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EX-2.1 - EXHIBIT 2.1 - GSI COMMERCE INCc04090exv2w1.htm
EX-10.4 - EXHIBIT 10.4 - GSI COMMERCE INCc04090exv10w4.htm
EX-10.6 - EXHIBIT 10.6 - GSI COMMERCE INCc04090exv10w6.htm
EX-32.1 - EXHIBIT 32.1 - GSI COMMERCE INCc04090exv32w1.htm
EX-10.3 - EXHIBIT 10.3 - GSI COMMERCE INCc04090exv10w3.htm
EX-31.1 - EXHIBIT 31.1 - GSI COMMERCE INCc04090exv31w1.htm
EX-10.5 - EXHIBIT 10.5 - GSI COMMERCE INCc04090exv10w5.htm
EX-10.7 - EXHIBIT 10.7 - GSI COMMERCE INCc04090exv10w7.htm
EX-31.2 - EXHIBIT 31.2 - GSI COMMERCE INCc04090exv31w2.htm
Table of Contents

 
 
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
For the quarterly period ended July 3, 2010
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     .
Commission file number 0-16611
 
GSI COMMERCE, INC.
(Exact name of registrant as specified in its charter)
     
     
DELAWARE
(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   Smaller reporting company o
        (Do not check if a smaller reporting company)    
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 66,333,845 shares of the registrant’s Common Stock outstanding as of the close of business on July 28, 2010.
 
 

 

 


 

GSI COMMERCE, INC.
FORM 10-Q
FOR THE QUARTER ENDED JULY 3, 2010
INDEX
         
    Page  
       
 
       
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    20  
 
       
    27  
 
       
    27  
 
       
       
 
       
    28  
 
       
    28  
 
       
    29  
 
       
    30  
 
       
    30  
 
       
    30  
 
       
    30  
 
       
    31  
 
       
 Exhibit 2.1
 Exhibit 10.3
 Exhibit 10.4
 Exhibit 10.5
 Exhibit 10.6
 Exhibit 10.7
 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

 

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PART I
ITEM 1:   FINANCIAL STATEMENTS
GSI COMMERCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
                 
    January 2,     July 3,  
    2010     2010  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 228,430     $ 63,660  
Accounts receivable, net
    70,582       61,078  
Inventory
    55,678       61,945  
Deferred tax assets
    12,347       15,484  
Prepaid expenses and other current assets
    13,187       15,155  
 
           
Total current assets
    380,224       217,322  
 
               
Property and equipment, net
    163,329       172,981  
Goodwill
    373,003       395,541  
Intangible assets, net
    132,875       154,614  
Long-term deferred tax assets
          10,925  
Other assets, net
    12,417       30,667  
 
           
Total assets
  $ 1,061,848     $ 982,050  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
  $ 126,914     $ 70,107  
Accrued expenses
    150,173       114,194  
Deferred revenue
    20,645       21,026  
Convertible notes
    55,443        
Current portion — long-term debt
    5,260       7,529  
 
           
Total current liabilities
    358,435       212,856  
 
               
Convertible notes
    116,948       120,102  
Long-term debt
    28,142       27,138  
Deferred acquisition payments
    63,763       67,161  
Deferred tax liabilities
    8,534        
Deferred revenue and other long-term liabilities
    9,686       9,447  
 
           
Total liabilities
    585,508       436,704  
 
               
Commitments and contingencies
               
 
               
Stockholders’ equity:
               
Preferred stock, $0.01 par value:
               
Authorized shares — 5,000
               
Issued and outstanding shares — none
           
Common stock, $0.01 par value:
               
Authorized shares — 90,000 and 180,000
               
Issued and outstanding shares — 60,033 and 66,327
    600       663  
Additional paid in capital
    642,852       747,160  
Accumulated other comprehensive loss
    (1,498 )     (3,007 )
Accumulated deficit
    (165,614 )     (199,470 )
 
           
Total stockholders’ equity
    476,340       545,346  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 1,061,848     $ 982,050  
 
           
 
               
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
                                 
    Three Months Ended     Six Months Ended  
    July 4,     July 3,     July 4,     July 3,  
    2009     2010     2009     2010  
 
                               
Revenues:
                               
Net revenues from product sales
  $ 91,192     $ 146,154     $ 197,383     $ 305,429  
Service fee revenues
    95,989       118,075       186,273       231,391  
 
                       
 
                               
Net revenues
    187,181       264,229       383,656       536,820  
 
                               
Costs and expenses:
                               
Cost of revenues from product sales
    70,442       107,452       149,797       224,926  
Marketing
    7,054       7,702       17,915       18,509  
Account management and operations
    59,055       79,295       116,796       156,989  
Product development
    28,101       42,062       56,475       76,379  
General and administrative
    19,527       27,689       38,804       52,087  
Depreciation and amortization
    15,279       20,575       30,680       39,335  
Changes in fair value of deferred acquisition payments
          2,074             4,148  
 
                       
 
                               
Total costs and expenses
    199,458       286,849       410,467       572,373  
 
                       
 
                               
Loss from operations
    (12,277 )     (22,620 )     (26,811 )     (35,553 )
 
                               
Other (income) expense:
                               
Interest expense
    4,759       4,739       9,555       9,947  
Interest income
    (54 )     (71 )     (205 )     (305 )
Other (income) expense
    (394 )     938       (165 )     1,412  
 
                       
 
                               
Total other expense
    4,311       5,606       9,185       11,054  
 
                       
 
                               
Loss before income taxes
    (16,588 )     (28,226 )     (35,996 )     (46,607 )
Benefit for income taxes
    (3,475 )     (2,495 )     (10,773 )     (12,751 )
 
                       
 
                               
Net loss
  $ (13,113 )   $ (25,731 )   $ (25,223 )   $ (33,856 )
 
                       
 
                               
Basic and diluted loss per share
  $ (0.27 )   $ (0.41 )   $ (0.52 )   $ (0.55 )
 
                       
 
                               
Weighted average shares outstanding — basic and diluted
    48,681       63,286       48,304       61,866  
 
                       
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
                 
    Six Months Ended  
    July 4,     July 3,  
    2009     2010  
 
       
Cash Flows from Operating Activities:
               
Net loss
  $ (25,223 )   $ (33,856 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation
    25,821       30,252  
Amortization
    4,859       9,083  
Amortization of discount on convertible notes
    5,092       5,180  
Changes in fair value of deferred acquisition payments
          4,148  
Stock-based compensation
    13,046       14,670  
Foreign currency transaction losses
    (153 )     1,414  
Deferred income taxes
    (10,737 )     (13,812 )
Changes in operating assets and liabilities:
               
Accounts receivable, net
    28,156       12,701  
Inventory
    5,721       (6,267 )
Prepaid expenses and other current assets
    (923 )     (1,263 )
Other assets, net
    1,824       352  
Accounts payable and accrued expenses
    (97,290 )     (95,832 )
Deferred revenue
    155       (1,817 )
 
           
 
               
Net cash used in operating activities
    (49,652 )     (75,047 )
 
               
Cash Flows from Investing Activities:
               
Payments for acquisitions of businesses, net of cash acquired
    (2,273 )     (47,355 )
Cash paid for property and equipment, including internal use software
    (17,929 )     (34,298 )
Purchase of investments
          (18,391 )
Release from restricted cash escrow funds
    1,052        
 
           
 
               
Net cash used in investing activities
    (19,150 )     (100,044 )
 
               
Cash Flows from Financing Activities:
               
Debt issuance costs paid
    (42 )     (887 )
Repayments of capital lease obligations
    (2,353 )     (2,912 )
Repayments of mortgage note
    (91 )     (97 )
Excess tax benefit in connection with exercise of stock options and awards
          978  
Proceeds from exercise of common stock options
    522       14,675  
 
           
 
               
Net cash provided by (used in) financing activities
    (1,964 )     11,757  
 
               
Effect of exchange rate changes on cash and cash equivalents
    284       (1,436 )
 
