Executives
Michael Conn – EVP, Finance and CFO
Michael Rubin – Chairman, President and CEO
Ben Fishman – CEO, Retail Convergence
Analysts
Shawn Milne – Janney Montgomery Scott
Christa Quarles – Thomas Weisel
Brian Fitzgerald – UBS
Shyam Patil – Raymond James
James Friedland – Cowen & Co.
Aaron Kessler – Kaufman Bros.
Kerry Rice – Wedbush Morgan
Herman Leung – Deutsche Bank Securities
Ross MacMillan – Jefferies
GSI Commerce Inc. (GSIC) Q3 2009 Earnings Call Transcript October 27, 2009 4:45 PM ET
Michael Conn
Thanks. This is Michael Conn, CFO of GSI Commerce, and I am joined by Michael Rubin, our Chairman and CEO, and Ben Fishman, CEO of Retail Convergence
Before we get into the discussion of our results and the overview of the Retail Convergence acquisition, I would like to make the following remarks concerning forward-looking statements. All statements in this conference call other than historical facts are forward-looking statements.
The words anticipate, believe, estimate, expect, intend, will, guidance, confident and similar expressions typically are used to identify forward-looking statements. These forward-looking statements are based on current expectations, beliefs, assumptions, estimates and forecasts about the business of GSI Commerce.
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 that may affect GSI's business, financial condition and operating results are discussed in its filings with the SEC, including the risk that the planned acquisition of Retail Convergence may not close on the terms agree upon or at all. GSI Commerce expressly disclaims any intent or obligation to update these forward-looking statements.
During this call, we also will present certain non-GAAP financial measures; including non-GAAP net revenues, non-GAAP income from operations and free cash flow and certain ratios that use these measures.
In our Form 8-K which is located on our website at gsicommerce.com under SEC Filings, you will find our definition of these non-GAAP financial measures, a reconciliation of these non-GAAP financial measures with the closest GAAP measures and a discussion about why we think these non-GAAP measures are relevant. These financial measures are included for the benefit of investors and should be considered in addition to and not instead of GAAP measures.
Well, thanks as always to everyone for joining us this afternoon. As I'm sure you're all aware, in addition to announcing our third quarter results today, we have also announced an important acquisition. Today, we will discuss both beginning with the overview of our third quarter, followed by a specific overview of the announced acquisition of Retail Convergence.
I will cover our results and then GSIC CEO Michael Rubin, and Retail Convergence CEO Ben Fishman will join me in the acquisition overview.
GSI was originally scheduled to report our earnings results this Wednesday. But because of the importance of the acquisition, we felt it was best to let investors analyze the deal and the context of the most up-to-date information on GSI, so we chose to pull the earnings release forward. We appreciate everyone joining us for this call in short notice.
Now, let me turn to our third quarter results. Our momentum continued in the third quarter, as we again delivered impressive financial results that were above our guidance. Revenue for the quarter was stronger than expected and expenses were well managed. Our trailing 12 months non-GAAP income from operations now stands at $99.4 million compared to $61.2 million at the same time last year, an increase of 62%. Cash flow generation continues to standout for GSI with trailing 12 months free cash reaching a record level of $49.3 million.
Now for more details on the quarter, net revenues for the third quarter were $190.3 million, a 2% increase from $186.8 million last year, and above our guidance range of $181 million to $186 million. Improving comparable store growth, new e-commerce clients and growth in marketing services all contributed to the increase, offsetting the revenue challenges that we have discussed on previous calls, including the absence of revenues from Linens 'N Things, BabyCenter and Woolworth's, the change in our revenue model with Dick Sporting Goods and a decline in owned electronics product revenues, comparable store growth where we have visibility into transaction volumes sequentially from the first half of the year reaching mid single digit year-over-year growth.
Net revenues from product sales declined 11% in the third quarter to $90.8 million from $102.1 million last year. As has been the case for the last three quarters, the change in our revenue model for Dick Sporting Goods and the decline in sales of our owned electronics products were the primary drivers of the drop in product revenue.
Service fees increased 18% in the third quarter to $99.5 million from $84.7 million last year. Growth in service fees was driven by comparable store growth, new business and growth in marketing services. Notably strong e-commerce services categories included apparel and health and beauty.
Non-GAAP net revenues increased 11% to $113.7 million from $102.3 million last year. Loss from operations in the third quarter was $9.9 million compared to a loss from operations of $16.5 million last year and guidance for loss from operations of $15.5 million to $17.5 million.
Non-GAAP income from operations in the third quarter was $12.1 million, an increase of 111% from $5.8 million last year and above our guidance of $4 million to $6 million. Non-GAAP operating margins were 6.4% in the third quarter, an increase of 330 basis points from 3.1% last year. The significant increase in non-GAAP income from operations on only a 2% increase in net revenues reflects favorable revenue mix with strong growth in higher margin service fees, excellent operating efficiencies and the timing of investments spending.
Cost of product sales declined 8% compared to last year, driven by the decline in product revenue. Product sales gross margin declined 280 basis points to 25.6% from 28.4% last year. The decline in product margins is primarily due to freight accounting for a higher percentage of product sales on a year-over-year basis.
Marketing expenses decreased 20% to $9.1 million from $11.4 million last year, driven primarily by the change in our model with Dick Sporting Goods. On a combined basis, account management and operations, product development, and general and administrative expenses increased only 6% to $107.9 million from $102 million, comparing favorably to 11% growth in non-GAAP net revenue.
On a net basis, net loss was $9.4 million for the quarter or $0.18 per share compared to a net loss of $14.2 million or $0.30 per share a year earlier. On a trailing 12-month basis at the end of the third quarter, cash flow from operations was $90.1 million, an increase of 75% compared to $51.5 million at the end of the third quarter of 2008. Trailing 12-month free cash improved to a record $49.3 million, an increase of $57.7 million from negative $8.4 million at the end of the third quarter of 2008, and $10.8 million above the $38.5 million we had at the end of the second quarter.
The significant growth in free cash flow was driven both by the increase in cash flow from operations as well as the decline in trailing 12-month capital expenditures of $19.1 million to $40.8 million from $59.9 million. Driving the increase in cash flow from operations is trailing 12 months non-GAAP income from operations of $99.4 million, compared to trailing 12 months non-GAAP income from operations of $61.2 million.
Turning to our balance sheet, cash and cash equivalents were a $135.3 million, an increase of $90.2 million and $75.4 million from last year and last quarter respectively, reflecting increase free cash flow and the net proceeds from our recent equity offering. We had nothing drawn on our $90 million line of credit at the end of the third quarter compared to $40 million at the end of the third quarter last year. Inventories at the end of third quarter was $43.9 million, a decline of 18% from $53.9 million last year.
