##### Table of Contents

---



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---



FORM 10-Q/A



(Mark One)



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



FOR THE QUARTERLY PERIOD ENDED APRIL 2, 2005.



or



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



FOR THE TRANSITION PERIOD FROM
 TO
.



Commission File Number 0-16611



---



GSI COMMERCE, INC.

(Exact name of registrant as specified in its charter)



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



610-265-3229

(Registrants telephone number,

including area code)



---



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



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



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



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



|                             |  |                   
|---------------------------- |  | ------------------
|Common Stock, $.01 par value |  | 41,848,514        
|(Title of each class)        |  | (Number of Shares)



---



---

##### Table of Contents

FORM 10-Q/A

FOR THE QUARTER ENDED APRIL 2, 2005

EXPLANATORY NOTE



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



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



TABLE OF CONTENTS



|                                                                                                                             |  |     
|---------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                             |  | Page
|PART IFINANCIAL INFORMATION                                                                                                 |  |     
|                                                                                                                             | 
|Item 1. Financial Statements (unaudited):                                                                                    |  |     
|Condensed Consolidated Balance Sheets (restated) as of January 1, 2005 and April 2, 2005                                     |  | 1   
|Condensed Consolidated Statements of Operations (restated) for the three-month periods ended April 3, 2004 and April 2, 2005 |  | 2   
|Condensed Consolidated Statements of Cash Flows (restated) for the three-month periods ended April 3, 2004 and April 2, 2005 |  | 3   
|Notes to Condensed Consolidated Financial Statements                                                                         |  | 4   
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                                |  | 23  
|Item 4. Controls and Procedures                                                                                              |  | 41  
|                                                                                                                             | 
|PART IIOTHER INFORMATION                                                                                                    |  |     
|                                                                                                                             | 
|Item 6. Exhibits                                                                                                             |  | 43  
|                                                                                                                             | 
|SIGNATURES                                                                                                                   |  | 44  



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 and fiscal 2004 refer to the fiscal years ended January 1, 2000, December 30,
2000, December 29, 2001, December 28, 2002, January 3, 2004 and the fiscal year ending January 1, 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           |          |   | April 2, 2005             |  
|                                                                                                                                                                                                                                                               |  | (as restated,see Note 17) |          |   | (as restated,see Note 17) |  
|ASSETS                                                                                                                                                                                                                                                         |  |                           |          |   |                           |   |          |  
|Current assets:                                                                                                                                                                                                                                                |  |                           |          |   |                           |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                                                      |  | $                         | 20,064   |   |                           | $ | 10,736   |  
|Marketable securities                                                                                                                                                                                                                                          |  |                           | 55,359   |   |                           |   | 32,487   |  
|Accounts receivable, net of allowance of $406 and $388, respectively                                                                                                                                                                                           |  |                           | 14,734   |   |                           |   | 9,296    |  
|Inventory                                                                                                                                                                                                                                                      |  |                           | 37,773   |   |                           |   | 34,013   |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                      |  |                           | 2,382    |   |                           |   | 2,193    |  
|                                                                                                                                                                                                                                                               |  |                           |          |   |                           |   |          |  
|Total current assets                                                                                                                                                                                                                                           |  |                           | 130,312  |   |                           |   | 88,725   |  
|Property and equipment, net                                                                                                                                                                                                                                    |  |                           | 74,387   |   |                           |   | 76,453   |  
|Goodwill                                                                                                                                                                                                                                                       |  |                           | 13,453   |   |                           |   | 13,453   |  
|Other equity investments                                                                                                                                                                                                                                       |  |                           | 2,847    |   |                           |   | 5,650    |  
|Other assets, net of accumulated amortization of $4,416 and $4,913, respectively                                                                                                                                                                               |  |                           | 10,824   |   |                           |   | 10,317   |  
|                                                                                                                                                                                                                                                               |  |                           |          |   |                           |   |          |  
|Total assets                                                                                                                                                                                                                                                   |  | $                         | 231,823  |   |                           | $ | 194,598  |  
|                                                                                                                                                                                                                                                               |  |                           |          |   |                           |   |          |  
|                                                                                                                                                                                                                                                               |  |                          
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                                           |  |                           |          |   |                           |   |          |  
|Current liabilities:                                                                                                                                                                                                                                           |  |                           |          |   |                           |   |          |  
|Accounts payable                                                                                                                                                                                                                                               |  | $                         | 58,023   |   |                           | $ | 31,179   |  
|Accrued expenses and other                                                                                                                                                                                                                                     |  |                           | 31,842   |   |                           |   | 21,558   |  
|Deferred revenue                                                                                                                                                                                                                                               |  |                           | 9,370    |   |                           |   | 8,679    |  
|Current portion  long-term debt and other                                                                                                                                                                                                                     |  |                           | 971      |   |                           |   | 589      |  
|                                                                                                                                                                                                                                                               |  |                           |          |   |                           |   |          |  
|Total current liabilities                                                                                                                                                                                                                                      |  |                           | 100,206  |   |                           |   | 62,005   |  
|                                                                                                                                                                                                                                                               |  |                          
|Long-term debt and other                                                                                                                                                                                                                                       |  |                           | 13,564   |   |                           |   | 13,410   |  
|Mandatorily redeemable preferred stock, Series A, $0.01 par value, 10,000 shares authorized; 0 shares issued and outstanding as of
January 1, 2005 and April 2, 2005                                                                                           |  |                           |         |   |                           |   |         |  
|                                                                                                                                                                                                                                                               |  |                           |          |   |                           |   |          |  
|Total liabilities                                                                                                                                                                                                                                              |  |                           | 113,770  |   |                           |   | 75,415   |  
|Commitments and contingencies                                                                                                                                                                                                                                  |  |                           |          |   |                           |   |          |  
|Stockholders equity:                                                                                                                                                                                                                                          |  |                           |          |   |                           |   |          |  
|Preferred stock, $0.01 par value, 4,990,000 shares authorized; 0 shares issued and outstanding as of January 1, 2005 and April 2,
2005                                                                                                                         |  |                           |         |   |                           |   |         |  
|Common stock, $0.01 par value, 90,000,000 shares authorized; 41,584,061 and 41,778,856 shares issued as of January 1, 2005 and
April 2, 2005, respectively; 41,582,851 and 41,772,246 shares outstanding as of January 1, 2005 and April 2, 2005, respectively |  |                           | 416      |   |                           |   | 418      |  
|Additional paid in capital                                                                                                                                                                                                                                     |  |                           | 294,471  |   |                           |   | 294,982  |  
|Accumulated other comprehensive (loss) income                                                                                                                                                                                                                  |  |                           | (104     | ) |                           |   | 2,067    |  
|Accumulated deficit                                                                                                                                                                                                                                            |  |                           | (176,730 | ) |                           |   | (178,284 | )
|                                                                                                                                                                                                                                                               |  |                           |          |   |                           |   |          |  
|Total stockholders equity                                                                                                                                                                                                                                     |  |                           | 118,053  |   |                           |   | 119,183  |  
|                                                                                                                                                                                                                                                               |  |                           |          |   |                           |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                                                                     |  | $                         | 231,823  |   |                           | $ | 194,598  |  
|                                                                                                                                                                                                                                                               |  |                           |          |   |                           |   |          |  



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        |       
|                                                                                                                 |  | April 3,2004              |        |   | April 2,2005              |  
|                                                                                                                 |  | (as restated,see Note 17) |        |   | (as restated,see Note 17) |  
|Revenues:                                                                                                        |  |                           |        |   |                           |   |        |  
|Net revenues from product sales                                                                                  |  | $                         | 56,878 |   |                           | $ | 76,652 |  
|Service fee revenues                                                                                             |  |                           | 9,390  |   |                           |   | 14,706 |  
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Net revenues                                                                                                     |  |                           | 66,268 |   |                           |   | 91,358 |  
|Cost of revenues from product sales                                                                              |  |                           | 41,508 |   |                           |   | 57,587 |  
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Gross profit                                                                                                     |  |                           | 24,760 |   |                           |   | 33,771 |  
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Operating expenses:                                                                                              |  |                           |        |   |                           |   |        |  
|Sales and marketing, exclusive of $494 and $183 reported below as stock-based compensation, respectively         |  |                           | 17,577 |   |                           |   | 20,859 |  
|Product development, exclusive of $49 and $(30) reported below as stock-based compensation, respectively         |  |                           | 4,530  |   |                           |   | 6,589  |  
|General and administrative, exclusive of $84 and $(398) reported below as stock-based compensation, respectively |  |                           | 3,920  |   |                           |   | 5,225  |  
|Stock-based compensation                                                                                         |  |                           | 627    |   |                           |   | (245   | )
|Depreciation and amortization                                                                                    |  |                           | 2,599  |   |                           |   | 3,122  |  
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Total operating expenses                                                                                         |  |                           | 29,253 |   |                           |   | 35,550 |  
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Other (income) expense:                                                                                          |  |                           |        |   |                           |   |        |  
|Other (income) expense                                                                                           |  |                           |       |   |                           |   | (115   | )
|Interest expense                                                                                                 |  |                           |       |   |                           |   | 233    |  
|Interest income                                                                                                  |  |                           | (290   | ) |                           |   | (343   | )
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Total other (income) expense                                                                                     |  |                           | (290   | ) |                           |   | (225   | )
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Net loss                                                                                                         |  | $                         | (4,203 | ) |                           | $ | (1,554 | )
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Loss per sharebasic and diluted:                                                                                |  |                           |        |   |                           |   |        |  
|Net loss                                                                                                         |  | $                         | (0.10  | ) |                           | $ | (0.04  | )
|                                                                                                                 |  |                           |        |   |                           |   |        |  
|Weighted average shares outstandingbasic and diluted                                                            |  |                           | 40,868 |   |                           |   | 41,662 |  
|                                                                                                                 |  |                           |        |   |                           |   |        |  



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)