           
 
               
Net decrease in cash and cash equivalents
    (70,482 )     (164,770 )
Cash and cash equivalents, beginning of period
    130,315       228,430  
 
           
 
               
Cash and cash equivalents, end of period
  $ 59,833     $ 63,660  
 
           
 
               
Supplemental Cash Flow Information
               
Cash paid during the period for interest
  $ 4,080     $ 4,428  
Cash paid during the period for income taxes
    2,352       603  
Noncash Investing and Financing Activities:
               
Accrual for purchases of property and equipment
    4,494       2,964  
Equipment financed under capital lease
          4,136  
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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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 $38,804 of amounts payable to the Company’s clients and accrued payroll of $20,953 as of July 3, 2010. No other item included in accrued expenses was greater than 5% of total current liabilities as of July 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, a guaranteed annual amount, or both. Client revenue share charges were $4,288 and $10,466 for the three- and six-month periods ended July 3, 2010 and $5,013 and $12,287 for the three- and six-month periods ended July 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 $24,330 and $49,415 for the three- and six-month periods ended July 3, 2010 and $19,462 and $39,810 for the three- and six-month periods ended July 4, 2009, and are included in account management and operations expenses in the Condensed Consolidated Statements of Operations.

 

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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”):
                 
                Effective Date for The
Subject   Date Issued   Summary   Effect of Adoption   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 July 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
  $ 3,577     $     $  
Liabilities
                       
Deferred acquisition payments(2)
  $     $     $ 65,111  
     
(1)   Cash and cash equivalents totaled $63,660 as of July 3, 2010, and were comprised of $3,577 of money market mutual funds and $60,083 of bank deposits. Cash and cash equivalents totaled $228,430 as of January 2, 2010, and were comprised of $13,606 of money market mutual funds and $214,824 of bank deposits.
 
(2)   Deferred acquisition payments represent the fair value of estimated acquisition payments that are contingent upon Retail Convergence, Inc. (“Rue La La”) achieving specified minimum earnings thresholds over one or more years. The Company utilized a discounted cash flow model and a discount rate of 13.6% to determine fair value. The Company accreted $2,074 and $4,148 of its deferred acquisition payments from the acquisition date of Rue La La during the three- and six-month periods ended July 3, 2010 and $0 during the three- and six-month periods ended July 4, 2009, and the corresponding charge was recorded to changes in fair value of deferred acquisition payments on the Condensed Consolidated Statements of Operations.

 

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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     Six Months Ended  
    July 3, 2010     July 3, 2010  
 
               
Balance, beginning of period
  $ 63,037     $ 60,963  
Changes in fair value of deferred acquisition payments included in the Company’s Condensed Consolidated Statements of Operations
    2,074       4,148  
 
           
 
               
Balance, end of period
  $ 65,111     $ 65,111  
 
           
NOTE 4—PROPERTY AND EQUIPMENT
The major classes of property and equipment, at cost, as of January 2, 2010 and July 3, 2010 are as follows:
                 
    January 2,     July 3,  
    2010     2010  
Computer hardware and software
  $ 231,954     $ 264,284  
Building and building improvements
    44,822       44,923  
Furniture, warehouse and office equipment, and other
    45,722       46,556  
Land
    7,889       7,889  
Leasehold improvements
    8,847       10,279  
Capitalized leases
    29,132       33,315  
 
           
 
               
 
    368,366       407,246  
Less: Accumulated depreciation
    (205,037 )     (234,265 )
 
           
 
               
Property and equipment, net
  $ 163,329     $ 172,981  
 
           
The Company’s net book value in capital leases was $19,729 as of July 3, 2010 and $18,500 as of January 2, 2010. The Company’s capital leases primarily relate to warehouse equipment, computer hardware, and computer software. The depreciation of capital leases is included within depreciation and amortization expense on the Condensed Consolidated Statements of Operations. Interest expense recorded on capital leases was $322 and $643 for the three- and six-month periods ended July 3, 2010 and $373 and $769 for the three- and six-month periods ended July 4, 2009.

 

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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  
Acquisitions
    2,556       20,708             23,264  
Foreign currency translation
    (726 )                 (726 )
 
                       
July 3, 2010
  $ 84,920     $ 137,733     $ 172,888     $ 395,541  
 
                       
The Company’s intangible assets are as follows:
                         
                    Weighted-  
    January 2,     July 3,     Average  
    2010     2010     Life  
                (in years)  
Gross carrying value of intangible assets subject to amortization:
                       
Customer contracts
  $ 41,190     $ 56,148       2.5  
Member relationships
    22,200       22,200       2.6  
Supplier relationships
    11,186       11,186       3.4  
Non-compete agreements
    4,079       4,481       3.0  
Purchased technology
    4,805       13,723       3.6  
Trade names
    840       840       1.5  
Foreign currency translation
    (482 )     (606 )        
 
                 
 
    83,818       107,972       2.7  
Accumulated amortization:
                       
Customer contracts
    (22,907 )     (26,721 )        
Member relationships
    (489 )     (3,569 )        
Supplier relationships
          (472 )        
Non-compete agreements
    (2,888 )     (3,590 )        
Purchased technology
    (2,428 )     (3,332 )        
Trade names
    (532 )     (624 )        
Foreign currency translation
    72       146          
 
                 
 
    (29,172 )     (38,162 )        
Net carrying value:
                       
Customer contracts
    18,283       29,427          
Member relationships
    21,711       18,631          
Supplier relationships
    11,186       10,714          
Non-compete agreements
    1,191       891          
Purchased technology
    2,377       10,391          
Trade names
    308       216          
Foreign currency translation
    (410 )     (460 )        
 
                 
Total intangible assets subject to amortization, net
    54,646       69,810          
 
       
Indefinite life intangible assets:
                       
Trade names
    78,229       84,804          
 
                 
Total intangible assets
  $ 132,875     $ 154,614          
 
                 

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
Amortization expense of intangible assets was $4,959 and $9,064 for the three- and six-month periods ended July 3, 2010 and $2,514 and $4,962 for the three- and six-month periods ended July 4, 2009. Estimated future amortization expense related to intangible assets as of July 3, 2010, is as follows:
         
Fiscal 2010
  $ 11,027  
Fiscal 2011
    20,922  
Fiscal 2012
    16,122  
Fiscal 2013
    12,452  
Fiscal 2014
    8,044  
Thereafter
    1,243  
 
     
 
  $ 69,810  
 
     
NOTE 6—ACQUISITIONS AND INVESTMENT
The Company accounts for acquisitions using the acquisition method of accounting. Under the acquisition method, assets acquired and liabilities assumed from acquisitions are recorded at their fair values as of the acquisition date. Any excess of the purchase price over the fair values of the net assets acquired are recorded as goodwill. The Company’s purchased intangible assets and goodwill are not deductible for tax purposes. However, acquisition method accounting allows for the establishment of deferred tax liabilities on purchased intangible assets, other than goodwill.
MBS
On April 30, 2010, the Company acquired 100% of the issued and outstanding capital stock of MBS Insight, Inc. (“MBS”), a wholly owned subsidiary of World Marketing, Inc. for $22,200. MBS is a database marketing solutions provider that offers a knowledge-based marketing services and solutions that help marketers innovate, advance, and automate their marketing efforts for greater return on their investment. The acquisition strengthens e-Dialog’s suite of products providing marketers with an operational, multichannel view of customers in order to understand customer behavior and preferences in real time.
The table below summarizes the fair values of the MBS’s assets and acquired liabilities assumed, including cash acquired, as of acquisition date:
         
Total current assets
  $ 2,472  
Property, plant, and equipment
    949  
Goodwill
    11,563  
Indentifiable intangible assets:
       
Customer relationships
    8,611  
Technology
    2,551  
Trade name
    1,710  
 
     
Total assets acquired
    27,856  
 
       
Total current liabilities
    (1,476 )
Long-term deferred tax liabilities
    (4,180 )
 
