##### Table of Contents

---



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 OCTOBER 1, 2005.



or



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



FOR THE TRANSITION PERIOD FROM
 TO
.



Commission File Number 0-16611



---



GSI COMMERCE, INC.

(Exact name of registrant as specified in its charter)



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



610-265-3229

(Registrants telephone number,

including area code)



---



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



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



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



Indicate the number of shares outstanding of each of the issuers classes of common stock, as of November 4, 2005:



|                             |  |                   
|---------------------------- |  | ------------------
|Common Stock, $.01 par value |  | 44,443,859        
|(Title of each class)        |  | (Number of shares)



---



---

##### Table of Contents

FORM 10-Q

FOR THE QUARTER ENDED OCTOBER 1, 2005



TABLE OF CONTENTS



|                               |  |                                                                                                                                                       |  |   
|------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------- |  | --
|                               |  | Page                                                                                                                                                 
|PART I - FINANCIAL INFORMATION |  |                                                                                                                                                      
|                               |  |                                                                                                                                                      
|Item 1.                        |  | Financial Statements:                                                                                                                                 |  |   
|                               |  | Condensed Consolidated Balance Sheets (unaudited) as of January 1, 2005 (restated) and October 1, 2005                                                |  | 1 
|                               |  | Condensed Consolidated Statements of Operations (unaudited) for the three-and nine-month periods ended October 2, 2004 (restated) and October 1, 2005 |  | 2 
|                               |  | Condensed Consolidated Statements of Cash Flows (unaudited) for the nine-month periods ended October 2, 2004 (restated) and October 1, 2005           |  | 3 
|                               |  | Notes to Condensed Consolidated Financial Statements (Unaudited)                                                                                      |  | 4 
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                                 |  | 23
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                            |  | 44
|Item 4.                        |  | Controls and Procedures                                                                                                                               |  | 44
|                               | 
|PART II - OTHER INFORMATION    |  |                                                                                                                                                      
|                               |  |                                                                                                                                                      
|Item 1.                        |  | Legal Proceedings                                                                                                                                     |  | 46
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                                                           |  | 46
|Item 3.                        |  | Defaults Upon Senior Securities                                                                                                                       |  | 46
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                                                                                   |  | 46
|Item 5.                        |  | Other Information                                                                                                                                     |  | 46
|Item 6.                        |  | Exhibits                                                                                                                                              |  | 46
|                               | 
|SIGNATURES                     |  | 47                                                                                                                                                   



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



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



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



i



---

##### Table of Contents

PART IFINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------



GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)



|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | -------- | - | -------------- | - | -------- | -
|                                                                                                                                                                                                                                                                |  | January 1,2005            |          |   | October 1,2005 |  
|                                                                                                                                                                                                                                                                |  | (as restated,see Note 17) |          |   |                |  
|ASSETS                                                                                                                                                                                                                                                          |  |                           |          |   |                |   |          |  
|Current assets:                                                                                                                                                                                                                                                 |  |                           |          |   |                |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                                                       |  | $                         | 20,064   |   |                | $ | 16,672   |  
|Marketable securities                                                                                                                                                                                                                                           |  |                           | 55,359   |   |                |   | 95,498   |  
|Accounts receivable, net of allowance of $408 and $346                                                                                                                                                                                                          |  |                           | 14,734   |   |                |   | 13,661   |  
|Inventory                                                                                                                                                                                                                                                       |  |                           | 37,773   |   |                |   | 33,935   |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                       |  |                           | 2,382    |   |                |   | 3,498    |  
|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  
|Total current assets                                                                                                                                                                                                                                            |  |                           | 130,312  |   |                |   | 163,264  |  
|Property and equipment, net                                                                                                                                                                                                                                     |  |                           | 74,387   |   |                |   | 85,987   |  
|Goodwill                                                                                                                                                                                                                                                        |  |                           | 13,453   |   |                |   | 13,932   |  
|Equity investments and other                                                                                                                                                                                                                                    |  |                           | 2,847    |   |                |   | 1,569    |  
|Other assets, net of accumulated amortization of $4,416 and $6,358                                                                                                                                                                                              |  |                           | 10,824   |   |                |   | 11,413   |  
|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  
|Total assets                                                                                                                                                                                                                                                    |  | $                         | 231,823  |   |                | $ | 276,165  |  
|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                                            |  |                           |          |   |                |   |          |  
|Current liabilities:                                                                                                                                                                                                                                            |  |                           |          |   |                |   |          |  
|Accounts payable                                                                                                                                                                                                                                                |  | $                         | 58,023   |   |                | $ | 31,817   |  
|Accrued expenses and other                                                                                                                                                                                                                                      |  |                           | 31,842   |   |                |   | 25,439   |  
|Deferred revenue                                                                                                                                                                                                                                                |  |                           | 9,370    |   |                |   | 6,400    |  
|Current portion - long-term debt and other                                                                                                                                                                                                                      |  |                           | 971      |   |                |   | 629      |  
|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  
|Total current liabilities                                                                                                                                                                                                                                       |  |                           | 100,206  |   |                |   | 64,285   |  
|Convertible notes                                                                                                                                                                                                                                               |  |                           |         |   |                |   | 57,500   |  
|Long-term debt and other                                                                                                                                                                                                                                        |  |                           | 13,564   |   |                |   | 13,241   |  
|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  
|Total liabilities                                                                                                                                                                                                                                               |  |                           | 113,770  |   |                |   | 135,026  |  
|Commitments and contingencies (see note 12)                                                                                                                                                                                                                     |  |                           |          |   |                |   |          |  
|Stockholders equity:                                                                                                                                                                                                                                           |  |                           |          |   |                |   |          |  
|Preferred stock, $0.01 par value, 4,990,000 shares authorized; 0 shares issued and outstanding as of January 1, 2005 and October 1,
2005.                                                                                                                       |  |                           |         |   |                |   |         |  
|Common stock, $0.01 par value, 90,000,000 shares authorized; 41,584,061 and 44,405,525 shares issued as of January 1, 2005 and
October 1, 2005, respectively; 41,582,851 and 44,405,322 shares outstanding as January 1, 2005 and October 1, 2005, respectively |  |                           | 416      |   |                |   | 444      |  
|Additional paid in capital                                                                                                                                                                                                                                      |  |                           | 294,471  |   |                |   | 328,638  |  
|Accumulated other comprehensive loss                                                                                                                                                                                                                            |  |                           | (104     | ) |                |   | (2,174   | )
|Accumulated deficit                                                                                                                                                                                                                                             |  |                           | (176,730 | ) |                |   | (185,769 | )
|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  
|Total stockholders equity                                                                                                                                                                                                                                      |  |                           | 118,053  |   |                |   | 141,139  |  
|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                      |  | $                         | 231,823  |   |                | $ | 276,165  |  
|                                                                                                                                                                                                                                                                |  |                           |          |   |                |   |          |  



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



1



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------ | - | ----------------- | - | ------ | ------------------------- |  | - | -------------- | - |  | - | ------- | -
|                                                                                                                     |  | Three Months Ended        |        |   | Nine Months Ended |  
|                                                                                                                     |  | October 2,2004            |        |   | October 1,2005    |   |        | October 2,2004            |  |   | October 1,2005 |  
|                                                                                                                     |  | (as restated,see Note 17) |        |   |                   |   |        | (as restated,see Note 17) |  |   |                |  
|Revenues:                                                                                                            |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Net revenues from product sales                                                                                      |  | $                         | 55,873 |   |                   | $ | 68,484 |                           |  | $ | 165,882        |   |  | $ | 220,294 |  
|Service fee revenues                                                                                                 |  |                           | 12,715 |   |                   |   | 16,422 |                           |  |   | 33,663         |   |  |   | 47,844  |  
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Net revenues                                                                                                         |  |                           | 68,588 |   |                   |   | 84,906 |                           |  |   | 199,545        |   |  |   | 268,138 |  
|Cost of revenues from product sales                                                                                  |  |                           | 42,171 |   |                   |   | 50,724 |                           |  |   | 123,243        |   |  |   | 165,749 |  
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Gross profit                                                                                                         |  |                           | 26,417 |   |                   |   | 34,182 |                           |  |   | 76,302         |   |  |   | 102,389 |  
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Operating expenses:                                                                                                  |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Sales and marketing, exclusive of $385, $699, $1,075 and $1,808 reported below as stock-based compensation expense   |  |                           | 16,818 |   |                   |   | 21,667 |                           |  |   | 51,182         |   |  |   | 63,755  |  
|Product development, exclusive of $1, $151, $3 and $375 reported below as stock-based compensation expense           |  |                           | 5,137  |   |                   |   | 7,414  |                           |  |   | 14,165         |   |  |   | 20,439  |  
|General and administrative, exclusive of ($2), $236, $86 and $391 reported below as stock-based compensation expense |  |                           | 4,499  |   |                   |   | 4,852  |                           |  |   | 12,794         |   |  |   | 14,596  |  
|Stock-based compensation                                                                                             |  |                           | 384    |   |                   |   | 1,086  |                           |  |   | 1,164          |   |  |   | 2,574   |  
|Depreciation and amortization                                                                                        |  |                           | 2,733  |   |                   |   | 3,693  |                           |  |   | 7,978          |   |  |   | 10,433  |  
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Total operating expenses                                                                                             |  |                           | 29,571 |   |                   |   | 38,712 |                           |  |   | 87,283         |   |  |   | 111,797 |  
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Other (income) expense:                                                                                              |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Interest expense                                                                                                     |  |                           | 244    |   |                   |   | 788    |                           |  |   | 298            |   |  |   | 1,434   |  
|Interest income                                                                                                      |  |                           | (423   | ) |                   |   | (1,015 | )                         |  |   | (955           | ) |  |   | (1,834  | )
|Other (income) expense                                                                                               |  |                           | 66     |   |                   |   | 237    |                           |  |   | 66             |   |  |   | 31      |  
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Total other (income) expense                                                                                         |  |                           | (113   | ) |                   |   | 10     |                           |  |   | (591           | ) |  |   | (369    | )
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Net loss                                                                                                             |  | $                         | (3,041 | ) |                   | $ | (4,540 | )                         |  | $ | (10,390        | ) |  | $ | (9,039  | )
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Loss per share- basic and diluted:                                                                                   |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Net loss                                                                                                             |  | $                         | (0.07  | ) |                   | $ | (0.10  | )                         |  | $ | (0.25          | ) |  | $ | (0.21   | )
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  
|Weighted average shares outstanding - basic and diluted                                                              |  |                           | 41,081 |   |                   |   | 44,203 |                           |  |   | 40,980         |   |  |   | 42,805  |  
|                                                                                                                     |  |                           |        |   |                   |   |        |                           |  |   |                |   |  |   |         |  



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



2



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, except per share data)

(Unaudited)



|                                                                            |  |                           |         |   |                |   |          |  
|--------------------------------------------------------------------------- |  | ------------------------- | ------- | - | -------------- | - | -------- | -
|                                                                            |  | Nine Months Ended         |        
|                                                                            |  | October 2,2004            |         |   | October 1,2005 |  
|                                                                            |  | (as restated,see Note 17) |         |   |                |  
|Cash Flows from Operating Activities:                                       |  |                           |         |   |                |   |          |  
|Net loss                                                                    |  | $                         | (10,390 | ) |                | $ | (9,039   | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                           |         |   |                |   |          |  
|Depreciation and amortization                                               |  |                           | 7,978   |   |                |   | 10,433   |  
|Stock-based compensation                                                    |  |                           | 1,164   |   |                |   | 2,574    |  
|Gain on exchange of note receivable                                         |  |                           | (6      | ) |                |   |         |  
|Changes in operating assets and liabilities:                                |  |                           |         |   |                |   |          |  
|Accounts receivable, net                                                    |  |                           | (4,584  | ) |                |   | 1,325    |  
|Inventory                                                                   |  |                           | (4,394  | ) |                |   | 3,838    |  
|Prepaid expenses and other current assets                                   |  |                           | (30     | ) |                |   | (1,021   | )
|Notes receivable                                                            |  |                           | (195    | ) |                |   |         |  
|Other assets, net                                                           |  |                           | (204    | ) |                |   | 229      |  
|Accounts payable and accrued expenses and other                             |  |                           | (820    | ) |                |   | (31,657  | )
|Deferred revenue                                                            |  |                           | (4,040  | ) |                |   | (2,970   | )
|                                                                            |  |                           |         |   |                |   |          |  
|Net cash used in operating activities                                       |  |                           | (15,521 | ) |                |   | (26,288  | )
|                                                                            |  |                           |         |   |                |   |          |  
|Cash Flows from Investing Activities:                                       |  |                           |         |   |                |   |          |  
|Acquisition of a controlling interest of a business, net of cash acquired   |  |                           |        |   |                |   | (440     | )
|Acquisition of property and equipment                                       |  |                           | (26,596 | ) |                |   | (23,178  | )
|Payments received on notes receivable                                       |  |                           | 3,246   |   |                |   |         |  
|Other deferred cost                                                         |  |                           |        |   |                |   | (347     | )
|Cash paid for equity investment                                             |  |                           |        |   |                |   | (136     | )
|Purchases of marketable securities                                          |  |                           | (29,188 | ) |                |   | (116,971 | )
|Sales of marketable securities                                              |  |                           | 29,230  |   |                |   | 76,525   |  
|                                                                            |  |                           |         |   |                |   |          |  
|Net cash used in investing activities                                       |  |                           | (23,308 | ) |                |   | (64,547  | )
|                                                                            |  |                           |         |   |                |   |          |  
|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     | )
|Proceeds from mortgage note                                                 |  |                           | 13,000  |   |                |   |         |  
|Repayments of mortgage note                                                 |  |                           | (20     | ) |                |   | (110     | )
|Proceeds from sales of common stock                                         |  |                           |        |   |                |   | 28,205   |  
|Equity issuance costs paid                                                  |  |                           |        |   |                |   | (1,838   | )
|Proceeds from exercise of common stock options                              |  |                           | 1,973   |   |                |   | 6,995    |  
|                                                                            |  |                           |         |   |                |   |          |  
|Net cash provided by financing activities                                   |  |                           | 14,953  |   |                |   | 87,447   |  
|                                                                            |  |                           |         |   |                |   |          |  
|Effect of exchange rate changes on cash and cash equivalents                |  |                           |        |   |                |   | (4       | )
|                                                                            |  |                           |         |   |                |   |          |  
|Net decrease in cash and cash equivalents                                   |  |                           | (23,876 | ) |                |   | (3,392   | )
|Cash and cash equivalents, beginning of period                              |  |                           | 38,808  |   |                |   | 20,064   |  
|                                                                            |  |                           |         |   |                |   |          |  
|Cash and cash equivalents, end of period                                    |  | $                         | 14,932  |   |                | $ | 16,672   |  
|                                                                            |  |                           |         |   |                |   |          |  



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



3



---

##### Table of Contents

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 significant 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 17, 2005, as
amended by Form 10-K/Amendment No.1 filed with the SEC on May 2, 2005 and further amended by Form 10-K/Amendment No. 2 filed with the SEC on May 6, 2005. The Company will file as soon as reasonably practicable a Form 10-K/A Amendment
No. 3 (Form 10-K/A) for the fiscal year ended January 1, 2005 to restate the Companys consolidated statements of operations and statements of cash flows for the fiscal years ended January 1,
2005, January 3, 2004 and December 28, 2002 and its consolidated balance sheets for the fiscal years ended January 1, 2005 and January 3, 2004. The Company will file contemporaneously with Form 10-K/A, Form 10-Q/A for the
three-months ended April 2, 2005 and Form 10-Q/A for the three- and six-months ended July 2, 2005. See Note 17.



