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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended January 3, 2004 or

For the transition period from                   to                  .

Commission file number 0-16611

GSI COMMERCE, INC.

(Exact name of registrant as specified in its charter)

1075 FIRST AVENUE, KING OF PRUSSIA, PA 19406, (610) 265-3229

(Address of principal executive offices, including zip code, telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share

(Title of Class)

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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

The aggregate market value of the registrant’s voting stock held by non-affiliates of the registrant as of the close of business on July 3, 2003, was approximately $85,457,281.⁽¹⁾ There were 40,878,560 shares of the registrant’s Common Stock outstanding as of the close of business on March 3, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

(Specific sections incorporated are identified under applicable items herein)

Certain information required for Part III of this Form 10-K is incorporated herein by reference to the Proxy Statement for the 2004 Annual Meeting of our shareholders.

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GSI COMMERCE, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED JANUARY 3, 2004

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For all years prior to 1999, our fiscal year ended on December 31. Effective for 1999, we changed our fiscal year from the last day of December to 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 years ended January 1, 2000, December 30, 2000, December 29, 2001, December 28, 2002, January 3, 2004 and the 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.

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PART I

Overview

We provide an e-commerce platform that enables retailers, branded manufacturers, entertainment companies and professional sports organizations to operate e-commerce businesses. Our e-commerce platform includes Web site design, e-commerce technology, managed hosting, order fulfillment, customer service, merchandising and order management, online merchandising, customer relationship management, content development and online marketing. We currently operate or have agreements to operate either all or a portion of the e-commerce businesses for over 40 partners.

As used in this Annual Report on Form 10-K, “GSI,” “we,” “our” and similar terms include GSI Commerce, Inc. and its subsidiaries, unless the context indicates otherwise.

Industry Background

E-Commerce.    The U.S. market for general merchandise online retail sales represents an increasingly growing opportunity. Forrester Research estimates that such online sales are expected to be $64.9 billion in 2004 and $130.3 billion in 2008 and are expected to represent 13% of total general merchandise retail sales by 2008. We believe that the growing adoption of e-commerce for consumer purchases is being driven by a number of factors including:

As a result, we believe that consumer demand for making purchases online will continue to increase over time. Accordingly, we believe that significant opportunities exist to use the brand and marketing power of our partners to attract consumers to the e-commerce businesses on our platform.

Challenges of E-Commerce.    We believe that traditional retailers, branded manufacturers, entertainment companies and professional sports organizations which desire to operate e-commerce businesses face challenges to compete successfully in e-commerce in a cost-effective manner. It is expensive for these companies to operate a single e-commerce business in-house as there are significant upfront and ongoing expenses to develop or acquire e-commerce capabilities. In-house e-commerce businesses often exhibit a lack of scale and in many cases e-commerce represents a small percentage of these companies’ businesses as a whole. Additionally, these companies generally lack the expertise in e-commerce operations as it is not their core competency.

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Our Solution

Scalable and Cost Effective Solution.    We believe that our business model allows us to provide a cost effective and flexible solution to many of the challenges facing retailers, branded manufacturers, entertainment companies and professional sports organizations that desire to maximize their e-commerce businesses. Our e-commerce platform enables our partners to remain focused on their core businesses, drive incremental e-commerce revenue and build and operate their e-commerce businesses for less than they would be able to on their own. We also believe that we can generate attractive economic returns by operating multiple e-commerce businesses on our e-commerce platform under the established brands of our partners.

Comprehensive E-Commerce Solution.    We can develop and implement all aspects of an e-commerce business on our platform including:

Modular and Flexible E-Commerce Solution.    We have created a core technology infrastructure that we call The Common Engine^™ that operates and manages the applications and functionality across our e-commerce platform. This system allows us to efficiently add new partners on a common infrastructure while allowing each store to be personalized to fit the brand equity and identity of our individual partners. Some of our partners choose to have us operate all aspects of their e-commerce business while others select only some of the services we offer. For example, some of our partners choose us to provide e-commerce technology, managed hosting and order processing but fulfill e-commerce orders from their own fulfillment centers and provide their own customer service.

Partner-Centric E-Commerce Solution.    We customize the design and operation of partners’ e-commerce businesses with a broad range of characteristics that include differentiated user interfaces on partners’ Web sites, partner-specific content pages and partner specific customer service and fulfillment. In addition, we can custom develop features and functionality requested by our partners, as illustrated by the following capabilities that we have developed for some of our partners:

E-Commerce Expertise.    We believe we have achieved a “critical mass” of e-commerce expertise. Furthermore, we believe that our degree of expertise is accelerating fast and positions us favorably relative to in-house solutions and our competitors. We believe that three primary factors are contributing to this trend. First, as our partner base grows across many categories, we benefit from a heightened level of collaboration and constructive feedback, which allows for improvements and capability enhancements. Second, as our employee base grows, we are gaining deeper knowledge across a broader set of direct-to-consumer sales competencies. Lastly, we continue to emphasize a cross-functional entrepreneurial approach and view ourselves as a hybrid service provider and extension of our partners’ businesses, combining a technology, consulting and retailer-based mindset.

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Growth Strategy

The key elements of our growth strategy are as follows:

Expand Our Partner Base.     We intend to increase our revenue and market share by adding new partners that have strong brand franchises within the categories in which we currently operate and that desire to establish, grow or transition their e-commerce businesses. New partners could include companies with major brand names in retail, footwear and apparel, home, consumer electronics, beauty products, entertainment and professional sports.

Grow Our Existing Partners’ Businesses.    We also intend to increase our revenue and market share by working with our current partners to identify new initiatives to grow their e-commerce businesses and enhance their offerings. New initiatives could include online and email marketing campaigns, shipping products to customers outside of the United States, adding additional brands for existing partners and providing more customized technology development to meet the changing needs of our partners and grow our partners’ businesses.

Continue to Reinvest and Enhance Our Capabilities.    We enhance our capabilities continuously to improve our partners’ e-commerce businesses and enrich the overall customer experience. In addition, we plan to continue to invest in technology and infrastructure to improve the features and functionality, speed, navigation, search and usability of our partners’ e-commerce businesses and the customer service, fulfillment and other services we offer as part of our e-commerce platform.

Our E-Commerce Platform

Web Site Design.    We collaborate with our partners to create an online shopping experience that reinforces their brand, maximizes conversion and encourages repeat buying. We provide our partners with a number of capabilities — significant experience and an understanding of on-line customers, an online brand that marries customer expectations to their corporate vision and a user experience that realizes that vision on our e-commerce platform. Our cross-functional team is comprised of art directors, graphic designers, information architects, technical writers, usability engineers, technical designers, project managers, quality assurance specialists and HTML and JSP developers. These professionals develop user interfaces including the overall imagery and tone, home page presentation, page flow and navigation, the structure of the category and product pages, effective messaging and consistent communication, an intuitive purchasing process and a full archive of online customer service information.

E-Commerce Technology.    We use a combination of proprietary and third-party applications that form the basis of The Common Engine^™. Our core shopping features, functionality, search, data gathering and checkout processes reside on The Common Engine^™. These applications are upgraded periodically by our engineering and information services teams in the form of new releases designed to encourage and promote product research, increase purchases and convey a positive and intuitive user-friendly shopping experience.

Managed Hosting.    Partner sites are hosted in two separately located third-party data centers. This configuration enhances Web site uptime performance and fail-over reliability We own substantially all of the hardware and software used by us at these data centers and actively manage and monitor the operations and infrastructure including communications, bandwidth, network, systems administration, load balancing, production support, security and data and storage requirements.

