UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

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

Commission file number 0-16611

GSI COMMERCE, INC.

(Exact name of registrant as specified in its charter)

DELAWARE (State or other jurisdiction of incorporation or organization)		04-2958132 (I.R.S. employer identification no.)

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

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

There were 62,113,936 shares of the registrant’s Common Stock outstanding as of the close of business on May 3, 2010.

 

 

GSI COMMERCE, INC.
FORM 10-Q
FOR THE QUARTER ENDED APRIL 3, 2010

INDEX

		Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of January 2, 2010 and April 3, 2010			3
Condensed Consolidated Statements of Operations for the three-month periods ended April 4, 2009 and April 3, 2010			4
Condensed Consolidated Statements of Cash Flows for the three-month periods ended April 4, 2009 and April 3, 2010			5
Notes to Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			25
Item 4. Controls and Procedures			25
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			26
Item 1A. Risk Factors			26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			27
Item 3. Defaults Upon Senior Securities			27
Item 4. (Reserved)			27
Item 5. Other Information			27
Item 6. Exhibits			28
SIGNATURES			29
Exhibit 10.3
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

The Company’s fiscal year ends on the Saturday nearest the last day of December. The Company’s fiscal year ends are as follows:

References To		Refer to the Years Ended/Ending
Fiscal 2009		January 2, 2010
Fiscal 2010		January 1, 2011
Fiscal 2011		December 31, 2011
Fiscal 2012		December 29, 2012
Fiscal 2013		December 28, 2013
Fiscal 2014		January 3, 2015

PART I

ITEM 1:		FINANCIAL STATEMENTS

GSI COMMERCE, INC. AND SUBSIDIARIES

		January 2,				April 3,
		2010				2010
ASSETS
Current assets:
Cash and cash equivalents		$	228,430			$	132,403
Accounts receivable, net of allowance of $4,648 and $3,641			70,582				53,879
Inventory			55,678				58,299
Deferred tax assets			12,347				14,436
Prepaid expenses and other current assets			13,187				13,678
Total current assets			380,224				272,695
Property and equipment, net			163,329				165,518
Goodwill			373,003				372,611
Intangible assets, net of accumulated amortization of $29,172 and $33,201			132,875				128,723
Long-term deferred tax assets			—				7,371
Other assets, net of accumulated amortization of $17,264 and $17,875			12,417				12,949
Total assets		$	1,061,848			$	959,867
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	126,914			$	71,094
Accrued expenses			150,173				95,858
Deferred revenue			20,645				21,553
Convertible notes			55,443				56,675
Current portion of long-term debt			5,260				5,246
Total current liabilities			358,435				250,426
Convertible notes			116,948				118,525
Long-term debt			28,142				26,632
Deferred acquisition payments			63,763				65,960
Deferred tax liabilities			8,534				—
Deferred revenue and other long-term liabilities			9,686				9,596
Total liabilities			585,508				471,139
Commitments and contingencies (Note 8)
Stockholders’ equity:
Preferred stock, $0.01 par value, 5,000,000 shares authorized; 0 shares issued and outstanding as of January 2, 2010 and April 3, 2010			—				—
Common stock, $0.01 par value, 90,000,000 shares authorized; 60,033,393 and 61,480,819 shares issued as of January 2, 2010 and April 3, 2010 respectively; 60,033,190 and 61,480,616 shares outstanding as of January 2, 2010 and April 3, 2010, respectively			600				615
Additional paid in capital			642,852				664,053
Accumulated other comprehensive loss			(1,498	)			(2,201	)
Accumulated deficit			(165,614	)			(173,739	)
Total stockholders’ equity			476,340				488,728
Total liabilities and stockholders’ equity		$	1,061,848			$	959,867

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

GSI COMMERCE, INC. AND SUBSIDIARIES

		Three Months Ended
		April 4,				April 3,
		2009				2010
Revenues:
Net revenues from product sales		$	106,191			$	159,275
Service fee revenues			90,284				113,317
Net revenues			196,475				272,592
Costs and expenses:
Cost of revenues from product sales			79,355				117,474
Marketing			10,861				10,807
Account management and operations, inclusive of $2,256 and $2,446 of stock-based compensation			57,741				77,694
Product development, inclusive of $1,451 and $1,869 of stock-based compensation			28,374				34,317
General and administrative, inclusive of $3,247 and $2,616 of stock-based compensation			19,277				24,397
Depreciation and amortization			15,401				18,761
Changes in fair value of deferred acquisition payments			—				2,074
Total costs and expenses			211,009				285,524
Loss from operations			(14,534	)			(12,932	)
Other (income) expense:
Interest expense			4,796				5,208
Interest income			(151	)			(234	)
Other (income) expense			229				474
Total other expense			4,874				5,448
Loss before income taxes			(19,408	)			(18,380	)
Benefit for income taxes			(7,298	)			(10,255	)
Net loss		$	(12,110	)		$	(8,125	)
Basic and diluted loss per share		$	(0.25	)		$	(0.13	)
Weighted average shares outstanding — basic and diluted			47,926				60,446

