10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2006

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 no.)

935 FIRST AVENUE, KING OF PRUSSIA, PA	19406
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code (610) 491-7000

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

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

There were 45,640,883 shares of the registrant’s Common Stock outstanding as of the close of business on November 1, 2006.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2006

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited):
	Condensed Consolidated Balance Sheets as of December 31, 2005 and September 30, 2006	3
	Condensed Consolidated Statements of Operations for the three- and nine-month periods ended October 1, 2005 and September 30, 2006	4
	Condensed Consolidated Statements of Cash Flows for the nine-month periods ended October 1, 2005 and September 30, 2006	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25
Item 4.	Controls and Procedures	25
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	26
Item 1A.	Risk Factors	26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Submission of Matters to a Vote of Security Holders	27
Item 5.	Other Information	27
Item 6.	Exhibits	27
SIGNATURES		28

Our fiscal year ends on the Saturday nearest to the last day of December. Accordingly, references to fiscal 2003, fiscal 2004, fiscal 2005, fiscal 2006 and fiscal 2007 refer to the years ended January 3, 2004, January 1, 2005, December 31, 2005, and the years ending December 30, 2006 and December 29, 2007.

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.

2

PART I

ITEM 1: FINANCIAL STATEMENTS

GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

	December 31, 2005			September 30, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	48,361		$	14,549
Marketable securities		108,298			88,999
Accounts receivable, net of allowance of $727 and $598		24,288			23,427
Inventory		34,601			43,332
Prepaid expenses and other current assets		3,135			7,780
Total current assets		218,683			178,087
Property and equipment, net		87,851			96,745
Goodwill		13,932			17,786
Equity investments and other		1,210			2,578
Other assets, net of accumulated amortization of $7,885 and $10,721		10,970			13,181
Total assets	$	332,646		$	308,377
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	58,720		$	36,119
Accrued expenses and other		42,949			38,548
Deferred revenue		6,573			12,209
Current portion of long-term debt and other		637			591
Total current liabilities		108,879			87,467
Convertible notes		57,500			57,500
Long-term debt		13,019			12,542
Other liabilities		75			199
Total liabilities		179,473			157,708
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock, $0.01 par value, 4,990,000 shares authorized; 0 shares issued and outstanding as of December 31, 2005 and September 30, 2006		—			—
Common stock, $0.01 par value, 90,000,000 shares authorized; 44,469,969 and 45,394,136 shares issued as of December 31, 2005 and September 30, 2006, respectively; 44,469,766 and 45,393,933 shares outstanding as December 31, 2005 and September 30, 2006, respectively		445			454
Additional paid in capital		329,103			338,675
Accumulated other comprehensive loss		(2,344	)		(262	)
Accumulated deficit		(174,031	)		(188,198	)
Total stockholders’ equity		153,173			150,669
Total liabilities and stockholders’ equity	$	332,646		$	308,377

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

3

GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended						Nine Months Ended
	October 1, 2005			September 30, 2006			October 1, 2005			September 30, 2006
Revenues:
Net revenues from product sales	$	68,484		$	84,673		$	220,294		$	270,856
Service fee revenues		16,422			33,802			47,844			81,490
Net revenues		84,906			118,475			268,138			352,346
Cost of revenues from product sales		50,724			60,811			165,749			200,914
Gross profit		34,182			57,664			102,389			151,432
Operating expenses:
Sales and marketing, inclusive of $699, $668, $1,808 and $3,046 of stock-based compensation		22,366			34,824			65,563			94,398
Product development, inclusive of $151, $215, $375 and $635 of stock-based compensation		7,565			13,944			20,814			31,111
General and administrative, inclusive of $236, $1,232, $391 and $2,205 of stock-based compensation		5,088			9,465			14,987			24,827
Depreciation and amortization		3,693			5,535			10,433			14,912
Total operating expenses		38,712			63,768			111,797			165,248
Other (income) expense:
Interest expense		788			776			1,434			2,332
Interest income		(1,015	)		(1,445	)		(1,834	)		(4,428	)
Other expense, net		237			194			31			101
Loss on investment		—			737			—			2,763
Total other (income) expense		10			262			(369	)		768
Loss before income taxes and cumulative effect of change in accounting principle		(4,540	)		(6,366	)		(9,039	)		(14,584	)
Benefit for income taxes		—			(151	)		—			(149	)
Loss before cumulative effect of change in accounting principle		(4,540	)		(6,215	)		(9,039	)		(14,435	)
Cumulative effect of change in accounting principle		—			—			—			268
Net loss	$	(4,540	)	$	(6,215	)	$	(9,039	)	$	(14,167	)
Basic and diluted loss per share:
Prior to cumulative effect of change in accounting principle	$	(0.10	)	$	(0.14	)	$	(0.21	)	$	(0.32	)
Cumulative effect of change in accounting principle	$	—		$	—		$	—		$	0.01
Net loss	$	(0.10	)	$	(0.14	)	$	(0.21	)	$	(0.31	)
Weighted average shares outstanding - basic and diluted		44,203			45,344			42,805			45,005

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

4

GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended
	October 1, 2005			September 30, 2006
Cash Flows from Operating Activities:
Net loss	$	(9,039	)	$	(14,167	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		10,433			14,912
Stock-based compensation		2,574			5,886
Loss on investment		—			2,763
Loss on disposal of equipment		—			334
Cumulative effect of change in accounting principle		—			(268	)
Changes in operating assets and liabilities:
Accounts receivable, net		1,325			912
Inventory		3,838			(8,727	)
Prepaid expenses and other current assets		(1,021	)		(4,644	)
Other assets, net		229			(2,414	)
Accounts payable and accrued expenses and other		(31,657	)		(26,155	)
Deferred revenue		(2,970	)		5,732
Net cash used in operating activities		(26,288	)		(25,836	)
Cash Flows from Investing Activities:
Payments for acquisitions of businesses, net of cash acquired		(440	)		(5,847	)
Cash paid for property and equipment, including internal use software		(23,178	)		(26,955	)
Proceeds from government grant related to corportate headquarters		—			2,925
Other deferred cost		(347	)		95
Cash paid for equity investment		(136	)		(2,435	)
Purchases of marketable securities		(116,971	)		(172,315	)
Sales of marketable securities		76,525			191,803
Net cash used in investing activities		(64,547	)		(12,729	)
Cash Flows from Financing Activities
Proceeds from convertible notes		57,500			—
Debt issuance costs paid		(2,588	)		—
Repayments of loan		(339	)		—
Repayments of capital lease obligations		(378	)		(388	)
Repayments of mortgage note		(110	)		(139	)
Proceeds from sale of common stock		28,205			—
Equity issuance costs paid		(1,838	)		—
Proceeds from exercise of common stock options and warrants		6,995			5,252
Net cash provided by financing activities		87,447			4,725
Effect of exchange rate changes on cash and cash equivalents		(4	)		28
Net decrease in cash and cash equivalents		(3,392	)		(33,812	)
Cash and cash equivalents, beginning of period		20,064			48,361
Cash and cash equivalents, end of period	$	16,672		$	14,549
Supplemental Cash Flow Information
Cash paid during the period for interest	$	864		$	1,975
Noncash Investing and Financing Activities:
Temporary unrealized loss on investment in Odimo recorded at fair value		(1,763	)		—
Changes in accrual for purchases of property and equipment		(1,153	)		21
Common stock issued to finance acquistion		—			1,300

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

5

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

NOTE 1—BASIS OF PRESENTATION

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.