Merchandising and Order Management.    We manage all traditional retail-based applications through a centralized ERP and supply chain system in connection with merchandise assortment classification and maintenance. These applications also govern the primary information sources and data flow with respect to style and SKU merchandising management and pricing and inventory management. Order processing is also managed through the ERP application and interacts with proprietary and third-party payment processing, warehouse management, customer service and data warehousing systems. We accept multiple forms of tender including credit cards, checks and gift certificates/cards and maintain an internal team focused on order review and fraud prevention, claims processing and sales recovery functions.

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Online Merchandising.    The display of our partners’ online product catalogs is administered by use of a proprietary content and catalog management tool. The tool allows for, among other things, the ability to:

Order Fulfillment.    We offer a full range of order fulfillment services from our 470,000 square foot Company-owned fulfillment center located in Louisville, Kentucky and through integration with over 300 third-party “drop shippers” using a proprietary application. Fulfillment activities include inbound receipt and profiling of merchandise, storage, picking, packing and shipping and returns processing. We also offer a variety of value-added fulfillment services including customized package branding, gift wrapping, gift messaging, product bundling, promotional inserts, bulk orders and product customization. We maintain relationships with major carriers and seek to achieve cost efficiencies through rate shopping opportunities. We offer multiple forms of shipping methods to customers including standard and expedited options, with pricing based on order value, dimensional characteristics or shipping promotions.

Customer Contact Center.    We operate an 82,000 square foot leased facility in Melbourne, Florida. This facility is operated 24 hours per day, seven days per week and has 500 agent workstations. Our primary activities include inbound contact management via phone and email. Our contact center workstations contain a variety of applications and informational tools that provide agents with access to customer profile information including service history, previous purchases and personal preferences. Service agents also have visibility into product information, inventory availability and order status. The agent tools are integrated with our order management and fulfillment operations to provide a consistent experience across all customer touch points including our partners’ web sites, direct mail circulars, catalogs, promotional events and direct response television campaigns. In addition to partner level training, we utilize a variety of contact center practices and systems to improve quality and efficiency including skills-based call routing, interactive voice response, call monitoring, work flow planning, data tracking and forecasting.

Reporting, Analytics and Business Intelligence.    We offer our partners access to a secure, Web-based reporting portal which provides customer, demand, fulfillment and behavioral information. These applications and tools provide partners with insightful business intelligence metrics and visibility into their e-commerce business. We also offer customized reporting tailored to a partner’s specific needs.

Customer Relationship Management.    We use a suite of CRM applications. Within our contact center, call agents have access to all relevant customer account, product, promotional and inventory information as well as the ability to present personalized selling recommendations in an effort to convert customer interactions into sales opportunities. Our e-mail marketing teams develop customized and targeted email campaigns based upon demographic, purchase and preference data gathered and segmented within our data warehouse. We also offer personalized shopping experiences through the use of real-time analytics to present product recommendations and associations based upon behavioral profiles and product affinity models.

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Content Development.    We operate and make available to partners an in-house professional photography studio to create digital product images and color swatches, as well as a copywriting staff focused on developing product descriptions and related value-added content such as buyers guides, sizing charts, products tours and comparison shopping tools.

Online Marketing Services.    We generally make available to partners the services of our in-house online marketing team. This team is dedicated to developing and managing programs for partners to increase online exposure, generate incremental revenue and drive new customer acquisition. The services of this team include the conceptualization, creation and management of advertising through highly trafficked portal relationships, affiliate programs and search engine and comparison-shopping related sites.

Our Partners

We operate e-commerce businesses for our partners pursuant to contractual agreements. We generally operate each of these e-commerce businesses based on one of three models, or a combination of those models — GSI-owned inventory model, partner-owned inventory model or business-to-business model.

GSI-Owned Inventory Model — We select and purchase inventory from vendors, sell the inventory directly to customers through our e-commerce platform, record revenues generated from the sale of products through our e-commerce platform and generally pay a percentage of those revenues to the respective partners in exchange for the rights to use their brand names and logos and the promotions and advertising that our partners agree to provide. In addition, for our sporting goods partners, we centralize inventory management across multiple partner businesses increasing both the assortment of inventory and the frequency of inventory turns, thus reducing obsolescence risk and financing costs. We have a buying and merchandising organization that buys and sources products in the following merchandise categories: sporting goods, consumer electronics, general merchandise and branded and unique licensed entertainment products. For products from our inventory, we establish the prices for products that we offer through our e-commerce platform. For our retail partners, to the extent possible, we strategically price these products to be consistent with the prices in our partners’ retail stores or other selling venues. Accordingly, we may maintain different pricing for the same products across our e-commerce platform and between our e-commerce platform and our partners’ retail stores and other selling venues.

We believe that we have strong relationships with our vendors and sources of unique products, and we continuously seek to add new vendors, brands and sources of unique products. During fiscal 2003, we purchased $50.4 million of inventory from one vendor, which accounted for 37% of the total amount of inventory we purchased.

Partner-Owned Inventory Model — We manage certain aspects of our partners’ overall e-commerce businesses in exchange for a combination of fixed and/or variable service fees, usually calculated as a percentage of sales. Our partners select the merchandise to be sold, buy and own all or a portion of the inventory and provide offline marketing support. The partner is the seller of the merchandise and establishes the prices.

Business-to-Business Model — We generally provide a product information database to these partners which they use to merchandise certain departments of their e-commerce businesses. These partners process orders on their Web sites and deliver the orders to us electronically. We then sell the products from our inventory or through our network of drop shippers and transfer title to the partners at a predetermined price. The orders are then sent to consumers on behalf of these partners. These partners generally perform all of their own customer service.

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The following table lists as of January 3, 2004 partners for which we operated all or a portion of their e-commerce businesses or with which we have publicly-announced agreements:

Competition

The market for outsourced solutions for the development and operation of e-commerce businesses is continuously evolving and intensely competitive. We primarily compete with companies who can offer a full range of e-commerce services similar to the services we provide through our e-commerce platform, such as Amazon.com, Digital River, Foot Locker (principally in the sporting goods category) and ValueVision. We also compete with companies that can provide some of the components 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. We also compete with companies that may choose to develop and operate their e-commerce businesses in-house and the online and offline businesses of a variety of retailers and manufacturers.

We believe that we compete with these competitors primarily on the basis of the following:

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Intellectual Property

We use our partners’ names, URLs, logos and other marks in connection with the operation and promotion of their e-commerce businesses. Our agreements with our partners generally provide us with licenses to use this intellectual property in connection with the operation of their e-commerce businesses. These licenses typically are coterminous with the agreements.

We also rely on technologies that we license from third parties. These licenses may not continue to be available to us on commercially reasonable terms in the future. As a result, we may be required to obtain substitute technology of lower quality or at greater cost, which could materially adversely affect our business, results of operations and financial condition.

In order to protect our proprietary rights in services and technology, we rely on various intellectual property laws and contractual restrictions. These include confidentiality, invention assignment and nondisclosure agreements with our partners, employees, contractors and suppliers. Despite these precautions, it may be possible for a third-party to copy or otherwise obtain and use our intellectual property without our authorization.

Government Regulation

We generally are not regulated other than pursuant to federal, state and local laws applicable to businesses in general or to e-commerce specifically. Certain regulatory authorities have proposed specific laws and regulations governing the Internet and online retailing. These laws and regulations may cover taxation, user privacy, pricing, content, distribution, electronic contracts, characteristics and quality of products and services, intellectual property rights and information security. Changes in consumer protection laws also may impose additional burdens on companies conducting business online. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet and e-commerce. Unfavorable resolution of these issues may increase our cost of doing business.

