hardware and software, home electronics, digital imaging, watches and jewelry, housewares, DVD movies, video games and cellular/wireless.
Growth is a key element to achieving our future goals, including achieving and maintaining sustainable profitability. Growth in our business process outsourcing segment 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, which, by nature, require a longer duration to close but also often provide the opportunity to be higher-quality and longer duration engagements.
Growth within our product revenue business is primarily driven by our ability to attract new master distributor arrangements with IPS or other manufacturers and the sales and marketing efforts of the manufacturers and third party sales partners.
Growth within our web-commerce product revenue model is primarily driven by eCOST's ability to increase sales and expand its product line.
We continue to monitor and control our costs to focus on profitability. While we are targeting our new service fee contracts to yield increased gross profit, we also expect to incur incremental investments to implement new contracts, investments in infrastructure and sales and marketing to support our targeted growth and increased public company professional fees.
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) operating expenses. Cost of product revenues - 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 master distributor agreements. Vendor marketing programs, such as co-op advertising, also reduce cost of product revenue. 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. Operating expenses - consist primarily of selling, general and administrative ("SG&A") expenses such as compensation and related expenses for sales and marketing staff, advertising, on-line marketing and catalog production, distribution costs (excluding freight) applicable to the Supplies Distributors and eCOST businesses, 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 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. In recent years we have added to our available cash and liquidity positions through various transactions:
• Each of our primary operating subsidiaries has one or more asset based working capital financing agreements with various lenders.

• Between 2003 and 2006, we raised approximately $9.3 million in net proceeds from the sale of common stock in private placements to certain investors.

Results of Operations
For the Interim Periods Ended September 30, 2008 and 2007
   The following table sets forth certain historical financial information from
our unaudited interim condensed consolidated statements of operations expressed
as a percent of net revenues.

                                                 Three Months Ended                                                       Nine Months Ended
                                                   September 30,                                                            September 30,
                                                                      % of Net Revenues                                                        % of Net Revenues
                          2008          2007         Change           2008           2007          2008          2007         Change           2008           2007
Revenues:
Product revenue, net     $  79.1       $  85.3       $  (6.2 )           72.0 %        76.1 %     $ 252.5       $ 250.4       $   2.1             74.4 %        77.1 %
Service fee revenue         22.9          18.4           4.5             20.9 %        16.4 %        65.0          53.0          12.0             19.2 %        16.3 %
Pass-through revenue         7.9           8.3          (0.4 )            7.1 %         7.5 %        21.6          21.4           0.2              6.4 %         6.6 %

Total net revenues         109.9         112.0          (2.1 )          100.0 %       100.0 %       339.1         324.8          14.3            100.0 %       100.0 %
Cost of Revenues
Cost of product
revenue (1)                 73.1          78.9          (5.8 )           92.4 %        92.5 %       233.5         231.5           2.0             92.5 %        92.4 %
Cost of service fee
revenue (2)                 15.6          12.9           2.7             68.1 %        70.2 %        44.5          38.2           6.3             68.6 %        72.1 %
Pass-through cost of
revenue (3)                  7.9           8.3          (0.4 )          100.0 %       100.0 %        21.6          21.4           0.2            100.0 %       100.0 %

Total cost of
revenues                    96.6         100.1          (3.5 )           87.9 %        89.4 %       299.6         291.1           8.5             88.4 %        89.6 %

Product revenue
gross profit                 6.0           6.4          (0.4 )            7.6 %         7.5 %        19.0          18.9           0.1              7.5 %         7.6 %
Service fee gross
profit                       7.3           5.5           1.8             31.9 %        29.8 %        20.5          14.8           5.7             31.4 %        27.9 %
Pass-through gross
profit                         -             -             -                - %           - %           -             -             -                - %           - %

Total gross profit          13.3          11.9           1.4             12.1 %        10.6 %        39.5          33.7           5.8             11.6 %        10.4 %

Operating Expenses          12.7          10.9           1.8             11.5 %         9.7 %        37.0          33.2           3.8             10.9 %        10.2 %

Income (loss) from
operations                   0.6           1.0          (0.4 )            0.6 %         0.9 %         2.5           0.5           2.0              0.7 %         0.2 %
Interest expense,
net                          0.4           0.6          (0.2 )            0.4 %         0.6 %         1.2           1.9          (0.7 )            0.3 %         0.6 %