(Unaudited)



|                                                                            |  |                                       |         |   |                                       |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------------------- | ------- | - | ------------------------------------- | - | ------- | -
|                                                                            |  | Three Months Ended                    |        
|                                                                            |  | April 3,2004(as restated,see Note 17) |         |   | April 2,2005(as restated,see Note 17) |  
|Cash Flows from Operating Activities:                                       |  |                                       |         |   |                                       |   |         |  
|Net loss                                                                    |  | $                                     | (4,203  | ) |                                       | $ | (1,554  | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                       |         |   |                                       |   |         |  
|Depreciation and amortization                                               |  |                                       | 2,599   |   |                                       |   | 3,122   |  
|Stock-based compensation                                                    |  |                                       | 627     |   |                                       |   | (245    | )
|Changes in operating assets and liabilities:                                |  |                                       |         |   |                                       |   |         |  
|Accounts receivable, net                                                    |  |                                       | (2,870  | ) |                                       |   | 5,438   |  
|Inventory                                                                   |  |                                       | 1,847   |   |                                       |   | 3,760   |  
|Prepaid expenses and other current assets                                   |  |                                       | (79     | ) |                                       |   | 189     |  
|Notes receivable                                                            |  |                                       | 180     |   |                                       |   |        |  
|Other assets, net                                                           |  |                                       | 35      |   |                                       |   | 9       |  
|Accounts payable and accrued expenses and other                             |  |                                       | (12,568 | ) |                                       |   | (35,546 | )
|Deferred revenue                                                            |  |                                       | (1,773  | ) |                                       |   | (691    | )
|                                                                            |  |                                       |         |   |                                       |   |         |  
|Net cash used in operating activities                                       |  |                                       | (16,205 | ) |                                       |   | (25,518 | )
|                                                                            |  |                                       |         |   |                                       |   |         |  
|Cash Flows from Investing Activities:                                       |  |                                       |         |   |                                       |   |         |  
|Acquisition of property and equipment,                                      |  |                                       | (2,234  | ) |                                       |   | (6,761  | )
|Deferred cost in other                                                      |  |                                       |        |   |                                       |   | (247    | )
|Net cash paid for equity investments                                        |  |                                       |        |   |                                       |   | (136    | )
|Purchases of marketable securities                                          |  |                                       | (8,664  | ) |                                       |   | (9,177  | )
|Sales of marketable securities                                              |  |                                       | 8,455   |   |                                       |   | 32,000  |  
|Cash (used in) provided by investing activities                             |  |                                       | (2,443  | ) |                                       |   | 15,679  |  
|                                                                            |  |                                       |         |   |                                       |   |         |  
|Cash Flows from Financing Activities:                                       |  |                                       |         |   |                                       |   |         |  
|Repayments of loan                                                          |  |                                       |        |   |                                       |   | (339    | )
|Repayments of capital lease obligations                                     |  |                                       |        |   |                                       |   | (160    | )
|Repayments of mortgage note                                                 |  |                                       |        |   |                                       |   | (38     | )
|Deferred cost paid                                                          |  |                                       |        |   |                                       |   | (199    | )
|Proceeds from exercises of common stock options                             |  |                                       | 903     |   |                                       |   | 1,247   |  
|                                                                            |  |                                       |         |   |                                       |   |         |  
|Net cash provided by financing activities                                   |  |                                       | 903     |   |                                       |   | 511     |  
|                                                                            |  |                                       |         |   |                                       |   |         |  
|Net decrease in cash and cash equivalents                                   |  |                                       | (17,745 | ) |                                       |   | (9,328  | )
|Cash and cash equivalents, beginning of period                              |  |                                       | 38,808  |   |                                       |   | 20,064  |  
|                                                                            |  |                                       |         |   |                                       |   |         |  
|Cash and cash equivalents, end of period                                    |  | $                                     | 21,063  |   |                                       | $ | 10,736  |  
|                                                                            |  |                                       |         |   |                                       |   |         |  



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



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



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



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



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



NOTE 2ACCOUNTING POLICIES



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



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



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



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



4



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



Marketable Securities: Marketable securities, which consist of investments in various
debt securities, are classified as available-for-sale and are reported at fair value, with unrealized gains and losses recorded as a component of stockholders equity. The Company does not intend to hold its marketable securities for more than
one year from the most recent balance sheet date and has therefore classified them as a current asset. All investments with original maturities of greater than 90 days are accounted for in accordance with Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company determines the appropriate classification at the time of purchase. At January 1, 2005, the Company held $39,700 and at
April 2, 2005 $12,400 of investments in auction rate securities classified as available-for-sale. Investments in these securities are recorded at cost, which approximates fair value due to their variable interest rates, which reset
approximately every 30 to 45 days. Despite the long-term nature of their stated contractual maturities, there is a ready liquid market for these securities based on the interest reset mechanism. As a result, there are no cumulative gross realized or
unrealized holding gains or (losses) from our auction rate securities. All income generated from these marketable securities was recorded as interest income. As of January 1, 2005, the Company recorded net unrealized losses on its marketable
securities, other than auction rate securities, of $104. As of April 2, 2005, the Company recorded net unrealized losses on its marketable securities, other than auction rate securities, of $153. 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 or amortization.
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 and amortization is provided using the straight-line method over the estimated useful lives of the assets, which are generally:



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



| |  |  | Three to ten years for furniture, and fulfillment center and office 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 or amortization are 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 from maintenance and repairs are expensed as incurred.



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



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



5



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



Other Equity Investments: Other equity investments consist of 824,594 shares of Odimo
Incorporated (Odimo) common stock, which was converted from Series C and Series D preferred stock when Odimo completed an initial public offering through the issuance of 3,125,000 shares of its common stock in February of 2005. The
Company accounts for the investment in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.. The initial cost of the Companys investment was determined based on the fair value of the
investment at the time of its acquisition. At the time, an observable market price did not exist for non-marketable securities. In order to determine the fair value of the investment in Odimo, the Company obtained an independent, third-party
valuation. The valuation incorporated a variety of methodologies to estimate fair value, including comparing the security with securities of publicly traded companies in similar lines of business, applying price multiples to estimated future
operating results for Odimo and estimating discounted cash flows. Factors affecting the valuation included restrictions on control and marketability of Odimos equity securities and other information available to the Company, such as the
Companys knowledge of the industry and knowledge of specific information about Odimo. Using this valuation, the Company determined the estimated fair value of the investment to be approximately $2,847 as of January 1, 2005. The fair value
of the Odimo investment as of April 2, 2005 was $5,203, which was determined by the current market price of the common stock of Odimo on April 1, 2005, which resulted in a gain of $2,220 in the first fiscal quarter of 2005, which is
recorded in accumulated other comprehensive income/(loss) as a component of stockholders equity. During the first quarter, the Company exercised warrants related to Odimo for $136 of common stock.



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 $9,609 for the three-month period ended April 2, 2005, and are being amortized as stock-based compensation expense as the partner revenue share expense is incurred. The partner revenue share expense incurred is based on
actual revenues recognized in a given period and the imputed partner revenue share percentage, which is based on the value of the Companys common stock that was issued upon exercise of the right. Stock-based compensation expense related to the
amortization of deferred partner revenue share charges was $360 for the three-month periods ended April 3, 2004, and $488 for the three-month periods ended April 2, 2005.



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



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



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



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



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



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. We specifically do not record cost of service fee revenue. The cost of the sales of the merchandise
on which we earn service fees are incurred by our service-fee partners because they are the owners and sellers of the merchandise.



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



Sales and Marketing: Sales and marketing expenses include fulfillment costs, customer service costs, credit card fees, net partner revenue
share charges, net advertising and promotional expenses incurred by us on behalf of the Companys partners e-commerce businesses, and payroll related to the buying, business management and marketing functions of its 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. Net advertising and promotional expenses include promotional free shipping and subsidized shipping and handling costs and are net of amounts
reimbursed to the Company by its partners. Partner revenue share charges were $3,004 for the three-month period ended April 3, 2004 and $1,806 for the three-month period ended April 2, 2005.



7



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



Shipping and Handling Costs: The Company defines shipping and handling costs as only
those costs incurred for a third-party shipper to transport products to the customer and these costs are included in cost of revenues from product sales. 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 $579 for the three-month period ended April 3, 2004 and $874 for the three-month period ended April 2, 2005, and was charged to sales and marketing expense.



Fulfillment Costs: The Company defines fulfillment costs as personnel, occupancy and other costs associated with
its Kentucky fulfillment center, personnel and other costs associated with its logistical support and vendor operations departments and third-party warehouse and fulfillment services costs. Fulfillment costs were $4,964 for the three-month period
ended April 3, 2004, and $6,407 for the three-month period ended April 2, 2005, and are included in sales and marketing expense.



Advertising: The Company expenses the cost of advertising, which includes online marketing fees, media, agency and production expenses, in
accordance with the AICPA Accounting Standards Executive Committees Statement of Position (SOP) 93-7, Reporting on Advertising Costs. Advertising production costs are expensed the first time the advertisement runs.
Online marketing fees and media (television, radio and print) placement costs are expensed in the month the advertising appears. Agency fees are expensed as incurred. Advertising costs were $410 for the three-month period ended April 3, 2004
and $30 for the three-month period ended April 2, 2005 and are included in sales and marketing expenses.



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



Stock-Based Compensation: SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value.
The Company has chosen to continue to account for stock-based compensation using the intrinsic method prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. Accordingly, compensation expense for stock options issued to employees is measured as the excess, if any, of the quoted market price of the Companys stock at the date of the grant over the amount an employee must pay to
acquire the stock. The Company accounts for stock-based compensation for stock options and warrants issued to non-employees in accordance with SFAS No. 123 and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and EITF No. 00-18, Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees. Accordingly,
compensation expense for stock options and warrants issued to non-employees is 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.



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 losses per share for the three-month
periods ended April 3, 2004 and April 2, 2005 as if compensation expense for stock options issued to employees had been determined consistent with SFAS No. 123:



|                                                                                               |  |                    |        |   |              |   |        |  
|---------------------------------------------------------------------------------------------- |  | ------------------ | ------ | - | ------------ | - | ------ | -
|                                                                                               |  | Three Months Ended |       
|                                                                                               |  | April 3,2004       |        |   | April 2,2005 |  
|                                                                                               |  | (in thousands)     |       
|Net loss, as reported                                                                          |  | $                  | (4,203 | ) |              | $ | (1,554 | )
|Add: Stock-based compensation expense included in reported net loss                            |  |                    | 261    |   |              |   | (694   | )
|Deduct: Total stock-based compensation determined under fair value based method for all awards |  |                    | (1,352 | ) |              |   | (1,326 | )
|                                                                                               |  |                    |        |   |              |   |        |  
|Pro forma net loss                                                                             |  | $                  | (5,294 | ) |              | $ | (3,574 | )
|                                                                                               |  |                    |        |   |              |   |        |  
|Losses per sharebasic and diluted:                                                            |  |                    |        |   |              |   |        |  
|Net loss per share, as reported                                                                |  | $                  | (0.10  | ) |              | $ | (0.04  | )
|                                                                                               |  |                    |        |   |              |   |        |  
|Pro forma net loss per share                                                                   |  | $                  | (0.13  | ) |              | $ | (0.09  | )
|                                                                                               |  |                    |        |   |              |   |        |  



Stock-based
compensation expense related to the amortization of deferred partner revenue share charges was $360 for the three-month periods ended April 3, 2004, and $488 for the three-month periods ended April 2, 2005.



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



New Accounting Pronouncements



Inventory
Costs an Amendment of ARB No. 43, Chapter 4: In November 2004, the 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.



