UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, ~~2005~~2007


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 (State or Other Jurisdiction of Incorporation or Organization) 33-0844285 (IRS Employer Identification No.)


Delaware		33-0844285
(State or Other Jurisdiction of		(IRS Employer
Incorporation or Organization)		Identification No.)

149 New Montgomery Street,
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~~ 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~~ been subject to such filing ~~requirement~~requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. ~~(as~~See definition of “accelerated filer” and “large accelerated ~~defined~~filer” in Rule 12b-2 of the Exchange Act). ~~Yes o No þ~~

~~The~~Large ~~number~~Accelerated ofFiler ~~outstanding~~o Accelerated ~~shares~~Filer ofo Non-Accelerated ~~the~~Filer ~~registrant’s common stock, $0.01 par value per share, was 8,993,290 as of August 1, 2005.~~ þ

~~RedEnvelope,~~ Indicate ~~Inc. REPORT~~by ONcheck ~~FORM~~mark ~~10-Q For~~whether the ~~Quarter~~registrant ~~Ended~~is ~~July~~a shell company (as defined in Rule 3,12b-2 ~~2005~~of ~~TABLE~~the OFAct). ~~CONTENTS~~Yes o No þ

		Page
	PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Balance Sheets as of July 3, 2005, April 3, 2005 and June 27, 2004	2
	Condensed Statements of Operations for the thirteen weeks ended July 3, 2005 and June 27, 2004	3
	Condensed Statements of Cash Flows for the thirteen weeks ended July 3, 2005 and June 27, 2004	4
	Notes to Condensed Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	8
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.	Controls and Procedures	26
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	II-1
Item 2.	Changes in Securities, Use of Proceeds and Issues or Purchases of Equity Securities	II-1
Item 6.	Exhibits	II-1
EXHIBIT 10.53
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

The number of outstanding shares of the registrant’s common stock, $0.01 par value per share, was 9,522,982 as of August 28, 2007.

RedEnvelope, Inc. REPORT ON FORM 10-Q For the Quarter Ended July 1, 2007 TABLE OF CONTENTS


		Page
	PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)		3
	Condensed Balance Sheets as of July 1, 2007, April 1, 2007 and July 2, 2006		3
	Condensed Statements of Operations for the thirteen weeks ended July 1, 2007 and July 2, 2006		4

	Condensed Statements of Cash Flows for the thirteen weeks ended July 1, 2007 and July 2, 2006		5

	Notes to Condensed Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		9
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		12
Item 4.	Controls and Procedures		13

	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings		13
Item 1A.	Risk Factors		13
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		22
Item 3.	Defaults Upon Senior Securities		22
Item 4.	Submission of Matters to a Vote of Security Holders		22
Item 5.	Other Information		22
Item 6.	Exhibits		22
EXHIBIT 10.73
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

RedEnvelope, Inc.

CONDENSED BALANCE SHEETS (Unaudited)

(Unaudited)


	July 1,			April 1,			July 2,
	2007			2007			2006
	(In thousands, except for share data)
ASSETS
Current assets:
Cash and cash equivalents	$	9,727		$	13,245		$	2,311
Short-term investments		—			—			5,058
Accounts receivable, net		2,089			1,050			1,611
Inventory		12,929			14,288			19,209
Prepaid catalog costs and other current assets		2,056			2,423			2,430


Total current assets		26,801			31,006			30,619
Property and equipment, net		9,255			8,221			7,576
Other assets		374			184			258


Total assets	$	36,430		$	39,411		$	38,453


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,133		$	7,092		$	6,285
Accrued expenses and other current liabilities		4,120			3,084			2,904
Accrued compensation		2,310			2,287			1,737
Capital lease obligations, current		184			207			284


Total current liabilities		12,747			12,670			11,210
Capital lease obligations, long-term		323			350			507
Deferred rent		454			502			644


Total liabilities		13,524			13,522			12,361


Stockholders’ equity:

Common stock, $0.01 par value; 100 million shares authorized; 9.5 million, 9.5 million, and 9.4 million issued and outstanding as of July 1, 2007, April 1, 2007, and July 2, 2006, respectively		96			96			96
Additional paid-in capital		119,371			118,800			116,367
Deferred compensation		—			(1	)		—
Notes receivable from stockholders		(44	)		(44	)		(44	)
Accumulated deficit		(96,517	)		(92,962	)		(90,327	)