We currently provide individual personal information regarding users of a partner’s e-commerce business to that partner and to certain third parties that we use to process credit cards, process and fulfill orders, send emails and evaluate and maintain the performance of our Web sites. We currently do not identify registered users by age. However, the adoption of the CAN-SPAM Act of 2003 or other privacy or consumer protection laws could create uncertainty in Web usage and reduce the demand for our products and services or require us to redesign our partners’ Web sites or the operation of their e-commerce businesses.

We are not certain how our business may be affected by the application of existing laws governing issues such as property ownership, copyrights, encryption and other intellectual property issues, taxation, libel, obscenity, qualification to do business and export or import matters. Many of these laws were adopted prior to the advent of the Internet. As a result, they do not contemplate or address the unique issues of the Internet and related technologies. Changes in laws intended to address these issues could create uncertainty in e-commerce. This uncertainty could reduce demand for our services or increase the cost of doing business as a result of litigation costs or increased service delivery costs.

In addition, because our services are available through the Internet and toll-free telephone numbers in multiple states, other jurisdictions may claim that we are required to qualify to do business in those jurisdictions. Our failure to qualify in a jurisdiction where we are required to do so could subject us to taxes and penalties. It could also hamper our ability to enforce contracts in these jurisdictions. The application of laws or regulations from jurisdictions whose laws do not currently apply to our business could have a material adverse effect on our business, results of operations and financial condition.

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Employees

As of February 27, 2004, we employed 1,074 full-time employees, the majority of which are based at our headquarters in King of Prussia, PA, our fulfillment center in Louisville, KY and our customer contact center in Melbourne, FL. We consider our relationship with our employees to be good. Competition for qualified personnel in our industry is intense. We believe that our future success will depend in part on our continued ability to attract, hire and retain qualified personnel.

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, the 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. For additional information, see Note 20 to our consolidated financial statements included in this Annual Report on Form 10-K.

Investor Information

We are subject to the informational requirements of the Securities Exchange Act of 1934. Therefore, we file reports and information, proxy statements and other information with the Securities and Exchange Commission. Such reports, proxy and information statements and other information may be obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street, NW, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically.

You can access financial and other information at our Investor Relations Web site. The address is www.gsicommerce.com/investors. We make available through our Web site, free of charge, copies of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after filing such material electronically or otherwise furnishing it to the SEC. In addition, we will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC. Requests should be directed to Investor Relations, 1075 First Avenue, King of Prussia, Pennsylvania 19406. The information on the Web site listed above is not and should not be considered part of this Annual Report on Form 10-K and is not incorporated by reference in this document. This Web site is and is only intended to be an inactive textual reference.

We are a Delaware corporation organized in 1986. Our executive offices are located at 1075 First Avenue, King of Prussia, Pennsylvania 19406. Our telephone number is (610) 265-3229.

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 Annual Report on Form 10-K. 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.

All statements made in this Annual Report on Form 10-K, 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

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are based on the then-current expectations, beliefs, assumptions, estimates and forecasts about our business and the industry 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, 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, 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 provided below. We expressly disclaim any intent or obligation to update these forward-looking statements, except as otherwise specifically stated by us.

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 incurred substantial losses over the past five fiscal years while operating our business. As of the end of fiscal 2003, we had an accumulated deficit of $177.6 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 2004, 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:

Because we will incur many of these expenses before we receive any revenues from our efforts, our losses will be greater than the losses we would incur or our profits will be less than we would generate if we developed our business more slowly. In addition, we may find that these efforts are more expensive or less productive than we currently anticipate, which could further increase our losses. Also, the timing of these expenses may contribute to fluctuations in our quarterly operating results.

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We have recently expanded our operations into new categories. If we do not successfully expand our operations into these new categories, our growth could be limited.

Until fiscal 2001, our business was limited to sporting goods. Today, our operations have expanded into other categories, including consumer electronics, home products, apparel and footwear, beauty products and licensed entertainment merchandise. In order to successfully expand our business into these and other categories, we must develop and maintain relationships with manufacturers and other suppliers in those categories and hire and retain skilled personnel to help manage these areas of our business. Our failure to successfully expand our business into these and other categories could limit our ability to increase revenues and attract new partners.

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

Our future success is substantially dependent upon the success of the partners for which we operate e-commerce businesses. If our partners were to have financial difficulties or seek protection from their creditors or if they were to suffer impairment of their brand, or if we are unable to replace our partners or obtain new partners, it could adversely affect our ability to grow our business. The growth of 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 investment or number of retail stores.

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 us, 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.

We have an e-commerce agreement with Bluelight.com, a subsidiary of Kmart, pursuant to which we operate the Kmart.com Web site. Even though Kmart and Bluelight emerged from bankruptcy in 2003, we may not realize all of the economic benefits of that agreement.

Kmart, as well as Bluelight.com, operated in bankruptcy from January 2002 until May 2003. In connection with its bankruptcy restructuring plan, Bluelight assumed its e-commerce agreement with us. In March 2003, we and Bluelight modified our agreement to shorten the term, eliminate the last two of eight fixed fee payments required under the agreement and provide for early termination rights for both us and Bluelight. We will, however, continue to receive a percentage of sales through the Bluelight Web site for the services that we provide under this agreement. Bluelight.com may terminate its agreement with us early. If Bluelight.com terminates its agreement with us, we will not realize all of the economic benefits of that agreement.

We enter into contracts with our partners. Some of these partners’ online retail stores account for a significant portion of our revenue. If we do not maintain good working relationships with our partners or perform as required under these agreements, it could adversely affect our business. Additionally, if our partners terminate their contracts with us due to our failure to cure contractual breaches, it could negatively 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 2003, sales to customers through one of our partner’s e-commerce businesses accounted for 28% of our revenue, sales 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. For fiscal 2002, sales to customers through one of our partner’s e-commerce businesses accounted for 20% of our revenue, sales to customers through another one of our partner’s e-commerce businesses accounted for 12% of our revenue, sales to Kmart as well as related service

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fees accounted for 14% of our revenue, and sales through our top four partners’ e-commerce businesses and sales to Kmart accounted for 56.4% of our revenue. If we do not maintain good working relationships with our partners, our partners could decide not to renew their agreements at the end of the term. Additionally, if we do not perform as required under these agreements, our partners could seek to terminate their agreements prior to the end of the term. This could adversely affect our business, financial condition and results of operations. Moreover, our partners could decide not to renew these contracts for reasons not related to our performance.

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, quarter-to-quarter comparisons of our operating results may not be a good indication of our future performance. In some future quarter, our operating results may also fall below our 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:

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

We have experienced and expect to continue to experience seasonal fluctuations in our revenues. These seasonal patterns have caused and will 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. In anticipation of increased sales activity during our fourth fiscal quarter, we typically hire a significant number of temporary employees to supplement our permanent staff and significantly increase our inventory levels. For this reason, 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. If our revenues exceed seasonal expectations during the fourth quarter, it could put significant strain on our fulfillment and customer service operations.

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, product distribution and shipment activities and may cause a shortfall in revenues as compared to expenses in a given period.

We have been unable to fund our e-commerce operations with the cash generated from our business. If we do not generate cash sufficient to fund our operations, we may in the future need additional financing to continue our growth or our growth may be limited.