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



Share-Based Payment. In December 2004, the Financial Accounting
Standards Board, or FASB, issued Financial Accounting Standards Board Statement No. 123R Share-Based Payment, or SFAS 123R, which replaces Financial Accounting



9



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



Standards Board Statement No. 123, Accounting for Stock-Based Compensation,
or SFAS 123, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in
the financial statements based on their fair values. In addition, SFAS 123R will cause unrecognized expense (based on the amounts in our pro forma footnote disclosure) related to options vesting after the date of initial adoption to be recognized as
a charge to results of operations over the remaining vesting period. In April 2005, the SEC announced that it would delay the initial adoption of SFAS 123R from interim periods that begin after June 15, 2005, to annual periods. The Company will
now be required to adopt SFAS 123R in its first quarter of 2006. 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 has preliminarily decided to use the prospective method for transition as of the effective date of SFAS 123R. The prospective method requires that compensation expense be recorded for
all unvested stock options and share awards at the beginning of the first quarter of adoption of SFAS 123R. 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.



NOTE
3MARKETABLE SECURITIES



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



|                                  |  |                 |        |                        |  |                           |   |      |                     |  |   |       
|--------------------------------- |  | --------------- | ------ | ---------------------- |  | ------------------------- | - | ---- | ------------------- |  | - | ------
|                                  |  | January 1, 2005
|                                  |  | AmortizedCost   |        | Gross Unrealized Gains |  | GrossUnrealizedLosses (1) |   |      | EstimatedFair Value
|                                  |  | (in thousands) 
|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
|                                  |  |                 |        |                        |  |                           |   |      |                     |  |   |       



|                                  |  |                |        |                      |   |                           |  |   |                      |   |  |   |       
|--------------------------------- |  | -------------- | ------ | -------------------- | - | ------------------------- |  | - | -------------------- | - |  | - | ------
|                                  |  | April 2, 2005 
|                                  |  | AmortizedCost  |        | GrossUnrealizedGains |   | GrossUnrealizedLosses (1) |  |   | Estimated Fair Value
|                                  |  | (in thousands)
|Auction rate securities           |  |                | 12,400 |                      |   |                           |  |   |                      |   |  |   | 12,400
|Corporate bonds                   |  |                | 8,441  |                      |   | 6                         |  |   | (66                  | ) |  |   | 8,381 
|U.S. government agency securities |  |                | 11,799 |                      |   |                          |  |   | (93                  | ) |  |   | 11,706
|                                  |  |                |        |                      |   |                           |  |   |                      |   |  |   |       
|                                  |  | $              | 32,640 |                      | $ | 6                         |  | $ | (159                 | ) |  | $ | 32,487
|                                  |  |                |        |                      |   |                           |  |   |                      |   |  |   |       



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



|                                       |  |                |        |                      |   |       
|-------------------------------------- |  | -------------- | ------ | -------------------- | - | ------
|                                       |  | Amortized Cost |        | Estimated Fair Value
|                                       |  | (in thousands)
|Due within one year                    |  | $              | 19,907 |                      | $ | 19,792
|Due after one year through five years  |  |                | 7,733  |                      |   | 7,695 
|                                       |  |                |        |                      |   |       
|Due after five years through ten years |  |                |        |                      |   |       
|                                       |  |                |        |                      |   |       
|Due after ten years                    |  |                | 5,000  |                      |   | 5,000 
|                                       |  |                |        |                      |   |       
|                                       |  | $              | 32,640 |                      | $ | 32,487
|                                       |  |                |        |                      |   |       



The fair value of marketable
securities with loss positions was $15,659 as of January 1, 2005 and $19,562 as of April 2, 2005, and the gross unrealized losses on these marketable securities were $104 as of January 1, 2005 and $159 as of April 2, 2005. The
Company considered the nature of these marketable securities, which are primarily U.S. government agency securities, the amount of the impairments relative to the carrying value of the related investments and the duration of the impairments, which
are all less than twelve months, and concluded that the impairments were not other than temporary.



10



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)





NOTE 4PROPERTY AND EQUIPMENT



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



|                                                |  |                |         |   |              |   |         |  
|----------------------------------------------- |  | -------------- | ------- | - | ------------ | - | ------- | -
|                                                |  | January 1,2005 |         |   | April 2,2005 |  
|                                                |  | (in thousands) |        
|Computer hardware and software                  |  | $              | 51,841  |   |              | $ | 54,960  |  
|Building and building improvements              |  |                | 39,751  |   |              |   | 40,095  |  
|Furniture, warehouse and office equipment       |  |                | 10,651  |   |              |   | 10,835  |  
|Land                                            |  |                | 7,663   |   |              |   | 7,663   |  
|Leasehold improvements                          |  |                | 529     |   |              |   | 532     |  
|Capitalized Lease                               |  |                | 1,692   |   |              |   | 1,692   |  
|Construction in progress                        |  |                | 387     |   |              |   | 1,805   |  
|                                                |  |                |         |   |              |   |         |  
|                                                |  |                | 112,514 |   |              |   | 117,582 |  
|Less: Accumulated depreciation and amortization |  |                | (38,127 | ) |              |   | (41,129 | )
|                                                |  |                |         |   |              |   |         |  
|Property and equipment, net                     |  | $              | 74,387  |   |              | $ | 76,453  |  
|                                                |  |                |         |   |              |   |         |  



NOTE 5LEASES



Capital Leases



During the third quarter of fiscal 2004, the Company entered into capital leases for computer hardware and software. As of
April 2, 2005, the leases had an aggregate outstanding balance of $1,091, with $444 classified as current. The Companys net investment in these capital leases as of April 2, 2005 was $1,483, which is included in property and
equipment. Interest expense recorded on the capital leases for the three month period ended April 2, 2005 was $24.



Operating Leases



The Company leases its Melbourne, FL customer contact center, as well as, its Shepherdsville, KY fulfillment center and certain fixed assets under
noncancellable operating leases. Rent expense under operating lease agreements was $227 for the three-month period ended April 3, 2004 and $492 for the three-month period ended April 2, 2005.



11



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)





NOTE 6CHANGES IN
STOCKHOLDERS EQUITY



The following table summarizes
the changes in stockholders equity for the three-month periods ended April 3, 2004 and April 2, 2005:



|                                                                   |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   |         |  
|------------------------------------------------------------------ |  | -------------- |  | ------------------------ | --- |  | ------------------ | ------- | - | -------------------------- | - | -------- | ------------------------------------------ |  | - | -------------- | - | ----- | - | ----- | - |  | - |  | - | - |  | - | ------- | -
|                                                                   |  | Common Stock   |  | AdditionalPaid inCapital |     |  | AccumulatedDeficit |         |   | Comprehensive(Loss) Income |   |          | AccumulatedOtherComprehensiveIncome (Loss) |  |   | Treasury Stock |   | Total |  
|                                                                   |  | Shares         |  | Dollars                  |     |  |                    |         |   | Shares                     |   | Dollars  |                                           
|                                                                   |  | (in thousands) | 
|Consolidated balance at January 3, 2004 (as restated, see Note 17) |  | 40,781         |  | $                        | 408 |  | $                  | 287,571 |   |                            | $ | (176,393 | )                                          |  |   |                |   |       | $ |      |   |  | 1 |  | $ |  |  | $ | 111,586 |  
|Net loss (as restated, see Note 17)                                |  |                |  |                          |     |  |                    |         |   |                            |   | (4,203   | )                                          |  | $ | (4,203         | ) |       |   |       |   |  |   |  |   |   |  |   | (4,203  | )
|Net unrealized losses on available-for-sale securities             |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   | (25            | ) |       |   | (25   | ) |  |   |  |   |   |  |   | (25     | )
|                                                                   |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   |         |  
|Comprehensive loss (as restated, see Note 17)                      |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  | $ | (4,228         | ) |       |   |       |   |  |   |  |   |   |  |   |         |  
|                                                                   |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   |         |  
|Stock-based compensation expense                                   |  |                |  |                          |     |  |                    | 267     |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   | 267     |  
|Issuance of common stock upon exercise of options                  |  | 193            |  |                          | 2   |  |                    | 901     |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   | 903     |  
|Consolidated balance at April 3, 2004 (as restated, see Note 17)   |  | 40,974         |  | $                        | 410 |  | $                  | 288,739 |   |                            | $ | (180,596 | )                                          |  |   |                |   |       | $ | (25   | ) |  | 1 |  | $ |  |  | $ | 108,528 |  
|                                                                   |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   |         |  
|Consolidated balance at January 1, 2005 (as restated, see Note 17) |  | 41,584         |  | $                        | 416 |  | $                  | 294,471 |   |                            | $ | (176,730 | )                                          |  |   |                |   |       | $ | (104  | ) |  | 1 |  | $ |  |  | $ | 118,053 |  
|Net loss (as restated, see Note 17)                                |  |                |  |                          |     |  |                    |         |   |                            |   | (1,554   | )                                          |  | $ | (1,554         | ) |       |   |       |   |  |   |  |   |   |  |   | (1,554  | )
|Net unrealized losses on available-for-sale securities             |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   | (49            | ) |       |   | (49   | ) |  |   |  |   |   |  |   | (49     | )
|Unrealized gain on investment in Odimo recorded at fair value      |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   | 2,220          |   |       |   | 2,220 |   |  |   |  |   |   |  |   | 2,220   |  
|                                                                   |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   |         |  
|Comprehensive income (as restated, see Note 17)                    |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  | $ | 617            |   |       |   |       |   |  |   |  |   |   |  |   |         |  
|                                                                   |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   |         |  
|Stock-based compensation expense (as restated, see Note 17)        |  |                |  |                          |     |  |                    | (734    | ) |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   | (734    | )
|Issuance of common stock upon exercise of options                  |  | 195            |  |                          | 2   |  |                    | 1,245   |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   | 1,247   |  
|                                                                   |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   |         |  
|Consolidated balance at April 2, 2005 (as restated, see Note 17)   |  | 41,779         |  | $                        | 418 |  | $                  | 294,982 |   |                            | $ | (178,284 | )                                          |  |   |                |   |       | $ | 2,067 |   |  | 1 |  | $ |  |  | $ | 119,183 |  
|                                                                   |  |                |  |                          |     |  |                    |         |   |                            |   |          |                                            |  |   |                |   |       |   |       |   |  |   |  |   |   |  |   |         |  



NOTE 7STOCK OPTIONS, WARRANTS
AND RESTRICTED STOCK UNITS



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 may grant incentive and non-incentive options, restricted stock and unrestricted
stock awards and restricted stock units to purchase up to 10,025,071 shares of common stock. The options 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. Generally, recipients of SARs
are entitled to receive, upon exercise, cash or shares of common stock (valued at the then fair market value of the Companys common stock) equal to such fair market value on the date of exercise minus such fair market value on the date of
grant of the shares subject to the SAR, although certain other measurements also may be used. A SAR granted in tandem with a stock option is exercisable only if and to the extent that the option is exercised. No SARs have been granted to date under
the Plans.