Total stockholders’ equity		22,906			25,889			26,092


Total liabilities and stockholders’ equity	$	36,430		$	39,411		$	38,453

	July 3,			April 3,			June 27,
	2005			2005			2004
	(In thousands, except per share data)
ASSETS
Current assets:
Cash and cash equivalents	$	2,172		$	4,807		$	8,061
Short-term investments		14,471			14,356			21,101
Accounts receivable, net		1,109			992			849
Inventory		11,794			14,048			8,275
Prepaid catalog costs and other current assets		2,243			3,905			1,792
Total current assets		31,789			38,108			40,078
Property and equipment, net		7,423			7,587			6,236
Other assets		538			573			471
Total assets	$	39,750		$	46,268		$	46,785
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,632		$	10,044		$	7,700
Accrued expenses and other current liabilities		3,716			3,454			3,228
Accrued compensation		1,148			993			1,215
Capital lease obligations, current		578			579			597
Total current liabilities		10,074			15,070			12,740
Capital lease obligations, long-term		141			290			671
Deferred rent		833			874			—
Total liabilities		11,048			16,234			13,411
Common stock, $0.01 par value; 100 million shares authorized; 9.0 million, 8.9 million, and 8.7 million issued and outstanding as of July 3, 2005, April 3, 2005, and June 27, 2004, respectively		90			90			88
Additional paid-in capital		114,232			113,831			113,011
Deferred compensation		(16	)		(43	)		(71	)
Notes receivable from stockholders		(44	)		(44	)		(44	)
Accumulated deficit		(85,560	)		(83,805	)		(79,604	)
Accumulated other comprehensive income (loss)		—			5			(6	)
Total stockholders’ equity		28,702			30,034			33,374
Total liabilities and stockholders’ equity	$	39,750		$	46,268		$	46,785

See accompanying notes to these condensed financial statements.

RedEnvelope, Inc.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

	Thirteen Weeks Ended
	July 3,			June 27,
	2005			2004
	(In thousands, except for per share data)
Net revenues	$	24,978		$	21,131
Cost of sales		11,729			9,899
Gross profit		13,249			11,232
Operating expenses:
Fulfillment		3,405			3,395
Marketing		6,863			4,944
General and administrative		4,811			3,841
Total operating expenses		15,079			12,180
Loss from operations		(1,830	)		(948	)
Interest income		140			75
Interest expense		(62	)		(79	)
Net loss	$	(1,752	)	$	(952	)
Net loss per share — basic and diluted	$	(0.20	)	$	(0.11	)
Weighted average shares outstanding — basic and diluted		8,919			8,635

See accompanying notes to these condensed financial statements.

RedEnvelope, Inc.

CONDENSED STATEMENTS OF ~~CASH FLOWS~~OPERATIONS (Unaudited)

(Unaudited)


	Thirteen Weeks Ended
	July 1,			July 2,
	2007			2006
	(In thousands, except for per share data)
Net revenues	$	24,529		$	26,858
Cost of sales		12,222			12,608


Gross profit		12,307			14,250

Operating expenses:
Fulfillment		3,366			3,419
Marketing		6,198			6,285
General and administrative		6,443			5,489


Total operating expenses		16,007			15,193


Loss from operations		(3,700	)		(943	)
Interest income, net		145			43


Net loss	$	(3,555	)	$	(900	)


Net loss per share — basic and diluted	$	(0.37	)	$	(0.10	)


Weighted average shares outstanding — basic and diluted		9,519			9,377

	Thirteen Weeks Ended
	July 3,			June 27,
	2005			2004
	(In thousands)
Cash Flows From Operating Activities:
Net loss	$	(1,752	)	$	(952	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		798			618
Amortization of deferred stock compensation		4			7
Other non-cash charges		(7	)		59
Changes in current assets and liabilities:
Accounts receivable		(118	)		206
Inventory		2,255			1,334
Prepaid catalog and other assets		1,661			245
Accounts payable		(5,412	)		2,161
Accrued expenses and other current liabilities		414			115
Net cash (used in) provided by operating activities		(2,157	)		3,793
Cash Flows From Investing Activities:
Maturities of investments		1,300			6,089
Purchase of investments		(1,420	)		(18,378	)
Purchase of property and equipment		(633	)		(2,117	)
Net cash used in investing activities		(753	)		(14,406	)
Cash Flows From Financing Activities:
Proceeds from exercise of common stock options and warrants		424			410
Principal payments on capital lease obligations		(149	)		(145	)
Net cash provided by financing activities		275			265
Net decrease in cash and cash equivalents		(2,635	)		(10,348	)
Cash and cash equivalents at beginning of period		4,807			18,409
Cash and cash equivalents at end of period	$	2,172		$	8,061

See accompanying notes to these condensed financial statements.

