Executives:
Michael R. Conn - Senior Vice President of Finance and Chief Financial Officer
Michael G. Rubin - Chairman and Chief Executive Officer
Analysts:
Anthony Noto - Goldman Sachs
David Joseph - Morgan Stanley
Brian J Pitz - Banc of America Securities
Shawn Milne – Oppenheimer
Scott Devitt – Stifel Nicolaus
Jim Friedland – Cowen and Company
Robert Peck – Bear Stearns
Christa Quarles - Thomas Weisel Partners
TRANSCRIPT SPONSOR |
GSI Commerce, Inc. (GSIC) Q1 2007 Earnings Call April 25, 2007 4:45 PM ET
Operator
Welcome to the 2007 first quarter operating results of GSI Commerce. My name is Latisha and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of today’s conference.
If at any time during the call you require assistance, please press star followed by zero and a coordinator will be happy to assist you. As a reminder, this call is being recorded for replay purposes.
I would now like to turn the presentation over to the host of today’s call, Mr. Michael Conn, GSI Commerce Chief Financial Officer. Please proceed sir.
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Michael R. Conn
Thanks everyone and welcome to the GSI Commerce conference call for the first quarter ended March 31st 2007. This is Michael Conn, GSI’s Chief Financial Officer. And I’m here with Michael Rubin our CEO.
I’d like to comment on 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 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 guaranteed future performance and involve risks, uncertainties and assumptions, which are difficult to predict.
Therefore, factual outcomes may differ materially from what is expressed or implied by these forward-looking statements. Factors that may affect GSI’s business, financial conditions, and operating results, are discussed in its filings with the SEC.
GSI Commerce expressly disclaims any intent or obligation to update these forward-looking statements. During this call we also present certain non-GAAP financial measures: (inaudible), adjusted merchandise sales, and non-GAAP net income, and certain ratios that use these measures.
At our form 10K which is located on our website at www.gsicommerce.com under SEC filings, you will find our definitions of these non-GAAP financial matters. A reconciliation of these non-GAAP financial measures with the closest GAAP measures, and a discussion of 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.
We started the year out strong, delivering an excellent first quarter, with highlights including better than expected metrics for all of our key revenue and profitability measures.
Net revenue increased 28% verses last year, to $146 million with 19% growth in product sales and 66% growth in service fees. Non-GAAP net sales, or total transaction volume to our platform, increased 69% verses last year to $322 million with 36% growth in sporting goods and 87% growth in other categories.
Computer store trends were strong during the quarter and non-computer partners including Toys R Us, NFL, Baby Center, iRobot, and Adidas, showed meaningful growth.
Our three largest categories during the quarter were sporting goods, toys, and baby apparel, while our three fastest categories were health and beauty, home and jewelry.
Our gross margins improved 620 basis points from last year to 47.5% driven by 250 basis point improvement in product margins and strong growth and service fees.
Higher year over year product margins in sporting goods and the fact that sporting goods accounted for a higher percentage of product sales drove the product margin improvement. Loss from operations was $4.8 million compared to guidance of a loss of $6.5 to $7.5 million and (inaudible) was $3.8 million verses $1.5-2.5 million.
Net loss for the quarter was $2.3 million compared to guidance of a net loss of $5.5-6.5 million and non-GAAP net loss was $1 million compared to guidance of a loss of $3.1-4.1 million.
Net loss and non-GAAP loss were positively impacted by a $1.3 million and $700,000 tax benefit respectively which were not factored into our guidance. Even excluding this un-forecasted benefit, net loss and non-GAAP net loss were better than the high end of our guidance.
The upside in our earnings metrics were driven by the upside in volume and better than planned variable operating efficiency. On the cost side, our fulfillment and customer service operations performed very well.
It’s important to remember that we’re carrying fixed costs of our second call center this year, and that we’re not in the prior year period. We also had a small amount of start of costs associated with our new fulfillment center. Although these start up costs will be more significant in Q2.
Technology spending, which hits our product development line, was up significantly year over year as expected. But also as expected, it flattened out the second half of 2006 levels as you begin the anniversaried significant ramp-up in technology spending in the back half of 2006.
Overall our investment spending remains on track and our investments in areas including technology, fulfillment, marketing services and international are all included in our updated guide.
An interesting anecdote that shows how our business has evolved in the last few years is to compare our first quarter of ’07 results to results for the entire fiscal year 2003. Two periods in which total merchandise sales were relatively similar.
In the first quarter of ’07 our net revenues were $146 million. That compares to net revenues of $242 million for all of fiscal 2003. Yet in the first quarter of ’07, merchandise sales were $323 million compared to $282 million for all of fiscal 2003. In other words we had lower net revenue in the first quarter of ’07 but higher merchandise sales.