     
Total liabilities assumed
    (5,656 )
 
     
 
       
Net Assets Acquired
  $ 22,200  
 
     

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
Rue La La
In November 2009, the Company completed the acquisition of substantially all of the outstanding common stock of Rue La La pursuant to the terms of an Agreement and Plan of Merger dated October 27, 2009. In December 2009, the Company acquired the remaining outstanding common stock of Rue La La.
Other Acquisitions
During the six months ended July 3, 2010, the Company made three other acquisitions. The results of operations for these acquisitions have been included in the Company’s Condensed Consolidated Statements of Operations since their respective acquisition dates and were not material to its consolidated financial statements.
Unaudited Pro Forma Financial Information
The financial information in the table below summarizes the combined results of operations of the Company, MBS, 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     Six Months Ended  
    July 4,     July 3,     July 4,     July 3,  
    2009     2010     2009     2010  
Net revenues
  $ 223,258     $ 265,611     $ 449,593     $ 542,483  
Net loss
  $ (15,631 )   $ (25,791 )   $ (33,263 )   $ (34,174 )
Equity Method Investment
During the second quarter of fiscal 2010 the Company purchased 27% of the common stock of Intershop Communications AG (“Intershop”), a provider of e-commerce software based in Germany and publicly traded on the Frankfurt Stock Exchange, for $18,391. The Company accounts for this investment using the equity method of accounting, and monitors its investment periodically to evaluate whether any changes in fair value below its cost basis become other-than-temporary. The Company has elected to record its share of earnings/losses for Intershop on a one quarter lag due to timeliness considerations. The Company’s investment in Intershop is included in other assets, net on the Company’s Condensed Consolidated Balance Sheets.

 

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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,     July 3,  
    2010     2010  
 
               
Convertible notes
  $ 172,391     $ 120,102  
Notes payable (1)
    12,479       12,382  
Capital lease obligations
    20,923       22,285  
Line of credit
           
 
           
 
               
Total debt
    205,793       154,769  
Less: Current portion of convertible notes
    (55,443 )      
Less: Current portion of notes payable
    (195 )     (202 )
Less: Current portion of capital lease obligations
    (5,065 )     (7,327 )
 
           
 
               
Total long-term debt
  $ 145,090     $ 147,240  
 
           
     
(1)   The estimated fair market value of the notes payable approximated their carrying value as of July 3, 2010 and January 2, 2010.
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.
In April 2010, the Company called the notes for redemption and in June 2010, the Company issued 3,227 shares of common stock upon the conversion of $57,469 of the 3% convertible notes at the election of the holders of the notes, which was recorded as an increase to additional paid in capital on the Condensed Consolidated Balance Sheets. The Company paid $31 for the remaining 3% convertible notes that were not converted by the holders of the notes.
The following table provides additional information about the Company’s 3% convertible notes:
                 
    As of     As of  
    January 2, 2010     July 3, 2010  
Carrying amount of the equity component
  $ 18,187     $  
Principal amount of the liability component
  $ 57,500     $  
Unamortized discount of liability component
  $ 2,057     $  
Net carrying amount of liability component
  $ 55,443     $  
The following table provides the components of interest expense for the Company’s 3% convertible notes:
                                 
    Three Months Ended     Six Months Ended  
    July 4,     July 3,     July 4,     July 3,  
    2009     2010     2009     2010  
Amortization of the discount on the liability component
  $ 1,097     $ 821     $ 2,193     $ 2,053  
Contract interest coupon
    432       288       863       719  
Amortization of the liability component of the issue costs
    94       69       191       173  
 
                       
Interest expense
  $ 1,623     $ 1,178     $ 3,247     $ 2,945  
 
                       

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
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 $27.67 on July 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     July 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     $ 29,898  
Net carrying amount of liability component
  $ 116,948     $ 120,102  
Remaining amortization period of discount
          47 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     Six Months Ended  
    July 4,     July 3,     July 4,     July 3,  
    2009     2010     2009     2010  
Amortization of the discount on the liability component
  $ 1,449     $ 1,577     $ 2,899     $ 3,154  
Contract interest coupon
    937       937       1,875       1,875  
Amortization of the liability component of the issue costs
    114       119       226       238  
 
                       
Interest expense
  $ 2,500     $ 2,633     $ 5,000     $ 5,267  
 
                       
The estimated fair market value of the 2.5% subordinated convertible notes was $164,520 as of July 3, 2010 and $157,125 as of January 2, 2010 based on quoted market prices.
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 $8,262 of outstanding letters of credit under the secured revolving credit facility as of July 3, 2010.

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
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-commerce 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 such other 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.
Operating and Capital Commitments
The following summarizes the Company’s principal operating and capital commitments as of July 3, 2010:
                                                         
    Payments due by fiscal year  
    2010     2011     2012     2013     2014     Thereafter     Total  
 
                                                       
Operating lease obligations(1)
  $ 10,684     $ 20,715     $ 20,870     $ 16,678     $ 13,212     $ 21,216     $ 103,375  
Purchase obligations and marketing commitments(1)
    76,468       12,386       13,403       6,875       5,570       45,000       159,702  
Client revenue share payments(1)
    8,824       21,400       22,158       23,368       15,991       33,269       125,010  
Debt interest(1)
    2,802       4,509       4,498       4,481       2,277       8,784       27,351  
Debt obligations
    99       209       563       237       150,253       11,022       162,383  
Capital lease obligations, including interest(2)
    3,872       8,168       7,085       3,819       1,800             24,744  
Deferred acquisition payments(3)
    500       1,500       750       1,000                   3,750  
 
                                         
 
                                                       
Total
  $ 103,249     $ 68,887     $ 69,327     $ 56,458     $ 189,103     $ 119,291     $ 606,315  
 
                                         
     
(1)   Not required to be recorded in the Condensed Consolidated Balance Sheet as of July 3, 2010 in accordance with accounting principles generally accepted in the United States of America.
 
(2)   Capital lease obligations, excluding interest, are recorded in the Condensed Consolidated Balance Sheets.
 
(3)   The $3,750 of deferred acquisition payments in the table above represent fixed contractual future payments. The Company is also obligated to pay up to an additional $208,400 from fiscal 2011 through fiscal 2016 based on the achievement of certain financial targets by some of our acquired companies, of which the Company has the ability to pay up to $45,800 with shares of the Company’s common stock. 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.

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
Approximately $3,005 of unrecognized tax benefits have been recorded as liabilities as of July 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
In May 2010, the Company’s stockholders approved the 2010 Equity Incentive Plan (“2010 Plan”). The 2010 Plan authorizes the award of 3,500 shares of the Company’s common stock. In addition, any outstanding stock awards previously granted under the Company’s 2005 Equity Incentive Plan (the “2005 Plan”) or the Company’s Amended and Restated 1996 Equity Incentive Plan that expire, are terminated, cancelled or forfeited, or are withheld in satisfaction of payment of withholding taxes after May 28, 2010 will become available for grant under the 2010 Plan. The 2010 Plan will terminate on March 2, 2020, after which no further awards may be granted under the 2010 Plan.
In May 2010, the Company’s stockholders also approved an increase to the total number of authorized shares of common stock from 90,000 shares to 180,000 shares.
As of July 3, 2010, 3,594 shares of common stock were available for future grants under the 2010 Plan. The equity awards granted under the Plan generally vest at various times over periods ranging up to five years and have terms of up to ten years after the date of grant, unless the optionee’s service to the Company is interrupted or terminated.
Stock Options and Warrants
The following table summarizes the stock option and warrant activity for the six-month period ended July 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
    (1,649 )   $ 8.90                  
Forfeited/Cancelled
    (1 )   $ 14.21                  
 
                             
 
                               
Outstanding at July 3, 2010
    1,602     $ 10.88       3.07     $ 26,891  
 
                             
Vested and expected to vest at July 3, 2010
    1,602     $ 10.88       3.07     $ 26,891  
 