Looking to our segment results, net revenues from e-commerce services declined 1% to $166.6 million from $168 million last year, reflecting the factors I discussed earlier. E-commerce segment operating profit increased 145% to $4.9 million from $2 million last year with segment operating margins increasing 180 basis points to 3% from 1.2%. Marketing services revenues increased 34% to $31 million from $23.1 million last year driven by strong organic revenue growth.
Marketing services segment operating profit increased 126% to $6.5 million from $2.9 million last year and segment operating margins increased 850 basis points to 20.9% from 12.4% last year.
We have been quite active since our last call with several new e-commerce web store launches, significant progress in new business and renewals for e-commerce and marketing services that only in North America, but internationally as well. In addition, we closed the strategic acquisition of marketing services, completed an equity offering and have expanded our North American fulfillment capacity.
We launched five new web stores since our last call, four North America and one internationally. Two launches were in the apparel category including Maurices for Dress Barn and Peak Performance for IC Companys. Two were in the sporting goods category including Eastern Mountain Sports and one was in the toy category.
We successfully signed two meaningful e-commerce service client renewals, which included a 10-year extension with Toys"R"Us that runs until 2019 and also includes an expansion of services. Since our last call, we have also signed contracts with four new e-commerce service clients in North America and one internationally, including three in the apparel category, one in the home category, and one in the toy category.
We also continued to have a strong new business pipeline. Our international growth strategy continues to develop well. As year-to-date, we have signed a total of five deals that have an international component including new clients and expansion of services to existing clients.
Marketing services is also enjoying strong new business momentum with e-Dialog signing 10 new clients in the third quarter and GSI Interactive signing more than 20 pieces of new business with existing e-commerce clients in North America and internationally, and significant new business with non e-commerce clients.
The non e-commerce client wins are driven by momentum from Silver Line and Pepperjam. Pepperjam, an acquisition we completed in early September has expanded our marketing services capabilities with the addition of an affiliate network and it enhanced our scale in search and affiliate agency services.
Affiliate marketing is a powerful interactive tool. In 2008, our affiliate marketing channel for programs managed by GSI generated more than $100 million in sales for our clients. By owning our own affiliate network, we believe we can more rapidly drive innovation and service enhancements to our clients, while also expanding our marketing services offering to a broader universe and prospective clients. We expect the affiliate business to represent an important opportunity over time.
According to independent firm Forrester Research April 2009 report Online Marketing Benchmarks for Internet Retailers, online retailers spend 20% of their advertising budgets on affiliate marketing and online marketplaces. With the acquisition of Pepperjam and our prior acquisition of e-Dialog, we are now powering two important marketing services channels, e-mail and affiliate network with proprietary technology that we believe is industry leading, representing two key opportunities for us to add value to our clients.
I would note that one of the new e-commerce clients we saw since our last call, a multibillion dollar consumer brand company not only selected our entire suite of e-commerce services including technology, fulfillment, and call center, but also selected our Ship Quick Freight program, hired Silver Line for creative services, Pepperjam for affiliate marketing, and e-Dialog for email, with all marketing services sold jointly through GSI Interactive. I would also note this is the second GSI client to sign with the Pepperjam network in the less than two months since we made the acquisition.
Not only does this speak to our strong ability to cross-sell marketing services, but it also highlights of the success we have had with strategic acquisitions. Given the success and the meaningful opportunities we continue to see, we capitalized on improved equity market conditions in the quarter by raising approximately $88 million in primary proceeds that can be used to fund acquisitions. We expect to use this new capital to fund the upfront cash portion of the Retail Convergence acquisition.
An additional important strategic development since our last call has been the expansion of our North American fulfillment network including commencing shipments from our new Canadian fulfillment center and the addition of a new facility in California that represents the beginning of our regional fulfillment strategy. The facility will initially handle non-conveyable sporting goods products and overflow for our direct response business this fourth quarter.
With over 2.5 million square feet of North American fulfillment capacity in the US and Canada, the beginnings of a regional US network and our successful Ship Quick Freight program, we believe we are building truly differentiated e-commerce fulfillment business with meaningful scale that offers significant operating advantages to our clients.
Now, let me turn to guidance. At the beginning of fiscal 2009, we provided the following initial guidance, a decline in net revenues from the $966 million reported in fiscal year 2008, growth in non-GAAP income from operations of at least 10% which implied $90 million or greater in non-GAAP income from operations for fiscal 2009 compared to $81.9 million in 2008, and capital expenditures of no more than $50 million compared to $57 million in fiscal year 2008.
In each of the first three quarters, we have exceeded our expectations for net revenues and non-GAAP income from operations, while maintaining our view on capital spending. This is has led us to post strong operating results for the first nine months of 2009 with notably impressive cash flow generation. We have also produced strong results in new business front and notably have seen momentum in our global expansion efforts.
As we look to the fourth quarter, we expect a continuation of this momentum, a view that is enhanced by favorable sales trends in October. At the same time, we will ramp up some investments spending particularly as it relates to international web store launches and also in Asia to support recently signed new business. We are also expecting the acquisition of Retail Convergence to close within 30 days which would provide modest incremental contribution to net revenue and non-GAAP income from operations this year.
With that as a backdrop, we expect the net revenues for the year should show a small increase from last year and we would now expect non-GAAP income from operations to increase by at least 15% to 20% from last year, while maintaining our original outlook for capital expenditures of no more than $50 million.
Two items I would point out that will impact comparability in the fourth quarter. First, last year’s fourth quarter was a 14-week period and this year is 13 weeks. Second, last year, the company paid approximately 60% of its bonus pool and our guidance reflects expectations for a 100% payout this year. These two items accounted for approximately $6 million of benefit to the fourth quarter of fiscal 2008 and we believe they should be considered when determining expectations for the balance of this year.
As I mentioned in our last call, our underlying business momentum including solid new business trends in North America and internationally gives us confidence in our ability to show strong growth in revenue and profitability in 2010, while still continuing growth in capital expenditures to a modest level. We are also expecting solid contribution from Retail Convergence to revenue and non-GAAP income from operations. At the same time, we will continue to invest in longer-term opportunities, so a caution against overly aggressive expectations.
As we enter the holiday season, we are very pleased with our results for the nine months of 2009 and the trajectory of our business. And roughly flat year-over-year revenues of $575 million, we have delivered non-GAAP income from operations of $30.7 million compared to $13.2 million last year, an increase of 133%. Our cash flow generation has been excellent with trailing 12 months free cash flow of just under $50 million, and trailing 12 months non-GAAP income from operations of just under $100 million.
And with that, I would like to shift to our overview of Retail Convergence, and I will turn the call over Michael Rubin, CEO of GSI Commerce.
Michael Rubin
Thanks Mike, and thanks to all of you again for joining us on a such short notice. We’re really pleased to have you join us, and we're really pleased to announce such a strong third quarter and a great start to 2009, really pleased with the first three quarters of the year, feel really good about 2009 overall, also very excited today to talk about our entrance into the private sale space.