The drop in net revenue as a percentage of merchandise sales in this comparison, from 45% to 85% reflects the meaningful shift in our model to non-owned inventory. In fiscal 2003, owed inventory represented 77% of merchandise sales, while first quarter of ’07 owned inventory represented 34% of merchandise sales.
This shift is also driving higher gross margins. For our first quarter, ’07 gross margins of 47.5% were more than 1,000 basis points higher than fiscal 2003 levels of 36%. From a profitability standpoint, our loss from operations of $4.8 million and our (inaudible) $3.8 million first quarter of ’07 compares to a loss of operations of $13.1 million and breakeven adjusted EBITDA for all of fiscal 2003.
So in effect, in comparing the periods, the business today is capable of earning more profit dollars on lower net revenues based on the quality mix shift to higher margin service fees.
While comparing the quarter two years is obviously not apples for apples, it is in fact a tougher comparison for us because it does not offer the benefit of seasonality. However, it does provide a good illustration of the increasing leverage of our business and the benefits from our changing mix.
Now looking at our balance sheet, on a year over year basis, cash and marketable securities increased slightly despite our normal working capital run off. And inventory turns remain strong at 8.7 on a 12-month basis. Capital expenditures for the quarter were $10 million.
We’re raising our guidance for net revenue to a range of $710-760 million from a range of $685-735 million. We’re raising our guidance for merchandise sales for the year to a range of $1.6-1.7 billion from a range of $1.5-1.6 billion.
Revised revenue guidance reflects first quarter upside and strong underlying business momentum. We’re raising the bottom end of our guidance for income from operations by $1 ½ million to $9.5 million, and the bottom end of our adjusted EBITDA range by $2 million to $52 million from $50 million. The top end of our income from operations guidance is reduced by $500,000 to $12.5 million due to higher depreciation is partially offset by lower stock-based compensation.
The high end of our adjusted EBITDA guidance is unchanged at $55 million. Our revised net income range is $38-41 million, reflecting an increase of $4 million, the bottom end of the range, and $2 million the top end of the range.
We revised our methodology for non-GAAP net income to show this number tax that are estimated annual effected rate of 38.5% brining our new guidance of non-GAAP income to $12-$15 million. Using our prior methodologies the range would have been $21-$24 million compared to prior guidance of $19.5-24.5 million.
It is important to note that while we were showing our guidance fully taxed, we still have $186 million of net operating losses that we expect to utilize going forward. We expect capital expenditures for the year to be in the range of $50-55 million, up from prior guidance of approximately $50 million dollars, with the biggest driver being increased fulfillment capacity spending to support new and existing partner growth.
For the second quarter, consistent with our prior guidance, we expect year over year declines in our profitability metrics of income from operations, adjusted EBITDA, net income and non-GAAP income.
This is driven by a few factors, including an expectation for modest sequential decline in net revenue and merchandise sales because our seasonal patterns have changed a bit to the changing mix of our partner base, particularly the NFL, which is significantly larger in the first quarter and the second quarter.
In addition, we expect to incur start up expenses for our new fulfillment center of approximately $1.5 million in the second quarter in advance of its opening in Q3.
Finally overall fixed overhead technology spending will be modestly higher in the second quarter verses the first quarter as launch activity picks up.
All of this is consistent with our prior plan. Now I’m going to turn the call over to our chairman and CEO, Michael Rubin.
Michael G. Rubin
Let me start by saying that I'm very pleased with our 2007 fiscal first quarter results. There were trends embedded in the e-commerce that industry provided a strong tail wind to our first quarter performance, which exceeded the high end of our financial guidance on both the top and bottom lines.
We expect the macro trends in e-commerce to remain strong and we expect to continue to demonstrate the discipline necessary to execute solidly against our business plan. Additionally, today I am announcing that we are adding a new momentum to our growth strategy by explaining and enhancing our efforts on two emerging growth points: international and interactive market services.
First I'd like to talk about the quarter's highlights of our core business and then I will cover our merging growth initiatives. Our sales efforts in our core business returned strong results as we recently signed three new partners and our two new merchandise categories, marking our 12th and 13th categories.
During the quarter we welcomed the Hershey's company as a new partner. With Hershey's we enter the specialty foods portion of our broader food and beverage category. The launch of their e-commerce business on our platform is scheduled for late third or early fourth quarter this year.
The power category remains very strong for GSI and we reasonably partnered Charlotte Russe, a fast growing mall-based specialty apparel and accessories retailer. The rep store's expected to launch in the third quarter and will mark the debut of Charlotte Russe's as an online retailer.
