10-Q/A

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q/A

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

FOR THE QUARTERLY PERIOD ENDED JULY 2, 2005.

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934.

FOR THE TRANSITION PERIOD FROM                      TO                    .

Commission File Number 0-16611

GSI COMMERCE, INC.

(Exact name of registrant as specified in its charter)

Delaware	04-2958132
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
935 First Avenue, King of Prussia, PA	19406
(Address of principal executive offices)	(Zip Code)

610-265-3229

(Registrant’s telephone number,

including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes  x    No  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of August 5, 2005:

Common Stock, $.01 par value	44,142,100
(Title of each class)	(Number of shares)

FORM 10-Q/A

FOR THE QUARTER ENDED JULY 2, 2005

TABLE OF CONTENTS

EXPLANATORY NOTE

This Amendment No. 1 to this Form 10-Q/A is being filed in order to restate the previously issued historical condensed consolidated financial statements as of January 1, 2005 and July 2, 2005 and for the three and six months ended July 3, 2004 and July 2, 2005, initially filed with the Securities and Exchange Commission (“SEC”) on August 11, 2005 (the “Original Filing”). For further discussion regarding the restatement, see Note 17, “Restatement of the Consolidated Financial Statements” under Notes to Condensed Consolidated Financial Statements.

This Form 10-Q/A amends and restates only Items 1, 2, and 4 of Part I and Item 6 of Part II of the Original Filing to reflect the effects of the restatements of our financial statements for the periods presented. The remaining Items contained within the Original Filing on Form 10-Q have not been included herein. Except for the forgoing amended information, this Amendment No. 1 continues to describe conditions as of the date of the Original Filing, and we have not updated the disclosures contained herein to reflect events that occurred at a later date. We are also updating the Signature Page and certifications contained in Exhibits 31.1, 31.2 and 32.1.

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited):
	Condensed Consolidated Balance Sheets (restated) as of January 1, 2005 and July 2, 2005	1
	Condensed Consolidated Statements of Operations (restated) for the three-and six-month periods ended July 3, 2004 and July 2, 2005	2
	Condensed Consolidated Statements of Cash Flows (restated) for the six-month periods ended July 3, 2004 and July 2, 2005	3
	Notes to Condensed Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 4.	Controls and Procedures	46
PART II - OTHER INFORMATION
Item 6.	Exhibits	47
SIGNATURES		48

Our fiscal year ends on the Saturday nearest the last day of December. Accordingly, references to fiscal 1999, fiscal 2000, fiscal 2001, fiscal 2002, fiscal 2003, fiscal 2004, and fiscal 2005 refer to the fiscal years ended January 1, 2000, December 30, 2000, December 29, 2001, December 28, 2002, January 3, 2004, January 1, 2005 and the fiscal year ending December 31, 2005.

Although we refer to the retailers, branded manufacturers, entertainment companies and professional sports organizations for which we develop and operate e-commerce businesses as our “partners,” we do not act as an agent or legal representative for any of our partners. We do not have the power or authority to legally bind any of our partners. Similarly, our partners do not have the power or authority to legally bind us. In addition, we do not have the types of liabilities for our partners that a general partner of a partnership would have.

Certain financial information is presented on a rounded basis, which may cause minor differences.

i

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

	January 1, 2005			July 2, 2005
	(as restated, see Note 17)			(as restated, see Note 17)
ASSETS
Current assets:
Cash and cash equivalents	$	20,064		$	23,483
Marketable securities		55,359			94,006
Accounts receivable, net of allowance of $408 and $291		14,734			11,143
Inventory		37,773			33,108
Prepaid expenses and other current assets		2,382			3,141
Total current assets		130,312			164,881
Property and equipment, net		74,387			79,262
Goodwill		13,453			13,453
Other equity investments		2,847			5,108
Other assets, net of accumulated amortization of $4,416 and $5,640		10,824			12,107
Total assets	$	231,823		$	274,811
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	58,023		$	25,893
Accrued expenses and other		31,842			25,779
Deferred revenue		9,370			7,447
Current portion - long-term debt and other		971			600
Total current liabilities		100,206			59,719
Convertible notes		—			57,500
Long-term debt and other		13,564			13,257
Total liabilities		113,770			130,476
Commitments and contingencies (see note 12)
Stockholders’ equity:
Preferred stock, $0.01 par value, 4,990,000 shares authorized; 0 shares issued and outstanding as of January 1, 2005 and July 2, 2005.		—			—
Common stock, $0.01 par value, 90,000,000 shares authorized; 41,584,061 and 43,919,755 shares issued as of January 1, 2005 and July 2, 2005, respectively; 41,582,851 and 43,919,552 shares outstanding as January 1, 2005 and July 2, 2005, respectively		416			439
Additional paid in capital		294,471			323,757
Accumulated other comprehensive (loss) income		(104	)		1,368
Accumulated deficit		(176,730	)		(181,229	)
Total stockholders’ equity		118,053			144,335
Total liabilities and stockholders’ equity	$	231,823		$	274,811

The accompanying notes are an integral part of these condensed consolidated financial statements.

1

GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

	Three Months Ended						Six Months Ended
	July 3, 2004			July 2, 2005			July 3, 2004			July 2, 2005
				(as restated, see Note 17)			(as restated, see Note 17)			(as restated, see Note 17)
Revenues:
Net revenues from product sales	$	53,131		$	75,158		$	110,009		$	151,810
Service fee revenues		11,558			16,716			20,948			31,422
Net revenues		64,689			91,874			130,957			183,232
Cost of revenues from product sales		39,564			57,439			81,072			115,026
Gross profit		25,125			34,435			49,885			68,206
Operating expenses:
Sales and marketing, exclusive of $195, $927, $690 and $1,110 reported below as stock-based compensation expense		16,787			21,230			34,364			42,089
Product development, exclusive of $(47), $253, $2 and $223 reported below as stock-based compensation expense		4,498			6,436			9,028			13,025
General and administrative, exclusive of $5, $553, $88 and $155 reported below as stock-based compensation expense		4,375			4,519			8,295			9,744
Stock-based compensation		153			1,733			780			1,488
Depreciation and amortization		2,646			3,617			5,245			6,739
Total operating expenses		28,459			37,535			57,712			73,085
Other (income) expense:
Other (income) expense		2			(93	)		3			(208	)
Interest expense		54			413			54			646
Interest income		(244	)		(475	)		(535	)		(818	)
Total other (income) expense		(188	)		(155	)		(478	)		(380	)
Net loss	$	(3,146	)	$	(2,945	)	$	(7,349	)	$	(4,499	)
Loss per share- basic and diluted:
Net loss	$	(0.08	)	$	(0.07	)	$	(0.18	)	$	(0.11	)
Weighted average shares outstanding - basic and diluted		40,991			42,551			40,930			42,106

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, except per share data)

(Unaudited)

	Six Months Ended
	July 3, 2004			July 2, 2005
	(as restated, see Note 17)			(as restated, see Note 17)
Cash Flows from Operating Activities:
Net loss	$	(7,349	)	$	(4,499	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		5,245			6,739
Stock-based compensation		780			1,488
Gain on exchange of note receivable		(6	)		—
Changes in operating assets and liabilities:
Accounts receivable, net		(2,385	)		3,591
Inventory		879			4,665
Prepaid expenses and other current assets		346			(759	)
Notes receivable		32			—
Other assets, net		(182	)		99
Accounts payable and accrued expenses and other		(7,707	)		(37,281	)
Deferred revenue		(3,229	)		(1,923	)
Net cash used in operating activities		(13,576	)		(27,880	)
Cash Flows from Investing Activities:
Acquisition of property and equipment, net		(22,432	)		(12,508	)
Payments received on notes receivable		826			—
Deferred cost in other		—			(572	)
Cash paid for equity investment		—			(136	)
Purchases of marketable securities		(17,308	)		(81,728	)
Sales of marketable securities		15,105			43,000
Net cash used in investing activities		(23,809	)		(51,944	)
Cash Flows from Financing Activities
Proceeds from convertible notes		—			57,500
Debt issuance costs paid		—			(2,563	)
Repayments of loan		—			(339	)
Repayments of capital lease obligations		—			(268	)
Proceeds from mortgage note		13,000			—
Repayments of mortgage note		—			(71	)
Proceeds from sales of common stock		—			28,204
Equity issuance costs paid		—			(1,825	)
Proceeds from exercise of common stock options		1,052			2,605
Net cash provided by financing activities		14,052			83,243
Net (decrease) increase in cash and cash equivalents		(23,333	)		3,419
Cash and cash equivalents, beginning of period		38,808			20,064
Cash and cash equivalents, end of period	$	15,475		$	23,483

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

(Unaudited)

NOTE 1—BASIS OF PRESENTATION

GSI Commerce, Inc. (“GSI” or the “Company”), a Delaware corporation, is a leading provider of e-commerce solutions that enable retailers, branded manufacturers, entertainment companies and professional sports organizations to operate e-commerce businesses. The Company began its e-commerce business in 1999 and initially targeted the sporting goods category. Since fiscal 2001, the Company expanded into six additional categories: apparel, health and beauty, consumer electronics, entertainment, home, and jewelry and luxury items. The Company provides solutions for its partners through its integrated e-commerce platform, which is comprised of three components — core technology, supporting infrastructure and partner services. Through the Company’s integrated e-commerce platform, it provides Web site administration, Web infrastructure and hosting, business intelligence, an e-commerce engine, order management, fulfillment, drop shipping, customer service, buying, creative design, Web site usability, testing and enhancements, channel integration, business-to-business (B-to-B) services, content development and imaging, e-commerce strategy, online marketing and customer relationship management (CRM). The Company derives virtually all of its revenues from sales of products by the Company through its partners’ e-commerce businesses and service fees earned by the Company in connection with the development and operation of its partners’ e-commerce businesses.

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

The accompanying financial information is unaudited; however, in the opinion of the Company’s management, all adjustments (consisting of normal recurring adjustments and accruals) necessary to present fairly the financial position, results of operations and cash flows for the periods reported have been included. The results of operations for the periods reported are not necessarily indicative of those that may be expected for a full year.

This quarterly report should be read in conjunction with the financial statements and notes thereto included in the Company’s audited financial statements presented in the Company’s Annual Report on Form 10-K/A Amendment No.3 filed with the SEC on December 6, 2005.

NOTE 2—ACCOUNTING POLICIES

Basis of Consolidation: The financial statements presented include the accounts of the Company and all wholly and majority-owned subsidiaries. All significant inter-company balances and transactions among consolidated entities have been eliminated.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions.

Fair Values: The estimated fair value amounts presented in these consolidated financial statements have been determined by the Company using available market information and appropriate methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. The estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Such fair value estimates are based on pertinent information available to management as of January 1, 2005 and July 2, 2005, and have not been comprehensively revalued for purposes of these consolidated financial statements since such dates.

Cash and Cash Equivalents: The Company considers all highly liquid investments with maturities at date of purchase of three months or less to be cash equivalents. The carrying value of cash equivalents approximates their current market value.

4

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

Marketable Securities: Marketable securities, which consist of investments in various debt securities, are classified as available-for-sale and are reported at fair value, with unrealized gains and losses recorded as a component of stockholders’ equity. The Company does not intend to hold its marketable securities for more than one year from the most recent balance sheet date and has therefore classified them as a current asset. All investments with original maturities of greater than 90 days are accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The Company determines the appropriate classification at the time of purchase. At January 1, 2005, and July 2, 2005, the Company held $39,700 and $55,840, respectively, of investments in auction rate securities classified as available-for-sale. Investments in these securities are recorded at cost, which approximates fair value due to their variable interest rates, which reset approximately every 30 to 45 days. Despite the long-term nature of their stated contractual maturities, there is a ready liquid market for these securities based on the interest reset mechanism. As a result, there are no cumulative gross realized or unrealized holding gains or (losses) from our auction rate securities. All income generated from these marketable securities was recorded as interest income. As of January 1, 2005, the Company recorded net unrealized losses on its marketable securities, other than auction rate securities, of $104. As of July 2, 2005, the Company recorded net unrealized losses on its marketable securities, other than auction rate securities, of $184. Realized gains or losses and declines in value judged to be other than temporary, if any, on available-for-sale securities are reported in other income or loss.

Inventory: Inventory, primarily consisting of sporting goods, consumer electronics and licensed entertainment products, is valued at the lower of cost (determined using the weighted average method) or market. Inherent in this valuation are significant management judgments and estimates, including among others, assessments concerning obsolescence and shrinkage rates. Based upon the methodology underlying these judgments and estimates, which is applied consistently from period to period, the Company records a valuation allowance to adjust the carrying amount of its inventory.

Property and Equipment: Property and equipment are stated at cost, net of accumulated depreciation. Costs incurred to develop internal-use computer software during the application development stage, including those relating to developing partners’ Web sites, generally are capitalized. Costs of enhancements to internal-use computer software are also capitalized, provided that these enhancements result in additional functionality. Depreciation is provided using the straight-line method over the estimated useful lives of the assets, which are generally:

• Three years for office equipment;

• Three to four years for computer hardware and software;

• Seven years for furniture and fulfillment center equipment;

• The lesser of fifteen years or lease term for leasehold improvements;

• Fifteen years for building improvements; and

• Thirty years for buildings.

Upon retirement or other disposition of these assets, the cost and related accumulated depreciation is removed from the accounts and the resulting gain or loss, if any, is recognized as a gain or loss on disposition of the assets in other income/expense. Expenditures for maintenance and repairs are expensed as incurred.

Effective December 30, 2001, the Company adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Under an impairment-only approach, goodwill and certain intangibles are not amortized into results of operations but instead, are reviewed for impairment and written down and charged to results of operations only in the periods in which the recorded value of goodwill and certain intangibles is more than their fair value. The Company performed an annual impairment test of its recorded goodwill as of January 1, 2005, and found no instances of impairment.

Long-Lived Assets: The ability to realize long-lived assets is evaluated periodically as events or circumstances indicate a possible inability to recover their carrying amount. Such evaluation is based on various analyses, including undiscounted cash flow and profitability projections that incorporate, as applicable, the impact on the existing business. The analyses necessarily involve significant management judgment. Any impairment loss, if indicated, is measured as the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset.

5

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

Other Equity Investments: Other equity investments consist of 824,594 shares of Odimo Incorporated (“Odimo”) common stock, which was converted from Series C and Series D preferred stock when Odimo completed an initial public offering through the issuance of 3,125,000 shares of its common stock in February 2005. The Company accounts for the investment in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Prior to the initial public offering, the original cost of the Company’s investment was determined based on the fair value of the investment at the time of its acquisition. At the time, an observable market price did not exist for non-marketable securities. In order to determine the fair value of the investment in Odimo, the Company obtained an independent, third-party valuation. The valuation incorporated a variety of methodologies to estimate fair value, including comparing the security with securities of publicly traded companies in similar lines of business, applying price multiples to estimated future operating results for Odimo and estimating discounted cash flows. Factors affecting the valuation included restrictions on control and marketability of Odimo’s equity securities and other information available to the Company, such as the Company’s knowledge of the industry and knowledge of specific information about Odimo. Using this valuation, the Company determined the estimated fair value of the investment to be approximately $2,847 as of January 1, 2005. During the first quarter of 2005, the Company exercised warrants related to Odimo for $136, which represented 119,272 shares of common stock. The fair value of the Odimo investment as of July 2, 2005 was $4,535, which was determined by the current market price of the common stock of Odimo on July 2, 2005. This resulted in an unrealized gain of $1,552 for the six-month period ended July 2, 2005, which is recorded in accumulated other comprehensive (loss) income as a component of stockholders equity.

Other Assets, Net: Other assets, net consists primarily of deferred partner revenue share charges, resulting from the exercise of a right to receive 1,600,000 shares of the Company’s common stock in lieu of future cash partner revenue share payments. Deferred partner revenue share charges were $10,097 as of January 1, 2005 and $8,934 for the six-month period ended July 2, 2005, and are being amortized as stock-based compensation expense as the partner revenue share expense is incurred. The partner revenue share expense incurred is based on actual revenues recognized in a given period and the imputed partner revenue share percentage, which is based on the value of the Company’s common stock that was issued upon exercise of the right. Stock-based compensation expense related to the amortization of deferred partner revenue share charges was $332 and $692 for the three- and six-month periods ended July 3, 2004, and $675 and $1,163 for the three- and six-month periods ended July 2, 2005.

In addition, other assets include the underwriter’s discount and debt issuance costs of $2,520 as of July 2, 2005, relating to the June 1, 2005 public offering of $57,500 aggregate principal amount of 3% convertible unsecured obligations due June 1, 2025. The underwriter’s discount and debt issuance costs are being amortized using the straight-line method which approximates the effective interest method. Total amortization related to the underwriter’s discount and debt issuance costs was $43 for the three-month period ended July 2, 2005.

Deferred Revenue: Deferred revenue consists primarily of fees paid in advance to the Company under agreements to manage some aspects of certain partners’ e-commerce businesses, including fulfillment technology and customer service, existing at the balance sheet date. Deferred revenue also consists of amounts received from the sale of gift certificates redeemable through the Company’s partners’ e-commerce businesses.

Net Revenues from Product Sales: Net revenues from product sales are derived from the sale of products by the Company through our partners’ e-commerce businesses. Net revenues from product sales are net of allowances for returns and discounts and include outbound shipping charges and other product related services such as gift wrapping and monogramming.

The Company recognizes revenues from product sales when the following revenue recognition criteria are met: persuasive evidence of an arrangement exists, shipment has occurred, the selling price is fixed or determinable and collectibility is reasonably assured.

The Company recognizes revenue from product sales, net of estimated returns based on historical experience and current trends, upon shipment of products to customers. The Company ships the majority of products from its fulfillment centers in Louisville, KY and Shepherdsville, KY. The Company also relies upon certain vendors to ship products directly to customers on its behalf. The Company acts as principal in these transactions, as orders are initiated directly through the e-commerce businesses that the Company operates, the Company takes title to the goods at the shipping point and has the economic risk related to collection, customer service and returns.

