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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

     
(Mark One)
   
x
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the quarterly period ended June 27, 2004
 
   
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from                                      to                                      .

Commission File Number: 0-50387

RedEnvelope, Inc.

(Exact Name of Registrant as Specified in Its Charter)
     
Delaware   33-0844285
(State or Other Jurisdiction of   (IRS Employer
Incorporation or Organization)   Identification No.)

201 Spear Street, 3rd Floor,
San Francisco, California 94105

(Address of Principal Executive Offices and Zip Code)

(415) 371-9100
(Registrant’s Telephone Number, Including Area Code)

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

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

     The number of outstanding shares of the registrant’s common stock, $0.01 par value per share, was 8,731,215 as of July 25, 2004.




REDENVELOPE, INC.
REPORT ON FORM 10-Q
For the Quarter Ended June 27, 2004
TABLE OF CONTENTS

             
        Page
  PART I. FINANCIAL INFORMATION        
  Financial Statements (Unaudited)        
  Condensed Balance Sheets as of June 27, 2004, March 28, 2004 and June 29, 2003     2  
  Condensed Statements of Operations for the thirteen weeks ended June 27, 2004 and June 29, 2003     3  
  Condensed Statements of Cash Flows for the thirteen weeks ended June 27, 2004 and June 29, 2003     4  
  Notes to Condensed Financial Statements     5  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     9  
  Quantitative and Qualitative Disclosures About Market Risk     29  
  Controls and Procedures     30  
  PART II. OTHER INFORMATION   II-1
  Legal Proceedings   II-1
  Changes in Securities, Use of Proceeds and Issues or Purchases of Equity Securities   II-1
  Exhibits and Reports on Form 8-K   II-2
 EXHIBIT 10.40
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1
 EXHIBIT 32.2

 


Table of Contents

PART I.
FINANCIAL INFORMATION

Item 1. Financial Statements

REDENVELOPE, INC.

CONDENSED BALANCE SHEETS

(Unaudited)
                         
    June 27,   March 28,   June 29,
    2004
  2004
  2003
    (In thousands, except per share data)
ASSETS
                       
Current assets:
                       
Cash and cash equivalents
  $ 18,667     $ 18,409     $ 4,748  
Short-term investments
    10,495       6,971        
Accounts receivable, net
    849       1,055       407  
Inventory
    8,275       9,609       7,095  
Prepaid catalog costs, other current assets and restricted cash
    1,792       2,037       1,232  
 
   
 
     
 
     
 
 
Total current assets
    40,078       38,081       13,482  
Property and equipment, net
    6,236       4,746       3,926  
Long-term investments
          1,844        
Other assets and restricted cash
    471       505       1,384  
 
   
 
     
 
     
 
 
Total assets
  $ 46,785     $ 45,176     $ 18,792  
 
   
 
     
 
     
 
 
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY/(DEFICIT)
                       
Current liabilities:
                       
Accounts payable
  $ 7,700     $ 5,539     $ 4,699  
Accrued expenses and other current liabilities
    3,228       2,706       1,840  
Accrued compensation
    1,215       1,602       627  
Capital lease obligations, current
    597       596       654  
 
   
 
     
 
     
 
 
Total current liabilities
    12,740       10,443       7,820  
Capital lease obligations, long-term
    671       816       980  
 
   
 
     
 
     
 
 
Total liabilities
    13,411       11,259       8,800  
 
   
 
     
 
     
 
 
Commitments and contingencies
                       
Mandatorily redeemable convertible preferred stock
                82,556  
Stockholders’ equity (deficit):
                       
Series A preferred stock, $0.01 par value; 2,000,000 shares authorized, none, none, and 0.6 million issued and outstanding as of June 27, 2004, March 28, 2004 and June 29, 2003, respectively
                953  
Common stock, $0.01 par value; 100 million shares authorized; 8.7 million, 8.5 million, and 0.3 million issued and outstanding as of June 27, 2004, March 28, 2004, and June 29, 2003, respectively
    88       86       4  
Additional paid-in capital
    113,011       112,728       2,030  
Deferred compensation
    (71 )     (197 )     (766 )
Notes receivable from stockholders
    (44 )     (44 )     (44 )
Accumulated deficit
    (79,604 )     (78,652 )     (74,741 )
Accumulated other comprehensive loss
    (6 )     (4 )      
 
   
 
     
 
     
 
 
Total stockholders’ equity/(deficit)
    33,374       33,917       (72,564 )
 
   
 
     
 
     
 
 
Total liabilities, mandatorily redeemable convertible preferred stock and stockholders’ equity/(deficit)
  $ 46,785     $ 45,176     $ 18,792  
 
   
 
     
 
     
 
 

See accompanying notes to these condensed financial statements.

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REDENVELOPE, INC.

CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
                 
    Thirteen Weeks Ended
    June 27,   June 29,
    2004
  2003
    (In thousands, except for per share data)
Net revenues
  $ 21,131     $ 17,721  
Cost of sales
    9,899       9,050  
 
   
 
     
 
 
Gross profit
    11,232       8,671  
 
   
 
     
 
 
Operating expenses:
               
Fulfillment
    3,321       2,713  
Marketing
    4,944       3,747  
General and administrative
    3,915       3,269  
 
   
 
     
 
 
Total operating expenses
    12,180       9,729  
 
   
 
     
 
 
Loss from operations
    (948 )     (1,058 )
Interest income
    75       10  
Interest expense
    (79 )     (169 )
 
   
 
     
 
 
Net loss
  $ (952 )   $ (1,217 )
 
   
 
     
 
 
Net loss per share — basic and diluted
  $ (0.11 )   $ (3.52 )
Weighted average shares outstanding — basic and diluted
    8,635       346  

See accompanying notes to these condensed financial statements.

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REDENVELOPE, INC.

CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
                 
    Thirteen Weeks Ended
    June 27,   June 29,
    2004
  2003
    (In thousands)
Cash Flows From Operating Activities:
               
Net loss
  $ (952 )   $ (1,217 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    618       652  
Amortization of deferred stock compensation
    7       28  
Other non-cash charges
    59        
Issuance of stock for services rendered
          9  
Changes in current assets and liabilities:
               
Accounts receivable
    206       (121 )
Inventory
    1,334       2,621  
Other assets
    245       355  
Accounts payable
    2,161       (1,258 )
Accrued expenses and other current liabilities
    115       301  
 
   
 
     
 
 
Net cash provided by operating activities
    3,793       1,370  
 
   
 
     
 
 
Cash Flows From Investing Activities:
               
Maturities of investments
    6,089        
Purchase of investments
    (7,772 )      
Purchase of property and equipment
    (2,117 )     (116 )
 
   
 
     
 
 
Net cash used in investing activities
    (3,800 )     (116 )
 
   
 
     
 
 
Cash Flows From Financing Activities:
               
Proceeds from exercise of common stock options and warrants
    410       67  
Principal payments on capital lease obligations
    (145 )     (141 )
Repayment of loan
          (1,123 )
Payment of loan costs and other
          (306 )
 
   
 
     
 
 
Net cash provided (used) by financing activities
    265       (1,503 )
 
   
 
     
 
 
Net increase (decrease) in cash and cash equivalents
    258       (249 )
Cash and cash equivalents at beginning of period
    18,409       4,997  
 
   
 
     
 
 
Cash and cash equivalents at end of period
  $ 18,667     $ 4,748  
 
   
 
     
 
 
Supplemental Cash Flow Information:
               
Cash paid for interest
  $ 39     $ 66  

See accompanying notes to these condensed financial statements.

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REDENVELOPE, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

1. Financial Statements — Basis of Presentation

     The accompanying unaudited financial statements include the accounts of RedEnvelope, Inc. (referred to as the “Company”, “we”, “us”, and “our”). The condensed balance sheets as of June 27, 2004 and June 29, 2003, the condensed statements of operations for the thirteen-week periods ended June 27, 2004 and June 29, 2003, and the condensed statements of cash flows for the thirteen-week periods ended June 27, 2004 and June 29, 2003 have been prepared by us, without audit. In our opinion, the financial statements include all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position at the balance sheet dates and the results of operations for the thirteen-week periods then ended. The balance sheet at March 28, 2004, presented herein, has been derived from the Company’s audited balance sheet included in the Company’s Annual Report on Form 10K, for the fiscal year ended March 28, 2004.

     Certain information and disclosures normally included in the notes to the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. These financial statements should be read in conjunction with the condensed financial statements and notes thereto included in the Company’s Annual Report on Form 10K, for the fiscal year ended March 28, 2004. Certain reclassifications have been made to the prior period financial statements to conform to the presentation used in the current period.

     The results of operations for the thirteen weeks ended June 27, 2004 are not necessarily indicative of the operating results of the full year. Further, the preparation of condensed financial statements requires management to make estimates and assumptions that affect the recorded amounts reported therein. A change in facts or circumstances surrounding the estimates could result in a change to the estimates and impact future operating results.

     Our fiscal year ends on the Sunday closest to March 31, resulting in a 52 or 53 week year. Fiscal 2004 ended on March 28, 2004 and was 52 weeks long. Fiscal 2005 will end on April 3, 2005 and will be 53 weeks long. We report our interim results on a fiscal quarter basis rather than on a calendar quarter basis. Under the fiscal quarter basis, each of the first three fiscal quarters is thirteen weeks long, ending on the Sunday closest to the calendar quarter end, with the fourth fiscal quarter covering the remaining part of the fiscal year.

2. Accounting Policies

     Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies are set forth below.

     Stock Based Compensation The Company accounts for stock-based employee compensation arrangements using the intrinsic value method in accordance with provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and complies with the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”) as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure (“SFAS No. 148”). Under APB No. 25, compensation cost is recognized based on the difference, if any, between the fair market value of the Company’s stock on the date of grant and the amount an employee must pay to acquire the stock. Under SFAS 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models. Equity instruments issued to non-employees are accounted for in accordance with the provision of SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18.

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     The following table illustrates the effect on net loss and loss per share as if we had applied the fair value recognition provisions of SFAS No. 123 as amended by SFAS No. 148, to all our employee stock compensation arrangements:

                 
    Thirteen Weeks Ended
    June 27,   June 29,
    2004
  2003
    (In thousands, except per share data)
Net loss — as reported
  $ (952 )   $ (1,217 )
Stock-based employee compensation included in reported net loss
    7       39  
Stock-based compensation expense determined under fair value base method
    (144 )     (113 )
 
   
 
     
 
 
Pro forma net loss
  $ (1,089 )   $ (1,291 )
 
   
 
     
 
 
Basic and diluted loss per share:
               
As reported
  $ (0.11 )   $ (3.52 )
Pro forma
  $ (0.13 )   $ (3.73 )

     Loss Per Share For the thirteen weeks ended June 27, 2004 and June 29, 2003, basic net loss per share equals diluted net loss per share because the effect of stock options, unvested shares and warrants outstanding would have been antidilutive. The number of antidilutive stock options, unvested shares, and warrants excluded from the calculation for the thirteen weeks ended June 27, 2004 and June 29, 2003, were approximately 1.1 million and 1.0 million, respectively.

     For the thirteen weeks ended June 29, 2003, the effect of convertible preferred stock was excluded from the computation of loss per share, as the effect was antidilutive. The weighted average shares of common stock issuable from conversion of convertible preferred stock was approximately 6.0 million.

     Comprehensive Loss Total comprehensive loss for the period ended June 27, 2004 totalled $958 thousand. Comprehensive loss consists of two components, net loss and other comprehensive loss. Other comprehensive loss refers to revenue, expenses, gains and losses that under generally accepted accounting principles are recorded as an element of stockholders’ equity but are excluded from net loss. The Company’s other comprehensive loss for the period ended June 27, 2004 is comprised of unrealized losses of $6 thousand on marketable securities categorized as available-for-sale.