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

GSI COMMERCE, INC. AND SUBSIDIARIES

		Three Months Ended
		April 4,				April 3,
		2009				2010
Cash Flows from Operating Activities:
Net loss		$	(12,110	)		$	(8,125	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation			12,962				14,646
Amortization			2,439				4,115
Amortization of discount on convertible notes			2,546				2,809
Changes in fair value of deferred acquisition payments			—				2,074
Stock-based compensation			6,954				6,931
Foreign currency transaction losses			238				475
Deferred income taxes			(7,250	)			(11,191	)
Changes in operating assets and liabilities:
Accounts receivable, net			16,802				16,420
Inventory			3,483				(2,621	)
Prepaid expenses and other current assets			(549	)			(561	)
Other assets, net			1,965				149
Accounts payable and accrued expenses			(97,854	)			(110,530	)
Deferred revenue			(2,236	)			238
Net cash used in operating activities			(72,610	)			(85,171	)
Cash Flows from Investing Activities:
Payments for acquisitions of businesses, net of cash acquired			(750	)			—
Cash paid for property and equipment, including internal use software			(7,411	)			(15,868	)
Net cash used in investing activities			(8,161	)			(15,868	)
Cash Flows from Financing Activities:
Debt issuance costs paid			(38	)			(856	)
Repayments of capital lease obligations			(1,195	)			(1,473	)
Repayments of mortgage note			(47	)			(50	)
Excess tax benefit in connection with exercise of stock options and awards			—				978
Proceeds from exercise of common stock options			72				6,933
Net cash provided by (used in) financing activities			(1,208	)			5,532
Effect of exchange rate changes on cash and cash equivalents			(231	)			(520	)
Net decrease in cash and cash equivalents			(82,210	)			(96,027	)
Cash and cash equivalents, beginning of period			130,315				228,430
Cash and cash equivalents, end of period		$	48,105			$	132,403
Supplemental Cash Flow Information
Cash paid during the period for interest		$	703			$	866
Cash paid during the period for income taxes			1,458				602
Noncash Investing and Financing Activities:
Accrual for purchases of property and equipment			3,581				3,633

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

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

NOTE 1—BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements of GSI Commerce, Inc. and Subsidiaries (“the Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all information and note disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements.

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

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

This quarterly report should be read in conjunction with the financial statements and notes thereto included in the Company’s audited financial statements presented in the Company’s Annual Report on Form 10-K for the fiscal year ended January 2, 2010, filed with the Securities and Exchange Commission (“SEC”) on March 5, 2010.

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Accrued Expenses: Accrued expenses include $36,524 of amounts payable to the Company’s clients as of April 3, 2010. No other item included in accrued expenses was greater than 5% of total current liabilities as of April 3, 2010

Accrued expenses include $62,705 of amounts payable to the Company’s clients and accrued payroll of $25,617 as of January 2, 2010. No other item included in accrued expenses was greater than 5% of total current liabilities as of January 2, 2010.

Client Revenue Share: Client revenue share charges are payments made to the Company’s clients in exchange for the use of their brand names, logos, the promotion of its clients’ URLs, Web stores and toll-free telephone numbers in clients’ marketing and communications materials, the implementation of programs to provide incentives to consumers to shop through the e-commerce businesses that the Company operates for its clients and other programs and services provided to the consumers of the e-commerce businesses that the Company operates for its clients, net of amounts reimbursed to the Company by its clients. Client revenue share is calculated as either a percentage of product sales or a guaranteed annual amount. Client revenue share charges were $6,178 for the three-month period ended April 3, 2010 and $7,274 for the three-month period ended April 4, 2009 and, are included in marketing expenses in the Condensed Consolidated Statements of Operations.

Fulfillment Costs: The Company defines fulfillment costs as personnel, occupancy and other costs associated with its fulfillment centers, personnel and other costs associated with its logistical support and vendor operations departments and third-party warehouse and fulfillment services costs. Fulfillment costs were $25,085 for the three-month period ended April 3, 2010 and $20,348 for the three-month period ended April 4, 2009, and are included in account management and operations expenses in the Condensed Consolidated Statements of Operations.

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

Recent Accounting Pronouncements:

The following is a summary of recent accounting standards issued by the Financial Accounting Standards Board (“FASB”):

Subject		Date Issued		Summary		Effect of Adoption		Effective Date for The Company
Multiple Element Arrangements		October 2009		Removes the objective-and-reliable-evidence-of-fair-value criterion from the separation criteria used to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. Replaces references to “fair value” with “selling price” to distinguish from the fair value measurements required under accounting standards for “Fair Value Measurements.” Provides a hierarchy that entities must use to estimate the selling price, eliminates the use of the residual method for allocation, and expands the ongoing disclosure requirements.		No material impact.		January 2, 2011, with early adoption permitted. The Company chose to prospectively adopt this standard on January 3, 2010

NOTE 3— FAIR VALUE OF FINANCIAL AND NONFINANCIAL INSTRUMENTS

The Company’s financial assets and liabilities subject to fair value measurements on a recurring basis are as follows (in thousands):

		Fair Value Measurements on January 2, 2010
		Quoted Prices in								Significant
		Active Markets for				Significant Other				Unobservable
		Identical Assets				Observable Inputs				Inputs
		(Level 1)				(Level 2)				(Level 3)
Assets
Cash and cash equivalents:(1)
Money market mutual funds		$	13,606			$	—			$	—
Liabilities
Deferred acquisition payments(2)		$	—			$	—			$	60,963

		Fair Value Measurements on April 3, 2010
		Quoted Prices in								Significant
		Active Markets for				Significant Other				Unobservable
		Identical Assets				Observable Inputs				Inputs
		(Level 1)				(Level 2)				(Level 3)
Assets
Cash and cash equivalents:(1)
Money market mutual funds		$	13,606			$	—			$	—
Liabilities
Deferred acquisition payments(2)		$	—			$	—			$	63,037

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

The following table provides a reconciliation between the beginning and ending balances of items measured at fair value on a recurring basis in the table above that used significant unobservable inputs (Level 3):

		Three Months Ended
		April 3, 2010
Balance, beginning of period		$	60,963
Changes in fair value of deferred acquisition payments included in the Company’s Condensed Consolidated Statements of Operations			2,074
Balance, end of period		$	63,037

NOTE 4—PROPERTY AND EQUIPMENT

The major classes of property and equipment, at cost, as of January 2, 2010 and April 3, 2010 are as follows:

		January 2,				April 3,
		2010				2010
Computer hardware and software		$	231,954			$	247,019
Building and building improvements			44,822				44,886
Furniture, warehouse and office equipment, and other			45,722				46,478
Land			7,889				7,889
Leasehold improvements			8,847				8,863
Capitalized leases			29,132				29,132
			368,366				384,267
Less: Accumulated depreciation			(205,037	)			(218,749	)
Property and equipment, net		$	163,329			$	165,518

The Company’s net book value in capital leases, which consist of warehouse equipment and computer hardware, was $17,186 as of April 3, 2010 and $18,500 as of January 2, 2010. Amortization of capital leases is included within depreciation and amortization expense on the Condensed Consolidated Statements of Operations. Interest expense recorded on capital leases was $321 for the three-month period ended April 3, 2010 and $396 for the three-month period ended April 4, 2009.