6

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

The Company considers the criteria presented in Emerging Issues Task Force (“EITF”) No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” in determining the appropriate revenue recognition treatment. Generally, when the Company is the primary obligor in a transaction, has general inventory risk, establishes the selling price, has discretion in supplier selection, has physical loss inventory risk after order placement or during shipping, and has credit risk, or has several but not all of these indicators, the Company records revenue gross as a principal.

The Company pays to its partners a percentage of the revenues generated from the sale of products sold by the Company through the e-commerce businesses that the Company operates in exchange for the rights to use their brand names and the promotions and advertising that its partners agree to provide. The Company refers to these royalty payments as partner revenue share charges. The Company has considered the revenue reduction provisions addressed in EITF No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products,” which was codified in EITF No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products,” and believes that the payment of partner revenue share charges, or the issuance of warrants or stock in lieu of cash partner revenue share charges, to its partners should not result in any reduction of revenues. EITF No. 00-25 addresses consideration paid to parties along a distribution chain. The Company purchases merchandise from its vendors, at its discretion, and is responsible for paying those vendors. The amounts purchased and the prices paid to the Company’s vendors are not in any way impacted by the revenue share provisions of the Company’s agreements with its partners. Accordingly, the Company’s partners and vendors are not linked in the distribution chain and the Company believes that the provisions of EITF No. 00-25 do not apply.

Service Fee Revenues: The Company derives its service fee revenues from service fees earned by it in connection with the development and operation of its partners’ e-commerce businesses. Service fees primarily consist of variable fees based on the value of merchandise sold or gross profit generated through its partners’ e-commerce businesses. To a lesser extent, service fees include fixed periodic payments by partners for the development and operation of their e-commerce businesses and fees related to the provision of marketing, design, development and other services. The Company recognizes revenues from services provided when the following revenue recognition criteria are met: persuasive evidence of an arrangement exists, services have been rendered, the fee is fixed or determinable and collectibility is reasonably assured. If the Company receives payments for services in advance, these amounts are deferred and then recognized over the service period. Cost of service fee revenues includes the cost of products sold and inbound freight related to those products, as well as outbound shipping and handling costs, other than those related to promotional free shipping and subsidized shipping and handling which would be included in sales and marketing expense. The Company does not specifically record “Cost of service fee revenues” as these costs are incurred by the Company’s fee-based partners rather than by the Company. Operating expenses relating to service fee revenues consist primarily of personnel and other costs associated with the Company’s engineering, production and creative departments which are included in product development expense, as well as fulfillment costs and personnel and other costs associated with its marketing and customer service departments which are included in sales and marketing expense.

Cost of Revenues: Cost of revenues consist of cost of revenues from product sales and cost of service fee revenues. Cost of revenues from product sales include the cost of products sold and inbound freight related to these products, as well as outbound shipping and handling costs, other than those related to promotional free shipping and subsidized shipping and handling which are included in sales and marketing expense. We specifically do not record cost of service fee revenue. The cost of the sales of the merchandise on which we earn service fees are incurred by our service-fee partners because they are the owners and sellers of the merchandise.

Vendor Allowances: In accordance with EITF 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor,” for all contracts entered into or modified after December 31, 2002, vendor allowances are recorded as a reduction in the cost of the applicable vendor’s products and recognized in cost of sales when the related product is sold unless the allowances represent reimbursement of a specific incremental and identifiable cost incurred to promote the vendor’s product. If the allowance represents a reimbursement of cost, it is recorded as an offset to the associated expense incurred. Any reimbursement greater than the costs incurred is recognized as a reduction in the cost of the product.

Sales and Marketing: Sales and marketing expenses include fulfillment costs, customer service costs, credit card fees, net partner revenue share charges, net advertising and promotional expenses incurred by us on behalf of the Company’s partners’ e-commerce businesses, and payroll related to the buying, business management and marketing functions of the company. Net partner revenue share charges are royalty payments made to the Company’s partners in exchange for the use of their brands, the promotion of its partners’ URLs, Web sites and toll-free telephone numbers in their marketing and communications materials, the

7

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

implementation of programs to provide incentives to customers to shop through the e-commerce businesses that the Company operates for its partners and other programs and services provided to the customers of the e-commerce businesses that the Company operates for its partners, net of amounts reimbursed to the Company by its partners. Net advertising and promotional expenses include promotional free shipping and subsidized shipping and handling costs and are net of amounts reimbursed to the Company by its partners. Partner revenue share charges were $2,323 and $5,328 for the three- and six-month periods ended July 3, 2004, and $2,629 and $4,435 for the three- and six-month periods ended July 2, 2005.

The Company defines shipping and handling costs as only those costs incurred for a third-party shipper to transport products to the customer and these costs are included in cost of revenues from product sales. In some instances, shipping and handling costs exceed shipping charges to the customer and are subsidized by the Company. Additionally, the Company selectively offers promotional free shipping whereby it ships merchandise to customers free of all shipping and handling charges. The cost of promotional free shipping and subsidized shipping and handling was $473 and $1,176 for the three-and six-month periods ended July 3, 2004, and $954 and $1,826 for the three- and six-month periods ended July 2, 2005, and was charged to sales and marketing expense.

The Company defines fulfillment costs as personnel, occupancy and other costs associated with its Kentucky fulfillment center, personnel and other costs associated with its logistical support and vendor operations departments and third-party warehouse and fulfillment services costs. Fulfillment costs were $4,731 and $9,695 for the three- and six-month periods ended July 3, 2004, and $6,224 and $13,000 for the three- and six-month period ended July 2, 2005, and are included in sales and marketing expense.

The Company expenses the cost of advertising, which includes online marketing fees, media, agency and production expenses, in accordance with the AICPA Accounting Standards Executive Committee’s Statement of Position (“SOP”) 93-7, “Reporting on Advertising Costs.” Advertising production costs are expensed the first time the advertisement runs. Online marketing fees and media (television, radio and print) placement costs are expensed in the month the advertising appears. Agency fees are expensed as incurred. Advertising costs were $1,627 and $2,855 for the three- and six-month period ended July 3, 2004, and $1,864 and $3,737 for the three- and six-month period ended July 2, 2005, and are included in sales and marketing expenses.

Product Development: Product development expenses consist primarily of expenses associated with planning, maintaining and operating the Company’s partners’ e-commerce businesses, and payroll and related expenses for the Company’s engineering, production, creative and management information systems departments. Costs incurred to develop internal-use computer software during the application development stage, including those relating to developing the Company’s partners’ Web sites, generally are capitalized. Costs of enhancements to internal-use computer software are also capitalized, provided that these enhancements result in additional functionality.

Stock-Based Compensation: SFAS No. 123, “Accounting for Stock-Based Compensation,” encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, compensation expense for stock options issued to employees is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of the grant over the amount an employee must pay to acquire the stock. The Company accounts for stock-based compensation for stock options and warrants issued to non-employees in accordance with SFAS No. 123 and EITF No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” and EITF No. 00-18, “Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees.” Accordingly, compensation expense for stock options and warrants issued to non-employees are measured using a Black-Scholes multiple option pricing model that takes into account significant assumptions as to the expected life of the option or warrant, the expected volatility of the Company’s common stock and the risk-free interest rate over the expected life of the option or warrant. Compensation expense for restricted stock awards is recorded on a straight-line method over the vesting period.

8

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

The following table illustrates the pro forma net loss and loss per share for the three- and six-month periods ended July 3, 2004 and July 2, 2005 as if compensation expense for stock options issued to employees had been determined consistent with SFAS No. 123:

	Three Months Ended						Six Months Ended
	July 3, 2004			July 2, 2005			July 3, 2004			July 2, 2005
Net loss, as reported	$	(3,146	)	$	(2,945	)	$	(7,349	)	$	(4,499	)
Add: Stock-based compensation expense included in reported net loss		(246	)		1,049			14			326
Deduct: Total stock-based compensation determined under fair value based method for all stock option awards		(1,396	)		(5,047	)		(2,748	)		(6,373	)
Pro forma net loss	$	(4,788	)	$	(6,943	)	$	(10,083	)	$	(10,546	)
Loss per share - basic and diluted:
Net loss per share, as reported	$	(0.08	)	$	(0.07	)	$	(0.18	)	$	(0.11	)
Pro forma net loss per share	$	(0.12	)	$	(0.16	)	$	(0.24	)	$	(0.25	)

Stock-based compensation expense related to the amortization of deferred partner revenue share charges was $332 and $692 for the three- and six-month periods ended July 3, 2004, and $675 and $1,163 for the three- and six-month periods ended July 2, 2005.

Income Taxes: The Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities and expected benefits of utilizing net operating loss carryforwards. The impact on deferred taxes from changes in tax rates and laws, if any, applied to the years during which temporary differences are expected to be settled, is reflected in the consolidated financial statements in the period of enactment. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

New Accounting Pronouncements

In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs an Amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends the guidance in ARB No. 43 Chapter 4, “Inventory Pricing” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43 Chapter 4, previously stated that “…under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges.” SFAS No. 151 requires that those items be recognized as current period charges regardless of whether they meet the criterion of “so abnormal”. SFAS No. 151 is effective for inventory costs incurred during the fiscal years beginning after June 15, 2005. In addition, SFAS No. 151 requires that allocation of fixed production overheads to the costs of conversion be based on normal capacity of the production facility. The Company anticipates that adoption of SFAS No. 151 will have no significant impact on the Company’s financial position or results of operations.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets an Amendment of APB Opinion No. 29”. SFAS No. 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29 and replaces it with an exception for exchanges that do not have commercial substance. This Statement specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company anticipates that adoption of SFAS No. 153 will have no significant impact on the Company’s financial position or results of operations.

9

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

In December 2004, the FASB issued Financial Accounting Standards Board Statement No. 123R “Share-Based Payment”, or SFAS 123R, which replaces Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation”, or SFAS 123, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, or APB 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. In addition, SFAS 123R will cause unrecognized expense (based on the amounts in our pro forma footnote disclosure) related to options vesting after the date of initial adoption to be recognized as a charge to results of operations over the remaining vesting period. In April 2005, the SEC announced that it would delay the initial adoption of SFAS 123R from interim periods that begin after June 15, 2005, to annual periods beginning after June 15, 2005. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The Company is evaluating the requirements of SFAS 123R and it expects that the adoption of SFAS 123R will have a material impact on its consolidated results of operations and earnings per share.

In June 2005, the FASB, issued FSP FAS 150-5, “Issuer’s Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable.” This FSP clarifies that freestanding warrants and other similar instruments on shares that are redeemable should be accounted for as liabilities under Statement 150 regardless of the timing of the redemption feature or price. The guidance in this FSP shall be applied to the first reporting period beginning after June 30, 2005. The Company is evaluating the requirements of FSP FAS 150-5 and it expects that the adoption of FSP FAS 150-5 will not have a material impact on its financial position, consolidated results of operations and earnings per share.

10

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 3—MARKETABLE SECURITIES

Marketable securities, at estimated fair value, consist of the following:

	January 1, 2005
	Amortized Cost		Gross Unrealized Losses			Estimated Fair Value
Auction rate securities	$	39,700	$	—		$	39,700
Corporate bonds		5,963		(41	)		5,922
U.S. government agency securities		9,800		(63	)		9,737
	$	55,463	$	(104	)	$	55,359

	July 2, 2005
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Auction rate securities	$	55,840	$	—	$	—		$	55,840
Corporate bonds		20,092		2		(77	)		20,017
U.S. government agency securities		18,258		—		(109	)		18,149
	$	94,190	$	2	$	(186	)	$	94,006

The fair value of marketable securities with loss positions was $15,659 as of January 1, 2005 and $35,624 as of July 2, 2005, and the gross unrealized losses on these marketable securities were $104 as of January 1, 2005 and $186 as of July 2, 2005. The Company considered the nature of these marketable securities, which are primarily U.S. government agency securities, the amount of the impairments relative to the carrying value of the related investments and the duration of the impairments, which are all less than twelve months, and concluded that the impairments were not other than temporary.

The amortized cost and estimated fair value of investments in debt securities as of July 2, 2005, by contractual maturity, are as follows:

	Amortized Cost		Estimated Fair Value
Due within one year	$	34,384	$	34,298
Due after one year through five years		51,116		51,018
Due after five years through ten years		—		—
Due after ten years		8,690		8,690
	$	94,190	$	94,006

11

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 4— PROPERTY AND EQUIPMENT

The major classes of property and equipment, at cost, as of January 1, 2005 and July 2, 2005 are as follows:

	January 1, 2005			July 2, 2005
Computer hardware and software	$	51,841		$	58,644
Building and building improvements		39,751			40,888
Furniture, warehouse and office equipment		10,651			11,204
Land		7,663			7,663
Leasehold improvements		529			564
Capitalized lease		1,692			1,692
Construction in progress		387			3,329
		112,514			123,984
Less: Accumulated depreciation		(38,127	)		(44,722	)
Property and equipment, net	$	74,387		$	79,262

NOTE 5—LEASES

Capital Leases

During the third quarter of fiscal 2004, the Company entered into capital leases for computer hardware and software. As of July 2, 2005, the leases had an aggregate outstanding balance of $983, with $453 classified as current. The Company’s net investment in these capital leases as of July 2, 2005 was $1,371, which is included in property and equipment. Interest expense recorded on the capital leases for the three- and six-month period ended July 2, 2005 was $21 and $45.

Operating Leases

The Company leases its Melbourne, FL customer contact center, as well as its Shepherdsville, KY fulfillment center and certain fixed assets under noncancellable operating leases. Rent expense under operating lease agreements was $364 and $695 for the three- and six-month periods ended July 3, 2004, and $553 and $1,143 for the three- and six-month period ended July 2, 2005.

12

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 6—CHANGES IN STOCKHOLDERS’ EQUITY

	Common Stock			Additional Paid in Capital			Accumulated Deficit			Comprehensive (Loss) Income			Accumulated Other Comprehensive Income (Loss)			Treasury Stock				Total
	Shares	Dollars														Shares		Dollars
Consolidated balance at January 3, 2004 (as restated, see Note 17)	40,781	$	408	$	287,571		$	(176,393	)				$	—		1		$	—	$	111,586
Net loss (as restated, see Note 17)								(7,349	)	$	(7,349	)									(7,349	)
Net unrealized losses on available-for-sale securities											(97	)		(97	)						(97	)
Comprehensive loss (as restated, see Note 17)										$	(7,446	)
Stock-based compensation expense					88																88
Issuance of common stock upon exercise of options and warrants	231		2		1,049																1,051
Consolidated balance at July 3, 2004 (as restated, see Note 17)	41,012	$	410	$	288,708		$	(183,742	)				$	(97	)	1		$	—	$	105,279
Consolidated balance at January 1, 2005 (as restated, see Note 17)	41,584	$	416	$	294,471		$	(176,730	)				$	(104	)	1		$	—	$	118,053
Net loss (as restated, see Note 17)								(4,499	)		(4,499	)									(4,499	)
Net unrealized losses on available-for-sale securities											(80	)		(80	)						(80	)
Unrealized gain on investment in Odimo recorded at fair value (See Note 2)											1,552			1,552							1,552
Comprehensive loss (as restated, see Note 17)										$	(3,027	)
Stock-based compensation expense (as restated, see Note 17)					325																325
Issuance of common stock during public offering	1,962		19		28,185																28,204
Issuance costs related to the common stock public offering					(1,825	)															(1,825	)
Issuance of common stock upon exercise of options	374		4		2,601											(1	)				2,605
Consolidated balance at July, 2 2005 (as restated, see Note 17)	43,920	$	439	$	323,757		$	(181,229	)				$	1,368		—		$	—	$	144,335

The following table summarizes the changes in stockholders’ equity for the year ended January 1, 2005 and the six-months ended July 2, 2005:

In June 2005, the Company completed the sale of approximately 1.9 million common shares related to the Company’s public offering, which raised approximately $26,380 in net proceeds, which the Company will use for working capital and general corporate purposes, including possible acquisitions.

NOTE 7—STOCK OPTIONS, WARRANTS AND STOCK AWARDS

The Company maintains incentive and non-incentive stock option plans for certain employees, directors and other persons (the “Plans”). Under the terms of the Plans, the Company is authorized to grant incentive and non-incentive options, restricted stock and unrestricted stock awards and restricted stock units a maximum of 11,500,000 shares of common stock. The options and restricted stock awards granted under the Plans generally vest at various times over periods ranging up to five years and have terms of up to ten years after the date of grant, unless the optionee leaves the employ of or ceases to provide services to the Company. Stock appreciation rights (“SARs”) may be granted under the Plans either alone or in tandem with stock options. No SARs have been granted to date under the Plans.

13

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

The following table summarizes the stock option activity for the three-month periods ended July 3, 2004 and July 2, 2005:

	Three Months Ended
	July 3, 2004				July 2, 2005
	Number of Shares		Weighted Average Exercise Price		Number of Shares		Weighted Average Exercise Price
Outstanding, beginning of period	6,401		$	8.28	5,813		$	8.62
Granted	385			9.40	1,178			13.75
Exercised	(37	)		4.00	(255	)		6.97
Cancelled	(227	)		8.97	(52	)		10.79
Outstanding, end of period	6,522		$	8.35	6,684		$	9.58
Exercisable, end of period	4,008		$	8.00	5,363		$	9.61

During the three-month period ended July 2, 2005, the Company granted to employees options to purchase an aggregate of 1,177,750 shares of the Company’s common stock at prices ranging from $13.46 to $16.75 per share and restricted stock units to purchase an aggregate of 133,027 shares of the Company’s common stock. The weighted average fair value and the weighted average exercise price of the options granted with exercise prices at the then-current market prices of the underlying stock during the three-month period ended July 2, 2005 was $4.16 and $13.75 per share, respectively. For the three- and six-month periods ended July 2, 2005, the Company recorded stock-based compensation expense of $1,058 and $325, respectively, relating to options and restricted stock.