12



---

##### 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 stock option activity for the three-month periods ended
April 3, 2004 and April 2, 2005:



|                                 |  |                    |   |               |                              |       |                 |       |   |                              |   |      
|-------------------------------- |  | ------------------ | - | ------------- | ---------------------------- | ----- | --------------- | ----- | - | ---------------------------- | - | -----
|                                 |  | Three Months Ended
|                                 |  | April 3, 2004      |   | April 2, 2005
|                                 |  | Number of Shares   |   |               | WeightedAverageExercisePrice |       | Number ofShares |       |   | WeightedAverageExercisePrice
|                                 |  | (in thousands)     |   |               |                              |       | (in thousands)  |       |   |                             
|Outstanding, beginning of period |  | 6,716              |   |               | $                            | 8.37  |                 | 6,109 |   |                              | $ | 8.50 
|Granted                          |  | 90                 |   |               |                              | 9.88  |                 | 58    |   |                              |   | 14.78
|Exercised                        |  | (193               | ) |               |                              | 4.67  |                 | (195  | ) |                              |   | 6.40 
|Cancelled                        |  | (212               | ) |               |                              | 13.99 |                 | (159  | ) |                              |   | 8.94 
|                                 |  |                    |   |               |                              |       |                 |       |   |                              |   |      
|Outstanding, end of period       |  | 6,401              |   |               |                              | 8.28  |                 | 5,813 |   |                              |   | 8.62 
|                                 |  |                    |   |               |                              |       |                 |       |   |                              |   |      
|Exercisable, end of period       |  | 3,982              |   |               |                              | 8.00  |                 | 4,378 |   |                              |   | 8.35 
|                                 |  |                    |   |               |                              |       |                 |       |   |                              |   |      



During the three-month
period ended April 2, 2005, the Company granted to employees options to purchase an aggregate of 58,375 shares and restricted stock units to purchase an aggregate of 106,464 shares of the Companys common stock at prices ranging from
$14.78 to $14.92 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
April 2, 2005 was $6.34 and $14.78 per share, respectively. For the three-month period ended April 2, 2005, the Company recorded a reduction of $704 of stock-based compensation relating to options and restricted stock.



During the three-month period ended April 3, 2004, the Company granted
to employees options to purchase an aggregate of 90,000 shares of the Companys common stock at prices ranging from $9.15 to $9.93 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 April 3, 2004 was $6.89 and $9.88 per share, respectively. For the three-period ended April 3, 2004, the Company recorded $267 of
stock-based compensation expense relating to options and restricted stock.



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



|                                 |  |                    |  |                              |      |                 |     |                              |   |     
|-------------------------------- |  | ------------------ |  | ---------------------------- | ---- | --------------- | --- | ---------------------------- | - | ----
|                                 |  | Three Months Ended
|                                 |  | April 3, 2004      |  | April 2, 2005               
|                                 |  | Number of Shares   |  | WeightedAverageExercisePrice |      | Number ofShares |     | WeightedAverageExercisePrice
|                                 |  | (in thousands)     |  |                              |      | (in thousands)  |     |                             
|Outstanding, beginning of period |  | 803                |  | $                            | 7.68 |                 | 815 |                              | $ | 7.71
|Granted                          |  |                   |  |                              |     |                 |    |                              |   |    
|Exercised                        |  |                   |  |                              |     |                 |    |                              |   |    
|Cancelled                        |  |                   |  |                              |     |                 |    |                              |   |    
|                                 |  |                    |  |                              |      |                 |     |                              |   |     
|Outstanding, end of period       |  | 803                |  |                              | 7.68 |                 | 815 |                              |   | 7.71
|                                 |  |                    |  |                              |      |                 |     |                              |   |     
|Exercisable, end of period       |  | 603                |  |                              | 9.40 |                 | 615 |                              |   | 9.40
|                                 |  |                    |  |                              |      |                 |     |                              |   |     



No warrants were
granted or issued by the Company during the three-month periods ended April 3, 2004 and April 2, 2005, respectively.



13



---

##### 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 information regarding options and warrants outstanding and exercisable
as of April 2, 2005:



|                        |  |                   |  |                                                   |  |                                 |       |                   |       |                                 |   |      
|----------------------- |  | ----------------- |  | ------------------------------------------------- |  | ------------------------------- | ----- | ----------------- | ----- | ------------------------------- | - | -----
|                        |  | Outstanding       |  | Exercisable                                      
|Range of ExercisePrices |  | NumberOutstanding |  | Weighted AverageRemainingContractual LifeIn Years |  | Weighted Average Exercise Price |       | NumberExercisable |       | Weighted Average Exercise Price
|                        |  | (in thousands)    |  |                                                   |  |                                 |       | (in thousands)    |       |                                
|$  0.01  $  5.56       |  | 2,231             |  | 5.63                                              |  | $                               | 4.50  |                   | 1,928 |                                 | $ | 4.82 
|$  5.69  $10.00        |  | 3,165             |  | 6.97                                              |  |                                 | 8.65  |                   | 2,077 |                                 |   | 8.29 
|$10.60  $24.69         |  | 1,233             |  | 6.35                                              |  |                                 | 15.37 |                   | 988   |                                 |   | 16.00
|                        |  |                   |  |                                                   |  |                                 |       |                   |       |                                 |   |      
|$  0.01  $24.69        |  | 6,629             |  | 6.40                                              |  |                                 | 8.51  |                   | 4,993 |                                 |   | 8.48 
|                        |  |                   |  |                                                   |  |                                 |       |                   |       |                                 |   |      



As of April 2,
2005, 1,208,683 shares of common stock were available for future grants under the Plan.



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



|                                |  |                    |   |  |               |  
|------------------------------- |  | ------------------ | - |  | ------------- | -
|                                |  | Three Months Ended |  
|Assumption                      |  | April 3, 2004      |   |  | April 2, 2005 |  
|Dividend yield                  |  | None               |   |  | None          |  
|Expected volatility             |  | 103.00             | % |  | 81.4          | %
|Average risk free interest rate |  | 2.40               | % |  | 3.92          | %
|Average expected lives          |  | 3.95 years         |   |  | 1.82 years    |  



NOTE 8LOSS PER SHARE



Loss per share for all periods have been computed in
accordance with SFAS No. 128, Earnings Per Share. Basic and diluted loss per share are computed by dividing net loss by the weighted average number of shares of common stock outstanding during the period. Outstanding common stock
options and warrants have been excluded from the calculation of diluted losses per share because their effect would be antidilutive.



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



|                                                            |  |                    |        |   |               |   |        |  
|----------------------------------------------------------- |  | ------------------ | ------ | - | ------------- | - | ------ | -
|                                                            |  | Three Months Ended |       
|                                                            |  | April 3, 2004      |        |   | April 2, 2005 |  
|                                                            |  | (in thousands)     |       
|Net loss                                                    |  | $                  | (4,203 | ) |               | $ | (1,554 | )
|                                                            |  |                    |        |   |               |   |        |  
|Weighted average shares outstandingbasic and diluted       |  |                    | 40,868 |   |               |   | 41,662 |  
|                                                            |  |                    |        |   |               |   |        |  
|Outstanding common stock options having no dilutive effect  |  |                    | 6,401  |   |               |   | 5,813  |  
|                                                            |  |                    |        |   |               |   |        |  
|Outstanding common stock warrants having no dilutive effect |  |                    | 803    |   |               |   | 815    |  
|                                                            |  |                    |        |   |               |   |        |  



14



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)





NOTE 9COMPREHENSIVE INCOME
(LOSS):



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



|                                                               |  |                    |        |   |              |   |        |  
|-------------------------------------------------------------- |  | ------------------ | ------ | - | ------------ | - | ------ | -
|                                                               |  | Three Months Ended |       
|                                                               |  | April 3,2004       |        |   | April 2,2005 |  
|                                                               |  | (in thousands)     |       
|Net loss                                                       |  | $                  | (4,203 | ) |              | $ | (1,554 | )
|                                                               |  |                    |        |   |              |   |        |  
|Other comprehensive income (loss):                             |  |                    |        |   |              |   |        |  
|Net unrealized losses on available-for-sale Securities         |  |                    | (25    | ) |              |   | (49    | )
|                                                               |  |                    |        |   |              |   |        |  
|Unrealized gain on investments in Odimo recorded at fair value |  |                    |       |   |              |   | 2,220  |  
|                                                               |  |                    |        |   |              |   |        |  
|Other comprehensive (loss) income                              |  |                    | (25    | ) |              |   | 2,171  |  
|                                                               |  |                    |        |   |              |   |        |  
|Comprehensive (loss) income                                    |  | $                  | (4,228 | ) |              | $ | 617    |  
|                                                               |  |                    |        |   |              |   |        |  



NOTE 10SIGNIFICANT
TRANSACTIONS/CONCENTRATIONS OF CREDIT RISK



The Company
had $12,397 as of January 1, 2005 and $5,103 as of April 2, 2005, of operating cash and $63,026 as of January 1, 2005 and $38,120 as of April 2, 2005 of cash equivalents and marketable securities invested with three financial
institutions, which are potentially subject to credit risk. The composition of these investments is regularly monitored by management of the Company.



NOTE 11MAJOR SUPPLIERS/ECONOMIC DEPENDENCY



During the three-month period ended April 2, 2005, the Company purchased inventory from one supplier amounting to $24,713 or 48.7% of total inventory
purchased.



During the three-month period ended April 3,
2004, the Company purchased inventory from one supplier amounting to $12,431 or 36.9% 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



15



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



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



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



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



Advertising and Media Agreements



As of April 2, 2005, the Company was contractually committed for the purchase of future advertising totaling approximately $30 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 April 2, 2005 and subject to the satisfaction of certain
conditions, the Company was contractually committed to future minimum cash revenue share payments as follows:



|                                                             |  |                                                  |       
|------------------------------------------------------------ |  | ------------------------------------------------ | ------
|                                                             |  | Fiscal Year-Ended Partner Revenue Share Payments
|                                                             |  | (in thousands)                                  
|2005                                                         |  | $                                                | 2,050 
|2006                                                         |  |                                                  | 4,200 
|2007                                                         |  |                                                  | 4,500 
|2008                                                         |  |                                                  | 4,850 
|2009                                                         |  |                                                  | 5,150 
|Thereafter                                                   |  |                                                  | 2,650 
|Total conditional future minimum cash revenue share payments |  | $                                                | 23,400
|                                                             |  |                                                  |       



16



---

##### 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



|                                                              |  |                    |     |   |              |   |        |  
|------------------------------------------------------------- |  | ------------------ | --- | - | ------------ | - | ------ | -
|                                                              |  | Three Months Ended |    
|                                                              |  | April 3,2004       |     |   | April 3,2005 |  
|                                                              |  | (in thousands)     |    
|Cash paid during the period for interest                      |  | $                  |    |   |              | $ | 234    |  
|Noncash Investing and Financing Activities:                   |  |                    |     |   |              |   |        |  
|Unrealized gain on investment in Odimo recorded at fair value |  | $                  |    |   |              | $ | 2,220  |  
|Changes in accrual for purchases of property and equipment    |  |                    | 159 |   |              | $ | (1,582 | )
|Net unrealized losses on available-for-sale securities        |  | $                  | (25 | ) |              | $ | (49    | )



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 us through its
partners e-commerce businesses and service fees earned by the Company in connection with the development and operation of its partners e-commerce businesses. The Company also derives revenue from fixed and variable fees earned in
connection with the development and operation of partners e-commerce businesses and the provision of marketing and other services. All of the Companys net revenues and operating results are in the United States and Canada. Net revenues
and operating results in Canada are not significant. All of the Companys identifiable assets are in the United States.