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. Cash from revenues must increase significantly for us to fund anticipated operating expenses internally. If our cash flows are insufficient to fund these expenses, we may in the future need to fund our growth through additional equity or debt financings or reduce costs. Further, we may not be able to obtain financing on satisfactory terms. 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.

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 categories in which we own inventory, we primarily purchase products from the manufacturers and distributors of the products. For the categories in which we provide e-commerce services to our partners, our partners purchase products from the manufacturers and distributors of products. If we or our partners are unable to develop and maintain relationships with these manufacturers, 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 business could be adversely impacted. We do not have written contracts with many manufacturers or distributors. During the fiscal 2003, we purchased 37% of the total amount of inventory we purchased from one manufacturer. In addition, during fiscal 2002, we purchased 20% of the total amount of inventory we purchased from one manufacturer and during fiscal 2001, we purchased 23% and 16% of the total amount of inventory we purchased from two manufacturers. Manufacturers could stop selling products to our partners or us and may ask us or our partners to remove their products or logos from our partners’ Web sites. If our partners or we are unable

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to obtain products directly from manufacturers, especially popular brand manufacturers, we may not be able to obtain the same or comparable merchandise in a timely manner or on acceptable commercial terms.

We may not be successful in finding, developing and marketing products that consumers of the direct response television campaigns we operate will want to purchase.

For the direct response television campaigns we operate or for which we provide services, our success depends on our ability to find, develop and market products that consumers will want to purchase. We promote these products on our partners’ Web sites as well as through direct response television programming. If we do not select products that consumers want to purchase, this could result in lost opportunities which could reduce sales.

We may be unable to source product for direct response television campaigns on favorable terms. Additionally, we may not be successful in selling the products we source at a profit or at all.

For direct response television campaigns, our financial performance depends on our ability to develop products or acquire the rights to products that will be appealing to consumers. We select products based on management’s retail experience. We may not be successful in finding and sourcing products that consumers will want to purchase. Any failure to meet consumers’ desires could result in lost opportunities and excess inventory which could reduce our revenues. Additionally, we may select products that are not profitable which could result in lower margins.

Capacity constraints or system failures could materially and adversely affect our business, results of operations and financial condition.

Any system failure, including network, telecommunications, software or hardware failure, that causes interruption of the availability of our partners’ e-commerce businesses could result in decreased usage and sales. If these failures are sustained or repeated, they could reduce the attractiveness of our partners’ e-commerce businesses to customers, vendors and advertisers. Our operations are subject to damage or interruption from:

The inherent unpredictability of these events makes it difficult to predict whether the occurrence of any of these events is likely. If any of these events does occur, it could result in interruptions, delays or cessations in service to customers of our partners’ e-commerce businesses.

In addition, we maintain the computers on which we operate our partners’ e-commerce businesses at two facilities of a third-party hosting company. We cannot control the security, maintenance or operation of these facilities, which is also susceptible to similar disasters and problems. Our insurance policies may not adequately compensate us for any losses that we may incur. Any system failure that causes an interruption in our service or a decrease in responsiveness could harm our relationships with our customers, partners and vendors and result in reduced revenues.

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We may be unable to protect our proprietary technology or keep up with that of our competitors.

Our success depends to a significant degree upon the protection of our software and other proprietary intellectual property rights. We may be unable to deter misappropriation of our proprietary information, detect unauthorized use or take appropriate steps to enforce our intellectual property rights. In addition, our competitors could, without violating our proprietary rights, develop technologies that are as good as or better than our technology.

Our failure to protect our software and other proprietary intellectual property rights or to develop technologies that are as good as our competitors’ could put us at a disadvantage to our competitors. In addition, the failure of our partners to protect their intellectual property rights, including their trademarks and domain names, could impair our operations. These failures could have a material adverse effect on our ability to generate revenues.

If we do not respond to rapid technological changes, our services could become obsolete and we could lose customers.

Due to the costs and management time required to introduce new services, products and enhancements, we may be unable to respond to rapid technological changes in a timely enough manner to avoid our services becoming uncompetitive. If this happens, our customers may forgo the use of our services or our partners’ e-commerce businesses and use those of our competitors. To remain competitive, we must continue to enhance and improve the functionality and features of our partners’ e-commerce businesses. The Internet and e-commerce are constantly changing. If competitors introduce new products and 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.

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

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 their intellectual property rights. From time to time, we may receive notices from third parties questioning our right to offer certain services or products or to present specific images or logos on our partners’ e-commerce businesses, or stating that 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 licensing 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.

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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 that link 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 enter into satisfactory 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 could provide advertising services for other marketers of goods. As a result, these parties may be reluctant to enter into or maintain relationships with us. Failure to achieve sufficient traffic or generate sufficient revenue from purchases originating from third parties may result in termination of these types of agreements. Without these relationships, we may not be able to sufficiently increase our market share and revenue.

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, President and Chief Executive Officer. We have employment agreements with most of our executive officers and key personnel. Due to the costs associated with compensating executive officers and key personnel and 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 the skilled personnel necessary to develop our business.

We intend to continue 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, assimilate 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.

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

E-commerce and the provision of e-commerce services are constantly evolving and are extremely competitive. Increased competition could result in fewer successful outsourced opportunities, price reductions, reduced gross margins and loss of market share, any of which could seriously harm our business, financial condition and results of operations. We primarily compete with companies who can offer a full range of e-commerce services similar to the services we provide through our e-commerce platform, such as Amazon.com, Digital River, Foot Locker (principally in the sporting goods category) and ValueVision. We also compete with companies that can provide some of the components 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. We also compete with companies that may choose to develop and operate their e-commerce businesses in-house and the online and offline businesses of a variety of retailers and manufacturers.

We also compete with companies that may choose to develop and operate their e-commerce business in house and the online and offline businesses of a variety of retailers and manufacturers.

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If we experience problems in our fulfillment, warehouse and distribution operations, we could lose customers.

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 customers. As a result, we are subject to the risks associated with the ability of these vendors to successfully and timely fulfill and ship customer orders and to successfully handle our inventory delivery services to meet our shipping needs. The failure of these vendors to provide these services, or the termination or interruption of these services, could adversely affect the satisfaction of our customers, which could result in reduced sales.

Consumers are constantly changing their buying preferences. If we fail to anticipate these changes, 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, our partners and we must accurately predict consumers’ tastes and avoid overstocking or understocking products. If we fail to identify and respond to changes in merchandising and consumer preferences, our sales could suffer and we could be required to mark down unsold inventory. If our partners fail to identify and respond to changes in merchandising and customer preferences, our sales could suffer. 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 could adversely affect our business, financial condition and results of operations.

Our policy for allowing our customers to return products is generally consistent with the policies of each of our partners for which we operate e-commerce businesses. If merchandise returns are significant, our revenues and expenses related to our fulfillment center could be adversely affected.

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 of the product. Our insurance coverage may not be adequate to cover every claim that could be asserted. Similarly, we could be subject to claims that customers of our partners’ e-commerce businesses were harmed due to their reliance on our product information, product selection guides, advice or instructions. If a successful claim were brought against us in excess of our insurance coverage, it could adversely affect our business. Even unsuccessful claims could result in the expenditure of funds and management time and could have a negative impact on our business.

We may be liable if third parties misappropriate our customers’ personal information.

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 use of personal information are introduced or if government agencies investigate our privacy practices.