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

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 filed with the Securities and Exchange Commission (“SEC”) on March 15, 2006 as amended by Amendment No. 1 to Form 10-K filed with the SEC on May 1, 2006.

Certain reclassifications have been made to the prior year condensed consolidated financial statements to conform to those used in the current period. The Consolidated Statements of Operations for the three- and nine-month periods ended October 1, 2005 have been reclassified, in accordance with Staff Accounting Bulletin 107, to present stock-based compensation within specific line items, as disclosed parenthetically, instead of presented separately as its own line item.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Equity Investments and Other: Equity investments and other primarily consist of investments in Odimo Incorporated (“Odimo”) and WebCollage Inc. (“WebCollage”). In accordance with Statement of Financial Accounting Standards (“SFAS”) 115, “Accounting for Certain Investments in Debt and Equity Securities,” (“SFAS 115”) the Company has determined that the Odimo investment is available for sale, and therefore, any temporary unrealized gains and losses are reported as a component of accumulated other comprehensive loss in stockholders’ equity.

In accordance with Financial Accounting Standards Board (“FASB”) Staff Position FAS115-1/124-1: “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” the Company assesses whether declines in fair value of Odimo are considered other-than-temporary and records impairment expense for any declines in fair value that the Company determines to be other-than-temporary. Realized gains and losses are included in other income based on the specific identification method. Based on the Company’s inquiry and review of actions and activities of Odimo, the Company determined that the fair value is not expected to recover fully before the expected time of the sale of the investment and recognized an other-than-temporary impairment of $679 and $2,706 for the three- and nine-month periods ended September 30, 2006. In addition, sales of shares of Odimo stock resulted in a realized loss of $57 for the three- and nine-month periods ended September 30, 2006. The other-than-temporary impairment is calculated per the quoted market value and is reflected as a separate line item in other (income) expense in the Consolidated Statements of Operations.

In February 2006, the Company acquired a minority interest in WebCollage through the purchase of preferred stock for $2,435, including direct acquisition costs. The Company accounts for its investment in WebCollage using the cost method in accordance with Accounting Principle Board (“APB”) Opinion 18: “The Equity Method of Accounting for Investments in Common Stock.” Since WebCollage is privately-held, the Company monitors this investment periodically to evaluate whether any changes in fair value become other-than-temporary. In connection with its investment in WebCollage, the Company also acquired a ten-year warrant to purchase 2,000 shares of WebCollage common stock which vests and becomes exercisable upon the achievement of certain performance conditions during the first three years. The fair value of the warrant will be determined when the performance conditions are met. As of September 30, 2006, none of the performance conditions have been met.

6

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

Other Assets, Net: Other assets, net consists primarily of deferred partner revenue share charges, prepaid revenue share payments, the underwriter’s discount and issuance costs related to the June 2005 convertible debt public offering and intangible assets.

Deferred partner revenue share charges, resulting from the exercise of a right to receive 1,600 shares of the Company’s common stock in lieu of future cash partner revenue share payments, were $6,978 as of December 31, 2005 and $4,604 as of September 30, 2006. As a result of certain revenue thresholds being achieved in the third quarter of fiscal 2006, the remaining partner revenue share charges related to the exercise of common stock are being amortized on a straight-line basis over the remaining term of the contract. Stock-based compensation expense related to the amortization of deferred partner revenue share charges was $577 and $1,740 for the three- and nine-month periods ended October 1, 2005, and $410 and $2,374 for the three- and nine-month periods ended September 30, 2006, which is reflected within sales and marketing expense in the Consolidated Statements of Operations.

The total prepaid revenue share payments included in other assets were $0 as of December 31, 2005 and $2,625 as of September 30, 2006 and will be amortized on a straight-line basis over the remaining term of the contract within sales and marketing expense in the Consolidated Statements of Operations.

The underwriter’s discount and issuance costs related to the June 1, 2005 public offering of $57,500 aggregate principal amount of 3% convertible unsecured notes due June 1, 2025 were $2,589 as of September 30, 2006. 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 issuance costs, which is reflected as a portion of interest expense, was $130 and $173 for the three- and nine-month periods ended October 1, 2005, and $129 and $388 for the three- and nine-month periods ended September 30, 2006.

On September 29, 2006, the Company purchased the remaining minority interest of a joint venture for $3,218, including direct acquisition expenses. The joint venture was created in 2003 and was party to certain of the Company’s contracts. The purchase price was allocated to the identifiable intangible assets acquired, which resulted in $2,138 recorded as an intangible asset.

As of September 30, 2006, other assets, net included intangible assets with a cost of $2,466 and net book value of $2,416. Amortization expense for intangible assets was $14 and $51 for the three- and nine-month periods ended September 30, 2006. There was no amortization expense for intangibles for the three- and nine-month periods ended October 1, 2005.

Revenue Recognition: The Company recognizes revenues from product sales or services provided when the following revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable and collectibility is reasonably assured. Additionally, revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: the delivered item has value to the customer on a standalone basis, there is objective and reliable evidence of the fair value of undelivered items, and delivery of any undelivered item is probable.

The Company considers the criteria presented in Emerging Issues Task Force (“EITF”) 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, has established 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, it records revenue gross as a principal.

Deferred revenue consists primarily of fees paid to the Company in advance for service fees related to enhancements to its partners’ e-commerce businesses which are recognized ratably over the service period or upon completion of the service. The Company recognizes amounts received from the sale of gift certificates redeemable through its partners’ e-commerce businesses when the gift certificates are redeemed.

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 an allowance represents 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.

7

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

Sales and Marketing: Sales and marketing expenses include fulfillment costs, customer care costs, credit card fees, net partner revenue share charges, net advertising and promotional expenses incurred by the Company on behalf of its 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 implementation of programs to provide incentives to customers to shop through the e-commerce businesses 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. Partner revenue share charges were $2,839 and $7,274 for the three- and nine-month periods ended October 1, 2005, and $5,386 and $11,241 for the three- and nine-month periods ended September 30, 2006.

Shipping and Handling Costs: 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 to the extent of shipping revenue. 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 $313 and $2,129 for the three- and nine-month periods ended October 1, 2005, and $0 and $2,434 for the three- and nine-month periods ended September 30, 2006 and are included in sales and marketing expense in the Consolidated Statements of Operations.

Fulfillment Costs: The Company defines fulfillment costs as personnel, occupancy and other costs associated with its fulfillment centers, personnel and other costs associated with its logistical support and vendor operations departments and third-party warehouse and fulfillment services costs. Fulfillment costs were $6,374 and $19,374 for the three- and nine-month periods ended October 1, 2005, and $9,431 and $25,765 for the three- and nine-month periods ended September 30, 2006, and are included in sales and marketing expense in the Consolidated Statements of Operations.

Advertising: 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” (“SOP 93-7”). 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. 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. Advertising costs were $2,000 and $5,737 for the three- and nine-month periods ended October 1, 2005, and $3,598 and $8,801 for the three- and nine-month periods ended September 30, 2006, and are included in sales and marketing expenses in the Consolidated Statements of Operations.