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

NOTE 5—GOODWILL AND OTHER INTANGIBLE ASSETS

The following table summarizes the changes in the carrying amount of goodwill for each of the Company’s reportable segments:

		E-Commerce				Marketing				Consumer
		Services				Services				Engagement				Consolidated
January 2, 2010		$	83,090			$	117,025			$	172,888			$	373,003
Foreign currency translation			(392	)			—				—				(392	)
April 3, 2010		$	82,698			$	117,025			$	172,888			$	372,611

The Company’s intangible assets are as follows:

										Weighted-
		January 2,				April 3,				Average
		2010				2010				Life
										(in years)
Gross carrying value of intangible assets subject to amortization:
Customer contracts		$	41,190			$	41,190				2.4
Member relationships			22,200				22,200				2.6
Supplier relationships			11,186				11,186				3.4
Non-compete agreements			4,079				4,079				3.0
Purchased technology			4,805				4,805				4.0
Trade names			840				840				1.5
Foreign currency translation			(482	)			(605	)
			83,818				83,695				2.7
Accumulated amortization:
Customer contracts			(22,907	)			(24,544	)
Member relationships			(489	)			(2,029	)
Supplier relationships			—				(236	)
Non-compete agreements			(2,888	)			(3,227	)
Purchased technology			(2,428	)			(2,735	)
Trade names			(532	)			(578	)
Foreign currency translation			72				148
			(29,172	)			(33,201	)
Net carrying value:
Customer contracts			18,283				16,646
Member relationships			21,711				20,171
Supplier relationships			11,186				10,950
Non-compete agreements			1,191				852
Purchased technology			2,377				2,070
Trade names			308				262
Foreign currency translation			(410	)			(457	)
Total intangible assets subject to amortization, net			54,646				50,494
Indefinite life intangible assets:
Trade names			78,229				78,229
Total intangible assets		$	132,875			$	128,723

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

Amortization expense of intangible assets was $4,105 for the three-month period ended April 3, 2010 and $2,448 for the three-month period ended April 4, 2009. Estimated future amortization expense related to intangible assets as of April 3, 2010, is as follows:

Fiscal 2010		$	11,989
Fiscal 2011			14,260
Fiscal 2012			10,105
Fiscal 2013			7,715
Fiscal 2014			6,425
		$	50,494

NOTE 6—ACQUISITIONS

On November 17, 2009, the Company completed the acquisition of 100% of the outstanding common stock of Rue La La pursuant to the terms of an Agreement and Plan of Merger dated October 27, 2009.

Unaudited Pro Forma Financial Information

The financial information in the table below summarizes the combined results of operations of the Company and Rue La La on a pro forma basis, as though the companies had been combined as of the beginning of each of the periods presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had actually taken place at the beginning of each of the periods presented and is not intended to be a projection of future results or trends.

		Three Months Ended
		April 4,				April 3,
		2009				2010
Net revenues		$	224,658			$	272,592
Net loss		$	(17,537	)		$	(8,125	)

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

NOTE 7—LONG-TERM DEBT AND CREDIT FACILITY

The following table summarizes the Company’s long-term debt as of:

		January 2,				April 3,
		2010				2010
Convertible notes		$	172,391			$	175,200
Notes payable (1)			12,479				12,428
Capital lease obligations			20,923				19,450
Line of credit			—				—
Total debt			205,793				207,078
Less: Current portion of convertible notes			(55,443	)			(56,675	)
Less: Current portion of notes payable			(195	)			(199	)
Less: Current portion of capital lease obligations			(5,065	)			(5,047	)
Total long-term debt		$	145,090			$	145,157

3% Convertible Notes due 2025

In 2005, the Company completed a public offering of $57,500 aggregate principal amount of 3% subordinated convertible notes due June 1, 2025. The notes bear interest at 3%, payable semi-annually on June 1 and December 1.

Holders may convert the notes into shares of the Company’s common stock (or cash or a combination of the Company’s common stock and cash, if the Company so elects) at a conversion rate of 56.1545 shares per $1,000 principal amount of notes (representing a conversion price of approximately $17.81 per share). Based on the Company’s closing stock price of $27.88 on April 3, 2010, the if-converted value of the notes exceeds the aggregate principal amount of the notes by $32,515.

In April 2010, the Company called the notes for redemption on June 7, 2010. Any notes not converted to common stock prior to the close of business on June 4, 2010, will be redeemed for cash at 100% of the principal amount of the notes.

The following table provides additional information about the Company’s 3% convertible notes:

		As of				As of
		January 2, 2010				April 3, 2010
Carrying amount of the equity component		$	18,187			$	18,187
Principal amount of the liability component		$	57,500			$	57,500
Unamortized discount of liability component		$	2,057			$	825
Net carrying amount of liability component		$	55,443			$	56,675
Remaining amortization period of discount						2 months
Effective interest rate on liability component							12.00	%

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

The following table provides the components of interest expense for the Company’s 3% convertible notes:

		Three Months Ended
		April 4,				April 3,
		2009				2010
Amortization of the discount on the liability component		$	1,096			$	1,232
Contract interest coupon			431				431
Amortization of the liability component of the issue costs			97				104
Interest expense		$	1,624			$	1,767

The estimated fair market value of the 3% subordinated convertible notes was $89,916 as of April 3, 2010 and $82,584 as of January 2, 2010 based on quoted market prices.

2.5% Convertible Notes due 2027

In 2007, the Company completed a private placement of $150,000 of aggregate principal amount of 2.5% subordinated convertible notes due June 1, 2027, raising net proceeds of approximately $145,000, after deducting initial purchaser’s discount and issuance costs. The notes bear interest at 2.5%, payable semi-annually on June 1 and December 1.