If you turn to page 3, for those of you who are not already members of Rue La La, entrance to Rue La La is by invitation only. You need to be a member. We are inviting all of you to join today. Please go to ruelala\gsi, we have got exclusive access for the next 48 hours and we encourage all of you to go spend lots of money and enjoy the benefits of Rue La La.
Turning to page 4, acquisition overview, again we are very excited today to make the acquisition of Retail Convergence and add both smartbargains.com and Rue La La to our portfolio. Rue La La is a rapidly growing leader in a very fast-growing private sell space. I think for many of you today on the call, the private sale space maybe new to you and beneficiary and the Founder and CEO of Rue La La will tell you about both the space and Rue La La.
I will give you just a few highlights to whet your appetite. Rue La La is a rapidly growing leader in this space, and again the space is growing very, very quickly. Just in the third quarter, revenues were around $28 million compared to $5.8 million a year ago, so almost 5x revenue growth in the third quarter.
Rue La La has already brought on 1.2 million members and has only been launched for around 18 months. And just in the last year, Rue La La has added 800,000 members. Again, just in the last 12 months. And the membership, the speed of adding members continues to be very, very rapid.
Overall, Retail Convergence has trailing 12 months revenue of $135 million, that’s a 66% increase on year-over-year, but it’s really all driven by the creation of Rue La La. This transaction is expected to be accretive of in 2010. Again, we expect the transaction to be accretive in 2010. We expect RCI to bring a minimum of $230 million of revenues, and at least $15 million in incremental non-GAAP income from operations in 2010.
And just to quickly walk through the deal value, the deal is valued up to $350 million, that includes an upfront payment of $180 million, that’s $90 million in cash and $90 million in stock and a potential earn out of $170 million based on achieving approximately $52 million in non-GAAP income from operations by 2012.
So if you just think about the trajectory of non-GAAP income from operations from a start-up business of 2008 to approximately $52 million of the total earn out is earned, that’s certainly a very, very aggressive and grant that we’re really excited to help Rue La La accomplish.
Turning to page 5, to the acquisition rationale and really why these two companies are such a good fit. I think probably the first two questions that everybody is thinking is, is this private sale space a really big opportunity, and how relevant is the private sale space to GSI? Those are the questions that we really want to answer for you today.
I think I will start by saying that the integration of Rue La La and Smart Bargains really furnish GSI’s evolution as an innovative global e-commerce platform, really able to service all aspects of our client’s online sales. When you think about the private sale space, I think one of the questions that I ask myself upfront was, who were the larger co-companies to really be the global private sale space winners, and really should we own this private sale space. And I think GSI is very uniquely positioned to capture the value in this fast-growing space.
If you think about Rue La La’s already tremendous growth and you combine that with so many GSI’s assets, we think it’s a very, very, compelling combination. The relationships that GSI has with so many world-class retailers and world-class brands and just the infrastructure and the large scale operating infrastructure that we have, and you combine that with, again, this already very successfully fast-growing company, we think this is a terrific opportunity.
One other things that really drives our M&A strategy is the brands often tell us what are the services that they need. And one of the things that we’ve consistently been asked over the last several years by brands is for capacity to move excess offline and online inventory in an online channel. So this service is very, very important to clients. I think when you look at our three businesses today, e-commerce services, interactive marketing services, and now these new services that we’re creating, this really creates a great cross-selling opportunity, we will talk more about that as we get into the presentation.
And with that, I am going to turn it over to Ben Fishman. Ben is the CEO of Retail Convergence, and he is the Founder and the Creator of the Rue La La business.
Ben Fishman
Thank you, Michael. And to both Michael and Michael congratulations on a very strong quarter. Retail Convergence is very excited about the transaction and joining the GSI family. We do believe there is a number of synergies and while we have seen tremendous growth over the past 18 months, we believe that this partnership is going to create a new leadership structure that it’s really going to accelerate our already aggressive growth.
Let me tell you a little bit about Retail Convergence. Retail Convergence was founded two years ago and were comprised of two companies. The primary growth vehicle as Michael spoke out before within Retail Convergence is Rue La La. What is Rue La La? Rue La La is a membership-only private shopping destination, where we offer premier brands at great value to our currently over 1.2 million members. It’s a terrific, elegant and efficient channel where brands can move through a great deal of inventory, while at the same time maintaining their brand desire ability and making sure that all that they are doing is done within the character of the brand they work so hard to achieve.
In 2009, we are expected to do over $100 million in revenue as compared to just $20 million a year ago. The other business, smartbargains.com is about nine years old and smartbargains.com is a online off-price marketplace, where we carry a wide variety of brands across a wide spectrum of categories and we sell all those brands obviously at also tremendous value.
Turning to page 9, I want to try to give you all a overview of the private sale space, it’s a new space and a space that many of you are learning about probably on this call today. I think most importantly, the simplest thing to say is that this is an entirely new way to shop.
It is an elegant and efficient channel for brands to move through high levels of inventory, and as I said before, to move to that inventory in a very brand positive way. Historically, brands have struggled with one of two things, one, selling high volumes of inventory quickly; and two, doing so without hurting themselves. We believe this model helps overcome both of those features. Selling inventory quickly and selling a lot of inventory quickly.
The other key to this model is the membership pace and how that membership is created, and the activity that ensues. Our customer acquisition costs are very low simply because the vast majority of our membership is gained through virality, through friends telling friends who tell more friends. And the more people buy, the more friends they tell about it. And the more friends they tell about it, the more inventory we are able to sell and to help the brands out even further. The high virality also leads to a very unique behavior pattern, whereby everyday at a specific time, large numbers of our membership show up and participate in the events that are taking place.
Specifically now in talking about the private sale benefit to the two different constituencies, we value much focus on two customer bases, one, the brands that we offer their service to, and second, through the membership. First let me tell you some of the benefits for the brands and retailers.
First and foremost as I mentioned before, our brands are able to sell through high levels of inventory in a very, very short period of time. In essence, they sell through this inventory as this has never happened. Even in that first hour, when an event goes live, we can see upwards of 40% to 50% sell-throughs of that merchandise. Because it happens so quickly, we are able to protect the brand, we are able to ensure that visibility is at a brief period of time, and we are able to make sure that their inventory is sold without creating any significant channel conflict, and for that matter, any channel conflict whatsoever.
The platform itself is closed. What do I mean by that? First of all, it’s membership-only. The only way you can become a member is if you are invited by a friend. Second, it is private. The site cannot be searched by the different search engines in the marketplace. None of the product is ever advertised, both online or offline. You have to be a member to gain access and the only way to become a member is to be invited by one of your friends.