During the three-month period ended July 3, 2004, the Company granted to employees options to purchase an aggregate of 384,750 shares of the Company’s common stock at prices ranging from $8.51 to $10.89 per share. The weighted average fair value and the weighted average exercise price of the options granted with exercise prices at the then-current market prices of the underlying stock during the three-month period ended July 3, 2004 was $5.88 and $9.40 per share, respectively. For the three-and six-month periods ended July 3, 2004, the Company recorded $268 and $1 reductions in stock-based compensation expense, respectively, relating to options and restricted stock.

The following table summarizes the warrant activity for the three-month periods ended July 3, 2004 and July 2, 2005:

	Three Months Ended
	July 3, 2004			July 2, 2005
	Number of Shares	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price
Outstanding, beginning of period	803	$	7.68	815	$	7.71
Granted	12		9.31	—		—
Exercised	—		—	—		—
Cancelled	—		—	—		—
Outstanding, end of period	815	$	7.71	815	$	7.71
Exercisable, end of period	615	$	9.40	615	$	9.40

No warrants were granted or issued by the Company during the three- and six-month periods ended July 2, 2005.

14

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

The following table summarizes information regarding options and warrants outstanding and exercisable as of July 2, 2005:

	Outstanding				Exercisable
Range of Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life In Years	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$1.00   - $6.20	2,546	4.96	$	4.80	2,200	$	5.06
$6.38   - $10.00	2,586	7.34		9.09	1,620		8.76
$10.87 - $24.69	2,367	7.85		14.63	2,158		14.83
$1.00   - $24.69	7,499	6.69	$	9.38	5,978	$	9.59

As of July 2, 2005, 1,944,202 shares of common stock were available for future grants under the Plans.

The fair value of options granted under the Plans during the three-month periods ended July 3, 2004 and July 2, 2005 were estimated on the date of grant using the Black-Scholes multiple option pricing model, with the following weighted average assumptions:

	Three Months Ended
Assumption	July 3, 2004		July 2, 2005
Dividend yield	None		None
Expected volatility	96.00	%	57.25	%
Average risk free interest rate	3.35	%	3.76	%
Average expected lives	3.30 years		1.58 years

NOTE 8— NET LOSS PER SHARE

Basic earnings (loss) per share for all periods have been computed in accordance with SFAS No. 128, “Earnings Per Share.” Basic and diluted loss per share are computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Potential common shares from outstanding common stock options and warrants, and convertible notes have been excluded from the calculation of diluted losses per share because their effect would be anti-dilutive.

The amounts used in calculating loss per share data are as follows:

	Three Months Ended						Six Months Ended
	July 3, 2004			July 2, 2005			July 3, 2004			July 2, 2005
Net loss	$	(3,146	)	$	(2,945	)	$	(7,349	)	$	(4,499	)
Weighted average shares outstanding - basic and diluted		40,991			42,551			40,930			42,106
Outstanding common stock options having no dilutive effect		6,522			6,684			6,522			6,684
Outstanding common stock warrants having no dilutive effect		815			815			815			815
Convertible shares having no dilutive effect		—			3,229			—			3,229

15

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 9 — COMPREHENSIVE INCOME (LOSS):

The following table summarizes the components of comprehensive income (loss):

	Three Months Ended						Six Months Ended
	July 3, 2004			July 2, 2005			July 3, 2004			July 2, 2005
Net loss	$	(3,146	)	$	(2,945	)	$	(7,349	)	$	(4,499	)
Other comprehensive loss:
Net unrealized losses on available-for-sale securities		(72	)		(31	)		(97	)		(80	)
Unrealized (loss) gain on investment in Odimo recorded at fair value		—			(668	)		—			1,552
Other comprehensive loss		(72	)		(699	)		(97	)		1,472
Comprehensive loss	$	(3,218	)	$	(3,644	)	$	(7,446	)	$	(3,027	)

NOTE 10—SIGNIFICANT TRANSACTIONS/CONCENTRATIONS OF CREDIT RISK

The Company had $12,397 as of January 1, 2005 and $12,928 as of July 2, 2005, of operating cash and $63,026 as of January 1, 2005 and $104,561 as of July 2, 2005 of cash equivalents and marketable securities invested with three financial institutions, which are potentially subject to credit risk. The composition of these investments is regularly monitored by management of the Company.

NOTE 11—MAJOR SUPPLIERS/ECONOMIC DEPENDENCY

During the three-month period ended July 2, 2005, the Company purchased inventory from one supplier amounting to $24,576 or 49.3% of total inventory purchased. During the six-month period ended July 2, 2005, the Company purchased inventory from one supplier amounting to $49,289 or 49.0% of total inventory purchased.

During the three-month period ended July 3, 2004, the Company purchased inventory from one supplier amounting to $12,820 or 37.2% of total inventory purchased. During the six-month period ended July 3, 2004, the Company purchased inventory from one supplier amounting to $25,251 or 37.1% of total inventory purchased.

No other supplier amounted to more than 10% of total inventory purchased for any period presented.

NOTE 12—COMMITMENTS AND CONTINGENCIES

Legal Proceedings

The Company is involved in various litigation incidental to its current and discontinued businesses, including alleged infringement of intellectual property rights of third parties, contractual claims and claims relating to the manner in which goods are sold through its e-commerce platform.

While the Company sold certain assets of Ashford.com, Inc. in December 2002, Ashford.com continues to be a party to certain litigation that was commenced prior to the Company’s acquisition of Ashford.com in March 2002. Since July 11, 2001, several stockholder class action complaints have been filed in the United States District Court of the Southern District of New York against Ashford.com, several of Ashford.com’s officers and directors, and various underwriters of Ashford.com’s initial public offering. The purported class actions have all been brought on behalf of purchasers of Ashford.com common stock during various periods beginning on September 22, 1999, the date of Ashford.com’s initial public offering. The plaintiffs allege that Ashford.com’s prospectus, included in Ashford.com’s Registration Statement on Form S-1 filed with the Securities and Exchange

16

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

Commission, was materially false and misleading because it failed to disclose, among other things, certain fees and commissions collected by the underwriters or arrangements designed to inflate the price of the common stock. The plaintiffs further allege that because of these purchases, Ashford.com’s post-initial public offering stock price was artificially inflated. As a result of the alleged omissions in the prospectus and the purported inflation of the stock price, the plaintiffs claim violations of Sections 11 and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. The complaints have been consolidated into a single action, and the consolidated cases against Ashford.com have been consolidated with similarly consolidated cases filed against 308 other issuer defendants for the purposes of pretrial proceedings. The claims against Ashford.com’s officers and directors were dismissed in exchange for tolling agreements which permit the refiling of claims against officers and directors at a later date. A motion to dismiss filed on behalf of all issuer defendants, including Ashford.com, was denied in all aspects relevant to Ashford.com on February 19, 2003. Ashford.com and its insurers have entered into a memorandum of understanding regarding terms for settlement of this suit. Under the settlement, plaintiffs’ claims against Ashford.com and other issuers will be dismissed in exchange for certain consideration from the issuers’ insurers and for the issuers’ assignment to plaintiffs of certain potential claims against the underwriters of the relevant initial public offerings. Formal documentation of the settlement contemplated by the memorandum of understanding is complete and the Judge presiding over this matter has preliminarily approved the settlement. In the event that a settlement is not finalized, the Company believes that Ashford.com has defenses against these actions.

In September 2003, the Company learned that it, along with several of its partners, were named in an action in the Circuit Court of Cook County, Illinois, by a private litigant who is alleging that the Company, along with certain of its partners, wrongfully failed to collect and remit sales and use taxes for sales of personal property to customers in Illinois and knowingly created records and statements falsely stating the Company was not required to collect or remit such taxes. The complaint seeks injunctive relief, unpaid taxes, interest, attorneys’ fees, civil penalties of up to $10 per violation, and treble damages under the Illinois Whistleblower Reward and Protection Act. The Company is aware that this same private litigant has filed similar actions against retailers in other states, and it may be possible that the Company and/or its partners may have been or may be named in similar cases in other states. The Company does not believe that it is liable under existing laws and regulations for any failure to collect sales or other taxes relating to internet sales and intends to vigorously defend itself in this matter.

The Company does not believe, based on current knowledge, that any of the foregoing claims are likely to have a material adverse effect on its business, financial position or results of operations. However, the Company may incur substantial expenses and devote substantial time to defend third-party claims whether or not such claims are meritorious. In the event of a determination adverse to the Company, the Company may incur substantial monetary liability, and may be required to implement expensive changes in its business practices or enter into costly royalty or licensing agreements. Any of these could have a material adverse effect on the Company’s business, financial position or results of operations.

Acquisitions

On May 25, 2005 the Company announced it entered into a definitive agreement to acquire control of privately-held Aspherio, S.L., a Barcelona, Spain-based provider of outsourced e-commerce solutions. Effective July 6, 2005, the Company has obtained a usufruct (a right that is irrevocable during its term and that conveys the voting and economic rights to the underlying shares without transferring title to the shares) right over the shares representing 51% of the participations in Aspherio, S.L. The Company is working strategically with Aspherio to offer its international e-commerce capabilities to the Company’s existing partners and prospects. The Company will consolidate the third quarter results of Aspherio, S.L., showing the remaining 49% within minority interest. Under the terms of the agreement, subject to the satisfaction of certain conditions, the Company also has the right to acquire all of the outstanding shares of Aspherio, S.L. If consummated, the purchase price for the acquisition of control and for the acquisition of the shares of Aspherio would be approximately $4.0 million plus an earn-out based on performance of the Aspherio business. Of the $4.0 million, $2.7 million would be paid in cash and $1.3 million would be paid in cash or the Company’s common stock, at the Company’s election. Subject to the satisfaction of certain conditions, the acquisition is expected to close in late 2005 or early 2006. The Company does not expect that the acquisition would have a material impact on its financial results for fiscal year 2005 or 2006.

Advertising and Media Agreements

As of July 2, 2005, the Company was contractually committed for the purchase of future advertising totaling approximately $3 through the fiscal year ending December 31, 2005. The expense related to these commitments will be recognized in accordance with the Company’s accounting policy related to advertising (see Note 2).

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GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

Partner Revenue Share Payments

As of July 2, 2005 and subject to the satisfaction of certain conditions, the Company was contractually committed to future minimum cash revenue share payments as follows:

Fiscal Year-Ended	Partner Revenue Share Payments
2005	$	3,304
2006		3,654
2007		4,500
2008		4,850
2009		5,150
Thereafter		2,650
Total conditional future minimum cash revenue share payments	$	24,108

NOTE 13—SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

	Six Months Ended
	July 3, 2004			July 2, 2005
Cash paid during the period for interest	$	54		$	464
Noncash Investing and Financing Activities:
Receipt of shares of, and warrants to purchase, Odimo’s Series C preferred stock in connection with a conversion of principal due under a note		688			—
Exchange of a portion of a promissory note in connection with a conversion of principal due under the note		(682	)		—
Unrealized gain on investment in Odimo recorded at fair value		—			1,552
Changes in accrual for purchases of property and equipment		1,226			(907	)
Net unrealized losses on available-for-sale securities		(97	)		(80	)

NOTE 14—BUSINESS SEGMENTS

The Company operates in one principal business segment. The Company provides e-commerce solutions that enable retailers, branded manufacturers, entertainment companies and professional sports organizations to operate e-commerce businesses. The Company provides solutions for its partners through its integrated e-commerce platform, which is comprised of three components — core technology, supporting infrastructure and partner services. Through the Company’s integrated e-commerce platform, it provides Web site administration, Web infrastructure and hosting, business intelligence, an e-commerce engine, order management, fulfillment, drop shipping, customer service, buying, creative design, Web site usability, testing and enhancements, channel integration, business-to-business (B-to-B) services, content development and imaging, e-commerce strategy, online marketing and customer relationship management (CRM). The Company currently derives virtually all of its revenues from the sales of products by the Company through its partners’ e-commerce businesses and service fees earned by the Company in connection with the development and operation of its partner’s e-commerce businesses. The Company also derives revenue from fixed and variable fees earned in connection with the development and operation of partners’ e-commerce businesses and the provision of marketing and other services. All of the Company’s net revenues and operating results are in the United States and Canada. Net revenues and operating results in Canada are not significant. All of the Company’s identifiable assets are in the United States.

18

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

NOTE 15—RELATED PARTY TRANSACTIONS

In the fiscal years-ended December 30, 2000 and December 29, 2001, Interactive Technology Holdings, LLC, a joint venture of Comcast Corporation and QVC, Inc., acquired 10,797,900 shares of the Company’s common stock and warrants to purchase 300,000 shares of the Company’s common stock, which accounted for approximately 26.0% of the Company’s outstanding common stock as of January 1, 2005. On January 31, 2005, ITH effected a distribution of all of its assets, including shares of GSI common stock, to entities affiliated with Comcast and QVC. As of July 2, 2005, QVC beneficially owned approximately 19.3% of our outstanding common stock. M. Jeffrey Branman, one of our directors, was the President of Interactive Technology Services, which served as financial advisor to ITH through its dissolution. Mr. Branman is no longer affiliated with ITH, Interactive Technology Services or QVC.

In the fiscal year-ended 2000, the Company entered into a website development and distribution agreement with iQVC, a division of QVC, Inc., pursuant to which the Company provides technology, procurement and fulfillment services for QVC, including selling sporting goods, recreational and/or fitness related equipment and related products, apparel and footwear to QVC for resale through the QVC Web site. The Company recognized net revenues on sales to this related party for the three- and six-month periods ended July 3, 2004 of $238 and $571, and for the three- and six-month periods ended July 2, 2005 of $113 and $511 under this Web site development and distribution agreement. The terms of these sales are comparable to those with other business-to-business partners of the Company. As of July 2, 2005, the amount included in accounts receivable net was $34 related to these sales.

In the fiscal year ended January 3, 2004, the Company entered into a service agreement with QVC pursuant to which QVC provided shipping services to the Company in exchange for fees. The fees charged to the Company by QVC were determined through arms-length negotiations. The Company incurred fees of $264 and $583 for the three- and six-month period ended July 3, 2004, of which $250 and $557 related directly to products shipped and was charged to cost of revenues from product sales and $14 and $26 related to professional services provided and was charged to sales and marketing expense. This agreement terminated effective April 3, 2005. The Company incurred fees of $26 for the six-month period ended July 2, 2005, of which $13 related directly to products shipped and was charged to cost of revenues from product sales and $13 related to professional services provided and was charged to sales and marketing expense. All fees were incurred in the first quarter due to the termination of the agreement.

In exchange for Rustic Canyon forfeiting the rights to designate one member to the Company’s Board, on June 26, 2004, the Company granted to Rustic Canyon a warrant to purchase 12,500 shares of the Company’s common stock with a term of five years and an exercise price of $9.31 per share. The fair value of the warrant was estimated on the date of grant using Black-Sholes multiple option pricing model and the Company recorded $89 of stock-based compensation expense, relating to the warrant.

NOTE 16—LONG-TERM DEBT AND OTHER

On June 1, 2005, the Company completed a public offering of $57.5 million aggregate principal amount of 3% convertible unsecured notes due June 1, 2025, raising net proceeds of approximately $55.0 million, net of approximately $2.5 million of underwriter’s discount and debt issuance costs. The underwriter’s discount and debt issuance costs are being amortized using the straight-line method which approximates the effective interest method. The convertible unsecured notes bear interest at 3%, payable semi-annually on June 1 and December 1, beginning December 1, 2005.

Holders may convert the notes into shares of the Company’s common stock at a conversion rate of 56.1545 shares per $1,000 principal amount of notes (representing a conversion price of approximately $17.81 per share), subject to adjustment, on or prior to the close of business on the business day immediately preceding May 1, 2010. Holders may convert only if (i ) the trading price of the notes for a defined period is less than 103% of the product of the closing sale price of the Company common stock and the conversion rate or (ii) the Company elects to make certain distributions of assets or securities to all holders of common stock. Upon conversion, the Company will have the right to deliver, in lieu of shares of the Company’s common stock, cash or a combination of cash and shares of the Company’s common stock, which is at the Company’s election. At any time prior to maturity date the Company may irrevocably elect to satisfy the Company’s conversion obligation with respect to the principal amount of the notes to be converted with a combination of cash and shares of the Company’s common stock, which is at the Company’s election. If holders elect to convert their notes in connection with a fundamental change (any transaction or event, as

19

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

defined and further described in the Indenture, whereby more than 50% of the Company’s common stock is exchanged, converted and/or acquired) that occurs on or prior to June 1, 2010, the Company is required to deliver shares of the Company’s common stock, cash or a combination of cash and shares of the Company’s common stock, which is at the Company’s election, inclusive of a make whole adjustment that could result in up to 11.23 additional shares issued per $1,000 principal amount of notes. This make whole adjustment is based on the sale price of the Company’s common stock.

At any time on or after June 6, 2010, the Company may redeem any of the notes for cash at a redemption price of 100% of their principal amount, plus accrued and unpaid interest, if any, up to but excluding the redemption date. Holders may require the Company to repurchase the notes at a repurchase price equal to 100% of their principal amount plus accrued and unpaid interest, if any, on June 1 of 2010, 2015, and 2020, or at any time prior to maturity upon the occurrence of a designated event.

The following table summarizes the Company’s long-term debt and other long-term liabilities as of January 1, 2005 and July 2, 2005:

	January 1, 2005			July 2, 2005
Convertible notes	$	—		$	57,500
Note payable		12,945			12,874
Capital lease obligation		1,590			983
		14,535			71,357
Less: Current portion of note payable		(142	)		(147	)
Less: Current portion of capital lease obligation		(829	)		(453	)
Total convertible notes and long-term debt and other	$	13,564		$	70,757

NOTE 17—RESTATEMENTS OF THE CONSOLIDATED FINANCIAL STATEMENTS

First Restatement

As previously disclosed in Amendment No. 2 to Form 10-K/A for the fiscal year ended January 1, 2005, the Company determined that the Company’s investments in auction rate securities should have been classified as marketable securities within current assets. Previously, such investments had been classified as cash and cash equivalents. Accordingly, the Company restated the classification to report these investments as marketable securities for the six-months ended July 3, 2004, to reflect the gross purchases and sales of these investments as investing activities.