Holders may convert the notes into shares of the Company’s common stock (or cash or a combination of the Company’s common stock and cash, if the Company so elects) at a conversion rate of 33.3333 shares per $1,000 principal amount of notes (representing a conversion price of approximately $30.00 per share) beginning on March 1, 2014. Holders can require the Company to repurchase the notes for 100% of principal amount of the notes on June 1, 2014. At any time on or after June 8, 2014, the Company may redeem any of the notes for cash at a redemption price of 100% of their principal amount, plus accrued and unpaid interest, if any, up to but excluding, the redemption date. Based on the Company’s closing stock price of $27.88 on April 3, 2010, the if-converted value of the notes does not exceed the aggregate principal amount of the notes.

The following table provides additional information about the Company’s 2.5% convertible notes:

		As of				As of
		January 2, 2010				April 3, 2010
Carrying amount of the equity component		$	26,783			$	26,783
Principal amount of the liability component		$	150,000			$	150,000
Unamortized discount of liability component		$	33,052			$	31,475
Net carrying amount of liability component		$	116,948			$	118,525
Remaining amortization period of discount						50 months
Effective interest rate on liability component							8.60	%

The following table provides the components of interest expense for the Company’s 2.5% convertible notes:

		Three Months Ended
		April 4,				April 3,
		2009				2010
Amortization of the discount on the liability component		$	1,450			$	1,577
Contract interest coupon			938				938
Amortization of the liability component of the issue costs			112				119
Interest expense		$	2,500			$	2,634

The estimated fair market value of the 2.5% subordinated convertible notes was $165,375 as of April 3, 2010 and $157,125 as of January 2, 2010 based on quoted market prices.

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

Credit Facility

In March 2010, the Company amended and expanded its existing secured revolving credit facility. By exercising the accordion feature in its existing credit facility, the Company expanded the credit facility by $60,000 to $150,000. The credit facility is available for letters of credit, working capital, and general corporate purposes, including possible acquisitions. The $150,000 secured revolving credit facility provides for the issuance of up to $30,000 of letters of credit, which is included in the $150,000 available under the secured revolving credit facility. The secured revolving credit facility is collateralized by substantially all of the Company’s assets. The Company may elect to have amounts outstanding under the credit facilities bear interest at either a LIBOR rate plus an applicable margin of 2.0% to 3.25%, the prime rate plus an applicable margin of 2.0% to 3.25%, Daily LIBOR plus 1.0% plus an applicable margin of 2.0% to 3.25%, or at the Federal Funds Open Rate plus 0.5% plus an applicable margin of 2.0% to 3.25%. The applicable margin is determined by the leverage ratio of funded debt to EBITDA, as defined in the credit facility. The Company had no outstanding borrowings and $7,236 of outstanding letters of credit under the secured revolving credit facility as of April 3, 2010.

NOTE 8—COMMITMENTS AND CONTINGENCIES

Legal Proceedings

The Company is involved in various litigation incidental to its business, including alleged contractual claims, claims relating to infringement of intellectual property rights of third parties, claims relating to the manner in which goods are sold through its integrated platform and claims relating to the Company’s collection of sales taxes in certain states. The Company collects sales taxes for goods owned and sold by it and shipped into certain states. As a result, the Company is subject from time to time to claims from other states alleging that the Company failed to collect and remit sales taxes for sales and shipments of products to customers in states.

Based on the merits of the cases and/or the amounts claimed, the Company does not believe that any claims are likely to have a material adverse effect on its business, financial position or results of operations. The Company may, however incur substantial expenses and devote substantial time to defend these claims whether or not such claims are meritorious. In addition, litigation is inherently unpredictable. In the event of a determination adverse to the Company, the Company may incur substantial monetary liability and may be required to implement expensive changes in its business practices, enter into costly royalty or licensing agreements, or begin to collect sales taxes in states in which it previously did not. An adverse determination could have a material adverse effect on the Company’s business, financial position or results of operations. Expenditures for legal costs are expensed as incurred.

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

Operating and Capital Commitments

The following summarizes the Company’s principal operating and capital commitments as of April 3, 2010:

		Payments due by fiscal year
		2010				2011				2012				2013				2014				Thereafter				Total
Operating lease obligations(1)		$	15,539			$	18,738			$	18,476			$	14,375			$	10,876			$	17,662			$	95,666
Purchase obligations and marketing commitments(1)			51,757				13,403				13,403				4,876				3,570				45,000				132,009
Client revenue share payments(1)			13,638				21,400				14,658				4,368				4,491				24,269				82,824
Debt interest(1)			5,632				4,509				4,497				4,481				2,278				8,784				30,181
Debt obligations			57,645				209				563				237				150,253				11,022				219,929
Capital lease obligations, including interest(2)			4,558				6,119				5,815				3,671				1,789				—				21,952
Deferred acquisition payments(3)			1,250				1,050				750				1,000				—				—				4,050
Total		$	150,019			$	65,428			$	58,162			$	33,008			$	173,257			$	106,737			$	586,611

Approximately $2,161 of unrecognized tax benefits have been recorded as liabilities as of April 3, 2010, and the Company is uncertain as to if or when such amounts may be settled; as a result, these obligations are not included in the table above. Changes to these tax contingencies that are reasonably possible in the next 12 months are not expected to be material.

NOTE 9—STOCK AWARDS

The Company currently maintains the 2005 Equity Incentive Plan (“the Plan”) which provides for the grant of equity to certain employees, directors and other persons. As of April 3, 2010, 446 shares of common stock were available for future grants under the Plan. The equity awards granted under the Plan generally vest at various times over periods ranging up to five years and have terms of up to ten years after the date of grant, unless the optionee’s service to the Company is interrupted or terminated.

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

Stock Options and Warrants

The following table summarizes the stock option and warrant activity for the three-month period ended April 3, 2010:

										Weighted
						Weighted				Average
		Number of				Average				Remaining				Aggregate
		Shares				Exercise				Contractual				Intrinsic
		(in thousands)				Price				Life (in years)				Value
Outstanding at January 2, 2010			3,252			$	9.88
Granted			—			$	—
Exercised			(677	)		$	10.25
Forfeited/Cancelled			(1	)		$	14.21
Outstanding at April 3, 2010			2,574			$	9.78				2.68			$	46,598
Vested and expected to vest at April 3, 2010			2,574			$	9.78				2.68			$	46,598
Exercisable at April 3, 2010			2,574			$	9.78				2.68			$	46,598

The Company recognized no stock-based compensation expense for stock options for the three-month periods ended April 3, 2010 and April 4, 2009, as all options were fully vested.