RedEnvelope, Inc.

~~NOTES~~CONDENSED TOSTATEMENTS ~~CONDENSED~~OF ~~FINANCIAL~~CASH ~~STATEMENTS~~FLOWS (Unaudited)

(Unaudited)


	Thirteen Weeks Ended
	July 1,			July 2,
	2007			2006
	(In thousands)
Cash Flows From Operating Activities:
Net loss	$	(3,555	)	$	(900	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		673			837
Stock-based compensation		528			593
Other non-cash charges		(39	)		(34	)
Changes in current assets and liabilities:
Accounts receivable, net		(1,039	)		(557	)
Inventory		1,359			481
Prepaid catalog costs and other current assets		167			363
Accounts payable		(340	)		(3,192	)
Accrued expenses and other current liabilities		1,059			571


Net cash used in operating activities		(1,187	)		(1,838	)


Cash Flows From Investing Activities:
Maturities of short-term investments		—			6,561
Purchases of short-term investments		—			(4,857	)
Purchases of property and equipment		(2,325	)		(945	)


Net cash (used in) provided by investing activities		(2,325	)		759


Cash Flows From Financing Activities:
Proceeds from issuance of common stock		44			409
Principal payments on capital lease obligations		(50	)		(155	)
Payment of debt issuance costs		—			(141	)


Net cash (used in) provided by financing activities		(6	)		113


Net decrease in cash and cash equivalents		(3,518	)		(966	)
Cash and cash equivalents at beginning of period		13,245			3,277


Cash and cash equivalents at end of period	$	9,727		$	2,311


Supplemental Cash Flow Information:
Cash paid for interest	$	19		$	28
Supplemental Non-Cash Investing and Financing Activities:
Property and equipment acquired through capital lease transactions	$	—		$	498
Property and equipment acquired but not paid for during the period	$	100		$	114

1.See ~~Financial~~accompanying ~~Statements~~notes —to ~~Basis~~these ofcondensed ~~Presentation~~financial statements.

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 July 3, 2005 and June 27, 2004 and the condensed statements of operations and cash flows for the thirteen week periods ended July 3, 2005 and June 27, 2004 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 April 3, 2005, 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 April 3, 2005.

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 financial statements and notes thereto included in the Company’s Annual Report on Form 10K, for the fiscal year ended April 3, 2005. 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 July 3, 2005 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 2005 ended on April 3, 2005 and was 53 weeks long. Fiscal 2006 will end on April 2, 2006 and will be 52 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

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates and such differences could affect the results of operations reported in future periods. Our significant accounting policies are set forth below.

Stock Based Compensation — The Company accounts for stock-based employee compensation arrangements 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”). 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. 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.

~~Had compensation cost for the Company’s stock options been determined based on the fair value of the options at the date of grant for options granted in the thirteen weeks ended July 3~~RedEnvelope, ~~2005 and June 27, 2004 consistent with the provisions of SFAS No~~Inc. ~~123, the Company’s pro forma net loss~~ ~~would have been as follows:~~

	Thirteen Weeks Ended
	July 3,			June 27,
	2005			2004
	(In thousands, except per share data)
Net loss — as reported	$	(1,752	)	$	(952	)
Stock-based employee compensation included in reported net loss		4			7
Stock-based compensation expense determined under fair value base method		(456	)		(144	)
Pro forma net loss	$	(2,204	)	$	(1,089	)
Basic and diluted loss per share:
As reported	$	(0.20	)	$	(0.11	)
Pro forma	$	(0.25	)	$	(0.13	)

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

~~Loss~~1. ~~Per~~Financial ~~Share~~Statements — ~~For~~Basis ~~the thirteen weeks ended July 3, 2005 and June 27, 2004, basic net loss per share equals diluted net loss per share because the effect~~ of ~~stock options, unvested~~Presentation 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 July 3, 2005 and June 27, 2004, were approximately 1.4 million and 1.1 million, respectively.