                             
Exercisable at July 3, 2010
    1,602     $ 10.88       3.07     $ 26,891  
 
                             
Restricted Stock Units and Awards
The following table summarizes the restricted stock unit and restricted stock award activity for the six-month period ended July 3, 2010:
                 
            Weighted  
    Number of     Average  
    Shares     Grant Date  
    (in thousands)     Fair Value  
Nonvested shares at January 2, 2010
    4,294     $ 16.64  
Granted
    1,323     $ 27.42  
Vested
    (1,537 )   $ 14.16  
Forfeited/Cancelled
    (216 )   $ 16.26  
 
             
 
               
Nonvested shares at July 3, 2010
    3,864     $ 21.34  
 
             

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
Stock-based Compensation Expense
The following table summarizes stock-based compensation expense included on the Company’s Condensed Consolidated Statements of Operations:
                                 
    Three Months Ended     Six Months Ended  
    July 4,     July 3,     July 4,     July 3,  
    2009     2010     2009     2010  
Includes stock-based compensation as follows:
                               
Account management and operations
  $ 2,394     $ 3,422     $ 4,650     $ 5,868  
Product development
  $ 1,185     $ 1,759     $ 2,636     $ 3,628  
General and administrative
  $ 2,513     $ 2,558     $ 5,760     $ 5,174  
NOTE 10—INCOME TAXES
In the first quarter of fiscal 2010, the Company’s tax provision was determined using an estimate of its annual effective rate of 65.3% plus any discrete items that occurred during the quarter. In the second quarter of fiscal 2010, due to the Company’s fiscal 2010 projected pre-tax income/loss being close to breakeven as well as the impact of the Company’s acquisitions made during the second quarter and other factors, small variations to the full-year projection would result in material variability in the Company’s estimated annual effective rate. Therefore, the Company has calculated the second quarter tax provision using a calculation of the actual tax rate on the actual results for the six months ended July 3, 2010, which is the best estimate of the Company’s estimated annual effective tax rate. Using this approach, the Company’s year-to-date effective tax rate is 23.4% for the six months ended July 3, 2010, while the reported effective tax rate for the six months ended July 3, 2010 is 27.4%. The difference between the year-to-date effective and the reported effective tax rate is due to discrete items. Both rates are lower than the 35% federal statutory tax rate primarily due to non-deductible permanent items and certain losses in foreign operations that generate no tax benefit. 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 reported effective tax rate for the six months ended July 4, 2009 was 29.9%. The estimated annual effective tax rate of 31.5% was different from the actual tax rate of 29.9% 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 $3,005 as of July 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 $845 and $954 for the three- and six-month periods ended July 3, 2010 and an income tax expense of $86 and $171 for the three- and six-month periods ended July 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.

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
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- and six-month periods ended:
                 
    July 4,     July 3,  
    2009     2010  
Stock units and awards
    4,465       3,864  
Stock options and warrants
    4,047       1,602  
Convertible notes
    8,229       5,000  
 
           
 
    16,741       10,466  
 
           
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     Six Months Ended  
    July 4,     July 3,     July 4,     July 3,  
    2009     2010     2009     2010  
 
                               
Net loss
  $ (13,113 )   $ (25,731 )   $ (25,223 )   $ (33,856 )
Other comprehensive loss:
                               
Cumulative translation adjustment
    845       (806 )     782       (1,509 )
 
                       
 
                               
Comprehensive loss
  $ (12,268 )   $ (26,537 )   $ (24,441 )   $ (35,365 )
 
                       
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 through an integrated platform which is comprised of technology, fulfillment and customer care and is available on a modular basis or as part of an integrated, end-to-end solution. For marketing services, the Company offers a full suite of interactive marketing services. For consumer engagement, the Company provides brands and retailers a platform for online private sales through RueLaLa.com. In addition, the consumer engagement segment includes expenses for the start up of a new business called ShopRunner.
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 profit (loss) before depreciation, amortization, changes in fair value of deferred acquisition payments and stock-based compensation expense. Beginning in the second quarter of fiscal 2010, the Company also excludes the following expenses from its segment profit (loss): acquisition related integration, transaction, due diligence expenses, non-cash inventory valuation adjustments, and the cash portion of deferred acquisition payments recorded as compensation expense. The Company has conformed its prior period segment results disclosed in this footnote to reflect this change. The Company believes this metric is an appropriate measure of evaluating the operational performance of the Company’s segments. The Company also uses this metric 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.

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
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.
The following table’s present summarized information by segment:
                                         
    Three Months Ended July 4, 2009  
    E-Commerce     Marketing     Consumer     Intersegment        
    Services     Services     Engagement     Eliminations     Consolidated  
Net revenues
  $ 163,770     $ 28,486     $     $ (5,075 )   $ 187,181  
 
                                       
Segment costs and expenses
    160,843       22,154             (5,075 )     177,922  
 
                             
 
                                       
Segment profit
    2,927       6,332                   9,259  
Acquisition related integration, transaction, due diligence expenses, non-cash inventory valuation adjustments, and the cash portion of deferred acquisition payments recorded as compensation expense
                                    165  
Depreciation and amortization
                                    15,279  
Changes in fair value of deferred acquisition payments
                                     
Stock-based compensation expense
                                    6,092  
 
                                     
Loss from operations
                                    (12,277 )
 
                                       
Interest expense
                                    4,759  
Interest income
                                    (54 )
Other expense, net
                                    (394 )
 
                                     
Loss before income taxes
                                  $ (16,588 )
 
                                     
                                         
    Three Months Ended July 3, 2010  
    E-Commerce     Marketing     Consumer     Intersegment        
    Services     Services     Engagement     Eliminations     Consolidated  
Net revenues
  $ 187,872     $ 44,040     $ 51,686     $ (19,369 )   $ 264,229  
 
                                       
Segment costs and expenses
    181,959       35,735       54,091       (19,369 )     252,416  
 
                             
 
                                       
Segment profit (loss)
    5,913       8,305       (2,405 )           11,813  
Acquisition related integration, transaction, due diligence expenses, non-cash inventory valuation adjustments, and the cash portion of deferred acquisition payments recorded as compensation expense
                                    4,045  
Depreciation and amortization
                                    20,575  
Changes in fair value of deferred acquisition payments
                                    2,074  
Stock-based compensation expense
                                    7,739  
 
                                     
Loss from operations
                                    (22,620 )
 
                                       
Interest expense
                                    4,739  
Interest income
                                    (71 )
Other expense, net
                                    938  
 
                                     
Loss before income taxes
                                  $ (28,226 )
 
                                     

 

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GSI COMMERCE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
                                         
    Six Months Ended July 4, 2009  
    E-Commerce     Marketing     Consumer     Intersegment        
    Services     Services     Engagement     Eliminations     Consolidated  
Net revenues
  $ 342,280     $ 53,608     $     $ (12,232 )   $ 383,656  
 
                                       
Segment costs and expenses
    334,242       43,107             (12,232 )     365,117  
 
                             
 
                                       
Segment profit
    8,038       10,501                   18,539  
Acquisition related integration, transaction, due diligence expenses, non-cash inventory valuation adjustments, and the cash portion of deferred acquisition payments recorded as compensation expense
                                    1,624  
Depreciation and amortization
                                    30,680  
Changes in fair value of deferred acquisition payments
                                     
Stock-based compensation expense
                                    13,046  
 
                                     
Loss from operations
                                    (26,811 )
 
                                       
Interest expense
                                    9,555  
Interest income
                                    (205 )
Other expense, net
                                    (165 )
 
                                     
Loss before income taxes
                                  $ (35,996 )
 
                                     
                                         
    Six Months Ended July 3, 2010  
    E-Commerce     Marketing     Consumer     Intersegment        
    Services     Services     Engagement     Eliminations     Consolidated  
Net revenues
  $ 389,244     $ 82,411     $ 96,139     $ (30,974 )   $ 536,820  
 
                                       
Segment costs and expenses
    374,123       64,775       99,703       (30,974 )     507,627  
 
                             
 
                                       
Segment profit (loss)
    15,121       17,636       (3,564 )           29,193  
Acquisition related integration, transaction, due diligence expenses, non-cash inventory valuation adjustments, and the cash portion of deferred acquisition payments recorded as compensation expense
                                    6,593  
Depreciation and amortization
                                    39,335  
Changes in fair value of deferred acquisition payments
                                    4,148  
Stock-based compensation expense
                                    14,670  
 
                                     
Loss from operations
                                    (35,553 )
 
                                       
Interest expense
                                    9,947  
Interest income
                                    (305 )
Other expense, net
                                    1,412  
 
                                     
Loss before income taxes
                                  $ (46,607 )
 
                                     
The Company’s operations are substantially within the United States.