Restricted Stock Units and Awards

The following table summarizes the restricted stock unit and restricted stock award activity for the three-month period ended April 3, 2010:

						Weighted
		Number of				Average
		Shares				Grant Date
		(in thousands)				Fair Value
Nonvested shares at January 2, 2010			4,294			$	16.64
Granted			1,081			$	27.48
Vested			(1,089	)		$	15.22
Forfeited/Cancelled			(21	)		$	12.20
Nonvested shares at April 3, 2010			4,265			$	19.77

The Company recognized $6,678 and $6,700 of stock-based compensation expense for restricted stock for the three-month periods ended April 3, 2010 and April 4, 2009 respectively.

NOTE 10—INCOME TAXES

At the end of each interim period, the Company estimates its annual effective tax rate and applies that rate to its ordinary year-to-date earnings. FASB’s accounting standards of “Accounting for Income Taxes in Interim Periods,” provides that if in a separate jurisdiction, the Company anticipates an ordinary loss for the year in which a tax benefit cannot be recognized in accordance with the FASB’s standards of “Accounting for Income Taxes,” then the Company excludes the ordinary loss in that jurisdiction and the related tax benefit from the computation of its estimated annual effective tax rate. In addition, the effect of changes in enacted tax laws, rates or tax status is recognized in the interim period in which the change occurs, however, the related benefit or expense is excluded from the annual effective tax rate. The tax expense or benefit related to significant, unusual, or extraordinary items are individually computed and recognized as a discrete item in the interim period in which the item occurs.

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

The computation of the annual estimated effective tax rate at each interim period requires certain estimates and significant judgment including, but not limited to, the expected operating income for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent and temporary differences as a result of differences between amounts measured and recognized in accordance with tax laws and financial accounting standards, and the likelihood of recovering deferred tax assets. The accounting estimates used to compute the provision for income taxes may change as new events occur, additional information is obtained or as the tax environment changes. The Company has a historical seasonal pattern of reporting a net loss before income taxes in the first three quarters of its fiscal year offset by income before income taxes in its fiscal fourth quarter. The Company recognizes a tax benefit and increases its deferred tax assets in its interim periods as realization of the tax benefit at the end of the fiscal year is more likely than not.

The Company’s tax provision for the three months ended April 3, 2010 was determined using an estimate of its annual effective tax rate which is 65.3% for fiscal 2010 plus any discrete items that affect taxes that occur during the quarter. The effective tax rate is higher than the 35% federal statutory tax rate primarily due to non-deductible permanent items. Estimated annual losses from international operations yield no tax benefit and were removed from the calculation of the estimated annual effective tax rate. The Company does not provide for U.S. taxes on its undistributed earnings of foreign subsidiaries, if any, since it intends to invest such undistributed earnings indefinitely outside of the U.S.

The Company’s reported effective tax rate for the three months ended April 3, 2010 was 55.8%. The annual effective tax rate of 65.3% was different from the actual tax rate of 55.8% primarily due to losses in foreign operations that generate no tax benefit and therefore are not included in the pre-tax book income calculation for the annual effective tax rate partially offset by the benefit from certain discrete items.

The reported effective tax rate for the three months ended April 4, 2009 was 37.6%. The annual effective tax rate of 37.9% was different from the actual tax rate of 37.6% primarily due to the benefit from certain discrete state items partially offset by losses in foreign operations that generate no tax benefit and therefore they are not included in the pre-tax book income calculation for the annual effective tax rate.

The total amount of liabilities, interest and penalties related to uncertain tax positions and recognized in the Condensed Consolidated Balance Sheets were $2,161 as of April 3, 2010, and $2,052 as of January 2, 2010. The Company recorded an increase in liabilities, including interest and penalties for uncertain tax positions that were recorded as income tax expense of $109 for the three month period ended April 3, 2010 and an income tax expense of $85 for the three month period ended April 4, 2009.

NOTE 11—LOSS PER SHARE

Basic and diluted net loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the fiscal year.

The following is a summary of the securities outstanding during the respective periods that have been excluded from the calculations because the effect on net loss per share would have been anti-dilutive for the three-month periods ended:

		April 4,				April 3,
		2009				2010
Stock units and awards			4,752				4,265
Stock options and warrants			4,138				2,574
Convertible notes			8,229				8,229
			17,119				15,068

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

NOTE 12 — COMPREHENSIVE LOSS

Comprehensive loss is computed as net loss plus certain other items that are recorded directly to shareholders’ equity in accordance with standards of accounting for “Reporting Comprehensive Income.” Comprehensive loss is calculated as follows:

		Three Months Ended
		April 4,				April 3,
		2009				2010
Net loss		$	(12,110	)		$	(8,125	)
Other comprehensive loss:
Cumulative translation adjustment			(62	)			(703	)
Comprehensive loss		$	(12,172	)		$	(8,828	)

NOTE 13—SEGMENT INFORMATION

The Company operates three reportable segments: e-commerce services, marketing services and consumer engagement. For e-commerce services, the Company delivers customized solutions to its clients through an integrated platform which is comprised of three components: technology, fulfillment and customer care. For marketing services, the Company offers a comprehensive digital and traditional agency and e-mail marketing services that include brand development and strategic account planning, user experience and creative design, marketing, traditional advertising, media buying, video, marketing content and promotional development, e-mail marketing and distribution, Web store usability, and product photography and content development. For consumer engagement, the Company offers an online platform on which retailers and brands can sell excess inventory through private sales as well as in the off-price marketplace.