Catalog Costs: Direct response advertising consists primarily of creative design, paper, printing, postage, and mailing costs, which are capitalized and amortized over the expected future revenue stream, which is generally a period not exceeding six months. The Company accounts for catalog costs in accordance with SOP 93-7, which requires that the amortization of capitalized advertising costs be based upon the ratio of actual revenues to the total of actual and estimated future revenues on an individual catalog basis. Deferred catalog costs included in prepaid expenses and other current assets were $805 as of September 30, 2006. There were no deferred catalog costs in fiscal 2005. Catalog costs were $97 and $259 for the three- and nine-month periods ended October 1, 2005, and $1,005 and $1,348 for the three- and nine-months periods ended September 30, 2006, and are reflected in sales and marketing expenses in the Consolidated Statements of Operations.

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 technology information systems and creative 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.

8

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

Stock-Based Compensation: Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic method prescribed in APB Opinion 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, compensation expense for stock options issued to employees was 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 accounted for stock-based compensation for stock options and warrants issued to non-employees in accordance with SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and EITF 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 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 was measured using a Black-Scholes valuation 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 was recorded on a straight-line method over the vesting period.

Effective January 1, 2006, the Company adopted SFAS 123(R), “Share-Based Payment” (“SFAS 123(R)”), using the modified prospective approach, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation expense over the service period during which awards are expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares granted and the quoted price of the Company’s common stock and the fair value of stock options is determined using the Black-Scholes valuation model, which is consistent with the valuation techniques previously utilized by the Company for options in the proforma disclosures required under SFAS 123. Such value is recognized as expense over the service period, net of estimated forfeitures, using the accelerated method under SFAS 123(R) for all unvested options as of January 1, 2006. The estimation of the number of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts will be recorded as a cumulative adjustment in the period in which estimates are revised. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. Actual results, and future changes in estimates, may differ substantially from the Company’s current estimates.

The adoption of SFAS 123(R) resulted in a cumulative benefit from accounting change of $268 and a decrease in loss per share of $0.01 in the first quarter of fiscal 2006, which reflects the cumulative impact of estimating future forfeitures in the determination of period expense, rather than recording forfeitures when they occur as previously permitted. The incremental stock-based compensation expense recognized due to the adoption of SFAS 123(R) for the three- and nine-month periods ended September 30, 2006 was $450 and $1,296.

Prior to the adoption of SFAS 123(R), the Company presented tax benefits resulting from stock-based compensation as operating cash flows within the Consolidated Statements of Cash Flows. SFAS 123(R) requires that cash flows resulting from tax deductions in excess of compensation cost recognized in the financial statements be classified as financing cash inflows within the consolidated statements of cash flows. There was no tax benefit resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes for the nine-month period ended September 30, 2006.

9

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

Stock-based compensation in the three- and nine-month periods ended October 1, 2005 was determined using the intrinsic value method. The following table provides supplemental information for the three- and nine-month periods ended October 1, 2005 as if stock-based compensation had been computed under SFAS 123:

	Three Months Ended October 1, 2005			Nine Months Ended October 1, 2005
Net loss, as reported	$	(4,540	)	$	(9,039	)
Add: Stock-based compensation expense included in reported net loss		499			824
Deduct: Total stock-based compensation expense determined under fair value based method for all stock options and awards		(875	)		(7,811	)
Pro forma net loss	$	(4,916	)	$	(16,026	)
Loss per share - basic and diluted:
As reported - basic and diluted	$	(0.10	)	$	(0.21	)
Pro forma - basic and diluted	$	(0.11	)	$	(0.37	)

The fair value of options granted under the 1996 and 2005 Equity Incentive Plans during the three- and nine-month period ended October 1, 2005 were estimated on the date of grant using the Black-Scholes multiple option pricing model, with the following weighted average assumptions:

Assumption	Three Months Ended October 1, 2005		Nine Months Ended October 1, 2005
Dividend yield	None		None
Expected volatility	45.19	%	61.28	%
Average risk free interest rate	4.18	%	3.95	%
Average expected lives	1.96 years		1.79 years

There were no options granted during the three- and nine-month periods ended September 30, 2006.

New Accounting Pronouncements: In July 2006, the FASB issued FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company is in the process of evaluating the impact of the adoption of this interpretation on the Company’s results of operations and financial condition.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year’s financial statements are materially misstated. SAB 108 is effective for the first fiscal year ending after November 15, 2006. The Company is in the process of evaluating the impact of the adoption of this interpretation on the Company’s results of operations and financial condition.

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of the adoption of this statement on the Company’s results of operations and financial condition.

10

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

NOTE 3—CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES

The Company had cash and cash equivalents of $48,361 as of December 31, 2005 and $14,549 as of September 30, 2006 and marketable securities of $108,298 as of December 31, 2005 and $88,999 as of September 30, 2006 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.

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. As of September 30, 2006, all securities had dates to maturity of less than two years, except for auction rate securities which have interest reset dates of approximately 30 to 45 days, which have maturity dates ranging from one to forty years. The Company classifies all of its available-for-sale securities as current assets, as these securities represent investments available for current corporate purposes. All investments in marketable securities with original maturities of greater than 90 days are accounted for in accordance with SFAS 115. At December 31, 2005 and September 30, 2006, the Company held $58,500 and $39,075, 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. 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. All income generated from these marketable securities is recorded as interest income. 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) expense in the Consolidated Statements of Operations.

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

	December 31, 2005
	Amortized Cost		Gross Unrealized Losses			Estimated Fair Value
Auction rate securities	$	58,500	$	—		$	58,500
Corporate bonds		31,270		(224	)		31,046
U.S. government agency securities		19,002		(250	)		18,752
	$	108,772	$	(474	)	$	108,298
	September 30, 2006
	Amortized Cost		Gross Unrealized Losses			Estimated Fair Value
Auction rate securities	$	39,075	$	—		$	39,075
Corporate bonds		32,476		(137	)		32,339
U.S. government agency securities		17,707		(122	)		17,585
	$	89,258	$	(259	)	$	88,999

The Company considered the nature of these marketable securities, which are primarily U.S. government agency securities and corporate bonds, the amount of the unrealized losses relative to the carrying value of the related investments and the duration of the unrealized losses, and concluded that the unrealized losses were not other-than-temporary.

11

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

The amortized cost and estimated fair value of investments in marketable securities as of September 30, 2006, by contractual maturity, are as follows:

	Amortized Cost		Estimated Fair Value
Due within one year	$	66,451	$	66,201
Due after one year through five years		5,007		4,998
Due after five years through ten years		—		—
Due after ten years		17,800		17,800
	$	89,258	$	88,999

NOTE 4—PROPERTY AND EQUIPMENT

The major classes of property and equipment, at cost, as of December 31, 2005 and September 30, 2006 are as follows:

	December 31, 2005			September 30, 2006
Computer hardware and software	$	71,987		$	92,494
Building and building improvements		41,085			38,608
Furniture, warehouse and office equipment, and other		16,703			20,671
Land		7,663			7,663
Leasehold improvements		997			1,060
Capitalized lease		1,692			1,692
Construction in progress		295			1,493
		140,422			163,681
Less: Accumulated depreciation		(52,571	)		(66,936	)
Property and equipment, net	$	87,851		$	96,745

During the three-month period ended April 1, 2006, the Company received a government economic development grant of $2,925 related to the purchase of its corporate headquarters. The cost basis of the Company’s building and building improvements was reduced by the full amount of this grant.

Depreciation and amortization is shown as a separate line item on the Consolidated Statement of Operations. Accordingly, cost of revenues is exclusive of depreciation and amortization.