NOTE 2ACCOUNTING POLICIES



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



The Company capitalizes inbound freight into the cost of inventory. During the three-months ended October 1, 2005, the Company changed its
estimate for computing the amount of inbound freight capitalized in inventory. This change in estimate resulted in a reduction of $600 of cost of revenues from product sales and net loss for the three and nine months ended October 1, 2005.
The change in estimate decreased the loss per share by $0.01.



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



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



Marketable Securities: Marketable securities, which consist of investments in various debt securities, are classified as available-for-sale
and are reported at fair value, with unrealized gains and losses recorded as a component of stockholders equity. As of October 1, 2005, 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. 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 with
original maturities of greater than 90 days are accounted for in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. At
January 1, 2005, and October 1, 2005, the Company held $39,700 and $42,026, respectively, of investments in auction rate securities classified as available-for-sale. Investments in these



4



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



securities are recorded at cost, which approximates fair value due to their variable interest rates, which reset approximately every 30 to 45 days. Despite
the long-term nature of their stated contractual maturities, there is a ready liquid market for these securities based on the interest reset mechanism. As a result, there are immaterial cumulative gross realized or unrealized holding gains or
(losses) from the Companys auction rate securities. 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 or loss.



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



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



| |  |  | Three years for office equipment;
| | - |  | ---------------------------------



| |  |  | Three to four years for computer hardware and software;
| | - |  | -------------------------------------------------------



| |  |  | Seven years for furniture and fulfillment center equipment;
| | - |  | -----------------------------------------------------------



| |  |  | The lesser of fifteen years or lease term for leasehold improvements;
| | - |  | ---------------------------------------------------------------------



| |  |  | Fifteen years for building improvements; and
| | - |  | --------------------------------------------



| |  |  | Thirty years for buildings.
| | - |  | ---------------------------



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



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



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



Other Equity Investments: Other equity investments consist of 824,594 shares of Odimo Incorporated
(Odimo) common stock, which was converted from Series C and Series D preferred stock when Odimo completed an initial public offering through the issuance of 3,125,000 shares of its common stock in February 2005. The Company accounts for
the investment in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Prior to the initial public offering, the original cost of the Companys investment was determined based on the
fair value of the investment at the time of its acquisition. At the time, an observable market price did not exist for non-marketable securities. In order to determine the fair value of the investment in Odimo, the Company obtained an independent,
third-party valuation. The valuation incorporated a variety of methodologies to estimate fair value, including comparing the security with securities of publicly traded companies in similar lines of business, applying price multiples to estimated
future operating results for Odimo and estimating discounted cash flows. Factors affecting the valuation included restrictions on control and marketability of Odimos equity securities and other information available to the Company, such as the
Companys knowledge of the industry and knowledge of specific information



5



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



about Odimo. Using this valuation, the Company determined the estimated fair value of the investment to be approximately $2,847 as of January 1, 2005.
During the first quarter of 2005, the Company exercised warrants related to Odimo for $136, which represented 119,272 shares of common stock. The fair value of the Odimo investment as of October 1, 2005 was $1,220, which was determined by the
current market price of the common stock of Odimo on October 1, 2005. This resulted in an unrealized loss of $1,763 for the nine-month period ended October 1, 2005, which is recorded in accumulated other comprehensive (loss) income as a
component of stockholders equity. In accordance with SFAS No. 115 and Emerging Issues Task Force (EITF) 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, the Company determined
that the impairment of the Odimo investment below cost basis is not other-than-temporary. This determination was derived from an evidence-based judgment about the potential recovery of fair value for an amount up to the cost of the investment. Such
evidence included the duration of the decline in value, and the nature of events that led to the decline in value.



Other Assets, Net: Other assets, net consists primarily of deferred partner revenue share charges, resulting from the exercise of a right to
receive 1,600,000 shares of the Companys common stock in lieu of future cash partner revenue share payments. Deferred partner revenue share charges were $10,097 as of January 1, 2005 and $8,357 for the nine-month period ended
October 1, 2005, and is being amortized as stock-based compensation expense as the partner revenue share expense is incurred. The partner revenue share expense incurred is based on actual revenues recognized in a given period and the imputed
partner revenue share percentage, which is based on the value of the Companys common stock that was issued upon exercise of the right. Stock-based compensation expense related to the amortization of deferred partner revenue share charges was
$374 and $1,066 for the three- and nine-month periods ended October 2, 2004, and $577 and $1,740 for the three- and nine-month periods ended October 1, 2005.



In addition, other assets include the underwriters discount and debt issuance costs of $2,588 as of October 1,
2005, relating to the June 1, 2005 public offering of $57,500 aggregate principal amount of 3% convertible unsecured obligations due June 1, 2025. The underwriters discount and debt issuance costs are being amortized using the
straight-line method which approximates the effective interest method. Total amortization related to the underwriters discount and debt issuance costs, which is reflected as a portion of interest expense, was $130 and $173 for the three- and
nine-month periods ended October 1, 2005.



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



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



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



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



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



6



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



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



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



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



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



Sales and Marketing: Sales and marketing expenses include
fulfillment costs, customer service costs, credit card fees, net partner revenue share charges, net advertising and promotional expenses incurred by us on behalf of the Companys partners e-commerce businesses, and payroll related to the
buying, business management and marketing functions of the company. Net partner revenue share charges are royalty payments made to the Companys partners in exchange for the use of their brands, the promotion of its partners URLs, Web
sites and toll-free telephone numbers in their marketing and communications materials, the implementation of programs to provide incentives to customers to shop through the e-commerce businesses that the Company operates for its partners and other
programs and services provided to the customers of the e-commerce businesses that the Company operates for its partners, net of amounts reimbursed to the Company by its partners. Partner revenue share charges were $1,367 and $6,695 for the three-
and nine-month periods ended October 2, 2004, and $2,839 and $7,274 for the three- and nine-month periods ended October 1, 2005.



7



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



The Company defines shipping and handling costs as only those costs incurred for a third-party
shipper to transport products to the customer and these costs are included in cost of revenues from product sales. In some instances, shipping and handling costs exceed shipping charges to the customer and are subsidized by the Company.
Additionally, the Company selectively offers promotional free shipping whereby it ships merchandise to customers free of all shipping and handling charges. The cost of promotional free shipping and subsidized shipping and handling was $361 and
$1,413 for the three-and nine-month periods ended October 2, 2004, and $313 and $2,129 for the three- and nine-month periods ended October 1, 2005, and was charged to sales and marketing expense.



The Company defines fulfillment costs as personnel, occupancy and other costs
associated with its Kentucky fulfillment 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 $5,472 and $15,167
for the three- and nine-month periods ended October 2, 2004, and $6,374 and $19,374 for the three- and nine-month period ended October 1, 2005, and are included in sales and marketing expense.



The Company expenses the cost of advertising, which includes online marketing
fees, media, agency and production expenses, in accordance with the AICPA Accounting Standards Executive Committees Statement of Position (SOP) 93-7, Reporting on Advertising Costs. Advertising production costs are
expensed the first time the advertisement runs. Online marketing fees and media (television, radio and print) placement costs are expensed in the month the advertising appears. Agency fees are expensed as incurred. 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 $1,377 and $4,232 for the three- and nine-month period ended
October 2, 2004, and $2,000 and $5,737 for the three- and nine-month period ended October 1, 2005, and are included in sales and marketing expenses.



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



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



8



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



The following table illustrates the pro forma net loss and loss per share for the three- and
nine-month periods ended October 2, 2004 and October 1, 2005 as if compensation expense for stock options issued to employees had been determined consistent with SFAS No. 123:



|                                                                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|----------------------------------------------------------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | -------------- |  | - | -------------- | - |  | - | ------- | -
|                                                                                                            |  | Three Months Ended |        |   | Nine Months Ended |  
|                                                                                                            |  | October 2,2004     |        |   | October 1,2005    |   |        | October 2,2004 |  |   | October 1,2005 |  
|Net loss, as reported                                                                                       |  | $                  | (3,041 | ) |                   | $ | (4,540 | )              |  | $ | (10,390        | ) |  | $ | (9,039  | )
|Add: Stock-based compensation expense included in reported net loss                                         |  |                    | 15     |   |                   |   | 499    |                |  |   | 30             |   |  |   | 824     |  
|Deduct: Total stock-based compensation determined under fair value based method for all stock option awards |  |                    | (1,709 | ) |                   |   | (640   | )              |  |   | (4,457         | ) |  |   | (7,013  | )
|                                                                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|Pro forma net loss                                                                                          |  | $                  | (4,735 | ) |                   | $ | (4,681 | )              |  | $ | (14,817        | ) |  | $ | (15,228 | )
|                                                                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|Loss per share - basic and diluted:                                                                         |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|Net loss per share, as reported                                                                             |  | $                  | (0.07  | ) |                   | $ | (0.10  | )              |  | $ | (0.25          | ) |  | $ | (0.21   | )
|                                                                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|Pro forma net loss per share                                                                                |  | $                  | (0.12  | ) |                   | $ | (0.11  | )              |  | $ | (0.36          | ) |  | $ | (0.36   | )
|                                                                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  



Stock-based
compensation expense related to the amortization of deferred partner revenue share charges was $374 and $1,066 for the three- and nine-month periods ended October 2, 2004, and $577 and $1,740 for the three- and nine-month periods ended
October 1, 2005.



New Accounting Pronouncements



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



In December 2004, the FASB issued Statement No. 123R
Share-Based Payment, or SFAS 123R, which replaces Statement No. 123, Accounting for Stock-Based Compensation, or SFAS 123, and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, or APB 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. In addition, SFAS 123R will cause
unrecognized expense (based on the amounts in the Companys pro forma footnote disclosure) related to options vesting after the date of initial adoption to be recognized as a charge to results of operations over the remaining vesting period. In
April 2005, the SEC announced that it would delay the initial adoption of SFAS 123R from interim periods that begin after June 15, 2005, to annual periods beginning after June 15, 2005. Under SFAS 123R, the Company must determine the
appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The Company is evaluating the requirements of SFAS 123R and it
expects that the adoption of SFAS 123R will have a material impact on its consolidated results of operations and earnings per share beginning in the fiscal year 2006.



9



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



In June 2005, the FASB issued FSP FAS 150-5, Issuers Accounting under FASB Statement
No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable. This FSP clarifies that freestanding warrants and other similar instruments on shares that are redeemable should be accounted for as
liabilities under Statement 150 regardless of the timing of the redemption feature or price. The guidance in this FSP shall be applied to the first reporting period beginning after June 30, 2005. The Company evaluated the requirements of this
FSP and the adoption of it had no impact on its financial position, consolidated results of operations and earnings per share.



NOTE 3MARKETABLE SECURITIES



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



|                                  |  |                 |        |                       |   |      |                     |  |   |       
|--------------------------------- |  | --------------- | ------ | --------------------- | - | ---- | ------------------- |  | - | ------
|                                  |  | January 1, 2005
|                                  |  | AmortizedCost   |        | GrossUnrealizedLosses |   |      | EstimatedFair Value
|Auction rate securities           |  | $               | 39,700 |                       | $ |     |                     |  | $ | 39,700
|Corporate bonds                   |  |                 | 5,963  |                       |   | (41  | )                   |  |   | 5,922 
|U.S. government agency securities |  |                 | 9,800  |                       |   | (63  | )                   |  |   | 9,737 
|                                  |  |                 |        |                       |   |      |                     |  |   |       
|                                  |  | $               | 55,463 |                       | $ | (104 | )                   |  | $ | 55,359
|                                  |  |                 |        |                       |   |      |                     |  |   |       



|                                  |  |                 |        |                      |   |                       |  |   |                     |   |  |   |       
|--------------------------------- |  | --------------- | ------ | -------------------- | - | --------------------- |  | - | ------------------- | - |  | - | ------
|                                  |  | October 1, 2005
|                                  |  | AmortizedCost   |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | EstimatedFair Value
|Auction rate securities           |  | $               | 42,030 |                      | $ |                      |  | $ | (4                  | ) |  | $ | 42,026
|Corporate bonds                   |  |                 | 33,886 |                      |   |                      |  |   | (203                | ) |  |   | 33,683
|U.S. government agency securities |  |                 | 19,993 |                      |   |                      |  |   | (204                | ) |  |   | 19,789
|                                  |  |                 |        |                      |   |                       |  |   |                     |   |  |   |       
|                                  |  | $               | 95,909 |                      | $ |                      |  | $ | (411                | ) |  | $ | 95,498
|                                  |  |                 |        |                      |   |                       |  |   |                     |   |  |   |       



The fair value of
marketable securities with loss positions was $15,659 as of January 1, 2005 and $54,468 as of October 1, 2005, and the gross unrealized losses on these marketable securities were $104 as of January 1, 2005 and $411 as of
October 1, 2005. The Company considered the nature of these marketable securities, which are primarily U.S. government agency securities and corporate bonds, the amount of the impairments relative to the carrying value of the related
investments and the duration of the impairments, which are all less than twelve months, and concluded that the impairments were not other than temporary.



10



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



The amortized cost and estimated fair value of investments in debt securities as of October 1,
2005, by contractual maturity, are as follows:



|                                       |  |               |        |                     |   |       
|-------------------------------------- |  | ------------- | ------ | ------------------- | - | ------
|                                       |  | AmortizedCost |        | EstimatedFair Value
|Due within one year                    |  | $             | 36,474 |                     | $ | 36,365
|Due after one year through five years  |  |               | 45,385 |                     |   | 45,083
|Due after five years through ten years |  |               |       |                     |   |      
|Due after ten years                    |  |               | 14,050 |                     |   | 14,050
|                                       |  |               |        |                     |   |       
|                                       |  | $             | 95,909 |                     | $ | 95,498
|                                       |  |               |        |                     |   |       



NOTE 4ACQUISITION



On July 6, 2005, the Company acquired an irrevocable
right that conveys the voting and economic rights to shares representing 51% of the shares in Aspherio S.L., a Barcelona, Spain-based provider of outsourced e-commerce solutions, for approximately $578, including acquisition expenses. The Company
controls Aspherio through its majority voting interest and majority of directors. The Company is working strategically with Aspherio to offer its international e-commerce capabilities to the Companys existing partners and prospects. The
consolidated financial statements for, and as of the nine-month period ended October 1, 2005, include the assets and liabilities and the operating results for the period from acquisition date through October 1, 2005, with the remaining 49%
recorded through minority interest. The Company also has the right to acquire all of the outstanding shares of Aspherio and the shareholders of Aspherio have the right to require us to acquire all of the outstanding shares of Aspherio. Subject to
the satisfaction of certain conditions, the acquisition of Aspherio is expected to close in late 2005 or early 2006. If consummated, the purchase price for the acquisition of control, and for the acquisition of the shares of Aspherio, will be
approximately $4.0 million plus an earn-out based on performance of the Aspherio business. Of the $4.0 million, $2.7 million will be paid in cash and $1.3 million will be paid in cash or the Companys common stock, at the Companys
election. The Company does not expect the acquisition to have a material impact on its consolidated results of operations for fiscal years ending December 31, 2005 or December 30, 2006.