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

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 not be able to successfully assimilate the additional personnel, operations, acquired technology or products or services into our business. Any acquisition may further 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 merger. 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 would occur as a result of any acquisition may result in disruptions that could seriously impair our business. Finally, we may have to incur debt or issue additional equity securities to pay for other acquisitions or investments, the issuance of which could 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 equity securities and an earn out that is dependent on Odimo’s consolidated earnings. Fluctuations in the value of these securities and Odimo’s performance will affect our actual realization of the amounts we expect to receive from this sale. Further, as an observable market price does not exist for equity securities of Odimo as it is a private company, our estimates of fair value of such securities are more subjective than for the securities of public companies. We also received a $4.5 million, five-year subordinated secured promissory note from Odimo in connection with this sale which, as of the date of sale, had a fair value of approximately $4.0 million. There is no guarantee that Odimo will be able to repay this note in full or at all. If Odimo does not pay this note in full, we will realize less than what we expected from this sale.

There are certain risks as a result of litigation pending or threatened against Ashford.com at the time of the acquisition and with respect to which Ashford.com may be liable.

While we sold certain assets of Ashford.com in December 2002, Ashford.com continues to be a party to certain litigation that was commenced prior to our acquisition of Ashford.com in March 2002. Since July 11, 2001, several stockholder class action complaints have been filed in the United States District Court of the Southern District of New York against Ashford.com, several of Ashford.com’s officers and directors, and various underwriters of Ashford.com’s initial public offering. The purported class actions have all been brought on behalf of purchasers of Ashford.com common stock during various periods beginning on September 22, 1999, the date of Ashford.com’s initial public offering. The plaintiffs allege that Ashford.com’s prospectus, included in Ashford.com’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission, was materially false and misleading because it failed to disclose, among other things, certain fees and commissions collected by the underwriters or arrangements designed to inflate the price of the common stock. The plaintiffs further allege that because of these purchases, Ashford.com’s post-initial public offering stock price was artificially inflated. As a result of the alleged omissions in the prospectus and the purported inflation of the stock price, the plaintiffs claim violations of Sections 11 and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. The complaints have been consolidated into a single action, and the consolidated cases against Ashford.com have been consolidated with similarly consolidated cases filed against 308 other issuer defendants for the purposes of pretrial proceedings. The claims against Ashford.com’s officers and directors were dismissed in exchange for tolling agreements which permit the refiling of claims against officers and directors at a later date. A motion to dismiss filed on behalf of all issuer defendants, including Ashford.com, was denied in all aspects relevant to Ashford.com on February 19, 2003. Ashford.com and its insurers have entered into a memorandum of understanding regarding terms for settlement of this suit. Under the

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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 currently in progress. In the event that a settlement is not finalized, we believe that Ashford.com has defenses against these actions.

We may expand our business internationally, causing our business to become increasingly susceptible to numerous international business risks and challenges that could affect our profitability.

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

Any negative impact on our international business could negatively impact our business, operating results and financial condition as a whole. In particular, gains and losses on the conversion of foreign payments into United States 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.

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:

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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 be materially affected 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, or if the Internet does not become a viable commercial medium, the number of our 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.

The technology of the Internet is changing rapidly and could render the e-commerce businesses which we operate obsolete.

The technology of the Internet and online retailing is evolving rapidly for many reasons, including:

If the costs associated with the changing technology of the Internet prevents us from enhancing our e-commerce platform, those businesses could become less effective, which would reduce our competitive advantage and put our ability to attract and retain customers at risk. Therefore, the potential negative impact of these businesses becoming less effective would affect us to a greater extent than it would affect a company that has other significant channels for the sale or distribution of its products.

In order to keep the Web sites that we operate from becoming obsolete, and maintain our ability to attract and retain customers, we must accomplish the following tasks:

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

Our long-term future 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. E-commerce is still a relatively new concept, and large numbers of customers may not begin or continue to use the Internet to purchase goods. The demand for and acceptance of products sold over the Internet are highly uncertain, and most e-commerce businesses have a short track record. If consumers are unwilling to use the Internet to conduct business, our business may not develop profitably. The Internet may not succeed as a medium of commerce because of 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.

The security risks of online retailing may discourage customers from purchasing goods from us.

In order for e-commerce to develop successfully, we and other market participants must be able to transmit confidential information securely over public networks. Third parties may have the technology or know-how to breach the security of customer transaction data and store confidential information on our own servers. Any breach could cause customers to lose confidence in the security of our partners’ e-commerce businesses and

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choose not to purchase from those 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 the growth of the Internet and e-commerce. Our security measures may not effectively prohibit others from obtaining improper access to the information on our partners’ e-commerce businesses. Any security breach could expose us to risks of loss, litigation and liability and could seriously disrupt our operations.

We need to continuously acquire and effectively use entertainment space to market and sell our direct response television campaign products.

We generally enter into agreements with entertainment companies, branded manufacturers and other sellers of products to run their e-commerce businesses, including some of their direct response television campaigns. In those agreements, the entertainment companies, branded manufacturers and other sellers of products generally agree to certain marketing, advertising and air-time commitments for the promotion of products sold through their e-commerce businesses, including direct response television and online retail stores. Air-time is very valuable and is essential for the success of direct response television campaigns. If we are unable to negotiate favorable marketing, advertising and air-time commitments in our agreements with our partners or if our partners do not fulfill their commitments, the amount of products we could sell likely would be lower which would cause our revenues to be lower.

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 general and administrative expenses. With respect to credit card fraud, we have put in place technology and processes to help us detect the fraudulent use of credit card information. With respect to other fraud, such as fraud related to checks and installment sales, we use third-party service providers to help us detect fraud. 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 even though the associated financial institution or third-party service provider approved payment of the orders. 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, generally we 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 may be 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 and intend to vigorously defend ourselves in this matter. However, we may incur

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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 government regulation could harm our business.

We are subject to the same federal, state and local laws as other companies conducting e-commerce businesses. Due to the increasing growth and popularity of the Internet and e-commerce, many laws and regulations relating to these businesses, particularly the Internet, are proposed and considered at the federal, state and local levels. These laws and regulations could cover issues such as user privacy, freedom of expression, pricing, fraud, quality of products and services, taxation, advertising, intellectual property rights and information security. Applicability of existing laws governing issues such as property ownership, copyrights and other intellectual property issues, taxation, libel, obscenity and personal privacy could also harm our business. For example, United States and foreign laws regulate our ability to use customer information and to develop, buy and sell mailing lists. Many of these laws may not contemplate or address the unique issues raised by the Internet or e-commerce. 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.

Laws or regulations relating to user information and online privacy may adversely affect the growth of our Internet business or our marketing efforts.

We are subject to increasing regulation at the federal and state levels relating to privacy and the use of personal user information. Several states have proposed legislation that would limit the uses of personal user information online or require collectors of information to establish privacy policies. The Federal Trade Commission has adopted regulations regarding the collection and use of personal identifying information obtained from children under 13. In addition, bills may be introduced in Congress that would extend online privacy protections to adults. Laws and regulations of this kind may include requirements that we establish procedures to disclose and notify users of privacy and security policies, obtain consent from users for collection and use of information, or provide users with the ability to access, correct and delete personal information stored by us. Even in the absence of those regulations, the Federal Trade Commission has settled several proceedings resulting in consent decrees in which Internet companies have been required to establish programs regarding the manner in which personal information is collected from users and provided to third parties. We could become a party to a similar enforcement proceeding. These regulatory and enforcement efforts could also harm our ability to collect demographic and personal information from users, which could be costly or adversely affect our marketing efforts.