NOTE 5—ACQUISITION

On July 6, 2005, the Company acquired an irrevocable right that conveyed the voting and economic rights to shares representing 51% of the outstanding shares in Aspherio S.L., now known as GSI Commerce Europe, S. L. (“GSI Europe”), a Barcelona, Spain-based provider of outsourced e-commerce solutions, for approximately $578, including acquisition expenses. On January 26, 2006, the Company acquired outright all of the outstanding shares in GSI Europe. The remaining purchase price was $2,629 in cash, and pursuant to its agreement with the shareholders of GSI Europe, the Company elected to deliver 82,638 shares of GSI common stock (valued at $15.73 per share) in lieu of $1,300 in cash. The Company does not expect the acquisition to have a material impact on its consolidated results of operations for fiscal 2006.

Pursuant to SFAS 141, “Business Combinations,” the GSI Europe acquisition was accounted for under the purchase method of accounting with the Company’s proportionate interest in the excess of the purchase price over the estimated fair

12

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

value of the net tangible and identifiable intangible assets acquired recorded as goodwill. The allocation of the purchase price over the estimated fair value of the tangible and identifiable intangible assets acquired resulted in $4,333 recorded as goodwill, of which $3,854 was recorded in the three-month period ended April 1, 2006. Pro forma disclosures related to this acquisition are not included as such disclosures are not material.

NOTE 6—STOCKHOLDERS EQUITY

On April 2, 2006, the Board of Directors authorized 95 shares of Series A Junior Preferred Stock (“Series A”) and declared a dividend distribution of one right (a “Right”) for each outstanding share of common stock to the stockholders of record on the close of business on April 14, 2006. Each Right entitles the registered holder to purchase from the Company a unit consisting of one one-thousandth of a share of Series A, at a price of $85 per unit, subject to adjustment. However, the Rights are not exercisable unless certain events occur, such as a person or group acquiring or obtaining the right to acquire, or making a tender offer or exchange offer for, beneficial ownership of 20% or more of our outstanding common stock (or, in the case of any stockholder that as of April 2, 2006 beneficially owned 19% or more of our outstanding shares of common stock, 25.1% or more). Subject to certain exceptions, upon exercise of the Right, each holder of a Right will have the right to receive shares of our common stock, or other consideration, having a value equal to two times the exercise price of the Right. Additionally, at certain times, we have the right to redeem the Rights in whole, but not in part, at a price of $.001 per Right. The description and terms of the Rights are set forth in a Rights Agreement, dated April 2, 2006. The Rights will expire on April 14, 2016, unless the Rights are earlier redeemed or exchanged in accordance with the terms of the Rights Agreement. As of September 30, 2006, no Series A shares are issued or outstanding.

NOTE 7—STOCK AWARDS

The Company currently maintains the 2005 Equity Incentive Plan (“the Plan”) which provides for the grant of equity to certain employees, directors and other persons. As of September 30, 2006, 1,255,201 shares of common stock were available for future grants under the Plan. The equity awards granted under the Plan 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’s service to the Company is interrupted or terminated. Stock appreciation rights (“SARs”) may be granted under the Plan either alone or in tandem with stock options. No SARs have been granted to date under the plan.

Stock Options and Warrants

The following table summarizes the stock option activity for the nine-month period ended September 30, 2006:

	Number of Shares (in thousands)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Outstanding at December 31, 2005	6,145		$	9.82
Granted	—			—
Exercised	(460	)		7.51
Forfeited/Cancelled	(215	)		9.79
Outstanding at September 30, 2006	5,470			10.02	6.16	$	28,030
Exercisable at September 30, 2006	4,734		$	10.05	6.00	$	24,336

During the three- and nine-month period ended October 1, 2005, the Company granted to employees options to purchase an aggregate of 77 and 1,313 shares of the Company’s common stock at weighted average fair value at grant date of $19.43 and $14.13. The total intrinsic value of options exercised during the three and nine months ended September 30, 2006 was $249 and $3,890 determined as of the date of exercise. Cash proceeds from options exercised during the nine months ended September 30, 2006 was $3,452. The total stock-based compensation cost recognized for stock options for the three- and nine-month periods ended October 1, 2005 was $274 and $37 and for the three- and nine-month periods ended

13

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

September 30, 2006 was $450 and $1,296. As of September 30, 2006, there was approximately $873 of unrecognized compensation cost, net of forfeitures, related to nonvested stock options, which is expected to be recognized over a weighted average period of approximately 0.7 years.

During the three-month period ended September 30, 2006 the Company extended the contractual life of 132 fully vested share options. As a result of that modification, the Company recognized additional stock-based compensation of $100.

The following table summarizes the warrant activity for the nine-month period ended September 30, 2006:

	Number of Shares (in thousands)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Outstanding at December 31, 2005	815		$	7.71
Granted	—			—
Exercised	(305	)		6.05
Forfeited/Cancelled	(220	)		16.21
Outstanding at September 30, 2006	290			3.00	3.50	$	3,437
Exercisable at September 30, 2006	90		$	4.11	1.26	$	969

No warrants were granted by the Company during fiscal 2005 and the first nine months of fiscal 2006. The total intrinsic value of warrants exercised for the nine months ended September 30, 2006 was $2,281 determined as of the date of exercise. Cash proceeds from warrant exercises during the nine months ended September 30, 2006 was $1,800. No warrant activity occurred during the nine months ended October 1, 2005.

The following table summarizes information regarding options and warrants outstanding and exercisable as of September 30, 2006:

	Outstanding				Exercisable
Range of Exercise Prices	Number Outstanding (in thousands)	Weighted Average Remaining Contractual Life In Years	Weighted Average Exercise Price		Number Exercisable (in thousands)	Weighted Average Exercise Price
$0.01 - $6.20	1,890	4.20	$	4.84	1,663	$	4.87
$6.21 - $10.89	2,038	6.42		9.40	1,336		9.07
$10.90- $24.69	1,832	7.47		14.93	1,825		14.93
$0.01 - $24.69	5,760	6.03	$	9.66	4,824	$	9.64

Restricted Stock Units

The Company also has issued restricted stock units to certain employees. The grant-date fair value of restricted stock units is based on the market price of the stock, and compensation cost is amortized to expense on a straight-line basis over the vesting period during which employees perform services.

14

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

The following summarizes the restricted stock unit activity for the nine-month period ended September 30, 2006:

	Number of Shares (in thousands)		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Nonvested shares at December 31, 2005	303		$	14.82
Granted	864			14.52
Vested	(79	)		13.65
Forfeited/Cancelled	(77	)		15.05
Nonvested shares at September 30, 2006	1,011		$	14.63	$	15,001

During the nine-month period ended October 1, 2005, the Company granted to employees restricted stock units at $0.01 per share to purchase an aggregate of 269 shares of the Company’s common stock at a weighted average fair value at grant date of $14.65.

The total intrinsic value of restricted stock units vested during the three and nine months ended September 30, 2006 was $506 and $1,071 determined based on the grant date fair value. The total stock-based compensation cost recognized for the three and nine months ended September 30, 2006 for restricted stock units was $1,239 and $2,173. As of September 30, 2006, there was approximately $8,032 of unrecognized compensation cost, net of forfeitures, related to nonvested stock units, which is expected to be recognized over a weighted average remaining period of approximately 2.9 years.

During the three-month period ended September 30, 2006, the Company accelerated the vesting period of 39 restricted stock units. As a result of that modification, the Company recognized additional stock-based compensation expense of $504.