 

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
All statements made in this Quarterly Report on Form 10-Q, other than statements of historical fact, are forward-looking statements, 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 to timely and successfully enhance, develop and maintain its product and service offerings; our ability to execute operationally to attract and retain qualified personnel, to successfully integrate our recent acquisitions of other businesses; 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
Second Quarter of Fiscal 2010 Financial Results and Significant Events:
    Net revenues increased by $77.0 million, or 41%, compared to the second quarter of fiscal 2009. Net revenues from product sales increased by $54.9 million and service fee revenues increased $22.1 million.
    Net loss was $25.7 million in the second quarter of fiscal 2010, including a benefit for income taxes of $2.5 million, compared to a net loss of $13.1 million in the second quarter of fiscal 2009, including a benefit for income taxes of $3.5 million. Loss from operations was $22.6 million in the second quarter of fiscal 2010 compared to a loss of $12.3 million in the second quarter of fiscal 2009.
 
    We made the following acquisitions:
    MBS Insight, Inc. (“MBS”), a database solutions provider;
 
    FetchBack, a provider of comprehensive retargeting solutions;
 
    VendorNet, a provider of supply chain management services; and
 
    M3 Mobile, a mobile marketing agency.
    In June 2010, our 3% convertible notes were converted into 3.2 million shares of our common stock.
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 to have a loss from operations in fiscal 2010. We expect our capital expenditures to increase in fiscal 2010 as we increase investments in technology and infrastructure. We believe we will have a net loss in fiscal 2010.
Results of Operations (amounts in tables in millions)
Net Revenues
We derive our net revenues from product sales and service fees.

 

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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 include revenues from the provision of e-commerce services, marketing services, and commissions earned from sales of certain product categories through our consumer engagement segment. 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 the sales of professional services, gift card breakage and the sale of software licenses and related 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. All of the revenues in our marketing services segment are service fee revenues and are derived from selling a broad suite of interactive marketing services.
                                                 
                                    Second Qtr Fiscal 2010  
                                    vs.  
                                    Second Qtr Fiscal 2009  
    Second Qtr Fiscal 2009     Second Qtr Fiscal 2010     Increase/(Decrease)     % Change  
Net Revenues by Type:
                                               
Net revenues from product sales
  $ 91.2       49 %   $ 146.1       55 %   $ 54.9       60 %
Service fee revenues
    96.0       51 %     118.1       45 %     22.1       23 %
 
                                   
Total net revenues
  $ 187.2       100 %   $ 264.2       100 %   $ 77.0       41 %
 
                                   
                                                 
                                    First Six Months of Fiscal 2010  
                                    vs.  
    First Six Months     First Six Months     First Six Months of Fiscal 2009  
    of Fiscal 2009     of Fiscal 2010     Increase/(Decrease)     % Change  
Net Revenues by Type:
                                               
Net revenues from product sales
  $ 197.4       51 %   $ 305.4       57 %   $ 108.0       55 %
Service fee revenues
    186.3       49 %     231.4       43 %     45.1       24 %
 
                                   
Total net revenues
  $ 383.7       100 %   $ 536.8       100 %   $ 153.1       40 %
 
                                   
Net Revenues by Type
Net Revenues from Product Sales. The product sales growth rate was 60% and 55% for the second quarter and first six months of fiscal 2010, respectively. This sales growth rate in both periods primarily reflects the impact of Retail Convergence (“Rue La La”) which we acquired in Q4 2009 and higher shipping revenue offset by a slight decline in other e-commerce product revenue. The increase in shipping revenue is due to increased unit shipments and higher adoption of our QuickShip freight program. The decline in other e-commerce product revenue is primarily due to the continuing transition by one large client from a product sales model to a service fee model. This transition began in the first quarter of fiscal 2009, has steadily progressed, and is expected to be completed by the end of fiscal 2010.
Service Fee Revenues. The service fee growth rate was 23% and 24% for the second quarter and first six months of fiscal 2010, respectively. This growth rate primarily reflects higher e-commerce fees from clients operated during the entirety of both periods, organic growth of marketing services, and the impact of companies acquired over the last twelve months. Higher e-commerce service fees from clients operated during the entirety of both periods were driven by increased consumer purchases offset by lower average fee rates due to volume pricing breaks. Organic marketing services growth was driven by increased spend from existing clients and the addition of new clients. Service fees from companies acquired in the last twelve months consisted of revenues from six companies, including four that were acquired in the second fiscal quarter of 2010.

 

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Supplemental Information
Supplemental information about segment net revenues is as follows:
                                                 
                                    Second Qtr Fiscal 2010  
                                    vs.  
                                    Second Qtr Fiscal 2009  
    Second Qtr Fiscal 2009     Second Qtr Fiscal 2010     Increase/(Decrease)     % Change  
Net Revenues by Segment:
                                               
E-Commerce services
  $ 163.8       88 %   $ 187.9       71 %   $ 24.1       15 %
Marketing services
    28.5       15 %     44.0       17 %     15.5       54 %
Consumer engagement
          0 %     51.7       19 %     51.7       100 %
Intersegment eliminations
    (5.1 )     (3 %)     (19.4 )     (7 %)     (14.3 )     280 %
 
                                   
Total net revenues
  $ 187.2       100 %   $ 264.2       100 %   $ 77.0       41 %
 
                                   
                                                 
                                    First Six Months of Fiscal 2010  
                                    vs.  
    First Six Months     First Six Months     First Six Months of Fiscal 2009  
    of Fiscal 2009     of Fiscal 2010     Increase/(Decrease)     % Change  
Net Revenues by Segment:
                                               
E-Commerce services
  $ 342.3       89 %   $ 389.3       73 %   $ 47.0       14 %
Marketing services
    53.6       14 %     82.4       15 %     28.8       54 %
Consumer engagement
          0 %     96.1       18 %     96.1       100 %
Intersegment eliminations
    (12.2 )     (3 %)     (31.0 )     (6 %)     (18.8 )     154 %
 
                                   
Total net revenues
  $ 383.7       100 %   $ 536.8       100 %   $ 153.1       40 %
 
                                   
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 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, business development 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 offices, fulfillment centers and customer care centers; the office buildings and other facilities owned by us; and acquisition-related intangible assets.