     New Accounting Pronouncements In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 requires instruments that are mandatorily redeemable, among other financial instruments, which embody an unconditional obligation requiring the issuer to redeem them by transferring its assets at a specified or determinable date or upon an event that is certain to occur, be classified as liabilities. The adoption of this statement during fiscal 2004 did not have an impact on the Company’s financial statements.

     In December 2003, the Financial Accounting Standards Board published a revision to Financial Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities” (hereafter referred to as “FIN 46R”) to clarify some of the provision of FIN 46, and to exempt certain entities from its requirements. Under the new guidance, there are new effective dates for companies that have interest in structures that are commonly referred to as special-purpose entities. The rules are effective in financial statements for periods ending after March 15, 2004. FIN 46R did not have any impact on our operating results or financial position as we do not have any variable interest entities.

     In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 provides a three-step impairment model for determining whether an investment is other-than-temporarily impaired and requires the Company to recognize such impairments as an impairment loss equal to the difference between the investment’s cost and fair value at the reporting date. The guidance is effective for periods ending after June 15, 2004. The Company does not believe that the adoption of EITF 03-1 will have a significant effect on its financial statements.

3. Investments

     Short-term investments consist of government securities and corporate bonds both with maturities beyond three months but less than one year. Long term investments consist of corporate bonds with maturities of one year or longer.

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     All of the Company’s investments are considered available-for-sale. Such securities are carried at fair market value. Fair value is based on market quotes. Unrealized gains and losses, net of tax, on securities in this category are reported as a separate component of stockholders’ equity. The cost of securities sold is based on the specific identification method. Interest earned on securities is included in interest income.

     Available-for-sale investments at June 27, 2004 were as follows (in thousands):

         
Corporate bonds and auction preferred stock (short-term)
  $ 7,235  
Government securities (short-term)
    3,260  
 
   
 
 
Total available-for-sale investments
  $ 10,495  
 
   
 
 

     There were no gross realized gains or losses the thirteen weeks ended June 27, 2004 and the gross realized gains or losses for the thirteen weeks ended June 29, 2003 were immaterial.

     The contractual maturity of all available-for-sale investments was less than one year at June 27, 2004.

4. Borrowing Arrangements

     The Company has a line of credit from CapitalSource Finance LLC. Per the terms of this agreement, CapitalSource Finance LLC has made available to the Company a credit facility under a revolving promissory note with a maximum principal amount of $11.0 million, subject to availability guidelines that specify the amount that can be borrowed under the facility at any given time. Amounts borrowed under this line of credit bear interest at rates equal to the greater of 9.5% or the prime lending rate plus 5.75%, for advances up to a fluctuating base amount, and equal to the greater of 11.5% or the prime lending rate plus 7.75% for advances in excess of that base amount. Amounts borrowed under this line of credit are secured by substantially all of the Company’s assets. The line of credit agreement provides for certain events of default, sets forth a number of affirmative and negative covenants to which the Company must adhere and expires on April 15, 2006. The Company must pay an unused line fee of up to $0.05 million per year, which is payable monthly, based on the unused portion of the loan commitment. The Company has borrowed funds under this credit facility from time to time and periodically repaid such borrowings with available cash. There were no borrowings outstanding during the quarter ended June 27, 2004.

     On June 21, 2004, the Company amended the terms of its credit facility with CapitalSource Finance LLC. Under the terms of this Second Amendment, certain covenants for inventory ratios and capital expenditure limitations were eliminated. The minimum earnings before interest, taxes, depreciation and amortization (EBITDA) covenant was modified, and quarterly minimum unrestricted cash balance levels were established. Further, under this Second Amendment, the EBITDA and minimum unrestricted cash balance covenants were modified such that they are not applicable unless borrowings are outstanding.

     In advance of any borrowings, the Company is required to deliver to CapitalSource Finance LLC written notification of its intent to borrow, certain consents from the Company’s landlords and credit card processing firm, a list of domain name registrations, evidence of compliance with EBITDA and minimum unrestricted cash balance levels on a prospective basis, and historical and prospective financial statements. In addition, CapitalSource Finance LLC may perform due diligence on the Company’s financial projections.

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     Events of default under this credit agreement include, subject to grace periods and notice periods in certain circumstances, failure to pay any amount owed under the line of credit when due, breach of representations contained in the agreement, failure to perform covenants contained in the agreement, termination of any loan document or security interest created under the agreement, a judgment against the Company in excess of certain amounts, failure to pay certain amounts of indebtedness due under, or another default under, debt or other agreements to which the Company is party, insolvency or petition for bankruptcy or dissolution, certain defined change of control transactions, the termination of the employment of the Company’s Chief Executive Officer or Brand Strategist if not timely replaced by suitable successors, a material adverse effect on the Company’s business or material adverse change in the validity of the credit agreement, the value of the Company’s assets that are pledged as collateral or the Company’s business, operations, prospects, properties, assets, liabilities or condition, the occurrence of an uninsured casualty loss in excess of certain amounts, indictment or conviction of any director or senior officer of a felony or a levy, attachment or garnishment that could lead to forfeiture of collateral under the agreement.

     The credit agreement requires us to pay and deliver all collections to an account over which CapitalSource Finance LLC has sole control. When we borrow under the credit agreement, the borrowings are repaid through the funds in this account. Under the terms of the Second Amendment, if the Company is not borrowing, this account will not be utilized. As a result, funds settled from our net revenues will be deposited directly into our bank account as long as no amounts are outstanding under the credit agreement.

     In addition, the credit agreement requires, subject to exceptions in certain limited circumstances, maintaining excess availability of a certain amount of capital at certain specified times, a covenant which among other things restricts the Company’s ability to engage in certain acquisition and investment transactions, and other covenants which restrict or place limitations on the Company’s ability to incur indebtedness, issue securities, create or allow to exist any liens on the Company’s assets, transfer the Company’s assets, or declare or pay dividends.

     As of June 27, 2004, the Company did not have an outstanding balance under this credit facility.

5. Commitment

     In July 2004, the Company entered into an operating lease agreement for 28,000 square feet of office space for our headquarters in San Francisco, California. The lease term is five years with one option to extend for additional two years and another option to extend for an additional five years. The monthly lease commitment is approximately $52 thousand which is approximately the same as the current office lease amount which expires in September 2004.

6. Legal Proceedings

     By its letter dated March 9, 2000, Red Letter Days Plc, a United Kingdom company (Red Letter Days), asserted trademark rights in the United Kingdom in the marks RED LETTER, RED LETTER DAYS and the image of a red envelope. Red Letter Days offers experiential gifts in the United Kingdom. The letter claimed that if we were to use our name and the REDENVELOPE service mark in the United Kingdom in connection with retail sales of gifts, it would infringe Red Letter Days’ trademark rights. We have made a number of attempts to reach an amicable resolution of this dispute, but Red Letter Days has declined, to date, to enter into settlement negotiations. Red Letter Days has opposed our applications to register the REDENVELOPE and RedEnvelope stylized logo marks in the United Kingdom and the European Community. Red Letter Days’ oppositions to our United Kingdom and European Community trademark applications are pending. Evidentiary submissions have been made by the parties in connection with those opposition proceedings and a decision is not expected for several months. The sole issue to be decided in the opposition proceedings is whether the REDENVELOPE mark is entitled to registration in the stated jurisdictions. Even if an opposition is successful in preventing the subject trademark from being registered, that decision by the registration authorities does not prevent the applicant from using the mark in that jurisdiction. In order to prevent us from using the RedEnvelope mark in the United Kingdom or European Community or to obtain any other equitable relief or monetary relief, Red Letter Days would need to bring a lawsuit against us in the appropriate jurisdiction. To the best of our knowledge, no such lawsuit has been filed. We opposed Red Letter Days application to register the RED LETTER mark in the United Kingdom, based on the descriptiveness of the RED LETTER mark as applied to the services of Red Letter Days. The United Kingdom trademark office has denied our opposition and has approved the registration of the Red Letter Days mark in the United Kingdom. This decision did not address a comparison of the REDENVELOPE and RED LETTER marks.

     On September 3, 2003, Activ8now, LLC filed a patent infringement lawsuit against the Company in the United States District Court, Northern District of Georgia. The lawsuit alleged a cause of action for infringement of U.S. Patent Nos. 6,535,889 and 6,557,006 based on the theory that certain of our website operations were covered by such patents. On June 18, 2004, the Company and Activ8now, LLC entered into a settlement agreement providing the Company with a non-exclusive, irrevocable, paid-up, worldwide license to such patents in exchange for a one-time fee and dismissal of the lawsuit with prejudice. The settlement did not have a material adverse effect on the Company’s financial position or results of operations.

     From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks and other intellectual property rights. The Company is not currently aware of such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on its financial position or results of operations.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion should be read in conjunction with the unaudited condensed financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q.

Forward-Looking Statements

     This report, together with the documents incorporated herein by reference, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. Such statements are based upon current expectations and involve risks and uncertainties. Any statements contained in this report that are not purely statements of historical fact may be deemed to be forward-looking statements. Such forward-looking statements may include but are not limited to statements regarding our future operations and enhancements, product offerings, business, financial condition, results of operations and prospects. Additionally, statements concerning possible changes in applicable rules or legislation are forward-looking statements. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimate,” “may,” “should,” “could” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this report. All forward-looking statements in this report are based upon information available to us as of the date hereof, and we assume no obligation to revise or update any such forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report. Actual results and the timing of certain events could differ materially from our current expectations. Factors that could cause or contribute to such differences include, but are not limited to, those set forth in this report under “Factors That May Affect Future Results,” and elsewhere in this report, and those contained from time to time in our other filings with the SEC. We caution investors that our business and financial performance are subject to substantial risks and uncertainties.

Overview

     During the first quarter of fiscal 2005, we continued our efforts around our three strategic initiatives for fiscal 2005: improving the operational execution throughout our supply chain including our fulfillment center, expanding our marketing campaigns and continued development and expansion of our unique and proprietary product assortments. While the benefits from these initiatives are currently anticipated to occur over the remaining quarters, we believe these investments in our business are vital to support the future growth of the Company.

     Our net revenues increased 19.2% from the first quarter of fiscal 2004 to $21.1 million in the first quarter of fiscal 2005. Gross margins in the first quarter of fiscal 2005 increased to 53.2% from 48.9% in first quarter of fiscal 2004. Net loss as a percentage of net revenues decreased from (6.8%) in the first quarter of fiscal 2004 to (4.5%) in the first quarter of fiscal 2005.

     We also continued to emphasize improving our order fulfillment rates at our fulfillment center. Based on internal quality control sampling, we processed orders during the Mother’s Day and Father’s Day events with approximately 99% accuracy. We were able to offer one-day turnaround time for personalized orders during these events. To further enhance our operational execution, we continued our projects related to a new warehouse management system and investment into our materials handling processing. As a result of the projects, certain team members at the fulfillment center were required to participate in the development and implementation efforts. Consequentially, we incurred more seasonal labor costs. If we are unable to improve the performance of the fulfillment process at our fulfillment center, we may incur additional labor and shipping costs, fail to satisfy demand for our products or experience customer dissatisfaction, any of which could have an adverse affect on our business, financial condition, and operating results. Achieving operational effectiveness at times of peak demand will continue to be a critical area of management focus.

     During the quarter, we increased our marketing efforts to acquire customers primarily through our catalog campaigns. As a result, our revenues from existing customers decreased slightly to 52% in the first quarter of fiscal 2005 from 55% in the first quarter of fiscal 2004. Our internal database of customer names (customers who have purchased from the Company in the past) increased to approximately 1.9 million, with approximately 0.1 million new customers names added in the first quarter of fiscal 2005. We intend to increase loyalty from existing customers by offering unique and innovative products, helpful and knowledgeable customer service, accurate fulfillment rates and targeted marketing programs.