The last piece for the brands is the new market that this business potentially creates. We introduce many new customers to brands that we run. Recently we ran an event with a beauty company. Over 30% of the people that shopped in that beauty event were new customers to that brand, had never bought that brand before. 70% of the customers that shopped in that event, bought merchandize from that brand that they had never purchased before either. So not only is this an efficient channel to move through inventory, and not only it is a safe channel for their brand, but lastly, it’s a new marketing vehicle in which they can introduce their brands to new potential customers in a very elegant fashion.
For the membership, there is a bunch of benefits for the membership and many come from those services that we provided the brands. First and foremost, we are a lifestyle destination, offering a wide variety of premium brands and offering all those brands to our membership at phenomenal values. They are getting access to great product at a great price. Second, Rue La La is fun.
We create a level of urgency and excitement everyday at 11 o’clock that people are beginning to plan their days around, truly behavior is changing, even within the four walls of our own offices. We don’t schedule any meetings from 10:45 AM until 11:30 AM, so that everyone can take advantage of the great events that are taking place.
Lastly, the convenience factor. We have a team of well over 30 merchants who are travelling around the country and around the world finding great merchandise, then editing that assortment of merchandise to make sure that it's just the best products at the best values that we put into the collection. That edited assortment makes it easy for the membership to scour through the event and find what they wanted quickly, buy their products and be delighted when they receive the products.
Flipping now to page 11, as mentioned, this is a very new space. People are learning about it by the day, and people are learning about it mostly through virality. But recently you are beginning to see a lot more pickup of this space in the different media outlets, including this quote provided by the Wall Street Journal on July 10th of 2009 that reads, the private sale business avoids two common pitfalls of online commerce, low margins to the inventory costs and spending on online ads, marketing centers on e-mail blasts to membership.
Moving on to page 13, I want to provide you now some specific characteristics of the Rue La La business, now that you have an understanding of the private sale sector in total. There are three key pillars within the Rue La La business, one is urgency. Urgency is created by these limited time events. All of our event start at 11:00 AM on day one, last for two days and then end at 10:59 on the second day. This creates a very unique behavior in which our membership will virtually lines up starting as early as 10:45 AM and is hitting refresh on their keyboard until they gain access at 11 o’clock to that boutique.
Next is exclusivity. It is the exclusivity that creates both the loyalty and the virality for this business. Exclusivity gives both the membership a great experience, a lot of fund and excitement about the business, and it is also that exclusivity that gives the brands tremendous confidence in the vehicle both to sell high volumes of goods and to ensure that their brand is protected.
And that last piece is virality. And what does virality do in essence? Virality provides us a very low cost for customer acquisition, a common pitfall of e-commerce. Right now, the vast majority of our membership is created by these member referrals which is incentive through virality. From an inventory perspective, we turn our inventory in mid-to-high double digits. Inventory is moving quickly and moving efficiently.
Moving on to slide 14, the essence of this business is that it is a virtually selling cycle. And this selling cycle is what creates the sustainability in the model. What do I mean? First and foremost, we acquire brands. Through the acquisition of brands, we create these daily timed events. Through these daily timed events, we create referrals, where friends tell friends who tell other friends. Through those referrals comes membership. Through that membership, buyers are created and revenues is created.
As that revenue is created, brands see how vital and important this tool can be. And more brands are then signed on. As we sign on more brands, that enables us to produce even more events. Events are truly the catalyst for referral, the more events we run, the more referrals we create, the more referrals create, the more membership we create, and so on and so on. This is what has allowed us the tremendous growth that we have seen over the past year and a half, and we think it’s what’s going to allow for the scale over the two, three, and four years.
Flipping to slide 15, we have spoke about this revenue growth, and obviously as you can see illustrated on this slide, starting a year and a half ago at $300,000 on sales and then comparing Q3 of ’09 which is going to be a 5x increase from Q3 of ’08. The growth is truly exceptional, and we think we will furthered by this merger with – by the acquisition buy and merger with GSI.
On slide 16, virality and addiction drives the model. The more they buy, the more they refer. Some amazing statistics. 70% of our file visits Rue La La on a monthly basis. And 10% of our file visits Rue La La on a daily basis. This is a very highly engaged membership base. This is a member base that is addicted to the experience and loves telling their friends about it.
I am now going to turn the call back over to Michael Rubin.
Michael Rubin
Thanks Ben. That was a great overview of both the private sell space and Rue La La.
Turning to page 18, this acquisition marks yet another strategic growth pillar for GSI. We continued to create innovative solutions for brands, retailers and consumers. The addition of Rue La La provides yet another service for existing clients and it provides opportunity to gain new clients. It’s probably important to put all this in the context of the past 10 years for GSI.
The business started in 1999. From 1999 till 2006, we’ve really been focused on the e-commerce services business and to build out several categories. Beginning in 2007, we started to add several very critical strategic growth pillars for the company. The first was the interactive marketing services business, that’s been incredibly successful for us.
We begun that in late 2006, early 2007, already in 2009, our marketing services business represent 25% of this year’s operating income. It’s also highly strategic to our clients and helping our clients do more revenue, and additional revenue helps our clients do, helps GSI and our clients in totality.
Another example is international. It’s another growth pillar that we’ve added. Very excited, Mike made some comments earlier about the successes that we have had with five pieces of international business year-to-date. This will be a yet another terrific growth pillar for the company. And today, I am very excited to be adding smarbargains.com and Rue La La to GSI, and how that’s really going to help us to best serve our clients.
Turning to page 19, this really gives you a look at the way we think about our business to date. So when we think about the business going forward, we’re really going from two segments to three segments. We started in the e-commerce services business. We then have built the interactive marketing services segment. And today, I am very proud to introduce our consumer engagement segment. And the first two businesses in the consumer engagement segment are Rue La La and Smart Bargains. I think these new capabilities that we have added really help us manage all aspects of our clients' online businesses.
I think the one big difference that I want to highlight today is for the first time, GSI is going to own the consumer. And we’ve never owned relationships directly with the consumer before. And these first two businesses are great examples of how we can add more value to our clients over time.
With this acquisition, we now have millions of customers in our database that we can use to help drive our clients business. This is something our clients have been asking us to do to help them to compete more effectively. So we are very, very excited about this new segment. We are excited about the introduction of Rue La La and Smart Bargains, who are also very excited to add other businesses to the consumer engagement segment in the future.
Also really important to look at clients that we have in common, I think when you think about these three segments, they’re really all going after the same type of clients, and they are all going after the same type of consumers, and that’s the cross-selling opportunity we have that benefits both GSI and its shareholders, and also our clients and how we better serve them.
Turning to page 20, I want to refresh with you GSI’s growth strategy. We really start with North America e-commerce. We go out and we acquire clients and we bring them on, and we start primarily with North America e-commerce. Once we get a client, we want to retain these clients. We want to have a good diversified base of clients under long-term contract. We want to continue to expand these relationships, and then we want to grow their businesses and do more things with these clients.