Restricted Stock Awards

The Company also has issued restricted stock awards to certain employees. At December 31, 2005, there were nonvested restricted stock awards of 19 shares with a weighted average grant date fair value of $9.47. No restricted stock awards were granted during the nine-month periods ended October 1, 2005 or September 30, 2006. For the nine month period ended September 30, 2006, restricted stock awards for six shares vested with a weighted average grant date fair value of $9.47 and an intrinsic value of $85. As of September 30, 2006, the Company had nonvested restricted stock awards of 13 shares for certain employees with a weighted average grant date fair value of $9.47. The total stock-based compensation cost recognized for the three and nine months ended September 30, 2006 for restricted stock awards was $16 and $43. As of September 30, 2006, there was approximately $100 of unrecognized compensation cost, net of forfeitures, related to nonvested stock awards, which is expected to be recognized over a weighted average remaining period of approximately 1.9 years.

NOTE 8—LOSS PER SHARE

Basic and diluted loss per share is 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, awards and warrants, and convertible notes have been excluded from the calculation of diluted loss per share because their effect would be anti-dilutive.

15

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

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

	Three Months Ended						Nine Months Ended
	October 1, 2005			September 30, 2006			October 1, 2005			September 30, 2006
Net loss attributable to common shares	$	(4,540	)	$	(6,215	)	$	(9,039	)	$	(14,167	)
Weighted average shares outstanding - basic and diluted		44,203			45,344			42,805			45,005
Outstanding common stock options having no dilutive effect		6,203			5,470			6,203			5,470
Outstanding common stock warrants having no dilutive effect		815			290			815			290
Nonvested restricted stock having no dilutive effect		266			1,024			266			1,024
Convertible notes having no dilutive effect		3,229			3,229			3,229			3,229

The potential number of common shares and dilution from the Series A Junior Participating Preferred Stock cannot be determined because these shares are not exercisable unless certain future contingent events occur (see Note 6).

NOTE 9 – COMPREHENSIVE LOSS

	Three Months Ended						Nine Months Ended
	October 1, 2005			September 30, 2006			October 1, 2005			September 30, 2006
Net loss	$	(4,540	)	$	(6,215	)	$	(9,039	)	$	(14,167	)
Other comprehensive loss:
Net unrealized gain (loss) on available-for-sale securities		(227	)		186			(307	)		212
Unrealized loss on investment in Odimo recorded at fair value		(3,315	)		(679	)		(1,763	)		(835	)
Add: reclassification adjustment for losses realized in net income		—			679			—			2,763
Other comprehensive income (loss)		(3,542	)		186			(2,070	)		2,140
Comprehensive loss	$	(8,082	)	$	(6,029	)	$	(11,109	)	$	(12,027	)

NOTE 10—MAJOR SUPPLIERS/ECONOMIC DEPENDENCY

The Company purchased inventory from one supplier amounting to $17,332 or 39.0% of total inventory purchased during the three-month period ended October 1, 2005 and $66,621 or 45.9% of total inventory purchased during the nine-month period ended October 1, 2005.

The Company purchased inventory from two suppliers amounting to $18,623 or 32.5% of total inventory purchased during the three-month period ended September 30, 2006 and from one supplier amounting to $55,668 or 31.9% of total inventory purchased during the nine-month period ended September 30, 2006.

No customer accounted for more than 10% of net revenues for any period presented.

16

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

NOTE 11—COMMITMENTS AND CONTINGENCIES

Legal Proceedings

The Company is involved in various litigation incidental to its business, including alleged contractual claims, claims relating to infringement of intellectual property rights of third parties and claims relating to the manner in which goods are sold through its e-commerce platform. The Company does not believe, based on current knowledge, that any of these 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.

Advertising and Media Agreements

As of September 30, 2006, the Company was contractually committed for the purchase of future advertising for the promotion of the Company’s partners’ e-commerce sites totaling approximately $172 for fiscal 2006 and $342 for fiscal 2007.

Partner Revenue Share and Other Partner Agreement Payments

As of September 30, 2006, subject to the satisfaction of certain conditions, the Company was contractually committed to future minimum cash revenue share and other partner agreement payments as follows:

Fiscal Year Ended	Partner Revenue Share and Other Partner Agreement Payments
2006	$	1,100
2007		16,800
2008		19,450
2009		20,500
2010		12,050
Thereafter		—
Total conditional future minimum cash revenue share and other partner agreement payments	$	69,900

NOTE 12—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 — technology, logistics and customer care, and marketing 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 care, buying, interactive design, partnerships and alliances, content development and imaging, interactive marketing and 1-to-1 marketing. 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. Substantially all of the Company’s net revenues and operating results are in the United States. Net revenues and operating results outside of the United States are not significant. Substantially all of the Company’s identifiable assets are in the United States.

17

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except per share data)

(unaudited)

NOTE 13—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 into interest expense 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.

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 the 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 defined 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:

	December 31, 2005			September 30, 2006
Convertible notes	$	57,500		$	57,500
Note payable		12,803			12,677
Capital lease obligation		798			410
Other		130			245
		71,231			70,832
Less: Current portion of note payable		(152	)		(160	)
Less: Current portion of capital lease obligation		(468	)		(410	)
Less: Other		(17	)		(21	)
	$	70,594		$	70,241

18

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

All statements made in this Quarterly Report on Form 10-Q, 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,”, “schedule” and similar expressions typically are used to identify forward-looking statements. Forward-looking statements are based on then-current expectations, beliefs, assumptions, estimates and forecasts about our business. 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, consumer spending, the financial markets and the industries in which we and our partners operate, changes affecting the Internet, our ability to develop and maintain relationships with strategic partners and suppliers and the timing of the establishment, extension or termination of our relationship with strategic partners, our ability to timely and successfully develop, maintain and protect our technology, confidentiality and proprietary information, and product and service offerings, our ability to execute operationally, our ability to attract and retain qualified personnel, our ability to successfully integrate our acquisitions of other businesses, if any, the performance of any acquired businesses and the impact of SFAS 123(R). More information about potential factors that could affect us are described in Part II, Section 1A under the heading “Risk Factors” in our Form 10-K. We expressly disclaim any intent or obligation to update these forward-looking statements.

Executive Overview

• We are a leading provider of e-commerce solutions that enable 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: technology, logistics and customer care and marketing services. Through our platform, we provide Web site administration, Web infrastructure and hosting, business intelligence, an e-commerce engine, order management, fulfillment, drop shipping, customer care, buying, interactive design, partnerships and alliances, content development and imaging, interactive marketing services and 1-to-1 marketing.

• While we expect the opportunity for partnered e-commerce to continue to grow, we also anticipate continuing intense competition. We compete with in-house solutions and a variety of third-party vendors that provide e-commerce software or partial e-commerce solutions. To satisfy our existing partners and to continue to attract new partners, we offer a comprehensive and compelling value proposition that includes a high level of direct-to-consumer expertise and infrastructure. Through our solution, we help our partners grow their e-commerce businesses and use their e-commerce businesses as a channel to complement and enhance their offline businesses. Our solution is provided to partners on a platform that includes shared technology, logistics, supporting infrastructure and marketing services. To differentiate our solution in the marketplace, we continually add new services and functions to our platform. As part of our continuing efforts to add value to our platform, we evaluate opportunities to acquire complementary or new businesses or assets.

• We grow our business by expanding the e-commerce businesses of our existing partners and by adding new partners. Generally, we launch the Web site of a new partner within three to nine months after entering into a contract with the new partner. We anticipate that new Web sites typically will contribute to our income from operations in their first full year of operations.