~~Comprehensive~~The ~~Loss~~condensed —balance ~~Comprehensive~~sheets ~~loss~~of ~~consists~~RedEnvelope, Inc. (referred to as the “Company”, “we”, “us”, and “our”) as of ~~net~~July 1, ~~loss~~2007 and ~~other~~July 2, 2006, the condensed statements of operations for the ~~comprehensive~~thirteen ~~loss.~~week ~~Other~~periods ~~comprehensive~~ended ~~loss~~July 1, ~~refers~~2007 toand ~~revenue~~July 2, ~~expenses~~2006, ~~gains~~ and ~~losses~~the ~~that~~condensed ~~are~~statements of cash ~~recorded~~flows asfor anthe ~~element~~thirteen ofweek ~~stockholders’~~periods ~~equity~~ended ~~but~~July 1, ~~are~~2007 ~~excluded~~and ~~from~~July 2, ~~net~~2006 ~~loss~~have been prepared by us, without audit. ~~The~~In ~~Company’s~~our ~~other~~opinion, the financial statements include all adjustments (which include only ~~comprehensive~~normal ~~loss~~recurring isadjustments) ~~comprised~~necessary ofto ~~unrealized~~present ~~gains~~fairly ~~and~~the ~~losses~~financial onposition ~~marketable~~at ~~securities~~the ~~categorized~~balance assheet ~~available-for-sale.~~dates ~~Total~~and ~~comprehensive~~the ~~loss~~results of operations for the thirteen ~~weeks~~week periods then ended. ~~July~~The balance sheet at April 31, ~~2005~~2007, ~~and~~presented ~~June~~herein, has been derived from the Company’s audited balance sheet 27included in the Company’s Annual Report on Form 10-K, ~~2004~~for ~~was~~the ~~$1.8 million~~fiscal ~~and~~year ~~$1.0~~ended April ~~million~~1, ~~respectively~~2007.

~~New~~Certain ~~Accounting~~information Pronouncements — In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123R”). This statement replaces FASB Statement No. 123, “Accounting for Stock-Based Compensation,” and ~~supersedes~~disclosures ~~APB~~normally ~~Opinion~~included ~~No. 25,~~in ~~“Accounting~~the ~~for Stock~~notes ~~Issued~~ to ~~Employees.” SFAS 123R requires all companies to measure compensation cost for all share-based payments, including stock options, at fair value. Under~~ the ~~terms~~annual ~~of SFAS 123R, the~~financial ~~fair~~statements ~~value~~prepared ofin ~~any~~accordance ~~equity~~with ~~award~~accounting ~~will~~principles begenerally ~~estimated~~accepted atin the ~~grant date and this fair value will be~~United ~~recognized~~States asof ~~compensation~~America ~~cost~~have ~~over~~been ~~the service period for all awards that are subject to a vesting period~~omitted. ~~SFAS~~These ~~123R~~financial ~~requires~~statements ~~that~~should ~~fair value~~ be ~~estimated~~read ~~using~~in anconjunction ~~option pricing model that~~with ~~takes into account at least~~ the ~~following~~financial ~~items~~statements —and ~~the~~notes ~~exercise~~thereto ~~price,~~included ~~the~~in ~~expected term of~~ the ~~option,~~ ~~the~~Company’s ~~current~~Annual ~~price~~Report ofon ~~the~~Form ~~underlying share~~10-K, ~~the expected volatility of the price of the~~ ~~underlying share, the expected dividends on the underlying share and the risk free rate of interest. The statement will be effective~~ for the ~~Company~~fiscal ~~beginning~~year inended ~~fiscal~~April 1, 2007. ~~The Company~~ ~~is currently evaluating the effect that SFAS 123R will have on its financial statements.~~

3 The results of operations for the thirteen weeks ended July 1, 2007 are not indicative of the operating results of the full year. ~~Investments~~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.

~~Short-term~~Our ~~investments~~fiscal ~~consist~~year ofends ~~government~~on ~~securities~~the Sunday closest to March 31, resulting in a 52 or 53 week year. Fiscal 2007 ended on April 1, 2007 and ~~corporate~~was ~~bonds~~52 weeks ~~both~~long. ~~with~~Fiscal 2008 will end on March 30, 2008 ~~maturities~~and ~~beyond~~will also be 52 weeks long. We report our interim results on a fiscal quarter basis where each of the first three ~~months~~fiscal ~~but~~quarters ~~less~~is ~~than~~thirteen ~~one~~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.

~~The Company considers all highly liquid investments purchased with an original or remaining maturity of three months or less to be cash equivalents~~2. AtCertain ~~June 27,~~Significant ~~2004~~Accounting ~~action rate securities~~Policies ~~were classified as “Cash and cash equivalents.” These securities have been reclassified for all periods presented from “Cash and cash equivalents” to~~

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates and such differences could affect the results of operations reported in future periods. Our significant accounting policies are set forth below.