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 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 April 2, 2005, QVC beneficially owned approximately 20.3% of our outstanding common stock. M. Jeffrey
Branman, one of our directors, was the President of Interactive Technology Services, which served as financial advisor to ITH through its dissolution.



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. Interactive Technology Holdings, LLC, which is a major stockholder of the Company, is a joint venture company of Comcast Corporation and QVC. The Company recognized net revenues on sales to this related party for the three-month period ended
April 3, 2004 of $333 and for the three-month period ended April 2, 2005 of $398 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 April 2, 2005, the amount included in accounts receivable net was $68.9 related to these sales.



In the fiscal year ended January 3, 2004, the Company entered into a service agreement with QVC pursuant to which QVC provided shipping services to
the Company in exchange for fees. The fees charged to the Company by QVC were determined through arms-length negotiations. The Company incurred fees $319 for the three-month period ended April 3, 2004, of which $307 related directly to products
shipped and was charged to cost of revenues from product sales and $12 related to professional



17



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



services provided and was charged to sales and marketing expense. The Company incurred fees of $26 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 $13 related to professional services provided and was charged to sales and marketing expense. On February 1, 2005 we provided a 60 day
termination notice to QVC, which would terminate this agreement effective April 3, 2005.



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-Scholes 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



The following table
summarizes the Companys long-term debt and other long-term liabilities as of April 2, 2005:



|                                                  |  |                |        |  
|------------------------------------------------- |  | -------------- | ------ | -
|                                                  |  | April 2, 2005  |       
|                                                  |  | (in thousands) |       
|Note payable                                      |  | $              | 12,908 |  
|Capital lease obligation                          |  |                | 1,091  |  
|                                                  |  |                |        |  
|                                                  |  |                | 13,998 |  
|Less: Current portion of note payable             |  |                | (145   | )
|Less: Current portion of capital lease obligation |  |                | (444   | )
|                                                  |  |                |        |  
|Long-term debt and other                          |  | $              | 13,410 |  
|                                                  |  |                |        |  



NOTE 17RESTATEMENTS OF THE
CONSOLIDATED FINANCIAL STATEMENTS



First Restatement



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



Second Restatement



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



The impact on net loss of correcting for the above errors in the accompanying condensed consolidated financial statements for the three months ended
April 3, 2004 and April 2, 2005 was an increase of $175 and a decrease of $122, respectively. The impact on accumulated deficit of correcting for these errors as of January 3, 2004, April 3, 2004 and January 1, 2005 was
a decrease of $1,216, $1,041 and $539, respectively.



18



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



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



19



---

##### Table of Contents

GSI COMMERCE, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(In thousands, except per share data)

(Unaudited)



|                                              |  |                                       |          |   |                  |   |         |                   |  |   |             |   |  |   |          |  
|--------------------------------------------- |  | ------------------------------------- | -------- | - | ---------------- | - | ------- | ----------------- |  | - | ----------- | - |  | - | -------- | -
|                                              |  | Condensed Consolidated Balance Sheets |         
|                                              |  | As PreviouslyReported                 |          |   | FirstRestatement |   |         | SecondRestatement |  |   | As Restated |  
|January 1, 2005                               |  |                                       |          |   |                  |   |         |                   |  |   |             |   |  |   |          |  
|Cash and cash equivalents                     |  | $                                     | 56,564   |   |                  | $ | (36,500 | )                 |  | $ |            |   |  | $ | 20,064   |  
|Marketable securities                         |  |                                       | 18,859   |   |                  |   | 36,500  |                   |  |   |            |   |  |   | 55,359   |  
|Accounts receivable, net of allowance of $408 |  |                                       | 14,908   |   |                  |   |        |                   |  |   | (174        | ) |  |   | 14,734   |  
|Total current assets                          |  |                                       | 130,486  |   |                  |   |        |                   |  |   | (174        | ) |  |   | 130,312  |  
|Property and equipment, net                   |  |                                       | 74,286   |   |                  |   |        |                   |  |   | 101         |   |  |   | 74,387   |  
|Total assets                                  |  |                                       | 231,896  |   |                  |   |        |                   |  |   | (73         | ) |  |   | 231,823  |  
|Accounts payable                              |  |                                       | 58,762   |   |                  |   |        |                   |  |   | (739        | ) |  |   | 58,023   |  
|Accrued expenses and other                    |  |                                       | 31,691   |   |                  |   |        |                   |  |   | 151         |   |  |   | 31,842   |  
|Total current liabilities                     |  |                                       | 100,794  |   |                  |   |        |                   |  |   | (588        | ) |  |   | 100,206  |  
|Total liabilities                             |  |                                       | 114,358  |   |                  |   |        |                   |  |   | (588        | ) |  |   | 113,770  |  
|Additional paid in capital                    |  |                                       | 294,495  |   |                  |   |        |                   |  |   | (24         | ) |  |   | 294,471  |  
|Accumulated deficit                           |  |                                       | (177,269 | ) |                  |   |        |                   |  |   | 539         |   |  |   | (176,730 | )
|Total stockholders equity                    |  |                                       | 117,538  |   |                  |   |        |                   |  |   | 515         |   |  |   | 118,053  |  
|Total liabilities and stockholders equity    |  |                                       | 231,896  |   |                  |   |        |                   |  |   | (73         | ) |  |   | 231,823  |  
|                                              |  |                                       |          |  
|                                              |  | As PreviouslyReported                 |          |   | FirstRestatement |   |         | SecondRestatement |  |   | As Restated |  
|April 2, 2005                                 |  |                                       |          |   |                  |   |         |                   |  |   |             |   |  |   |          |  
|Accounts receivable, net of allowance of $388 |  | $                                     | 9,431    |   |                  | $ |        |                   |  | $ | (135        | ) |  | $ | 9,296    |  
|Total current assets                          |  |                                       | 88,860   |   |                  |   |        |                   |  |   | (135        | ) |  |   | 88,725   |  
|Total assets                                  |  |                                       | 194,733  |   |                  |   |        |                   |  |   | (135        | ) |  |   | 194,598  |  
|Accounts payable                              |  |                                       | 31,918   |   |                  |   |        |                   |  |   | (739        | ) |  |   | 31,179   |  
|Accrued expenses and other                    |  |                                       | 21,576   |   |                  |   |        |                   |  |   | (18         | ) |  |   | 21,558   |  
|Total current liabilities                     |  |                                       | 62,762   |   |                  |   |        |                   |  |   | (757        | ) |  |   | 62,005   |  
|Total liabilities                             |  |                                       | 76,172   |   |                  |   |        |                   |  |   | (757        | ) |  |   | 75,415   |  
|Additional paid in capital                    |  |                                       | 295,021  |   |                  |   |        |                   |  |   | (39         | ) |  |   | 294,982  |  
|Accumulated deficit                           |  |                                       | (178,945 | ) |                  |   |        |                   |  |   | 661         |   |  |   | (178,284 | )
|Total stockholders equity                    |  |                                       | 118,561  |   |                  |   |        |                   |  |   | 622         |   |  |   | 119,183  |  
|Total liabilities and stockholders equity    |  |                                       | 194,733  |   |                  |   |        |                   |  |   | (135        | ) |  |   | 194,598  |  



20



---

##### 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 April 3, 2004 |  |                                                 |        |   |                   |   |      |             |  |   |        |  
|Sales and Marketing              |  | $                                               | 17,449 |   |                   | $ | 128  |             |  | $ | 17,577 |  
|Product development              |  |                                                 | 4,483  |   |                   |   | 47   |             |  |   | 4,530  |  
|Total operating expenses         |  |                                                 | 29,078 |   |                   |   | 175  |             |  |   | 29,253 |  
|Net loss                         |  |                                                 | (4,028 | ) |                   |   | (175 | )           |  |   | (4,203 | )
|Loss per share                   |  |                                                 | (0.10  | ) |                   |   |     |             |  |   | (0.10  | )



|                                    |  |                       |        |   |                   |   |     |             |  |   |        |  
|----------------------------------- |  | --------------------- | ------ | - | ----------------- | - | --- | ----------- |  | - | ------ | -
|                                    |  | As PreviouslyReported |        |   | SecondRestatement |   |     | As Restated | 
|Three Months Ended April 2, 2005    |  |                       |        |   |                   |   |     |             |  |   |        |  
|Cost of revenues from product sales |  | $                     | 57,626 |   |                   | $ | (39 | )           |  | $ | 57,587 |  
|Gross profit                        |  |                       | 33,732 |   |                   |   | 39  |             |  |   | 33,771 |  
|Sales and marketing                 |  |                       | 20,911 |   |                   |   | (52 | )           |  |   | 20,859 |  
|Stock-based compensation            |  |                       | (230   | ) |                   |   | (15 | )           |  |   | (245   | )
|Total operating expenses            |  |                       | 35,617 |   |                   |   | (67 | )           |  |   | 35,550 |  
|Other (income) expense              |  |                       | (99    | ) |                   |   | (16 | )           |  |   | (115   | )
|Total other (income) expense        |  |                       | (209   | ) |                   |   | (16 | )           |  |   | (225   | )
|Net loss                            |  |                       | (1,676 | ) |                   |   | 122 |             |  |   | (1,554 | )
|Loss per share                      |  |                       | (0.04  | ) |                   |   |    |             |  |   | (0.04  | )