Pursuant to SFAS 141, Business Combinations, the
July 6, 2005 Aspherio transaction was accounted for under the purchase method of accounting with the Companys proportionate interest in the excess of the initial purchase price over the estimated fair value of the net tangible and
identifiable intangible assets acquired recorded as goodwill. The allocation of the initial purchase price over the estimated fair value of the tangible and identifiable intangible assets acquired resulted in $479 recorded as goodwill. Pro forma
disclosures related to this acquisition are not included as such disclosures are not material.



11



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



NOTE 5PROPERTY AND EQUIPMENT



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



|                                          |  |                |         |   |                |   |         |  
|----------------------------------------- |  | -------------- | ------- | - | -------------- | - | ------- | -
|                                          |  | January 1,2005 |         |   | October 1,2005 |  
|Computer hardware and software            |  | $              | 51,841  |   |                | $ | 66,125  |  
|Building and building improvements        |  |                | 39,751  |   |                |   | 40,936  |  
|Furniture, warehouse and office equipment |  |                | 10,651  |   |                |   | 11,599  |  
|Land                                      |  |                | 7,663   |   |                |   | 7,663   |  
|Leasehold improvements                    |  |                | 529     |   |                |   | 609     |  
|Capitalized lease                         |  |                | 1,692   |   |                |   | 1,692   |  
|Construction in progress                  |  |                | 387     |   |                |   | 5,757   |  
|                                          |  |                |         |   |                |   |         |  
|                                          |  |                | 112,514 |   |                |   | 134,381 |  
|Less: Accumulated depreciation            |  |                | (38,127 | ) |                |   | (48,394 | )
|                                          |  |                |         |   |                |   |         |  
|Property and equipment, net               |  | $              | 74,387  |   |                | $ | 85,987  |  
|                                          |  |                |         |   |                |   |         |  



NOTE 6CHANGES IN
STOCKHOLDERS EQUITY



The following table summarizes
the changes in stockholders equity for the nine-months ended October 1, 2005:



|                                                                           |  |              |  |                          |     |  |                     |         |   |                            |   |          |                                            |  |   |                |   |       |   |        |   |  |    |   |  |   |   |  |   |         |  
|-------------------------------------------------------------------------- |  | ------------ |  | ------------------------ | --- |  | ------------------- | ------- | - | -------------------------- | - | -------- | ------------------------------------------ |  | - | -------------- | - | ----- | - | ------ | - |  | -- | - |  | - | - |  | - | ------- | -
|                                                                           |  | Common Stock |  | AdditionalPaid inCapital |     |  | Accumulated Deficit |         |   | Comprehensive(Loss) Income |   |          | AccumulatedOtherComprehensiveIncome (Loss) |  |   | Treasury Stock |   | Total |  
|                                                                           |  | Shares       |  | Dollars                  |     |  |                     |         |   | Shares                     |   |          | Dollars                                    | 
|Consolidated balance at January 1, 2005, (as restated, see note 17)        |  | 41,584       |  | $                        | 416 |  | $                   | 294,471 |   |                            | $ | (176,730 | )                                          |  |   |                |   |       | $ | (104   | ) |  | 1  |   |  | $ |  |  | $ | 118,053 |  
|Net loss                                                                   |  |              |  |                          |     |  |                     |         |   |                            |   | (9,039   | )                                          |  |   | (9,039         | ) |       |   |        |   |  |    |   |  |   |   |  |   | (9,039  | )
|Net unrealized losses on available-for-sale securities                     |  |              |  |                          |     |  |                     |         |   |                            |   |          |                                            |  |   | (307           | ) |       |   | (307   | ) |  |    |   |  |   |   |  |   | (307    | )
|Unrealized loss on investment in Odimo recorded at fair value (See Note 2) |  |              |  |                          |     |  |                     |         |   |                            |   |          |                                            |  |   | (1,763         | ) |       |   | (1,763 | ) |  |    |   |  |   |   |  |   | (1,763  | )
|                                                                           |  |              |  |                          |     |  |                     |         |   |                            |   |          |                                            |  |   |                |   |       |   |        |   |  |    |   |  |   |   |  |   |         |  
|Comprehensive loss                                                         |  |              |  |                          |     |  |                     |         |   |                            |   |          |                                            |  | $ | (11,109        | ) |       |   |        |   |  |    |   |  |   |   |  |   |         |  
|                                                                           |  |              |  |                          |     |  |                     |         |   |                            |   |          |                                            |  |   |                |   |       |   |        |   |  |    |   |  |   |   |  |   |         |  
|Stock based compensation expense                                           |  |              |  |                          |     |  |                     | 834     |   |                            |   |          |                                            |  |   |                |   |       |   |        |   |  |    |   |  |   |   |  |   | 834     |  
|Issuance of common stock during public offering                            |  | 1,962        |  |                          | 19  |  |                     | 28,185  |   |                            |   |          |                                            |  |   |                |   |       |   |        |   |  |    |   |  |   |   |  |   | 28,204  |  
|Issuance costs related to the common stock public offering                 |  |              |  |                          |     |  |                     | (1,838  | ) |                            |   |          |                                            |  |   |                |   |       |   |        |   |  |    |   |  |   |   |  |   | (1,838  | )
|Issuance of common stock upon exercise of options                          |  | 860          |  |                          | 9   |  |                     | 6,986   |   |                            |   |          |                                            |  |   |                |   |       |   |        |   |  | (1 | ) |  |   |   |  |   | 6,995   |  
|                                                                           |  |              |  |                          |     |  |                     |         |   |                            |   |          |                                            |  |   |                |   |       |   |        |   |  |    |   |  |   |   |  |   |         |  
|Consolidated balance at October, 1 2005                                    |  | 44,406       |  | $                        | 444 |  | $                   | 328,638 |   |                            | $ | (185,769 | )                                          |  |   |                |   |       | $ | (2,174 | ) |  |   |   |  | $ |  |  | $ | 141,139 |  
|                                                                           |  |              |  |                          |     |  |                     |         |   |                            |   |          |                                            |  |   |                |   |       |   |        |   |  |    |   |  |   |   |  |   |         |  



In June 2005, the
Company completed the sale of approximately 1.9 million shares of common stock in the Companys public offering, which raised approximately $26,366 in net proceeds, which the Company will use for working capital and general corporate
purposes, including possible acquisitions.



12



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



NOTE 7STOCK OPTIONS, WARRANTS AND STOCK AWARDS



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



The following table summarizes the stock option activity for
the three-month periods ended October 2, 2004 and October 1, 2005:



|                                 |  |                    |   |                 |                              |       |                 |       |   |                              |   |      
|-------------------------------- |  | ------------------ | - | --------------- | ---------------------------- | ----- | --------------- | ----- | - | ---------------------------- | - | -----
|                                 |  | Three Months Ended
|                                 |  | October 2, 2004    |   | October 1, 2005
|                                 |  | Number ofShares    |   |                 | WeightedAverageExercisePrice |       | Number ofShares |       |   | WeightedAverageExercisePrice
|Outstanding, beginning of period |  | 6,522              |   |                 | $                            | 8.35  |                 | 6,684 |   |                              | $ | 9.58 
|Granted                          |  | 143                |   |                 |                              | 7.15  |                 | 77    |   |                              |   | 19.43
|Exercised                        |  | (183               | ) |                 |                              | 5.05  |                 | (486  | ) |                              |   | 9.04 
|Cancelled                        |  | (90                | ) |                 |                              | 17.56 |                 | (72   | ) |                              |   | 12.11
|                                 |  |                    |   |                 |                              |       |                 |       |   |                              |   |      
|Outstanding, end of period       |  | 6,392              |   |                 |                              | 8.26  |                 | 6,203 |   |                              |   | 9.72 
|                                 |  |                    |   |                 |                              |       |                 |       |   |                              |   |      
|Exercisable, end of period       |  | 3,990              |   |                 |                              | 7.90  |                 | 4,916 |   |                              |   | 9.60 
|                                 |  |                    |   |                 |                              |       |                 |       |   |                              |   |      



During the three-month
period ended October 1, 2005, the Company granted to employees options to purchase an aggregate of 77,250 shares of the Companys common stock at prices ranging from $17.07 to $19.50 per share and restricted stock units to purchase an
aggregate of 29,954 shares of the Companys common stock. The weighted average fair value and the weighted average exercise price of the options granted with exercise prices at the then-current market prices of the underlying stock during the
three-month period ended October 1, 2005 was $5.40 and $19.43 per share, respectively. For the three- and nine-month periods ended October 1, 2005, the Company recorded stock-based compensation expense of $509 and $834, respectively,
relating to options and restricted stock.



During the
three-month period ended October 2, 2004, the Company granted to employees options to purchase an aggregate of 80,550 shares of the Companys common stock at prices ranging from $0.01 to $9.00 per share and granted to directors options to
purchase an aggregate of 62,500 shares of the Companys common stock at a price of $8.11 per share. The weighted average fair value and the weighted average exercise price of the options granted with exercise prices at the then-current market
prices of the underlying stock during the three-month period ended October 2, 2004 was $4.57 and $8.53 per share,



13



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



respectively. The weighted average fair value and the weighted average exercise price of the restricted stock awards granted with exercise prices below the
then-current market prices of the underlying stock during the three-month period ended October 2, 2004 was $9.31 and $0.01 per share, respectively. For the three- and nine-month periods ended October 2, 2004, the Company recorded
stock-based compensation expense of $11 and $9, respectively, relating to options and restricted stock.



The following table summarizes the warrant activity for the three-month periods ended October 2, 2004 and October 1, 2005:



|                                 |  |                    |  |                              |      |                 |     |                              |   |     
|-------------------------------- |  | ------------------ |  | ---------------------------- | ---- | --------------- | --- | ---------------------------- | - | ----
|                                 |  | Three Months Ended
|                                 |  | October 2, 2004    |  | October 1, 2005             
|                                 |  | Number ofShares    |  | WeightedAverageExercisePrice |      | Number ofShares |     | WeightedAverageExercisePrice
|Outstanding, beginning of period |  | 815                |  | $                            | 7.71 |                 | 815 |                              | $ | 7.71
|Granted                          |  |                   |  |                              |     |                 |    |                              |   |    
|Exercised                        |  |                   |  |                              |     |                 |    |                              |   |    
|Cancelled                        |  |                   |  |                              |     |                 |    |                              |   |    
|                                 |  |                    |  |                              |      |                 |     |                              |   |     
|Outstanding, end of period       |  | 815                |  |                              | 7.71 |                 | 815 |                              |   | 7.71
|                                 |  |                    |  |                              |      |                 |     |                              |   |     
|Exercisable, end of period       |  | 615                |  |                              | 9.40 |                 | 615 |                              |   | 9.40
|                                 |  |                    |  |                              |      |                 |     |                              |   |     



No warrants were
granted or issued by the Company during the three- and nine-month periods ended October 1, 2005.



The following table summarizes information regarding options and warrants outstanding and exercisable as of October 1, 2005:



|                         |  |                   |  |                                                   |  |                              |       |                   |       |                              |   |      
|------------------------ |  | ----------------- |  | ------------------------------------------------- |  | ---------------------------- | ----- | ----------------- | ----- | ---------------------------- | - | -----
|                         |  | Outstanding       |  | Exercisable                                      
|Range of Exercise Prices |  | NumberOutstanding |  | Weighted AverageRemainingContractual LifeIn Years |  | WeightedAverageExercisePrice |       | NumberExercisable |       | WeightedAverageExercisePrice
|$0.01 - $6.00            |  | 2,340             |  | 4.68                                              |  | $                            | 4.78  |                   | 2,064 |                              | $ | 5.09 
|$6.20 - $10.00           |  | 2,409             |  | 7.18                                              |  |                              | 9.06  |                   | 1,475 |                              |   | 8.74 
|$10.87- $24.69           |  | 2,269             |  | 7.53                                              |  |                              | 14.80 |                   | 1,992 |                              |   | 14.86
|                         |  |                   |  |                                                   |  |                              |       |                   |       |                              |   |      
|$0.01 - $24.69           |  | 7,018             |  | 6.46                                              |  | $                            | 9.49  |                   | 5,531 |                              | $ | 9.58 
|                         |  |                   |  |                                                   |  |                              |       |                   |       |                              |   |      



As of October 1,
2005, 1,907,741 shares of common stock were available for future grants under the Plans.



14



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



The fair value of options granted under the Plans during the three-month periods ended
October 2, 2004 and October 1, 2005 were estimated on the date of grant using the Black-Scholes multiple option pricing model, with the following weighted average assumptions:



|                                |  |                    |   |  |                 |  
|------------------------------- |  | ------------------ | - |  | --------------- | -
|                                |  | Three Months Ended |  
|Assumption                      |  | October 2, 2004    |   |  | October 1, 2005 |  
|Dividend yield                  |  | None               |   |  | None            |  
|Expected volatility             |  | 91.00              | % |  | 45.19           | %
|Average risk free interest rate |  | 2.73               | % |  | 4.18            | %
|Average expected lives          |  | 2.39 years         |   |  | 1.96 years      |  



NOTE 8NET LOSS PER SHARE



Basic earnings (loss) per share for all periods have been
computed in accordance with SFAS No. 128, Earnings Per Share. Basic and diluted loss per share 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 and warrants, and convertible notes have been excluded from the calculation of diluted losses per share because their effect would be anti-dilutive.