Income (loss) before
income taxes                 0.2           0.4          (0.2 )            0.2 %         0.3 %         1.3          (1.4 )         2.7              0.4 %        (0.4 )%

Income tax expense,
net                          0.2           0.2             -              0.2 %         0.2 %         0.8           0.7           0.1              0.2 %         0.2 %

Net income (loss)        $   0.0       $   0.2       $  (0.2 )              - %         0.1 %     $   0.5       $  (2.0 )     $   2.5              0.2 %        (0.6 )%

(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. eCOST product revenue was $23.7 million in the three months ended September 30, 2008, a 12.0% decrease as compared to $26.9 million in the comparable quarter of the prior year. eCOST product revenue was $74.7 million in the nine months ended September 30, 2008, a 1.3% decrease as compared to $75.7 million in the comparable period of the prior year. The decrease for both periods is primarily due to a decline in sales to its business to business channel during the 2008 period partially offset by an increase in its higher margin business to consumer sales channel. The business to consumer sales channel increase is primarily due to continued emphasis on growth through an expanded product line, improved service capabilities and enhanced website capabilities.
Supplies Distributors product revenue of $55.4 million decreased $2.9 million, or 4.9% in the three months ended September 30, 2008 as compared to the same quarter of the prior year. The decrease is primarily due to decreased sales volume on certain products partially offset by the impact of foreign exchange rates.
Supplies Distributors product revenue of $177.8 million increased $3.1 million, or 1.8% in the nine months ended September 30, 2008 as compared to the same period of the prior year. The increase is

primarily due to the negative impact of foreign currency fluctuations during the 2007 nine month period that created alternative purchasing channels for certain customers, which did not occur in 2008.
Service Fee Revenue. Service fee revenue for the three and nine months ended September 30, 2008 included increased service fees generated from the impact of new service contract relationships that were added in 2007, benefits from incremental project work and a modified contract with an existing client. The change in service fee revenue is shown below ($ millions):

                                                                   Three          Nine
                                                                  Months         Months
Period ended September 30, 2007                                   $  18.4        $  53.0
New service contract relationships, including certain
incremental projects under new contracts                              2.0            5.1
Change in existing client service fees and certain
incremental projects with existing clients                            3.6            9.8
Terminated clients not included in 2008 revenue                      (1.1 )         (2.9 )

Period ended September 30, 2008                                   $  22.9        $  65.0

Cost of Product Revenue. The gross margin for eCOST was $2.2 million or 9.2% of product revenue in the three months ended September 30, 2008 and $2.4 million or 8.8% of product revenue during the comparable period of 2007. eCOST gross margin was $6.3 million or 8.5% of product revenue in the nine months ended September 30, 2008 and $6.4 million or 8.4% of product revenue during the comparable period of 2007. The increase in gross margin is primarily due to a shift in product sales to the higher margin business to consumer channel.
Supplies Distributors cost of product revenue decreased by $2.7 million, or 5.0%, to $51.6 million in the three months ended September 30, 2008, primarily as a result of decreased product sales. The resulting gross profit margin was $3.8 million or 6.9% of product revenue for the three months ended September 30, 2008 and $4.0 million or 6.9% of product revenue for the comparable 2007 period.
Supplies Distributors cost of product revenue increased by $3.0 million, or 1.8%, to $165.1 million in the nine months ended September 30, 2008, primarily as a result of increased product sales. The resulting gross profit margin was $12.7 million or 7.1% of product revenue for the nine months ended September 30, 2008 and $12.6 million or 7.2% of product revenue for the comparable 2007 period. The gross profit margin in each of the nine month periods ended September 30, 2008 and 2007 includes the impact of certain incremental inventory cost reductions.
Cost of Service Fee Revenue. The increase in gross profit as a percentage of service fees to 31.9% in the three months ended September 30, 2008 from 29.8% in same period of 2007 is primarily due to the impact of certain existing client projects and the impact of a modified contract with an existing client.
The increase in gross profit as a percentage of service fees to 31.4% in the nine months ended September 30, 2008 from 27.9% in same period of 2007 is primarily due to the impact of certain existing client projects and the impact of a modified contract with an existing client. We expect to earn an overall average gross profit of 25-30% on existing and new service fee contracts, but we have and may continue to accept lower gross margin percentages on certain contracts depending on contract scope and other factors.
Operating Expenses. Operating expenses for the three months ended September 30, 2008 increased $1.8 million to $12.7 million from the same 2007 period. Operating expenses were $37.0 million for the nine months ended September 30, 2008, or 10.9% of total net revenues, as compared to $33.3 million, or 10.2% of total net revenues, for the nine months ended September 30, 2007. The increase is primarily due to certain personnel related expenses and the prior year results benefitting from a favorable impact of exchange rates on certain intercompany balances.
Income Taxes. We recorded a tax provision associated primarily with state income taxes and our subsidiary Supplies Distributors' Canadian and European operations. A valuation allowance has been provided for the majority of our net deferred tax assets as of September 30, 2008 and December 31, 2007, which are primarily related to our net operating loss carryforwards, and certain foreign deferred tax assets.