Two examples of additional activities would be the marketing services business. These are very important activities that we provide to our clients that help them to drive more business and do more revenue. Today the consumer engagement activities will be again very important and very critical to GSI and how we help our clients become more successful.
We want to do all this globally, which is another key pillar of our growth strategy, and then we want to pursue strategic M&A, help bring all these pieces together. I think the really important point that I want to make here is that each one of these pieces supports each other and creates a better business for GSI and our shareholders and better services for GSI and its clients.
Turning to page 22, synergies were a really important part of this acquisition. When we went out, we thought about getting into the private sale business. We thought that there were terrific synergies for us to obtain. I guess the fundamental question that you need to ask yourself is of all the companies in the e-commerce space and in the Internet, who’s best positioned to be the global private sale leader? And I would argue that no one's better positioned than GSI. Why?
Think about all the operational expertise and scale that we have. Think about the relationships we have to so many great retailers and so many great brands. If you think about what you need to be successful to build a private sale business, those are two of the really fundamental important points, combine that together with already one of the best and biggest private sale players in the world, and I think you have a very, very powerful combination.
So we think Rue La La on a standalone basis is a great business, it is providing a great service to brands and to consumers. And we think when you combine that together with all the operational expertise and scale that we have, and all the client relationships, we think it’s a very, very powerful combination, and one plus one equals a lot more than two.
So we are very excited about this, and we are very excited to work together to really create these synergies. We also think there's some synergies, quite frankly, being part of a much bigger company in just the scale that we operate, the purchasing efficiencies and also the best practices that we have.
Turning to page 23, and this will just give you an idea of some of the clients that Rue La La works with today. I think the important key thing that I want to show here is there is a big opportunity to sell e-commerce services and marketing services to Rue La La clients, and also to sell Rue La La and Smart Bargain services to GSI clients.
I think many of you have seen over the past few years, we have become very good at cross-selling our capabilities, and we think this is just another very important move for us to better serve our clients in the totality of their online needs.
And with that, I am going to turn it back over to Mike, who is going to go through the deal in more details on some of the specific numbers.
Michael Conn
Thanks Mike, I will pick it up on slide 25 with the financial highlights. First of all, the deal is expected to be accretive right out of the gate in 2010 on an NGIO per share basis. And as Michael mentioned earlier, we are looking for $230 million or more of revenue from Retail Convergence in 2010 and at least $15 million of incremental NGIO.
I am going to walk through the details of the earn out in a moment, but the key highlight I would point out there is the incentives of the two companies are aligned, we are both working together to achieve great financial performance, the NPV of this deal is better if the earn out gets paid.
I will touch on RCI’s financials and the great growth and emerging profitability they are delivering, really driven by their great cash flow model and also just touch again on that this is all being done in the context of great financial performance with GSI.
Slide 26 is the transaction overview. As Michael mentioned, it’s up to $350 million, $180 million in closing, which is 50% cash and 50% stock, and the earn out potential is a $170 million based on achieving $51.9 million in NGIO for 2012. We expect that this acquisition will close within 30 days, and HSR clearance is the only major obstacle for clearance.
We expect the acquisition to close in 30 days with the following HSR clearance. Retail Convergence had $7.5 million of cash as of the end of September of ’09 with no debt. We do expect to record about $2 million of transaction related expenses in the fourth quarter of 2009, and there it should be between $2 million and $4 million in integration expenses next year, primarily for the transition of their fulfillment and call center into our infrastructure.
Turning to slide 27 on the earn out, as again I mentioned, it’s tied to strong performance. The trajectory of the business will need to be able to deliver in order to get the full earn out would be NGIO of $18 million in 2010, $34 million in 2011, and $51.9 million in 2012. There is one accounting nuance that I have pointed out which is that to date, investors own 80% of Retail Convergence and employees own 20%.
But the employees have the opportunity to earn 50% of the earn out. So that proportion of the earn out that is above the pro rata percentage ownership to the employees will for GAAP purposes be treated as compensation expense, although for the purposes of GSI reporting NGIO, and we will exclude those earn out payments.
Turning to slide 28, is a summary of Retail Convergence financial metrics over the last 12 months. We can see net revenues of $135 million have grown 66%, and in just 18 months of operation, the company has achieved both positive NGIO and positive free cash flow, free cash flow of almost $4 million, again in just less than 18 months of operations.
Turning to slide 29, I will touch on this attractive cash flow model that Rue La La brings. Low customer acquisition cost, as Ben touched on, mostly viral marketing. The biggest amount of marketing spend they do is actually e-mail with e-Dialog. The inventory model is great with solid double-digit inventory returns, the gross margins are healthy in mid-to-high 30% rate and capital intensity as well.
Turning to slide 30, just to reiterate this acquisition is being done in the context of GSI having very strong financial momentum. We have been exceeding our expectations, our cash flow is strong, our cash position is strong, and our fourth quarter trends early on are favorable.
And finally at slide 31, just to wrap up, we really view this acquisition as a great fit. We feel it’s an evolution of our growth strategy, another great service to add to brands, we think we are uniquely positioned to really add value to Rue La La and then help further its remarkable growth trajectory, and the cross-sell opportunities to enable by this transaction are very attractive.
And with that, we would like to turn over the call to questions. Myself, Michael Rubin and Ben Fishman will welcome questions on the acquisition, and we are also here to answer questions on our third quarter results.
Question-and-Answer Session
Operator
(Operator instructions). Our first question comes from the line of Shawn Milne. Please proceed.
Shawn Milne – Janney Montgomery Scott
Thank you, and thanks for taking my questions, and congratulations on the transaction, just one at the strategic level and then one for Michael in terms of guidance. Just first on getting into the space, clearly in the last couple of years, we have seen channel conflict go away with what’s gone on in the economy, I mean we have seen eBay and some others look at the secondary market a little bit more proactively. One of the companies that we saw chopped out of work this year was gilt.com. I wondered if you can maybe just address how Rue La La looks relative to Gilt, and my understanding was given Gilt’s recent evaluation at the VC round was $400 million, if you could maybe confirm that? And then secondly, in terms of guidance, Michael you talked on the last call that the $107 million that the Street was looking for was a bit low. If I look at – yes, I think the Street number now is $115 million in fiscal 2010, are you saying that we could add the $15 million in here that you would endorse $130 million, is that the best way to think about it? Thanks.
Michael Conn
Go ahead, Ben, probably best position to talk about Rue in terms of how they fit into the overall landscape, and then I will touch on the guidance question.
Ben Fishman
So I think a couple of points Shawn. First of all, channel conflict and all, one of the real value propositions in using Rue La La is the pace of which these events take happen. We are able to move through so much inventory, but we are also able to do it so quickly.
Where historically where channel conflict exists is where products sit on shelves for a long period of time or ones exposed to everyone, everywhere, all the time. And so the pace with which we sell product and also the exclusivity in the membership-only really has alleviated the channel conflict, hence why brands see this as a solution through a challenge versus an additional exposure.