 

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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.
                                                 
                                    Second Quarter of Fiscal 2010  
    Second Quarter     Second Quarter     vs.  
    of Fiscal 2009     of Fiscal 2010     Second Quarter of Fiscal 2009  
            % of             % of              
            Net             Net     Increase/        
    $     Revenues     $     Revenues     (Decrease)     % Change  
Cost of revenues from product sales
  $ 70.4       38 %   $ 107.4       41 %   $ 37.0       53 %
Marketing
    7.1       4 %     7.7       3 %     0.6       8 %
Account management and operations
    59.1       32 %     79.3       30 %     20.2       34 %
Product development
    28.1       15 %     42.0       16 %     13.9       49 %
General and administrative
    19.5       10 %     27.7       10 %     8.2       42 %
Depreciation and amortization
    15.3       8 %     20.6       8 %     5.3       35 %
Changes in fair value of deferred acquisition payments
          0 %     2.1       1 %     2.1       100 %
 
                                   
Total costs and expenses
  $ 199.5       107 %   $ 286.8       109 %   $ 87.3       44 %
 
                                   
                                                 
                                    First Six Months of Fiscal 2010  
    First Six Months     First Six Months     vs.  
    of Fiscal 2009     of Fiscal 2010     First Six Months of Fiscal 2009  
            % of             % of              
            Net             Net     Increase /        
    $     Revenues     $     Revenues     (Decrease)     % Change  
Cost of revenues from product sales
  $ 149.8       39 %   $ 224.9       42 %   $ 75.1       50 %
Marketing
    17.9       5 %     18.5       4 %     0.6       3 %
Account management and operations
    116.8       30 %     157.0       29 %     40.2       34 %
Product development
    56.5       15 %     76.4       14 %     19.9       35 %
General and administrative
    38.8       10 %     52.1       10 %     13.3       34 %
Depreciation and amortization
    30.7       8 %     39.3       7 %     8.6       28 %
Changes in fair value of deferred acquisition payments
          0 %     4.2       1 %     4.2       100 %
 
                                   
Total costs and expenses
  $ 410.5       107 %   $ 572.4       107 %   $ 161.9       39 %
 
                                   
Cost of Revenues from Product Sales:
                                 
    Second Qtr     Second Qtr     First Six Months     First Six Months  
    Fiscal 2009     Fiscal 2010     of Fiscal 2009     of Fiscal 2010  
Cost of revenues from product sales
  $ 70.4     $ 107.4     $ 149.8     $ 224.9  
As a percentage of net revenues from product sales
    77 %     74 %     76 %     74 %
Cost of revenues from product sales increased by $37.0 million in the second quarter of fiscal 2010 and $75.1 million in the first six months of fiscal 2010. Almost all of the increase was from Rue La La, acquired in November 2009. The decrease in cost of revenues as a percentage of product sales was primarily due to the inclusion of Rue La La whose gross margins are typically higher than in our e-commerce segment. Gross margins in the e-commerce segment were relatively unchanged.
Marketing:
                                 
    Second Qtr     Second Qtr     First Six Months     First Six Months  
    Fiscal 2009     Fiscal 2010     of Fiscal 2009     of Fiscal 2010  
Marketing
  $ 7.1     $ 7.7     $ 17.9     $ 18.5  
As a percentage of net revenues from product sales
    8 %     5 %     9 %     6 %
Marketing expenses increased by $0.6 million in both the second quarter of fiscal 2010 and in the first six months of fiscal 2010. As a percentage of net revenues from product sales, marketing expenses decreased from 8% to 5% in the second quarter of fiscal 2010 and from 9% to 6% in the first six months of fiscal 2010 due to the increase in product sales from the consumer engagement segment which have lower marketing expenses as a percentage of net revenues from product sales than the e-commerce segment. The absolute dollar increase was primarily driven by marketing expenses in the consumer engagement segment, which did not have expenses in the prior year, partially offset by decreased revenue share expenses in the e-commerce segment.

 

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Account Management and Operations. Account management and operations expenses increased by $20.2 million in the second quarter of fiscal 2010 and $40.2 million in the first six months of fiscal 2010. The increase was due to companies acquired in the last year as well as increased fulfillment expenses and credit card fees driven by increased order and shipment volume.
Product Development. Product development expenses increased by $13.9 million in the second quarter of fiscal 2010 and $19.9 million in the first six months of fiscal 2010. The increase was primarily driven by payroll and professional fees for enhancements to our technology platforms, the expansion and upgrading of our technology operations infrastructure and costs associated with launching new webstores on our platforms. The increase is also related to companies acquired in the last year.
General and Administrative. General and administrative expenses increased by $8.2 million in the second quarter of fiscal 2010 and $13.3 million in the first six months of fiscal 2010. The increase was primarily due to increased payroll and related expenses and professional fees including expenses from the companies acquired in the last year. General and administrative expenses included $3.0 million and $4.3 million of transaction expenses related to the acquisitions made in the second quarter of fiscal 2010 and the first six months of fiscal 2010, respectively.
Depreciation and Amortization. Depreciation and amortization expenses increased by $5.3 million in the second quarter of fiscal 2010 and $8.6 million in the first six months of fiscal 2010. Depreciation expenses increased by $2.7 million and $4.4 million primarily due to an increase in capital expenditures in fiscal 2010 compared to fiscal 2009 as well as depreciation on assets acquired from companies acquired in the past year. Amortization expenses increased by $2.6 million and $4.2 million due to the intangible asset amortization related to the companies acquired in the past year.
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 second quarter of fiscal 2010 and $0 to $4.2 million in the first six months of fiscal 2010 due to the acquisition of Rue La La. Assuming our estimate of 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.

 

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Other (Income) Expense
                                                 
                                    Second Quarter of Fiscal 2010  
    Second Quarter     Second Quarter     vs.  
    of Fiscal 2009     of Fiscal 2010     Second Quarter of Fiscal 2009  
            % of             % of              
            Net             Net     Increase /        
    $     Revenues     $     Revenues     (Decrease)     % Change  
Interest expense
  $ 4.8       2 %   $ 4.8       2 %         $ 0 %
Interest income
    (0.1 )     0 %     (0.1 )     0 %           0 %
Other (income) expense
    (0.4 )     0 %     0.9       0 %     1.3       (325 %)
 
                                   
Total other expense
  $ 4.3       2 %   $ 5.6       2 %   $ 1.3       30 %
 
                                   
                                                 
                                    First Six Months of Fiscal 2010  
    First Six Months     First Six Months     vs.  
    of Fiscal 2009     of Fiscal 2010     First Six Months of Fiscal 2009  
            % of             % of              
            Net             Net     Increase /        
    $     Revenues     $     Revenues     (Decrease)     % Change  
Interest expense
  $ 9.6       2 %   $ 10.0       2 %   $ 0.4       4 %
Interest income
    (0.2 )     0 %     (0.3 )     0 %     (0.1 )     50 %
Other (income) expense
    (0.2 )     0 %     1.4       0 %     1.6       (800 %)
 
                                   
Total other expense
  $ 9.2       2 %   $ 11.1       2 %   $ 1.9       21 %
 
                                   
Total other expense increased by $1.3 million in the second quarter of fiscal 2010 and $1.9 million in the first six months of fiscal 2010. The increases in other (income) expense were primarily due to increases in foreign currency exchange losses on transactions denominated in currencies other than the functional currency. In the second quarter of fiscal 2010 interest expense remained constant and we expect interest expense to decrease through the remainder of fiscal 2010 due to the conversion of our $57.5 million 3% convertible notes into common shares in June 2010. For the first six months of fiscal 2010 interest expense increased by $0.4 million due to the amortization of the debt discount on our convertible notes in accordance with the FASB’s accounting standard for “Convertible Debt Instruments that May Be Settled in Cash Upon Conversion, (Including Partial Cash Settlement).”
Income Taxes
In the first quarter of 2010, our tax provision was determined using an estimate of our annual effective rate of 65.3% plus any discrete items that occurred during the quarter. In the second quarter of 2010, due to our fiscal 2010 projected pre-tax income/loss being close to breakeven as well as the impact of our acquisitions made during the second quarter and other factors, small variations to the full-year projection can result in material variability in our estimated annual effective rate. Therefore, we have calculated the second quarter tax provision using a calculation of the actual tax rate on the actual results for the six months ended July 3, 2010, which is the best estimate of the our estimated annual effective tax rate. Using this approach, we recorded a benefit of $12.8 million in the first six months of fiscal 2010. Our tax provision for this interim period resulted in a tax rate of 27.4% based on the actual result for the first six months of fiscal 2010. The actual tax rate is lower than the 35% federal statutory tax rate primarily due to non- deductible permanent items and certain losses in foreign operations that generate no tax benefit. We do not provide for U.S. taxes on our undistributed earnings of foreign subsidiaries, if any, since we intend to invest such undistributed earnings indefinitely outside of the U.S.
As of January 2, 2010, we had available federal net operating loss carryforwards of approximately $507.3 million which expire in the years 2010 through 2029. Approximately $308.6 million, out of the total $507.3 million, will expire as a result of the Internal Revenue Code Section 382 limitation regardless of the amount of future taxable income, and thus has a full valuation allowance recorded against this deferred tax asset. As such, we expect a majority of our 2010 net tax provision to be non-cash. As of January 2, 2010, we had available state net operating loss carryforwards of approximately $268.6 million which expire in the years 2010 through 2029 and foreign net operating loss carryforwards of approximately $18.7 million that either begin expiring in 2023 or have no expiration date. A portion of these net operating loss carryforwards are offset by a valuation allowance. Management monitors all available positive and negative evidence related to our ability to utilize our deferred tax assets. Should management determine that it is more likely than not that these deferred tax assets will be utilized, we will release a portion of the remaining valuation allowance. Should management determine that it is more likely than not that these deferred tax assets will not be utilized, we will increase the valuation allowance.