I'd also like to announce that we've entered yet another new retail merchandise category, our 13th, with a new partner that we cannot mention by name until the launch later this fall. I would add that this new partner is a publicly traded multi-billion dollar specialty retailer.
Our profit pipeline continues to be healthy and I remain confident that it will reach our target to hit the high end of our goal of setting five to ten new partners this year.
It's also important to note that we extended our long term agreement with the Sports Authority, which is one of our top 10 partners and also the first major partner to sign on with us back in 1999. I believe renewals and extension validate the positive impact that our offering has had on our partners' businesses.
As I noted in our last call, the recent success we've had with renewals and extensions reflect what I believe is a trend that we will continue to see. That is that satisfied partners continue to set long term agreements to extend their partnerships with us under the terms that are not materially different, if at all, from their original agreements.
Also during the first quarter we rolled out a new webstore for Palm. The new site provides customers with an easier and more convenient way to find and shop for all their favorite Palm and Treo products and accessories from a single shopping cart. The site also features new functionality that provides customers with a wider selection of wireless carriers and plans, as well as an opportunity to customize those plans and match them with a smart phone of their choice.
Still on the core business front, our product management team rolled out the latest functions and features developed for our partners as part of the product management roadmap. This quarter we introduced a broad set of Web 2.0 technologies, including powerful new product reviews and ratings functionality.
We also introduced a blog solution and an RSS syndication feature, both of which enable our partners to deepen the social and community aspects of their websites. And example where you can see the blog and RSS feature is in a special feature of the NFL's online store called “Inside the NFL Shop,” a place where fans can interact and find savings on products, premium new arrivals, and the hottest special offers on merchandise.
We also recently deployed a new hassle-free label return label system that streamlines the product return process for customers and in turn their confidence at the time of purchase. We also enhanced the tools that our partners used to manage their online stores, including launching a new flexible motions tool that puts marketing power and control in the hands of our partners and will enhance our catalog management tool suite based on an extensive usability study we conducted in the later half of 2006.
This year we've significantly increased our investment in product management over the investments we made in 2006, which itself is more than double our investment in 2005. That annual investment that we make in our product roadmap is the way we continue to enhance the technology features and functions that deliver strategic value to our partners' online businesses.
We provide the bulk of the development effort for all roadmap initiatives while allowing the final interface, design, and customization to be managed (inaudible) to our platform investment or allowing them to implement the technologies in ways we deliver custom benefits to the businesses. Our partner roadmap is an example of the focus and attention we place on the needs of our partners.
Along the same lines, at the end of February we welcomed Fiona Dias as our Executive Vice President of Partner Strategy Marketing. Fiona's a recognized leader in large scale multi channel e-commerce marketing. Her addition to our senior management team strengthens the company's industry insight and better positions us to provide our partners with best practice expertise. She brings a wealth of leadership capabilities and innovative ideas to the position and her success at CircuitCity.com adds valuable experience to the team.
Fiona's leading a new partner strategy group that's responsible for delivering industry insight and identifying best practices and opportunities that will help our partners further grow their e-commerce businesses. Her group, which includes our product roadmap team, will direct the vision and focus on direct-to-consumer selling, multi-channel integration, and interactive marketing and branding.
Now let me turn to our merging growth opportunities. Individually I believe these areas hold tremendous opportunity for GSI while collectively I believe these new initiatives have the potential to transform GSI into a much larger and more successful enterprise, capable of delivering better results for our partners and in turn, our shareholders.
Let me start by addressing the international. In 2004, IDC estimates the global PC online market to be approximately $295 billion. It’s estimated the 2004 US global online market to be approximately $141 billion, which made up 48% of the online global market at that time. By 2009 IDC estimates that the global online market will grow to approximately $1.1 trillion, while Foster’s estimates the US online market to grow to approximately $213 billion.
Using these estimates approximately, 81% of the global online market will be located outside of the US by 2009. Thus while the US market has historically accounted for virtually all of the company's revenues, this initiative is designed to grow our company's international business to account for a meaningful portion of our revenue in the future.
Large-cap internet companies including Google, Amazon, Ebay, and Yahoo, have substantial international businesses. Last year as a group, the international components of these businesses averaged more than 39% of their overall sales. I believe a similar opportunity exists for GSI. We're now invested in our foothold in Barcelona, Spain, and we've been going to make investments in our core e-commerce technology platform to internationalize its capabilities.