As far as the competition goes, there has been a few different people that have gotten into the private sale space over the past couple of years, and I think good for everybody, there has been some good success out there.
How does Rue La La differentiate itself from whether it be gilt.com or any of the other players is, we think of ourselves as a lifestyle destination. We are not just trying to cater to the high-end consumer. We in fact want to go after a very wide breadth of consumers in the marketplace, whether they are buying high end or they are buying mid range products.
And so I think for the most part, the biggest differences you will see with us and the other people on this space is this notion of lifestyle destination showing selling a wide variety of merchandise all at great value, but not just trying to dominate one very small niche of the marketplace.
Michael Conn
Great. Shawn, the question on guidance, I think it’s we are always a bit hesitant, we wouldn’t put out guidance as we normally would until after our fourth quarter results for the following year. I think ballpark what you are saying is reasonable, $115 million on a base business based on how the business has been performing year-to-date, certainly does feel reasonable, we do expect at least $15 million from Retail Convergence.
So I think $130 million for next year is a reasonable expectation at this point. I certainly wouldn’t want a see things get much higher in terms of where people’s expectations are at this point. I mentioned in that in the remarks in terms of caution against overly aggressive expectations. But we feel good the business is performing well, and I think that type of the range seems reasonable at this point in time.
Shawn Milne – Janney Montgomery Scott
Okay, thank you.
Operator
Our next question comes from the line of Christa Quarles. Please proceed.
Christa Quarles – Thomas Weisel
Hi, I am just kind of following up on the prior question a little bit. So if you look into 2010, the revenue contribution of $230 million, is there a synergy baked in from GSI? It looks like GSI is already a customer of Rue La La. So I am just trying to figure out how much uniquely Rue La La and Rue La La at all I guess and how much is going to be contributed from GSI? And then, I was wondering if you could also kind of give some more color around sort of the average price point. You made a distinction that Gilt and maybe Vente-Privee are more on the luxury end, so I was wondering if that manifests in a different price point. And then, the third question is just could you be very explicit about the EBITDA contribution from the acquisition in the fourth quarter? Thanks.
Michael Conn
So I think I'll do the first and the third and then I'll let Ben touch on price points and where Rue La La fits into that spectrum. The expectation for at least $230 million of revenue contribution in 2010 from Retail Convergence is a number that excludes any kind of revenue synergies, that’s the trajectory that we believe the business is on currently. We certainly are expecting to add value on that front, but that is a number that we think is a number that they are really tracking to achieve on their own.
Fourth quarter, it’s somewhat dependent. I mean I think we are expecting this to close within 30 days. We think we will get a little bit of contribution, it wouldn’t be all that meaningful to the overall fourth quarter. We don’t have a specific number that we’ve put out there. This will be reportable segments, so we will report separately on the results of Retail Convergence as part of our new consumer engagement segment. So certainly the results will be there when we report fourth quarter results. Ben.
Ben Fishman
And the question regarding price point differential, once again I think the good news about the space is that whether it will be Gilt or Vente-Privee in France and Europe, there are positive results coming out of few different players in the marketplace, and I mean that’s good for everybody.
From a price point perspective, it’s not that we sell – that we don’t sell the high end, the biggest difference between us and in some of the other players is that we sell a wide variety of price points. We sell watches that are normally $2000 for $1000. We may sell a bottle of wine that is normally a $150 for $75 and we may sell a sweater that is normally $299 for a $150.
And what our customer loves about the experience on Rue La La is they can buy a very high-end expensive item at a much better price, and then they can buy something that is normally $50 and they can buy it for $29.99. And it’s that breadth and breakdown of price point that I think really engages the membership.
Christa Quarles – Thomas Weisel
Okay, thank you.
Operator
Our next question comes from the line of Brian Fitzgerald. Please proceed.
Brian Fitzgerald – UBS
Thanks. A couple of housekeeping and then maybe I will jump back in the queue. It looks like the break of RCI is kind of 60-40 Rue, Smart Bargains. Can you give us a sense of how that trajectory has changed over the course of time? And then maybe for Ben, can you tell us – give us a sense of any product lines or offerings that you are not into now that you would like to expand into?
Michael Conn
Sure. I think on the contribution it’s when Retail Convergence was formed a little bit less than two years ago, it started with the acquisition of Smart Bargains which was a predecessor company. So, at its beginning, Smart Bargains was a 100% in 2009. It’s a little bit more than 60-40 with Rue La La versus Smart Bargains and that will continue to shift dramatically.
Rue La La is the growth vehicle. Smart Bargains is actually stable, solid component of the business and certainly fits well with the business. But the growth vehicle is Rue La La, so that contribution will continue to shift more towards Rue La La. And, Ben, on emerging or new category opportunities.
Ben Fishman
Yes, so we have a variety of – we are always evaluating new category opportunities, whether it be new brands or new category or classifications, and we certainly have a variety of categories that you are going to see us expand into in the coming months and well into next year where we're continuing to build out our existing classifications, so we think there is an enormous amount of growth within the fashion classifications, within apparel, within accessories, within footwear and we know obviously the men’s business is an enormous opportunity for us that we are going to expand tremendously in the coming weeks and months.
And as we go into next year, you will see a bunch of new classifications. The beauty of this model is the expansive nature of what it can do, it is not just a footwear category, not just an apparel category, we do wine events that I mentioned before that do spectacularly well, and there is jewelry events that do spectacularly well.
And as I am sure you have seen if you have been on the site there have been some different travel and destination events which have done far better than we even expected, and we think there is a great opportunity to expand in that classification. So I think the opportunity for expansion is enormous.
Brian Fitzgerald – UBS
Great, thank you.
Operator
Our next question comes from the line of Shyam Patil. Please proceed.
Shyam Patil – Raymond James
Hi, good evening. Congrats on the quarter and the acquisition. I had a couple of questions, the first one is, if you could talk a little bit about the relationships you guys have with the brands in terms of – and how we should think about a typical contract, and what kind of terms you guys negotiate there, and also how many brands you guys currently have, if a particular brand uses multiple private sale sites? And then additionally, Mike, if you can elaborate on some of the investment areas you mentioned for Q4? Thank you.
Michael Conn
Sure. Ben will handle the first couple, and then I'll come back on where we're investing in some high brand relationships.
Ben Fishman
Yes, so we have relationships with well over 300 brands today. We have a target list of thousands of brands that we’ve all look to work with in the coming months and years. The relationships for the most part are not contractual relationships. They are relationships that we engage in and set up a group of expectations that our brands have with us and that we have with them, and we have set up annual plans with all of these brands, we try to understand what the brands needs are, where their sore points are, where they need help, where – what are the areas that are most alarming to them, what are the areas that are of greatest opportunity and then build a plan based on that.