|                                                |  |                                                |         |   |                  |        |   |                   |   |        |             |  |   |         |  
|----------------------------------------------- |  | ---------------------------------------------- | ------- | - | ---------------- | ------ | - | ----------------- | - | ------ | ----------- |  | - | ------- | -
|                                                |  | Condensed Consolidated Statement of Cash Flows |        
|                                                |  | As PreviouslyReported                          |         |   | FirstRestatement |        |   | SecondRestatement |   |        | As Restated | 
|Three-Month Period Ended April 3, 2004          |  |                                                |         |   |                  |        |   |                   |   |        |             |  |   |         |  
|Net loss                                        |  | $                                              | (4,028  | ) |                  |       |   |                   | $ | (175   | )           |  | $ | (4,203  | )
|Accounts payable and accrued expenses and other |  |                                                | (12,584 | ) |                  |       |   |                   |   | 16     |             |  |   | (12,568 | )
|Net cash used in operating activities           |  |                                                | (16,046 | ) |                  |       |   |                   |   | (159   | )           |  |   | (16,205 | )
|Acquisition of property and equipment           |  |                                                | (2,393  | ) |                  |       |   |                   |   | 159    |             |  |   | (2,234  | )
|Purchases of marketable securities              |  |                                                | (5,314  | ) |                  | (3,350 | ) |                   |   |       |             |  |   | (8,664  | )
|Sales of marketable securities                  |  |                                                | 1,105   |   |                  | 7,350  |   |                   |   |       |             |  |   | 8,455   |  
|Net cash used in investing activities           |  |                                                | (6,602  | ) |                  | 4,000  |   |                   |   | 159    |             |  |   | (2,443  | )
|Net decrease in cash and cash equivalents       |  |                                                | (21,745 | ) |                  | 4,000  |   |                   |   |       |             |  |   | (17,745 | )
|                                                |  |                                                |         |   |                  |        |   |                   |   |        |             |  |   |         |  
|                                                |  | As PreviouslyReported                          |         |   | FirstRestatement |        |   | SecondRestatement |   |        | As Restated | 
|Three-Month Period Ended April 2, 2005          |  |                                                |         |   |                  |        |   |                   |   |        |             |  |   |         |  
|Net loss                                        |  | $                                              | (1,676  | ) |                  |       |   |                   | $ | 122    |             |  | $ | (1,554  | )
|Stock-based compensation                        |  |                                                | (230    | ) |                  |       |   |                   |   | (15    | )           |  |   | (245    | )
|Accounts receivable, net                        |  |                                                | 5,477   |   |                  |       |   |                   |   | (39    | )           |  |   | 5,438   |  
|Accounts payable and accrued expenses and other |  |                                                | (36,959 | ) |                  |       |   |                   |   | 1,413  |             |  |   | (35,546 | )
|Net cash used in operating activities           |  |                                                | (26,999 | ) |                  |       |   |                   |   | 1,481  |             |  |   | (25,518 | )
|Acquisition of property and equipment           |  |                                                | (5,280  | ) |                  |       |   |                   |   | (1,481 | )           |  |   | (6,761  | )
|Net cash used in investing activities           |  |                                                | 17,160  |   |                  |       |   |                   |   | (1,481 | )           |  |   | 15,679  |  



21



---

##### 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/A, other than
statements of historical fact, are forward-looking statements. The words anticipate, believe, estimate, expect, intend, may, plan, will,
would, should, guidance, potential, continue, project, forecast, confident, prospects, and similar expressions typically are used to identify
forward-looking statements. Forward-looking statements are based on the then-current expectations, beliefs, assumptions, estimates and forecasts about our business and the industries and markets in which we operate. These statements are not
guarantees of future performance and involve risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied by these forward-looking statements.
Factors which may affect our business, financial condition and operating results include the effects of changes in the economy, the impact of SFAS 123R, consumer spending, the financial markets and the industries in which we and our partners
operate, changes affecting the Internet and e-commerce, our ability to develop and maintain relationships with strategic partners and suppliers and the timing of our establishment or extension or termination of our relationships with strategic
partners, our ability to timely and successfully develop, maintain and protect our technology and product and service offerings and execute operationally, our ability to attract and retain qualified personnel, our ability to successfully integrate
our acquisitions of other businesses, if any, and the performance of acquired businesses. More information about potential factors that could affect us 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 enables retailers, branded manufacturers, entertainment companies and professional sports organizations to operate e-commerce
businesses. We provide solutions for our partners through our integrated e-commerce platform, which is comprised of three components: core technology, supporting infrastructure and partner services. Through our platform, we provide Web site
administration, Web infrastructure and hosting, business intelligence, an e-commerce engine, order management, fulfillment, drop shipment, customer service, buying, creative design, Web site usability, testing and enhancement services, channel
integration, business-to-business (B-to-B) services, content development and imaging, e-commerce strategy, online marketing and customer relationship management (CRM).
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Based on forecasts of Forrester Research, we expect online general merchandise sales in the United States to expand at approximately a 14.3% compounded annual growth rate from 2004
through 2010. While we expect the opportunity for partnered e-commerce to continue to grow, we also anticipate competition to continue to be intense. We compete with traditional, in-house solutions as well as a variety of third-party vendors that
provide e-commerce software or partial e-commerce solutions. To satisfy our existing partners and continue to attract new partners, 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. To differentiate our solution in the marketplace, we continually add new services and functions to our
platforms. As part of our continuing efforts to add value to our platform, we evaluate opportunities to acquire complimentary or new businesses or assets.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | We derive virtually all of our revenues from sales of products by us through our partners e-commerce businesses and service fees earned by us in connection with the
development and operation of our partners e-commerce businesses. Our revenue growth in the first quarter of fiscal 2005 as compared to the first quarter of fiscal 2004 was due to an increase in revenues from product sales in both our sporting
goods and other categories, as well as an increase in service fee revenues. These increases were driven by the addition of new partners in fiscal 2004 and the first quarter of fiscal 2005.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | Operating expenses as a percentage of net revenues decreased from 44.1% in first quarter of fiscal 2004 to 38.9% in first quarter of fiscal 2005, primarily as a result of sales and
marketing expenses increasing at a slower rate than net revenues.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



22



---

##### Table of Contents

| |  |  | In December 2004, the Financial Accounting Standards Board, or FASB, issued Financial Accounting Standards Board Statement No. 123R Shared-Based Payment, or SFAS
123R. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. In addition, SFAS 123R will cause expense related to options vesting
after the date of initial adoption to be recognized as a charge to results of operations over the remaining vesting period. In April 2005, the SEC delayed the initial adoption of SFAS 123R from interim periods that begin after June 15, 2005 to
annual periods. We are continuing to evaluate the requirements of SFAS 123R and we still expect that the adoption of SFAS 123R will have a material impact on our consolidated results of operations and earnings per share. In light of our anticipated
adoption of SFAS 123R, we and our compensation committee are reevaluating our current incentive compensation strategies.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Restatements of Financial Statements



First Restatement



As previously disclosed in Amendment No. 2 to Form 10-K/A for fiscal 2004, we determined that our investments in auction rate securities should have
been classified as marketable securities within current assets. 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 three-months ended April 3, 2004, to reflect the gross purchases and sales of these investments as investing activities.



Second Restatement



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



The impact on net loss of correcting for the above errors in the accompanying condensed consolidated financial statements for the three-months ended
April 3, 2004 and April 2, 2005 was an increase of $175,000 and a decrease of $122,000, respectively. The impact on accumulated deficit of correcting for these errors as of January 3, 2004, April 3, 2004 and January 1, 2005 was a
decrease of $1.2 million, $1.0 million and $0.5 million, respectively.



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



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



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



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



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



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



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



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



| |  |  | Second quarter of fiscal 2004: Previously reported net loss of $3.1 million was not affected by the restatement.
| | - |  | ----------------------------------------------------------------------------------------------------------------



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



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



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



23



---

##### Table of Contents



Results of Operations



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



Net Revenues



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



|                                                 |  |                       |      |   |                       |   |   |                                                |      |  |      |          |  |         |      |  |      |  
|------------------------------------------------ |  | --------------------- | ---- | - | --------------------- | - | - | ---------------------------------------------- | ---- |  | ---- | -------- |  | ------- | ---- |  | ---- | -
|                                                 |  | First Qtr Fiscal 2004 |      |   | First Qtr Fiscal 2005 |   |   | First Qtr Fiscal 2005 vs First Qtr Fiscal 2004 |     
|                                                 |  | $                     |      | % |                       |   | $ |                                                | %    |  |      | $ Change |  | %Change |     
|                                                 |  | (dollars in millions) |     
|Net revenues from product sales - sporting goods |  | $                     | 33.5 |   | 50.5                  | % |   | $                                              | 39.8 |  | 43.5 | %        |  | $       | 6.3  |  | 18.8 | %
|Net revenues from product sales - other          |  |                       | 23.4 |   | 35.3                  | % |   |                                                | 36.9 |  | 40.4 | %        |  |         | 13.5 |  | 57.7 | %
|                                                 |  |                       |      |   |                       |   |   |                                                |      |  |      |          |  |         |      |  |      |  
|Net revenues from product sales                  |  |                       | 56.9 |   | 85.8                  | % |   |                                                | 76.7 |  | 83.9 | %        |  |         | 19.8 |  | 34.8 | %
|Service fee revenues                             |  |                       | 9.4  |   | 14.2                  | % |   |                                                | 14.7 |  | 16.1 | %        |  |         | 5.3  |  | 56.6 | %
|                                                 |  |                       |      |   |                       |   |   |                                                |      |  |      |          |  |         |      |  |      |  
|Net revenues                                     |  |                       | 66.3 |   | 100                   | % |   |                                                | 91.4 |  | 100  | %        |  |         | 25.1 |  | 37.9 | %



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



Net revenues from product sales increased $19.8 million in the first quarter of fiscal 2005. Of this increase, $6.3 million was due to an increase in sales in our sporting goods category and $13.5 million was due to
an increase in sales in our other product category, which includes increased sales of consumer electronics and licensed entertainment products.



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



Service fee revenues increased $5.3 million for the first quarter of 2005, due primarily to the launch of new fee-based
partners in fiscal 2004.



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



|                                           |  |                       |      |   |                       |   |   |                                                |      |  |      |          |  |         |      |  |      |  
|------------------------------------------ |  | --------------------- | ---- | - | --------------------- | - | - | ---------------------------------------------- | ---- |  | ---- | -------- |  | ------- | ---- |  | ---- | -
|                                           |  | First Qtr Fiscal 2004 |      |   | First Qtr Fiscal 2005 |   |   | First Qtr Fiscal 2005 vs First Qtr Fiscal 2004 |     
|                                           |  | $                     |      | % |                       |   | $ |                                                | %    |  |      | $ Change |  | %Change |     
|                                           |  | (dollars in millions) |     
|Cost of revenues from product sales        |  | $                     | 41.5 |   | 62.6                  | % |   | $                                              | 57.6 |  | 63.1 | %        |  | $       | 16.1 |  | 38.8 | %
|Cost of revenues from service fee revenues |  |                       |     |   |                      | % |   |                                                |     |  |     | %        |  |         |     |  |     | %
|                                           |  |                       |      |   |                       |   |   |                                                |      |  |      |          |  |         |      |  |      |  
|Cost of revenues                           |  | $                     | 41.5 |   | 62.6                  | % |   | $                                              | 57.6 |  | 63.1 | %        |  | $       | 16.1 |  | 38.8 | %



24



---

##### Table of Contents

As a percentage of net revenues, cost of revenues increased from 62.6% in first quarter of fiscal 2004 to
63.1% in first quarter of fiscal 2005. The change in cost of revenues as a percentage of net revenues resulted from lower margins in our other product category. Cost of revenues from product sales as a percentage of net revenues from product sales
increased from approximately 72.9% in first quarter of fiscal 2004 to approximately 75.1% in first quarter of fiscal 2005.