In the next two years we tend to use the enterprise capabilities of an internationalized core platform together with potential acquisition opportunities to duplicate our domestic end-to-end offering overseas and build a significant new revenue stream for the company. Europe is the first logical step to grow our global presence given our current presence in Barcelona and size of the overall European market, but we're also looking to move quickly into Asia.
We believe that an end-to-end outsourced e-commerce solution is a strategy for us that will translate well into these regions. To take advantage of the growth opportunity I've appointed Steve Davis as President of GSI's International Operations. Steve will be relocating to Spain and has already begun assembling his business plan. Steve will be tasked with building our international offering, which may include acquisitions.
As a GSI executive since 2000, and as someone who has led many different areas for us, including account management and product management, and who started and led our interactive marketing services group, I believe Steve is the perfect person to take on this new challenge and I expect him to deliver great results for GSI.
Next I'd like to address interactive marketing services. As I noted on past calls we continue to see a channel shift of our partners' marketing dollars from traditional media to the online channel. This shift not only includes moving offline dollars to online advertising, but also moving offline dollars to web-based branding efforts, such as store redesign and branding projects.
Our partners are beginning to realize the overall influence and growing use of the online channel as a destination for both information and commerce and the importance this holds for their brands. When you add to that our strategic and intimate knowledge of our partners' e-commerce businesses, I believe there's a tremendous opportunity for us to provide our partners with the marketing services they need to establish the online channel as a unifying link between the offline and online worlds.
A little less than two years ago we started a marketing group to service this opportunity. Last year in its first full year of operation, marketing services generated almost $10 million in incremental revenue while also supporting our own inventoried businesses. Today that group is named GSI Interactive and functions as our interactive marketing service agency. This business employs approximately 135 people and provides online marketing services to approximately 50 of our partners.
To build on the momentum we've created and build this business into significant revenue generating for the long term we are currently conducting a search for an industry executive to lead the agency business. This position will report directly to me.
One of the agency's most recently demonstrated successes is Ace’s newly redesigned website. Ace Hardware’s makeover which has received praise from users offers consumers a host of advanced interactive features and services that supports Ace’s multi-channel strategy across its 4600 retail stores. Among these new features is a premier store locator that incorporates both geo-location software and enhanced maps functionality. In summary, I’m confident that as we continue to manage the business effectively we will again be able to reach our goals of increased profitability and margin expansion or continue to drive growth in our core business in developing our emerging growth initiatives.
With each quarter, we add scale and scope to our platform, and we continue to operate in the industry with healthy global growth trends. The results have allowed us to continue to build a broader and stronger base on which we can execute against our strategy for world business. Since 1999, a single focus has been almost entirely on the US business.
We’ve put a world class end-to-end platform and have added partners quickly. We plan to continue our US business and to expand our leadership position in the market, but as I’ve outlined today, we’re now taking steps to use our assets in the commerce leadership position to actively pursue growth opportunities in two emergent areas; marketing services and international. As a result, the company has a much larger opportunity.
With that, I’ll open the call up for questions.
Question-and-Answer Session
Operator
Ladies and Gentleman, if you wish to ask a question, please key star followed by 1 on your touchtone telephone. If your question has been answered or you wish to withdraw your question, please key star followed by 2. Please press Star 1 to begin and please standby for your first question.
And your first question comes from the line of Anthony Noto with Goldman Sachs. Please proceed.
Anthony Noto - Goldman Sachs
Thank you very much. My first question is 69% NMS growth…I was wondering if you could give us a sense of what the unit growth was in the first quarter and how on the year over year basis and how that may have compared with unit growth in the fourth quarter of 2006?
And second question, given the investment that you’re making internationally, based on your 2007 guidance, how much are you losing in the international market if any at all?
Thank you.
Michael R. Conn
I think on the unit growth question, we haven’t seen huge variability in our average order value, since we started it’s been pretty close to 100 as the mix change has come down a little bit, but in general, our (inaudible) growth is pretty similar to our overall merchandise sales growth so there’s not much of a use difference.
If you look at the sequential trend first quarter, you know 69% up is significant growth. It was up more in the fourth quarter. Some of that really just relates to the timing of when we count certain partners so there were more non-count partners in the fourth quarter than in the first quarter. So I would say, from an underlying business momentum perspective, business really felt as it was a continuation of the strength that we saw in the first quarter.
From an international perspective in terms of the P&L impact, I think you recall, we made an acquisition that we closed at the beginning of last year that really got us our foothold in the European market with a company that’s based in Spain, which is really not a foothold for our operations in Europe. And that company has customers that are up on its platform who were starting to spend on top of that, but the incremental spending the overall loss as a result that we’re generating in 2007 from international is not anything that I would characterize as material.