• 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.

• We generate cash from operating activities primarily in our fourth fiscal quarter due to the seasonality of our business. In our first fiscal quarter, we typically use cash from operating activities to satisfy accounts payable and accrued expenses incurred in the fourth fiscal quarter of our prior fiscal year. We typically have not generated cash from operating activities in our second and third fiscal quarters.

19

Results of Operations

Three-month period ended October 1, 2005 and September 30, 2006 (amounts in tables in millions):

Net Revenues

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.

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. We recognize revenue from shipping when products are shipped and title passes to the common carrier.

Service Fee Revenues. Service fee revenues are derived from service fees earned by us 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.

	Third Qtr Fiscal 2005				Third Qtr Fiscal 2006				Third Qtr Fiscal 2006 vs. Third Qtr Fiscal 2005
	$		%		$		%		$ Change			% Change
Net revenues from product sales - sporting goods	$	38.1	44.9	%	$	55.9	47.2	%	$	17.8		46.7	%
Net revenues from product sales - other		30.4	35.8	%		28.8	24.3	%		(1.6	)	-5.3	%
Net revenues from product sales		68.5	80.7	%		84.7	71.5	%		16.2		23.6	%
Service fee revenues		16.4	19.3	%		33.8	28.5	%		17.4		106.1	%
Net revenues	$	84.9	100	%	$	118.5	100	%	$	33.6		39.6	%

Net revenues from product sales increased $16.2 million in the third quarter of fiscal 2006. Of this increase, $16.7 million was attributable to the addition of partners that were launched after the third quarter of fiscal 2005, partly offset by a $0.5 million decrease in product sales from partners’ e-commerce businesses that were operated for the entirety of both periods. Net revenues from product sales included shipping revenue from certain partners from both our owned-inventory model and our partner-inventory model of $7.9 million for the third quarter of fiscal 2005 and $11.9 million for the third quarter of fiscal 2006.

Service fee revenues increased $17.4 million in the third quarter of fiscal 2006 due to an increase of $13.4 million attributable to the addition of new partners that were launched after the third quarter of fiscal 2005, an increase of $3.3 million in project related service fees and an increase of $0.7 million from partners’ e-commerce businesses that were operated for the entirety of both periods.

Gross Profit

Gross profit consists of gross profit from product sales and net revenues from service fees. 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. Costs of revenues from product sales 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 are included in sales and marketing expense. Depreciation and amortization is shown as a separate line item on the Consolidated Statement of Operations. Accordingly, cost of revenues is exclusive of depreciation and amortization.

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	Third Qtr Fiscal 2005								Third Qtr Fiscal 2006								Third Qtr Fiscal 2006 vs. Third Qtr Fiscal 2005
	$		% 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	$	17.8	26.0	%	—				$	23.9	28.2	%	—				$	6.1	34.3	%
Gross profit from service fees		16.4	—		100	%			$	33.8	—		100	%				17.4	106.1	%
Gross profit	$	34.2					40.3	%	$	57.7					48.7	%	$	23.5	68.7	%

The increase in gross profit as a percentage of net revenues from 40.3% to 48.7% is primarily due to the larger percentage increase in service fees over the percentage increase in product sales, which service fees have no associated cost of revenue. Service fee revenue growth was driven by increases in marketing service fees, partner-paid technology fees and new partner service fees.

The gross profit percentage for product sales increased from 26.0% to 28.2% primarily due to increased sales for sporting goods, which carry a higher gross margin than other product sales in the other category, and an increase in margin for product sales in the sporting goods and electronics categories.

Operating Expenses

Operating expenses consist of sales and marketing expenses, product development expenses, general and administrative expenses and depreciation and amortization expenses.

	Third Qtr Fiscal 2005				Third Qtr Fiscal 2006				Third Qtr Fiscal 2006 vs. Third Qtr Fiscal 2005
	$		% of Net Revenues		$		% of Net Revenues		$ Change		% Change
Sales and marketing expenses	$	22.3	26.3	%	$	34.8	29.4	%	$	12.5	56.1	%
Product development expenses		7.6	9.0	%		13.9	11.7	%		6.3	82.9	%
General and administrative expenses		5.1	6.0	%		9.5	8.0	%		4.4	86.3	%
Depreciation and amortization expenses		3.7	4.4	%		5.5	4.6	%		1.8	48.6	%
Total operating expenses	$	38.7	45.7	%	$	63.7	53.7	%	$	25.0	64.6	%

Sales and Marketing Expenses: Sales and marketing expenses include net 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 care costs, credit card fees, merchandising costs and payroll and related expenses. These expenses also include net partner revenue share charges, which are royalty payments made to our partners in exchange for the use of their brands, our partners’ promotion of their 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, net of amounts reimbursed by our partners.

Sales and marketing expenses increased $12.5 million in the third quarter of fiscal 2006 primarily due to a $4.5 million increase in payroll and related costs principally in our customer care and fulfillment operations, a $4.4 million increase in marketing expense, which includes catalog costs and partner revenue share expenses, a $2.4 million increase in credit card fees and a $1.2 million increase in other costs, which include costs for communications, occupancy and office expenses. As a percentage of net revenues, sales and marketing expenses increased from 26.3% to 29.4% primarily due to the larger percentage increase in service fee revenues over the percentage increase in product sales.

Product Development Expenses: Product development expenses consist primarily of expenses associated with planning, maintaining and operating the technology platform on which we operate our partners’ e-commerce businesses and payroll and related expenses for our technology information systems and creative departments.

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Product development expenses increased $6.3 million in the second quarter of fiscal 2006 primarily due to a $3.0 million increase in personnel and related costs, a $2.3 million increase in professional fees, a $0.4 million increase in data communication cost for our leased data centers, and a $0.6 million increase in other product development costs. The increases in these costs were 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. As a percentage of net revenues, product development expense increased from 9.0% to 11.7% primarily due to the larger percentage increase in service fee revenues over the percentage increase in product sales.

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

General and administrative expenses increased $4.4 million in the third quarter of fiscal 2006 primarily due to a $2.2 million increase in personnel and related costs incurred to support the growth of our business, a $1.0 million increase in stock-based compensation primarily related to an executive retirement package, a $0.4 million increase in professional fees and a $0.8 million increase in other general and administrative expenses. As a percentage of net revenues, general and administrative expense increased from 6.0% to 8.0% primarily due to the larger percentage increase in service fee revenues over the percentage increase in product sales.

Depreciation and Amortization Expense: Depreciation and amortization expenses relate primarily to the depreciation of three facilities owned by us; our corporate headquarters in King of Prussia, Pennsylvania, our other corporate facility in King of Prussia, Pennsylvania and our 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 and our purchased hardware and software; and the depreciation of improvements, furniture and equipment at our corporate headquarters, our Louisville and Shepherdsville, Kentucky fulfillment centers and our Melbourne, Florida customer contact center.

Depreciation and amortization expenses increased $1.8 million primarily due to increased technology purchases and capitalized costs related to internal-use software.