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 March 3, 2004, Michael G. Rubin, our Chairman, President and Chief Executive Officer, beneficially owned 19.1%, funds affiliated with SOFTBANK Holdings Inc., or SOFTBANK, beneficially owned 21.2% and Interactive Technology Holdings, LLC, or ITH, a joint venture company of Comcast Corporation and QVC, Inc., beneficially owned 26.8% of our outstanding common stock, including currently exercisable warrants and

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options to purchase common stock. Should they decide to act together, any two of Mr. Rubin, SOFTBANK and ITH would be in a position to exercise effective 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, the stock purchase agreements pursuant to which SOFTBANK and ITH acquired their shares of our common stock provide that SOFTBANK and ITH each have the right to designate up to two members of our board of directors. This concentration of ownership and SOFTBANK’s and ITH’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 current market prices for their shares.

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

Pursuant to our amended and restated certificate of incorporation, we have authorized a class of 5,000,000 shares of preferred stock, which our board of directors may issue with terms, rights, preferences and designations as the board may determine and without any vote of the stockholders, unless otherwise required by law. Issuing the preferred stock, depending upon the terms, rights, preferences and designations set by our board, may delay, deter or prevent a change in control of us. In addition, issuing additional shares of common stock could result in dilution of the voting power of the current holders of our common stock. Moreover, “anti-takeover” provisions of Delaware law may restrict the ability of the stockholders to approve a merger or business combination or obtain control of us. As many investors consider a change of control as 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.

There are limitations on the liabilities of our directors.

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. These agreements, among other things, require us to indemnify each director 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. Our directors are not currently subject to legal action that would require us to indemnify them; however, if any such actions were brought, the costs associated with such actions could be harmful to our business.

Our principal executive offices are located in a 56,000 square-foot facility purchased by us in August 1999 and located in King of Prussia, Pennsylvania. We provide our fulfillment operations from a 470,000 square-foot facility purchased by us in April 2002 and located in Louisville, Kentucky. We own both our King of Prussia offices and our Louisville fulfillment center free of any debt. We provide customer service from an 82,000 square-foot customer contact center leased by us and located in Melbourne, FL.

We are currently looking for new office space for our corporate headquarters in Pennsylvania that will provide us with more space than we have in our current office. On March 16, 2004, we entered into an agreement to purchase a new corporate headquarters in King of Prussia, Pennsylvania. We expect to close on the purchase in early May 2004 and will be required to complete improvements on the building in order to occupy it. We have a thirty day period beginning on the signing date to investigate the property and may elect to terminate this agreement for any reason prior to the end of such thirty day period without any penalty or further obligation. For additional information, see Note 21 to our consolidated financial statements included in this Annual Report on Form 10-K. In connection with acquiring a new corporate headquarters, we are seeking a buyer for our Pennsylvania facility. We believe that our other properties are adequate for our present needs and that suitable additional or replacement space will be available as required.

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We are involved in various litigation incidental to our 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 our e-commerce platform.

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

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 may be 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 and intend to vigorously defend ourselves in this matter.

We do not believe, based on current knowledge, that any of the foregoing claims are likely to have a material adverse effect on our business, financial position or results of operations. However, we 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 us, we may incur substantial monetary liability, and may be required to implement expensive changes in our business practices or enter into costly royalty or licensing agreements. Any of these could have a material adverse effect on our business, financial position or results of operations.

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No matters were submitted to a vote of our stockholders during the fiscal quarter ended January 3, 2004.

ITEM 4.1:    EXECUTIVE OFFICERS OF THE REGISTRANT.

The following table sets forth information regarding each of our executive officers:

Michael G. Rubin has served as our Chairman of the Board and Chief Executive Officer since July 1995 and as our President since June 2000. Mr. Rubin was named Entrepreneur of the Year in 1994 and 2000 at the Greater Philadelphia Entrepreneur of the Year Awards sponsored by Ernst & Young. Mr. Rubin attended Villanova University, Villanova, Pennsylvania.

Jordan M. Copland has served as our Executive Vice President and Chief Financial Officer since February 2000. From March 1999 to February 2000, Mr. Copland served as Senior Vice President and Chief Financial Officer of Virgin Entertainment Group, Inc.’s United States-based Megastore and global e-commerce businesses. While at Virgin, Mr. Copland oversaw financial administration and technology. From October 1990 to March 1999, Mr. Copland held a variety of positions with increasing responsibility within The Walt Disney Company, a worldwide entertainment company. Most recently Mr. Copland was Vice President of Finance and Planning for the Disney Consumer Products division. He has also held various leadership and management positions within several other divisions of Disney, including the Disney Publishing Group, Disney Consumer Products Europe, the Middle East and Africa and Walt Disney Records.

Robert W. Liewald has served as our Executive Vice President, Merchandising since July 1999 and worked as a consultant to us and to other companies in the sporting goods industry from June 1998 to July 1999. From January 1995 to June 1998, Mr. Liewald served as Senior Executive Vice President of FILA USA, an athletic footwear and apparel manufacturer. From June 1972 to January 1995, Mr. Liewald held a variety of positions at Foot Locker, Inc. (formerly Venator Group), an athletic footwear and apparel retailer based in New York, New York, most recently as Senior Vice President, Corporate Merchandiser, with merchandising responsibility for all of Foot Locker’s specialty athletic divisions. Also while at Foot Locker, Mr. Liewald served as Vice President, General Merchandise Manager for Champs Sports and Vice President, Merchandise Manager at Foot Locker and Lady Foot Locker.

Arthur H. Miller has served as our Executive Vice President and General Counsel since September 1999. From January 1988 to September 1999, Mr. Miller was a partner in the corporate department of Blank Rome Comisky & McCauley LLP, a law firm based in Philadelphia, Pennsylvania. Mr. Miller joined Blank Rome in April 1983.

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Mark S. Reese has served as our Executive Vice President and Chief Operating Officer since May 2000. From February 1999 to May 2000, Mr. Reese served as Chief eCommerce Officer of Toysmart.com, an e-tailer of family products. While at Toysmart.com, Mr. Reese was responsible for the leadership and management of the Internet production, merchandising, fulfillment, customer care, research and online content groups. From December 1997 to February 1999, Mr. Reese was a Senior Manager with Andersen Consulting’s Strategic Services practice group, where he led strategic e-commerce initiatives for Fortune 50 companies.

Michael R. Conn has served as our Senior Vice President, Business Development since February 1999. From June 1993 to February 1999, Mr. Conn served as Vice President, Research at Gruntal & Co. L.L.C., an investment bank based in New York, New York. Mr. Conn worked as a sell-side securities analyst specializing in footwear, apparel, retail and leisure products. While at Gruntal, Mr. Conn was named to the 1998 Wall Street Journal All-Star Analyst Team.

Steven C. Davis served as our Senior Vice President, Marketing from January 2000 until February 2004. From June 1996 to January 2000, Mr. Davis held a number of management positions at Just for Feet, Inc., a specialty sporting goods retailer based in Birmingham, Alabama. Most recently, Mr. Davis was Vice President of Marketing and previously he served as Director of Marketing and Director of Special Projects. Effective February 2, 2004, our Board of Directors accepted the resignation of Mr. Davis as an employee and executive officer of GSI. On February 2, 2004, the Department of Justice announced that Mr. Davis agreed to plead guilty to making false statements in connection with the federal government’s investigation of Just for Feet. Mr. Davis is currently assisting us in a consulting capacity during a transition period of up to one year.