Loss Per Share — For all periods presented, basic net loss per share equals diluted net loss per share because the effect of stock equivalents (stock options and warrants outstanding) would have been antidilutive. The weighted average number of stock options and warrants outstanding excluded from the calculation for the thirteen weeks ended July 1, 2007 and July 2, 2006 were approximately 1.3 million and 1.4 million, respectively.

Comprehensive Loss — Comprehensive loss consists of two components, net loss and other comprehensive income (loss). Other comprehensive income (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 income (loss). The Company’s only source of comprehensive loss is net loss.

Investments — All of the Company’s investments are considered available-for-sale. Available-for-sale investments are recorded at fair market value, with unrealized gains or losses included in accumulated other comprehensive income. Short-term investments are comprised of auction rate securities with an auction maturity of three months or less but an underlying long-term maturity.

There were no realized gains or losses during the thirteen weeks ended July 1, 2007 and July 2, 2006.

~~“Short-term available-for-sale investments”~~3. ~~These~~Results ~~auction rates securities have an underlying long-term maturity; however, they are traded or mature on a shorter term based on an auction bid that resets the interest rate over time intervals~~ of 28Operations toand ~~49 days.~~Discussion ~~These resets allow for a much higher level~~ of ~~liquidity than typical long-term investments. Accordingly, we have~~Liquidity ~~reclassified these securities to short-term available-for-sale investments. The table below summarizes the effect of the reclassification:~~

	June 27, 2004
	Cash and Cash			Short-term
	Equivalents			Investments
	(in thousands)
As previously reported	$	18,667		$	10,495
Aucton-rate securities		(10,606	)		10,606
As adjusted	$	8,061		$	21,101

In the first quarter of fiscal 2008, the Company incurred a net loss of $3.6 million, used approximately $1.2 million of cash for operating activities and had cash and cash equivalents of $9.7 million as of July 1, 2007. Although the Company experienced an increase in the average number of items per order and an increase in the average revenue per order shipped, the Company experienced a 10.4% decrease in the number of orders shipped over the same period in the prior year. The decline in orders shipped in the first quarter of fiscal 2008 resulted from a reduction in marketing expenditures for new customer prospecting in the third and fourth quarters of fiscal 2007, which reduction also resulted in a 6.4% decrease in new customer acquisitions in the first quarter of fiscal 2008 as compared to the first quarter of fiscal 2007. Management expects this reduction to result in downward pressures on revenues until renewed prospecting initiatives take effect in the latter part of fiscal 2008.

~~This~~The ~~reclassification~~Company ~~also~~has ~~resulted~~in place a revolving credit facility with a lender, which is described more fully in ~~changes~~Note to6. As of July 1, 2007, the ~~Company’s~~borrowing ~~Statement~~base ofreflected ~~Cash~~an ~~Flows~~availability ~~for~~of $4.5 million and the ~~thirteen~~Company ~~weeks~~had ~~ended~~no borrowings under the revolving credit facility. On June 2729, ~~2004~~2007, the Company executed a subordinated promissory note with a related party that provides for a term loan with availability of up to $2.6 million, ~~The~~which ~~changes~~is described more fully in ~~auction~~Note ~~rate~~6. ~~securities~~As ~~previously~~of July 1, ~~presented~~2007, asthe Company had no borrowings under the subordinated promissory note. We believe that the cash currently on hand and the cash ~~equivalents~~available ~~have~~to ~~been~~us ~~reclassified~~through our credit facility and subordinated promissory note and cash flow from operations will be sufficient to ~~Investing~~continue ~~activities~~operations inthrough at least the next twelve months. Our assessment is based on historical working capital needs, ~~Statement~~operating loss trends, and current business outlook. Beyond the next twelve months, we intend to utilize the cash generated from operations and cash available through the credit facility to fund operations and capital expenditures. Additionally, equity and or additional debt financing may need to be obtained 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 have an adverse impact on the rights of, ~~Cash~~our ~~Flows~~existing stockholders.