Nine-month period ended October 1, 2005 and September 30, 2006 (amounts in tables in millions):

Net Revenues

	First Nine Months of Fiscal 2005				First Nine Months of Fiscal 2006				First Nine Months of Fiscal 2006 vs. First Nine Months of Fiscal 2005
	$		%		$		%		$ Change		% Change
Net revenues from product sales - sporting goods	$	119.8	44.7	%	$	166.4	47.2	%	$	46.6	38.9	%
Net revenues from product sales - other		100.5	37.5	%		104.4	29.7	%		3.9	3.9	%
Net revenues from product sales		220.3	82.2	%		270.8	76.9	%		50.5	22.9	%
Service fee revenues		47.8	17.8	%		81.5	23.1	%		33.7	70.5	%
Net revenues	$	268.1	100	%	$	352.3	100	%	$	84.2	31.4	%

Net revenues from product sales increased $50.5 million in the first nine months of fiscal 2006. Of this increase, $22.6 million was attributable to the addition of partners that were launched after the third quarter of fiscal 2005, $21.4 million was attributable to growth in sales from partners’ e-commerce businesses that were operated for the entirety of both periods and $6.5 million was attributable to growth in sales from partners’ e-commerce businesses that were operated for part of the first nine months of fiscal 2005 and all of the first nine months of fiscal 2006. Net revenues from product sales included shipping revenue from certain partners from both our owned-inventory model and our partner-inventory model of $24.1 million for the first nine months of fiscal 2005 and $35.4 million for the first nine months of fiscal 2006.

Service fee revenues increased $33.7 million in the first nine months of fiscal 2006 due an increase of $29.6 million attributable to the addition of new partners that were launched after the third quarter of fiscal 2005, an increase of $5.0 million in project related service fees, offset by a decrease of $0.9 million from partners’ e-commerce businesses that were operated for the entirety of both periods.

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Gross Profit

	First Nine Months of Fiscal 2005								First Nine Months of Fiscal 2006								First Nine Months of Fiscal 2006 vs. First Nine Months of Fiscal 2005
	$		% 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	$	54.6	24.8	%	—				$	69.9	25.8	%	—				$	15.3	28.0	%
Gross profit from service fees		47.8	—		100	%				81.5	—		100	%				33.7	70.5	%
Gross profit	$	102.4					38.2	%	$	151.4					43.0	%	$	49.0	47.9	%

The increase in gross profit as a percentage of net revenues from 38.2% to 43.0% is primarily due to the larger percentage increase in service fees over the percentage increase in product sales, which service fees have no associated cost of revenue. Service fee revenue growth was driven by increases in marketing service fees, partner paid technology fees and new partner service fees. In addition, the increase in gross profit percentage for product sales increased from 24.8% to 25.8% was primarily due to increased sales for sporting goods, which carry a higher gross margin than other product sales in the other category, and an increase in margin for product sales in the sporting goods and electronics categories.

Operating Expenses

	First Nine Months of Fiscal 2005				First Nine Months of Fiscal 2006				First Nine Months of Fiscal 2006 vs. First Nine Months of Fiscal 2005
	$		% of Net Revenues		$		% of Net Revenues		$ Change		% Change
Sales and marketing expenses	$	65.6	24.5	%	$	94.4	26.8	%	$	28.8	43.9	%
Product development expenses		20.8	7.8	%		31.1	8.8	%		10.3	49.5	%
General and administrative expenses		15.0	5.6	%		24.8	7.0	%		9.8	65.3	%
Depreciation and amortization expenses		10.4	3.9	%		14.9	4.2	%		4.5	43.3	%
Total operating expenses	$	111.8	41.8	%	$	165.2	46.8	%	$	53.4	47.8	%

Sales and marketing expenses increased $28.8 million in the first nine months of fiscal 2006 primarily due to a $11.5 million increase in payroll and related costs principally in our customer care and fulfillment operations, a $8.5 million increase in marketing expense, a $4.9 million increase in credit card fees, a $1.2 million increase in office expense and occupancy costs, a $1.2 million increase in stock-based compensation expense, of which $0.6 related to deferred partner revenue share charges resulting from higher product sales from a partner’s e-commerce business, and a $1.5 million increase in other costs. The increases in these costs were principally caused by higher sales volumes in the third quarter of fiscal 2006. As a percentage of net revenues, sales and marketing expenses increased from 24.5% to 26.8% primarily due to the larger percentage increase in service fee revenues over the percentage increase in product sales.

Product development expenses increased $10.3 million in the first nine months of fiscal 2006 primarily due to a $5.2 million increase in personnel and related costs, a $2.8 million increase in professional fees, a $0.9 million increase in office expenses and a $1.4 million increase in other product development costs. The increases in these costs were 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. As a percentage of net revenues, product development expense increased from 7.8% to 8.8% primarily due to the larger percentage increase in service fee revenues over the percentage increase in product sales.

General and administrative expenses increased $9.8 million in the first nine months of fiscal 2006 primarily due to a $4.2 million increase in personnel and related costs incurred to support the growth of our business, a $1.8 million increase in professional fees, a $1.8 million increase in stock-based compensation expense, a $0.4 million increase in bad debt expense due to increased credit card sales and a $1.6 million increase in other general and administrative expenses. As a percentage of net revenues, general and administrative expenses increased from 5.6% to 7.0% primarily due to the larger percentage increase in service fee revenues over the percentage increase in product sales.

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Depreciation and amortization expenses increased $4.5 million primarily due to increased technology purchases and capitalized costs related to internal-use software.

Income Taxes

Net operating losses generated through fiscal 2004 have been carried back to offset income taxes paid in prior years. The remaining net operating losses will be carried forward. As of the end of fiscal 2005, we had available net operating loss carryforwards of approximately $442.4 million which will expire in the years 2006 through 2025. 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 $251.8 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.

Liquidity and Capital Resources

Our principal sources of liquidity are our cash, cash equivalents and marketable securities. Our cash, cash equivalents, and marketable securities were $156.7 million as of the end of fiscal 2005 and $103.5 million as of the end of the third quarter of fiscal 2006.

In June 2005, we received proceeds of approximately $80.0 million, net of underwriter’s discounts and offering expenses, from the completion of our public offering of common stock and convertible notes. We still intend to use the net proceeds from the offering for working capital and general corporate purposes, including possible acquisitions.

We had working capital of $109.8 million as of the end of fiscal 2005 and $90.6 million as of the end of the third quarter of fiscal 2006, and we had an accumulated deficit of $174.0 million as of the end of fiscal 2005 and $188.0 million as of the end of the third quarter of fiscal 2006.

We used $25.8 million in net cash for operating activities during the first nine months of fiscal 2006. Our principal sources of operating cash during the first nine months of fiscal 2006 were payments received from customers in our owned-inventory model and from partners in our partner-inventory model, which generally approximate our net revenues from product sales and our service fee revenues, respectively. Our principal uses of operating cash during the first nine months of fiscal 2006 were cash paid to product suppliers, which generally approximates our cost of revenues from product sales, employee compensation and partner revenue share payments. Changes in our operating assets and liabilities during the first nine months of fiscal 2006 resulted in a net cash outflow of $35.3 million. The most significant change was a decrease in accounts payable, accrued expenses and other, and an increase in inventory, offset, in part, by an increase in deferred revenue compared to the end of fiscal 2005. The decrease in accounts payable, accrued expenses and other was due primarily to a decrease in partner revenue share payments due at the end of the first nine months of fiscal 2006 due to the seasonality of our business. Our investing activities during the first nine months of fiscal 2006 consisted primarily of $27.0 million paid in capital expenditures and the acquisition of and investment in businesses for $8.2 million. Offsetting these outflows, in part, we sold $191.8 million and purchased $172.3 of marketable securities and we received cash of $2.9 million from a government economic development grant for the construction and renovation of our headquarters. Our financing activities during the first nine months of fiscal 2006 consisted primarily of the receipt of $5.3 million in gross proceeds from exercises of common stock options and warrants.