Anthony Noto - Goldman Sachs
OK great, thank you.
Operator
And your next question comes from the line of David Joseph with Morgan Stanley. Please proceed.
David Joseph - Morgan Stanley
Yeah hi guys, just two quick ones. The 13% that you guys are projecting at the high end of your guidance, I know that there is some magnified seasonality and we’ve seen that in other businesses and the NFL is a part of that. I just want make to make sure that there’s nothing anything else there in terms of timing that might be depressing that number as well.
In addition, you guys talked a little about GSI Interactive. I like the idea that you’re starting a Dial-Up Marketing services, that’s another trend that seems to be emerging, I’m wondering if you could get a little bit more specific in terms of how you’re going to be driving that business or expanding it.
Michael R. Conn
Sure, I think on the second quarter revenue growth and the sequential trend, I think that what you’re seeing in part is some of the nuances of the mix in our partner base quarter to quarter, owned versus non-owned partners…overall business momentum, we’re looking for more of the same in the second quarter continuation of the strength that we’ve seen.
We do have more business in the second quarter that we’re expecting to come from non-owned inventory partners, so the merchandise sales growth that we would be looking for would be greater than ordinary in terms of its spread verses net revenue. I think you would see that translates through to the gross profit line with nice increase with gross margin percent as we’ve been seeing. So really, nothing beyond just partner mix owned, non-owned, that’s factoring into that.
Michael G. Rubin
I’ll touch on the question as it relates to GSI Interactive. When we started this business 18 months ago, I think we thought that it represented a good opportunity to serve our existing partners and to provide some strategic benefit to help grow at a faster pace through online businesses. 18 months later, what I can tell is that all the partners that work with GSI Interactive that have significant relationships, we are strategically that much more together with our partners, and helping them in that’s what more important to their business. So we’ve found that it’s really growing the overall business, but also it’s also helping to accelerate the growth of the re-commerce business.
I think today our perspective is different than it was even six months ago. We think the marketing services business has a much larger opportunity as a standalone business, and I think today we think it could be a much bigger business. So we’re definitely more aggressively to grow in all of the key areas: design, interactive marketing, catalog services, email management, photography studios…we think all these represent big opportunities.
And quite frankly, if you look around at some of the other companies in this space, there are some pretty big companies out there that dream of working with customers like GSI works with today. So we think in the 60+ partners that we have today, the captive base, the way we continue to grow that, that this represents again, a very meaningful business and we’re organizing against that based on how big we think the opportunity is.
David Joseph - Morgan Stanley
Yeah, thanks guys.
Operator
OK, your next question comes from the line of Brian Pitz with Banc of America Securities. Please proceed.
Brian J Pitz - Banc of America Securities
Great thanks. Can you talk a little bit more about the growing international and marketing services businesses? Will this include more organic or acquired growth in each of these segments?
And separately on the (inaudible) side, what if any impact is the postal rate increases that are going into effect in mid-May potentially having on either your or your partners businesses, and are you factoring this into guidance for the full year? Thanks.
Michael R. Conn
I’ll address the first part of the question as it relates to international and marketing services and organic versus acquisition and Mike will give the second part of the question. I think in both the marketing services area and the international area, I think it definitely, first and foremost, it will be great organic growth and we’ve seen that already.
I think I referenced today in the first year of business, which was last year, marketing services did almost $10 million dollars and that was up from less than a million dollars I think in 2000 in the previous year. I think going forward we believe again first and foremost, that the organic growth for both these businesses would be terrific. We look forward to internationally leveraging our technology platform and to really leverage all the dollar investment that we’ve made historically.
At the same time, we feel that in both areas that there certainly should be acquisitions that could help us to get to our goal more quickly. So, I think historically this company has grown very much organically.
I think going forward, that will still be the biggest part of our growth. I definitely think there will be things that can compliment on both businesses, and can help us to get better capabilities more quickly, and to really achieve on a scale we want to achieve on a more expedited basis.
Michael G. Rubin
On the postal rate increase, Brian, catalog services are clearly a growing part of our business though not all that large relative to the total. If you just isolate the impact of the postal increase relative prior to our prior forecast, it’s about a $200,000 impact, relatively immaterial when you look into buying efficiencies on the paper side that were gaining as well as just getting better at list management. So not really anything I would characterize as material but certainly a pretty significant increase relative to that total line item for us.
Brian J Pitz - Bank of America Securities
Great, thanks.
Operator
And your next question comes from the line of Shawn Milne with Oppenheimer. Please proceed.
Shawn Milne - Oppenheimer
Thank you and good quarter guys. A couple questions. First, you talked about the impact of opening the distribution center in the second quarter. Do you expect that fully out of the way in the third quarter and they're still drag year-over-year in Q3?