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



|                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |        |  
|----------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | -------------- |  | - | -------------- | - |  | - | ------ | -
|                                                            |  | Three Months Ended |        |   | Nine Months Ended |  
|                                                            |  | October 2,2004     |        |   | October 1,2005    |   |        | October 2,2004 |  |   | October 1,2005 |  
|Net loss                                                    |  | $                  | (3,041 | ) |                   | $ | (4,540 | )              |  | $ | (10,390        | ) |  | $ | (9,039 | )
|                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |        |  
|Weighted average shares outstanding - basic and diluted     |  |                    | 41,081 |   |                   |   | 44,203 |                |  |   | 40,980         |   |  |   | 42,805 |  
|                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |        |  
|Outstanding common stock options having no dilutive effect  |  |                    | 6,392  |   |                   |   | 6,203  |                |  |   | 6,392          |   |  |   | 6,203  |  
|                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |        |  
|Outstanding common stock warrants having no dilutive effect |  |                    | 815    |   |                   |   | 815    |                |  |   | 815            |   |  |   | 815    |  
|                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |        |  
|Convertible shares having no dilutive effect                |  |                    |       |   |                   |   | 3,229  |                |  |   |               |   |  |   | 3,229  |  
|                                                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |        |  



NOTE 9COMPREHENSIVE INCOME
(LOSS):



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



|                                                              |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|------------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | -------------- |  | - | -------------- | - |  | - | ------- | -
|                                                              |  | Three Months Ended |        |   | Nine Months Ended |  
|                                                              |  | October 2,2004     |        |   | October 1,2005    |   |        | October 2,2004 |  |   | October 1,2005 |  
|Net loss                                                      |  | $                  | (3,041 | ) |                   | $ | (4,540 | )              |  | $ | (10,390        | ) |  | $ | (9,039  | )
|                                                              |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|Other comprehensive income (loss):                            |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|Net unrealized gain (loss) on available-for-sale securities   |  |                    | 25     |   |                   |   | (227   | )              |  |   | (72            | ) |  |   | (307    | )
|Unrealized loss on investment in Odimo recorded at fair value |  |                    |       |   |                   |   | (3,315 | )              |  |   |               |   |  |   | (1,763  | )
|                                                              |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|Other comprehensive income (loss)                             |  |                    | 25     |   |                   |   | (3,542 | )              |  |   | (72            | ) |  |   | (2,070  | )
|                                                              |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  
|Comprehensive loss                                            |  | $                  | (3,016 | ) |                   | $ | (8,082 | )              |  | $ | (10,462        | ) |  | $ | (11,109 | )
|                                                              |  |                    |        |   |                   |   |        |                |  |   |                |   |  |   |         |  



15



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



NOTE 10SIGNIFICANT TRANSACTIONS/CONCENTRATIONS OF CREDIT RISK



The Company had $20,064 as of January 1, 2005 and $16,672 as of
October 1, 2005, of operating cash and $55,359 as of January 1, 2005 and $95,498 as of October 1, 2005 of cash equivalents and marketable securities invested with three financial institutions, which are potentially subject to credit
risk. The composition of these investments is regularly monitored by management of the Company.



NOTE 11MAJOR SUPPLIERS/ECONOMIC DEPENDENCY



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



During the three-month period ended October 2, 2004, the Company purchased inventory from one supplier amounting to $18,786 or 45.7% of total
inventory purchased. During the nine-month period ended October 2 2004, the Company purchased inventory from one supplier amounting to $44,037 or 40.3% of total inventory purchased.



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



NOTE 12COMMITMENTS AND CONTINGENCIES



Legal Proceedings



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



While the Company sold certain assets of Ashford.com, Inc. in December 2002,
Ashford.com continues to be a party to certain litigation that was commenced prior to the Companys acquisition of Ashford.com in March 2002. Since July 11, 2001, several stockholder class action complaints have been filed in the United
States District Court of the Southern District of New York against Ashford.com, several of Ashford.coms officers and directors, and various underwriters of Ashford.coms initial public offering. The purported class actions have all been
brought on behalf of purchasers of Ashford.com common stock during various periods beginning on September 22, 1999, the date of Ashford.coms initial public offering. The plaintiffs allege that Ashford.coms prospectus, included in
Ashford.coms Registration Statement on Form S-1 filed with the Securities and Exchange Commission, was materially false and misleading because it failed to disclose, among other things, certain fees and commissions collected by the
underwriters or arrangements designed to inflate the price of the common stock. The plaintiffs further allege that because of these purchases, Ashford.coms post-initial public offering stock price was artificially inflated. As a result of the
alleged omissions in the prospectus and the purported inflation of the stock price, the plaintiffs claim violations of Sections 11 and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. The complaints
have been consolidated into a single action, and the consolidated cases against Ashford.com have been consolidated with similarly consolidated cases filed against 308 other issuer defendants for the purposes of pretrial proceedings. The claims
against Ashford.coms officers and directors were dismissed in exchange for tolling agreements which permit the refiling of claims against officers and directors at a later date. A motion to dismiss filed on behalf of all issuer defendants,
including Ashford.com, was denied in all aspects relevant to Ashford.com on February 19, 2003. Ashford.com and its insurers have entered into a memorandum of understanding regarding terms for settlement of this suit. Under the settlement,
plaintiffs claims against Ashford.com and other issuers will be dismissed in exchange for certain consideration from the issuers insurers and for the issuers assignment to plaintiffs of certain potential claims against the
underwriters of the relevant initial public offerings. Formal documentation of the settlement contemplated by the memorandum of understanding is complete and the Judge presiding over this matter has preliminarily approved the settlement. In the
event that a settlement is not finalized, the Company believes that Ashford.com has defenses against these actions.



In September 2003, the Company learned that it, along with several of its partners, were named in an action in the Circuit Court of Cook County, Illinois,
by a private litigant who is alleging that the Company, along with certain of its partners, wrongfully failed to collect and remit sales and use taxes for sales of personal property to customers in Illinois and knowingly created records and
statements falsely stating the Company was not required to collect or remit such taxes. The complaint seeks



16



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



injunctive relief, unpaid taxes, interest, attorneys fees, civil penalties of up to $10 per violation, and treble damages under the Illinois
Whistleblower Reward and Protection Act. The Company is aware that this same private litigant has filed similar actions against retailers in other states, and it may be possible that the Company and/or its partners may have been or may be named in
similar cases in other states. In November 2005, the judge presiding over this matter granted the State of Illinois motion to dismiss all claims against the Company and its partners with the exception of one. For the remaining motion, a
response is due by the Company in December 2005. While the private litigant can file an appeal with respect to the dismissed claim and while there is one remaining claim being considered by the court, the Company does not believe that it is liable
under existing laws and regulations for any failure to collect sales or other taxes relating to internet sales and intends to vigorously defend itself in this matter.



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



Acquisitions



See Note 4 for the Aspherio transaction and the related contingent considerations.



Advertising and Media Agreements



As of October 1, 2005, the Company was contractually committed for the purchase of future advertising totaling
approximately $81 through the fiscal year ending December 31, 2005. The expense related to these commitments will be recognized in accordance with the Companys accounting policy related to advertising (see Note 2).



Partner Revenue Share Payments



As of October 1, 2005 and subject to the satisfaction of certain
conditions, the Company was contractually committed to future minimum cash revenue share payments as follows:



|                                                             |  |                               |       
|------------------------------------------------------------ |  | ----------------------------- | ------
|Fiscal Year-Ended                                            |  | Partner RevenueShare Payments
|2005                                                         |  | $                             | 2,643 
|2006                                                         |  |                               | 3,654 
|2007                                                         |  |                               | 4,500 
|2008                                                         |  |                               | 4,850 
|2009                                                         |  |                               | 5,150 
|Thereafter                                                   |  |                               | 2,650 
|                                                             |  |                               |       
|Total conditional future minimum cash revenue share payments |  | $                             | 23,447
|                                                             |  |                               |       



17



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



NOTE 13SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION



|                                                                                                                                               |  |                   |       |   |                |   |        |  
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ----- | - | -------------- | - | ------ | -
|                                                                                                                                               |  | Nine Months Ended |      
|                                                                                                                                               |  | October 2,2004    |       |   | October 1,2005 |  
|Cash paid during the period for interest                                                                                                       |  | $                 | 201   |   |                | $ | 864    |  
|                                                                                                                                               |  |                  
|Noncash Investing and Financing Activities:                                                                                                    |  |                   |       |   |                |   |        |  
|Receipt of shares of, and warrants to purchase, Odimo's Series C preferred stock in connection with a conversion of principal due under a
note |  |                   | 688   |   |                |   |       |  
|Exchange of a portion of a promissory note in connection with a conversion of principal due under the note                                     |  |                   | (682  | ) |                |   |       |  
|Unrealized loss on investment in Odimo recorded at fair value                                                                                  |  |                   |      |   |                |   | (1,763 | )
|Equipment financed under capital leases                                                                                                        |  |                   | 1,604 |   |                |   |       |  
|Changes in accrual for purchases of property and equipment                                                                                     |  |                   | 1,509 |   |                |   | (1,153 | )
|Net unrealized losses on available-for-sale securities                                                                                         |  |                   | (72   | ) |                |   | (411   | )



NOTE 14BUSINESS SEGMENTS



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



NOTE 15RELATED PARTY TRANSACTIONS



In the fiscal years-ended December 30, 2000 and December 29, 2001, Interactive Technology Holdings, LLC, a joint venture of Comcast Corporation
and QVC, Inc., acquired 10,797,900 shares of the Companys common stock and warrants to purchase 300,000 shares of the Companys common stock, which accounted for approximately 26.0% of the Companys outstanding common stock as of
January 1, 2005. On January 31, 2005, ITH effected a distribution of all of its assets, including shares of GSI common stock, to entities affiliated with Comcast and QVC. As of October 1, 2005, entities affiliated QVC beneficially
owned approximately 19.1% of the Companys outstanding common stock. M. Jeffrey Branman, one of the Companys directors, was the President of Interactive Technology Services, which served as financial advisor to ITH through its
dissolution. Mr. Branman is no longer affiliated with ITH, Interactive Technology Services or QVC.



In the fiscal year-ended 2000, the Company entered into a website development and distribution agreement with iQVC, a division of QVC, Inc., pursuant to
which the Company provides technology, procurement and fulfillment services for QVC, including selling sporting goods, recreational and/or fitness related equipment and related products, apparel and footwear to QVC for resale through the QVC Web
site. The Company recognized net revenues on sales to this related party for the three- and nine-month periods ended October 2, 2004 of $267 and $838, and for the three- and nine-month periods ended October 1, 2005 of $140 and $651 under
this Web site development and distribution agreement. The terms of these sales are comparable to those with other business-to-business partners of the Company. As of October 1, 2005, the amount included in accounts receivable net was $12
related to these sales.



18



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



In the fiscal year ended January 3, 2004, the Company entered into a service agreement with QVC
pursuant to which QVC provided shipping services to the Company in exchange for fees. The fees charged to the Company by QVC were determined through arms-length negotiations. The Company incurred fees of $290 and $872 for the three- and nine-month
period ended October 2, 2004, of which $278 and $834 related directly to products shipped and was charged to cost of revenues from product sales and $12 and $38 related to professional services provided and was charged to sales and marketing
expense. This agreement terminated effective April 3, 2005. The Company incurred fees of $17 for the three-month period ended April 2, 2005, of which $13 related directly to products shipped and was charged to cost of revenues from product
sales and $4 related to professional services provided and was charged to sales and marketing expense. All fees were incurred in the first quarter due to the termination of the agreement.



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



NOTE 16LONG-TERM DEBT AND OTHER



On June 1, 2005, the Company completed a public offering of $57.5 million aggregate principal amount of 3% convertible unsecured notes due
June 1, 2025, raising net proceeds of approximately $55.0 million, net of approximately $2.5 million of underwriters discount and debt issuance costs. The underwriters discount and debt issuance costs are being amortized 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, beginning December 1, 2005.



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



19



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



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



|                                                     |  |                |        |   |                |   |        |  
|---------------------------------------------------- |  | -------------- | ------ | - | -------------- | - | ------ | -
|                                                     |  | January 1,2005 |        |   | October 1,2005 |  
|Convertible notes                                    |  | $              |       |   |                | $ | 57,500 |  
|Note payable                                         |  |                | 12,945 |   |                |   | 12,903 |  
|Capital lease obligation                             |  |                | 1,590  |   |                |   | 873    |  
|Other                                                |  |                |       |   |                |   | 94     |  
|                                                     |  |                |        |   |                |   |        |  
|                                                     |  |                | 14,535 |   |                |   | 71,370 |  
|Less: Current portion of note payable                |  |                | (142   | ) |                |   | (166   | )
|Less: Current portion of capital lease obligation    |  |                | (829   | ) |                |   | (463   | )
|                                                     |  |                |        |   |                |   |        |  
|Total convertible notes and long-term debt and other |  | $              | 13,564 |   |                | $ | 70,741 |  
|                                                     |  |                |        |   |                |   |        |  



NOTE 17RESTATEMENTS OF THE
FINANCIAL STATEMENTS



First Restatement



As previously disclosed in Amendment No. 2 to Form 10-K/A for the
fiscal year ended January 1, 2005 and in Forms 10-Q for the interim periods ended April 2, 2005 and July 2, 2005, the Company determined that the Companys investments in auction rate securities should have been classified as
marketable securities within current assets. Previously, such investments had been classified as cash and cash equivalents. Accordingly, the Company restated the classification to report these investments as marketable securities for the
nine-month period ended October 2, 2004, to reflect the gross purchases and sales of these investments as investing activities rather than as a component of cash and cash equivalents.



Second Restatement



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



The impact on net loss of correcting for the above errors in the accompanying condensed consolidated financial statements for the three- and nine-months ended October 2, 2004 was a decrease of $6 and an increase
of $169, respectively. The impact on accumulated deficit of correcting for these errors as of January 1, 2005 was a decrease of $539. The impact on beginning accumulated deficit for the fiscal year ended December 28, 2002 of correcting for
these errors was a decrease of $1,041, which was related solely to the reconciliation of accounts payable.



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



This Form 10-Q includes restated
financial information for prior periods. The Company will file as soon as reasonably practicable a Form 10-K/A Amendment No. 3 (Form 10-K/A) for the fiscal year ended January 1, 2005 to restate its consolidated statements of
operations and consolidated statements of cash flows for the fiscal years ended January 1, 2005, January 3, 2004 and December 28, 2002 and its consolidated balance sheets for the fiscal years ended January 1, 2005 and
January 3, 2004. The Company will file contemporaneously with the Form 10-K/A, Forms 10-Q/A for the three-months ended April 2, 2005 and the three- and six-months ended July 2, 2005.



