GSI Commerce Q1 Results in Detail (GSIC)

From Stifel Nicolaus analyst Scott Devitt's note to clients today on GSI Commerce's (NASDAQ: GSIC) Q1 results:

Solid Management Execution; Maintain Hold

• We maintain our Hold rating on GSI Commerce but believe the company had a very solid quarter. The company is executing well against its business plan, in our opinion. We believe the shares to be fairly valued at current levels of 15x 2007 EBITDA and 37x 2007 FCF. Were GSI Commerce to win the Toys R Us deal our fair value estimate would adjust accordingly. We would become interested in GSI Commerce shares on weakness, all else equal.

• The company reported 1Q06 net revenue of $114.2 million and a loss per share of $0.10. We were looking for revenue of $104 million and a loss of $0.09.

• GSI Commerce generated $67.5 million, or 35% of its merchandise sales in the sporting goods category. No other category account for more than 20% of merchandise sales in the period. Total net revenue from product sales were $91.7 million, or 80% of total revenue.

• For 2Q06, we forecast net revenues of $111.3 million and a loss per share of $0.11. For 2006, we expect net revenues of $571.8 million and EPS of $0.16.

Our Thoughts

The company executed well against our metrics for the business in the quarter including 40% sporting goods revenue growth, 54% service fee revenue growth, and a 41.3% gross profit margin (up 440 bps YOY). Net merchandise sales (NMS) from sporting goods and other product revenues (Palm) declined to 54% of total NMS from 62% last year, a metric we pay close attention to and one that is a significant positive trend in our view. Also, inventory turns improved to 6.6x from 5.4x last year. Finally, sales and marketing spending as a percentage of NMS was 15.4% consistent with 1Q05 levels despite increasing online advertising rates.

We expect GSI to generate $35 million in EBITDA in 2006 and $47 million in 2007. The shares trade for 15x 2007 EBITDA and 37x FCF. We don't find the shares to be particularly inexpensive but the company's business plan is working and we find its competitive position to be improving with time. We would be buyers of the shares on weakness.

On the subject of Toys R Us, Amazon has appealed a court ruling which terminated the services contract between the companies. Until the appeal is resolved, we do not expect an announcement regarding a new partner. We estimate the online operations of Toys R Us to be a $350 million business and believe a chosen partner could generate $20 million (6% EBITDA margin) on a deal. If GSI won the deal it would be a material positive for the business both in terms of profits of the deal and the benefits of scale it could present

Results

Total net revenues for the quarter were $114.2 million, up 25% year/year. Merchandise sales for the quarter were $191.0 million, up 40% from the year ago quarter. Net revenues from product sales of the sporting goods category were $55.8 million, or an increase of 40% from the year ago quarter. Merchandise sales from the sporting goods category were $67.5 million, up 42% year/year. Service fee revenues were $22.6 million, or an increase of $7.8 million from the year ago quarter. Service fee growth benefited from strong merchandise sales increases for non-inventory owned partners as well as momentum in the company's marketing services efforts. Net revenue from the other product category was $35.8 million, down 3% from the year-ago quarter.

Net loss was $4.4 million, or a loss per share of $0.10. Adjusted EBITDA for the quarter was $2.7 million. Included in net loss per share for 1Q06 is a non-cash charge of approximately $1.6 million, or $0.04 per share, relating to a reduction in carrying value of the shares owned by the company in Odimo Incorporated, stemming from the sale of Ashford.com to Odimo in 2002.

Gross profit in the quarter was $47.2 million, up 34%, with a margin of 40%. Sales and marketing expenses increased to $29.4 million, up $8.5 million year/year in the quarter. As a percentage of net revenues, cost of revenues decreased from 63.0% in first quarter 2005 to 58.8% in first quarter of 2006. Capital expenditures for the quarter were approximately $3.7 million compared to $6.8 million last year.

GSI's top five partners represented 47% of merchandise sales in the quarter compared on 60% in the quarter of last year. The company's largest partner accounted for 13% of first quarter merchandise sales volume, compared to the largest partner representing 24% of first quarter merchandise sales volume last year. Product sales which is from GSI's own inventory, represented 48% of merchandise sales in the first quarter, compared to 56% from last year's first quarter.

Cash and equivalents at the end of 1Q06 were $132.1 million. Ending inventories for the quarter were $31.3 million.

Estimates and Conclusion

For 2Q06, the company gave net revenue guidance between $110 million and $115 million with adjusted EBITDA in the range of $1 million to $2 million. Net loss for the second quarter is expected to be between $4.7 million and $5.7 million. For full year 2006, management expects net revenues to be between $559 million to $579 million with merchandise sales between $923 million and $973 million. Adjusted EBITDA was guided between $32 million and $35 million with net income between $5 million and $7.5 million. Management also noted that they have begun a search for a third fulfillment center and expect it to open in 2007.

For 2Q06, we forecast net revenues of $111.3 million and a loss per share of $0.11. For 2006, we expect net revenues of $571.8 million and EPS of $0.16. We maintain our Hold rating on GSI Commerce but believe the company had a very solid quarter. The company is executing well against its business plan, in our opinion. We believe the shares to be fairly valued at current levels of 15x 2007 EBITDA and 37x 2007 FCF. Were GSI Commerce to win the Toys R Us deal our fair value estimate would adjust accordingly. We would become interested in GSI Commerce shares on weakness, all else equal.