And the notion is different than most part we run with any one brand four to six times a year, and that’s how we established that relationship. Some brands work with multiple private sale sides. I think there has been a little bit of a fueling out over the past six months or so as to what the different sites do and what the different capacities are. I think that Rue La La has faired very well in that comparison. And as I mentioned before, because the industry itself is doing well that has just created momentum as part as brands endorsing the channel. So, hopefully, that answers the question.
Michael Conn
As far as investment areas for GSI, I mean the one that stands out the most has us spending incrementally beyond our plans, really just relates to the pace of new business. So we’ve added more new business this year than we would have planned for, and so just the implementation costs and the support around it. That's particularly notable on the international side where we have seen a very significant uptick.
And as I mentioned, Asia is a component of that. It’s primarily Europe, but we have now also started to put some investment dollars against Asia, particularly Japan and so that would be an area that I would highlight. There are other areas of the business continued investments in technology, continued investments just groups to work with clients to drive more business. But the single biggest area would be around new business with international being the standout.
Shyam Patil – Raymond James
Great, thank you.
Operator
Our next question comes from the line of James Friedland. Please proceed.
James Friedland – Cowen & Co.
Thanks. Looking at the core business for Q3 and also some of the October trend, first I just want to confirm that you said that same-store sales are up in the mid single digits, does that include or exclude some of the businesses that have gone under this year? And then the second question is, can you maybe expand on your comments about how October is looking on a same-store sales basis and what categories you're seeing surprising strength from, where you’re seeing weakness, any color on the current environment?
Michael Conn
Sure. So the commentary that same-store sales in the third quarter were in the mid single digit range is excluding any stores that are no longer with GSI, so the Linens 'N Things, the BabyCenter is pulled out. That's historically always been our convention for how we’ve calculated same-store sales, so nothing new and certainly consistent with how we’ve looked at things year-to-date.
What we have seen into October – and I would caution we are three weeks into October. It’s early in the year going up against the period of time where comparisons became get significantly easier for us. But it’s been a pretty noticeable uptick in terms of the pace of same-store sales. We are pleased to see that. It’s been broad based. I wouldn’t single out a particular category that is driving it. But pleased to see it, but it’s early in the quarter, and obviously the big holiday weeks are still in front of us, and that’s what’s going to really matter for the results of the quarter.
James Friedland – Cowen & Co.
Okay, great. Thank you.
Operator
Our next question comes from the line of Aaron Kessler. Please proceed.
Aaron Kessler – Kaufman Bros.
Well, I don't think I've ever been called that before, but hello. A couple – I'm just following up on the last question in terms of some of the metrics you can provide, maybe just in terms of are you seeing in changes in maybe basket size, kind of conversion rates and kind of unique growth? And then, just on the kind of the acquisition, is for sites like Rue La La, maybe you can just give us a sense for what really drives the stickiness factor. I mean, there's a several of these sites now. I mean obviously social networking sites we've seen come in and out. I know it’s not exactly as social networking site, but maybe just what drives the stickiness factor longer term for a site like Rue La La? Thank you.
Michael Conn
Sure. I think the first question on comps – or the basket size, the metrics that are driving it.
Aaron Kessler – Kaufman Bros.
Yes. Basket size, conversion rates, any metrics.
Michael Conn
I wouldn’t say that we are seeing material changes on our versus last year basis. We are seeing it’s stabilizing and that's sort of a trend that we've seen developing over the course of the year. So, as we got into last year's fourth quarter, we certainly saw some drop in basket size not dramatic. And we certainly saw some drop in conversion. We are seeing those metrics start to stabilize and improve a little bit as business trends have improved here. And I will let Ben talk on the model and the stickiness.
Ben Fishman
The model/stickiness, why is it so engaging I guess is the question. And I think the simplest answer is putting great offers forward. What enables this business to maintain and in fact see such an increase in its overall customer acquisition and retention is constantly surprising and delighting the membership with great offers. And so we are always putting new brands on the site. We are always putting new merchandise from those brands on the site. And we are relentless and making sure that user experience is a great one. It’s an addictive experience.
As I mentioned before, at 10:45 AM, we have the – millions of – or tens of thousands, hundreds of thousands of customers virtually queuing up and then boom, at 11 o’clock when the store opens, they come in like you can’t imagine. And the amount of merchandise that we sell even in that first hour is somewhat startling. People are planning their day around it. So it’s – the entire model is based on that addictive nature and it’s up to us to make sure that we continue to surprise and delight the membership with great merchandise.
Aaron Kessler – Kaufman Bros.
Great. And Michael, can you just give us a brief overview to how the accounting will work in terms of how this will be recognized on the income statement? I realize it to be a separate category, but will this be a product sale, and then just how it may flow through the income statement?
Michael Conn
Yes, so in terms of from reporting, we will include it into reportable segments, so its results will be seen on a standalone basis. It is product sales, so it will look like the other product sales that report in terms of the revenue that they get from consumers in terms of purchasing products from them will be with the top line revenue is, and the cost of goods sold will be the cost of the inventory and freights, so similar to how the other product revenue flows for us.
Aaron Kessler – Kaufman Bros.
Great, thank you.
Operator
Our next question comes from the line of Kerry Rice. Please proceed.
Kerry Rice – Wedbush Morgan
Hi, a great quarter. One question on the acquisition, and just maybe a little slow here, but on the accretion, is that on an NGIO basis, is it on kind of the pro forma or GAAP EPS basis. How –?
Michael Conn
Yes. I think that the specific metric that we are sighting is NGIO per share. Clearly on a free cash flow per share basis it’s even more accretive just based on the cash flow dynamics of the business. But the specific reference was NGIO per share.
Kerry Rice – Wedbush Morgan
And then as it relates to engaging the customer, is this a strategy that you think about long-term building out more type of customer specific sites that they can go to in this manner versus kind of staying back on the technology site?
Michael Rubin
I think it’s definitely an important pillar of growth for us. What we’ve really heard from our clients is they want us to help them in all the aspects of their online business, and to be able to be more successful and drive more business for them. So I think we look at these two businesses as our first step in doing it.
But long-term, we think the ability for GSI to own multiple businesses that do business on behalf of our clients that can drive meaningful volume on behalf of our clients is very important. I think they can call it in many different forms and shapes. What’s important is that they benefit our clients and they can drive meaningful demand.
Kerry Rice – Wedbush Morgan
Okay, thank you.
Operator
Our next question comes from the line of Herman Leung. Please proceed.
Herman Leung – Deutsche Bank Securities
Hi, thanks. Couple of questions. First on this acquisition that you guys made looks like on the 2010 numbers, it assumes a 7% to 8% EBITDA margin in 2010. Could you talk about the longer-term operating margins you guys provided some earn out data, but wondering what that implies in terms of margins for 2011 and 2012? And second, wanted to see if there is any revenue concentration in terms of category or clients standpoint? And then I have a quick follow-ups.
