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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended January 3, 2004 or

For the transition period from                   to                  .

Commission file number 0-16611

GSI COMMERCE, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

Common Stock, par value $.01 per share

(Title of Class)

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

(Specific sections incorporated are identified under applicable items herein)

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

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GSI COMMERCE, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED JANUARY 3, 2004

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For all years prior to 1999, our fiscal year ended on December 31. Effective for 1999, we changed our fiscal year from the last day of December to the Saturday nearest the last day of December. Accordingly, references to fiscal 1999, fiscal 2000, fiscal 2001, fiscal 2002, fiscal 2003 and fiscal 2004 refer to the years ended January 1, 2000, December 30, 2000, December 29, 2001, December 28, 2002, January 3, 2004 and the year ending January 1, 2005.

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

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PART I

Overview

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

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

Industry Background

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

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

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

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Our Solution

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

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

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

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

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

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Growth Strategy

The key elements of our growth strategy are as follows:

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

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

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

Our E-Commerce Platform

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

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

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

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

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

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

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

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

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

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

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

Our Partners

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

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

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

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

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

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

Competition

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

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

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Intellectual Property

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

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

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

Government Regulation

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

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

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

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

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Employees

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

Seasonality

We have experienced and expect to continue to experience seasonal fluctuations in our revenues. These seasonal patterns will cause quarterly fluctuations in our operating results. In particular, the fourth fiscal quarter has accounted for and is expected to continue to account for a disproportionate percentage of our total annual revenues. We believe that results of operations for a quarterly period may not be indicative of the results for any other quarter or for the full year. For additional information, see Note 20 to our consolidated financial statements included in this Annual Report on Form 10-K.

Investor Information

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

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

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

Risk Factors

Any investment in our common stock or other securities involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information contained in this Annual Report on Form 10-K. If any of the following risks occur, our business could be materially harmed. In these circumstances, the market price of our common stock could decline, and you may lose all or part of the money you paid to buy our common stock.

All statements made in this Annual Report on Form 10-K, other than statements of historical fact, are forward-looking statements. The words “anticipate”, “believe”, “estimate”, “expect”, “intend”, “may”, “plan”, “will”, “would”, “should”, “guidance”, “potential”, “continue”, “project”, “forecast”, “confident”, “prospects”, and similar expressions typically are used to identify forward-looking statements. Forward-looking statements

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are based on the then-current expectations, beliefs, assumptions, estimates and forecasts about our business and the industry and markets in which we operate. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied by these forward-looking statements. Factors which may affect our business, financial condition and operating results include the effects of changes in the economy, consumer spending, the financial markets and the industries in which we and our partners operate, changes affecting the Internet and e-commerce, our ability to develop and maintain relationships with strategic partners and suppliers, our ability to timely and successfully develop, maintain and protect our technology and product and service offerings and execute operationally, our ability to attract and retain qualified personnel, our ability to successfully integrate our acquisitions of other businesses, if any, and the performance of acquired businesses. More information about potential factors that could affect us is provided below. We expressly disclaim any intent or obligation to update these forward-looking statements, except as otherwise specifically stated by us.

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

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

We have an accumulated deficit and may incur additional losses.

We incurred substantial losses over the past five fiscal years while operating our business. As of the end of fiscal 2003, we had an accumulated deficit of $177.6 million. We may not obtain an appropriate volume of purchases through our e-commerce platform, generate an appropriate amount of service fee revenue from our existing partners, add an appropriate amount of new partners to generate sufficient revenues or adequately control our expenses in order to achieve profitability. While we expect to be profitable in fiscal 2004, there can be no assurances that we will be able to achieve profitability.

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

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

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

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

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

Our future success is substantially dependent upon the success of the partners for which we operate e-commerce businesses. If our partners were to have financial difficulties or seek protection from their creditors or if they were to suffer impairment of their brand, or if we are unable to replace our partners or obtain new partners, it could adversely affect our ability to grow our business. The growth of our business could also be adversely affected if our partners’ marketing, brands or retail stores are not successful or if our partners reduce their marketing investment or number of retail stores.

The uncertainty regarding the general economy may reduce our revenues.

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

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

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

We enter into contracts with our partners. Some of these partners’ online retail stores account for a significant portion of our revenue. If we do not maintain good working relationships with our partners or perform as required under these agreements, it could adversely affect our business. Additionally, if our partners terminate their contracts with us due to our failure to cure contractual breaches, it could negatively affect our business.

The contracts with our partners establish complex relationships between our partners and us. We spend a significant amount of time and effort to maintain our relationships with our partners and address the issues that from time to time may arise from these complex relationships. For fiscal 2003, sales to customers through one of our partner’s e-commerce businesses accounted for 28% of our revenue, sales through another one of our partner’s e-commerce businesses accounted for 17% of our revenue and sales through our top five partners’ e-commerce businesses accounted for 70% of our revenue. For fiscal 2002, sales to customers through one of our partner’s e-commerce businesses accounted for 20% of our revenue, sales to customers through another one of our partner’s e-commerce businesses accounted for 12% of our revenue, sales to Kmart as well as related service

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

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

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

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

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

We have experienced and expect to continue to experience seasonal fluctuations in our revenues. These seasonal patterns have caused and will cause quarterly fluctuations in our operating results. In particular, our fourth fiscal quarter has accounted for and is expected to continue to account for a disproportionate percentage of our total annual revenues. In anticipation of increased sales activity during our fourth fiscal quarter, we typically hire a significant number of temporary employees to supplement our permanent staff and significantly increase our inventory levels. For this reason, if our revenues are below seasonal expectations during the fourth fiscal quarter, our operating results could be below the expectations of securities analysts and investors. If our revenues exceed seasonal expectations during the fourth quarter, it could put significant strain on our fulfillment and customer service operations.

Due to the nature of our business, it is difficult to predict the seasonal pattern of our sales and the impact of this seasonality on our business and financial results. In the future, our seasonal sales patterns may become more pronounced, may strain our personnel, product distribution and shipment activities and may cause a shortfall in revenues as compared to expenses in a given period.

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

Because we have not generated sufficient cash from operations to date, we have funded our e-commerce business primarily from the sale of equity securities. Cash from revenues must increase significantly for us to fund anticipated operating expenses internally. If our cash flows are insufficient to fund these expenses, we may in the future need to fund our growth through additional equity or debt financings or reduce costs. Further, we may not be able to obtain financing on satisfactory terms. Our inability to finance our growth, either internally or externally, may limit our growth potential and our ability to execute our business strategy. If we issue securities to raise capital, our existing stockholders may experience dilution or the new securities may have rights senior to those of our common stock.

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

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

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

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

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

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

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

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

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