Joseph N. Seibert has served as our Senior Vice President and Chief Information Officer since February 2003. From May 2002 until January 2003, Mr. Seibert served as a consultant to the Chief Information Officer of Bertelsmann AG, an entertainment company. From March 2000 until May 2002, Mr. Seibert served as Vice President and Chief Information Officer for Viacom, Inc., a leading global entertainment company. From 1993 until 2000, Mr. Seibert held a variety of positions within CBS, Inc. including Chief Information Officer from 1998 until 2000.

Damon Mintzer has served as President and Chief Operating Officer of Global-QVC Solutions, Inc., a wholly owned subsidiary of GSI Commerce, Inc., since June 2001. From October 1999 to May 2001, Mr. Mintzer worked for WHN.com. He first served as Vice President of Business Development and then as Senior Vice President as well as General Manager of one of WHN’s two business units. From 1998 to October 1999, Mr. Mintzer served as Director of Sales for the Asia Pacific region for Modus Media International, Inc. From 1995 to 1998, Mr. Mintzer served as Director of Business Development for Modus Media International/Stream International, a subsidiary of R.R. Donnelley & Sons Co.

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PART II

Market Price of and Dividends on Common Stock

The following table sets forth the high and low bid information of our common stock as reported on the Nasdaq National Market under the symbol “GSIC”. The prices shown do not include retail markups, markdowns or commissions and may not necessarily represent actual transactions.

As of March 1, 2004, we had approximately 1,964 stockholders of record. The closing share price for our common stock on March 1, 2004, as reported on the Nasdaq National Market, was $9.32.

We have never declared or paid a cash dividend on our common stock. We currently intend to retain any future earnings for funding growth and, therefore, do not anticipate declaring or paying any cash dividends on our common stock for the foreseeable future.

We made no repurchases of our common stock during the fourth quarter of fiscal 2003.

Information about securities authorized for issuance under our equity compensation plans appears in Part III, Item 12 of this Annual Report on Form 10-K.

The following tables present portions of our financial statements and are not complete. You should read the following selected consolidated financial data together with our consolidated financial statements and related notes to our financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected statement of operations data for the years ended December 29, 2001, December 28, 2002 and January 3, 2004 and the balance sheet data as of December 28, 2002 and January 3, 2004 are derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected statement of operations data for the years ended January 1, 2000 and December 30, 2000 and the balance sheet data as of January 1, 2000, December 30, 2000 and December 29, 2001 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K.

On April 20, 1999, we formalized a plan to sell our historic branded athletic footwear and our off-price athletic footwear and apparel and action sports divisions in order to focus exclusively on our e-commerce business. Accordingly, for financial statement purposes, the assets, liabilities, results of operations and cash flows of those divisions have been segregated from that of continuing operations and are presented as discontinued operations. The following selected consolidated financial data has been reclassified to reflect this presentation.

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All statements made in this Annual Report on Form 10-K, 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, consumer spending, the financial markets and the industries in which we and our partners operate, changes affecting the Internet, our ability to develop and maintain relationships with strategic partners and suppliers, our ability to timely and successfully develop, maintain and protect our technology and product and service offerings and execute operationally, our ability to attract and retain qualified personnel, our ability to successfully integrate our acquisitions of other businesses, if any, and the performance of acquired businesses. More information about potential factors that could affect us are described in Item 1 of this Annual Report on Form 10-K 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

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Results of Operations

Comparison of Fiscal 2002 and 2003

The following table sets forth the dollar amount and percentage of net revenues for certain line items of our statements of operations for fiscal 2002 and fiscal 2003 and the dollar and percentage change in these line items from fiscal 2002 to fiscal 2003.

Net Revenues from Product Sales

Net revenues from product sales are derived from the sale of goods through our partners’ e-commerce businesses, toll-free telephone number sales, bulk sales, business-to-business and group sales and related outbound shipping charges, net of allowances for returns and discounts. Net revenues from product sales include the revenues of Ashford.com, Inc. from March 14, 2002, the date our acquisition of Ashford.com was completed.

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The following table provides information about our net revenues from product sales by category for fiscal 2002 and fiscal 2003:

Net revenues from product sales increased $61.7 million, of which $31.7 million was due to an increase in sales in the sporting goods category and $50.6 million was due to an increase in sales in our other product categories, which include consumer electronics, general merchandise and licensed entertainment products, offset, in part, by a $20.6 million decrease in sales from our Ashford.com operations which we ceased during fiscal 2002. The increases in the sporting goods and other categories were due to the addition of new partners in fiscal 2003, increases in sales from partners’ e-commerce businesses that were operated for the entirety of both periods and increases in sales from partners’ e-commerce businesses that were operated for part of fiscal 2002 and all of fiscal 2003. Net revenues from product sales for fiscal 2002 and fiscal 2003 included $15.3 million and $23.6 million in shipping revenue, respectively.

Service Fee Revenues

Service fee revenues are derived from fixed and variable fees earned in connection with the development and operation of our partners’ e-commerce businesses and the provision of marketing and other services. 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. We do not specifically record “Cost of service fee revenues” as these costs are incurred by our fee-based partners rather than by us. Operating expenses relating to service fee revenues consist primarily of personnel and other costs associated with our engineering, production and creative departments which are included in product development expense, as well as fulfillment costs and personnel and other costs associated with our marketing and customer service departments which are included in sales and marketing expense.

Service fee revenues increased $7.6 million primarily due to a $9.1 increase in fixed and variable service fees from partners for which we provided services. This increase was due primarily to the launch of new fee-based partners in the second half of fiscal 2003, offset, in part, by a $1.5 million decrease related to fixed service fees earned from services completed in fiscal 2002.

Net Revenues

We expect net revenues, which include net revenues from product sales and service fee revenues, to increase between $48.0 million and $63.0 million compared to fiscal 2003. We expect that service fee revenues will grow at a significantly higher rate in fiscal 2004 than in fiscal 2003 because we will operate for the entirety of fiscal 2004 a number of partners’ e-commerce businesses that were launched in fiscal 2003. We expect that net revenues from product sales will grow more slowly in fiscal 2004 than in fiscal 2003.

Cost of Revenues from Product Sales

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.

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As a percentage of net revenues from product sales, cost of revenues from product sales was 73.8% and 71.5% for fiscal 2002 and fiscal 2003, respectively. This decrease was due primarily to lower product costs in the sporting goods category in fiscal 2003, a $1.2 million charge in fiscal 2002 for inventory write downs as a result of the Ashford.com restructuring and the closure of our Kentucky retail store and lower margins associated with a $2.5 million bulk sale which occurred in fiscal 2002, offset, in part, by sales in the consumer electronics category, which have lower margins and which increased as a percentage of total product sales in fiscal 2003 compared to fiscal 2002. We anticipate that cost of revenues from product sales for fiscal 2004 as a percentage of net revenues from product sales will be approximately the same as fiscal 2003.

Gross Profit

The increase in gross profit dollars for fiscal 2003 compared to fiscal 2002 was due primarily to a $61.7 million increase in net revenues from product sales in fiscal 2003. The increase in gross profit percentage for fiscal 2003 compared to fiscal 2002 was due primarily to higher margins on sales in the sporting goods category in fiscal 2003, the increase in service fee revenues in fiscal 2003, inventory write downs in fiscal 2002 related to the Ashford.com restructuring and the closure of our Kentucky retail store and lower margins associated with a bulk sale in fiscal 2002, offset, in part, by increased sales in the consumer electronics category in fiscal 2003. We believe that gross profit as a percentage of net revenues will increase by a few percentage points in fiscal 2004 because service fee revenues, which have 100% gross profit margin, will represent a larger percentage of total net revenues.