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     Our merchandising strategy continues to emphasize the development of unique products that are difficult to find elsewhere in the marketplace. For each of Mother’s Day and Father’s Day, 35% of our top 20 best sellers were designed in-house. We also offered a growing number of products that are exclusive to the Company. For Mother’s Day and Father’s Day 65% and 80%, respectively, of our top 20 best sellers were exclusive to the Company.

     Although we are committed to our strategic initiatives, there are inherent risks associated with our business that may present challenges for us in the future and could prevent us from achieving intended revenue growth, scalability and increased efficiencies. We have outlined currently identified risks within the “Factors That May Affect Future Results” section of this report. In addition, the following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with our audited financial statements and the notes thereto.

Critical Accounting Policies

     Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies are set forth below.

     Revenue recognition. We derive our revenues from merchandise sales made to consumers and businesses. We generally require payment by credit card prior to shipment. We recognize revenue on the date on which we estimate that the product has been received by the customer and any payments received prior to the estimated date of receipt of the goods by the customer are deferred. We use our third-party freight carrier information to estimate when delivery has occurred. Revenues are recorded net of estimated returns, coupons redeemed by customers, and other discounts. Significant management judgments and estimates must be made and used in connection with determining revenue recognized in any accounting period. In particular, our management must make estimates of potential future product returns related to current period revenue. We analyze historical returns, current economic trends and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances in any accounting period. Actual returns may differ materially from our estimated reserve. As a result, our operating results and financial condition could be affected adversely. The reserve for returns was $0.4 million, $0.2 million and $0.2 million as of June 27, 2004, March 28, 2004 and June 29, 2003, respectively.

     Shipping and Handling Costs. Shipping costs, which include inbound and outbound freight costs and the cost of gift wrap, are included in cost of sales. Handling costs, which include fees paid to our former third-party fulfillment service provider as well as distribution center expenses, are included in operating expenses — fulfillment. Handling costs included in operating expenses — fulfillment for the thirteen weeks ended June 27, 2004 and June 29, 2003 were $1.2 million and $1.1 million, respectively. Our gross profit may not be comparable to other entities, which may allocate all shipping and handling costs to either cost of sales, resulting in lower gross profit, or to operating expenses, resulting in higher gross profit.

     Inventory. Inventories are stated at the lower of cost or market. We estimate a provision for damaged, obsolete, excess and slow-moving inventory based on inventory aging reports and specific identification. If actual obsolescence is different from our estimate, we will adjust our provision accordingly. Specific provisions are recorded in the event the cost of the inventory exceeds the fair market value. In addition, we estimate a reserve for expected inventory shrinkage based on historical shrinkage factors and our current inventory levels. Actual shrinkage is recorded at fiscal year-end based on the results of our physical inventory count. The obsolescence reserve was $0.6 million, $0.3 million and $0.7 million as of June 27, 2004, March 28, 2004 and June 29, 2003, respectively.

     Accounting for income taxes. Significant management judgment is required in determining our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. As of March 28, 2004, we had recorded a valuation allowance of $28.0 million against our net deferred tax asset balance due to uncertainties related to our deferred tax assets as a result of our history of operating losses. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our

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deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to change the valuation allowance, which could materially impact our financial position and results of operations.

     Catalog Amortization. Prepaid catalog costs consist of third-party costs including paper, printing, postage and mailing costs for all of our direct response catalogs. Such costs are capitalized as prepaid catalog costs and are amortized over their expected period of future benefit which generally does not exceed two months. Such amortization is based upon the ratio of actual revenues to the total of actual and estimated future revenues on an individual catalog basis. Prepaid catalog costs are evaluated for realizability at each reporting period by comparing the carrying amount associated with each catalog to the estimated probable remaining future net benefit of the catalog (defined as net revenues less merchandise cost of goods sold, selling expenses and catalog completion costs) associated with that catalog. If the carrying amount is in excess of the estimated probable remaining future net benefit of the catalog, the excess is expensed in the reporting period.

     Valuation of long-lived assets. Long-lived assets held and used by us are reviewed for impairment whenever events or changes in circumstances indicate the net book value may not be recoverable. An impairment loss is recognized if the sum of the expected future cash flows from use of the asset is less than the net book value of the asset. The amount of the impairment loss will generally be measured as the difference between net book values of the assets and their estimated fair values. Our estimate of undiscounted future cash flows is based upon our experience, historical operations, estimates of future profitability and economic conditions.

     Stock based compensation. We account for stock options granted to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation expense has been recognized in the financial statements for stock options. SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” however, requires the disclosure of pro forma net earnings and earnings per share as if we had adopted the fair value method. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models. These models require subjective assumptions, including future stock price volatility and expected time to exercise, which affect the calculated values. Our calculations are based on a single option valuation approach and forfeitures are recognized as they occur.

     In fiscal 2000, we granted approximately 0.4 million options to employees at an exercise price that was less than the fair market value of our stock on the date of grant. We recorded $1.8 million of deferred compensation related to these option grants, which is included as a separate component of stockholders’ equity, and is being amortized over the vesting period of the awards. We recorded amortization expense of $39,000 for the thirteen weeks ended June 29, 2003, which is included in general and administrative expenses in the statements of operations. There was no amortization expense recorded during the quarter ended June 27, 2004.

     In fiscal 2004, we granted approximately 0.3 million options to employees at an exercise price that was less than the fair market value of our stock on the date of grant. We recorded $0.7 million of deferred compensation related to these option grants, which is included as a separate component of stockholders’ equity, and is being amortized over the vesting period of the awards. We recorded amortization expense of $7,000 for the thirteen weeks ended June 27, 2004, which is included in general and administrative expenses in the statements of operations.

Results of Operations

     The following table sets forth our statements of operations data for the thirteen weeks ended June 27, 2004 and June 29, 2003, respectively, expressed as a percentage of net revenues.

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    Thirteen Weeks
    June 27,   June 29,
    2004
  2003
Statements of Operation Data:
               
Net revenues
    100.0 %     100.0 %
Cost of sales
    46.8       51.1  
 
   
 
     
 
 
Gross profit
    53.2       48.9  
Operating expenses:
               
Fulfillment
    15.7       15.3  
Marketing
    23.4       21.1  
General and administrative
    18.5       18.4  
 
   
 
     
 
 
Total operating expenses
    57.6       54.8  
Loss from operations
    (4.4 )     (5.9 )
Interest income
    0.3       0.1  
Interest expense
    (0.4 )     (1.0 )
 
   
 
     
 
 
Net loss
    (4.5 )%     (6.8 )%
 
   
 
     
 
 

     Revenues

     Our net revenues are comprised of product sales, shipping revenue and gift-wrap revenue. Revenues are recorded net of estimated returns, coupons redeemed by customers, and other discounts. Our shipping revenue represents the amounts we charge our customers for delivering the product. Our gift wrap revenue consists of amounts we charge our customers for our signature red gift boxes.

     Net revenues were $21.1 million and $17.7 million for the thirteen weeks ended June 27, 2004 and June 29, 2003, respectively, representing a 19.2% increase. The increase was primarily due to increased demand for our products resulting from additional marketing efforts through our online and catalog campaigns. Online revenues, through search, portals, and affiliates, grew 20.8% over the same quarter in the prior year. Revenues from customers who receive our catalogs grew 29.0% over the first quarter of fiscal 2004. During the first quarter of fiscal 2005, we increased our catalog circulation by approximately 1.1 million catalogs, or 22.6%. The number of orders increased by approximately 14.8% over the first quarter of fiscal 2004, primarily as a result of the increased catalog circulation. Net revenues per order increased by approximately 3.9% over the first quarter of fiscal 2004 due to increased customer demand for some of the higher priced items within our home, children and women’s accessories product categories. In August of 2003, we changed the delivery charge for standard ground delivery to a flat rate regardless of order value. As a result, our shipping revenues decreased in the first quarter of fiscal 2005 compared to the first quarter of fiscal 2004. Our customer base increased from approximately 1.8 million at the end of fiscal 2004 to approximately 1.9 million at the end of the first quarter of fiscal 2005.

     Cost of Sales

     Cost of sales consists of the cost of the product sold, inbound and outbound freight and gift-wrap expense. Shipping costs, which include inbound and outbound freight, and the cost of gift wrap are also included in cost of sales. Handling costs, which include fees paid to our former third-party fulfillment service provider and fulfillment center expenses, are included in operating expenses — fulfillment.

     Cost of sales were $9.9 million and $9.1 million for the thirteen weeks ended June 27, 2004 and June 29, 2003, respectively, representing 46.8% and 51.1% of net revenues respectively. The 9.4% increase in costs of sales was mainly attributable to the 19.2% increase in net revenues. The decrease in cost of sales as a percentage of net revenues was primarily attributable to higher average product margins resulting from an increase in overseas product sourcing, which typically has lower product costs.

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     Operating Expenses

     Fulfillment. Fulfillment expenses consist of wages and benefits for employees and seasonal hires working in our distribution center and customer service facility, fees incurred to process credit card transactions and certain fixed costs, such as rent and utilities, incurred by our distribution center and customer service facility. Prior to August 2003, fulfillment expenses also included fees paid to our former third-party fulfillment service provider. Services performed by our former third-party fulfillment service provider included receiving, picking, packing, shipping and other warehousing activities.

     Fulfillment expenses were $3.3 million and $2.7 million for the thirteen weeks ended June 27, 2004 and June 29, 2003, respectively, representing 15.7% and 15.3% of net revenues, respectively. The increase in dollars and percentage of net revenues was primarily attributable to the 14.8% increase in the number of orders. In addition, we incurred certain preparation and training costs related to our new warehouse management systems and the revision of certain materials handling processes at the fulfillment center in connection with our initiative to improve the operational execution throughout our supply chain. As a result of improved order fulfillment rates, our customer service center was able to focus on phone calls for order placing and less resources were needed for phone calls associated with order fulfillment inaccuracies. In addition, our return rates in the first quarter of fiscal 2005 improved compared to the first quarter of fiscal 2004.

     We are in the process of revising certain materials handling processes and implementing new warehouse management software, which we believe will allow us to better manage our fulfillment operations and scale our business. If we are unable to improve the performance of the fulfillment process at our distribution center or if our planned modifications cost more than we anticipate, our operating results could be materially harmed.

     Marketing. Marketing expenses consist primarily of online and catalog programs as well as advertising, public relations, and other promotional expenditures.

     Marketing expenses were $4.9 million and $3.7 million for the thirteen weeks ended June 27, 2004 and June 29, 2003, respectively, representing 23.4% and 21.1% of net revenues, respectively. The increase in dollars and percentage of net revenues was primarily due to additional spending in our online and catalog advertising campaigns. During the first quarter of fiscal 2005, we increased our catalog circulation by approximately 1.1 million catalogs, or 22.6%, over the first quarter of fiscal 2004. Currently, we plan on increasing the circulation of our Basics and Fall catalogs for the next fiscal quarter. In addition, we incurred costs related to marketing studies and agency fees related to our upcoming advertising campaigns. These costs were incurred in advance of the expected revenue stream from our advertising campaigns.

     In addition, we plan to increase our marketing through print and outdoor advertising campaigns. As a result, we anticipate the costs of marketing to increase compared to the prior fiscal year. The print and outdoor advertising campaigns are expected to begin in the second half of our 2005 fiscal year. In addition, the costs to develop these marketing campaigns will be made in advance of the expected revenue stream. We are also currently developing a catalog for corporate gift-giving that includes specific products and creative marketing designed for the corporate customer. If we are unsuccessful in generating sufficient revenues through these marketing vehicles, our operating results could be adversely affected.

     General and Administrative. General and administrative expenses consist of wages and benefits for our administrative employees, located primarily at our corporate office. These expenses also include costs incurred for computer and communications technology, rent and utilities for our headquarters, travel, depreciation, and other general corporate expenditures.