Second Restatement

During August 2005, the Company became aware of potential discrepancies related to vendor and other credits recorded in the fiscal year ended January 1, 2005. Management informed the Audit Committee about the discrepancies, and the Audit Committee commenced an independent investigation into these matters. As a result of the investigation, which is now concluded, the Company identified $91 of credits recorded in the fiscal year ended January 1, 2005 that should have been recorded in the fiscal year ending December 31, 2005. In addition, the Company separately had identified errors relating to the reconciliation of accounts payable and a misinterpretation of a service fee contract. In connection with the restatement for these errors, the Company also corrected errors identified as of the end of the fiscal year ended January 1, 2005 relating to the reversal of an accrual for marketing expenses and certain other items.

20

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

The impact on net loss of correcting for the above errors in the accompanying condensed consolidated financial statements for the six-months ended July 3, 2004 was an increase of $175. There was no impact on net loss for the three-months ended July 3, 2004. The impact on net loss of correcting for the above errors in the accompanying condensed consolidated financial statements for the three- and six-months ended July 2, 2005 was an increase of $168 and $46, respectively. The impact on accumulated deficit of correcting for these errors as of January 3, 2004, July 3, 2004 and January 1, 2005 was a decrease of $1,216, $1,041 and $539, respectively.

The Company also identified an error in the presentation of unpaid acquisitions of property and equipment at the end of each reporting period within the statements of cash flows. Previously, unpaid amounts for property additions were reported as a component of changes in operating assets and liabilities and acquisition of property and equipment. Such unpaid amounts should have been reported as a non-cash investing activity. As a result, the accompanying condensed consolidated financial statements as of January 1, 2005 and July 2, 2005 and for the three- and six- months ended July 3, 2004 and July 2, 2005, have been restated from amounts previously reported. The following tables present a summary of the significant effects of the restatements:

21

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

	Condensed Consolidated Balance Sheets
	As Previously Reported			First Restatement			Second Restatement			As Restated
January 1, 2005
Cash and cash equivalents	$	56,564		$	(36,500	)	$	—		$	20,064
Marketable securities		18,859			36,500			—			55,359
Accounts receivable, net of allowance of $408		14,908			—			(174	)		14,734
Total current assets		130,486			—			(174	)		130,312
Property and equipment, net		74,286			—			101			74,387
Total assets		231,896			—			(73	)		231,823
Accounts payable		58,762			—			(739	)		58,023
Accrued expenses and other		31,691			—			151			31,842
Total current liabilities		100,794			—			(588	)		100,206
Total liabilities		114,358			—			(588	)		113,770
Additional paid in capital		294,495			—			(24	)		294,471
Accumulated deficit		(177,269	)		—			539			(176,730	)
Total stockholders’ equity		117,538			—			515			118,053
Total liabilities and stockholders’ equity		231,896			—			(73	)		231,823
	As Previously Reported			First Restatement			Second Restatement			As Restated
July 2, 2005
Accounts payable	$	26,332		$	—		$	(439	)	$	25,893
Total current liabilities		60,158			—			(439	)		59,719
Total liabilities		130,915			—			(439	)		130,476
Additional paid in capital		323,811			—			(54	)		323,757
Accumulated deficit		(181,722	)		—			493			(181,229	)
Total stockholders’ equity		143,896			—			439			144,335

22

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(In thousands, except per share data)

(Unaudited)

	Condensed Consolidated Statements of Operations
	As Previously Reported			Second Restatement			As Restated
Three Months Ended July 2, 2005
Service fee revenues	$	16,488		$	228		$	16,716
Net revenues		91,646			228			91,874
Cost of revenues from product sales		57,046			393			57,439
Gross profit		34,600			(165	)		34,435
Sales and marketing		21,288			(58	)		21,230
Stock-based compensation		1,748			(15	)		1,733
Total operating expenses		37,608			(73	)		37,535
Other (income) expense		(169	)		76			(93	)
Total other (income) expense		(231	)		76			(155	)
Net loss		(2,777	)		(168	)		(2,945	)
Loss per share		(0.07	)		—			(0.07	)
	As Previously Reported			Second Restatement			As Restated
Six Months Ended July 3, 2004
Sales and marketing	$	34,236		$	128		$	34,364
Product development		8,981			47			9,028
Total operating expenses		57,537			175			57,712
Net loss		(7,174	)		(175	)		(7,349	)
Loss per share		(0.18	)		—			(0.18	)

	As Previously Reported			Second Restatement			As Restated
Six Months Ended July 2, 2005
Service fee revenues	$	31,194		$	228		$	31,422
Net revenues		183,004			228			183,232
Cost of revenues from product sales		114,672			354			115,026
Gross profit		68,332			(126	)		68,206
Sales and marketing		42,199			(110	)		42,089
Stock-based compensation		1,518			(30	)		1,488
Total operating expenses		73,225			(140	)		73,085
Other (income) expense		(268	)		60			(208	)
Total other (income) expense		(440	)		60			(380	)
Net income (loss)		(4,453	)		(46	)		(4,499	)
Loss per share		(0.11	)		—			(0.11	)

23

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Concluded)

(In thousands, except per share data)

(Unaudited)

	Condensed Consolidated Statement of Cash Flows
	As Previously Reported			First Restatement			Second Restatement			As Restated
Six-Month Period Ended July 3, 2004
Net loss	$	(7,174	)	$	—		$	(175	)	$	(7,349	)
Accounts payable and accrued expenses and other		(6,656	)		—			(1,051	)		(7,707	)
Net cash used in operating activities		(12,350	)		—			(1,226	)		(13,576	)
Acquisition of property and equipment		(23,658	)		—			1,226			(22,432	)
Purchases of marketable securities		(6,058	)		(11,250	)		—			(17,308	)
Sales of marketable securities		2,605			12,500			—			15,105
Net cash used in investing activities		(26,285	)		1,250			1,226			(23,809	)
Net decrease in cash and cash equivalents		(24,583	)		1,250			—			(23,333	)
	As Previously Reported			First Restatement			Second Restatement			As Restated
Six-Month Period Ended July 2, 2005
Net loss	$	(4,453	)	$	—		$	(46	)	$	(4,499	)
Stock-based compensation		1,518			—			(30	)		1,488
Accounts receivable, net		3,765			—			(174	)		3,591
Accounts payable and accrued expenses and other		(38,337	)		—			1,056			(37,281	)
Net cash used in operating activities		(28,686	)		—			806			(27,880	)
Acquisition of property and equipment		(11,702	)		—			(806	)		(12,508	)
Net cash used in investing activities		(51,138	)		—			(806	)		(51,944	)

24

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

All statements made in this Quarterly Report on Form 10-Q/A, other than statements of historical fact, are forward-looking statements. The words “anticipate”, “believe”, “estimate”, “expect”, “intend”, “may”, “plan”, “will”, “would”, “should”, “guidance”, “potential”, “continue”, “project”, “forecast”, “confident”, “prospects”, and similar expressions typically are used to identify forward-looking statements. Forward-looking statements are based on the then-current expectations, beliefs, assumptions, estimates and forecasts about our business and the industries and markets in which we operate. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied by these forward-looking statements. Factors which may affect our business, financial condition and operating results include the effects of changes in the economy, the impact of SFAS 123R, consumer spending, the financial markets and the industries in which we and our partners operate, changes affecting the Internet and e-commerce, our ability to develop and maintain relationships with strategic partners and suppliers and the timing of our establishment or extension or termination of our relationships with strategic partners, our ability to timely and successfully develop, maintain and protect our technology and product and service offerings and execute operationally, our ability to attract and retain qualified personnel, our ability to successfully integrate our acquisitions of other businesses, if any, and the performance of acquired businesses. More information about potential factors that could affect us are described under the heading of “Risk Factors.” We expressly disclaim any intent or obligation to update these forward-looking statements, except as otherwise specifically stated by us.

Overview and Executive Summary

• We are a leading provider of e-commerce solutions that enables retailers, branded manufacturers, entertainment companies and professional sports organizations to operate e-commerce businesses. We provide solutions for our partners through our integrated e-commerce platform, which is comprised of three components: core technology, supporting infrastructure and partner services. Through our platform, we provide Web site administration, Web infrastructure and hosting, business intelligence, an e-commerce engine, order management, fulfillment, drop shipment, customer service, buying, creative design, Web site usability, testing and enhancement services, channel integration, business-to-business (B-to-B) services, content development and imaging, e-commerce strategy, online marketing and customer relationship management (CRM).

• We offer what we believe is a comprehensive and compelling value proposition that includes the provision of expertise and infrastructure to enable our partners to grow their e-commerce businesses and to use their e-commerce businesses as a channel to complement and enhance their offline businesses. We have built and continue to develop expertise in integrated online technology, marketing and retailing, which we deliver across a shared technology, supporting infrastructure and partner services platform. We continually add new services and functions to our platforms. As part of our continuing efforts to add value to our platform, we evaluate opportunities to acquire complimentary or new businesses or assets.

• Generally, we launch the website of a new partner within three to six months after entering into a contract with such new partner. During the period in which we are planning and developing a new partner’s Web site, we incur development and launch expenses without any accompanying revenues. We anticipate that new Web sites typically will contribute to our income from operations in their first full year of operation.

• We derive virtually all of our revenues from sales of products by us through our partners’ e-commerce businesses and service fees earned by us in connection with the development and operation of our partners’ e-commerce businesses. Our revenue growth in the first six months of fiscal 2005 as compared to the first six months of fiscal 2004 was due to an increase in revenues of $41.8 million from product sales in both our sporting goods and other categories, as well as an increase of $10.4 million in service fee revenues. These increases were driven primarily by our existing partners as well as the launch of new partners in fiscal 2004, which contributed to increased sales in the first six months of fiscal 2005.

• Our gross profit increased $18.3 million in the first six months of fiscal 2005 as compared to the first six months of fiscal 2004 as a result of sales growth in new and existing partners. The gross margin decrease from 26.3% to 24.2%, which was a result of a shift in sales mix from sporting goods to consumer electronics, which carry a lower gross margin than product sales of sporting goods. We specifically do not record cost of service fee revenue. The cost of sales of the merchandise on which we earn service fees are costs incurred by our service-fee partners because they are the owners and sellers of the merchandise. Accordingly, our gross margin on service revenues is 100%. Our gross margin on products has typically been impacted by the mix of products sold between our sporting goods and other categories as well as within our sporting goods category.

• Operating expenses increased from $57.7 million in the first six months of fiscal 2004 to $73.1 million in the first six months of fiscal 2005, primarily as a result of increased expenses in payroll and related costs to support the growth of our business.

• On May 25, 2005, we entered into a definitive agreement to acquire control of privately-held Aspherio, S.L., a Barcelona, Spain-based provider of outsourced solutions. Effective July 6, 2005, we obtained a usufruct (a right that is irrevocable during its term and that conveys the voting and economic rights to the underlying shares without transferring title to the shares) right over the shares representing 51% of the participations in Aspherio, S.L. Under the terms of the

25

agreement, subject to the satisfaction of certain conditions, we also have the right to acquire all of the outstanding shares of Aspherio, S.L. If consummated, the purchase price for the acquisition of control and for the acquisition of the shares of Aspherio would be approximately $4.0 million plus an earn-out based on performance of the Aspherio business. Of the $4.0 million, $2.7 million would be paid in cash and $1.3 million would be paid in cash or our common stock, at the our election. Subject to the satisfaction of certain conditions, the acquisition is expected to close in late 2005 or early 2006. We do not expect that the acquisition to have a material impact on our financial results for fiscal year 2005 or 2006.

• On June 1, 2005, we raised approximately $80 million of net proceeds through the concurrent sale of 1.8 million common shares and $57.5 million aggregate principal amount of 3% convertible notes due 2025. We will use the net proceeds for working capital and general corporate purposes, including possible acquisitions.

Restatements of Financial Statements

First Restatement

As previously disclosed in Amendment No. 2 to Form 10-K/A for fiscal 2004, we determined that our investments in auction rate securities should have been classified as marketable securities within current assets. Previously, such investments had been classified as cash and cash equivalents. Accordingly, we restated the classification to report these investments as marketable securities for the six-months ended July 3, 2004, to reflect the gross purchases and sales of these investments as investing activities.

Second Restatement

During August 2005, we became aware of potential discrepancies related to vendor and other credits recorded in fiscal 2004. Management informed the Audit Committee about the discrepancies, and the Audit Committee commenced an independent investigation into these matters. As a result of the investigation, which is now concluded, we identified $91,000 of credits recorded in fiscal 2004 that should have been recorded in fiscal 2005. In addition, we separately had identified errors relating to the reconciliation of accounts payable and a misinterpretation of a service fee contract. In connection with the restatement for these errors, we also corrected errors identified as of the end of fiscal 2004 relating to the reversal of an accrual for marketing expenses and certain other items.

The impact on net loss of correcting for the above errors in the accompanying condensed consolidated financial statements for the six-months ended July 3, 2004 was an increase of $175,000. There was no impact on net loss for the three-months ended July 3, 2004. The impact on net loss of correcting for the above errors in the accompanying condensed consolidated financial statements for the three and six-months ended July 2, 2005 was an increase of $168,000 and $46,000, respectively. The impact on accumulated deficit of correcting for these errors as of January 3, 2004, July 3, 2004 and January 1, 2005 was a decrease of $1.2 million, $1.0 million and $0.5 million, respectively.

We also identified an error in the presentation of unpaid acquisitions of property and equipment at the end of each reporting period within the statements of cash flows. Previously, unpaid amounts for property additions were reported as a component of changes in operating assets and liabilities and acquisition of property and equipment. Such unpaid amounts should have been reported as a non-cash investing activity.

The impact on net income (loss) of correcting for all of the above errors is summarized as follows:

• Fiscal 2004: Previously reported net income of $0.3 million is restated to a net loss of $0.3 million.

• Fiscal 2003: Previously reported net loss of $12.1 million is restated to a net loss of $11.9 million.

• Fiscal 2002: Previously reported net loss of $33.8 million was not affected by the restatements.

• Six-months ended July 2, 2005: Previously reported net loss of $4.45 million is restated to a net loss of $4.50 million.

• Six-months ended July 3, 2004: Previously reported net loss of $7.2 million is restated to a net loss of $7.3 million.

• Second quarter of fiscal 2005: Previously reported net loss of $2.8 million is restated to a net loss of $2.9 million.

• Second quarter of fiscal 2004: Previously reported net loss of $3.1 million was not affected by the restatements.

• First quarter of fiscal 2005: Previously reported net loss of $1.7 million is restated to a net loss of $1.6 million.

• First quarter of fiscal 2004: Previously reported net loss of $4.0 million is restated to a net loss of $4.2 million.

As a result, the accompanying condensed consolidated financial statements as of January 1, 2005 and July 2, 2005 and for the three- and six- months ended July 3, 2004 have been restated from amounts previously reported. Accordingly, amounts presented in Management’s Discussion and Analysis include the effects of the above restatements. See Note 17 to the notes to the

26

accompanying condensed consolidated financial statements for a summary of the significant effects of the restatements referred to above.

Results of Operations

Comparison of the three and six-month periods ended July 3, 2004 and July 2, 2005

Net Revenues

We derive virtually all of our revenues from sales of product by us through our partners’ e-commerce businesses and service fees earned by us in connection with the development and operation of our partners’ e-commerce businesses. The following tables show net revenues by source for the second quarter of fiscal 2004 and the second quarter of fiscal 2005, the first six months of fiscal 2004 and the first six months of fiscal 2005, the percentages that such revenues bear to total net revenues and the period over period changes in net revenues.

Three-month period ended July 3, 2004 and July 2, 2005:

	Second Fiscal Qtr. 2004				Second Fiscal Qtr. 2005				Second Fiscal Qtr. 2005 vs Second Fiscal Qtr. 2004
	$		%		$		%		$		%
Net revenues from product sales - sporting goods	$	33.6	51.9	%	$	41.9	45.6	%	$	8.3	24.7	%
Net revenues from product sales - other		19.5	30.2	%		33.3	36.2	%		13.8	70.8	%
Net revenue from product sales		53.1	82.1	%		75.2	81.8	%		22.1	41.6	%
Service fee revenue		11.6	17.9	%		16.7	18.2	%		5.1	44.0	%
Net Revenues	$	64.7	100	%	$	91.9	100	%	$	27.2	42.0	%

Net Revenues from Product Sales. Net revenues from product sales are derived from the sale of products by us through our partners’ e-commerce businesses. Net revenues from product sales are net of allowances for returns and discounts and include outbound shipping charges and other product related services such as gift wrapping and monogramming.

Net revenues from product sales increased $22.1 million in the second quarter of fiscal 2005 primarily due to the growth of our existing partners. Of this increase, $8.3 million was due to an increase in sales in our sporting goods category and $13.8 million was due to an increase in sales in our other product category, which primarily includes consumer electronics.

Service Fee Revenue. Service fee revenues are derived from service fees earned in connection with the development and operation of our partners’ e-commerce businesses. Service fees primarily consist of variable fees based on the value of merchandise sold or gross profit generated through our partners’ e-commerce businesses. To a lesser extent, service fees include fixed periodic payments by partners for the development and operation of their e-commerce businesses and fees related to the provision or marketing, design, development and other services.

Service fee revenues increased $5.1 million for the second quarter of 2005, due primarily to the launch of new fee-based partners in fiscal 2004 and 2005 and growth in existing partners.