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



| |  |  | Fiscal year ended January 1, 2005: Previously reported net income of $340 is restated to a net loss of $337.
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | Fiscal year ended January 3, 2004: Previously reported net loss of $12,062 is restated to a net loss of $11,887.
| | - |  | ----------------------------------------------------------------------------------------------------------------



20



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



| |  |  | Fiscal year ended December 28, 2002: Previously reported net loss of $33,809 is unchanged.
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | Six-months ended July 2, 2005: Previously reported net loss of $4,453 is restated to a net loss of $4,499.
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | Six-months ended July 3, 2004: Previously reported net loss of $7,174 is restated to a net loss of $7,349.
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | Three-months ended July 2, 2005: Previously reported net loss of $2,777 is restated to a net loss of $2,945.
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | Three-months ended July 3, 2004: Previously reported net loss of $3,146 is unchanged.
| | - |  | -------------------------------------------------------------------------------------



| |  |  | Three-months ended April 2, 2005: Previously reported net loss of $1,676 is restated to a net loss of $1,554.
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | Three-months ended April 3, 2004: Previously reported net loss of $4,028 is restated to a net loss of $4,203.
| | - |  | -------------------------------------------------------------------------------------------------------------



As a result, the accompanying condensed consolidated financial statements for the three- and
nine- months ended October 2, 2004 and as of January 1, 2005 have been restated from amounts previously reported. The following tables present a summary of the significant effects of the restatements:



|                                              |  |                                       |          |   |                   |   |         |                    |  |      |             |  |   |          |  
|--------------------------------------------- |  | ------------------------------------- | -------- | - | ----------------- | - | ------- | ------------------ |  | ---- | ----------- |  | - | -------- | -
|                                              |  | Condensed Consolidated Balance Sheets |         
|                                              |  | As Previously Reported                |          |   | First Restatement |   |         | Second Restatement |  |      | As Restated | 
|January 1, 2005                               |  |                                       |          |   |                   |   |         |                    |  |      |             |  |   |          |  
|Cash and cash equivalents                     |  | $                                     | 56,564   |   |                   | $ | (36,500 | )                  |  |     |             |  | $ | 20,064   |  
|Marketable securities                         |  |                                       | 18,859   |   |                   |   | 36,500  |                    |  |     |             |  |   | 55,359   |  
|Accounts receivable, net of allowance of $408 |  |                                       | 14,908   |   |                   |   |        |                    |  | (174 | )           |  |   | 14,734   |  
|Property and equipment, net                   |  |                                       | 74,286   |   |                   |   |        |                    |  | 101  |             |  |   | 74,387   |  
|Total assets                                  |  |                                       | 231,896  |   |                   |   |        |                    |  | (73  | )           |  |   | 231,823  |  
|Accounts payable                              |  |                                       | 58,762   |   |                   |   |        |                    |  | (739 | )           |  |   | 58,023   |  
|Accrued expenses and other                    |  |                                       | 31,691   |   |                   |   |        |                    |  | 151  |             |  |   | 31,842   |  
|Total current liabilities                     |  |                                       | 100,794  |   |                   |   |        |                    |  | (588 | )           |  |   | 100,206  |  
|Additional paid in capital                    |  |                                       | 294,495  |   |                   |   |        |                    |  | (24  | )           |  |   | 294,471  |  
|Accumulated deficit                           |  |                                       | (177,269 | ) |                   |   |        |                    |  | 539  |             |  |   | (176,730 | )
|Total stockholders equity                    |  |                                       | 117,538  |   |                   |   |        |                    |  | 515  |             |  |   | 118,053  |  
|Total liabilities and stockholders equity    |  |                                       | 231,896  |   |                   |   |        |                    |  | (73  | )           |  |   | 231,823  |  



21



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Concluded)

(In thousands, except per share data)

(Unaudited)



|                                   |  |                                                 |         |   |                   |   |      |             |  |   |         |  
|---------------------------------- |  | ----------------------------------------------- | ------- | - | ----------------- | - | ---- | ----------- |  | - | ------- | -
|                                   | 
|                                   |  | Condensed Consolidated Statements of Operations |        
|                                   |  | As PreviouslyReported                           |         |   | SecondRestatement |   |      | As Restated | 
|Three Months Ended October 2, 2004 |  |                                                 |         |   |                   |   |      |             |  |   |         |  
|Stock-based compensation           |  | $                                               | 390     |   |                   | $ | (6   | )           |  | $ | 384     |  
|Total operating expenses           |  |                                                 | 29,577  |   |                   |   | (6   | )           |  |   | 29,571  |  
|Net loss                           |  |                                                 | (3,047  | ) |                   |   | 6    |             |  |   | (3,041  | )
|Loss per share                     |  |                                                 | (0.07   | ) |                   |   |     |             |  |   | (0.07   | )
|                                   |  |                                                 |        
|Nine Months Ended October 2, 2004  |  |                                                 |         |   |                   |   |      |             |  |   |         |  
|Sales and marketing                |  | $                                               | 51,054  |   |                   | $ | 128  |             |  | $ | 51,182  |  
|Product development                |  |                                                 | 14,118  |   |                   |   | 47   |             |  |   | 14,165  |  
|Stock-based compensation           |  |                                                 | 1,170   |   |                   |   | (6   | )           |  |   | 1,164   |  
|Total operating expenses           |  |                                                 | 87,114  |   |                   |   | 169  |             |  |   | 87,283  |  
|Net loss                           |  |                                                 | (10,221 | ) |                   |   | (169 | )           |  |   | (10,390 | )
|Loss per share                     |  |                                                 | (0.25   | ) |                   |   |     |             |  |   | (0.25   | )



|                                                |  |                                                |         |   |                  |   |         |                   |  |   |             |   |  |   |         |  
|----------------------------------------------- |  | ---------------------------------------------- | ------- | - | ---------------- | - | ------- | ----------------- |  | - | ----------- | - |  | - | ------- | -
|                                                |  | Condensed Consolidated Statement of Cash Flows |        
|                                                |  | As PreviouslyReported                          |         |   | FirstRestatement |   |         | SecondRestatement |  |   | As Restated |  
|Nine Months Ended October 2, 2004               |  |                                                |         |   |                  |   |         |                   |  |   |             |   |  |   |         |  
|Net loss                                        |  | $                                              | (10,221 | ) |                  | $ |        |                   |  | $ | (169        | ) |  | $ | (10,390 | )
|Stock-based compensation                        |  |                                                | 1,170   |   |                  |   |        |                   |  |   | (6          | ) |  |   | 1,164   |  
|Accounts payable and accrued expenses and other |  |                                                | 514     |   |                  |   |        |                   |  |   | (1,334      | ) |  |   | (820    | )
|Net cash used in operating activities           |  |                                                | (14,012 | ) |                  |   |        |                   |  |   | (1,509      | ) |  |   | (15,521 | )
|Acquisition of property and equipment           |  |                                                | (28,105 | ) |                  |   |        |                   |  |   | 1,509       |   |  |   | (26,596 | )
|Purchases of marketable securities              |  |                                                | (7,513  | ) |                  |   | (21,675 | )                 |  |   |            |   |  |   | (29,188 | )
|Sales of marketable securities                  |  |                                                | 2,605   |   |                  |   | 26,625  |                   |  |   |            |   |  |   | 29,230  |  
|Net cash used in investing activities           |  |                                                | (29,767 | ) |                  |   | 4,950   |                   |  |   | 1,509       |   |  |   | (23,308 | )
|Net decrease in cash and cash equivalents       |  |                                                | (28,826 | ) |                  |   | 4,950   |                   |  |   |            |   |  |   | (23,876 | )



22



---

##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------



Forward-Looking Statements



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



Overview and Executive Summary



| |  |  | We are a leading provider of e-commerce solutions that 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: core technology, supporting infrastructure and partner services. Through our platform, we provide Web site
administration, Web infrastructure and hosting, business intelligence, an e-commerce engine, order management, fulfillment, drop shipment, customer service, buying, creative design, Web site usability, testing and enhancement services, channel
integration, business-to-business (B-to-B) services, content development and imaging, e-commerce strategy, online marketing and customer relationship management (CRM).
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | We derive virtually all of our revenues from sales of products by us through our partners e-commerce businesses and service fees earned by us in connection with the
development and operation of our partners e-commerce businesses. Our revenue growth of $68.6 million in the first nine months of fiscal 2005 compared to the first nine months of fiscal 2004 was due to an increase in revenues of $54.5 million
from product sales in both our sporting goods and other categories, as well as an increase of $14.1 million in service fee revenues. These increases were driven primarily by our partners e-commerce businesses that were operated for the
entirety of both periods as well as the addition of new partners in fiscal 2004, which contributed to increased sales in the first nine months of fiscal 2005.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our gross profit increased $26.1 million in the first nine months of fiscal 2005 as compared to the first nine months of fiscal 2004 as a result of sales growth in new and existing
partners. The gross margin on product sales decreased from 25.7% to 24.8%, which was a result of a shift in sales mix from sporting goods to consumer electronics, which carry a lower gross margin than sporting goods. We specifically do not record
cost of service fee revenue. The cost of sales of the merchandise on which we earn service fees are costs incurred by our service-fee partners because they are the owners and sellers of the merchandise. Accordingly, our gross margin on service
revenues is 100%. Our gross margin on product sales has typically been impacted by the mix of products sold between our sporting goods and other categories as well as within our sporting goods category.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Operating expenses increased from $87.3 million in the first nine months of fiscal 2004 to $111.8 million in the first nine months of fiscal 2005, primarily as a result of increased
payroll related costs and variable expenses such as credit card fees, advertising costs, subsidized shipping, partner revenue share and communication costs to support the growth of our business.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Effective July 6, 2005, we acquired an irrevocable right that conveys the voting and economic rights to shares representing 51% of the shares in Aspherio, S.L. We also have the
right to acquire all of the outstanding shares of Aspherio and the shareholders of Aspherio have the right to require us to acquire all of the outstanding shares of Aspherio. Subject to the satisfaction of certain conditions, the acquisition of
Aspherio is expected to close in late 2005 or early 2006. If consummated, the purchase price for the acquisition of control, and for the acquisition of the shares of Aspherio, will be approximately $4.0 million plus an earn-out based on performance
of the Aspherio business. Of the $4.0 million, $2.7 million will be paid in cash and $1.3 million will be paid in cash or our common stock, at our election. We do not expect the acquisition to have a material impact on our financial results for
fiscal 2005 or 2006.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | During the third quarter of fiscal 2005, we changed our estimate for computing the amount of inbound freight capitalized in inventory. In the three and nine months
ended
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



23



---

##### Table of Contents

| | October 1, 2005, the impact of the change in estimate decreased cost of revenues by $0.6 million, and decreased loss per share by $0.01.
| | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On November 12, 2005, we determined to restate our consolidated statements of operations and consolidated statements of cash flows for fiscal 2004, fiscal 2003 and fiscal 2002
and our consolidated balance sheets as of January 1, 2005 and January 3, 2004 and previously reported interim condensed consolidated financial statements for fiscal 2005 and fiscal 2004. See Restatements of Financial Statements
below and Note 17.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Results of Operations



Comparison of the three and nine-month periods ended October 2, 2004
and October 1, 2005



Net Revenues



We derive virtually all of our revenues from sales of product by us through
our partners e-commerce businesses and service fees earned by us in connection with the development and operation of our partners e-commerce businesses.



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.



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



The following tables show net revenues by source for
the third quarter of fiscal 2004 and the third quarter of fiscal 2005, the first nine months of fiscal 2004 and the first nine months of fiscal 2005, the percentages that such revenues bear to total net revenues and the period over period changes in
net revenues.



Three-month period ended October 2, 2004
and October 1, 2005:



|                                                 |  |                       |      |   |                       |   |   |                                                  |      |  |      |   |  |   |      |  |      |  
|------------------------------------------------ |  | --------------------- | ---- | - | --------------------- | - | - | ------------------------------------------------ | ---- |  | ---- | - |  | - | ---- |  | ---- | -
|                                                 |  | Third FiscalQtr. 2004 |      |   | Third FiscalQtr. 2005 |   |   | Third Fiscal Qtr. 2005 vs Third Fiscal Qtr. 2004 |     
|                                                 |  | $                     |      | % |                       |   | $ |                                                  | %    |  |      | $ |  | % |     
|Net revenues from product sales - sporting goods |  | $                     | 29.8 |   | 43.4                  | % |   | $                                                | 38.1 |  | 44.9 | % |  | $ | 8.3  |  | 27.9 | %
|Net revenues from product sales - other          |  |                       | 26.1 |   | 38.0                  | % |   |                                                  | 30.4 |  | 35.8 | % |  |   | 4.3  |  | 16.5 | %
|                                                 |  |                       |      |   |                       |   |   |                                                  |      |  |      |   |  |   |      |  |      |  
|Net revenue from product sales                   |  |                       | 55.9 |   | 81.5                  | % |   |                                                  | 68.5 |  | 80.7 | % |  |   | 12.6 |  | 22.5 | %
|Service fee revenue                              |  |                       | 12.7 |   | 18.5                  | % |   |                                                  | 16.4 |  | 19.3 | % |  |   | 3.7  |  | 29.1 | %
|                                                 |  |                       |      |   |                       |   |   |                                                  |      |  |      |   |  |   |      |  |      |  
|Net revenues                                     |  | $                     | 68.6 |   | 100                   | % |   | $                                                | 84.9 |  | 100  | % |  | $ | 16.3 |  | 23.8 | %
|                                                 |  |                       |      |   |                       |   |   |                                                  |      |  |      |   |  |   |      |  |      |  



Net revenues from
product sales increased $12.6 million in the third quarter of fiscal 2005 primarily due to the growth of our existing partners businesses. Of this increase, $8.3 million was due to an increase in sales in our sporting goods category and $4.3
million was due to an increase in sales in our other product category, which primarily includes consumer electronics.



Service fee revenues increased $3.7 million for the third quarter of 2005, due primarily to a $3.2 million increase related to the launch of new fee-based
partners in fiscal 2004 and 2005 and growth in existing partners.



24



---

##### Table of Contents

Nine-month period ended October 2, 2004 and October 1, 2005:



|                                                 |  |                              |       |   |                              |   |   |                                                                |       |  |       |   |  |   |      |  |      |  
|------------------------------------------------ |  | ---------------------------- | ----- | - | ---------------------------- | - | - | -------------------------------------------------------------- | ----- |  | ----- | - |  | - | ---- |  | ---- | -
|                                                 |  | First Nine MonthsFiscal 2004 |       |   | First Nine MonthsFiscal 2005 |   |   | First Nine Months Fiscal 2005 vs First Nine Months Fiscal 2004 |      
|                                                 |  | $                            |       | % |                              |   | $ |                                                                | %     |  |       | $ |  | % |     
|Net revenues from product sales - sporting goods |  | $                            | 95.1  |   | 47.7                         | % |   | $                                                              | 119.8 |  | 44.7  | % |  | $ | 24.7 |  | 26.0 | %
|Net revenues from product sales - other          |  |                              | 70.7  |   | 35.4                         | % |   |                                                                | 100.5 |  | 37.5  | % |  |   | 29.8 |  | 42.1 | %
|                                                 |  |                              |       |   |                              |   |   |                                                                |       |  |       |   |  |   |      |  |      |  
|Net revenue from product sales                   |  |                              | 165.8 |   | 83.1                         | % |   |                                                                | 220.3 |  | 82.2  | % |  |   | 54.5 |  | 32.9 | %
|Service fee revenue                              |  |                              | 33.7  |   | 16.9                         | % |   |                                                                | 47.8  |  | 17.8  | % |  |   | 14.1 |  | 41.8 | %
|                                                 |  |                              |       |   |                              |   |   |                                                                |       |  |       |   |  |   |      |  |      |  
|Net revenues                                     |  | $                            | 199.5 |   | 100.0                        | % |   | $                                                              | 268.1 |  | 100.0 | % |  | $ | 68.6 |  | 34.4 | %
|                                                 |  |                              |       |   |                              |   |   |                                                                |       |  |       |   |  |   |      |  |      |  



Net revenues from
product sales increased $54.5 million for the first nine months of fiscal 2005 primarily due to the growth of our existing partners businesses. Of this increase, $24.7 million was due to an increase in sales in our sporting goods category and
$29.8 million was due to an increase in sales in our other product category, which primarily includes consumer electronics.



Service fee revenues increased $14.1 million for the first nine months of fiscal 2005 due primarily to an increase of $13.6 million related to the launch
of new fee-based partners in fiscal 2004 and 2005 and growth in existing partners.



Cost of Revenues



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



The following tables show cost of revenues for the third quarter of fiscal 2004 and third quarter of fiscal 2005, the first nine months of fiscal 2004 and
the first nine months of fiscal 2005, the percentages that such costs bear to total net revenues and the period over period changes in cost of revenues.