We used $26.3 million in net cash for operating activities during the first nine months of fiscal 2005. Our principal sources of operating cash during the first nine 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 nine 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 nine months of fiscal 2005 resulted in a net cash outflow of $30.3 million. The most significant changes were a decrease in accounts payable, accrued expenses and other, offset, in part, by a decrease in inventory 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 third 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 nine months of fiscal 2005 consisted primarily of the purchase of $117.0 million and sale of $76.5 million of marketable securities. During the first nine months of fiscal 2005, we also incurred capital expenditures of $23.2 million and the acquisition of GSI Europe, net of cash, of $0.4 million. Our financing activities during the first nine months of fiscal 2005 consisted of the receipt of $7.0 million in gross proceeds from exercises of common stock options and $85.7 million in gross proceeds from public offering of equity and debt.

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Certain Related Party Transactions

As of November 1, 2006, Liberty Media Corporation, through its subsidiary QVC, Inc., and QVC’s affiliate QK Holdings, Inc., beneficially owned approximately 20.3% of our outstanding common stock including a right to purchase common stock. On June 15, 2006, QK Holdings, Inc. exercised its warrant to purchase 300,000 shares of our common stock at an exercise price of $6.00 per share. We received $1.8 million in proceeds from the exercise of the warrants. 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 Web site. We recognized net revenues of $0.5 million during the first nine months of fiscal 2006 on sales to QVC under this Web site development and distribution agreement. The terms of these sales are comparable to those with other similar partners.

As of November 1, 2006, we owned approximately 9.6% of the outstanding common stock of Odimo. SOFTBANK Capital Partners LLC and its affiliates collectively own approximately 16.1% of the outstanding common stock of Odimo. As of November 1, 2006, SOFTBANK Capital Partners LLC and its affiliates collectively own approximately 17.9% 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, another of our directors, is venture partner of SOFTBANK Capital Partners LP.

In exchange for Rustic Canyon Partners forfeiting its right to designate one member to our board of directors on June 25, 2004, our board of directors approved the issuance to Rustic Canyon Partners of a warrant to purchase 12,500 shares of our common stock. On June 2, 2006, Rustic Canyon exercised its warrant to purchase 12,500 shares at an exercise price of $9.31. In lieu of paying the exercise price in cash, Rustic Canyon Partners elected to exercise the warrant on a net settlement basis. Accordingly, we released 5,054 shares to Rustic Canyon Partners. Mark S. Menell, one of our directors, is a partner of Rustic Canyon Partners.

We entered into an agreement as of December 20, 2005 with Interactive Commerce Partners LLC, or ICP, for certain financial advisory services in connection with our evaluation of two proposed transactions: a proposed acquisition and a proposed strategic relationship. M. Jeffrey Branman, one of our directors, is President and owner of ICP. Under the agreement, we agreed to pay ICP $450,000 upon the successful consummation of the proposed acquisition and $50,000 upon the successful consummation of the proposed strategic relationship. On February 3, 2006, we agreed to pay ICP $350,000 in connection with the proposed acquisition, which we chose not to pursue. ICP also earned $50,000 upon the successful completion of the strategic relationship in the first quarter of fiscal 2006.

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.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no significant changes in market risks for the nine-month period ended September 30, 2006. See the information set forth in Part 1, Item 7A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005 filed with the Securities and Exchange Commissions (“SEC”) on March 15, 2006, as amended by Amendment No. 1 to Form 10-K filed with the SEC on May 1, 2006.

ITEM 4: CONTROLS AND PROCEDURES.

Evaluation of disclosure controls and procedures. Our management, with the participation of our chief executive officer and our chief financial officer, conducted an evaluation, as of September 30, 2006, of the effectiveness of our disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e).

Based on this evaluation, our chief executive officer and our chief financial officer have concluded that, as of September 30, 2006, our disclosure controls and procedures, as defined in Rule 13a-15(e), were effective at the reasonable assurance level, to ensure that (i) information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

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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 an evaluation of our internal control over financial reporting to determine whether any changes occurred during the fiscal quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there has been no such change during the quarter ended September 30, 2006.

PART II – OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS.

See Item 1 of Part I, “Financial Statements – Note 11- Commitments and Contingencies.”

ITEM 1A: RISK FACTORS.

Risk Factors

Our Form 10-K for fiscal 2005 includes a detailed discussion of our risk factors. The information presented below should be read in conjunction with the risk factors and information disclosed in our Form 10-K for fiscal 2005.

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, bylaws, stockholder rights agreement and Delaware law may have the effect of discouraging, delaying or preventing transactions that involve any actual or threatened change in control. The rights issued under our stockholder rights agreement may be a substantial deterrent to a person acquiring beneficial ownership of 20% or more (or, in the case of any stockholder that as of April 2, 2006 beneficially owned 19% or more of the outstanding shares of common stock, 25.1% or more) of our common stock without the approval of our board of directors. The stockholder rights agreement would cause extreme dilution to such person.

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.

Delaying or preventing a change in control of our company may reduce the number of investors interested in our common stock or the price that investors might be willing to pay for shares of our common stock and result in the market price being lower than it would be without these provisions.

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

We are controlled by certain principal stockholders.

As of November 1, 2006, Michael G. Rubin, our chairman and chief executive officer, beneficially owned approximately 15.9%, funds affiliated with SOFTBANK Holdings Inc., or SOFTBANK, beneficially owned approximately 17.9%, and Liberty Media Corporation, through its subsidiary QVC, Inc. and QVC’s affiliate QK Holdings, Inc. beneficially owned approximately 20.3% of our outstanding common stock, including options to purchase common stock, which are exercisable on or before September 30, 2006. If they decide to act together, any two of Mr. Rubin, SOFTBANK, and Liberty 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 stock purchase agreements, SOFTBANK and Liberty each have the right to designate up to one member of our board of directors. This concentration of ownership and the right of SOFTBANK and Liberty 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. Furthermore, Mr. Rubin has entered into voting agreements with each of SOFTBANK and Liberty, and SOFTBANK and Liberty 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.

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ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3: DEFAULTS UPON SENIOR SECURITIES.

None

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS WHO ARE NOT ALSO DIRECTORS.

None

ITEM 5: OTHER INFORMATION.

None

ITEM 6: EXHIBITS.

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 Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf on the date indicated by the undersigned thereunto duly authorized.

Date: November 6, 2006

GSI COMMERCE, INC.
By:	/s/ MICHAEL G. RUBIN
	Michael G. Rubin
	Chairman, President and Chief Executive Officer
By:	/s/ MICHAEL R. CONN
	Michael R. Conn
	Senior Vice President, Finance and Chief Financial Officer (principal financial officer & principal accounting officer)

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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 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.

November 6, 2006

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, Michael R. Conn, certify that:

1. I have reviewed this report on Form 10-Q 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.

November 6, 2006

By:	/s/ Michael R. Conn
	Michael R. Conn
	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 for the period ended September 30, 2006 (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 result of operations of the Company.

	By:	/s/ Michael G. Rubin
		Michael G. Rubin
		Chief Executive Officer
November 6, 2006
	By:	/s/ Michael R. Conn
		Michael R. Conn
		Chief Financial Officer
November 6, 2006

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.