Gross Profit



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



| | 
| | 



|                                |  |   |      |                       |      |   |                   |       |                       |                  |      |                                                |   |   |                    |  |      |                   |  |       |                  |  |      |          |  |          |     |  |      |  
|------------------------------- |  | - | ---- | --------------------- | ---- | - | ----------------- | ----- | --------------------- | ---------------- | ---- | ---------------------------------------------- | - | - | ------------------ |  | ---- | ----------------- |  | ----- | ---------------- |  | ---- | -------- |  | -------- | --- |  | ---- | -
|                                |  |   |      | First Qtr Fiscal 2004 |      |   |                   |       | First Qtr Fiscal 2005 |                  |      | First Qtr Fiscal 2005 vs First Qtr Fiscal 2004 |  
|                                |  | $ |      | % of Product Sales    |      |   | % of service fees |       |                       | % of Net revenue |      |                                                | $ |   | % of Product sales |  |      | % of service fees |  |       | % of Net revenue |  |      | $ Change |  | % Change |    
|Gross Profit from product sales |  | $ | 15.4 |                       | 27.1 | % |                   |       |                       |                  |      |                                                |   | $ | 19.1               |  | 24.9 | %                 |  |       |                  |  |      |          |  | $        | 3.7 |  | 24.0 | %
|Gross Profit from service fees  |  |   | 9.4  |                       |      |   |                   | 100.0 | %                     |                  |      |                                                |   |   | 14.7               |  |      |                   |  | 100.0 | %                |  |      |          |  |          | 5.3 |  | 56.4 | %
|Gross profit                    |  | $ | 24.8 |                       |      |   |                   |       |                       |                  | 37.4 | %                                              |   | $ | 33.8               |  |      |                   |  |       |                  |  | 37.0 | %        |  | $        | 9.0 |  | 36.3 | %



The increase in gross
profit for the first quarter of fiscal 2005 was due to a $5.3 million increase in service fee revenues and a $3.7 million increase in gross profit from product sales. The decrease in gross profit as a percentage of net revenues in first quarter of
fiscal 2005 was largely driven by greater than planned product sales in the other category, which is primarily electronics, which carry a lower gross margin than product sales of sporting goods. Gross profit from product sales represented 62.1% of
total gross profit in first quarter of fiscal 2004 and 56.5% in first quarter of fiscal 2005. Gross profit from service fee revenues represented 37.9% of total gross profit in first quarter of fiscal 2004 and 43.5% in first quarter of fiscal 2005.
The gross profit on product sales decreased from 27.1% in first quarter of fiscal 2004 to 24.9% in first quarter of fiscal 2005 due primarily to a shift in sales to consumer electronics from sporting goods.



Operating Expenses



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



|                                       |  |                       |      |   |                       |   |   |                                                |      |   |  |      |          |  |   |         |   |  |        |   
|-------------------------------------- |  | --------------------- | ---- | - | --------------------- | - | - | ---------------------------------------------- | ---- | - |  | ---- | -------- |  | - | ------- | - |  | ------ | --
|                                       |  | First Qtr Fiscal 2004 |      |   | First Qtr Fiscal 2005 |   |   | First Qtr Fiscal 2005 vs First Qtr Fiscal 2004 |     
|                                       |  | $                     |      | % |                       |   | $ |                                                |      | % |  |      | $ Change |  |   | %Change |  
|                                       |  | (dollars in millions) |     
|Sales and marketing expenses           |  | $                     | 17.6 |   | 26.5                  | % |   | $                                              | 20.8 |   |  | 22.8 | %        |  | $ | 3.2     |   |  | 18.2   | % 
|Product development expenses           |  |                       | 4.6  |   | 6.9                   | % |   |                                                | 6.6  |   |  | 7.2  | %        |  |   | 2.0     |   |  | 43.5   | % 
|General and administrative expenses    |  |                       | 3.9  |   | 5.9                   | % |   |                                                | 5.2  |   |  | 5.7  | %        |  |   | 1.3     |   |  | 33.3   | % 
|Stock-based compensation expense       |  |                       | 0.6  |   | 0.9                   | % |   |                                                | (0.2 | ) |  | (0.2 | )%       |  |   | (0.8    | ) |  | (133.3 | )%
|Depreciation and amortization expenses |  |                       | 2.6  |   | 3.9                   | % |   |                                                | 3.1  |   |  | 3.4  | %        |  |   | 0.5     |   |  | 19.2   | % 
|                                       |  |                       |      |   |                       |   |   |                                                |      |   |  |      |          |  |   |         |   |  |        |   
|Total operating expenses               |  | $                     | 29.3 |   | 44.1                  | % |   | $                                              | 35.5 |   |  | 38.9 | %        |  | $ | 6.2     |   |  | 21.1   | % 



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



25



---

##### Table of Contents

Sales and marketing expenses increased $3.2 million from the first quarter of fiscal 2005 primarily due
to a $1.4 million increase in payroll and related costs principally in our fulfillment operations, a $1.1 million increase in credit card fees, a $0.5 million increase in online marketing and a $0.2 million increase in subsidized shipping costs
related to increased promotional shipping activity. The increases in these costs were principally caused by higher sales volumes in the first quarter of fiscal 2005.



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



Product development expenses increased $2.0 million in the first quarter of fiscal 2005 compared to the first quarter of
fiscal 2004 primarily due to a $1.5 million increase in staffing and related costs, and a $0.5 million increase in communication, web hosting and equipment maintenance costs. The increases in these costs were necessary to support new partner
launches, deliver enhanced functionality for our partners e-commerce businesses and continue to improve the capacity, stability and security of our e-commerce platform.



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



General and administrative expenses increased $1.3 million from the first quarter of fiscal 2005 primarily due to a $1.0
million increase in payroll and related costs to support the growth of our business, a $0.2 million increase in occupancy costs due to the purchase of our new headquarters and a $0.1 million increase in other general and administrative expenses.



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



Stock-based compensation expense decreased $0.8 million for the first quarter of fiscal 2005 primarily due to a $0.9 million decrease in the amortization
of deferred compensation expense relating to options subject to variable accounting as well as a $0.1 million increase in deferred partner revenue share charges resulting from higher product sales from the partners e-commerce business. As of
the end of first quarter of fiscal 2005, we had an aggregate of $1.4 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 first quarter of fiscal 2004 and $0.5 million for first quarter of fiscal 2005.



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



Depreciation and amortization expenses increased $0.5 million for the first quarter of fiscal 2005 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.



Other (Income) Expense



Other (income) expense consists of expenses related to a minority interest held by a third party in a joint venture with us and losses and gains on the
disposition of assets. Interest expense consists primarily of interest expense paid in connection with a mortgage note that we have on our new corporate headquarters and interest expense on capital leases, and interest income consists primarily of
interest earned on cash, cash equivalents, short-term investments and marketable securities. The following table shows other (income) expense, interest expense and interest income for the first quarter of fiscal 2004 and for the first quarter of
fiscal 2005, the percentages that such amounts bear to net revenues and the period over period changes in each of other (income) expense, interest expense and interest income:



26



---

##### Table of Contents

|                       |  |                       |   |  |                       |    |  |                                                |   |  |      |    |  |          |   |  |         |  
|---------------------- |  | --------------------- | - |  | --------------------- | -- |  | ---------------------------------------------- | - |  | ---- | -- |  | -------- | - |  | ------- | -
|                       |  | First Qtr Fiscal 2004 |   |  | First Qtr Fiscal 2005 |    |  | First Qtr Fiscal 2005 vs First Qtr Fiscal 2004 |  
|                       |  | $                     |   |  | %                     |    |  | $                                              |   |  | %    |    |  | $ Change |   |  | %Change |  
|                       |  | (dollars in millions) |  
|Other (income) expense |  | 0.0                   |   |  | 0.0                   | %  |  | (0.1                                           | ) |  | (0.1 | )% |  | (0.1     | ) |  | N/A     |  
|Interest expense       |  | 0.0                   |   |  | 0.0                   | %  |  | 0.2                                            |   |  | 0.3  | %  |  | 0.2      |   |  | N/A     |  
|Interest income        |  | (0.3                  | ) |  | (0.5                  | )% |  | (0.3                                           | ) |  | (0.3 | )% |  | 0.0      |   |  | 0.0     | %



The $0.1 million
increase in other (income) expense in the first quarter of fiscal 2005 was primarily due to a minority interest held by a third party in a joint venture with us.



The increase in interest expense of $0.2 million for the first quarter of fiscal 2005 was due primarily to the mortgage on
our new corporate headquarters.



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 April 2, 2005, we
had available net operating loss carryforwards of approximately $443.0 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 $245.0 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 April 2, 2005, QVC
beneficially owned approximately 20.3% of our outstanding common stock. M. Jeffrey Branman, one of our directors, was the President of Interactive Technology Services, which served as financial advisor to ITH through its dissolution.



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 $397,759 for the first quarter 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 first quarter of fiscal 2005 was $68.9 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. We incurred fees of $25,442 in three-month period ended April 2, 2005. Of those fees, $12,794 related directly to products shipped and was
charged to cost of revenues from product sales and the remaining $12,648 related to fulfillment services provided and was charged to sales and marketing expense. On February 1, 2005 we provided a 60 day termination notice to QVC, which
terminated this agreement effective April 3, 2005.



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



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



27



---

##### Table of Contents

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



Liquidity and Capital Resources



Our principal source of liquidity is our cash, cash equivalents and
marketable securities. Our cash, cash equivalents, short-term investments and marketable securities balances were $75,423 as of the end of fiscal 2004 and $43,223 as of the end of the first quarter of fiscal 2005.



Since our entry into the e-commerce business in 1999, we have primarily
funded our operations with approximately $176.3 million in cash raised in equity 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.



We have incurred substantial costs to develop our e-commerce platform and to recruit, train and compensate personnel for our
creative, engineering, business development, marketing, merchandising, customer service, management information systems and administrative departments. During the first quarter of fiscal 2005, we spent approximately $2.7 million on continued
upgrades to our technology infrastructure.



We had working
capital of $30.1 million as of the end of fiscal 2004 and $26.7 million as of the end of the first quarter of fiscal 2005, and an accumulated deficit of $176.7 million as of the end fiscal 2004 and $178.3 million as of the end of the first quarter
of fiscal 2005.