     General and administrative expenses were $3.9 million and $3.3 million for the thirteen weeks ended June 27, 2004 and June 29, 2003, respectively, representing 18.5% and 18.4% of net revenues, respectively. The increase was primarily due to training and consulting fees related to our software and systems implementations projects, personnel related costs and the costs associated with being a publicly-held company. The planned implementation of new software systems in fiscal year 2005 will result in additional depreciation expense. We also currently plan on increasing our general and administrative employee headcount (i.e., employees other than fulfillment and customer service employees) in order to support future business needs, which will add to general and administrative expenses. Also, the compliance requirements associated with being a public company will likely increase our accounting and legal expenses. In addition, we currently anticipate incurring additional costs, such as legal and proxy solicitation fees, related to our 2004 Annual Meeting and Proxy. As a result of the solicitation of proxies by a group of stockholders, the Company’s expenses related to its solicitation of proxies will exceed those normally spent for an annual meeting.

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     Other Income and Expenses

     Interest Income. Interest income was $0.07 million and $0.01 million in the thirteen weeks ended June 27, 2004 and June 29, 2003 respectively. The increase is primarily due to higher average cash balances and slightly higher interest rates.

     Interest Expense. Interest expense was $0.08 million and $0.2 million in the thirteen weeks ended June 27, 2004 and June 29, 2003, respectively. The decrease is primarily attributable to lower amounts of debt outstanding.

     Liquidity and Capital Resources

     We have funded our operations primarily through private sales of equity securities, borrowings, and the completion of our initial public offering which resulted in net offering proceeds of approximately $29.0 million. Historically, revenues have been seasonal. Revenues have been higher in the third fiscal quarter, reflecting higher consumer holiday spending. As a result, our cash balances are seasonal in nature, with the third fiscal quarter representing a significantly higher level of cash than other periods. Throughout the fiscal year, we utilize our cash balances to build our inventory levels with the most significant use of working capital occurring immediately prior to the month of December. In addition to our current cash balances on-hand, we have an $11.0 million revolving credit facility which allows us to borrow funds for working capital purposes, subject to certain provisions.

     Cash Flows From Operating Activities — Net cash flows provided by operating activities were $3.8 million and $1.4 million for thirteen weeks ended June 27, 2004 and June 29, 2003 respectively. In the first quarter of fiscal 2005, net cash provided by operating activities increased by $2.4 million from the first quarter of fiscal 2004, resulting primarily from changes in working capital and lower net loss. Specifically, there was an increase in our accounts payable and a decrease in our merchandise inventories. This was primarily due to the timing of seasonal inventory receipts and payable disbursements.

     Cash Flows From Investing Activities — Net cash flows used in investing activities were ($3.8) million and ($0.1) million for thirteen weeks ended June 27, 2004 and June 29, 2003 respectively. Uses of cash flow from investing activities consisted of capital expenditures for property and equipment purchases and maturities of investments. Currently, we are planning capital expenditures for software systems to support our financial, warehouse management, and order management functions. We believe the implementation of these software systems will support the needs of our business and customers. Software implementation projects entail significant technical and business risks. If we are unsuccessful in implementing these systems, it may hinder our ability to process and fulfill customer orders as well as complete critical financial processing transactions. These capital expenditures will result in an increase in our depreciation expense. For the thirteen weeks ended June 27, 2004, we have spent approximately $1.7 million for our warehouse management system, materials handling equipment, and order management system projects. We currently estimate spending between $1.0 million and $1.2 million over the remaining fiscal year 2005 on our warehouse management system, materials handling equipment, and order management system projects. Although we believe these estimates on expenditures to be reasonable given the current facts and circumstances available to us, we can offer no assurance that the actual amounts expended will not be greater.

     Cash Flows From Financing Activities — Net cash flows provided by (used in) financing activities were $0.3 million and ($1.5) million for the thirteen weeks ended June 27, 2004 and June 29, 2003 respectively. For the first quarter of fiscal 2005, net cash flows from financing activities consisted of proceeds from the exercises of stock options which were slightly offset by payments for capital lease obligations.

     Revolving Credit Facility — We also have funds available of up to $11 million pursuant to our revolving credit facility with CapitalSource Finance LLC, which is described more fully in Note 4 to the financial statements contained in this report. Our ability to borrow under this credit facility is subject to compliance with its terms. At June 27, 2004, we had no borrowings under the revolving credit facility.

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     On June 21, 2004, the Company amended the terms of its credit facility with CapitalSource Finance LLC. Under the terms of this Second Amendment, certain covenants for inventory ratios and capital expenditure limitations were eliminated. The minimum earnings before interest, taxes, depreciation and amortization (EBITDA) covenant was modified, and quarterly minimum unrestricted cash balance levels were established. Further, under this Second Amendment, the EBITDA and minimum unrestricted cash balance covenants were modified such that they are not applicable unless borrowings are outstanding. CapitalSource Finance LLC previously has waived non-compliance with such covenants as of prior dates, be we can offer no assurance that they will do so in the future.

     In advance of any borrowings, the Company is required to deliver to CapitalSource Finance LLC written notification of its intent to borrow, certain consents from the Company’s landlords and credit card processing firm, a list of domain name registrations, evidence of compliance with EBITDA and minimum unrestricted cash balance levels on a prospective basis, and historical and prospective financial statements. In addition, CapitalSource Finance LLC may perform due diligence on the Company’s financial projections.

     In July 2004, we entered into an operating lease agreement for 28,000 square feet of office space for our headquarter in San Francisco, California. Our current headquarters lease expires in September 2004. The new monthly lease commitment is approximately the same as the current office lease amount.

     We believe that the cash currently on hand will be sufficient to continue operations through at least the next twelve months. Our assessment is based on historical working capital needs, operating loss trends, and current business outlook. Beyond the next twelve months, we intend to utilize the cash generated from operations to fund operations and capital expenditures. We may, in the future, be required to raise funds through additional equity and /or debt financings to support our long-term obligations and needs. However, there can be no assurance that if additional financing is necessary it will be available, or if available, that such financing can be obtained on satisfactory terms or without undue dilution to, or an adverse impact on the rights of, our existing stockholders. Failure to generate sufficient revenues or raise additional capital could have a material adverse effect on our ability to continue as a going concern and to achieve our intended business objectives.

Factors That May Affect Future Results

     You should consider carefully the risks and uncertainties relating to our business described below. Additional risks and uncertainties not currently known to us or that we currently do not deem material may also become important factors that may harm our business. The trading price of our common stock could decline due to any of these risks and uncertainties.

     Our limited operating history makes evaluation of our business difficult.

     We were originally incorporated in 1997 and began selling products in September 1997. As a result, we have limited historical financial data upon which to base planned operating expenses or forecast accurately our future operating results. Further, our limited operating history will make it difficult for investors and securities analysts to evaluate our business and prospects. You must consider our business and prospects in light of the risks and difficulties we may face as an early stage company with limited operating history. These risks and difficulties include challenges in accurate financial planning as a result of limited historical data and the uncertainties resulting from having had a relatively limited time period in which to implement and evaluate our business strategies as compared to older companies with longer operating histories. Our failure to successfully address these risks and difficulties would seriously harm our business.

We have a history of significant losses. If we do not achieve or sustain profitability, our financial condition and stock price could suffer.

     We have a history of losses and we may continue to incur losses for the foreseeable future. As of June 27, 2004, our accumulated deficit was $79.6 million. We have not achieved profitability for a full fiscal year. If our revenues grow more slowly than we anticipate, or if our operating expenses exceed our expectations, we may not be able to achieve profitability in the near future or at all. Even if we do achieve profitability, we may not be able to sustain or increase profitability on an annual basis in the future. If we are unable to achieve profitability within a short period of time, or at all, or if we are unable to sustain profitability at satisfactory levels, our financial condition and stock price could be adversely affected.

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Because we experience seasonal fluctuations in our net sales, our quarterly results will fluctuate and our annual performance will depend largely on results from one quarter.

     Our business is highly seasonal, reflecting the general pattern of peak sales for the retail industry during the holiday shopping season. Typically, a substantial portion of our net revenues occur during our third fiscal quarter ending around December 31. We generally experience lower net revenues during the first, second and fourth fiscal quarters and, as is typical in the retail industry, have incurred and may continue to incur losses in these quarters. The third fiscal quarter accounted for approximately 45% of net revenues in the fiscal year ended March 28, 2004. We cannot predict with certainty what percentage of our total net revenues for fiscal year 2005 will be represented by our third fiscal quarter revenues. In anticipation of increased sales activity during the third fiscal quarter, we incur significant additional expenses, including significantly higher inventory and staffing costs. If sales for the third fiscal quarter do not meet anticipated levels, then increased expenses may not be offset, which would adversely affect our financial condition. If we were to experience lower than expected sales during one of our third fiscal quarters, for whatever reason, it would have a disproportionately large negative impact on our annual operating results and financial condition for that fiscal year. If our net revenues during our third fiscal quarter were to fall below the expectations of securities analysts, our stock price could decline, perhaps significantly.

Our operating results are volatile and difficult to predict and may adversely affect our stock price.

     Our annual and quarterly operating results have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. Further, because our business is seasonal, our operating results may vary significantly from one quarter to the next as part of our normal business cycle. As a result, we believe that quarterly comparisons of our operating results are not necessarily meaningful and that you should not rely on the results of one quarter as an indication of our future performance. It is likely that in some future quarter our operating results may fall below the expectations of securities analysts and investors. In this event, the trading price of our common stock could decline significantly.

     Factors that could cause our operating results to fluctuate include the following:

  The seasonality of our business
 
  Decreases in the number of visitors to our website or our inability to convert those visitors into customers
 
  Technical difficulties, including system or Internet failures
 
  Fluctuations in the demand for our products
 
  The number of prior customers that make repeat purchases
 
  Overstocking or understocking of our merchandise
 
  Offering of new or enhanced services or more popular products by our competitors
 
  Fluctuations in the level of our product returns
 
  Termination of existing marketing relationships or failure to develop successful new marketing relationships
 
  Fluctuations in shipping costs, particularly during the holiday season

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  Fluctuations in advertising, marketing or catalog production and distribution costs
 
  Fluctuations in personalization and fulfillment costs
 
  The amount and timing of operating costs and capital expenditures relating to expansion or upgrade of our operations
 
  Changes in government regulations and taxation related to use of the Internet or otherwise applicable to our business
 
  Economic conditions generally or economic conditions specific to the Internet, online commerce, the retail industry, the mail order industry or the gift industry
 
  Changes in the mix of products that we sell
 
  Fluctuations in levels of inventory theft, damage or obsolescence

Our computer and communications hardware and software systems are vulnerable to damage and interruption, which could harm our business.

Our ability to receive and fulfill orders successfully through our website is critical to our success and largely depends upon the efficient and uninterrupted operation of our computer and communications hardware and software systems. Our systems and operations are vulnerable to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches, catastrophic events (such as natural disasters or terrorist attacks), and errors in usage by our employees and customers. Further, our servers are located at the facilities of, and hosted by, a third-party service provider in Santa Clara, California. In the event that this service provider experiences any interruption in its operations or ceases operations for any reason or if we are unable to agree on satisfactory terms for a continued hosting relationship, we would be forced to enter into a relationship with another service provider or take over hosting responsibilities ourselves. We cannot assure you that, in the event it became necessary to switch hosting facilities, we would be successful in finding an alternative service provider on acceptable terms or in hosting the computer servers ourselves. Any significant interruption in the availability or functionality of our website, or our sales processing, fulfillment or communications systems for any reason, particularly an interruption during the holiday season, could seriously harm our business.

If we fail to offer a broad selection of innovative merchandise that consumers find attractive, our revenues could decline or fail to reach anticipated levels and our stock price could be harmed.