 

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Guidance
We provided the following guidance for fiscal 2010 on July 28, 2010, in our earnings released furnished on Form 8-K:
    Net revenues are expected to be $1.3 billion.
    Loss from operations is expected to be $0.9 million.
These projections are subject to substantial uncertainty. 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.
Seasonality
We have experienced and expect to continue to experience seasonal fluctuations in our revenues from e-commerce services. These seasonal patterns will cause quarterly fluctuations in our operating results. We also expect to experience seasonal fluctuations from our consumer engagement segment, but to a lesser degree than with our e-commerce services segment. We experience less seasonality in our revenues from marketing services. 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 any quarterly period may not be indicative of the results for any other quarter or for the full year.
Liquidity and Capital Resources
                 
    As of  
    January 2,     July 3,  
    2010     2010  
    (in millions)  
Cash and cash equivalents
  $ 228.4     $ 63.7  
Percentage of total assets
    21 %     6 %
In June 2010 we called all of our $57.5 million 3% convertible notes for redemption and substantially all of the notes were converted into 3.2 million shares of our common stock. Also in June 2010, we paid $0.03 million to redeem the convertible notes that were not converted by the holders of the notes.
Sources of Cash
Our principal sources of liquidity in the first six months of fiscal 2010 were our cash and cash equivalents balances. As of July 3, 2010, we had cash and cash equivalents totaling $63.7 million, compared to $228.4 million of cash and cash equivalents as of January 2, 2010. Our cash equivalents are comprised of money market mutual funds.
We have experienced and expect to continue to experience seasonal fluctuations in our cash flows. We generate the substantial majority of cash from our operating activities in our fourth fiscal quarter. In our first fiscal quarter, we typically use cash generated from operating activities in the fourth quarter of the prior fiscal year to satisfy accounts payable and accrued expenses incurred in the fourth fiscal quarter of our prior fiscal year. During our second and third fiscal quarters, we generally fund our operating expenses and capital expenditures from either cash generated from operating activities, cash and cash equivalents, or financing activities.
We generated $11.8 million of cash from financing activities primarily from the proceeds from exercise of common stock options in the first six months of fiscal 2010, compared to using $2.0 million of cash for financing activities in the first six months of fiscal 2009.
As of July 3, 2010 and January 2, 2010, we had no outstanding borrowings and $8.3 million of letters of credit outstanding under our $150 million secured revolving bank credit facility. The credit facility contains financial and restrictive covenants that limit our ability to engage in activities that may be in our long term best interests. We do not believe the financial covenants will limit our ability to utilize the entire borrowing availability in fiscal 2010, if necessary.

 

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Uses of Cash
We used $75.0 million and $49.7 million of cash to fund operating activities in the first six months of fiscal 2010 and fiscal 2009, respectively.
We utilized $47.4 million in cash for acquisitions in the first six months of fiscal 2010. We acquired MBS for $22.5 million and made other smaller acquisitions that totaled $24.9 million. In addition, we may be obligated to pay earnout payments of up to $208.4 million through 2016 based on the achievement of certain performance targets by some of our acquired companies, of which we have the ability to pay up to $45.8 million with shares of our common stock. We invested $18.4 million for a noncontrolling interest in a company.
Our capital expenditures totaled $34.3 million and $17.9 million in the first six months of fiscal 2010 and fiscal 2009, respectively. Our capital expenditures have generally comprised purchases of computer hardware and software, internally developed software, and furniture and fixtures. We continue to expect an increase in capital expenditures in fiscal 2010.
Outlook
We expect to generate positive cash flow from operations in fiscal 2010, the majority of which will be generated in our fourth fiscal quarter. We believe that our cash flow from operating activities, cash and cash equivalents balances, and borrowing availability under our secured revolving credit facility will be sufficient to meet our anticipated operating cash needs for at least the next 12 months, which includes any deferred acquisition payments. However, any projections of future cash needs and cash flows are subject to substantial uncertainty.
We continually evaluate opportunities to sell additional equity or debt securities, obtain credit facilities, or repurchase, refinance, or otherwise restructure our long-term debt for strategic reasons or to further strengthen our financial position. Our secured revolving bank credit facility contains negative covenants including prohibitions on our ability to incur additional indebtedness. The sale of additional equity or convertible debt securities would likely be dilutive to our stockholders. In addition, we will, from time to time, consider the acquisition of, or investment in, complementary businesses, products, services, and technologies, which might affect our liquidity requirements or cause us to issue additional equity or debt securities. There can be no assurance that additional lines-of-credit or financing instruments will be available in amounts or on terms acceptable to us, if at all.
Critical Accounting Policies
The preparation of our consolidated financial statements requires us to make estimates, assumptions and judgments that affect our assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. We base these estimates and assumptions on historical data and trends, current fact patterns, expectations and other sources of information we believe are reasonable. Actual results may differ from these estimates under different conditions. For a full description of our critical accounting policies, see Item 7— Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2009 Annual Report on Form 10-K for the fiscal year ended January 2, 2010, filed with the SEC on March 5, 2010.
Recent Accounting Pronouncements
See Item 1 of Part I, “Financial Statements — Note 2, Summary of Significant Accounting Policies” for recent accounting pronouncements that could have an effect on us.
ITEM 3:   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
There have been no significant changes in market risks for the fiscal quarter ended July 3, 2010. See the information set forth in Part II, Item 7A of the Company’s Annual Report on Form 10-K for the fiscal year ended January 2, 2010 filed with the Securities and Exchange Commissions (“SEC”) on March 5, 2010.
ITEM 4: CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures. Our management, with the participation of our chief executive officer and our chief financial officer, conducted an evaluation, as of July 3, 2010, of the effectiveness of our disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e).