We used approximately $25.5 million in net
cash for operating activities during the first quarter of fiscal 2005. Our principal sources of operating cash during the first quarter 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 quarter of fiscal 2005 were cash paid to product suppliers, which generally approximates our cost of revenues from product
sales, employee compensation and partner revenue share payments. Changes in our operating assets and liabilities during the first quarter of fiscal 2005 resulted in a net cash outflow of $26.8 million. The most significant changes were a decrease in
accounts payable, accrued expenses and other, offset, in part, by an increase in accounts receivable compared to the end of fiscal 2004. The decrease in accounts payable, accrued expenses and other was due primarily to a decrease in trade accounts
payable due primarily to lower inventory levels at the end of the first 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 quarter of fiscal 2005 consisted primarily of the purchase of $9.2 million and sale of $32.0 million of marketable securities. During the first quarter of fiscal 2005, we also incurred capital expenditures of $6.8 million. Our
financing activities during the first quarter of fiscal 2005 consisted of the receipt of $1.2 million in gross proceeds from exercises of common stock options.



We used approximately $16.2 million in net cash for operating activities during the first quarter of fiscal 2004. Our principal sources of operating
cash during the first quarter 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 quarter of fiscal 2004 were cash paid to product suppliers, which generally approximates our cost of revenues from product sales, employee compensation and partner revenue share payments. Changes in our operating assets and
liabilities during the first quarter of fiscal 2004 resulted in a net cash outflow of $15.2 million. The most significant changes were a decrease in accounts payable, accrued expenses and other and an increase in accounts receivable compared to the
end of fiscal 2003. The decrease in accounts payable, accrued expenses and other was due primarily to a decrease in trade accounts payable due primarily to lower inventory levels at the end of the first quarter of fiscal 2004 and a decrease in
amounts owed to partners, which were related to increased sales volume in the fourth quarter of fiscal 2003. The increase in accounts receivable was due primarily to decreases in our accounts receivable reserves. Our investing activities during the
first quarter of fiscal 2004 consisted primarily of the purchase of $8.7 million and sale of $8.5 million of marketable securities. During the first quarter of fiscal 2004, we also incurred capital expenditures of $2.4 million. Our financing
activities during the first quarter of fiscal 2004 consisted of the receipt of $903,000 in gross proceeds from exercises of common stock options.



28



---

##### Table of Contents



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 business in a relatively new and unproven market or a new
business in an existing market, many of which may be beyond our control. If we are unable to address these issues, we may not be financially or operationally successful.



We have an accumulated deficit and may incur additional losses.



We have incurred losses over the prior six fiscal years while operating our
business. As of the end of the first quarter of fiscal 2005, we had an accumulated deficit of $178.3 million. We may not obtain an appropriate volume of purchases through our e-commerce platform, generate an appropriate amount of service fee revenue
from our existing partners, add an appropriate amount of new partners to generate sufficient revenues or adequately control our expenses in order to achieve profitability. While we expect to be profitable in fiscal 2005, there can be no assurances
that we will be able to achieve profitability.



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



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



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



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



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



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



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



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



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



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



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



Because we have not generated sufficient cash from
operations to date, we have funded our e-commerce business primarily from the sale of equity securities. If our cash flows are insufficient to fund our operations, we may in the future need to seek additional equity or debt financings or reduce
costs. Further, we may not be able to obtain financing on satisfactory terms or



29



---

##### Table of Contents

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 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
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, beauty, consumer electronics, entertainment and home. 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 and our partners
must accurately predict consumers tastes and avoid overstocking or understocking products. If we and our partners fail to identify and respond to changes in merchandising and consumer preferences, sales on our partners e-commerce
businesses could suffer and we and 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.



30



---

##### Table of Contents

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 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 respected 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 first quarter of fiscal 2005, we purchased 48.7% of the total amount of inventory we purchased from one manufacturer. In addition, during the first quarter of fiscal 2004, we purchased 36.9% of the
total amount of inventory we purchased from the same manufacturer. While we have a contract with this manufacturer, this manufacturer and other manufacturers could stop selling products to us or our partners to remove their products or logos from
our partners Web sites. If we or our partners are unable to obtain products directly from manufacturers, especially popular brand manufacturers, we or our partners may not be able to obtain the same or comparable merchandise in a timely manner
or on acceptable commercial terms.



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



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



31



---

##### Table of Contents

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 our 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 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 or 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 or 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.
| | - |  | ---------------------



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



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



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



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



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



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



32



---

##### Table of Contents

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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



Our success depends to a significant degree
upon the protection of our intellectual property rights in the core technology and other components of our e-commerce platform including our software and other proprietary information, and material, and our ability to develop technologies that are
as good as or better than 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



33



---

##### Table of Contents

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 or better than as our competitors
could put us at a disadvantage to our competitors. These failures could have a material adverse effect on our business.



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



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



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



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



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



We currently do not offer e-commerce services outside of the United States and Canada. 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 a 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 our 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



34



---

##### Table of Contents

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



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



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



We are subject to the same
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



35



---

##### Table of Contents

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



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



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



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



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



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



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



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



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



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



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



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



36



---

##### Table of Contents

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 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 of 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 also sell
products, may result in decreased revenue or growth. Terrorist attacks and armed hostilities create economic and consumer uncertainty that could adversely affect our revenue or growth.



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



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



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



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



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



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



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



Beginning in early 2004, we began a process to document
and evaluate our internal controls over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal controls over financial
reporting and a report by our independent registered public accounting firm addressing these assessments. In this regards, management has been dedicating internal resources, has engaged outside consultants and had adopted a detailed work plan to
(i) assess and document the adequacy of internal controls over financial reporting, (ii) take steps to improve control processes, where appropriate, (iii) validate through testing that controls are



37



---

##### Table of Contents

functioning as documented and (iv) implement a continuous reporting and improvement process for internal control over financial reporting. If we fail to
correct any issues in the design or operating effectiveness of internal controls over financial reporting or fail to prevent fraud, current and potential stockholders and partners could lose confidence in our financial reporting, which could harm
our business, the trading price of our common stock and our ability to retain our current partners and obtain new partners.



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



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



Risk Related
to Our Common Stock



Our operating results have 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 consumers at a reasonable cost or encourage repeat purchases;
| | - |  | ---------------------------------------------------------------------------------------------------------



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



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



| |  |  | our ability to adequately maintain, 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 promotions we offer;
| | - |  | ----------------------------------------------------------------------------



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



38



---

##### Table of Contents

| |  |  | 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 or 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 May 2, 2005, Michael G. Rubin, our chairman and chief executive officer, beneficially owned 19.5%, entities affiliated with SOFTBANK Capital Partners LP, SOFTBANK Capital LP and SOFTBANK Capital Advisor
Fund LP, or SOFTBANK, beneficially owned 20.7%, and entities affiliated with QVC beneficially owned 20.2% of our outstanding common stock, including warrants and options to purchase common stock, which are exercisable on or before July 1, 2005.
If they decide to act together, any two of Mr. Rubin, SOFTBANK, and QVC would be in a position to exercise considerable control, and all three would be in a position to exercise complete control, over most matters requiring stockholder
approval, including the election or removal of directors, approval of significant corporate transactions and the ability generally to direct our affairs. Furthermore, pursuant to the stock purchase agreements, SOFTBANK and QVC each have the right to
designate up to two members of our board of directors. This concentration of ownership and SOFTBANKs and QVCs right to designate members to our board of directors may have the effect of delaying or preventing a change in control of us,
including transactions in which stockholders might otherwise receive a premium over prevailing market prices for our common stock. See Management  Right to Designate Directors. Furthermore, Mr. Rubin has entered into voting
agreements with each of SOFTBANK and QVC, and SOFTBANK and QVC have entered into voting agreements with each other. The parties to these voting agreements have agreed to support the election of the directors designated by each of the other parties.
See Management  Voting Agreements.



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



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



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



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.



39



---

##### Table of Contents

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.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------



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



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



Changes in internal control over financial reporting. We monitor and evaluate on an ongoing basis our internal control over financial reporting in
order to improve its overall effectiveness. In the course of these evaluations, we modify and refine our internal processes and controls as conditions warrant. As required by Rule 13a-15(d), our management, including our chief executive officer and
our chief financial officer, also conducted a re-evaluation of our internal control over financial reporting to determine whether any changes occurred during the fiscal quarter ended April 2, 2005 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting. Based on that re-evaluation, there has been no such change during the quarter ended April 1, 2005.



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



Accounts Payable



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



40



---

##### Table of Contents

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



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



Preparation of Cash Flows



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



41



---

##### Table of Contents



PART IIOTHER INFORMATION



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



|         |  |                                                                                                                                                                                                                                  
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibits |  |                                                                                                                                                                                                                                  
|         | 
|3.1      |  | Amended and Restated Bylaws (filed with GSI Commerce, Inc.s Current Report on Form 8-K on March 11, 2005 and incorporated herein by reference)                                                                                  
|         | 
|10.1     |  | Form of Option Agreement Issued to Executive Officers Under the GSI Commerce, Inc. 1996 Equity Incentive Plan (filed with GSI Commerce, Inc.s Current Report on Form 8-K on March 11,
2005 and incorporated herein by reference)
|         | 
|10.2     |  | Form of Option Agreement Issued to Directors Under the GSI Commerce, Inc. 1996 Equity Incentive Plan (filed with GSI Commerce, Inc.s Current Report on Form 8-K on March 11, 2005 and
incorporated herein by reference)         
|         | 
|10.3     |  | Form of Restricted Stock Award Under the GSI Commerce, Inc. 1996 Equity Incentive Plan (filed with GSI Commerce, Inc.s Current Report on Form 8-K on March 11, 2005 and incorporated
herein by reference)                       
|         | 
|10.4     |  | Form of Deferred Stock Award Under the GSI Commerce, Inc. 1996 Equity Incentive Plan (filed with GSI Commerce, Inc.s Current Report on Form 8-K on March 11, 2005 and incorporated herein
by reference)                         
|         | 
|10.5     |  | Offer Letter, dated January 31, 2005, between GSI Commerce, Inc. and Stephen J. Gold (filed with GSI Commerce, Inc.s Current Report on Form 8-K on February 2, 2005 and incorporated
herein by reference)                       
|         | 
|10.6     |  | Letter Agreement, January 10, 2005, between GSI Commerce, Inc. and Joseph N. Seibert (filed with GSI Commerce, Inc.s Current Report on Form 8-K on January 31, 2005 and incorporated
herein by reference)                       
|         | 
|31.1     |  | Certification of Chief Executive Officer pursuant to Rule 13a - 14(a) under the Securities Exchange Act of 1934                                                                                                                  
|         | 
|31.2     |  | Certification of Chief Financial Officer pursuant to Rule 13a - 14(a) under the Securities Exchange Act of 1934                                                                                                                  
|         | 
|32.1     |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                    



42



---

##### 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: December 5, 2005



43