Sales and Marketing Expenses

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

Sales and marketing expenses increased $8.4 million primarily due to a $4.8 million increase in partner revenue share charges, a $3.1 million increase in personnel and related costs attributable to our fulfillment operations, which was primarily due to high processing volume in our fulfillment center, and a $2.0 million increase in credit card fees, offset, in part, by a $1.4 million decrease in subsidized shipping and handling costs. The increases in partner revenue share charges and credit card fees were due principally to increased sales volume in fiscal 2003. We expect that sales and marketing expenses for fiscal 2004 will show a slight improvement as a percentage of net revenues.

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 $2.5 million primarily due to a $2.7 million increase in personnel and related costs, a $383,000 increase in web hosting costs due to the increased number of e-commerce businesses that we operated and maintained and a $273,000 increase in costs related to our use of temporary technical professionals, offset, in part, by a $342,000 decrease in communication and bandwidth costs, a $175,000 decrease related to the closing of our West Coast technology services office in the second quarter of

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fiscal 2002 and a $175,000 decrease in equipment and software maintenance costs. We expect that product development expenses for fiscal 2004 will increase between $6.0 million and $8.0 million compared to fiscal 2003, due principally to increases in personnel and related costs as we continue to invest in technology personnel, which we believe is critical to our ability to effectively launch new partners, deliver enhanced functionality for our partners’ e-commerce businesses and continue to improve the capacity, stability and security of the technology solution we provide to our partners.

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 decreased $1.6 million primarily due to a $2.4 million decrease in bad debt expense and chargebacks related to lower direct response television sales for fiscal 2003 and the higher bad debt rate on such sales, a lower bad debt rate for sales through our partners’ e-commerce businesses and a $366,000 decrease in non-income taxes related primarily to Ashford.com, offset, in part, by a $1.3 million increase in personnel and related costs. The lower bad debt rate for sales through our partners’ e-commerce businesses was the result of order processing tools and credit card fraud verification initiatives that we implemented during fiscal 2003. We expect that general and administrative expenses for fiscal 2004 will remain relatively consistent as a percentage of net revenues.

Restructuring Costs Related to Ashford.com

Restructuring costs related to Ashford.com consist of charges attributable to the cessation of the operations of Ashford.com, including termination benefits, contractual obligations, asset impairments and other restructuring costs.

In conjunction with the sale of certain assets of Ashford.com, we also announced and implemented our plan to cease the operations of Ashford.com, which accounted for approximately $21.6 million and $1.0 million of our net revenues in fiscal 2002 and fiscal 2003, respectively. This plan involved the liquidation of Ashford.com’s remaining inventory, the closure of its Houston, Texas fulfillment center and offices and the termination of 71 employees. This plan was substantially completed in January 2003. As of the end of fiscal 2003, 71 employees had been terminated and actual termination benefits paid were $417,000.

Costs related to ongoing operations were not included in restructuring costs related to Ashford.com. In accordance with Emerging Issues Task Force, or EITF Issue No. 96-9, “Classification of Inventory Markdowns and Other Costs Associated with a Restructuring,” all inventory adjustments that resulted from the cessation of operations of Ashford.com were included in cost of revenues from product sales and were recorded in December 2002. As of the end of fiscal 2002, inventory write downs resulting from the restructuring totaled $1.2 million. No additional inventory write downs from the restructuring were recorded during fiscal 2003.

For fiscal 2002 and fiscal 2003, restructuring costs related to Ashford.com were as follows:

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Termination benefits were comprised of severance-related payments for all employees terminated in connection with the Ashford.com restructuring. The contractual obligations related to agreements entered into by Ashford.com prior to the sale of assets to Odimo Acquisition Corp. Asset impairments related to the closure of Ashford.com’s fulfillment center and offices. For assets held for disposal as of the end of fiscal 2002, we estimated the fair value based on expected salvage value less costs to sell, and the carrying amount of these assets held for disposal was not significant. Other restructuring costs included expenses which were directly attributable to the cessation of operations of Ashford.com.

Net Loss on Sale of Ashford.com Assets

We had a net loss on the sale of assets related to Ashford.com of $2.6 million for fiscal 2002. We had acquired these assets in March 2002. This net loss was due to a loss of $2.9 million on the sale in December 2002 of certain assets of Ashford.com to Odimo Acquisition Corp., offset, in part, by a gain of $379,000 on the sale in August 2002 of certain assets of a division of Ashford Corporate Gifts, Inc., which is a subsidiary of Ashford.com. We received $1.2 million in cash proceeds from the sale of this division.

Stock-Based Compensation Expense

Stock-based compensation expense consists of the amortization of deferred compensation expense for options granted to employees and certain non-employees, the value of options or warrants granted to certain partners and investors and amortization of deferred partner revenue share charges.

Stock-based compensation expense increased $1.5 million primarily due to an increase of $1.4 million in charges related to options subject to variable accounting and an increase of $514,000 related to the amortization of deferred partner revenue share charges, offset, in part, by a decrease of $279,000 in charges related to the issuance of options granted during fiscal 2000 and fiscal 2001 with exercise prices below the then-current market prices of the underlying stock and a decrease of $53,000 in charges related to the net exercise of warrants during fiscal 2002. As of the end of fiscal 2003, we had an aggregate of $1.2 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 $857,000 and $1.4 million for fiscal 2002 and fiscal 2003, respectively. We are unable to determine what stock-based compensation will be in fiscal 2004 as stock-based compensation expense is directly affected by fluctuations in the price of our common stock.

Depreciation and Amortization Expenses

Depreciation and amortization expenses relate primarily to the depreciation of our corporate headquarters and 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 $877,000 primarily due to additional assets to build, manage and operate our business, offset, in part, by an impairment charge of $645,000 in fiscal 2002. The impairment charge related to the disposal of furniture and computer hardware and software during the fourth quarter of fiscal 2002. We determined that these long-lived assets were no longer being used in our continuing operations and that, therefore, the carrying amounts of these assets were not recoverable. We expect that depreciation and amortization expenses for fiscal 2004 will decline approximately 50 basis points as a percentage of net revenues.

Other (Income) Expense

Interest income consists primarily of interest earned on cash, cash equivalents, short-term investments and marketable securities, and interest expense consists primarily of interest expense paid in connection with a mortgage note that we previously had on our corporate headquarters and interest expense on capital leases.

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The decrease in interest income of $200,000 was due to lower interest rates and lower average balances of cash, cash equivalents, short-term investments and marketable securities during fiscal 2003 compared to fiscal 2002. We expect that interest income for fiscal 2004 will decline to between 0.1% and 0.2% of net revenues.

The decrease in interest expense of $749,000 was due primarily to the early retirement of a mortgage note on our corporate headquarters in November 2002. We had no debt during fiscal 2003. On March 16, 2004, we entered into an agreement to purchase a new corporate headquarters in King of Prussia, Pennsylvania for $17.0 million. We will be required to invest in the building in order to occupy it. If we finance the purchase of a new building and the improvements in fiscal 2004, we could incur up to $500,000 of interest expense in fiscal 2004.

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 the end of fiscal 2003, we had available net operating loss carryforwards of approximately $428.1 million which expire in the years 2004 through 2023. 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 $243.2 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.

Comparison of Fiscal 2001 and 2002

The following table sets forth the dollar amount and percentage of net revenues for certain line items of our statements of operations for fiscal 2001 and fiscal 2002 and the dollar and percentage change in these line items from fiscal 2001 to fiscal 2002.