 

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Based on this evaluation, our chief executive officer and our chief financial officer have concluded that, as of July 3, 2010, our disclosure controls and procedures, as defined in Rule 13a-15(e), were effective at the reasonable assurance level, to ensure that (i) information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting. We monitor and evaluate on an ongoing basis our internal control over financial reporting in order to improve its overall effectiveness. In the course of these evaluations, we modify and refine our internal processes and controls as conditions warrant. As required by Rule 13a-15(d), our management, including our chief executive officer and our chief financial officer, also conducted an evaluation of our internal control over financial reporting to determine whether any changes occurred during the fiscal quarter ended July 3, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there has been no such change during the fiscal quarter ended July 3, 2010.
PART II — OTHER INFORMATION
ITEM 1:   LEGAL PROCEEDINGS.
See Item 1 of Part I, “Financial Statements — Note 7, Commitments and Contingencies.”
ITEM 1A:   RISK FACTORS.
Our Annual Report on Form 10-K for the fiscal year ended January 2, 2010, filed with the Securities and Exchange Commission on March 5, 2010, includes a detailed discussion of our risk factors. The information presented below updates and should be read in conjunction with the risk factors and information disclosed in our Form 10-K for the fiscal year ended January 2, 2010.
Our substantial leverage and significant debt service obligations could adversely affect our financial condition and our ability to fulfill our obligations and operate our business.
We currently have and expect to continue to have a significant amount of indebtedness. As of July 3, 2010, including our outstanding convertible notes, borrowings under our secured revolving bank credit facility and capital leases, we had approximately $154.8 million of indebtedness outstanding with an aggregate principal amount of $184.7 million and we had $150 million of borrowing capacity under the revolving portion of our secured revolving bank credit facility. We may also incur additional indebtedness in the future. In the event of a default under the notes or the secured revolving bank credit facility, our indebtedness could become immediately due and payable and could adversely affect our financial condition.
Our indebtedness could have significant negative consequences on us, including:
    our debt level increases our vulnerability to general adverse economic and industry conditions;
 
    we may have difficulty obtaining financing in the future for working capital, capital expenditures, acquisitions or other purposes;
 
    we may need to use a substantial portion of our cash flow from operations to pay interest and principal on our debt, which would reduce the amount of money available to finance our operations and other business activities;
 
    our debt level could limit our flexibility in planning for, or reacting to, changes in our business and in our industry in general; and
 
    our substantial amount of debt and the amount we must pay to service our debt obligations could place us at a competitive disadvantage compared to our competitors that have less debt.

 

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The terms of our secured revolving bank credit facility impose financial and operating restrictions on us.
We have a secured revolving bank credit facility with a borrowing capacity of $150 million. Our secured revolving bank credit facility contains restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. These covenants limit or restrict, among other things, our ability to:
  incur additional indebtedness or pre-pay existing indebtedness;
 
  pay dividends or make other distributions in respect of our equity securities;
 
  sell assets, including the capital stock of us and our subsidiaries;
 
  enter into certain transactions with our affiliates;
 
  transfer any capital stock of any subsidiary or permit any subsidiary to issue capital stock;
 
  create liens;
 
  make certain loans or investments; and
 
  effect a consolidation or merger or transfer of all or substantially all of our assets.
These limitations and restrictions may adversely affect our ability to finance our future operations or capital needs or engage in other business activities that may be in our best interests. In addition, our ability to borrow under the secured revolving bank credit facility is subject to compliance with covenants. If we breach any of the covenants in our secured revolving bank credit facility, we may be in default under our secured revolving bank credit facility. If we default, the lenders under our secured revolving bank credit facility could declare all borrowings owed to them, including accrued interest and other fees, to be immediately due and payable.
Our ability to use net operating loss carryforwards to reduce future tax payments may be limited.
As of January 2, 2010, we had approximately $507.3 million of U.S. Federal net operating loss carryforwards, referred to as “NOLs,” potentially available to reduce taxable income in future years. Of this amount, approximately $308.6 million will expire as a result of the Section 382 Limitation (described below in more detail) regardless of the amount of future taxable income and thus has a full valuation allowance recorded against this deferred tax asset.
Utilization of the NOLs may be subject to a substantial annual limitation due to ownership change limitations that may have occurred or that could occur in the future, as required by Section 382 of the Internal Revenue Code of 1986, as amended, referred to as the “Code.” These ownership changes may limit the amount of NOLs that can be utilized annually to offset future taxable income and tax. In general, an ownership change, as defined by Section 382 of the Code results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50 percentage points of the outstanding stock of a company by certain stockholders or public groups. The issuance of securities in connection with our acquisition of Rue La La, the disposition of our stock by certain selling stockholders, and the issuance of shares of our common stock upon the conversion of the 3% convertible notes may have resulted in an ownership change, or could result in an ownership change in the future upon subsequent dispositions of our stock. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of post-ownership change taxable income a corporation may offset with pre-ownership change NOLs. The limitation imposed by Section 382 for any post-change year would be determined by multiplying the value of our stock immediately before the ownership change (subject to certain adjustments) by the applicable long-term tax-exempt rate. Any unused annual limitation may be carried over to later years, and the limitation may under certain circumstances be increased by built-in gains which may be present with respect to assets held by us at the time of the ownership change that are recognized in the five-year period after the ownership change. Our use of NOLs arising after the date of an ownership change would not be affected.
In addition, the ability to use NOLs will be dependent on our ability to generate future taxable income. The NOLs may expire before we generate sufficient taxable income. There were no NOLs that expired in the fiscal years ended December 29, 2007 and January 3, 2009. The maximum NOLs that could expire if not utilized for the year ended January 2, 2010 is approximately $2.0 million.
ITEM 2:   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Pursuant to the terms of a Consulting Agreement dated April 22, 2009 between Arimor, LLC (“Arimor”) and GSI Commerce Solutions, Inc., the Company agreed to issue to Arimor shares of the Company’s common stock as a fee for consulting services provided by Arimor. In the fiscal quarter ended July 3, 2010, the Company issued an aggregate of 7,087 shares of common stock to Arimor (“Arimor Shares”) pursuant to such agreement.
On May 10, 2010, in connection with the acquisition of DirectNet Solutions LLC (d/b/a VendorNet) (“VendorNet”), the Company issued an aggregate of 87,465 shares of common stock to certain members of VendorNet (the “VendorNet Shares”).
The issuance of the Arimor Shares and VendorNet Shares were completed in accordance with Section 4(2) of the Securities Act of 1933, as amended, in offerings without any public offering or distribution. The Arimor Shares and the VendorNet Shares are restricted securities and include appropriate restrictive legends.

 

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ITEM 3:   DEFAULTS UPON SENIOR SECURITIES.
None
ITEM 4:   [Reserved]
None
ITEM 5:   OTHER INFORMATION.
None
ITEM 6:   EXHIBITS.
         
  2.1    
Stock Purchase Agreement by and among e-Dialog, Inc. (a wholly-owned subsidiary of GSI Commerce, Inc.), MBS Insight, Inc., and World Marketing, Inc., dated April 30, 2010. The schedules and exhibits to the merger agreement are omitted pursuant to Item 601(b)(2) of Regulation S-K. GSI agrees to furnish supplementally to the SEC, upon request, a copy of any omitted schedule or exhibit.+
  10.1    
GSI Commerce, Inc. 2010 Equity Incentive Plan (filed as Appendix A to GSI Commerce, Inc.’s Definitive Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on April 13, 2010 and incorporated herein by reference).
  10.2    
Separation Agreement, dated May 28, 2010, between GSI Commerce, Inc. and Stephen J. Gold (filed with GSI Commerce, Inc.’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 3, 2010 and incorporated herein by reference).
  10.3    
Form of Restricted Stock Unit Grant Notice Issued to Directors Under the GSI Commerce, Inc. 2010 Equity Incentive Plan (Initial Award).
  10.4    
Form of Restricted Stock Unit Grant Notice Issued to Directors Under the GSI Commerce, Inc. 2010 Equity Incentive Plan (Annual Award).
  10.5    
Form of Restricted Stock Unit Grant Notice Under the GSI Commerce, Inc. 2010 Equity Incentive Plan.
  10.6    
Form of Performance Restricted Stock Unit Award Under the GSI Commerce, Inc. 2010 Equity Incentive Plan.
  10.7    
Employment Agreement, between GSI Commerce, Inc. and Christopher Saridakis, dated March 23, 2010.
  31.1    
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
  31.2    
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
  32.1    
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
+   Confidential treatment has been requested for certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: August 3, 2010
         
  GSI COMMERCE, INC.
 
 
  By:   /s/ MICHAEL G. RUBIN    
    Michael G. Rubin   
    Chairman, President and Chief Executive Officer   
 
     
  By:   /s/ MICHAEL R. CONN    
    Michael R. Conn   
    Executive Vice President, Finance
and Chief Financial Officer
(principal financial officer &
principal accounting officer)
 
 

 

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