The Company manages its segments and makes financial decisions and allocates resources based on an internal management reporting process that provides segment revenue and segment operating income before depreciation, amortization, changes in fair value of deferred acquisition payments and stock-based compensation expense. The Company believes that segment operating income before depreciation, amortization, changes in fair value of deferred acquisition payments and stock-based compensation expense is an appropriate measure of evaluating the operational performance of the Company’s segments. The Company also uses these metrics for planning, forecasting and analyzing future periods. However, this measure should be considered in addition to, not as a substitute for, or superior to, income from operations or other measures of financial performance prepared in accordance with GAAP.

The Company manages its working capital on a consolidated basis and does not allocate long-lived assets to segments. Pursuant to accounting standards for “Disclosures about Segments of an Enterprise and Related Information,” total segment assets have not been disclosed.

GSI COMMERCE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)

The following tables present summarized information by segment:

		Three Months Ended April 4, 2009
		E-Commerce				Marketing				Consumer				Intersegment
		Services				Services				Engagement				Eliminations				Consolidated
Net revenues		$	178,510			$	25,122			$	—			$	(7,157	)		$	196,475
Costs and expenses before depreciation, amortization, changes in fair value of deferred acquisition payments and stock-based compensation expense			174,841				20,970				—				(7,157	)			188,654
Operating income before depreciation, amortization, changes in fair value of deferred acquisition payments and stock-based compensation expense			3,669				4,152				—				—				7,821
Depreciation and amortization																			15,401
Changes in fair value of deferred acquisition payments																			—
Stock-based compensation expense																			6,954
Loss from operations																			(14,534	)
Interest expense																			4,796
Interest income																			(151	)
Other expense, net																			229
Loss before income taxes																		$	(19,408	)

		Three Months Ended April 3, 2010
		E-Commerce				Marketing				Consumer				Intersegment
		Services				Services				Engagement				Eliminations				Consolidated
Net revenues		$	201,372			$	38,371			$	44,454			$	(11,605	)		$	272,592
Costs and expenses before depreciation, amortization, changes in fair value of deferred acquisition payments and stock-based compensation expense			193,383				28,804				47,176				(11,605	)			257,758
Operating income (loss) before depreciation, amortization, changes in fair value of deferred acquisition payments and stock-based compensation expense			7,989				9,567				(2,722	)			—				14,834
Depreciation and amortization																			18,761
Changes in fair value of deferred acquisition payments																			2,074
Stock-based compensation expense																			6,931
Loss from operations																			(12,932	)
Interest expense																			5,208
Interest income																			(234	)
Other expense, net																			474
Loss before income taxes																		$	(18,380	)

The Company’s operations are substantially within the United States.

 

NOTE 14—SUBSEQUENT EVENTS

On April 30, 2010, e-Dialog Inc. (“e-Dialog”), a wholly owned subsidiary of the Company, acquired all of the issued and outstanding capital stock of MBS Insight, Inc. (“MBS”), a wholly owned subsidiary of World Marketing, Inc. for $22,500 in cash. The purchase price is subject to increase or decrease, to the extent that the working capital of MBS is more or less than the agreed working capital target of $1,500. MBS is a database marketing solutions provider that offers a unique mix of knowledge-based marketing services and solutions that help marketers innovate, advance, and automate their marketing efforts for greater return on their investment. The Company believes the acquisition of MBS strengthens e-Dialog’s position of providing marketers with an operational, multichannel view of the customer in order to understand customer behavior and preferences in real time.

Due to the timing of the acquisition, the Company has not commenced the process of assigning a fair value to the various tangible and intangible assets acquired, including goodwill, and therefore has not provided fair value information relating to MBS’s assets acquired and liabilities assumed as of the acquisition date.

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

All statements made in this Annual Report on Form 10-Q, other than statements of historical fact, are forward-looking statements, as defined under federal securities law. The words “look forward to,” “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,” “would,” “should,” “could,” “guidance,” “potential,” “opportunity,” “continue,” “project,” “forecast,” “confident,” “prospects,” “schedule,” “designed,” “future” “discussions,” “if” 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. 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 clients operate, changes affecting the Internet e-commerce and marketing service, our ability to develop and maintain relationships with clients and suppliers and the timing of our establishment, extension or termination of our relationships with clients, our ability to timely and successfully develop, maintain and protect our technology, confidential and proprietary information, and product and service offerings, our ability to execute operationally to attract and retain qualified personnel, to successfully integrate our recent acquisitions, and the performance of acquired businesses. More information about potential factors that could affect us are described in Part I, Item 1A in our Form 10-K for the fiscal year ended January 2, 2010, filed with the SEC on March 5, 2010, and in Part II, Item 1A of this Quarterly Report. We expressly disclaim any intent or obligation to update these forward-looking statements.

Executive Overview

First Quarter of Fiscal 2010 Financial Results and Significant Events:

•

Net revenues increased by $76.1 million, or 39%, compared to the first quarter of fiscal 2009. Net revenues from product sales increased by $53.1 million and service fee revenues increased $23.0 million. Net revenues for our consumer engagement segment were $44.4 million from Retail Convergence, Inc. (“Rue La La”), which we acquired in November 2009, our e-commerce services segment increased $22.9 million, and our marketing services segment increased $13.3 million.

•

Net loss was $8.1 million in the first quarter of fiscal 2010, including a benefit for income taxes of $10.3 million, compared to a net loss of $12.1 million in the first quarter of fiscal 2009, including a tax benefit of $7.3 million. Loss from operations improved to $12.9 million in the first quarter of fiscal 2010 compared to a loss of $14.5 million in the first quarter of fiscal 2009.

•

In March 2010, we amended and expanded our existing secured revolving credit facility by $60 million to $150 million. The credit facility is available for letters of credit, working capital and general corporate purposes, including possible acquisitions.

2010 Outlook:

•

We continue to expect an increase in net revenue in fiscal 2010, with the majority of the increase to be generated by our consumer engagement segment. We also expect increased revenues in fiscal 2010 from e-commerce services and marketing services. We expect our income from operations in fiscal 2010 to increase. We expect our capital expenditures to increase in fiscal 2010, and that they will be similar to our capital expenditures in fiscal 2008 as we increase investments in our infrastructure and technology and as we integrate Rue La La. We believe we will have a net loss in fiscal 2010.