Additionally, I just want to follow up on all the questions on international. Can you talk about, Michael, you strategy on the fulfillment side? You've been able to effectively grow the marketing services business without hurting margins but of course on the international side you'll have to tackle this fulfillment issue. Can you talk about that? And then lastly on marketing services, you talked about $10 million in 2006; can you give us what you think '07 will be? And is the business currently profitable on a segment basis?
Thank you
Michael R. Conn
So Shawn, to kick off the question on the new fulfillment center, the drag impact in the second quarter will still be there in terms of those expenses will still be in place in the third quarter. Volume should be picking up in the third quarter versus second quarter. We'll be shipping out of that facility so we'll be load balancing our volume and starting to offset and take some capacity out of our existing facilities.
So the expenses will still be there, the drag impact will be less, and then from a fourth quarter perspective we would really expect that facility to really be moving significant volume for us in that the overhead that would be there would not be a meaningful drag. We still expect in 2008 and 2009 to get much further utilization out of that facility.
Michael G. Rubin
Shawn, to touch on your question as it relates to international fulfillment and how to approach it, I think we think that's an area where quite frankly there are many companies that offer a business-consumer outsourced fulfillment solution today and we think that probably can pretty readily be acquired that could help us to alleviate the startup expense that we do when we do things like we're doing here in the US.
It's a big difference, today we're building our large development center, today 550,000 square feet, fully automated, first time we've done that, serving the entire market. That's quite different from what we'll do when we go into individual regions internationally and throughout the world.
So I think that it's very likely that acquisitions of some of these small companies could be a way that we get to scale more quickly and really alleviate some of the pain of starting up a big center.
As it relates to marketing services, I don't want to give guidance specifically on what we're going to do in 2007, but I will say that it's immediately up from 2006 and I think if you look at the marketing services business and you split it into two pieces, there's part of the 135 employees that serve existing business, and there's part of the 135 employees that serve the newer growing business.
I certainly think the business is not financially meaningful either which way. I say probably profitable but you know, we're probably going to (inaudible) investments, same thing. Bottom line impact of the marketing services business, if you separate out the cost of supporting existing business would be pretty much neutral.
Shawn Milne - Oppenheimer
OK, thank you
Michael R. Conn
And Shawn, just to add, the reason for that is we continue to invest in the business and want to add capabilities in a very quick way, and I think that's really helping us to win business as well.
Operator
Your next question comes from the line of Scott Devitt with Stifel Nicolaus. Please proceed.
Scott Devitt – Stifel Nicolaus
Hey guys, thank you. The question relates to the domestic business. I think you've added a few direct sales people in terms of account gatherers and I was wondering how that's progressing, if you're getting better leads in terms of new partners and kind of what the lead time is with those new hires actually acquiring deals, if you think you can actually push this new add, figure closer to 10-15 in outer years? And within that context how you think about deal sizes if you do expand the number of deals?
Michael G. Rubin
Sure. Our investment in 2007 in the sales organization is roughly double what it was in 2006 and it had been fairly constant for the previous years up until that point. So it's definitely a big step of investment for us. As you invest in new people certainly takes a little bit of time to come up to the learning curve and then it takes a little bit of time for them to get out there are start prospecting.
But I think there's two fundamental changes brought to the marketplace today. Today I think GSI is the undisputed leader within outsourced e-commerce for physical goods. I certainly believe that our reputation is helping us gain partners everywhere we look. I think we never serviced partners better than we are today, I think our reference ability is the best it's every been, so that's definitely really helping us to drive business and at the same time doubling the investment in sales organization is also going to help.
So I think going forward as it relates to your question is can we take the average amount of partners up in future years, I definitely think we can. That's definitely something that we want to move toward. I don't want to specifically set a target today, but it is part of the investment in the sales organization and is definitely with the desire to move up the average partners that we bring on and this is what we've historically done.
I think also another historical issue we've had is we've been capacity constrained, both from a technology platform perspective and a fulfillment customer service perspective. Part of really investing in the technology platform and investing in this new fully automated DC and the new call center that we brought up last year is that for the first time I believe that the company has the capacity to add partners at a faster rate, and that's something we never had until 2007, so I'm really excited about that.
As it relates to the average size of partners that we bring along, it seems to really be consistent. I think that we bring on some big new great companies at the same time and we still every year when you think there's no more companies that haven't had an e-commerce business before that are just starting up for the first time and you find some.