     In order to meet our strategic goals, we must successfully offer, on a continuous basis, a broad selection of appealing products. These products must satisfy the diverse tastes of our customers and potential customers for a variety of gift-giving occasions. To be successful, our product offerings must be affordable, well made, innovative and attractive to a wide range of consumers whose preferences may change regularly. We cannot predict with certainty that we will be successful in offering products that meet these requirements. If our products become less popular with consumers, our revenues may decline or fail to meet expected levels or we may decide to offer our products at lower prices. If a wide range of consumers do not find our products attractive or if we are required to reduce our prices, our revenues and earnings may decline or fail to meet expected levels and our stock price could be affected adversely.

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Failure to successfully manage or expand our fulfillment and distribution operation would have a material adverse effect on us.

     Our fulfillment and distribution operation is located in leased facilities in Lockbourne, Ohio. Our agreement with the fulfillment services company that previously managed the fulfillment and distribution operations at the Lockbourne, Ohio facility expired in August 2003, at which point we assumed direct control of fulfillment and distribution operations. We have limited experience managing fulfillment and distribution operations, and we cannot assure you that we will be successful in this endeavor. We experienced significant difficulties managing the fulfillment and distribution operations during the 2003 holiday season, including difficulties in inventory management and timely gift personalization, and anticipated efficiencies from managing the distribution center ourselves did not materialize during that period. If we are unable to manage successfully our fulfillment and distribution operations and to meet our customers’ expectations regarding personalization, presentation and delivery, our operations and financial condition could be seriously harmed. Any difficulty in managing our fulfillment and distribution operations could require us to find one or more parties to provide these services for us. If we are required to engage one or more service providers, we could incur higher fulfillment expenses than anticipated or incur additional costs for balancing merchandise inventories among multiple distribution facilities. Further, we may need to expand or upgrade our distribution operations in the future to accommodate increases in customer orders, increased demand for personalized products or changes in available technology. If we fail to successfully manage, expand or make necessary upgrades to our fulfillment and distribution operations in a timely and cost-effective manner, it would have a material adverse effect on our business.

If we do not manage our inventory levels successfully, our operating results will be affected adversely.

     We must maintain sufficient inventory levels to operate our business successfully. Rapidly changing trends in consumer tastes for gift items expose us to significant inventory risks, particularly during our third fiscal quarter when inventory levels are highest due to the holiday shopping season. Consumer preferences can change between the time we order a product and the time it is available for sale. We base our product selection on our projections of consumer tastes and preferences in a future period, and we cannot guarantee that our projections of consumer tastes and preferences will be accurate. It is critical to our success that we accurately predict consumer tastes and stock our product offerings in appropriate quantities. In the event that one or more products do not achieve widespread consumer acceptance, we may be required to take significant inventory markdowns, which could reduce our net sales and gross margins. This risk may be greatest in the third fiscal quarter of each year, after we have significantly increased inventory levels for the holiday shopping season. In addition, to the extent that demand for our products increases over time, we may be forced to increase inventory levels. Any such increase would require the use of additional working capital and subject us to additional inventory risks. Further, our failure to stock sufficient quantities of popular products would likely cause us to miss revenue opportunities and could cause our customers to become dissatisfied and look to our competitors for their gift items. During the 2003 holiday season, some of our popular items were not stocked in quantities sufficient to meet the demand for such items, which likely led to missed sales opportunities. If we fail to stock popular products in sufficient quantities or if we overstock products, our business, financial condition and operating results would be affected adversely.

We may have difficulty in product sourcing.

     More than half of our products are unique designs manufactured by third-party suppliers. We enter into exclusive supply agreements for these products to maintain a competitive advantage. However, since we do not have long-term arrangements with any vendor or distributor that would guarantee the availability of products from year to year, we do not have a predictable or guaranteed supply of these products in the future. If we are unable to provide our customers with continued access to popular, exclusive products, our operating results could be harmed.

     In addition, we may receive products from our suppliers that do not meet our quality standards. From time to time, we receive products from suppliers that are of insufficient quality to provide to our customers. Generally the supplier is able to quickly rectify the problem, but occasionally we have been unable to obtain replacement product quickly enough to fulfill all customer orders for such product in a timely manner, particularly with respect to items sourced overseas which tend to have longer delivery lead time requirements. If we receive products from our suppliers that do not meet our high quality standards and we are unable to obtain suitable replacement products in a timely manner, our reputation and our operating results could be harmed. Further, customers who do not receive their products in a timely manner may look to our competitors for their gift items.

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     Many of our products are sourced overseas. While products sourced overseas typically have lower costs, our product margins may be slightly offset by an increase in inbound freight costs. As security measures around shipping ports increase, these additional costs may result in higher inbound freight costs. Furthermore, in recent years, U.S. companies were subject to port strikes which delayed the delivery of goods. As we increase our overseas sourcing, we face the risk of these delays which could harm our business and results of operations. We cannot predict whether any of the countries in which our merchandise currently is manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the U.S. and other foreign governments, including the likelihood, type or effect of any such restrictions. Trade restrictions, including increased tariffs or quotas, embargoes, and customs restrictions, against items that we offer or intend to offer to our customers, as well as U.S. or foreign labor strikes, work stoppages or boycotts, could increase the cost or reduce the supply of items available to us and adversely affect our business, financial condition and results of operations. Our sourcing operations also may be adversely affected by political and financial instability resulting in the disruption of trade from exporting countries, significant fluctuation in the value of the U.S. dollar against foreign currencies, restrictions on the transfer of funds and/or other trade disruptions. Any disruption or delays in, or increased costs of, importing our products could have an adverse effect on our business, financial condition and operating results.

Our facilities and systems are vulnerable to natural disasters or other catastrophic events.

     Our headquarters, customer service center and the majority of our infrastructure, including computer servers, are located in California, an area that is susceptible to earthquakes and other natural disasters. Our distribution facility, located in Lockbourne, Ohio, houses substantially all of our product inventory and is the location from which substantially all of our sales are shipped. A natural disaster or other catastrophic event, such as an earthquake, fire, flood, severe storm, break-in, terrorist attack or other comparable problems could cause interruptions or delays in our business and loss of data or render us unable to accept and fulfill customer orders in a timely manner, or at all. Further, California has in the recent past experienced power outages as a result of limited electrical power supplies. These outages may recur in the future and we cannot determine the effect, if any, that such outages would have on the operation of our business. In addition, as our inventory and distribution facility is located in an area that is susceptible to harsh weather, a major storm, heavy snowfall or other similar event could prevent us from delivering products in a timely manner. Also, areas in and around San Diego, California, the site of our customer service facility, have experienced severe wildfires. Such wildfires could destroy, render inoperable or cause the evacuation of our customer service facility, which could significantly disrupt our ability to provide satisfactory customer service. We have no formal disaster recovery plan and our business interruption insurance may not adequately compensate us for losses that may occur from any of the foregoing. In the event that an earthquake, natural disaster or other catastrophic event were to destroy any part of our facilities or interrupt our operations for any extended period of time, or if harsh weather conditions prevent us from delivering products in a timely manner, our business, financial condition and operating results would be seriously harmed.

We have grown quickly and if we fail to manage our growth, our business will suffer.

     We have rapidly and significantly expanded our operations, and anticipate that further significant expansion, including the possible acquisition of third-party assets, technologies or businesses, will be required to address market opportunities and desired growth in our customer base. Prior expansion has placed, and any future expansion is expected to continue to place, a significant strain on our management, operational and financial resources. Some of our officers or senior management personnel have no prior senior management experience at public companies. Our new employees include key officers as well as a number of key managerial, technical and operations personnel who have not yet been fully integrated into our operations. Additionally, we need to properly implement and maintain our financial and managerial controls, reporting systems and procedures, including the increased internal controls and procedures required by the recently enacted Sarbanes Oxley Act of 2002. Moreover, if we are presented with appropriate opportunities, we may in the future make investments in, or possibly acquire, assets, technologies or businesses that we believe are complementary to ours. Any such investment or acquisition may further strain our financial and managerial controls and reporting systems and procedures. These difficulties could disrupt our business, distract our management and employees or increase our costs. If we are unable to manage growth effectively, implement proper controls and systems in an efficient manner, or successfully integrate any assets, technologies or businesses that we may acquire, our business, financial condition and results of operations would be affected adversely.

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We experience intense competition in the rapidly-changing retail gift market.

     We operate in a highly competitive environment. We principally compete with a variety of department stores, Internet retailers, specialty retailers and other catalog merchandisers that offer products similar to or the same as our products. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any of which could seriously harm our net revenues and results of operations. We expect competition to intensify in the future because current and new competitors can enter our market with little difficulty and can launch new websites at a relatively low cost. We currently or potentially compete with a variety of other companies, including:

  other online retailers, such as Amazon.com
 
  major department stores, such as Macy’s, Bloomingdale’s and Neiman Marcus
 
  physical and online stores and catalog retailers that sell popular gift items such as Williams-Sonoma, Brookstone, The Sharper Image, Tiffany’s, Harry & David, J Crew, and 1-800-Flowers
 
  Internet portals and online service providers that feature shopping services, such as AOL, Yahoo! and Lycos

     Many of our traditional store-based, catalog-based and online competitors have longer operating histories, larger customer or user bases, greater brand recognition and significantly greater resources, particularly financial and marketing resources. Many of these competitors can devote substantially more resources to website development and catalog retailing than we can. In addition, large, well-established and well-financed entities may establish more robust online sales operations in the future. Our competitors may be able to secure products from vendors on more favorable terms, provide popular products to which we do not have access, fulfill customer orders more efficiently and adopt more aggressive pricing or inventory availability policies than we can.

     The U.S. retail industry, the specialty retail industry in particular, and the online commerce sector are highly competitive, dynamic in nature and have undergone significant changes over the past several years and will likely continue to undergo significant changes. Our ability to anticipate and respond successfully to these changes is critical to our long-term growth and we cannot assure you that we will anticipate and respond successfully to changes in the retail industry and online commerce sectors. If we are unable to maintain or increase our market share or compete effectively in the retail gift market, our business, financial condition and operating results would be adversely affected.

If we do not successfully expand our website and order processing systems or respond to rapid technological changes, we could lose customers and our net revenues could decline.

     If we fail to upgrade our website in a timely manner to accommodate higher volumes of traffic, our website performance could suffer and we may lose customers. In addition, if we fail to expand the computer systems that we use to process and ship customer orders and process customer payments, we may not be able to fulfill customer orders successfully. As a result, we could lose customers and our net revenues could be reduced. Further, to remain competitive, we must continue to enhance and improve the functionality and features of our online store. The Internet and the online commerce industry are subject to rapid technological change. If competitors introduce new features and website enhancements, or if new industry standards and practices emerge, our existing website and systems may become obsolete or unattractive. Developing our website and other systems entails significant technical and business risks. We may use new technologies ineffectively or we may fail to adapt our website, our transaction processing systems and our computer network to meet customer requirements or emerging industry standards. If we are unsuccessful in upgrading our systems to accommodate higher traffic or developing or implementing new technologies that enable us to meet evolving industry standards and remain competitive, our operating results would be seriously harmed.

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     We are currently in the process of implementing certain system enhancements and upgrades, including a new warehouse management system, an order-entry system, an updated financial software package and software to enhance the features of our website. Also, we are in the process of modifying certain internal processes for the purpose of improving our productivity and making our operations more cost efficient. However, we cannot assure you that we will be successful in these efforts. Possible cost overruns in these implementation efforts may result in higher than anticipated capital expenditures and delays in or other problems arising out of these implementations could lead to customer dissatisfaction. If we do not successfully implement one or more of these intended upgrades or modified processes or if we do not achieve desired efficiencies or cost savings as a result of these changes or if attempts to enhance our website are unsuccessful or are not appealing to our customers, our business and operating results could be harmed, perhaps significantly.