Three-month period ended October 2, 2004 and October 1, 2005:



|                                   |  |                       |      |   |                       |   |   |                                                  |      |  |      |   |  |   |     |  |      |  
|---------------------------------- |  | --------------------- | ---- | - | --------------------- | - | - | ------------------------------------------------ | ---- |  | ---- | - |  | - | --- |  | ---- | -
|                                   |  | Third FiscalQtr. 2004 |      |   | Third FiscalQtr. 2005 |   |   | Third Fiscal Qtr. 2005 vs Third Fiscal Qtr. 2004 |     
|                                   |  | $                     |      | % |                       |   | $ |                                                  | %    |  |      | $ |  | % |    
|Cost of revenue from product sales |  | $                     | 42.2 |   | 61.5                  | % |   | $                                                | 50.7 |  | 59.7 | % |  | $ | 8.5 |  | 20.1 | %
|                                   |  |                       |      |   |                       |   |   |                                                  |      |  |      |   |  |   |     |  |      |  



As a percentage of net
revenues, cost of revenues decreased from 61.5% in third quarter of fiscal 2004 to 59.7% in third quarter of fiscal 2005. The decrease in cost of revenues was primarily due to increased margins in the consumer electronics business and increased
margins due to new partner launches most of which were service fee partners. In addition, a change in estimate for inbound freight (see Note 2) decreased cost of revenues by 0.7% for the third quarter of fiscal 2005. Also, cost of revenues from
product sales as a percentage of net revenues from product sales decreased from approximately 75.5% in third quarter of fiscal 2004 to approximately 74.0% in third quarter of fiscal 2005.



Nine-month period ended October 2, 2004 and October 1, 2005:



|                                   |  |                              |       |   |                              |   |   |                                                               |       |  |      |   |  |   |      |  |      |  
|---------------------------------- |  | ---------------------------- | ----- | - | ---------------------------- | - | - | ------------------------------------------------------------- | ----- |  | ---- | - |  | - | ---- |  | ---- | -
|                                   |  | First Nine MonthsFiscal 2004 |       |   | First Nine MonthsFiscal 2005 |   |   | First Nine Months Fiscal 2005vs First Nine Months Fiscal 2004 |      
|                                   |  | $                            |       | % |                              |   | $ |                                                               | %     |  |      | $ |  | % |     
|Cost of revenue from product sales |  | $                            | 123.2 |   | 61.8                         | % |   | $                                                             | 165.7 |  | 61.8 | % |  | $ | 42.5 |  | 34.5 | %
|                                   |  |                              |       |   |                              |   |   |                                                               |       |  |      |   |  |   |      |  |      |  



As a percentage of net
revenues, cost of revenues remained the same at 61.8% for both the first nine months of fiscal 2004 and the first nine months of fiscal 2005. Cost of revenues from product sales as a percentage of net revenues from product sales increased from
approximately 74.3% in the first nine months of fiscal 2004 to approximately 75.2% in the first nine months of fiscal 2005.



25



---

##### Table of Contents

Gross Profit



Gross profit consists of gross profit from product sales and gross profit from service fees. Because we do not record cost of service fee revenues, net
revenues from service fees and gross profit from service fees are the same. The following tables show gross profit for the third quarter of fiscal 2004 and the third quarter of fiscal 2005, the first nine months of fiscal 2004 and the first nine
months of fiscal 2005, the percentages that such gross profit bears to product sales, service fees and total net revenues and the period over period changes in gross profit.



Three-month period ended October 2, 2004 and October 1, 2005:



|                                |  |                       |      |                  |                       |   |                 |                                                 |   |                |      |   |   |   |                  |  |      |                 |  |     |                |  |      |          |  |          |     |  |      |  
|------------------------------- |  | --------------------- | ---- | ---------------- | --------------------- | - | --------------- | ----------------------------------------------- | - | -------------- | ---- | - | - | - | ---------------- |  | ---- | --------------- |  | --- | -------------- |  | ---- | -------- |  | -------- | --- |  | ---- | -
|                                |  | Third Fiscal Qtr 2004 |      |                  | Third Fiscal Qtr 2005 |   |                 | Third Fiscal Qtr. 2005vs Third Fiscal Qtr. 2004 |  
|                                |  | $                     |      | % ofProductSales |                       |   | % ofServiceFees |                                                 |   | % ofNetRevenue |      |   | $ |   | % ofProductSales |  |      | % ofServiceFees |  |     | % ofNetRevenue |  |      | $ Change |  | % Change |    
|Gross profit from product sales |  | $                     | 13.7 |                  | 24.5                  | % |                 |                                                |   |                |      |   |   | $ | 17.8             |  | 26.0 | %               |  |    |                |  |      |          |  | $        | 4.1 |  | 29.9 | %
|Gross profit from service fees  |  |                       | 12.7 |                  |                      |   |                 | 100                                             | % |                |      |   |   |   | 16.4             |  |     |                 |  | 100 | %              |  |      |          |  |          | 3.7 |  | 29.1 | %
|                                |  |                       |      |                  |                       |   |                 |                                                 |   |                |      |   |   |   |                  |  |      |                 |  |     |                |  |      |          |  |          |     |  |      |  
|Gross profit                    |  | $                     | 26.4 |                  |                       |   |                 |                                                 |   |                | 38.5 | % |   | $ | 34.2             |  |      |                 |  |     |                |  | 40.3 | %        |  | $        | 7.8 |  | 29.5 | %
|                                |  |                       |      |                  |                       |   |                 |                                                 |   |                |      |   |   |   |                  |  |      |                 |  |     |                |  |      |          |  |          |     |  |      |  



The increase in gross
profit for the third quarter of fiscal 2005 was due to a $4.1 million increase in gross profit from product sales and a $3.7 million increase in service fee revenues primarily of our existing partners. The increase in gross profit as a percentage of
net revenues in third quarter of fiscal 2005 was largely driven by a lower percentage increase in product sales in the other category, which is primarily consumer electronics that carry a lower gross margin than product sales of sporting goods.
Gross profit from product sales represented 51.9% of total gross profit in third quarter of fiscal 2004 and 52.0% of total gross profit in third quarter of fiscal 2005. Gross profit from service fee revenues represented 48.1% of total gross profit
in third quarter of fiscal 2004 and 48.0% of total gross profit in third quarter of fiscal 2005. The gross profit on product sales increased from 24.5% in third quarter of fiscal 2004 to 26.0% in third quarter of fiscal 2005 due primarily to a
greater increase in sales from sporting goods than in consumer electronics.



Nine-month period ended October 2, 2004 and October 1, 2005:



|                                |  |                               |      |                  |                               |   |                 |                                                               |   |                |      |   |   |   |                  |  |      |                 |  |     |                |  |      |          |  |          |      |  |      |  
|------------------------------- |  | ----------------------------- | ---- | ---------------- | ----------------------------- | - | --------------- | ------------------------------------------------------------- | - | -------------- | ---- | - | - | - | ---------------- |  | ---- | --------------- |  | --- | -------------- |  | ---- | -------- |  | -------- | ---- |  | ---- | -
|                                |  | First Nine Months Fiscal 2004 |      |                  | First Nine Months Fiscal 2005 |   |                 | First Nine Months Fiscal 2005vs First Nine Months Fiscal 2004 |  
|                                |  | $                             |      | % ofProductSales |                               |   | % ofServiceFees |                                                               |   | % ofNetRevenue |      |   | $ |   | % ofProductSales |  |      | % ofServiceFees |  |     | % ofNetRevenue |  |      | $ Change |  | % Change |     
|Gross profit from product sales |  | $                             | 42.6 |                  | 25.7                          | % |                 |                                                              |   |                |      |   |   | $ | 54.6             |  | 24.8 | %               |  |    |                |  |      |          |  | $        | 12.0 |  | 28.2 | %
|Gross profit from service fees  |  |                               | 33.7 |                  |                              |   |                 | 100                                                           | % |                |      |   |   |   | 47.8             |  |     |                 |  | 100 | %              |  |      |          |  |          | 14.1 |  | 41.8 | %
|                                |  |                               |      |                  |                               |   |                 |                                                               |   |                |      |   |   |   |                  |  |      |                 |  |     |                |  |      |          |  |          |      |  |      |  
|Gross profit                    |  | $                             | 76.3 |                  |                               |   |                 |                                                               |   |                | 38.2 | % |   | $ | 102.4            |  |      |                 |  |     |                |  | 38.2 | %        |  | $        | 26.1 |  | 34.2 | %
|                                |  |                               |      |                  |                               |   |                 |                                                               |   |                |      |   |   |   |                  |  |      |                 |  |     |                |  |      |          |  |          |      |  |      |  



The increase in gross
profit for the first nine months of fiscal 2005 was due to a $14.1 million increase in service fee revenues and a $12.0 million increase in gross profit from product sales primarily of our existing partners. The lack of change in gross profit as a
percentage of net revenues in first nine months of fiscal 2005 was largely driven by a lower percentage increase in product sales in the other category, which is primarily consumer electronics that carry a lower gross margin than product sales of
sporting goods. Gross profit from product sales represented 55.8% of total gross profit in nine months of fiscal 2004 and 53.3% of total gross profit in first nine months of fiscal 2005. Gross profit from service fee revenues represented 44.2% of
total gross profit in first nine months of fiscal 2004 and 46.7% of total gross profit in first nine months of fiscal 2005. The gross profit on product sales decreased from 25.7% in first nine months of fiscal 2004 to 24.8% in first nine months of
fiscal 2005 due primarily to a shift in sales from sporting goods to consumer electronics.



Operating Expenses



Operating expenses consist of sales and marketing expenses, product development expenses, general and administrative expenses, stock-based compensation expense and depreciation and amortization expenses.



Sales and Marketing Expenses. Sales and marketing expenses include
advertising and promotional expenses, including promotional free shipping and subsidized shipping and handling costs, online marketing fees, commissions to participants in the



26



---

##### Table of Contents

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



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



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



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



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



The following tables show operating expenses for third quarter of fiscal 2004 and the third quarter of fiscal 2005, the first nine months of fiscal 2004 and the first nine months of fiscal 2005, the percentages that such expenses bear to
net revenues and the period over period changes in operating expenses.



Three-month period ended October 2, 2004 and October 1, 2005:



|                                       |  |                       |      |   |                       |   |   |                                               |      |  |      |          |  |          |     |  |       |  
|-------------------------------------- |  | --------------------- | ---- | - | --------------------- | - | - | --------------------------------------------- | ---- |  | ---- | -------- |  | -------- | --- |  | ----- | -
|                                       |  | Third Fiscal Qtr 2004 |      |   | Third Fiscal Qtr 2005 |   |   | Third Fiscal Qtr 2005vs Third Fiscal Qtr 2004 |     
|                                       |  | $                     |      | % |                       |   | $ |                                               | %    |  |      | $ Change |  | % Change |    
|Sales and marketing expenses           |  | $                     | 16.8 |   | 24.5                  | % |   | $                                             | 21.6 |  | 25.4 | %        |  | $        | 4.8 |  | 28.6  | %
|Product development expenses           |  |                       | 5.2  |   | 7.4                   | % |   |                                               | 7.4  |  | 8.7  | %        |  |          | 2.2 |  | 42.3  | %
|General and administrative expenses    |  |                       | 4.5  |   | 6.6                   | % |   |                                               | 4.9  |  | 5.8  | %        |  |          | 0.4 |  | 8.9   | %
|Stock-based compensation expense       |  |                       | 0.4  |   | 0.6                   | % |   |                                               | 1.1  |  | 1.3  | %        |  |          | 0.7 |  | 175.0 | %
|Depreciation and amortization expenses |  |                       | 2.7  |   | 3.9                   | % |   |                                               | 3.7  |  | 4.4  | %        |  |          | 1.0 |  | 37.0  | %
|                                       |  |                       |      |   |                       |   |   |                                               |      |  |      |          |  |          |     |  |       |  
|Total operating expenses               |  | $                     | 29.6 |   | 43.0                  | % |   | $                                             | 38.7 |  | 45.6 | %        |  | $        | 9.1 |  | 30.7  | %
|                                       |  |                       |      |   |                       |   |   |                                               |      |  |      |          |  |          |     |  |       |  



Sales and marketing
expenses increased $4.8 million in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004 primarily due to a $1.4 million increase in partner revenue share charges, a $1.1 million increase in payroll and related costs
principally in our fulfillment operations, a $1.1 million increase in other variable expenses primarily caused by higher sales volumes in the third quarter of fiscal 2005, a $0.6 million increase in credit card fees and a $0.6 million increase in
online marketing expense.



Product development expenses
increased $2.2 million in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004 primarily due to a $1.8 million increase in staffing and related costs and a $0.4 million increase in other product development expenses. The
increases in these costs were the result of new partner launches, the development of enhanced functionality for our partners e-commerce businesses and continue to improvements in the capacity, stability and security of our e-commerce platform.



27



---

##### Table of Contents

General and administrative expenses increased $0.4 million in the third quarter of fiscal 2005 compared
to third quarter of fiscal 2004 primarily due to a $0.5 million increase due to investments in payroll and related costs to support the growth of our business, offset by a $0.1 million reduction in other general and administrative expenses.



Stock-based compensation expense increased $0.7 million for
the third quarter of fiscal 2005 compared to the third quarter of 2004 primarily due to a $0.2 million increase in the amortization of deferred compensation expense relating to options subject to variable accounting, a $0.3 million increase in
expense relating to stock awards, and a $0.2 million increase in deferred partner revenue share charges resulting from higher product sales from the e-commerce business of the partner that received shares of common stock. As of the end of third
quarter of fiscal 2005, we had an aggregate of $0.8 million of deferred stock-based compensation remaining to be amortized. We had stock-based compensation expense related to the amortization of deferred partner revenue share charges of $0.4 million
for the third quarter of fiscal 2004 and $0.6 million for third quarter of fiscal 2005.



Depreciation and amortization expenses increased $1.0 million for the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004 primarily due to additional assets to build, manage and operate our
business, offset, in part, by certain previously purchased assets becoming fully depreciated in fiscal 2004.



Nine-month period ended October 2, 2004 and October 1, 2005:



|                                       |  |                              |      |   |                              |   |   |                                                               |       |  |      |          |  |          |      |  |       |  
|-------------------------------------- |  | ---------------------------- | ---- | - | ---------------------------- | - | - | ------------------------------------------------------------- | ----- |  | ---- | -------- |  | -------- | ---- |  | ----- | -
|                                       |  | First Nine MonthsFiscal 2004 |      |   | First Nine MonthsFiscal 2005 |   |   | First Nine Months Fiscal 2005vs First Nine Months Fiscal 2004 |      
|                                       |  | $                            |      | % |                              |   | $ |                                                               | %     |  |      | $ Change |  | % Change |     
|Sales and marketing expenses           |  | $                            | 51.2 |   | 25.6                         | % |   | $                                                             | 63.8  |  | 23.8 | %        |  | $        | 12.6 |  | 24.6  | %
|Product development expenses           |  |                              | 14.1 |   | 7.1                          | % |   |                                                               | 20.4  |  | 7.6  | %        |  |          | 6.3  |  | 44.7  | %
|General and administrative expenses    |  |                              | 12.8 |   | 6.4                          | % |   |                                                               | 14.6  |  | 5.4  | %        |  |          | 1.8  |  | 14.1  | %
|Stock-based compensation expense       |  |                              | 1.2  |   | 0.6                          | % |   |                                                               | 2.6   |  | 1.0  | %        |  |          | 1.4  |  | 116.7 | %
|Depreciation and amortization expenses |  |                              | 8.0  |   | 4.0                          | % |   |                                                               | 10.4  |  | 3.9  | %        |  |          | 2.4  |  | 30.0  | %
|                                       |  |                              |      |   |                              |   |   |                                                               |       |  |      |          |  |          |      |  |       |  
|Total operating expenses               |  | $                            | 87.3 |   | 43.7                         | % |   | $                                                             | 111.8 |  | 41.7 | %        |  | $        | 24.5 |  | 28.1  | %
|                                       |  |                              |      |   |                              |   |   |                                                               |       |  |      |          |  |          |      |  |       |  



Sales and marketing
expenses increased $12.6 million from the first nine months of fiscal 2005 compared to the first nine months of fiscal 2004 primarily due to a $6.8 million increase in volume related expenses such as credit card fees, advertising costs, ship
subsidy, communication costs, partner revenue share, and packaging and warehouse costs, a $3.8 million increase in payroll and related costs principally in our fulfillment operations, a $1.2 million increase in occupancy costs primarily due to the
opening of a second distribution center in Shepherdsville, Kentucky and a $0.8 million increase in other selling and marketing expenses.