~~All~~4. ~~of the Company’s investments are considered available~~Stock-~~for-sale.~~Based ~~Such securities are~~Compensation 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-~~The Company’s results for~~-sale~~ ~~investments~~the atthirteen weeks ended July 31, ~~2005~~2007 ~~consisted~~included of$0.5 million ~~auction~~of stock-~~rate~~based ~~securities~~compensation ~~classified~~for stock options. The Company’s results for the thirteen weeks ended July as2, ~~short-term~~2006 ~~available~~included $0.5 million of stock-based compensation for~~-sale~~ stock options and $0.1 million ~~There~~of stock-based ~~were~~compensation nofor ~~gross~~restricted ~~realized~~stock ~~gains~~awards. orStock-based ~~losses~~compensation ~~the~~costs for the thirteen weeks ended July 31, ~~2005~~2007 and ~~June~~July 272, ~~2004~~2006 were included in general and administrative expenses.

4 The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model and the assumptions noted in the table below. ~~Borrowing~~The ~~Arrangements~~expected term of options is based on observed historical exercise patterns. Groups of employees that have similar historical exercise patterns were considered separately for valuation purposes. The expected volatility of stock options is based upon historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield on a U.S. Treasury zero-coupon issue with a remaining term equal to the expected term of the option. The dividend yield reflects that the Company has not paid any cash dividends since inception and does not intend to pay any cash dividends in the foreseeable future.

The Company has a line of credit from a lender with a maximum borrowing 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, unless extended, renewed, or terminated pursuant to the terms of the agreement. 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. As of July 3, 2005 and June 27, 2004, the Company did not have any outstanding borrowings under this credit facility and was not subject to covenants compliance.


	Thirteen Weeks Ended
	July 1,			July 2,
	2007			2006
Stock Option Valuation Assumptions:
Expected volatility		51.1	%		56.8	%
Dividend yield		0	%		0	%

Expected term	3.3 – 5.5 years			3.8 – 5.7 years

Risk-free interest rate		4.6% — 5.0	%		4.8% — 5.2	%

A summary of stock option activity for the thirteen weeks ended July 1, 2007 is presented as follows:

5. Legal Proceedings


				Weighted
				Average
				Exercise
	Options			Price
	Outstanding			per Share
	(in
	thousands)
Balance, April 1, 2007		1,335		$	9.50
Granted		152		$	6.92
Cancelled		(115	)	$	8.85
Exercised		(1	)	$	5.86

Balance, July 1, 2007		1,371		$	9.27

Exercisable, July 1, 2007		624		$	9.89

~~From~~The ~~time~~weighted toaverage ~~time,~~fair ~~the~~value ~~Company~~of isstock ~~subject~~options togranted ~~legal~~during ~~proceedings and claims in~~ the ~~ordinary~~thirteen weeks ~~course~~ended ~~of business~~July 1, ~~including~~2007 ~~claims~~and ofJuly 2, ~~alleged~~2006, ~~infringement~~was of$3.16 ~~trademarks~~ and ~~other intellectual property rights~~$4. ~~The Company is not currently aware of such legal proceedings or claims that it believes will have~~95, ~~individually or in the aggregate, a material adverse effect on its financial position or results of operations~~respectively.

5. Income Taxes

On April 2, 2007, the Company adopted the provisions of FASB Interpretation (FIN) No. 48, Accounting for Income Tax Uncertainties (FIN 48). FIN 48 prescribes a more-likely-than not threshold for recognizing the benefits of tax return positions in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. There was no effect on the Company’s financial position, results of operations or cash flows as a result of adopting FIN 48. As of July 1, 2007, there was no accrued interest and penalties for unrecognized tax benefits. The total gross unrecognized tax benefits under FIN 48 was approximately $98,000.

The Company does not expect to realize taxable net income for its full fiscal year ending March 30, 2008. The Company has not recorded a tax benefit in any period due to losses incurred and uncertainty of realizing the net operating loss carryforwards. Accordingly, no provision for income taxes has been made for the thirteen week period ended July 1, 2007.

6. Borrowing Arrangements

On June 26, 2006, the Company executed a loan and security agreement with a lender that provides for a senior secured revolving credit facility in an amount equal to the lesser of $12.5 million or an amount determined under a borrowing base formula. The borrowing base formula is determined by the sum of the appraised net realizable liquidation value of eligible inventory, plus eligible credit card accounts receivable, less applicable reserves. As of July 1, 2007, the borrowing base reflected an availability of $4.5 million and the Company had no borrowings under the revolving credit facility. Interest will accrue on amounts borrowed under the credit facility at the prime lending rate or a LIBOR rate plus an applicable margin. The loan and security agreement provides for certain events of default, sets forth affirmative and negative covenants, including without limitation certain financial covenants, to which the Company must adhere, and expires in June 2010. Borrowings are secured by a first priority interest in all of the Company’s assets, tangible and intangible, and proceeds realized from the sale or other disposition thereof.