Delivery of our merchandise could be delayed or disrupted by factors beyond our control, and we could lose customers as a result.

     As timely gift delivery is essential to our customer’s satisfaction, any delay or disruption in order, fulfillment and shipping, particularly during the holiday shopping season, could cause us to lose customers and negatively affect our business. In addition, we rely upon third-party carriers for timely delivery of our product shipments. As a result, we are subject to carrier disruptions and increased costs due to factors that are beyond our control, including employee strikes, inclement weather and increased fuel costs. Any failure to deliver products to our customers in a timely and accurate manner would damage our reputation and brand and could cause us to lose customers.

     We also depend on temporary employees to adequately staff our distribution facility during busy periods such as the holiday shopping season, including individuals responsible for gift personalization and packaging. We cannot assure you that we will continue to receive adequate assistance from our temporary employees, or that we will continue to have access to sufficient numbers of competent temporary employees on a cost-effective basis, particularly during the holiday shopping season, which season is critical to our business. If we are unable to adequately staff our distribution and fulfillment facility during the holiday shopping season and other periods of increased activity, our operations and sales during such period could suffer, and our reputation could be harmed.

Increased merchandise returns and a failure to accurately predict merchandise returns could harm our business.

     As part of our customer service commitment, we maintain a merchandise return policy that allows recipients to return most non-personalized merchandise items received from us if they are dissatisfied with those items. We make allowances for merchandise returns in our financial statements based on historical return rates. We cannot assure you that actual merchandise returns will not significantly exceed our allowances for returns. In addition, because our allowances are based on historical return rates, we cannot assure you that the introduction of new merchandise in our catalogs, the introduction of new catalogs, increased sales over the Internet, changes in our merchandise mix, changes in the habits of our gift item recipients, or other factors will not cause actual returns to exceed return allowances, perhaps significantly. Any increase in merchandise returns that exceed our allowances would affect our business adversely. Also, returned merchandise that is personalized, perishable, or damaged likely cannot be re-sold, creating non-recoverable inventory costs which detrimentally affects our operating results.

If we are unable to successfully manage the costs of our catalog operations or our catalogs fail to produce sales at satisfactory levels it could adversely affect our business.

     Our catalog has been an important tool for the acquisition and retention of customers. We believe that the success of our catalog as a cost-effective marketing tool depends on the following factors:

  effective management of costs associated with the production and distribution of our catalog
 
  achievement of adequate response rates to our mailings
 
  displaying a mix of merchandise in our catalog that is attractive to our customers
 
  cost-effective production of appealing catalogs
 
  timely delivery of catalog mailings to our customers

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     Catalog production and mailings entail substantial paper, printing, postage and human labor costs. Increases in the costs of producing and distributing the RedEnvelope catalog, including increases in postage rates or paper, photography, or printing costs, may reduce the margin on sales derived from our catalog. The U.S. Postal Service is likely to increase its postage rates in the future and other delivery and overnight courier services that we utilize to deliver our products also will likely raise their rates in the future, which could significantly increase the aggregate cost of mailing our catalogs. As we incur nearly all of the costs associated with our catalogs prior to mailing, we are unable to adjust the costs being incurred in connection with a particular mailing to reflect the actual performance of the catalog. In addition, response rates to our mailings and, as a result, revenues generated by each mailing, are affected by factors such as constantly changing consumer preferences and our ability to include a product assortment that satisfies those preferences, economic conditions, the timing and mix of catalog mailings, the timely delivery by the postal system of our catalog mailings, and changes in our merchandise mix, several or all of which may be outside of our control. If we were to experience an increase in the costs associated with producing or distributing our catalogs or our catalogs fail to produce sales at satisfactory levels, our operating results would be adversely affected.

We are dependent on the success of our advertising and marketing efforts which are costly and may not achieve desired results.

     Our revenues depend on our ability to advertise and market our products effectively through the RedEnvelope catalog and our other advertising and marketing efforts. If we do not successfully advertise and market our products, our operating results will be seriously harmed. Increases in the cost of advertising and marketing, including paper and postage costs and the costs of complying with applicable regulations, may limit our ability to advertise and market our business without reducing our profitability. In addition, individuals are increasingly using software programs that block certain email marketing campaigns, and certain Federal and state laws and regulations may restrict our ability to effectively utilize email as a marketing tool. We are currently in the process of modifying our mix of advertising to include more print and outdoor advertising. If we decrease our advertising or marketing activities, if the effectiveness of such activities is diminished, due to increased costs, restrictions enacted by regulatory agencies or for any other reason or if our current advertising strategy does not yield anticipated results, our future operating results could be significantly harmed. We expect to increase spending on advertising and marketing in the future, and if such efforts do not produce a sufficient level of sales to cover their costs, it would harm our operating results.

Recent changes to our shipping rate policy could cause our revenues to decline.

     In August 2003, we changed our shipping rate policy from a graduated rate schedule, based on the cost of the item(s) purchased by a customer, to a consistent flat rate per shipment. This change will have the effect of lowering our average per-shipment shipping fee, thereby reducing our shipping revenues per order. While we believe that this change to our shipping rate policy will be conducive to an increase in our order volume, we cannot assure you that our order volume will be increased or that any increase in shipments will offset the reduction in per-shipment shipping revenues resulting from our shipping rate policy change. We believe that this change in shipping rate policy had an aggregate negative impact on our revenues for the third fiscal quarter of 2004, which was the first full quarter following the policy change, and it is possible that the policy change could have a negative impact on our revenues in future periods. If our aggregate shipping revenues decrease as a result of the change in our shipping rate policy without a commensurate rise in product revenue, our business, financial condition and results of operations could be harmed.

If we are unable to provide satisfactory customer service, we could lose customers.

     Our ability to provide satisfactory levels of customer service depends, to a large degree, on the efficient and uninterrupted operation of our call center. Any material disruption or slowdown in our order processing systems resulting from labor disputes, telephone or Internet failures, power or service outages, natural disasters or other events could make it difficult or impossible to provide adequate customer service and support. Further, we may be unable to attract and retain adequate numbers of competent customer service representatives, which is essential in

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creating a favorable interactive customer experience. Due to increased customer service needs during the holiday shopping season, we hire a relatively large number of temporary employees during our third fiscal quarter. As a result, we may have difficulty properly staffing our customer service operations during our peak sales season. Further, temporary employees may not have the same levels of training or professional responsibility as full-time employees and, as a result, may be more likely to provide unsatisfactory service to our customers and potential customers. If we are unable to continually provide adequate staffing for our customer service operations, our reputation could be seriously harmed. In addition, we cannot assure you that email and telephone call volumes will not exceed our present system capacities. If this occurs, we could experience delays in placing orders, responding to customer inquiries and addressing customer concerns. Our customer service facility currently accommodates customer service representatives at close to its capacity during our peak sales period. We currently plan on hiring additional customer service representatives in our distribution center in Ohio to accommodate the overflow of calls. Because our success depends in large part on keeping our customers satisfied, any failure to provide high levels of customer service or adequately staff our customer service operations would likely impair our reputation and have an adverse effect on our business and operating results.

The loss of our senior management or other key personnel could harm our current and future operations and prospects.

     Our performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel, particularly Alison L. May, our President and Chief Executive Officer. One of our long-time officers and directors, Hilary Billings, recently resigned from RedEnvelope. While we believe that this will have no material impact on our operations, we cannot assure you that disruptions occasioned by her departure will not have an adverse impact on our near-term operations. Our performance also depends on our ability to retain and motivate other officers and key employees. We do not have long-term employment agreements with any of our key personnel. The loss of the services of Ms. May or any of our executive officers or other key employees for any reason could harm our business, financial condition and operating results. Our future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly-skilled technical, managerial, editorial, merchandising, marketing and customer service personnel. Competition for such personnel is intense, particularly in the San Francisco Bay Area, and we cannot assure you that we will be able to successfully attract, assimilate or retain sufficiently qualified personnel. Our failure to attract and retain the necessary technical, managerial, editorial, merchandising, marketing and customer service personnel would harm our business, financial condition and results of operations.

Our current proxy contest will divert management and financial resources and could result in a substantial change in company management.

     Four of our stockholders have commenced a proxy contest seeking to have an opposing slate of directors elected to our Board at our upcoming stockholder meeting. This proxy contest is likely to be extremely costly and will require the attention of our senior management team, preventing them from focusing their full attention on our operations. Any diversion of our senior management personnel could have a detrimental effect on our operations. We currently anticipate that we will incur up to $250,000 in additional costs as a result of this proxy contest, which amount could increase significantly in the event that any litigation ensues. In addition, these stockholders may seek to have their proxy contest expenses, approximated at up to an additional $275,000, reimbursed by the Company, particularly if they are successful in their efforts. In the event that these stockholders are successful in having their opposing slate of directors elected, then the entire current Board of Directors, with the exception of Scott Galloway, would be replaced. Additionally, these stockholders have indicated that if they are successful in having their opposing slate of directors elected they will immediately replace the Company’s Chief Executive Officer. Such a wholesale change in leadership, particularly in advance of the Company’s holiday sales season, would likely be disruptive to the Company’s operations and could have a material adverse effect on the Company’s business and results of operations.

If the protection of our trademarks and proprietary rights is inadequate, our brand and reputation could be impaired and we could lose customers.

     We regard our copyrights, service marks, trademarks, trade dress, trade secrets and similar intellectual property as critical to our success. We rely on trademark and copyright law, trade secret protection and confidentiality agreements with our employees, consultants, partners, suppliers, and others to protect our proprietary rights. Nevertheless, the steps we take to protect our proprietary rights may be inadequate. Further, effective trademark, service mark, copyright and trade secret protection may not be available in every country in which we will sell our products and offer our services. Currently, we are involved in a trademark dispute with a company based in the United Kingdom regarding trademark rights in the United Kingdom and European Community. For more information on this dispute, see “Part I. Item 3 — Legal Proceedings” below. In addition, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear. Therefore, we may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights. If we are unable to protect or preserve the value of our trademarks, copyrights, trade secrets or other proprietary rights for any reason, our business would be harmed.

     We also rely substantially on technologies that we license from third parties. These licenses may not continue to be available to us on commercially reasonable terms, or at all, in the future. As a result, we may be required to develop or obtain substitute technology of lower quality or at greater cost, or we may be prevented from providing features or functionality on our website that our customers and potential customers desire, any of which could materially adversely affect our business, operating results and financial condition.

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Intellectual property claims against us could be costly and could impair our business.

     Other parties may assert infringement or unfair competition claims against us. In the past, we have received notices from third parties alleging that our trademarks or product offerings infringe proprietary rights held by them. We have also in the past received claims and have been a defendant in a lawsuit alleging that our Internet marketing program and website operations infringe patents held by third parties. For additional information on this lawsuit, see Part II Item 1 — Legal Proceedings below. We may receive other similar notices from, or have lawsuits filed against us by, third parties in the future. We cannot predict whether third parties will assert claims of infringement against us, or whether any past, present or future claims will prevent us from offering popular products or operating our business as planned. If we are forced to defend against thirty-party infringement claims, whether they are with or without merit or are determined in our favor, we could face expensive and time-consuming litigation, which could distract technical and management personnel, or result in product shipment delays. If an infringement claim is determined against us, we may be required to pay monetary damages or ongoing royalties. Further, as a result of infringement claims either against us or against those who license technology to us, we may be required to develop non-infringing intellectual property or enter into costly royalty or licensing agreements. Such royalty or licensing agreements, if required, may be unavailable on terms that are acceptable to us, or at all. If a third-party successfully asserts an infringement claim against us and we are required to pay monetary damages or royalties or we are unable to develop suitable non-infringing alternatives or license the infringed or similar intellectual property on reasonable terms on a timely basis, it could significantly harm our business.