You know, Charlotte Russe was a great example. Very successful mall based retail, but they're launching their e-commerce business for the first time with GSI. So I think that the one thing that may be different, today I don't think there's any company in the country outside of the internet-only companies like Amazon or eBay, I think there's not a traditional retailer brand not using GSI services and our scale's finally brought us to that point, so I do think that over time the same way we brought on Toys R Us last year, that was a big step up function for us. I think there will be other large opportunities like that that exist for us to continue to grow the business with.
Scott Devitt – Stifel Nicolaus
Great, thanks. And one follow-up for Michael Conn. I'm not sure I understand the tax provision. Maybe this is something we take offline but last year you had a big tax credit in 4Q which is what I had been modeling this year and now it seems like you're flowing through tax credits each quarter. Does that impact the fourth quarter estimates?
Michael R. Conn
What will show for each of the quarters this year is our regular tax provision using our estimated annual rate, which is 38.5%, so the first three quarters we would expect it to be a loss. We would expect to see a benefit in each of those three quarters.
In the fourth quarter similarly, we would expect to have our estimated tax provision of 38.5% creating a book tax expense, although again, from a cash perspective there's very little cash paid because of our NOL's. But in addition to that in the fourth quarter we still would expect to have a significant one time benefit of around $32 million so you'd still be looking for in the fourth quarter about $26 million overall tax benefit.
Scott Devitt – Stifel Nicolaus
OK, thanks.
Operator
And your next question comes from the line of Jim Friedland with Cowen and Company. Please proceed
Jim Friedland – Cowen and Company
Thanks, question on alternative payments. In Q4 you guys put out a press release about the significant percentage of total sales that were going through things like Google Checkout, but that was getting promoted a lot. So now that we're in Q1 and it's not the holiday season, I just wanted to get a sense of how Google Checkout's performing and any initial thoughts on the Yahoo PayPal Express Checkout service that was just launched.
And secondly, a quick question on fees as a percentage of the product business. Do you think the percentage that we're seeing has sort of stabilized now that Toys R Us is in the mix and we're going to see more of these interactive deals just in terms of trending?
Michael R. Conn
I'll start with the question on alternative payments and then turn it over to Mike for your other question. As it relates to alternative payments, they continue to be a very meaningful part of our overall business. I think quite frankly the big winner for us has been Google Checkout and even without the promotion in Q1, the service has really done well for us.
I think our partners overall are really pleased with it, and then we continue to see a lot of momentum and demand from new partners. When we originally launched Google Checkout I think it had eight partners live. I think last time we gave an update I think there were 16 partners live. I think today there's maybe 25-30 partners live and I think Google has made great progress really penetrating the majority of our partner base.
So I think today there's no question that Google's the largest of the payment systems and even without the promotion we're seeing very good adoption with it and are really exciting and are happy, quite frankly, to be the person that launched with them and benefited from this.
As it relates to Yahoo PayPal, I don't have any comment. I don't think it's really hit our radar screen yet. We do take PayPal's basic system today and that represents a small single-digit percentage of sales. I don't even know how many sites that's on today. I think several partners have it on today.
Michael G. Rubin
I think it’s a small single digit per sales and again as it relates to Yahoo PayPal, the new service, I think that time will tell. We'll give you updates on it in the future if it becomes meaningful.
Michael R. Conn
On the service retake rate, the percentage of the first quarter is probably actually a little bit lower than we would expect to see for the balance of the year. If we look at the new partners that we've added this year are all in the process of launching they are all of course full service deals.
If I look at the pipeline, it’s predominately full service deals so I would actually expect to see that trend upwards. Still in the high teens range but should be higher than the first quarter's amount for the rest of the year.
Jim Friedland – Cowen and Company
And one quick follow up on the alternative payments with Google check-out. What do you think the key driver of; why are you so positive? Is it that is improving quickly through rates or that it is improving conversion rates once people get to the site? Or is it both?
Michael G. Rubin
I think on an overall basis, Google is first and foremost doing a lot of things to give better placement to people that are accepting check-out so I think that it's really…I think the way they're highlighting partners that are accepting check-out is definitely helping.
I think that certainly the Google brand…I think you saw just a couple of days ago with the study that just came out that said that they were the number one brand. I think that quite frankly customers are very comfortable with Google as a brand and as a place to check-out. I think we've also seen some nice repeat rate.
I've heard that if the product continues to, Bob, the conversions continue to increase, so kind of what I look at is two key metrics. We continue to see a lot more demand and the second thing is market penetration. We ask ourselves the question, what would happen if the promotion was slowed down in the fourth quarter. And still with no promotion, it is our most meaningful payment method by far and away in that is why, I think, we’re still bullish on it.
Jim Friedland – Cowen and Company
OK, thank you.