Six-month period ended July 3, 2004 and July 2, 2005:

	First Six Months Fiscal 2004				First Six Months Fiscal 2005				First Six Months Fiscal 2004 vs First Six Months Fiscal 2004
	$		%		$		%		$		%
Net revenues from product sales - sporting goods	$	67.1	51.3	%	$	81.7	44.6	%	$	14.6	21.8	%
Net revenues from product sales - other		42.9	32.7	%		70.1	38.3	%		27.2	63.4	%
Net revenue from product sales		110.0	84.0	%		151.8	82.9	%		41.8	38.0	%
Service fee revenue		21.0	16.0	%		31.4	17.1	%		10.4	49.5	%
Net Revenues	$	131.0	100.0	%	$	183.2	100.0	%	$	52.2	39.8	%

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Net Revenues from Product Sales. Net revenues from product sales increased $41.8 million for the first six months of fiscal 2005 primarily due to the growth of our existing partners. Of this increase, $14.6 million was due to an increase in sales in our sporting goods category and $27.2 million was due to an increase in sales in our other product category, which primarily includes consumer electronics.

Service Fee Revenue. Service fee revenues increased $10.4 million for the first six months of fiscal 2005, due primarily to the launch of new fee-based partners in fiscal 2004 and 2005 and growth in existing partners.

Cost of Revenues

Cost of revenues consists of cost of revenues from product sales and cost of service fee revenues. Cost of revenues from product sales include the cost of products sold and inbound freight related to those products, as well as outbound shipping and handling costs, other than those related to promotional free shipping and subsidized shipping and handling which are included in sales and marketing expense. We specifically do not record cost of service fee revenue. The cost of the sales of the merchandise on which we earn service fees are incurred by our service-fee partners because they are the owners and sellers of the merchandise. The following tables show cost of revenues for the second quarter of fiscal 2004 and second quarter of fiscal 2005, the first six months of fiscal 2004 and the first six months of fiscal 2005, the percentages that such costs bear to total net revenues and the period over period changes in cost of revenues.

Three-month period ended July 3, 2004 and July 2, 2005:

	Second Fiscal Qtr. 2004				Second Fiscal Qtr. 2005				Second Fiscal Qtr. 2005 vs Second Fiscal Qtr. 2004
	$		%		$		%		$		%
Cost of revenue from product sales	$	39.6	61.2	%	$	57.5	62.6	%	$	17.9	45.2	%

As a percentage of net revenues, cost of revenues increased from 61.2% in second quarter of fiscal 2004 to 62.6% in second quarter of fiscal 2005. The increase in cost of revenues was primarily due to more product sales in the other category, which is primarily consumer electronics, which carry a lower gross margin or higher cost of revenue compared to product sales of sporting goods. Cost of revenues from product sales as a percentage of net revenues from product sales increased from approximately 74.5% in second quarter of fiscal 2004 to approximately 76.5% in second quarter of fiscal 2005.

Six-month period ended July 3, 2004 and July 2, 2005:

	First Six Months Fiscal 2004				First Six Months Fiscal 2005				First Six Months Fiscal 2004 vs First Six Months Fiscal 2004
	$		%		$		%		$		%
Cost of revenue from product sales	$	81.1	61.9	%	$	115.0	62.8	%	$	33.9	41.8	%

As a percentage of net revenues, cost of revenues increased from 61.9% in the first six months of fiscal 2004 to 62.8% in the first six months of fiscal 2005. The change in cost of revenues as a percentage of net revenues resulted from more product sales in the other category, which is primarily consumer electronics, which carry a lower gross margin or higher cost of revenue compared to product sales of sporting goods. Cost of revenues from product sales as a percentage of net revenues from product sales increased from approximately 73.7% in the first six months of fiscal 2004 to approximately 75.8% in the first six months of fiscal 2005.

Gross Profit

Gross profit consists of gross profit from product sales and gross profit from service fees. Because we do not record cost of service fee revenues, net revenues from service fees and gross profit from service fees are the same. The following tables show gross profit for the first quarter of fiscal 2004 and the first quarter of fiscal 2005, the first six months of fiscal 2004 and the first

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six months of fiscal 2005, the percentages that such gross profit bears to product sales, service fees and total net revenues and the period over period changes in gross profit.

Three-month period ended July 3, 2004 and July 2, 2005:

	Second Fiscal Qtr 2004								Second Fiscal Qtr 2005								Second Fiscal Qtr. 2005 vs Second Fiscal Qtr. 2004
	$		% of Product Sales		% of Service Fees		% of Net Revenue		$		% of Product Sales		% of Service Fees		% of Net Revenue		$ Change		% Change
Gross profit from product sales	$	13.6	25.6	%	—				$	17.7	23.5	%	—				$	4.1	30.1	%
Gross profit from service fees		11.5	—		100	%				16.7	—		100	%				5.2	45.2	%
Gross profit	$	25.1					38.8	%	$	34.4					37.4	%	$	9.3	37.1	%

The increase in gross profit for the second quarter of fiscal 2005 was due to a $5.2 million increase in service fee revenues and a $4.1 million increase in gross profit from product sales primarily of our existing partners. The decrease in gross profit as a percentage of net revenues in second quarter of fiscal 2005 was largely driven by greater than planned product sales in the other category, which is primarily consumer electronics, which carry a lower gross margin than product sales of sporting goods. Gross profit from product sales represented 54.2% of total gross profit in second quarter of fiscal 2004 and 51.5% in second quarter of fiscal 2005. Gross profit from service fee revenues represented 45.8% of total gross profit in second quarter of fiscal 2004 and 48.5% in second quarter of fiscal 2005. The gross profit on product sales decreased from 25.6% in second quarter of fiscal 2004 to 23.5% in second quarter of fiscal 2005 due primarily to a shift in sales from sporting goods to consumer electronics.

Six-month period ended July 3, 2004 and July 2, 2005:

	First Six Months Fiscal 2004								First Six Months Fiscal 2005								First Six Months Fiscal 2005 vs First Six Months Fiscal 2004
			% of		% of		% of				% of		% of		% of
			Product		Service		Net				Product		Service		Net		$		%
	$		Sales		Fees		Revenue		$		Sales		Fees		Revenue		Change		Change
Gross profit from product sales	$	28.9	26.3	%	—				$	36.8	24.2	%	—				$	7.9	27.3	%
Gross profit from service fees		21.0	—		100	%				31.4	—		100	%				10.4	49.5	%
Gross profit	$	49.9					38.1	%	$	68.2					37.2	%	$	18.3	36.7	%

The increase in gross profit for the first six months of fiscal 2005 was due to a $10.4 million increase in service fee revenues and an $7.9 million increase in gross profit from product sales primarily of our existing partners. The decrease in gross profit as a percentage of net revenues in first six months of fiscal 2005 was largely driven by greater than planned product sales in the other category, which is primarily consumer electronics, which carry a lower gross margin than product sales of sporting goods. Gross profit from product sales represented 58.0% of total gross profit in six months of fiscal 2004 and 54.0% in first six months of fiscal 2005. Gross profit from service fee revenues represented 42.0% of total gross profit in first six months of fiscal 2004 and 46.0% in first six months of fiscal 2005. The gross profit on product sales decreased from 26.3% in first six months of fiscal 2004 to 24.2% in first six months of fiscal 2005 due primarily to a shift in sales from sporting goods to consumer electronics.

Operating Expenses

Operating expenses primarily consist of sales and marketing expenses, product development expenses, general and administrative expenses, stock-based compensation expense and depreciation and amortization expenses. The following tables show operating expenses for second quarter of fiscal 2004 and the second quarter of fiscal 2005, the first six months of fiscal 2004 and the first six months of fiscal 2005, the percentages that such expenses bear to net revenues and the period over period changes in operating expenses.

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Three-month period ended July 3, 2004 and July 2, 2005:

	Second Fiscal Qtr 2004				Second Fiscal Qtr 2005				Second Fiscal Qtr 2005 vs Second Fiscal Qtr 2004
	$		%		$		%		$ Change		% Change
Sales and marketing expenses	$	16.8	25.9	%	$	21.2	23.1	%	$	4.4	26.2	%
Product development expenses		4.5	7.0	%		6.4	7.0	%		1.9	42.2	%
General and administrative expenses		4.3	6.8	%		4.5	4.9	%		0.2	4.7	%
Stock-based compensation expense		0.2	0.2	%		1.7	1.9	%		1.5	750.0	%
Depreciation and amortization expenses		2.6	4.1	%		3.7	4.0	%		1.1	42.3	%
Total operating expenses	$	28.4	44.0	%	$	37.5	40.9	%	$	9.1	32.0	%

Sales and Marketing Expenses. Sales and marketing expenses include advertising and promotional expenses, including promotional free shipping and subsidized shipping and handling costs, online marketing fees, commissions to participants in the affiliate programs for our partners’ Web sites, fulfillment costs, customer service costs, credit card fees, merchandising costs and payroll and related expenses. These expenses also include partner revenue share charges, which are royalty payments made to our partners in exchange for the use of their brands, the promotion of our partners’ URLs, Web sites and toll-free telephone numbers in their marketing and communications materials, the implementation of programs to provide incentives to customers to shop through the e-commerce businesses that we operate for our partners and other programs and services provided to the customers of the e-commerce businesses that we operate for our partners.

Sales and marketing expenses increased $4.4 million in the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004 primarily due to a $1.1 million increase in credit card fees, a $0.9 million increase in payroll and related costs principally in our fulfillment operations, a $0.5 million increase in subsidized shipping costs due to increased promotional shipping activity, a $0.4 million increase in occupancy costs related to the opening of a second fulfillment facility in the third quarter of 2004, and a $1.5 million increase in other variable expenses primarily caused by higher sales volumes in the second quarter of fiscal 2005.

Product Development Expenses. Product development expenses consist primarily of expenses associated with planning, maintaining and operating our partners’ e-commerce businesses and payroll and related expenses for engineering, production, creative and management information systems.

Product development expenses increased $1.9 million in the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004 primarily due to a $1.6 million increase in staffing and related costs, and a $0.3 million increase in communication, web hosting and equipment maintenance costs. The increases in these costs were necessary to support new partner launches, deliver enhanced functionality for our partners’ e-commerce businesses and continue to improve the capacity, stability and security of our e-commerce platform.

General and Administrative Expenses. General and administrative expenses consist primarily of payroll and related expenses for executive, finance, human resources, legal and administrative personnel, as well as bad debt expense and occupancy costs for our headquarters and other offices.

General and administrative expenses increased $0.2 million from the second quarter of fiscal 2005 as compared to second quarter of fiscal 2004 primarily due to a $0.7 million increase due to investments in payroll and related costs to support the growth of our business, which was partially offset by a $0.3 million in administrative costs in fiscal 2004 that we did not incur in fiscal 2005 and a $0.2 million reduction in other general and administrative expenses.

Stock-Based Compensation. Stock-based compensation expense consists of the amortization of deferred compensation expense for options and awards granted to employees and certain non-employees, including options subject to variable accounting (the expense for which may fluctuate from period to period based on the closing market price of our stock), the value of options or warrants granted to certain partners and investors and amortization of deferred partner revenue share charges. Deferred partner revenue share charges, which are included in other assets, relate to a partner’s exercise of a right to receive shares of our common stock in lieu of future cash revenue share payments.

Stock-based compensation expense increased $1.5 million for the second quarter of fiscal 2005 compared to the second quarter of 2004 primarily due to a $0.8 million increase in the amortization of deferred compensation expense relating to options subject to variable accounting, a $0.5 million increase in expense relating to stock awards, a $0.1 million decrease in expense relating to options for non-employees, as well as a $0.3 million increase in deferred partner revenue share charges resulting from

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higher product sales from the partner’s e-commerce business. As of the end of second quarter of fiscal 2005, we had an aggregate of $1.0 million of deferred stock-based compensation remaining to be amortized. We had stock-based compensation expense related to the amortization of deferred partner revenue share charges of $0.3 million for the second quarter of fiscal 2004 and $0.7 million for second quarter of fiscal 2005.

Depreciation and Amortization Expense. Depreciation and amortization expenses relate primarily to the depreciation of our corporate headquarters and Louisville, Kentucky fulfillment center, the depreciation and amortization of the capitalized costs for our purchased and internally developed technology, including a portion of the cost related to the employees that developed such technology, hardware and software and the depreciation of improvements, furniture and equipment at our corporate headquarters and our fulfillment and customer contact centers.

Depreciation and amortization expenses increased $1.1 million for the second quarter of fiscal 2005 compared to the second quarter of fiscal 2004 primarily due to additional assets to build, manage and operate our business, offset in part, by certain previously purchased assets becoming fully depreciated in fiscal 2004.

Six-month period ended July 3, 2004 and July 2, 2005:

	First Six Months Fiscal 2004				First Six Months Fiscal 2005				First Six Months Fiscal 2005 vs First Six Months Fiscal 2004
	$		%		$		%		$ Change		% Change
Sales and marketing expenses	$	34.4	26.3	%	$	42.1	23.0	%	$	7.7	22.4	%
Product development expenses		9.0	6.9	%		13.0	7.1	%		4.0	44.4	%
General and administrative expenses		8.3	6.3	%		9.8	5.3	%		1.5	18.1	%
Stock-based compensation expense		0.8	0.6	%		1.5	0.8	%		0.7	87.5	%
Depreciation and amortization expenses		5.2	4.0	%		6.7	3.7	%		1.5	28.8	%
Total operating expenses	$	57.7	44.1	%	$	73.1	39.9	%	$	15.4	26.7	%

Sales and marketing expenses increased $7.7 million from the first six months of fiscal 2005 compared to the first six months of fiscal 2004 primarily due to a $2.5 million increase in payroll and related costs principally in our fulfillment operations, a $2.2 million increase in credit card fees, a $0.9 million increase in occupancy related costs due to the opening of a second fulfillment facility in the third quarter of 2004, a $0.7 million increase in online marketing, a $0.8 million increase in subsidized shipping costs related to increased promotional shipping activity, and a $0.6 million increase in other variable expenses primarily caused by higher sales volumes in the first six months of fiscal 2005.

Product development expenses increased $4.0 million in the first six months of fiscal 2005 compared to the first six months of fiscal 2004 primarily due to a $3.2 million increase in staffing and related costs, and a $0.8 million increase in communication, web hosting and equipment maintenance costs. The increases in these costs were necessary to support new partner launches, deliver enhanced functionality for our partners’ e-commerce businesses and continue to improve the capacity, stability and security of our e-commerce platform.

General and administrative expenses increased $1.5 million from the first six months of fiscal 2005 compared to the first six months of fiscal 2004 primarily due to a $1.6 million increased investments in payroll and related costs to support the growth of our business, which was partially offset by a $0.1 million decrease in other general and administrative expenses.

Stock-based compensation expense increased $0.7 million for the first six months of fiscal 2005 compared to the first six months of fiscal 2005 primarily due to a $0.2 million decrease in the amortization of deferred compensation expense relating to options subject to variable accounting, a $0.6 million increase in expense relating to stock awards, a $0.1 million decrease in expense relating to options for non-employees, as well as a $0.4 million increase in deferred partner revenue share charges resulting from higher product sales from the partner’s e-commerce business. As of the end of first six months of fiscal 2005, we had an aggregate of $1.0 million of deferred stock-based compensation remaining to be amortized. We had stock-based compensation expense related to the amortization of deferred partner revenue share charges of $0.7 million for the first six months of fiscal 2004 and $1.1 million for first six months of fiscal 2005.

Depreciation and amortization expenses increased $1.5 million for the first six months of fiscal 2005 compared to the first six months of fiscal 2004 primarily due to additional assets to build, manage and operate our business, offset in part, by certain previously purchased assets becoming fully depreciated in fiscal 2004.

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Other (Income) Expense

Other (income) expense consists of expenses related to a minority interest held by a third party in a joint venture with us and losses and gains on the disposition of assets. Interest expense consists primarily of interest expense paid in connection with a mortgage note that we have on our new corporate headquarters, interest expense on capital leases and interest expense related to the issuance of convertible notes. Interest income consists primarily of interest earned on cash, cash equivalents, and marketable securities.

Income Taxes

Since the sales of our discontinued operations in fiscal 1999 and fiscal 2000, we have not generated taxable income. Net operating losses generated have been carried back to offset income taxes paid in prior years. The remaining net operating losses will be carried forward. As of January 1, 2005, we had available net operating loss carryforwards of approximately $443 million which expire in the years 2005 through 2024. The use of certain net operating loss carryforwards are subject to annual limitations based on ownership changes of our stock, as defined by Section 382 of the Internal Revenue Code. We expect that net operating losses of approximately $245 million will expire before they can be used. Any otherwise recognizable deferred tax assets have been offset by a valuation allowance for the net operating loss carryforwards.

Certain Related Party Transactions

In fiscal 2000 and 2001, Interactive Technology Holdings, LLC, a joint venture of Comcast Corporation and QVC, Inc., acquired 10,797,900 shares of our common stock and warrants to purchase 300,000 shares of our common stock, which accounted for approximately 26.0% of our outstanding common stock as of January 1, 2005. On January 31, 2005, ITH effected a distribution of all of its assets, including shares of GSI common stock, to entities affiliated with Comcast and QVC. As of July 2, 2005, QVC beneficially owned approximately 19.3% of our outstanding common stock. M. Jeffrey Branman, one of our directors, was the President of Interactive Technology Services, which served as financial advisor to ITH through its dissolution. Mr. Branman is no longer affiliated with ITH, Interactive Technology Services or QVC.

In fiscal 2000, we entered into a website development and distribution agreement with iQVC, a division of QVC, Inc., pursuant to which we provide technology, procurement and fulfillment services for QVC, including selling sporting goods, recreational and/or fitness related equipment and related products, apparel and footwear to QVC for resale through the QVC website. We recognized net revenues of $113,000 and $511,000 for the second quarter and first six months of fiscal 2005 sales to QVC under this website development and distribution agreement. The terms of these sales are comparable to those with our other business-to-business partners. Included in accounts receivable as of the end of the second quarter of fiscal 2005 was $34,000 related to these sales.