Product development expenses increased $6.3 million in the first nine months of fiscal 2005 compared to the first nine months of fiscal 2004 primarily due
to a $5.0 million increase in staffing and related costs, a $0.9 million increase in communication, software maintenance, and equipment maintenance costs and an increase of $0.4 million in other product development expenses. The increases in these
costs were the result of new partner launches, the development of enhanced functionality for our partners e-commerce businesses and improvements in the capacity, stability and security of our e-commerce platform.



General and administrative expenses increased $1.8 million from the first
nine months of fiscal 2005 compared to the first nine months of fiscal 2004 primarily due to a $2.5 million increase in payroll and related costs to support the growth of our business, which was partially offset by a $0.7 million decrease in other
employee costs.



Stock-based compensation expense increased
$1.4 million for the first nine months of fiscal 2005 compared to the first nine months of fiscal 2004 primarily due to a $0.8 million increase in expense relating to stock awards and a $0.6 million increase in deferred partner revenue share charges
resulting from higher product sales from the e-commerce business of the partner that received shares of common stock. As of the end of first nine months of fiscal 2005, we had an aggregate of $0.8 million of deferred stock-based compensation
remaining to be amortized. We had stock-based compensation expense related to the amortization of deferred partner revenue share charges of $1.1 million for the first nine months of fiscal 2004 and $1.7 million for first nine months of fiscal 2005.



Depreciation and amortization expenses increased $2.4 million
for the first nine months of fiscal 2005 compared to the first nine months of fiscal 2004 primarily due to additional assets to build, manage and operate our business, offset in part, by certain previously purchased assets becoming fully depreciated
in fiscal 2004.



28



---

##### Table of Contents

Other (Income) Expense



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



Income Taxes



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



Certain Related Party Transactions



In fiscal 2000 and 2001, Interactive Technology Holdings, LLC, a joint
venture of Comcast Corporation and QVC, Inc., acquired 10,797,900 shares of our common stock and warrants to purchase 300,000 shares of our common stock, which accounted for approximately 26.0% of our outstanding common stock as of January 1,
2005. On January 31, 2005, ITH effected a distribution of all of its assets, including shares of GSI common stock, to entities affiliated with Comcast and QVC. As of October 1, 2005, entities affiliated with QVC beneficially owned
approximately 19.1% of our outstanding common stock. M. Jeffrey Branman, one of our directors, was the President of Interactive Technology Services, which served as financial advisor to ITH through its dissolution. Mr. Branman is no longer
affiliated with ITH, Interactive Technology Services or QVC.



In fiscal 2000, we entered into a website development and distribution agreement with iQVC, a division of QVC, Inc., pursuant to which we provide technology, procurement and fulfillment services for QVC, including selling sporting goods,
recreational and/or fitness related equipment and related products, apparel and footwear to QVC for resale through the QVC website. We recognized net revenues of $140,000 and $651,000 for the third quarter and first nine months of fiscal 2005 sales
to QVC under this website development and distribution agreement. The terms of these sales are comparable to those with our other business-to-business partners. Included in accounts receivable as of the end of the third quarter of fiscal 2005 was
$12,000 related to these sales.



In fiscal 2003, we entered
into a services agreement with QVC, Inc. pursuant to which QVC provided shipping services to us in exchange for fees. The fees charged to us by QVC were determined through arms-length negotiations. This agreement terminated effective April 3,
2005. We incurred fees of $16,780 for the first nine months of fiscal 2005, of which $12,794 related directly to products shipped and was charged to cost of revenues from product sales and $3,986 related to fulfillment services provided and was
charged to sales and marketing expense. These fees were incurred in the first quarter of fiscal 2005 as the agreement terminated April 3, 2005.



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



In February, 2005, Odimo completed an initial public offering through the
issuance of 3,125,000 shares of its common stock. Effective upon completion of Odimos initial public offering, we exercised our warrants to acquire Series C and Series D Convertible Preferred Stock of Odimo and converted all of such shares,
along with our already held shares of Series C and Series D Convertible Preferred Stock of Odimo, into an aggregate of 824,594 shares of common stock of Odimo. We own approximately 11.5% of the outstanding common stock of Odimo Incorporated.
SOFTBANK Capital Partners LLC and its affiliates collectively own approximately 11.9% of the outstanding common stock of Odimo. As of November 4, 2005, SOFTBANK Capital Partners LLC and its affiliates collectively own approximately 18.4% of our
outstanding common stock. Ronald D. Fisher, one of our directors, is vice-chairman of SOFTBANK Holdings Inc. and SOFTBANK Corp. and a managing general partner of SOFTBANK Capital Partners LP, which are affiliates of SOFTBANK Capital Partners LLC,
and Michael S. Perlis, one of our directors, is also managing partner of SOFTBANK Capital Partners LP.



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



29



---

##### Table of Contents

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



Restatements of Financial Statements



First Restatement



As previously disclosed in Amendment No. 2 to Form 10-K/A for the
fiscal 2004 and in Forms 10-Q for the first and second quarters of fiscal 2005, we determined that our investments in auction rate securities should have been classified as marketable securities within current assets. Previously, such
investments had been classified as cash and cash equivalents. Accordingly, we restated the classification to report these investments as marketable securities for the nine-month period ended October 2, 2004, to reflect the gross purchases
and sales of these investments as investing activities rather than as a component of cash and cash equivalents.



Second Restatement



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



The
impact on net loss of correcting for the above errors in the accompanying condensed consolidated financial statements for the three- and nine-months ended October 2, 2004 was a decrease of $6,000 and an increase of $169,000, respectively. The
impact on accumulated deficit of correcting for these errors as of January 1, 2005 was a decrease of $0.5 million. The impact on beginning accumulated deficit for fiscal 2002 of correcting for these errors was a decrease of $1.04 million, which
was related solely to the reconciliation of accounts payable.



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



This Form 10-Q includes restated financial information for prior periods. We will file as soon as reasonably practicable a
Form 10-K/A Amendment No. 3 (Form 10-K/A) for the fiscal year ended January 1, 2005 to restate our consolidated statements of operations and consolidated statements of cash flows for the fiscal 2004, fiscal 2003 and fiscal 2002
and our consolidated balance sheets for fiscal 2004 and fiscal 2003. We will file contemporaneously with the Form 10-K/A, Forms 10-Q/A for the first and second quarter of fiscal 2005.



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



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



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



| |  |  | Fiscal 2002: Previously reported net loss of $33.8 million is unchanged.
| | - |  | ------------------------------------------------------------------------



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



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



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



| |  |  | Second quarter of fiscal 2004: Previously reported net loss of $3.1 million remains unchanged.
| | - |  | ----------------------------------------------------------------------------------------------



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



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



As a result, the condensed consolidated financial statements for the three- and nine- months
ended October 2, 2004 and as of January 1, 2005 have been restated from amounts previously reported, see Note 17. Accordingly, amounts presented in Managements Discussion and Analysis include the effects of the above restatements.



30



---

##### Table of Contents

Liquidity and Capital Resources



Our principal source of liquidity is our cash, cash equivalents and marketable securities. Our cash, cash equivalents, and
marketable securities balances were $75.4 million as of the end of fiscal 2004 and $112.2 million as of the end of the third quarter of fiscal 2005.



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



We had working capital of $30.1 million as of the end of fiscal 2004 and
$99.0 million as of the end of the third quarter of fiscal 2005, and an accumulated deficit of $176.7 million as of the end fiscal 2004 and $185.8 million as of the end of the third quarter of fiscal 2005.



We used approximately $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 Aspherio, net of cash, of $.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.



We used approximately $15.5 million in net cash for operating activities
during the first nine months of fiscal 2004. Our principal sources of operating cash during the first nine months of fiscal 2004 were payments received from customers and fee-based partners, which generally approximate our net revenues from product
sales and our service fee revenues, respectively. Our principal uses of operating cash during the first nine months of fiscal 2004 were cash paid to product suppliers, employee compensation and partner revenue share payments. Changes in our
operating assets and liabilities during the first nine months of fiscal 2004 resulted in a net cash outflow of $14.3 million. The most significant changes were an increase in accounts receivable, an increase in inventory and a decrease in deferred
revenue compared to the end of fiscal 2003. The increase in accounts



31



---

##### Table of Contents

receivable was due primarily to decreases in our accounts receivable reserves and an increase in term sales. The increase in inventory was due primarily to
the seasonal timing of inventory purchases. The decrease in deferred revenue was due to a decrease in service fees paid to us in advance by certain partners. Our investing activities during the first nine months of fiscal 2004 consisted primarily of
the purchase of our new corporate headquarters and other capital expenditures totaling approximately $26.6 million. During the first nine months of fiscal 2004, we also purchased $29.2 million and sold $29.2 million of marketable securities and
received $3.2 million in principal payments on notes receivable. Our financing activities during the first nine months of fiscal 2004 consisted primarily of the receipt of $13.0 million in gross proceeds from a mortgage note on our new corporate
headquarters.



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



Seasonality



We have experienced and expect to continue to experience seasonal
fluctuations in our revenues. These seasonal patterns will cause quarterly fluctuations in our operating results. In particular, our fourth fiscal quarter has accounted for and is expected to continue to account for a disproportionate percentage of
our total annual revenues. We believe that results of operations for a quarterly period may not be indicative of the results for any other quarter or for the full year.



Risk Factors



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



Risks Related to Our Business



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



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



We have an accumulated deficit and may incur additional losses.



Although we recorded a profit in fiscal 2004, we incurred losses over the prior five fiscal years and in the first three
quarters of fiscal 2005 while operating our business. As of the end of the third quarter of fiscal 2005, we had an accumulated deficit of $185.8 million. We may not generate sufficient revenue from our existing partners, add an appropriate number of
new partners or adequately control our expenses. While we expect to be profitable in fiscal 2005, there can be no assurances that we will be able to achieve profitability.



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



| |  |  | enhance our fulfillment capabilities;
| | - |  | -------------------------------------



| |  |  | further improve our order processing systems and capabilities;
| | - |  | --------------------------------------------------------------



| |  |  | develop new technologies and features to improve our partners e-commerce businesses;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | enhance our customer service center capabilities to better serve customers needs;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | improve our marketing, customer relationship management and design capabilities;
| | - |  | --------------------------------------------------------------------------------



| |  |  | increase our general and administrative functions to support our growing operations;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | continue our business development, sales and marketing activities; and
| | - |  | ----------------------------------------------------------------------



32



---

##### Table of Contents

| |  |  | make strategic or opportunistic acquisitions of complementary or new businesses or assets.
| | - |  | ------------------------------------------------------------------------------------------



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



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



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



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



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



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



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



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



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



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



Our success depends, in part, upon our ability and our partners ability to anticipate and respond to consumer trends with respect to products sold
through the e-commerce businesses we operate. Consumers tastes are subject to frequent and significant changes. In order to be successful, we or our partners must accurately predict consumers tastes and avoid overstocking or
understocking products. If we or our partners fail to identify and respond to changes in merchandising and consumer preferences,



33



---

##### Table of Contents

sales on our partners e-commerce businesses could suffer and we or our partners could be required to mark down unsold inventory. This would depress our
profit margins. In addition, any failure to keep pace with changes in consumers tastes could result in lost opportunities which could reduce sales.



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



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



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



One of the
principal components of our growth strategy is to add new partners. If we are unable to add our targeted number of new partners or if we are unable to add new partners on favorable terms, our growth may be limited. If we are unable to add and launch
new partners within the time frames projected by us, we may not be able to achieve our targeted results in the expected periods. In addition, our ability to add new partners depends on the quality of the services we provide and our reputation. To
the extent that we have difficulties with the quality of the services we provide or have operational issues that adversely affect our reputation, it could adversely impact our ability to add new partners. Because competition for new partners is
intense, we may not be able to add new partners on favorable terms, or at all.



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



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



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



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



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



For the e-commerce businesses for which we own inventory, we primarily purchase products from the manufacturers and
distributors of the products. For the e-commerce businesses for which our partners own inventory, our partners typically purchase products from the manufacturers and distributors of products or source their own products. If we or our partners are
unable to develop and maintain relationships with these manufacturers, distributors or sources we or our partners may be unable to obtain or continue to carry a sufficient assortment and quantity of quality merchandise on acceptable commercial terms
and our partners e-commerce businesses and our business could be adversely impacted. We do not have written contracts with some of our suppliers. During the third quarter of fiscal 2005, we purchased 39.0% of the total amount of inventory we
purchased from one manufacturer. In addition, during the third quarter of fiscal 2004, we purchased 45.7% of the total amount of inventory we purchased from the same manufacturer. During the first nine months of fiscal 2005, 45.9% of the total
amount of inventory we purchased was from one manufacturer. In addition, during the first nine months of fiscal 2004, 40.3% of the total amount of inventory we purchased was from the same manufacturer. While we have a contract with this
manufacturer, this manufacturer



34



---

##### Table of Contents

and other manufacturers could stop selling products to us or our partners to remove their products or logos from our partners Web sites. If we or our
partners are unable to obtain products directly from manufacturers, especially popular brand manufacturers, we or our partners may not be able to obtain the same or comparable merchandise in a timely manner or on acceptable commercial terms.



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



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



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



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



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



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



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



Our operations are subject to damage or interruption from:



| |  |  | fire, flood, hurricane, tornado, earthquake or other natural disasters;
| | - |  | -----------------------------------------------------------------------



| |  |  | power losses, interruptions or brown-outs;
| | - |  | ------------------------------------------



| |  |  | Internet, telecommunications or data network failures;
| | - |  | ------------------------------------------------------



| |  |  | physical and electronic break-ins or security breaches;
| | - |  | -------------------------------------------------------



| |  |  | computer viruses;
| | - |  | -----------------



| |  |  | acts of terrorism; and
| | - |  | ----------------------



| |  |  | other similar events.
| | - |  | ---------------------



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



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



Our insurance policies may not cover us for losses related to these events, and even if they do, may not adequately compensate us for any losses that we may incur. Any system failure that causes an interruption of the
availability of our partners



35



---

##### Table of Contents

e-commerce businesses could reduce the attractiveness of our partners e-commerce businesses to consumers and result in reduced revenues, which could
materially and adversely affect our business, results of operations and financial condition.