On June 29, 2007, the Company executed a subordinated promissory note with The Integrity Brands Fund, L.P., a fund that is managed by the Company’s Executive Chairman and Chairman of the Board of Directors and who is a holder of approximately 9% of the Company’s outstanding shares. The subordinated promissory note provides for a term loan in an amount up to a maximum principal amount of $2.6 million. All amounts borrowed under the subordinated promissory note will bear interest at a per annum rate equal to the prime rate, and the interest shall accrue at a per annum rate equal to the prime rate plus two percent in the event of a default (as defined therein). The note is subordinated and junior in right of payment to the prior payment in full of all the principal and unpaid accrued interest and all other obligations under the loan and security agreement dated as of June 26, 2006. The subordinated promissory note provides for certain events of default and expires on June 28, 2008. As of July 1, 2007, no amounts are outstanding under this subordinated promissory note.

7. Legal Proceedings

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 any 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.

8. Contingencies

The Company has completed an evaluation of whether the Company, through its business activities, has established nexus in various jurisdictions with respect to sales and use taxes. If a company has nexus in a particular jurisdiction it is required to collect and remit sales and use tax for sales into such jurisdiction. As a result of this evaluation, the Company recorded an estimated liability of $0.3 million as of July 1, 2007.

Determining if the level and nature of business activities are sufficient to create nexus raises complex factual and legal issues and is subject to uncertainties. Management believes that it is not probable that additional jurisdictions will be successful in asserting nexus over the Company, and has therefore not recorded a liability associated with these contingencies. If additional jurisdictions are successful in asserting nexus over the Company, the liability for any prior amounts owed to such jurisdictions may have a material adverse effect on the Company’s financial condition and operating results.

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~~ 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~~ statements are based upon current expectations and involve risks and uncertainties. Any statements ~~contained~~ 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 or service 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,” “would,” “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~~Risk ~~That May Affect Future Results~~Factors,” 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~~ and uncertainties.

Overview

RedEnvelope is ana ~~upscale~~branded online retailer of upscale gifts, ~~and~~dedicated to inspiring people to celebrate their relationships through giving. RedEnvelope offers an extensive ~~collection~~and fresh collection of imaginative and original gifts ~~for~~ ~~every~~through ~~occasion,~~our ~~recipient~~catalog, web store and ~~budget~~phone store. Our in-house design team creates unique proprietary products, and our merchants ~~travel~~source ~~the world sourcing~~ unique products domestically and from various parts of the world and often ~~commissioning~~commission artists and vendors to create exclusive gifts. Through our ~~website~~web store, www.redenvelope.com, customers can search for gifts by ~~occasion~~recipient, ~~recipient~~occasion, ~~product~~gift category and price point. We also publish our full-color catalog several times a year and sell directly to corporate clients through our Business Gifts Services (“BGS”) group.

~~Our~~In the first quarter of fiscal year 2008, our net revenues ~~increased~~decreased 188.27% from $26.9 million in the first quarter of fiscal ~~2005~~year 2007 to $2524.05 million in the first quarter of fiscal ~~2006~~year ~~primarily~~2008. ~~due~~Gross margin decreased from 53.1% in the first quarter of fiscal year 2007 to ~~increased~~50.2% ~~demand~~in the first quarter of fiscal year 2008. Our net loss for the first quarter of fiscal 2008 was $3.6 million compared to $0.9 million in the same ~~our~~period ~~products~~of ~~resulting~~the ~~from~~prior ~~additional~~fiscal year. During the first quarter of fiscal 2008, the number of shipped orders decreased by 10.4% which was a result of reduced marketing ~~efforts~~expenditures ~~through~~for ~~our~~new customer ~~online~~prospecting in the third and ~~catalog~~fourth ~~campaigns~~quarters of fiscal 2007. As of July 1, 2007, we had approximately 3.5 million customer names in our internal database, representing an increase of approximately 112,000 customers during the first quarter of fiscal 2008.