In fiscal 2003, we entered into a services agreement with QVC, Inc. pursuant to which QVC provided shipping services to us in exchange for fees. The fees charged to us by QVC were determined through arms-length negotiations. This agreement terminated effective April 3, 2005. We incurred fees of $25,442 for the first six months of fiscal 2005, of which $12,794 related directly to products shipped and was charged to cost of revenues from product sales and $12,648 related to fulfillment services provided and was charged to sales and marketing expense. These fees were incurred in the first quarter of fiscal 2005 as the agreement terminated April 3, 2005.

We were the beneficial owner of Series C and Series D Convertible Preferred Stock of Odimo Incorporated, referred to as Odimo, and warrants to acquire additional shares of Series C and Series D Convertible Preferred Stock of Odimo. These securities were acquired in connection with the sale of certain assets of our Ashford.com subsidiary in 2002.

In February, 2005, Odimo completed an initial public offering through the issuance of 3,125,000 shares of its common stock. Effective upon completion of Odimo’s initial public offering, we exercised our warrants to acquire Series C and Series D Convertible Preferred Stock of Odimo and converted all of such shares, along with our already held shares of Series C and Series D Convertible Preferred Stock of Odimo, into an aggregate of 824,594 shares of common stock of Odimo. We own approximately 11.5% of the outstanding common stock of Odimo Incorporated. SOFTBANK Capital Partners LLC and its affiliates collectively own approximately 11.9% of the outstanding common stock of Odimo. SOFTBANK Capital Partners LLC and its affiliates collectively own approximately 20.7% of our outstanding common stock. Ronald D. Fisher, one of our directors, is vice-chairman of SOFTBANK Holdings Inc. and SOFTBANK Corp. and a managing general partner of SOFTBANK Capital Partners LP, which are affiliates of SOFTBANK Capital Partners LLC, and Michael S. Perlis, one of our directors, is also managing partner of SOFTBANK Capital Partners LP.

In exchange for Rustic Canyon Partners forfeiting its right to designate one member to GSI’s board of directors on June 25, 2004, GSI’s board of directors approved the issuance to Rustic Canyon Partners of a warrant to purchase 12,500 shares of GSI’s common stock with a term of five years and an exercise price equal to the closing price of GSI’s common stock as reported on the

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Nasdaq National Market on the date immediately preceding the date of the approval of such issuance. Mark S. Menell, one of our directors, is a partner of Rustic Canyon Partners.

Liquidity and Capital Resources

Our principal source of liquidity is our cash, cash equivalents and marketable securities. Our cash, cash equivalents, and marketable securities balances were $75.4 million as of the end of fiscal 2004 and $117.5 million as of the end of the second quarter of fiscal 2005.

Since our entry into the e-commerce business in 1999, we have primarily funded our operations with approximately $258.5 million in cash raised in equity and debt financings. We also received an aggregate of $23.5 million in proceeds from the sales of our discontinued operations in fiscal 1999 and fiscal 2000 and $35.7 million in cash from the acquisition of Fogdog, Inc. in fiscal 2000. We used a portion of the cash from these transactions in connection with the exit from our discontinued operations and the balance for the working capital needs to fund operating losses incurred prior to fiscal 2004 and general business purposes of our e-commerce business. We also used $7.1 million in cash in connection with our acquisition of Ashford.com, Inc. in March 2002 and received $1.0 million in cash and a secured note in the principal amount of $4.5 million in connection with our sale of certain assets of Ashford in December 2002 and March 2003. This note was repaid in full in August 2004. In June 2005 we received proceeds of approximately $80 million net of underwriter’s discount and offering expenses from the completion of our public offering of equity and debt. We intend to use the net proceeds from the offering for working capital and general corporate purposes, including possible acquisitions.

We had working capital of $30.1 million as of the end of fiscal 2004 and $105.2 million as of the end of the second quarter of fiscal 2005, and an accumulated deficit of $176.7 million as of the end fiscal 2004 and $181.2 million as of the end of the second quarter of fiscal 2005.

We used approximately $27.9 million in net cash for operating activities during the first six months of fiscal 2005. Our principal sources of operating cash during the first six months of fiscal 2005 were payments received from customers and fee-based partners, which generally approximate our net revenues from product sales and our service fee revenues, respectively. Our principal uses of operating cash during the first six months of fiscal 2005 were cash paid to product suppliers, employee compensation and partner revenue share payments. Changes in our operating assets and liabilities during the first six months of fiscal 2005 resulted in a net cash outflow of $31.6 million. The most significant changes were a decrease in accounts payable, accrued expenses and other, offset, in part, by a decrease in accounts receivable compared to the end of fiscal 2004. The decrease in accounts payable, accrued expenses and other was due primarily to a decrease in trade accounts payable due primarily to lower inventory levels at the end of the second quarter of fiscal 2005 and a decrease in amounts owed to partners, which were related to increased sales volume in the fourth quarter of fiscal 2004. Our investing activities during the first six months of fiscal 2005 consisted primarily of the purchase of $81.7 million and sale of $43.0 million of marketable securities. During the first six months of fiscal 2005, we also incurred capital expenditures of $12.5 million. Our financing activities during the first six months of fiscal 2005 consisted of the receipt of $2.6 million in gross proceeds from exercises of common stock options and $85.7 million in gross proceeds from public offering of equity and debt.

We used approximately $13.6 million in net cash for operating activities during the first six months of fiscal 2004. Our principal sources of operating cash during the first six months of fiscal 2004 were payments received from customers and fee-based partners, which generally approximate our net revenues from product sales and our service fee revenues, respectively. Our principal uses of operating cash during the first six months of fiscal 2004 were cash paid to product suppliers, employee compensation and partner revenue share payments. Changes in our operating assets and liabilities during the first six months of fiscal 2004 resulted in a net cash outflow of $12.2 million. The most significant changes were a decrease in accounts payable, accrued expenses and other, a decrease in deferred revenue and an increase in accounts receivable compared to the end of fiscal 2003. The decrease in accounts payable, accrued expenses and other was due primarily to a decrease in operating accounts payable related to decreased sales volume in the fourth quarter of fiscal 2003. The decrease in deferred revenue was due to a decrease in service fees paid to us in advance by certain partners. The increase in accounts receivable was due primarily to decreases in our accounts receivable reserves. Our investing activities during the first six months of fiscal 2004 consisted primarily of the purchase of our new corporate headquarters and other capital expenditures totaling approximately $22.4 million. During the first six months of fiscal 2004, we also purchased $17.3 million and sold $15.1 million of marketable securities. Our financing activities during the first six months of fiscal 2004 consisted primarily of the receipt of $13.0 million in gross proceeds from a mortgage note on our new corporate headquarters.

During the three-months ended July 2, 2005, we increased our long-term debt contractual obligations. In June 2005, we completed an offering of $57.5 million of 3.0% convertible unsecured notes due June 1, 2025. Interest on the notes is payable semi-annually on June 1 and December 1, beginning December 1, 2005.

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Seasonality

We have experienced and expect to continue to experience seasonal fluctuations in our revenues. These seasonal patterns will cause quarterly fluctuations in our operating results. In particular, our fourth fiscal quarter has accounted for and is expected to continue to account for a disproportionate percentage of our total annual revenues. 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.

Risk Factors

Any investment in our common stock or other securities involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information contained in this Quarterly Report on Form 10-Q. If any of the following risks occur, our business could be materially harmed. In these circumstances, the market price of our common stock could decline, and you may lose all or part of the money you paid to buy our common stock. The risks described below are not the only ones facing our company. Additional risks not necessarily known to us or that we currently deem immaterial may also impair our business operations.

Risks Related to Our Business

Our future success cannot be predicted based upon our limited operating history.

Compared to certain of our current and potential competitors, we have a relatively short operating history. In addition, the nature of our business has undergone rapid development and change since we began operating it. Accordingly, it is difficult to predict whether we will be successful. Thus, our chances of financial and operational success should be evaluated in light of the risks, uncertainties, expenses, delays and difficulties associated with operating a new business in a relatively new market, many of which are beyond our control. If we are unable to address these issues, we may not be financially or operationally successful.

We have an accumulated deficit and may incur additional losses.

We have incurred losses over the prior six fiscal years and in the first two quarters of fiscal 2005 while operating our business. As of the end of the second quarter of fiscal 2005, we had an accumulated deficit of $181.2 million. We may not generate sufficient revenue from our existing partners, add an appropriate number of new partners or adequately control our expenses. While we expect to be profitable in fiscal 2005, there can be no assurances that we will be able to achieve profitability.

We will continue to incur significant operating expenses and capital expenditures as we:

• enhance our fulfillment capabilities;

• further improve our order processing systems and capabilities;

• develop new technologies and features to improve our partners’ e-commerce businesses;

• enhance our customer service center capabilities to better serve customers’ needs;

• improve our marketing, customer relationship management and design capabilities;

• increase our general and administrative functions to support our growing operations;

• continue our business development, sales and marketing activities; and

• make strategic or opportunistic acquisitions of complementary or new businesses or assets.

If we incur expenses at a greater pace than our revenues, we could incur additional losses.

Our growth may be limited if we do not generate sufficient cash to fund our operations. We may in the future need additional debt or equity financing to execute our business and continue our growth. Such additional financing may not be available on satisfactory terms or it may not be available when needed, or at all.

Because we have not generated sufficient cash from operations to date, we have funded our e-commerce business primarily from the sale of equity securities. If our cash flows are insufficient to fund our operations, we may in the future need to seek additional equity or debt financings or reduce costs. Further, we may not be able to obtain financing on satisfactory terms or it may not be available when needed, or at all. Our inability to finance our growth, either internally or externally, may limit our growth potential and our ability to execute our business strategy. If we issue securities to raise capital, our existing stockholders may experience dilution or the new securities may have rights senior to those of our common stock.

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Seasonal fluctuations in sales could cause wide fluctuations in our quarterly results.

We have experienced and expect to continue to experience seasonal fluctuations in our revenues. These seasonal patterns have caused and will continue to cause quarterly fluctuations in our operating results. Our results of operations historically have been seasonal primarily because consumers increase their purchases on our partners’ e-commerce businesses during the fourth quarter holiday season.

In anticipation of increased sales activity during our fourth fiscal quarter, we incur additional expenses by hiring a significant number of temporary employees to supplement our permanent staff. Our fourth fiscal quarter has accounted for and is expected to continue to account for a disproportionate percentage of our total annual revenues. For each of fiscal 2004 and fiscal 2003 approximately 40% of our annual net revenues were generated in our fiscal fourth quarter. Since fiscal 1999, we have not generated net income in any fiscal quarter other than a fiscal fourth quarter. If our revenues are below seasonal expectations during the fourth fiscal quarter, our operating results could be below the expectations of securities analysts and investors. Due to the nature of our business, it is difficult to predict the seasonal pattern of our sales and the impact of this seasonality on our business and financial results. In the future, our seasonal sales patterns may become more pronounced, may strain our personnel, customer service operations, fulfillment operations and shipment activities and may cause a shortfall in revenues compared to expenses in a given period.

In addition, if too many consumers access our partners’ e-commerce businesses within a short period of time due to increased holiday or other demand, we may experience system interruptions that make our partners’ e-commerce businesses unavailable or prevent us from transmitting orders to our fulfillment operations, which may reduce the volume of goods we sell as well as the attractiveness of our partners’ e-commerce businesses to consumers. In anticipation of increased sales activity during our fourth fiscal quarter, we and our partners increase our inventory levels. If we and our partners do not increase inventory levels for popular products in sufficient amounts or are unable to restock popular products in a timely manner, we and our partners may fail to meet customer demand which could reduce the attractiveness of our partners’ e-commerce businesses. Alternatively, if we overstock products, we may be required to take significant inventory markdowns or write-offs, which could reduce profits.

We have expanded into new categories and may expand into additional new categories in the future. If we do not successfully execute on the expansion of our operations into these new categories, our growth could be limited.

While we have operated in e-commerce since 1999, we did not expand beyond the sporting goods category until 2001. Today, our operations have expanded into categories including apparel, health and beauty, consumer electronics, entertainment, home and jewelry and luxury goods. Each category in which we operate requires unique capabilities and increases the complexity of our business. If we are unable to generate sufficient revenue in a category, we may not be able to cover the incremental staffing and expenses required to support the unique capabilities required by that category. If we do not expand into new categories, there can be no assurance that we will do so successfully.

Consumers are constantly changing their buying preferences. If we fail to anticipate these changes and adjust our inventory accordingly, we could experience lower sales, higher inventory markdowns and lower margins for the inventory that we own.

Our success depends, in part, upon our ability and our partners’ ability to anticipate and respond to consumer trends with respect to products sold through the e-commerce businesses we operate. Consumers’ tastes are subject to frequent and significant changes. In order to be successful, we or our partners must accurately predict consumers’ tastes and avoid overstocking or understocking products. If we or our partners fail to identify and respond to changes in merchandising and consumer preferences, sales on our partners’ e-commerce businesses could suffer and we or our partners could be required to mark down unsold inventory. This would depress our profit margins. In addition, any failure to keep pace with changes in consumers’ tastes could result in lost opportunities which could reduce sales.

High merchandise returns or shrinkage rates could adversely affect our business, financial condition and results of operations.

We cannot be assured that inventory loss and theft, or “shrinkage” and merchandise returns will not increase in the future. If merchandise returns are significant, or our shrinkage rate increases, our revenues and costs of operations could be adversely affected.

Our growth depends, in part, on our ability to add and launch new partners on a timely basis and on favorable terms.

One of the principal components of our growth strategy is to add new partners. If we are unable to add our targeted number of new partners or if we are unable to add new partners on favorable terms, our growth may be limited. If we are unable to add and launch new partners within the time frames projected by us, we may not be able to achieve our targeted results in the

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expected periods. In addition, our ability to add new partners depends on the quality of the services we provide and our reputation. To the extent that we have difficulties with the quality of the services we provide or have operational issues that adversely affect our reputation, it could adversely impact our ability to add new partners. Because competition for new partners is intense, we may not be able to add new partners on favorable terms, or at all.

Our success is tied to the success of the partners for which we operate e-commerce businesses.

Our success is substantially dependent upon the success of the partners for which we operate e-commerce businesses. The retail business in the United States is intensely competitive. If our partners were to have financial difficulties or seek protection from their creditors or if they were to suffer impairment of their brand, it could adversely affect our ability to maintain and grow our business. Our business could also be adversely affected if our partners’ marketing, brands or retail stores are not successful or if our partners reduce their marketing or number of retail stores.

We enter into contracts with our partners. We derived 62% of our revenue in fiscal 2004 from five partners. If we do not maintain good working relationships with our partners, particularly our large partners, or perform as required under these agreements, it could adversely affect our business.

The contracts with our partners establish complex relationships between our partners and us. We spend a significant amount of time and effort to maintain our relationships with our partners and address the issues that from time to time may arise from these complex relationships. For fiscal 2004, sales to customers through one of our partner’s e-commerce businesses accounted for 27% of our revenue, sales through another one of our partner’s e-commerce businesses accounted for 13% of our revenue and sales through our top five partners’ e-commerce businesses accounted for 62% of our revenue. For fiscal 2003, sales to customers through one of our partner’s e-commerce businesses accounted for 28% of our revenue, sales to customers through another one of our partner’s e-commerce businesses accounted for 17% of our revenue, and sales through our top five partners’ e-commerce businesses accounted for 70% of our revenue. Our partners could decide not to renew their agreements at the end of their respective terms. Additionally, if we do not perform as required under these agreements or if we breach these agreements, our partners could seek to terminate their agreements prior to the end of their respective terms or seek damages from us. Loss of our existing partners, particularly our major partners, could adversely affect our business, financial condition and results of operations.

We and our partners must develop and maintain relationships with key manufacturers to obtain a sufficient assortment and quantity of quality merchandise on acceptable commercial terms. If we or our partners are unable to do so, it could adversely affect our business, results of operations and financial condition.

For the e-commerce businesses for which we own inventory, we primarily purchase products from the manufacturers and distributors of the products. For the e-commerce businesses for which our partners own inventory, our partners typically purchase products from the manufacturers and distributors of products or source their own products. If we or our partners are unable to develop and maintain relationships with these manufacturers, distributors or sources we or our partners may be unable to obtain or continue to carry a sufficient assortment and quantity of quality merchandise on acceptable commercial terms and our partners’ e-commerce businesses and our business could be adversely impacted. We do not have written contracts with some of our suppliers. During the second quarter of fiscal 2005, we purchased 49.3% of the total amount of inventory we purchased from one manufacturer. In addition, during the second quarter of fiscal 2004, we purchased 37.2% of the total amount of inventory we purchased from the same manufacturer. During the first six months of fiscal 2005, 49.0% of the total amount of inventory we purchased was from one manufacturer. In addition, during the first six months of fiscal 2004, 37.1% of the total amount of inventory we purchased was from the same manufacturer. While we have a contract with this manufacturer, this manufacturer and other manufacturers could stop selling products to us or our partners to remove their products or logos from our partners’ Web sites. If we or our partners are unable to obtain products directly from manufacturers, especially popular brand manufacturers, we or our partners may not be able to obtain the same or comparable merchandise in a timely manner or on acceptable commercial terms.

We rely on our ability to enter into marketing and promotion agreements with online services, search engines, directories and other Web sites to drive traffic to the e-commerce businesses we operate. If we are unable to enter into or properly develop these marketing and promotional agreements, our ability to generate revenue could be adversely affected.

We have entered into marketing and promotion agreements with online services, search engines, directories and other Web sites to provide content, advertising banners and other links to our partners’ e-commerce businesses. We expect to rely on these agreements as significant sources of traffic to our partners’ e-commerce businesses and to generate new customers. If we are unable to maintain these relationships or enter into new agreements on acceptable terms, our ability to attract new customers could be harmed. Further, many of the parties with which we may have online advertising arrangements provide advertising services for other marketers of goods. As a result, these parties may be reluctant to enter into or maintain relationships with us.