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



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



Developing our e-commerce platform, offering our partners e-commerce businesses and other proprietary technology entails significant technical and
business risks. We may use new technologies ineffectively or fail to adapt our e-commerce platform, our partners e-commerce businesses and our technology to meet the requirements of partners and customers or emerging industry standards.
Additionally, the vendors we use for our partners e-commerce businesses may not provide the level of service we expect or may not be able to provide their product or service to us on commercially reasonable terms, if at all.



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



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



| |  |  | actual or perceived lack of security of information or privacy protection;
| | - |  | --------------------------------------------------------------------------



| |  |  | lack of access and ease of use;
| | - |  | -------------------------------



| |  |  | congestion of traffic on the Internet;
| | - |  | --------------------------------------



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



| |  |  | possible disruptions, computer viruses or other damage to the Internet servers or to users computers;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | governmental regulation;
| | - |  | ------------------------



| |  |  | uncertainty regarding intellectual property ownership;
| | - |  | ------------------------------------------------------



| |  |  | lack of high-speed modems and other communications equipment; and
| | - |  | -----------------------------------------------------------------



| |  |  | increases in the cost of accessing the Internet.
| | - |  | ------------------------------------------------



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



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



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



36



---

##### Table of Contents

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



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



Our success depends to a significant degree
upon the protection of our intellectual property rights in the core technology and other components of our e-commerce platform including our software and other proprietary information, and material, and our ability to develop technologies that are
as good as or better than that of our competitors. We may be unable to deter infringement or misappropriation of our software and other proprietary information and material, detect unauthorized use or take appropriate steps to enforce our
intellectual property rights. In addition, the failure of our partners to protect their intellectual property rights, including their trademarks and domain names, could impair our operations. Our competitors could, without violating our intellectual
property rights, develop technologies that are as good as or better than our technology. Protecting our intellectual property and other proprietary rights can be expensive. Any increase in the unauthorized use of our intellectual property could make
it more expensive to do business and consequently harm our operating results. Our failure to protect our intellectual property rights in our software and other information and material or to develop technologies that are as good as or better than
our competitors could put us at a disadvantage to our competitors. These failures could have a material adverse effect on our business.



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



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



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



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



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



37



---

##### Table of Contents

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



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



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



We sell products manufactured by third
parties, some of which may be defective. We also sell some products that are manufactured by third parties for us. If any product that we sell were to cause physical injury or injury to property, the injured party or parties could bring claims
against us as the retailer or manufacturer of the product. These claims may not be covered by insurance and, even if they are, our insurance coverage may not be adequate to cover every claim that could be asserted. Similarly, we could be subject to
claims that customers of our partners e-commerce businesses were harmed due to their reliance on our product information, product selection guides, advice or instructions. If a successful claim were brought against us in excess of our
insurance coverage, it could adversely affect our business. Even unsuccessful claims could result in the expenditure of funds and management time and could have a negative impact on our business.



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



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



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



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



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



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



In September 2003, we learned that we, along with several of our partners, were named in an action in the Circuit Court of Cook County, Illinois, by a private litigant who is alleging that we, along with certain of our partners, wrongfully
failed to collect and remit sales and use taxes for sales of personal property to customers in Illinois and knowingly created records and statements falsely stating we were not required to collect or remit such taxes. The complaint seeks injunctive
relief, unpaid taxes, interest, attorneys fees, civil penalties of up to $10,000 per violation, and treble damages under the Illinois Whistleblower Reward and Protection Act. We are aware that this same private litigant has filed similar
actions against retailers in other states, and it is possible that we and/or partners may have been or may be named in similar cases in other states. While in November 2005,



38



---

##### Table of Contents

the judge granted a motion to dismiss, one claim remains and the private litigate could fix an appeal for the dismissed claims. We do not believe that we are
liable under existing laws and regulations for any failure to collect sales or other taxes relating to Internet sales in Illinois and intend to vigorously defend ourselves in this matter. However, we may incur substantial expenses in defending
against this claim. In the event of a determination adverse to us, we may incur substantial monetary liability, and be required to change our business practices, either of which could have a material adverse effect on our business, financial
position or results of operations.



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



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



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



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



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



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



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



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



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



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



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



39



---

##### Table of Contents

| |  |  | compliance with international legal and regulatory requirements and tariffs;
| | - |  | ----------------------------------------------------------------------------



| |  |  | managing fluctuations in currency exchange rates;
| | - |  | -------------------------------------------------



| |  |  | difficulties in staffing and managing foreign operations;
| | - |  | ---------------------------------------------------------



| |  |  | greater difficulty in accounts receivable collection;
| | - |  | -----------------------------------------------------



| |  |  | potential adverse tax consequences;
| | - |  | -----------------------------------



| |  |  | uncertain political and economic climates;
| | - |  | ------------------------------------------



| |  |  | potential higher incidence of fraud;
| | - |  | ------------------------------------



| |  |  | price controls or other restrictions on foreign currency; and
| | - |  | -------------------------------------------------------------



| |  |  | difficulties in obtaining export and import licenses and compliance with applicable export controls.
| | - |  | ----------------------------------------------------------------------------------------------------



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



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



The uncertainty regarding the general economy may reduce our revenues.



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



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



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



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



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



40



---

##### Table of Contents

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



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



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



In fiscal 2004 we documented and evaluated our internal controls over financial reporting in order to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial reporting. In this regard, management dedicates internal resources, engages outside consultants and adopts a detailed work
plan to annually (i) assess and document the adequacy of internal controls over financial reporting, (ii) take steps to improve control processes, where appropriate, (iii) validate through testing that controls are functioning as
documented and (iv) implement a continuous reporting and improvement process for internal control over financial reporting. In the third quarter of fiscal 2005, we determined that a systemic report that we relied on to reconcile our accounts
payable balance was defective and our reliance on a defective report may be a material weakness. If we fail to correct any issues in the design or operating effectiveness of internal controls over financial reporting or fail to prevent fraud,
including creating a systemic report to be used to reconcile its accounts payable balance, current and potential stockholders and partners could lose confidence in our financial reporting, which could harm our business, the trading price of our
common stock and our ability to retain our current partners and obtain new partners.



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



In December 2004, the FASB issued Statement No. 123R
Share-Based Payment, or SFAS 123R, which replaces Statement No. 123, Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. In addition, SFAS 123R will cause unrecognized
expense (based on the amounts in our pro forma footnote disclosure) related to options vesting after the date of initial adoption to be recognized as a charge to results of operations over the remaining vesting period. In April 2005, the SEC
announced that it would delay the initial adoption of SFAS 123R from interim periods that begin after June 15, 2005, to annual periods beginning after June 15, 2005. Under SFAS 123R, we must determine the appropriate fair value model to be
used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. We are evaluating the requirements of SFAS 123R and expect that the adoption of SFAS 123R will have a
material impact on its consolidated results of operations and earnings per share beginning in the fiscal 2006.



Risks Related to Our Common Stock



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



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



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



| |  |  | our ability to obtain new partners or to retain existing partners;
| | - |  | ------------------------------------------------------------------



| |  |  | the performance of one or more of our partners e-commerce businesses;
| | - |  | ----------------------------------------------------------------------



| |  |  | our and our partners ability to obtain new customers at a reasonable cost or encourage repeat purchases;
| | - |  | ---------------------------------------------------------------------------------------------------------



41



---

##### Table of Contents

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



| |  |  | our and our partners ability to offer an appealing mix of products or to sell products that we purchase;
| | - |  | ---------------------------------------------------------------------------------------------------------



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



| |  |  | the timing and costs of upgrades and developments of our system and infrastructure;
| | - |  | -----------------------------------------------------------------------------------



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



| |  |  | price competition that results in lower profit margins or losses;
| | - |  | -----------------------------------------------------------------



| |  |  | the seasonality of our business, especially the importance of our fiscal fourth quarter to our business;
| | - |  | --------------------------------------------------------------------------------------------------------



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



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



| |  |  | the cost of advertising and the amount of free shipping and other promotions we offer;
| | - |  | --------------------------------------------------------------------------------------



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



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



| |  |  | inflation of prices of fuel and gasoline and other raw materials that impact our costs;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | technical difficulties, system security breaches, system downtime or Internet slowdowns;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | our inability to manage inventory levels or control inventory shrinkage;
| | - |  | ------------------------------------------------------------------------



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



| |  |  | an increase in the level of our product returns or our inability to effectively process returns;
| | - |  | ------------------------------------------------------------------------------------------------



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



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



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



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



We are controlled by certain principal stockholders.



As of November 4, 2005, Michael G. Rubin, our chairman and chief executive officer, beneficially owned 16.3%, entities affiliated with SOFTBANK Capital Partners LP, SOFTBANK Capital LP and SOFTBANK Capital
Advisor Fund LP, or SOFTBANK, beneficially owned 18.4%, and entities affiliated with QVC beneficially owned 19.0% of our outstanding common stock, including warrants and options to purchase common stock, which are exercisable on or before
January 3, 2006. If they decide to act together, any two of Mr. Rubin, SOFTBANK, and QVC would be in a position to exercise considerable control, and all three would be in a position to exercise complete control, over most matters
requiring stockholder approval, including the election or removal of directors, approval of significant corporate transactions and the ability generally to direct our affairs. Furthermore, pursuant to the stock purchase agreements, SOFTBANK and QVC
each have the right to designate up to two members of our board of directors. This concentration of ownership and SOFTBANKs and QVCs right to designate members



42



---

##### Table of Contents

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 QVC, and SOFTBANK and QVC have entered into voting agreements with each other.
The parties to these voting agreements have agreed to support the election of the directors designated by each of the other parties.



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



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



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



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



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



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



See - We are controlled by certain principal stockholders.



The price of our common stock may fluctuate significantly.



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



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



| |  |  | our performance and prospects;
| | - |  | ------------------------------



| |  |  | the performance and prospects of our partners;
| | - |  | ----------------------------------------------



| |  |  | the depth and liquidity of the market for our common stock;
| | - |  | -----------------------------------------------------------



| |  |  | investor perception of us and the industry in which we operate;
| | - |  | ---------------------------------------------------------------



| |  |  | changes in earnings estimates or buy/sell recommendations by analysts;
| | - |  | ----------------------------------------------------------------------



| |  |  | general financial and other market conditions; and
| | - |  | --------------------------------------------------



| |  |  | general economic conditions.
| | - |  | ----------------------------



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



43



---

##### Table of Contents

Risks Related to Our Indebtedness



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



On June 1, 2005, we completed an offering of
$57.5 million aggregate principal amount of our convertible notes due 2025. Including these notes, we have approximately $71.2 million of indebtedness outstanding as of October 1, 2005. Our indebtedness could have important consequences to you.
For example, it could:



| |  |  | increase our vulnerability to general adverse economic and industry conditions;
| | - |  | -------------------------------------------------------------------------------



| |  |  | limit our ability to obtain additional financing;
| | - |  | -------------------------------------------------



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



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



| |  |  | place us at a competitive disadvantage relative to competitors with less debt; and
| | - |  | ----------------------------------------------------------------------------------



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



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



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



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



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------



There have been no significant changes in market risk for the nine-months ended October 1, 2005. See the information set forth in Part II,
Item 7A of the Companys Annual Report on Form 10-K for the fiscal year ended January 2, 2005 filed with the Securities and Exchange Commission on March 17, 2005, as amended by Form 10-K/A Amendment No. 1 filed with the SEC
on May 2, 2005 and further amended by Form 10-K/A Amendment No. 2 filed with the SEC on May 6, 2005.



|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 the end of the period covered by this Quarterly Report on Form 10-Q, 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, taking into effect that the Company has not substantially completed remediation of the material weakness described below related to accounts payable, as of the end of the period covered by this Quarterly Report on Form
10-Q, our disclosure controls and procedures were not effective in reaching a reasonable level of assurance that management is timely alerted to material information relating to us during the period when our periodic reports are being prepared.



Changes in internal control over financial reporting.We monitor and evaluate on an ongoing basis our internal control over financial reporting in order to improve its overall effectiveness. In the course of these evaluations, we modify and refine our internal processes and controls as conditions
warrant. As required by Rule 13a-15(d), our management, including our chief executive officer and the 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 October 1, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



44



---

##### Table of Contents

Based on that evaluation, management has identified such a change. The change relates to our systemic
report which supports a component of our general ledger amounts for accounts payable. We previously relied on a systemic report to support the amount of our accounts payable reflected in our general ledger. In the fiscal quarter ended
October 1, 2005, management determined that this systemic report was defective and could no longer be relied on.



As of the end of the period covered by this report, we replaced this systemic control with a manual control which requires that we obtain statements from
our trade accounts payable vendors to support the amount of our accounts payables reflected in our general ledger. We performed detailed analyses and reconciliations of the vendor statements received to confirm that the general ledger amounts for
accounts payable is accurate.



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



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



Management has re-evaluated the effectiveness of its
internal control over accounts payable as of the end of fiscal 2004 and has determined that the defective systemic report referenced above indicates a material weakness in internal controls with respect to accounts payable. A material weakness in
internal controls is a significant deficiency, or combination of significant deficiencies, that result in more than a remote likelihood that a material misstatement of the financial statements would not be prevented or detected on a timely basis.



Management also has re-evaluated the effectiveness of its
internal control over the preparation and review of its statements of cash flows related to unpaid acquisition of property and equipment as of the end of fiscal 2004 and has determined that the error related to the preparation and review of the
statements of cash flows indicates a material weakness. As further described in Note 17 of the notes to the accompanying condensed consolidated financial statements included in Item 1, unpaid amounts for property additions previously were reported
as a component of changes in operating assets and liabilities and acquisition of property and equipment. Such unpaid amounts should have been reported as a non-cash investing activity. Management has remediated this weakness as of October 1, 2005 by
strengthening the control procedures surrounding the review and classification of cash flows, including using additional accounting research tools in connection with the preparation and review of statements of cash flows.



To correct the errors described above, we will restate financial statements
for the periods covered in our Form 10-K for fiscal years 2004, 2003 and 2002 and the Forms 10-Q for the first two quarters of fiscal 2005. See Restatements of Financial Statements in Managements Discussion and Analysis of
Financial Condition and Results of Operations.



Other than as
described above, there have been no changes in our internal controls during the fiscal quarter ended October 1, 2005 that has materially affected, or is reasonably likely to materially affect, internal controls.



45



---

##### Table of Contents

PART IIOTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS.
|------- | ------------------



See Item 1 of Part I, Financial StatementsNote 12  Commitments and Contingencies.



|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.
|------- | ----------------------------------------------------



None.



|ITEM 5. | OTHER INFORMATION.
|------- | ------------------



None.



|ITEM 6. | EXHIBITS
|------- | --------



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



46



---

##### Table of Contents

SIGNATURES



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



GSI COMMERCE, INC.By:

/s/    MICHAEL G. RUBINMichael G. RubinChairman &Chief Executive Officer(principal executive officer)By:

/s/    JORDAN M. COPLANDJordan M. CoplandExecutive Vice President &Chief Financial Officer(principal financial officer & principal accounting officer)




Date: November 15, 2005



47