Operator
OK, your next question comes from the line of Robert Peck with Bear Stearns. Please proceed.
Robert Peck – Bear Stearns
Hi it's actually (inaudible) for Bob Peck. The first question is on your EBITDA margin. It seems like adjusted EBITDA for this quarter beat the point of guidance by around $10 million and at the same time you also moved up lower end of your four year 2007 EBITDA guidance by $2 million, also keeping the higher end of your guidance unchanged. Does that mean your EBITDA for the rest of the year is sort of unchanged to slightly down?
Michael G. Rubin
I would say that it is relatively consistent. You know our internal plan, the upside was relatively consistent. So I think that ...we feel that the balance of the year really looks consistent with how we planned it previously.
Robert Peck – Bear Stearns
One quick follow up. What's your thoughts on Borders leaving the Amazon platform and do you view them as a possible candidate as (inaudible)?
Michael G. Rubin
We have continued at our new categories at a very aggressive pace and today we are, I suppose, we are in our thirteen category. I think one of the few categories that we are not interested in is the physical (inaudible) music and video category in a big way. So I think Borders certainly has an opportunity as an e-commerce business, but I'm not sure that it is something I would say would be a core focus for us to be quite frank.
Robert Peck – Bear Stearns
Thank you very much.
Operator
OK your next question comes from the line of Christa Quarles with Thomas Weisel Partners. Please proceed.
Christa Quarles - Thomas Weisel Partners
Hi, a couple of short term focus questions and then I have a long term one.
First, the gross margins in your own inventory business dipped in quarter 2 last year, do you expect a similar dip this year and if you could remind us why that is?
And then second, on your guidance for the remainder of this year, the increase…I saw $50+ million on the high end , is that just due to the new partners that you signed or is that related to better performance of your existing partners? And then I have a longer term question.
Michael G. Rubin
Sure, on the gross margin and product sales, the dip last year was both sequential and year over year as I look to this year I would expect it to be down sequentially but still up year over year. Last year, the driver was really the mix between chronic sales of sporting goods and electronics in that line and the electronics components moved up and that drove the gross margin down both year over year and sequentially. This year I would expect to see sporting goods higher as a percentage total mix which would have it up year over year, still down sequentially, just based on the mix within the base of partners within sporting goods for the quarter so less licensed product, more general sporting goods which adds a little bit of a lower margin.
Christa Quarles - Thomas Weisel Partners
And the guidance?
Michael R. Conn
The guidance from a merchandise sales perspective would be not just new partners but also reflective of underlying business momentum. The initial guidance that we put out does have some expectation that we will be launching new partners during the year although it has never a particularly large part of our guidance, we do have an expectation for that. Really the biggest driver in fact is underlying business momentum.
Christa Quarles - Thomas Weisel Partners
OK, and as you think about longer term, as I say building a DC effort, looking at my DTF anyway and I think about the international and the marketing services opportunities; are these more in terms of real contribution kind of O-9 kind of type of events? And then moreover when I think about the expansion from a capacity stand-point, 3% of G&V in terms of CapEx, is that an appropriate level to think about in terms of, again trying to think about building this business for the long term? Thank you.
Michael R. Conn
Sure I think from a contribution perspective, certainly as we sit today in building this business that would be a reasonable expectation and consistent with how we think about it. At the same time we're talking more about it because we are enthusiastic about the opportunity and so we are certainly going to be pushing in these areas but I think that realistically thinking about it that way is realistic.
Michael G. Rubin
G&V percent for CapEx…a reasonable rule of thumb but really is a somewhat mixed dependent for us from a business perspective. We're building capacity based on the mix of the services we are providing from a pipeline perspective. So it’s always a little bit tricky in terms of thinking about it from a percent perspective.
Certainly over time we're expecting to get a lot more efficient in that area. We're building facilities more efficiently. We're expecting to be able to get more volume through facilities as we build them to date, more automated in nature than historically, so while the old CapEx is rising the actually efficiency that we expect to get out of that, the actual volume that we expect to move through facilities, will become greater over time and that will allow us to get leverage on the cap back line moving forward.
Christa Quarles - Thomas Weisel Partners
OK, that’s very helpful.
Operator
Ladies and gentleman this concludes the question and answer portion of today's call. I would like to bring the presentation back to Michael Conn for closing remarks.
Michael R. Conn
I just want to thank everybody for joining us today and look forward to touching base with you again on our second quarter conference call.
Operator
Thank you this concludes today's presentation, the conference call for the fiscal 2007 first quarter Operator results of GSI Commerce. Thank you for your participation and interest, have a good evening.
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