Michael Conn
Sure. The – their businesses is still 18 months old, I think it’s important to remember. So this is early stage. It is a – it will increasingly dominated by Rue La La which is mid-to-high 30s, Smart Bargains is a little bit lower than that in terms of the gross margins. So I would say the margins that they achieve next year might be half of where they can get to over time.
So certainly I think in the near term up to 10% is something pretty quickly, and over time it has the possibility to go up to 15% in terms of an operating margin for the business. There is really no concentration to speak of in the business, which is great. I mean, it's very diversified. As Ben mentioned, they are working with over 300 brands. There is not a significant brand that represents a large percentage of sales. So there it’s very well diversified, something that we like a lot about the business.
Herman Leung – Deutsche Bank Securities
And then second is on your guidance in the fourth quarter, it seems like there is a bit of a conservatism baked in given when that was offset by some bonus payments and 13 and versus the 14-week impact. Could you talk about – and you also mentioned there was some timing of investment that was changed either from the third quarter towards the fourth quarter, was that because – was that what drove the EBITDA beat in the third quarter, and then sort of a more conservative guidance in the fourth quarter? Or could you just kind of give us a sense of how to think about that?
Michael Conn
Yes. I mean, I think all those things that you cited are a component of what’s – how we are thinking about the fourth quarter. So there are some comparability issues that created some hurdles for us as we looked at this fourth quarter results, the bonus and the extra week last year being the two ones that stood out.
The investment spending, we did ramp up investment spending a little bit more slowly than we planned in the third quarter and so some of that did just shift in the fourth quarter. That’s not huge large enough to point out, maybe a $1 million or so, but I certainly wouldn’t characterize that that was the driver of the upside in the third quarter, but it did contribute to it and it does put a little bit more of a hurdle in front of us for the fourth quarter, although again not so substantial that they would want to overstate it.
I would say in general for the fourth quarter guidance, and what we are looking at for the year is we said at least 15% to 20% we would hope to be above that 20% threshold. The business has performed great for us this year.
Through the first nine months, we are pleased with the start that we have had in the fourth quarter. So we are hopeful to do better, but at the same time, there is – the comparability issues that we pointed out are real. The biggest weeks of the holiday season are still in front of us, so as always, we try have a little bit of conservatism in terms of how we look at things.
Herman Leung – Deutsche Bank Securities
And just wanted to confirm that this fourth quarter guidance does not include any Rue La La contribution?
Michael Conn
We are assuming the deal will close within 30 days, so there is a presumption of a little bit in there, it wouldn’t be a material contributor to the fourth quarter, but we do expect to get a little bit of contribution in that material.
Herman Leung – Deutsche Bank Securities
Sorry to be a question hog. My last question, CapEx in 2010, could you talk about how this acquisition of RCI sort of changed that in terms of where you plan to spend, I assume it would be anywhere from $50 million to $60 million range for next year. But could you talk about – does that change your strategy in terms of where you want to spend your CapEx whether it’s international, Rue La La or kind of a new client build?
Michael Conn
So I would say that one of the things that we like about this business model is it’s a very capital efficient business model. So there is some capital expenditures for them every year. I think they are most significant, it is just in terms of systems enhancements and adding office space, but it’s been at $5 million or less. Since they started that business, that range won’t change as we get into next year.
So as we look at sort of the – if you are at a range of $50 million to $60 million for next year and I sort of really don’t think that even getting up to $60 million will be feasible, so it’s really not changed by this acquisition. One of the keys is we will be utilizing GSI’s infrastructure on the fulfillment in the customer care side and this fits within existing capacity that we have within that, so it’s actually very efficient for us from that perspective, and so a real nice synergy that’s embedded in the deal.
Operator
(Operator instructions). Our next question comes from the line of Ross MacMillan. Please proceed.
Ross MacMillan – Jefferies
Yes thanks and congratulations. Three questions, just to recap on the RCI business model, it’s an owned inventory model, is that correct? And I guess, second, if that is the case, if GSI was to cross-sell with the services to existing e-commerce service customers, could you provision it in the way that you didn’t have the inventory ownership? That’s the first one. And then two other just points of clarification, on the $6 million that you said was an incremental due to the 13 weeks and the bonuses, sorry, I wasn’t clear on where that $6 million hit, is it all investment or is it – I am not clear where that’s going to hit with the P&L? And then finally, just on the extraordinary costs for $2 million of transaction in Q4 and $4 million next year, are all those numbers excluded out of NGIO? Thanks.
Michael Conn
Sure, I will let Michael touch on the first one, and then I will hit the financial ones.
Michael Rubin
Sure. From an inventory perspective, generally it doesn’t make sense for GSI to own inventory other than our sports league business where we've owned inventory really since the inception I think if we deal with a retailer or a brand that generally consign that inventory to us. I think with this business, we will definitely own inventory and do own inventory.
Still, as Mike pointed out, it's a kind of a 10% to 15% margin business over the next several years. I think as far as the business leveraging inventory that’s in our infrastructure that definitely will be a scenario and there definitely will be clients to utilize GSI that have their inventory in our infrastructure and that we utilize that inventory for events they run with Rue La La.
But as the way we are going to treat the overall businesses, even in that case, that's likely to still show up as product sales with that kind of 10% to 15% margin business, and kind of a flash out to GSI for those particular sells. But I do think there’s definitely going to be a reasonable amount of GSI clients that leverage this avenue and certainly fulfillment will definitely incur from inventory that’s in our warehouse for some of the revenue.
Michael Conn
Great. And then on the couple of items of comparability that we pointed out, the first one on the bonus payment would have been a reduction to our operating expenses last year in the fourth quarter. And these are about evenly split between the two.
So, that was about a $3 million benefit in terms of a reduction of expenses that we had last year in the fourth quarter. The extra week really is the reflection of revenue and contribution that we would have had by having a 14-week period last year versus a 13-week period.
Ross MacMillan – Jefferies
And then on the two items, the $4 million, are those excluded from the NGIO?
Michael Conn
Right. So yes, both – it has been our practice. We will exclude any deal related or transaction expenses from our calculation of NGIO. And we will show that amount as part of the reconciliation. And similarly, integration expenses we would exclude from an NGIO similarly report those as part of the reconciliation to that amount to income from operations.
Ross MacMillan – Jefferies
Perfect. Thank you.
Operator
At this time, there are no further question. I will like to turn the call over to Michael Conn, Chief Financial Officer for closing remarks. You may proceed, Mr. Conn.
Michael Conn
Sure. Well, I appreciate everybody joining us on short notice, and look forward to speaking with you after our fourth quarter results.
Operator
Ladies and gentlemen that conclude today’s conference. Thank you for your participation. You may now disconnect, and have a great day.
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