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Failure to achieve sufficient traffic or generate sufficient revenue from purchases originating from third parties may limit our partners’ and our ability to maintain market share and revenue.

If we experience problems in our fulfillment operations, our business could be adversely affected.

Although we operate our own fulfillment center, we rely upon multiple third parties for the shipment of our products. We also rely upon certain vendors to ship products directly to consumers. As a result, we are subject to the risks associated with the ability of these vendors and other third parties to successfully and in a timely manner fulfill and ship customer orders. The failure of these vendors and other third parties to provide these services, or the termination or interruption of these services, could adversely affect the satisfaction of consumers, which could result in reduced sales by our partners’ e-commerce businesses.

Under some of our partner agreements, we maintain the inventory of our partners in our fulfillment centers. Our failure to properly handle and protect such inventory could adversely affect our relationship with our partners.

A disruption in our operations could materially and adversely affect our business, results of operations and financial condition.

Any disruption to our operations, including system, network, telecommunications, software or hardware failures, and any damage to our physical locations, could materially and adversely affect our business, results of operations and financial condition.

Our operations are subject to damage or interruption from:

• fire, flood, hurricane, tornado, earthquake or other natural disasters;

• power losses, interruptions or brown-outs;

• Internet, telecommunications or data network failures;

• physical and electronic break-ins or security breaches;

• computer viruses;

• acts of terrorism; and

• other similar events.

If any of these events occur, it could result in interruptions, delays or cessations in service to customers of our partners’ e-commerce businesses and adversely impact our partners’ e-commerce businesses. These events could also prevent us from fulfilling orders for our partners’ e-commerce businesses. Our partners might seek significant compensation from us for their losses. Even if unsuccessful, this type of claim likely would be time consuming and costly for us to address and damaging to our reputation.

Our primary data centers are located at two facilities of a third-party hosting company. We do not control the security, maintenance or operation of these facilities, which are also susceptible to similar disasters and problems.

Our insurance policies may not cover us for losses related to these events, and even if they do, may not adequately compensate us for any losses that we may incur. Any system failure that causes an interruption of the availability of our partners’ e-commerce businesses could reduce the attractiveness of our partners’ e-commerce businesses to consumers and result in reduced revenues, which could materially and adversely affect our business, results of operations and financial condition.

If we do not respond to rapid technological changes, our services and proprietary technology and systems may become obsolete.

The Internet and e-commerce are constantly changing. Due to the costs and management time required to introduce new services and enhancements, we may be unable to respond to rapid technological changes in a timely enough manner to avoid our services becoming uncompetitive. To remain competitive, we must continue to enhance and improve the functionality and features of our partners’ e-commerce businesses. If competitors introduce new services using new technologies or if new industry standards and practices emerge, our partners’ existing e-commerce businesses and our services and proprietary technology and systems may become uncompetitive and our ability to attract and retain customers may be at risk.

Developing our e-commerce platform, offering our partners’ e-commerce businesses and other proprietary technology entails significant technical and business risks. We may use new technologies ineffectively or fail to adapt our e-commerce platform, our partners’ e-commerce businesses and our technology to meet the requirements of partners and customers or

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emerging industry standards. Additionally, the vendors we use for our partners’ e-commerce businesses may not provide the level of service we expect or may not be able to provide their product or service to us on commercially reasonable terms, if at all.

Our success is tied to the continued growth in the use of the Internet and the adequacy of the Internet infrastructure.

Our future success is substantially dependent upon continued growth in the use of the Internet. The number of users and advertisers on the Internet may not increase and commerce over the Internet may not continue to grow for a number of reasons, including:

• actual or perceived lack of security of information or privacy protection;

• lack of access and ease of use;

• congestion of traffic on the Internet;

• inconsistent quality of service and lack of availability of cost-effective, high-speed service;

• possible disruptions, computer viruses or other damage to the Internet servers or to users’ computers;

• governmental regulation;

• uncertainty regarding intellectual property ownership;

• lack of high-speed modems and other communications equipment; and

• increases in the cost of accessing the Internet.

Published reports have also indicated that growth in the use of the Internet has resulted in users experiencing delays, transmission errors and other difficulties. As currently configured, the Internet may not support an increase in the number or requirements of users. In addition, there have been outages and delays on the Internet as a result of damage to the current infrastructure. The amount of traffic on our partners’ Web sites could decline materially if there are outages or delays in the future. The use of the Internet may also decline if there are delays in the development or adoption of modifications by third parties that are required to support increased levels of activity on the Internet. If any of the foregoing occurs, the number of our partners’ customers could decrease. In addition, we may be required to spend significant capital to adapt our operations to any new or emerging technologies relating to the Internet.

Consumers may be unwilling to use the Internet to purchase goods.

Our future success depends heavily upon the general public’s willingness to use the Internet as a means to purchase goods. The failure of the Internet to continue to develop as an effective commercial tool would seriously damage our future operations. If consumers are unwilling to use the Internet to conduct business, our business may not continue to grow. The Internet may not succeed as a medium of commerce because of security risks and delays in developing elements of the needed Internet infrastructure, such as a reliable network, high-speed modems, high-speed communication lines and other enabling technologies.

Third parties may have the technology or know-how to breach the security of customer transaction data and confidential information stored on our servers. Any breach could cause customers to lose confidence in the security of our partners’ e-commerce businesses and choose not to purchase from those businesses. Our security measures may not effectively prevent others from obtaining improper access to the information on our partners’ e-commerce businesses. If someone is able to circumvent our security measures, he or she could destroy or steal valuable information or disrupt the operation of our partners’ e-commerce businesses. Concerns about the security and privacy of transactions over the Internet could inhibit our growth.

We and/or our partners may be unable to protect our and their proprietary technology and intellectual property rights or keep up with that of our competitors.

Our success depends to a significant degree upon the protection of our intellectual property rights in the core technology and other components of our e-commerce platform including our software and other proprietary information, and material, and our ability to develop technologies that are as good as or better than that of our competitors. We may be unable to deter infringement or misappropriation of our software and other proprietary information and material, detect unauthorized use or take appropriate steps to enforce our intellectual property rights. In addition, the failure of our partners to protect their intellectual property rights, including their trademarks and domain names, could impair our operations. Our competitors could, without violating our intellectual property rights, develop technologies that are as good as or better than our technology. Protecting our

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intellectual property and other proprietary rights can be expensive. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and consequently harm our operating results. Our failure to protect our intellectual property rights in our software and other information and material or to develop technologies that are as good as or better than our competitors could put us at a disadvantage to our competitors. These failures could have a material adverse effect on our business.

We may be subject to intellectual property claims or competition or trade practices claims that could be costly and could disrupt our business.

Third parties may assert that our business or technologies infringe or misappropriate their intellectual property rights. Third parties may claim that we do not have the right to offer certain services or products or to present specific images or logos on our partners’ e-commerce businesses, or we have infringed their patents, trademarks, copyrights or other rights. We may in the future receive claims that we are engaging in unfair competition or other illegal trade practices. We may be unsuccessful in defending against these claims, which could result in substantial damages, fines or other penalties. The resolution of a claim could also require us to change how we do business, redesign our service offering or partners’ e-commerce businesses or enter into burdensome royalty or license agreements. These license or royalty agreements, if required, may not be available on acceptable terms, if at all, in the event of a successful claim of infringement. Our insurance coverage may not be adequate to cover every claim that third parties could assert against us. Even unsuccessful claims could result in significant legal fees and other expenses, diversion of management’s time and disruptions in our business. Any of these claims could also harm our reputation.

We may not be able to compete successfully against current and future competitors, which could harm our margins and our business.

The market for the development and operation of e-commerce businesses is continuously evolving and is intensely competitive. Increased competition could result in fewer successful opportunities to partner, price reductions, reduced gross margins and loss of market share, any of which could seriously harm our business, results of operations and financial condition. We primarily compete with companies that can offer a full range of e-commerce services similar to the services we provide through our e-commerce platform, such as the Services Division of Amazon^®, Digital River^®, Commerce5, Foot Locker^® (principally in the sporting goods category) and ValueVision Media. We also compete with companies that provide some components of an e-commerce solution similar to those that we offer through our e-commerce platform, including Web site developers, third-party consultants and third-party fulfillment and customer service providers. In addition, we compete with companies that provide components of an e-commerce solution that allow others to develop and operate their e-commerce business in-house. We also compete with online and offline businesses of a variety of retailers and manufacturers in our targeted categories.

Many of our current and potential competitors have longer operating histories, larger customer base, greater brand recognition and significantly greater financial, marketing and other resources than we have. They may be able to secure merchandise from vendors on more favorable terms and may be able to adopt more aggressive pricing policies. They may also receive investments from or enter into other commercial relationships with large, well-established companies with greater financial resources. Competitors in both the retail and e-commerce services industries also may be able to devote more resources to technology development and marketing than we do.

We currently do not offer e-commerce services outside of the United States, Canada and Europe. Some of our competitors offer international e-commerce services and our existing and potential partners may find these competitors more attractive for that reason.

Competition in the e-commerce industry may intensify. Other companies in the retail and e-commerce service industries may enter into business combinations or alliances that strengthen their competitive positions. Additionally, there are relatively low barriers to entry into the e-commerce market. As various Internet market segments obtain large, loyal customer bases, participants in those segments may expand into the market segments in which we operate. In addition, new and expanded Web technologies may further intensify the competitive nature of online retail. The nature of the Internet as an electronic marketplace facilitates competitive entry and comparison shopping and renders it inherently more competitive than conventional retailing formats. This increased competition may reduce our sales, our ability to operate profitably, or both.

We may be subject to product liability claims that could be costly and time-consuming.

We sell products manufactured by third parties, some of which may be defective. We also sell some products that are manufactured by third parties for us. If any product that we sell were to cause physical injury or injury to property, the injured party or parties could bring claims against us as the retailer or manufacturer of the product. These claims may not be covered by insurance and, even if they are, our insurance coverage may not be adequate to cover every claim that could be asserted. Similarly, we could be subject to claims that customers of our partners’ e-commerce businesses were harmed due to their reliance

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on our product information, product selection guides, advice or instructions. If a successful claim were brought against us in excess of our insurance coverage, it could adversely affect our business. Even unsuccessful claims could result in the expenditure of funds and management time and could have a negative impact on our business.

We may be liable if third parties misappropriate our customers’ personal information. Additionally, we are limited in our ability to use and disclose customer information.

Any security breach could expose us to risks of loss, litigation and liability and could seriously disrupt our operations. If third parties are able to penetrate our network or telecommunications security or otherwise misappropriate our customers’ personal information or credit card information or if we give third parties improper access to our customers’ personal information or credit card information, we could be subject to liability. This liability could include claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims. They could also include claims for other misuses of personal information, including unauthorized marketing purposes. These claims could result in litigation. Liability for misappropriation of this information could be significant. In addition, the Federal Trade Commission and state agencies regularly investigate various companies’ use of customers’ personal information. We could incur additional expenses if new regulations regarding the security or use of personal information are introduced or if government agencies investigate our privacy practices

Credit card fraud and other fraud could adversely affect our business.

We do not carry insurance against the risk of credit card fraud and other fraud, so the failure to adequately control fraudulent transactions could increase our expenses. To date, we have not suffered material losses due to fraud. However, we may in the future suffer losses as a result of orders placed with fraudulent credit card data. Under current credit card practices, we are liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature. With respect to checks and installment sales, we generally are liable for fraudulent transactions.

If one or more states successfully assert that we should collect sales or other taxes on the sale of our merchandise, our business could be harmed.

We currently collect sales or other similar taxes for goods sold by us and shipped into certain states. One or more local, state or foreign jurisdictions may seek to impose sales tax collection obligations on us or our partners and other out-of-state companies that engage in e-commerce. Recently, certain large retailers, such as Wal-Mart, Target and Toys “R” Us, expanded their collection of sales tax on purchases made through affiliated Web sites. Our business could be adversely affected if one or more states or any foreign country successfully asserts that we should collect sales or other taxes on the sale of merchandise through the e-commerce businesses we operate.

In September 2003, we learned that we, along with several of our partners, were named in an action in the Circuit Court of Cook County, Illinois, by a private litigant who is alleging that we, along with certain of our partners, wrongfully failed to collect and remit sales and use taxes for sales of personal property to customers in Illinois and knowingly created records and statements falsely stating we were not required to collect or remit such taxes. The complaint seeks injunctive relief, unpaid taxes, interest, attorneys’ fees, civil penalties of up to $10,000 per violation, and treble damages under the Illinois Whistleblower Reward and Protection Act. We are aware that this same private litigant has filed similar actions against retailers in other states, and it is possible that we and/or partners may have been or may be named in similar cases in other states. We do not believe that we are liable under existing laws and regulations for any failure to collect sales or other taxes relating to Internet sales in Illinois and intend to vigorously defend ourselves in this matter. However, we may incur substantial expenses in defending against this claim. In the event of a determination adverse to us, we may incur substantial monetary liability, and be required to change our business practices, either of which could have a material adverse effect on our business, financial position or results of operations.

Existing or future law or regulations could harm our business or marketing efforts.

We are subject to federal, state and local laws applicable to businesses in general and to e-commerce specifically. Due to the increasing growth and popularity of the Internet and e-commerce, many laws and regulations relating to the Internet and online retailing are proposed and considered at the federal, state and local levels. These laws and regulations could cover issues such as taxation, pricing, content, distribution, quality and delivery of products and services, electronic contracts, intellectual property rights, user privacy and information security.

For example, at least one state has enacted, and other states have proposed, legislation limiting the uses of personal information collected online or requiring collectors of information to establish procedures to disclose and notify users of privacy and security policies, obtain consent from users for use and disclosure of information, or provide users with the ability to access, correct and delete stored information. Even in the absence of such legislation, the Federal Trade Commission has settled several proceedings resulting in consent decrees in which Internet companies have been required to establish programs regulating the manner in which personal information is collected from users and provided to third parties. We could become a party to a similar

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enforcement proceeding. These regulatory and enforcement efforts could also harm our ability to collect demographic and personal information from users, which could be costly or adversely affect our marketing efforts.

The applicability of existing laws governing issues such as property ownership, intellectual property rights, taxation, libel, obscenity, qualification to do business and export or import matters could also harm our business. Many of these laws may not contemplate or address the unique issues of the Internet or online retailing. Some laws that do contemplate or address those unique issues, such as the Digital Millennium Copyright Act and the CAN-SPAM Act of 2003, are only beginning to be interpreted by the courts and their applicability and reach are therefore uncertain. These current and future laws and regulations could reduce our ability to operate efficiently.

From time to time, we may acquire or invest in other companies. There are risks associated with potential acquisitions and investments and we may not achieve the expected benefits of future acquisitions and investments.

If we are presented with appropriate opportunities, we may make investments in complementary companies, products or technologies or we may purchase other companies. We may not realize the anticipated benefits of any investment or acquisition. We may be subject to unanticipated problems and liabilities of acquired companies. We may not be able to successfully assimilate the additional personnel, operations, acquired technology or products or services into our business. Any acquisition may strain our existing financial and managerial controls and reporting systems and procedures. If we do not successfully integrate any acquired business, the expenditures on integration efforts will reduce our cash position without us being able to realize the expected benefits of the acquisition. In addition, key personnel of an acquired company may decide not to work for us. These difficulties could disrupt our ongoing business, distract our management and employees and increase our expenses. Further, the physical expansion in facilities that could occur as a result of any acquisition may result in disruptions that could seriously impair our business. Finally, we may have to use our cash resources, incur debt or issue additional equity securities to pay for other acquisitions or investments, which could increase our leverage or be dilutive to our stockholders.

The consideration we received in exchange for the sale of certain assets related to Ashford.com, Inc. may be subject to a number of risks.

In connection with the sale of certain assets of Ashford.com to Odimo Acquisition Corp., we received shares of Odimo common stock. Odimo recently became a public company and a well-established public market for its common stock does not exist. If Odimo fails to perform, the value of the Odimo common stock we hold may decrease below the amount at which we have valued this stock on our balance sheet and we may be required to take a charge to earnings.

We may further expand our business internationally, causing our business to become increasingly susceptible to numerous international business risks and challenges.

We believe that the current globalization of the economy requires businesses to consider pursuing international expansion. We recently began shipping certain products to Canada and other countries. In the future, we may expand our international efforts. International sales are subject to inherent risks and challenges that could adversely affect our business, including:

• the need to develop new supplier and manufacturer relationships, particularly because major manufacturers may require that our international operations deal with local distributors;

• compliance with international legal and regulatory requirements and tariffs;

• managing fluctuations in currency exchange rates;

• difficulties in staffing and managing foreign operations;

• greater difficulty in accounts receivable collection;

• potential adverse tax consequences;

• uncertain political and economic climates;

• potential higher incidence of fraud;

• price controls or other restrictions on foreign currency; and

• difficulties in obtaining export and import licenses and compliance with applicable export controls.

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Any negative impact from our international business efforts could negatively impact our business, operating results and financial condition as a whole. In addition, gains and losses on the conversion of foreign payments into U. S. dollars may contribute to fluctuations in our results of operations and fluctuating exchange rates could cause reduced revenues and/or gross margins from non-dollar-denominated international sales.

In addition, if we expand further internationally, we may face additional competition challenges. Local companies may have a substantial competitive advantage because their greater understanding of, and focus on, the local customer. In addition, governments in foreign jurisdictions may regulate e-commerce or other online services in such areas as content, privacy, network security, copyright, encryption, taxation, or distribution. We also may not be able to hire, train, motivate and manage the required personnel, which may limit our growth in international market segments.

The uncertainty regarding the general economy may reduce our revenues.

Our revenue and rate of growth depends on the continued growth of demand for the products offered by our partners, and our business is affected by general economic and business conditions. A decrease in demand, whether caused by changes in consumer spending or a weakening of the U.S. economy or the local economies outside of the United States where we sell products, may result in decreased revenue or growth. Terrorist attacks and armed hostilities create economic and consumer uncertainty that could adversely affect our revenue or growth.