We expect that we will continue to record an income tax provision associated with state income taxes and Supplies Distributors' Canadian and European results of operations.
Liquidity and Capital Resources
Net cash provided by operating activities was $11.3 million for the nine months ended September 30, 2008, and primarily resulted from cash income before working capital changes of $6.8 million, a $5.6 million of increase in accounts payable, accrued expenses and other liabilities and a $7.1 million decrease in accounts receivable. These benefits were offset by a $3.1 million increase in prepaid expenses, other receivables and other assets and a $5.3 million increase in inventories.
Net cash provided by operating activities was $2.1 million for the nine months ended September 30, 2007, and primarily resulted from $5.3 million of benefit from net loss as adjusted for non-cash items, a $3.8 million decrease in inventory, a decrease in prepaid expenses, other receivables and other assets of $2.0 million and a $1.6 million decrease in accounts receivable partially offset by a decrease in accounts payable, accrued expenses and other liabilities of $10.0 million and an increase in restricted cash of $0.6 million.
Net cash used in investing activities for the nine months ended September 30, 2008 and 2007 totaled $4.6 million and $2.8 million, respectively, resulting primarily from capital expenditures.
Capital expenditures have historically consisted primarily of additions to upgrade our management information systems, 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 will be approximately $4 to $7 million, although additional capital expenditures may be necessary to support the infrastructure requirements of new clients as well as the eCOST infrastructure. To maintain our current operating cash position, a portion of these expenditures may be financed through 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.
Net cash used in financing activities was approximately $6.2 million for the nine months ended September 30, 2008, primarily representing $4.0 million of payments on debt, a $1.0 million increase in restricted cash and payments on capital leases of $1.4 million.
Net cash used in financing activities was approximately $0.7 million for the nine months ended September 30, 2007, primarily representing $1.5 million of payments on capital leases partially offset by a $0.5 million decrease in restricted cash and $0.2 million of proceeds from debt.
Our liquidity has been negatively impacted as a result of the merger with eCOST. eCOST has experienced a net usage of cash primarily due to losses incurred. As a result, PFSweb has had to support eCOST's cash needs with the goal of achieving a stabilized operational position. The amount of further cash needed to support eCOST operations will depend upon the financing available as well as eCOST's continued ability to improve its financial results. eCOST's results improved in 2007 and during the first nine months of 2008 and we currently expect continued improvement as a result of efforts to increase sales, improve product mix and further improve operational efficiencies.
Our liquidity may also be negatively impacted by an expected decline in service fee revenue due to the current general economic decline as well as the nonrenewal of a large contract with an agency of the U.S. government. We currently intend to seek to offset the impact of lower service fee revenue by reducing variable costs and expenses and redeploying existing infrastructure to other client activities. No assurance can be given that we will be successful, in whole or in part, in such efforts, nor can any assurance be given that the decline in service fee revenue will not have a material adverse effect upon our business, financial condition or results of operations.

In June 2008, our Board of Directors authorized a 1-for-4.7 reverse stock split to reduce the number of outstanding shares of common stock. There was no impact on the number of authorized shares or the stated par value of our common stock as a result of the reverse stock split.
During the nine months ended September 30, 2008, our working capital decreased to $19.0 million from $22.5 million at December 31, 2007, primarily due to the reclassification of $2.4 million in taxable revenue bonds to short-term debt due to the April 2009 maturity of the related letters of credit . . .