Results of Operations

Three-month period ended April 3, 2010 and April 4, 2009 (amounts in tables in millions):

Net Revenues

We derive our net revenues from product sales and service fees.

Net Revenues from Product Sales. Net revenues from product sales are derived from the sale of products owned by us through our clients’ e-commerce Web stores as well as through the Web stores in our consumer engagement segment. Net revenues from product sales include outbound shipping charges for all of our Web stores for which we provide fulfillment services. Net revenues from product sales are net of allowances for returns and discounts and exclude sales tax. We recognize revenue from product sales and shipping when title and risk of ownership passes to the consumer either upon shipment of products to customers or upon receipt of products by customers dependent upon the terms and conditions of the Web store. Our revenue recognition accounting estimates contain uncertainties because they require management to make assumptions and to apply judgment to estimate future sales returns.

Service Fee Revenues. Service fee revenues primarily include revenues from the provision of e-commerce services and marketing services. E-commerce service fee revenues are generated from a client’s use of one or more of our e-commerce platform components, which include technology, fulfillment and customer care, as well as from professional services and gift card breakage. Marketing services service fee revenues are generated from online marketing, advertising, email and design services. E-commerce service fee revenues can be fixed or variable and are based on the activity performed, the value of merchandise sold, or the gross profit from a transaction.

																		First Qtr Fiscal 2010
																		vs.
																		First Qtr Fiscal 2009
		First Qtr Fiscal 2009								First Qtr Fiscal 2010								Increase/(Decrease)				% Change
Net Revenues by Type:
Net revenues from product sales		$	106.2				54	%		$	159.3				58	%		$	53.1				50	%
Service fee revenues			90.3				46	%			113.3				42	%			23.0				25	%
Total net revenues		$	196.5				100	%		$	272.6				100	%		$	76.1				39	%
Net Revenues by Segment:
E-Commerce services		$	178.5				91	%		$	201.4				74	%		$	22.9				13	%
Marketing services			25.1				13	%			38.4				14	%			13.3				53	%
Consumer engagement			—				0	%			44.4				16	%			44.4				100	%
Intersegment eliminations			(7.1	)			(4	%)			(11.6	)			(4	%)			(4.5	)			63	%
Total net revenues		$	196.5				100	%		$	272.6				100	%		$	76.1				39	%

Net Revenues by Type

Net Revenues from Product Sales. Net revenues from product sales increased by $53.1 million in the first quarter of fiscal 2010 primarily due to $44.0 million of revenues from Rue La La which we acquired in November 2009. Shipping revenue for all clients for which we provide fulfillment services increased by $10.4 million, of which $3.9 million was from Rue La La.

Service Fee Revenues. Service fee revenues increased by $23.0 million in the first quarter of fiscal 2010 due to an increase in revenues from our e-commerce services segment and the growth of our marketing services segment. Of the $23.0 million increase, $13.7 million was from our e-commerce services segment primarily due to increases in revenue from clients that operated for the entirety of both periods, $13.3 million was from our marketing services segment which includes $4.5 million of intersegment service fee revenue that is eliminated during corporate consolidation, and $0.5 million was from our consumer engagement segment.

For the remainder of fiscal 2010, we expect total net revenues to increase due to the addition of Rue La La as well as from the continued growth of our e-commerce services and marketing services segments.

Net Revenues by Segment

E-Commerce Services Segment Revenues. Net revenues from e-commerce services increased by $22.9 million in the first quarter of fiscal 2010 due to a $13.8 million increase in service fee revenues and a $9.1 million increase in net revenues from product sales.

Of the $22.9 million increase in net revenues from our e-commerce services segment, $21.0 million was from clients that operated for the entirety of both periods and $1.9 million from clients that began generating revenue for us after the first quarter of fiscal 2009.

Marketing Services Segment Revenues. Net revenues increased by $13.3 million, or 53%, primarily due to growth in TrueAction’s user experience and creative design and online marketing services, as well as the growth of e-Dialog’s e-mail marketing services business.

Consumer Engagement Segment Revenues. Net revenues were $44.4 million and were all attributable to Rue La La which we acquired in November 2009.

Costs and Expenses

Cost of Revenues from Product Sales. Costs of revenues from product sales consist primarily of direct costs associated with (i) products we own that we sell through our clients’ Web stores, (ii) products we own that we sell through the Web stores in our consumer engagement segment, and (iii) shipping expenses for all Web stores for which we provide fulfillment services in our e-commerce segment and all shipping expenses from the Web stores in our consumer engagement segment. Costs of revenues from product sales were attributable to our e-commerce services and consumer engagement segments.

Marketing. Marketing expenses consist primarily of net client revenue share charges, promotional free shipping and subsidized shipping and handling costs, catalog costs, and net advertising and promotional expenses. Marketing expenses support our net revenues from product sales.

Account Management and Operations. Account management and operations expenses consist primarily of costs to operate our fulfillment centers and customer care centers, credit card fees, and payroll related to our buying, business management, operations and sales and marketing functions.

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

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

Depreciation and Amortization. Depreciation and amortization expenses relate primarily to the depreciation or 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; furniture and equipment at our corporate headquarters, fulfillment centers and customer care centers; the office buildings and other facilities owned by us; and acquisition-related intangible assets.

Changes in Fair Value of Deferred Acquisition Payments. Changes in fair value of deferred acquisition payments expenses consist of the change in the fair value of future estimated acquisition payments.