Our success is dependent upon our executive officers and other key personnel.

Our success depends to a significant degree upon the contribution of our executive officers and other key personnel, particularly Michael G. Rubin, chairman of the board and chief executive officer. Although we have employment agreements with most of our executive officers and key personnel, these employees could terminate their employment with us at any time. Due to the competition for highly qualified personnel, we cannot be sure that we will be able to retain or attract executive, managerial or other key personnel. We have obtained key person life insurance for Mr. Rubin in the amount of $9.0 million. We have not obtained key person life insurance for any of our other executive officers or key personnel.

We may be unable to hire and retain skilled technical, operations, merchandising, sales, marketing, and business management personnel which could limit our growth.

Our future success depends on our ability to continue to identify, attract, retain and motivate skilled technical, operations, merchandising, sales, marketing and business management personnel. We intend to continue to seek to hire a significant number of skilled personnel. Due to intense competition for these individuals from our competitors and other employers, we may not be able to attract or retain highly qualified personnel in the future. Our failure to attract and retain the experienced and highly trained personnel that are integral to our business may limit our growth.

There are limitations on the liabilities of our directors and executive officers. Under certain circumstances, we are obligated to indemnify our directors and executive officers against liability and expenses incurred by them in their service to us.

Pursuant to our amended and restated certificate of incorporation and under Delaware law, our directors are not liable to us or our stockholders for monetary damages for breach of fiduciary duty, except for liability for breach of a director’s duty of loyalty, acts or omissions by a director not in good faith or which involve intentional misconduct or a knowing violation of law, dividend payments or stock repurchases that are unlawful under Delaware law or any transaction in which a director has derived an improper personal benefit. In addition, we have entered into indemnification agreements with each of our directors and executive officers. These agreements, among other things, require us to indemnify each director and executive officer for certain expenses, including attorneys’ fees, judgments, fines and settlement amounts, incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of the person’s services as one of our directors or executive officers. The costs associated with actions requiring indemnification under these agreements could be harmful to our business.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential stockholders and partners could lose confidence in our financial reporting, which could harm our business, the trading price of our common stock and our ability to retain our current partners and obtain new partners.

Beginning in early fiscal 2004, we began a process to document and evaluate our internal controls over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting. In this regard, management has been dedicating internal resources, has engaged outside consultants and has adopted a detailed work plan to (i) assess and document the adequacy of internal controls over financial reporting, (ii) take steps to improve control processes, where appropriate, (iii) validate through testing that controls are functioning as documented and (iv) implement a continuous reporting and improvement process for internal control over financial reporting. If we fail to correct any issues in the design or operating effectiveness of internal

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controls over financial reporting or fail to prevent fraud, current and potential stockholders and partners could lose confidence in our financial reporting, which could harm our business, the trading price of our common stock and our ability to retain our current partners and obtain new partners.

A change in accounting standards for employee stock options is expected to have a material impact on our consolidated results of operations and earnings per share.

In December 2004, the Financial Accounting Standards Board, or FASB, issued Financial Accounting Standards Board Statement No. 123R “Share-Based Payment,” or SFAS 123R. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. In addition, SFAS 123R will cause unrecognized expense related to options vesting after the date of initial adoption to be recognized as a charge to results of operations over the remaining vesting period. In April 2005, the SEC delayed the initial adoption of SFAS 123R from interim periods that begin after June 15, 2005, to annual periods that begin after June 15, 2005. We are continuing to evaluate the requirements of SFAS 123R and expect that we will record substantial non cash compensation expenses. The adoption of SFAS 123R is not expected to have a significant effect on our financial condition or cash flows but is expected to have a material impact on our consolidated results of operations and earnings per share.

Risks Related to Our Common Stock

Our operating results have fluctuated and may continue to fluctuate significantly, which may cause the market price of our common stock to be volatile.

Our annual and quarterly operating results have and may continue to fluctuate significantly due to a variety of factors, many of which are outside of our control. Because our operating results may be volatile and difficult to predict, period-to-period comparisons of our operating results may not be a good indication of our future performance. Our operating results may also fall below our published expectations and the expectations of securities analysts and investors, which likely will cause the market price of our common stock to decline significantly.

Factors that may cause our operating results to fluctuate or harm our business include but are not limited to the following:

• our ability to obtain new partners or to retain existing partners;

• the performance of one or more of our partner’s e-commerce businesses;

• our and our partners’ ability to obtain new customers at a reasonable cost or encourage repeat purchases;

• the number of visitors to the e-commerce businesses operated by us or our ability to convert these visitors into customers;

• our and our partners’ ability to offer an appealing mix of products or to sell products that we purchase;

• our ability to adequately develop, maintain, and upgrade our partners’ e-commerce businesses or the technology and systems we use to process customers’ orders and payments;

• the timing and costs of upgrades and developments of our system and infrastructure;

• the ability of our competitors to offer new or superior e-commerce businesses, services or products;

• price competition that results in lower profit margins or losses;

• the seasonality of our business, especially the importance of our fiscal fourth quarter to our business;

• our inability to obtain or develop specific products or brands or unwillingness of vendors to sell their products to us;

• unanticipated fluctuations in the amount of consumer spending on various products that we sell, which tend to be discretionary spending items;

• the cost of advertising and the amount of free shipping and other promotions we offer;

• increases in the amount and timing of operating costs and capital expenditures relating to expansion of our operations;

• our inability to manage our shipping costs on a profitable basis or unexpected increases in shipping costs or delivery times, particularly during the holiday season;

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• inflation of prices of fuel and gasoline and other raw materials that impact our costs;

• technical difficulties, system security breaches, system downtime or Internet slowdowns;

• our inability to manage inventory levels or control inventory shrinkage;

• our inability to manage fulfillment operations or provide adequate levels of customer service or our inability to forecast the proper staffing levels in fulfillment and customer service;

• an increase in the level of our product returns or our inability to effectively process returns;

• government regulations related to the Internet or e-commerce which could increase the costs associated with operating our businesses, including requiring the collection of sales tax on all purchases through the e-commerce businesses we operate; and

• unfavorable economic conditions in general or specific to the Internet or e-commerce, which could reduce demand for the products sold through our partners’ e-commerce businesses.

We have never paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future.

We have never paid cash dividends on our common stock and do not anticipate that any cash dividends will be declared or paid in the foreseeable future. As a result, holders of our common stock will not receive a return, if any, on their investment unless they sell their shares of our common stock.

We are controlled by certain principal stockholders.

As of August 5, 2005, Michael G. Rubin, our chairman and chief executive officer, beneficially owned 16.4%, entities affiliated with SOFTBANK Capital Partners LP, SOFTBANK Capital LP and SOFTBANK Capital Advisor Fund LP, or SOFTBANK, beneficially owned 18.5%, and entities affiliated with QVC beneficially owned 19.2% of our outstanding common stock, including warrants and options to purchase common stock, which are exercisable on or before October 4, 2005. If they decide to act together, any two of Mr. Rubin, SOFTBANK, and QVC would be in a position to exercise considerable control, and all three would be in a position to exercise complete control, over most matters requiring stockholder approval, including the election or removal of directors, approval of significant corporate transactions and the ability generally to direct our affairs. Furthermore, pursuant to the stock purchase agreements, SOFTBANK and QVC each have the right to designate up to two members of our board of directors. This concentration of ownership and SOFTBANK’s and QVC’s right to designate members to our board of directors may have the effect of delaying or preventing a change in control of us, including transactions in which stockholders might otherwise receive a premium over prevailing market prices for our common stock. See “Management – Right to Designate Directors.” Furthermore, Mr. Rubin has entered into voting agreements with each of SOFTBANK and QVC, and SOFTBANK and QVC have entered into voting agreements with each other. The parties to these voting agreements have agreed to support the election of the directors designated by each of the other parties. See “Management – Voting Agreements.”

It may be difficult for a third-party to acquire us and this could depress our stock price.

Certain provisions of our amended and restated certificate of incorporation and bylaws and Delaware law may have the effect of discouraging, delaying or preventing transactions that involve any actual or threatened change in control. Under our amended and restated certificate of incorporation, our board of directors may issue preferred stock from time to time in one or more series with such terms, rights, preferences and designations as the board may determine and without any vote of the stockholders, unless otherwise required by law.

In addition, we are subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, restricts certain transactions and business combinations between a corporation and a stockholder owning 15% or more of the corporation’s outstanding voting stock for a period of three years from the date the stockholder becomes a 15% stockholder. In addition to discouraging a third party from seeking to acquire control of us, the foregoing provisions could impair the ability of existing stockholders to remove and replace our management and/or our board of directors.

Holders of our convertible notes have the right to require us to repurchase the notes upon certain changes in control of us or termination of trading of our common stock on a national securities exchange or the Nasdaq National Market. These repurchase rights could discourage a third party from seeking to acquire control of us.

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Because the ownership of more than a majority of our common stock is concentrated in a few larger stockholders, a third party will not be able to acquire control of us without the agreement of some of these stockholders.

Because many investors consider a change of control a desirable path to liquidity, delaying or preventing a change in control of our company may reduce the number of investors interested in our common stock, which could depress our stock price.

See “- We are controlled by certain principal stockholders.”

The price of our common stock may fluctuate significantly.

The price of our common stock on the Nasdaq National Market has been volatile. During fiscal 2004, the high and low sale prices of our common stock ranged from $7.04 to $18.72 per share. During fiscal 2003, the high and low sale prices of our common stock ranged from $1.55 to $13.05 per share. We expect that the market price of our common stock may continue to fluctuate.

Our common stock price can fluctuate as a result of a variety of factors, many of which are beyond our control. These factors include, among others:

• our performance and prospects;

• the performance and prospects of our partners;

• the depth and liquidity of the market for our common stock;

• investor perception of us and the industry in which we operate;

• changes in earnings estimates or buy/sell recommendations by analysts;

• general financial and other market conditions; and

• general economic conditions.

In addition, the stock market in general has experienced extreme volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations may adversely affect the market price of our common stock.

Risks Related to Our Indebtedness

Our convertible notes could adversely affect our financial condition. We are not prohibited from incurring additional debt.

On June 1, 2005, we completed an offering of $57.5 million aggregate principal amount of our convertible notes due 2025. Including these notes, we have approximately $72.0 million of indebtedness outstanding. Our indebtedness could have important consequences to you. For example, it could:

• increase our vulnerability to general adverse economic and industry conditions;

• limit our ability to obtain additional financing;

• require the dedication of a substantial portion of our cash flow from operations to the payment of interest and principal on our indebtedness, thereby reducing the availability of such cash flow to fund our growth strategy, working capital, capital expenditures and other general corporate purposes;

• limit our flexibility in planning for, or reacting to, changes in our business and the industry;

• place us at a competitive disadvantage relative to competitors with less debt; and

• make it difficult or impossible for us to pay the principal amount of the convertible notes at maturity, thereby causing an event of default under the convertible notes.

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We may incur substantial additional debt in the future. The terms of the convertible notes will not prohibit us or our subsidiaries from doing so. If new debt is added, the related risks described above could intensify.

Holders of our common stock will be subordinated to our convertible notes and other indebtedness.

In the event of our liquidation or insolvency, holders of common stock would receive a distribution only after payment in full of all principal and interest due to holders of our convertible notes and other creditors, and there may be little or no proceeds to distribute to holders of common stock at such time.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures .We previously evaluated our disclosure controls and procedures in connection with filing our Form 10-Q for the second quarter of fiscal 2005 and concluded that our disclosure controls and procedures were effective. As a result of the second restatement discussed in Note 17 to our condensed consolidated financial statements, our management, with the participation of our chief executive officer and our chief financial officer, conducted a re-evaluation, as of July 2, 2005, of the effectiveness of our disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e).

Based on this re-evaluation, our chief executive officer and our chief financial officer have concluded that, taking into effect the material weaknesses described below, as of July 2, 2005, our disclosure controls and procedures were not effective in reaching a reasonable level of assurance that management is timely alerted to material information relating to us during the period when our periodic reports are being prepared.

Changes in internal control over financial reporting. We monitor and evaluate on an ongoing basis our internal control over financial reporting in order to improve its overall effectiveness. In the course of these evaluations, we modify and refine our internal processes and controls as conditions warrant. As required by Rule 13a-15(d), our management, including our chief executive officer and our chief financial officer, also conducted a re-evaluation of our internal control over financial reporting to determine whether any changes occurred during the fiscal quarter ended July 2, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that re-evaluation, there has been no such change during the quarter ended July 2, 2005.

In GSI’s annual report on internal control over financial reporting (as revised) filed with our Form 10-K/A Amendment No. 3 with the SEC on December 6, 2005, we disclosed material weaknesses in internal control over financial reporting as of January 1, 2005 with respect to the review and reconciliation of accounts payable and the preparation and review of the statement of cash flows, both as further described below and in Note 17.

Accounts Payable

We previously relied on a systemic report to support the amount of our accounts payable reflected in our general ledger. In the third quarter of fiscal 2005, management determined that this systemic report was defective and could no longer be relied on. During the third quarter of fiscal 2005, we replaced this systemic control with a manual control which requires that we obtain statements from our trade accounts payable vendors to support the amount of our accounts payables reflected in our general ledger. We performed detailed analyses and reconciliations of the vendor statements received to confirm that the general ledger amounts for accounts payable is accurate.

In addition to this manual control of reconciling vendor statements, we have other mitigating controls that allowed us to validate the general ledger amounts for accounts payable during the third quarter of fiscal 2005. These mitigating controls include monthly reconciliations of perpetual inventory to the general ledger inventory, monthly reconciliations of the accounts payables balance and transactions to reliable systemic reports, monthly reconciliations of cash to bank statements, a physical inventory performed for fiscal 2004 and daily cycle counts of inventory during fiscal 2004 and fiscal 2005.

Management is in the process of developing a systemic control to validate the amount of our accounts payable reflected in our general ledger, including hiring outside consultants to assist in designing and implementing the solution, reviewing the related business processes and making recommendations for improvement. Until we enhance this control, we will continue to obtain statements from our trade accounts payable vendors to support the amount of our accounts payables reflected in our general ledger and will continue to perform detailed analysis and reconciliations of the vendor statements received to confirm that the general ledger amounts for accounts payable is accurate. We will also continue to rely on the other mitigating controls referenced above.

Preparation of Cash Flows

As further described in Note 17 of the notes to the consolidated financial statements, unpaid amounts for property additions previously were reported as a component of changes in operating assets and liabilities and acquisition of property and equipment. Such unpaid amounts should have been reported as a non-cash investing activity. During the third quarter of fiscal 2005, management remediated this weakness by strengthening the control procedures surrounding the preparation, review and classification of cash flows, including using additional accounting research tools in connection with the preparation and review of statements of cash flows.

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PART II—OTHER INFORMATION

ITEM 6. EXHIBITS

Exhibits

3.1	Amended and Restated Certificate of Incorporation of Global Sports, Inc. (filed as Appendix B to GSI Commerce, Inc.’s Definitive Proxy Statement on Schedule 14A filed on April 27, 2001 and incorporated herein by reference)
3.2	Certificate of Amendment to Amended and Restated Certificate of Incorporation of Global Sports, Inc. (filed with GSI Commerce, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 29, 2002 and incorporated herein by reference)
3.3	Amended and Restated Bylaws GSI Commerce, Inc. (filed with GSI Commerce Inc’s Quarterly Report on Form 10-Q dated August 11, 2005 and incorporated herein by reference).
4.1	Indenture dated as of June 1, 2005 by and between GSI Commerce, Inc. and JPMorgan Chase Bank, N.A. (filed with GSI Commerce, Inc.’s Current Report on Form 8-K dated June 8, 2005 and incorporated herein by reference)
4.2	Form of 3% Convertible Note due 2025 (filed as Exhibit A to Exhibit 4.1 of GSI Commerce, Inc.’s Current Report on Form 8-K dated June 7, 2005 and incorporated herein by reference)
10.1	2005 Equity Incentive Plan (filed as Appendix A to GSI Commerce, Inc. Definitive Proxy Statement on Schedule 14A filed on June 9, 2005 and incorporated herein by reference)
31.1	Certification of Chief Executive Officer pursuant to Rule 13a - 14(a) under the Securities Exchange Act of 1934
31.2	Certification of Chief Financial Officer pursuant to Rule 13a - 14(a) under the Securities Exchange Act of 1934
32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, hereunto duly authorized.

GSI COMMERCE, INC.
By:	/s/    MICHAEL G. RUBIN
	Michael G. Rubin
	Chairman &
	Chief Executive Officer
	(principal executive officer)
By:	/s/    JORDAN M. COPLAND
	Jordan M. Copland
	Executive Vice President &
	Chief Financial Officer
	(principal financial officer &
	principal accounting officer)

Date: December 5, 2005

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EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO RULE 13a-14(a) UNDER

THE SECURITIES EXCHANGE ACT OF 1934

I, Michael G. Rubin, certify that:

1. I have reviewed this report on Form 10-Q/A of GSI Commerce, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

December 5, 2005

By:	/s/    MICHAEL G. RUBIN
	Michael G. Rubin
	Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO RULE 13a-14(a) UNDER

THE SECURITIES EXCHANGE ACT OF 1934

I, Jordan M. Copland, certify that:

1. I have reviewed this report on Form 10-Q/A of GSI Commerce, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

December 5, 2005

By:	/s/    JORDAN M. COPLAND
	Jordan M. Copland
	Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code), each of the undersigned officers of GSI Commerce, Inc. (the “Company”), does hereby certify with respect to the Quarterly Report on Form 10-Q/A for the quarterly period ended July 2, 2005 (the “Report”) that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

By:	/s/    MICHAEL G. RUBIN
	Michael G. Rubin
	Chief Executive Officer

December 5, 2005

By:	/s/    JORDAN M. COPLAND
	Jordan M. Copland
	Chief Financial Officer

December 5, 2005

The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code) and is not being filed as part of the Report or as a separate disclosure document.