We face the risk of inventory shrinkage.

     We are subject to the risk of inventory loss and theft, particularly with respect to our growing line of jewelry products. Although we believe that the levels of inventory shrinkage that we have suffered in the past are within an acceptable range, we cannot assure you that incidences of inventory loss and theft will not increase in the future or that the security measures we have taken in the past will effectively address the problem of inventory theft. If we were to suffer higher rates of inventory shrinkage or incur increased security costs to combat inventory theft, our financial condition could be affected adversely.

Poor economic conditions may constrain discretionary consumer spending on retail products such as ours.

     Consumer spending patterns, particularly discretionary spending for products such as ours, are affected by, among other things, prevailing economic conditions, stock market volatility, wars, threats of war, acts of terrorism, wage rates, interest rates, inflation, taxation, and consumer confidence. General economic, political and market conditions, such as recessions, may adversely affect our business results and the market price of our common stock. The terrorist attacks of September 11, 2001 and the wars in Afghanistan and Iraq had a negative effect on an already slowing economy and on consumer confidence. Our business and revenues have been, and could continue to be, negatively affected by poor economic conditions and any related decline in consumer demand for discretionary items such as our products. We face uncertainty in the degree to which poor performance in the retail industry, decreased consumer confidence or any economic slowdown will negatively affect demand for our products. We may not be able to accurately anticipate the magnitude of these effects on future quarterly results, which could seriously harm our financial condition. As we do not have large cash reserves, we may not be able to survive an extended recession or sluggish economy.

We may need additional financing and may not be able to raise additional financing on favorable terms or at all, which could increase our costs, limit our ability to grow and dilute the ownership interests of existing stockholders.

     We anticipate that we may need to raise additional capital in the future to facilitate long-term expansion, to respond to competitive pressures or to respond to unanticipated financial requirements. Since our inception, we have experienced negative cash flow from operations on a fiscal year basis and may experience negative cash flow from operations on a fiscal year basis for the foreseeable future. We cannot be certain that we will be able to obtain additional financing on commercially reasonable terms or at all.

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If we raise additional funds through the issuance of equity, equity-related or debt securities, such securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders will experience dilution of their ownership interests. Further, under the terms of our credit agreement with CapitalSource Finance LLC, we are subject to certain contractual limitations with respect to raising additional capital during the term of that agreement. A failure to obtain additional financing or an inability to obtain financing on acceptable terms could require us to incur indebtedness that has high rates of interest or substantial restrictive covenants, issue equity securities that will dilute the ownership interests of existing stockholders, or scale back, or fail to address opportunities for expansion or enhancement of, our operations.

If we default on any secured loan, all or a portion of our assets could be subject to forfeiture.

     We are currently party to a credit agreement that is secured by substantially all of our tangible and intangible assets, and we may enter into secured credit or loan agreements in the future. If we default on our current or any future secured loan for any reason and are unable to cure the default pursuant to the terms of the relevant agreement, our lenders could take possession of any or all assets in which they hold a security interest, including intellectual property, and dispose of those assets to the extent necessary to pay off our debts, which could materially harm our business.

We may face product liability claims that are costly and create adverse publicity.

     If any of the products that we sell causes harm or financial damages to any of our customers or other individuals, we could be vulnerable to product liability lawsuits. If we are found liable under product liability claims, we could be required to pay substantial monetary damages and our reputation could suffer. Further, even if we successfully defend ourselves against this type of claim, we could be forced to spend a substantial amount of money in litigation expenses, our management could be required to spend valuable time in the defense against these claims and the claims could bring adverse publicity to us, any of which could harm our business.

We may face difficulty expanding into international markets.

     We may expand our operations to sell our products internationally, but we have relatively little experience in purchasing, marketing and distributing products or services for international markets. It will be costly to establish international facilities and operations, promote our brand internationally, and develop localized websites, catalogs and other systems. Governments in other countries may regulate Internet or other online services in such areas as content, privacy, network security, encryption or distribution, which could significantly affect our ability to conduct business in those countries. If we are unsuccessful in our attempts to expand our operations into other countries, our operating results could be harmed.

We may incur significant costs or experience delays in product availability due to regulations applicable to the sale of food products and live plants, which may hurt our business.

     We currently offer select food items and live plants for sale to our customers. Applicable federal, state or local regulations may cause us to incur substantial compliance costs or delay the availability of those products. In addition, any inquiry or investigation from a regulatory authority could have a negative impact on our reputation. The occurrence of any of these events could adversely affect our financial condition.

If we fail to comply with the laws regulating the sale of tobacco products it may have a negative impact on our reputation and make us vulnerable to liability claims.

     We are required to verify the age of purchasers of our tobacco products. If we fail to request or are unable to properly identify the age of our purchasers, we could face substantial penalties and legal liability for sales of tobacco products to underage persons.

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Any inquiry or investigation from a regulatory authority could have a negative impact on our reputation and any liability claims could subject us to fines, mandatory damages or require us to spend significant time and money in litigation, any of which could adversely affect our business, financial condition and operating results.

Our charter documents, Delaware law and third-party contractual restrictions may make an acquisition of us more difficult, even if an acquisition would be beneficial to our stockholders.

     We are a Delaware corporation and the Delaware General Corporation Law contains certain provisions that may make a change in control of our company or the removal of incumbent directors more difficult. In addition, our Amended and Restated Certificate of Incorporation and Bylaws, contain provisions that may have the same effect, including the elimination of the ability of stockholders to call special meetings or vote by written consent, the elimination of cumulative voting for directors, and procedures requiring advance notification for stockholder proposals. The elimination of cumulative voting substantially reduces the ability of minority stockholders to obtain representation on the Board of Directors. These provisions may discourage potential acquirers from making a bid for our company, or make an acquisition of us or a tender offer to our stockholders more difficult, even if such acquisition or tender offer would be beneficial to our stockholders, and may reduce any premiums paid to stockholders for their common stock.

     Additionally, under the terms of our credit agreement with CapitalSource Finance LLC, we are subject to covenants that could restrict or place limitations on our ability to be acquired by another company during the term of the credit agreement, even if such acquisition would be beneficial to our stockholders.

Our success is tied in large part to the continued use of the Internet by a large number of consumers.

     Our future revenues and profits, if any, substantially depend upon the continued widespread use of the Internet as an effective medium of commerce and communication. Factors which could reduce the widespread use of the Internet include:

  actual or perceived lack of privacy protection
 
  actual or perceived lack of security of credit card information
 
  possible disruptions or other damage to the Internet or telecommunications infrastructure
 
  increased governmental regulation and taxation
 
  decreased use of personal computers

     Any decrease or less than anticipated growth in Internet usage could significantly harm our business.

Customers may be unwilling to purchase goods on the Internet.

     Approximately 72% of our products currently are purchased through our website. Our long-term prospects therefore depend upon the general public’s increasing willingness to use the Internet as a means to purchase goods. The failure of the Internet to continue to develop into an effective and reliable tool for consumer purchases would seriously damage our future operations. Online commerce is a relatively new concept, and online purchases may decline or fail to increase as projected. The future of online commerce is highly uncertain, many online commerce companies have ceased operations in recent years and most existing online commerce companies have a relatively short operating history. If consumers are unwilling to use the Internet to purchase retail products, our business will be harmed.

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The security risks of online commerce, including credit card fraud, may discourage customers from purchasing goods from us.

     In order for the online commerce market to develop successfully, we and other market participants must be able to transmit confidential information, including credit card information, securely over public networks. Third parties may have the technology or know-how to breach the security of customer transaction data. Any breach could cause consumers to lose confidence in the security of our website and choose not to purchase from us. Although we take the security of our systems very seriously, we cannot guarantee that our security measures will effectively prohibit others from obtaining improper access to our information and information of our customers. If a person is able to circumvent our security measures, he or she could destroy or steal valuable information or disrupt our operations. Any security breach could expose us to risks of data loss, litigation and liability and could seriously disrupt our operations and harm our reputation.

     We do not carry insurance against the risk of credit card fraud, so the failure to prevent fraudulent credit card transactions could reduce our net revenues and gross margin. We may suffer losses as a result of orders placed with fraudulent credit card data even though the associated financial institution approved payment of the orders. Under current credit card practices, we may be liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature. If we are unable to detect or control credit card fraud, our liability for these transactions could harm our business, operating results or financial condition.

If one or more states successfully assert that we should collect sales or other taxes on the sale of merchandise purchased from our website, our business could be harmed.

     We do not currently collect sales or other similar taxes for physical shipments of goods into states other than California and Ohio. In the future, one or more local, state or foreign jurisdictions may seek to impose sales tax collection obligations on us. If sales tax obligations are successfully imposed upon us by a state or other jurisdiction, we may suffer decreased sales into such state or jurisdiction as the effective cost of purchasing goods from us increases for those residing in such states or jurisdictions. We may also be subject to value added and other taxes if we sell merchandise to customers located in the European Union or elsewhere in the world and we may incur significant financial and organizational burdens in order to set up the infrastructure required to comply with applicable tax regulations. If additional states or any other jurisdictions successfully assert that we should collect sales or other taxes on the sale of our merchandise into these jurisdictions our business and operating results could be affected adversely.

Existing or future government regulation could harm our business.

     We are subject to the same federal, state and local laws as other companies conducting business on the Internet, including consumer protection laws, user privacy laws and regulations prohibiting unfair and deceptive trade practices. In particular, under federal and state financial privacy laws and regulations, we must provide notice to our customers of our policies on sharing non-public information with third parties, must provide advance notice of any changes to our privacy policies and, with limited exceptions, must give consumers the right to prevent sharing of their non-public personal information with unaffiliated third parties. Further, the growth of online commerce could result in more stringent consumer protection laws that impose additional compliance burdens on us. Today there are an increasing number of laws specifically directed at the conduct of business on the Internet. Moreover, due to the increasing use of the Internet, many additional laws and regulations relating to the Internet are being debated at the state and federal levels. These laws and regulations could cover issues such as freedom of expression, pricing, consumer privacy, fraud, quality of products and services, taxation, advertising, adult-oriented content, intellectual property rights and information security. Applicability of existing laws to the Internet relating to issues such as trademarks, copyrights and other intellectual property issues, taxation, libel, obscenity and personal privacy could also harm our business. For example, United States and international laws regulate our ability to use customer information and to develop, buy and sell mailing lists. The vast majority of these laws were adopted prior to the advent of the Internet, and do not contemplate or address the unique issues raised by the Internet. Those laws that do reference the Internet, such as the Digital Millennium Copyright Act and the recent federal law regulating the commercial use of e-mail (popularly known as “CAN-SPAM”), are only beginning to be interpreted by the courts and their applicability and reach are therefore uncertain. The restrictions imposed by, and costs of complying with, current and possible future laws and regulations related to our business could harm our business, operating results and financial condition.

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     Tax authorities in a number of states, as well as a Congressional advisory commission, are currently reviewing the appropriate tax treatment of companies engaged in online commerce, and new state tax regulations may subject us to additional state sales and income taxes, which could have an adverse effect on our cash flows and results of operations. Further, there is a possibility that we could be subject to significant fines or other payments for any past failures to comply with these requirements. In its most recent session, Congress refused to extend the U.S. Internet tax moratorium. Consequently, states are free to impose new taxes on Internet access, which could slow the growth of Internet use and of electronic commerce transactions over the Internet.