		First Quarter								First Quarter								First Quarter of Fiscal 2010
		of Fiscal 2009								of Fiscal 2010								vs.
						% of								% of				First Quarter of Fiscal 2009
						Net								Net				Increase /
		$				Revenues				$				Revenues				(Decrease)				% Change
Cost of revenues from product sales		$	79.4				41	%		$	117.5				43	%		$	38.1				48	%
Marketing			10.9				6	%			10.8				4	%			(0.1	)			(1	%)
Account management and operations			57.7				29	%			77.7				28	%			20.0				35	%
Product development			28.3				14	%			34.3				13	%			6.0				21	%
General and administrative			19.3				9	%			24.4				9	%			5.1				26	%
Depreciation and amortization			15.4				8	%			18.7				7	%			3.3				21	%
Changes in fair value of deferred acquisition payments			—				0	%			2.1				1	%			2.1				100	%
Total costs and expenses		$	211.0				107	%		$	285.5				105	%		$	74.5				35	%

Cost of Revenues from Product Sales:

		First Qtr				First Qtr
		Fiscal 2009				Fiscal 2010
Cost of revenues from product sales		$	79.4			$	117.5
As a percentage of net revenues from product sales			75	%			74	%

Cost of revenues from product sales increased by $38.1 million in the first quarter of fiscal 2010. The majority of the increase was from Rue La La, and we also had increases from shipping costs. As a percentage of net revenues, cost of revenues from product sales increased from 41% to 43% primarily due to Rue La La. Service fee revenues have no associated cost of revenue. Rue La La’s cost of revenues from product sales as a percentage of net revenues was higher than in our e-commerce business because a substantial majority of Rue La La’s revenues are net revenue from product sales. However, 42% of the total e-commerce net revenues are service fee revenues.

The decrease in cost of revenues from product sales as a percentage of net revenues from product sales from 75% to 74% is due to a decrease in shipping revenue as a percentage of net revenue from product sales from 25% in the first quarter of fiscal 2009 to 23% in the first quarter of fiscal 2010. Our cost of generating shipping revenue is higher than our cost of generating revenues from other product sales.

Marketing:

		First Qtr				First Qtr
		Fiscal 2009				Fiscal 2010
Marketing		$	10.9			$	10.8
As a percentage of net revenues from product sales			10	%			7	%

Marketing expense decreased by $0.1 million in the first quarter of fiscal 2010. As a percentage of net revenues, marketing expenses decreased from 6% to 4%. The decrease in marketing expenses was due to lower client revenue share expenses. The decrease in marketing expenses as a percentage of net revenues was primarily due to both the decreased client revenue share expenses compared to last year, and the addition of Rue La La which does not have significant marketing expenses.

As a percentage of net revenues from product sales, marketing expenses decreased from 10% to 7% primarily due to the lower client revenue share expenses and the addition of Rue La La which does not incur significant marketing expenses. We expect marketing expenses to increase in absolute dollars during fiscal 2010 compared to fiscal 2009. We continue to expect a decrease in marketing expenses as a percentage of net revenues, as the percentage of Rue La La’s marketing expenses to net revenues is lower than with our e-commerce services segment.

Account Management and Operations. Account management and operations expenses increased by $20.0 million in the first quarter of fiscal 2010. As a percentage of net revenues, account management and operations expenses decreased from 29% to 28%. The increase in absolute dollars was primarily due to our acquisitions of Rue La La, Silverlign and Pepperjam in fiscal 2009, an increase in credit card fees due to increased e-commerce transactions on our platform, and increases in personnel and related costs. We expect account management and operations expenses to increase in absolute dollars in fiscal 2010 due to the acquisition of Rue La La and growth in our e-commerce services and marketing services segments.

Product Development. Product development expenses increased by $6.0 million in the first quarter of fiscal 2010. As a percentage of net revenues, product development expenses decreased from 14% to 13%. The increase in absolute dollars was primarily due to our investment to expand our technology platform as well as from the addition of Rue La La. We saw a decrease in product development expenses as a percentage of net revenues because Rue La La’s product development expenses are lower as a percentage of net revenues than our other businesses. We expect product development expenses to increase in absolute dollars in fiscal 2010 due to the acquisition of Rue La La and the expansion of our technology platform.

General and Administrative. General and administrative expenses increased by $5.1 million in the first quarter of fiscal 2010. As a percentage of net revenues, general and administrative expenses remained constant at 9%. The increase in absolute dollars was primarily due to the addition of Rue La La as well as legal fees related to litigation and mergers and acquisition costs. We expect general and administrative expenses to increase in absolute dollars in fiscal 2010 compared to fiscal 2009 primarily due to the addition of Rue La La.

Depreciation and Amortization. Depreciation and amortization expenses increased by $3.3 million in the first quarter of fiscal 2010. As a percentage of net revenues, depreciation and amortization expenses decreased from 8% to 7%. Amortization expenses increased by $1.6 million due to the intangible asset amortization related to the Rue La La acquisition. Depreciation expenses increased by $1.7 million due to the depreciation of Rue La La’s fixed assets and from prior and current year fixed asset additions. We expect our capital expenditures for fiscal 2010 to increase, and we expect depreciation expenses to increase due to the continued depreciation of Rue La La’s fixed assets and as we continue to depreciate capital expenditures made in the current and prior years. We expect amortization expenses to continue to increase in fiscal 2010 compared to fiscal 2009 due to the amortization of intangible assets of Rue La La.

Changes in Fair Value of Deferred Acquisition Payments. Changes in fair value of deferred acquisition payments expenses increased from $0 to $2.1 million in the first quarter of fiscal 2010 due to the acquisition of Rue La La. Assuming the value of the Rue La La earnout does not change, we expect changes in fair value of deferred acquisition payments to continue to increase in fiscal 2010 as we accrete our deferred acquisition payments liability up to the estimated payment amount. Any change in our assumptions about the value of future earnout payments may result in a significant change to our change in fair value of deferred acquisition payments.

Other (Income) Expense

		First Quarter								First Quarter								First Quarter of Fiscal 2010
		of Fiscal 2009								of Fiscal 2010								vs.
						% of								% of				First Quarter of Fiscal 2009
						Net								Net				Increase /
		$				Revenues				$				Revenues				(Decrease)				% Change
Interest expense		$	4.8				1	%		$	5.2				2	%		$	0.4				8	%
Interest income			(0.1	)			0	%			(0.3	)			0	%			(0.2	)			200	%
Other (income) expense			0.2				0	%			0.5				0	%			0.3				150	%
Total other expenses		$	4.9				1	%		$	5.4				2	%		$	0.5				10	%