     The State of California recently enacted a law that requires any company that does business in California and possesses computerized data, in unencrypted form, containing certain personal information about California residents to provide prompt notice to such residents if that personal information was, or is reasonably believed to have been, obtained by an unauthorized person such as a computer hacker. The law defines personal information as an individual’s name together with one or more of that individual’s social security number, driver’s license number, California identification card number, credit card number, debit card number, or bank account information, including any necessary passwords or access codes. As our customers, including California residents, generally provide information to us that is covered by this definition of personal information in connection with their purchases via our website, our business will be affected by this new law. As a result, we will need to ensure that all computerized data containing the previously-described personal information is sufficiently encrypted or that we have implemented appropriate measures to detect unauthorized access to our data and to notify our California customers of any such access to the extent it involves their personal information. Such measures will likely increase the costs of doing business and, if we fail to detect and provide prompt notice of unauthorized access as required by the new law, we could be subject to potential claims for damages and other remedies available to California residents whose information was improperly accessed or, under certain circumstances, the State of California could seek to enjoin our business operations until appropriate corrective actions have been taken. While we intend to comply fully with this new law, we cannot assure you that we will be successful in avoiding all potential liability or disruption of business resulting from this law. If we were required to pay any significant amount of money in satisfaction of claims under this new law, or any similar law enacted by another jurisdiction, or if we were forced to cease our business operations for any length of time as a result of our inability to comply fully with any such law, our business, operating results and financial condition could be adversely affected. Further, complying with the applicable notice requirements in the event of a security breach could result in significant costs.

     Further, recently-enacted federal and state laws place restrictions on email marketing that could make it more difficult for us to acquire new customers, or to obtain repeat purchases from prior customers through inexpensive electronic marketing methods. The CAN-SPAM Act, for example, requires every commercial e-mail message to include an “opt-out” mechanism and requires all senders to comply with their recipients “opt out” requests. It also requires senders to label all commercial e-mail messages as advertisements or solicitations. These requirements may reduce the effectiveness of our e-mail marketing activities. If any current or future law requires us to eliminate or curtail our email marketing efforts, our ability to obtain new customers and increase revenues could be adversely affected or we could incur greater marketing costs, either of which could harm our business. While we intend to comply with applicable law regarding email marketing, there is no assurance that we will not incur fines or other liability as a result of an inadvertent violation of such a law.

     In addition, because our website is accessible over the Internet in multiple states and other countries, we may be subject to their laws and regulations or may be required to qualify to do business in those locations. We are qualified to do business only in California and Ohio at present. Our failure to qualify in a state or country where we are required to do so could subject us to taxes and penalties and we could be subject to legal actions and liability in those jurisdictions. The restrictions or penalties imposed by, and costs of complying with, these laws and regulations could harm our business, operating results and financial condition. Our ability to enforce contracts and other obligations in states and countries in which we are not qualified to do business could be hampered, which could have a material adverse effect on our business. Further, an important aspect of the new Internet-focused laws is that where federal legislation is absent, states have begun to enact consumer-protective laws of their own and these can vary significantly from state to state. Thus, it is difficult for any company to be sufficiently aware of the requirements of all applicable state laws and it is also difficult or impossible for any company to comply fully with the sometimes inconsistent standards and requirements set by various states. In addition to the consequences that could result from violating one or more state laws, the costs of attempting to comply could be considerable.

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Laws or regulations relating to privacy and data protection may adversely affect the growth of our Internet business or our marketing efforts.

     We are subject to increasing regulation relating to privacy and the use of personal user information. For example, we are subject to various telemarketing laws that regulate the manner in which we may solicit future suppliers and customers. Such regulations, along with increased governmental or private enforcement, may increase the cost of growing our business. California recently enacted a law that will require all commercial website operators that collect personal information about California residents to adopt and post a privacy policy that meets certain specified criteria. Any failure to comply with this new law could subject us to civil penalties, injunctions, and/or lawsuits. In addition, several states have proposed legislation that would limit the uses of personal user information gathered online or require online services to establish privacy policies. The Federal Trade Commission has adopted regulations regarding the collection and use of personal identifying information obtained from children under 13 years of age. Bills proposed in Congress would extend online privacy protections to adults. Moreover, proposed legislation in the United States and existing laws in other countries require companies to establish procedures to notify users of privacy and security policies, obtain consent from users for collection and use of personal information, and/or provide users with the ability to access, correct and delete personal information stored by companies. These data protection regulations and enforcement efforts may restrict our ability to collect demographic and personal information from users, which could be costly or harm our marketing efforts. Further, any violation of privacy or data protection laws and regulations may subject us to fines, penalties and damages and may otherwise have a material adverse effect on our business, results of operations and financial condition.

We may be subject to liability for the Internet content that we publish.

     As a publisher of catalogs and online content, we face potential liability for defamation, negligence, intellectual property infringement, or other claims based on the information and other content contained in our catalogs and website. In the past, parties have brought these types of claims and sometimes successfully litigated them against online services. If we incur liability for our catalog or online content, our financial condition could be affected adversely and our reputation could suffer.

Our directors, executive officers and significant stockholders hold a substantial portion of our stock, which may lead to conflicts with other stockholders over corporate transactions and other corporate matters.

     Our directors, executive officers and current beneficial holders of 5% or more of our outstanding common stock own a significant portion of our stock. These stockholders, acting together, are able to influence significantly all matters requiring stockholder approval, including the election of directors and significant corporate transactions such as mergers or other business combinations. This control may delay, deter or prevent a third-party from acquiring or merging with us.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     Interest Rate Risk We currently maintain a portfolio of fixed and variable rate investments consisting of cash equivalents and short-term marketable securities, which can be affected by changes in market interest rates. The objective of our investment activities is to preserve principal, while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in highly liquid, investment grade and government debt securities. Our investments in debt securities are subject to interest rate risk. According to our investment policy, we may invest in taxable and tax exempt instruments. In addition, the policy establishes limits on credit quality, maturity, issuer and type of instrument. Marketable securities are classified as “available for sale”. Marketable securities are comprised of government securities and corporate bonds. We do not use derivative financial instruments in our investment portfolio. (See Note 3 of Notes to Financial Statements)

     All highly liquid investments with maturity of three months or less at the date of purchase are considered to be cash equivalents. The remaining investments in marketable securities are considered short-term investments if maturities range over three months but less than one year, or long term investments if maturities are one year or longer.

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     The following table lists our cash and cash equivalents, short-term investments and long-term investments at June 27, 2004:

         
    June 27, 2004
    (In thousands)
Cash and cash equivalents
  $ 18,667  
Short-term investments
    10,495  
 
   
 
 
Total
  $ 29,162  
 
   
 
 

     If interest rates changed adversely by 100 basis points, our results from operations and cash flows would not be materially affected.

     Foreign Currency Risk We purchase a significant amount of inventory from vendors outside of the U.S. in transactions that are denominated in U.S. dollars. As of June 27, 2004, any currency risks related to these transactions were not significant to us. A decline in the relative value of the U.S. dollar to other foreign currencies could, however, lead to increased purchasing costs.

Item 4. Controls and Procedures

     The Company evaluated the design and operation of its disclosure controls and procedures to determine whether they are effective in ensuring that the disclosure of required information is timely and made in accordance with the Exchange Act and the rules and forms of the Securities and Exchange Commission. This evaluation was made as of the end of the Company’s most recent fiscal quarter under the supervision and with the participation of management, including the Company’s principal executive officer and principal financial officer. Maintenance of disclosure controls and procedures is an ongoing process and controls and procedures may change over time. The Company also has established a Disclosure Committee, which consists of certain members of the Company’s senior management. Based on this evaluation, our chief executive officer and our chief financial officer have concluded that our disclosure controls and procedures, as defined at Exchange Act Rules 13a-15(e) and 15d-15(e), are effective to ensure that information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. During the fiscal quarter, no changes were made to the Company’s internal controls over financial reporting that materially affected, or are reasonably likely to affect, such internal controls over financial reporting.

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PART II.
OTHER INFORMATION

Item 1. Legal Proceedings

     By its letter dated March 9, 2000, Red Letter Days Plc, a United Kingdom company (Red Letter Days), asserted trademark rights in the United Kingdom in the marks RED LETTER, RED LETTER DAYS and the image of a red envelope. Red Letter Days offers experiential gifts in the United Kingdom. The letter claimed that if we were to use our name and the REDENVELOPE service mark in the United Kingdom in connection with retail sales of gifts, it would infringe Red Letter Days’ trademark rights. We have made a number of attempts to reach an amicable resolution of this dispute, but Red Letter Days has declined, to date, to enter into settlement negotiations. Red Letter Days has opposed our applications to register the REDENVELOPE and RedEnvelope stylized logo marks in the United Kingdom and the European Community. Red Letter Days’ oppositions to our United Kingdom and European Community trademark applications are pending. Evidentiary submissions have been made by the parties in connection with those opposition proceedings and a decision is not expected for several months. The sole issue to be decided in the opposition proceedings is whether the REDENVELOPE mark is entitled to registration in the stated jurisdictions.

Even if an opposition is successful in preventing the subject trademark from being registered, that decision by the registration authorities does not prevent the applicant from using the mark in that jurisdiction. In order to prevent us from using the RedEnvelope mark in the United Kingdom or European Community or to obtain any other equitable relief or monetary relief, Red Letter Days would need to bring a lawsuit against us in the appropriate jurisdiction. To the best of our knowledge, no such lawsuit has been filed. We opposed Red Letter Days application to register the RED LETTER mark in the United Kingdom, based on the descriptiveness of the RED LETTER mark as applied to the services of Red Letter Days. The United Kingdom trademark office has denied our opposition and has approved the registration of the Red Letter Days mark in the United Kingdom. This decision did not address a comparison of the REDENVELOPE and RED LETTER marks.

     On September 3, 2003, Activ8now, LLC filed a patent infringement lawsuit against the Company in the United States District Court, Northern District of Georgia. The lawsuit alleged a cause of action for infringement of U.S. Patent Nos. 6,535,889 and 6,557,006 based on the theory that certain of our website operations were covered by such patents. On June 18, 2004, the Company and Activ8now, LLC entered into a settlement agreement providing the Company with a non-exclusive, irrevocable, paid-up, worldwide license to such patents in exchange for a one-time fee and dismissal of the lawsuit with prejudice. The settlement did not have a material adverse effect on the Company’s financial position or results of operations.

     From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks and other intellectual property rights. The Company is not currently aware of such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on its financial position or results of operations.

Item 2. Changes in Securities, Use of Proceeds and Issues or Purchases of Equity Securities

     On September 24, 2003, a Registration Statement on Form S-1 (Commission File No. 333-106120) relating to our initial public offering was declared effective by the Securities and Exchange Commission. The net proceeds to us from the offering were approximately $29.0 million after deducting underwriting discounts of $1.8 million. We used approximately $1.5 million of the net proceeds for fees related to the offering (excluding banker fees). Since the initial public offering, we have used approximately $4.1 million for purchases of property and equipment. We also use the net proceeds to fund our working capital requirements throughout the year.

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Item 6. Exhibits and Reports on Form 8-K

     (a) Exhibits

     
10.40
  Lease Agreement dated July 22, 2004 between 149 New Montgomery, LLC and RedEnvelope, Inc.
 
31.1
  Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)
 
   
31.2
  Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)
 
   
32.1
  Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002
 
   
32.2
  Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002

     (b) Reports on Form 8-K

     
Date:
  Item Reported On:
April 12, 2004
  Item 12: The Company issued a press release announcing the updated revenue outlook for the fiscal quarter ended March 28, 2004.
 
May 11, 2004
  Item 12: The Company issued a press release of the financial results for the fourth quarter and fiscal year ended March 28, 2004.

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SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

         
    REDENVELOPE, INC.
 
       
  By:   /s/ ERIC C. WONG
   
    Eric C. Wong
    Chief Financial Officer

Date: August 11, 2004

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EXHIBIT INDEX

     
10.40
  Lease Agreement dated July 22, 2004 between 149 New Montgomery, LLC and RedEnvelope, Inc.
 
31.1
  Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)
 
   
31.2
  Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)
 
   
32.1
  Certification required by 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002
 
   
32.2
  Certification required by 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002