~~Gross~~For ~~margins~~the ~~were~~remainder ~~relatively~~of ~~flat~~fiscal year 2008, ~~changing~~we ~~from~~intend ~~53.2%~~to infocus on re-energizing the ~~first~~RedEnvelope brand ~~quarter~~and ofproduct ~~fiscal~~offering ~~2005~~in order to ~~53.0%~~ inrealize the ~~first~~potential ~~quarter~~ of ~~fiscal~~our ~~2006~~business model. ~~Fulfillment~~Further, ~~expenses~~we ~~declined~~are committed to ~~13.6%~~cost ofeffective ~~net~~customer ~~revenue in~~acquisition ~~the~~and ~~first~~retention, ~~quarter~~primarily ofthrough ~~fiscal~~our ~~2006~~catalog circulation ~~versus~~strategy, ~~16.0%~~product inassortment ~~the~~and ~~same~~creative ~~period~~presentation. ofWe ~~last~~are ~~year~~currently ~~primarily~~upgrading ~~due to~~our ~~operating~~material ~~efficiencies~~handling ~~gained~~equipment in ~~both~~ our fulfillment center ~~and~~which ~~call~~we ~~center.~~believe ~~These~~will ~~efficiencies~~be ~~are~~completed ~~mainly~~during the ~~result~~second quarter of ~~process~~fiscal ~~and~~year ~~system~~2008. ~~improvements~~We ~~put~~currently inexpect ~~place~~that ~~over~~this upgrade will enhance our fulfillment capabilities by providing automated solutions to our fulfillment process and increasing the ~~past~~facility’s ~~year~~capacity.

~~Our~~Although ~~marketing~~we ~~expenses~~are ~~increased~~committed ~~from~~to ~~23.4%~~our ofstrategic ~~sales~~initiatives, there are inherent risks associated with our business that may present challenges for us in the ~~first~~future ~~quarter~~and ofcould ~~fiscal~~prevent ~~2005~~us tofrom ~~27.5%~~achieving ofintended ~~sales~~results ~~during~~within ~~the~~anticipated ~~first~~timelines ~~quarter~~or ofat ~~fiscal 2006~~all. ~~First~~We ~~quarter~~have ~~fiscal~~outlined ~~2006~~currently identified ~~contained~~risks within the ~~last~~ ~~part~~“Risk Factors” section of ~~our~~this ~~advertising~~report. ~~investment~~In ~~started~~addition, inthe ~~third~~following discussion ~~quarter~~and ~~fiscal~~analysis ~~2005~~of asfinancial ~~well~~condition, asresults ~~additional~~of operations, liquidity and capital ~~market~~resources ~~research~~should ~~spending.~~be ~~Furthermore,~~read ~~catalog~~in ~~spending~~conjunction ~~was~~with ~~increased~~our ~~primarily~~unaudited ~~due~~condensed tofinancial ~~increased circulation,~~statements and wethe notes ~~continued~~thereto toin ~~use~~this ~~online~~Quarterly ~~advertising~~Report toon ~~drive~~Form ~~revenue growth~~10-Q.

General and administrative expenses increased from 18.2% of net revenues during the first quarter of fiscal 2005 to 19.2% of net revenues during the first quarter of fiscal 2006 primarily due to being fully staffed during this quarter.

For the remainder of fiscal 2006, our focus will be on the following priorities: enhancing and expanding our product line, maintaining the operational efficiency of our fulfillment center, and increasing our conversion rates of our site traffic and improving the retention rates of our existing customers. We currently believe investments in these initiatives will result in higher top line growth, improved margins, and increased efficiency of our operations.

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 results within anticipated timelines or at all. 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 unaudited condensed financial statements and the notes thereto in this Quarterly Report on Form 10-Q.

Critical Accounting Policies

Our condensed financial statements have been prepared in accordance with accounting principles ~~generally~~ generally accepted in the United States of America. The preparation of these financial statements requires us management to make estimates and judgments that affect the reported amounts of assets, and liabilities, ~~revenues~~ and ~~expenses.~~disclosures Weof ~~base~~contingent ~~our~~assets ~~estimates~~and onliabilities ~~historical~~as ~~experience~~of ~~and~~the ondate ~~various~~of ~~other~~the ~~assumptions that~~financial westatements ~~believe~~and toreported beamounts ~~reasonable~~of ~~under~~revenues ~~the~~and ~~circumstances,~~expenses during the reporting period. Actual results ofcould ~~which~~differ ~~form~~from ~~the~~these ~~basis~~estimates ~~for~~and ~~making judgments~~such ~~about~~differences ~~the~~could ~~carrying~~affect ~~values~~the results of operations ~~assets~~reported ~~and~~in ~~liabilities~~future ~~that~~periods. ~~are~~There ~~not~~have ~~readily~~been ~~apparent~~no ~~from other~~significant ~~sources.~~changes ~~Actual~~to ~~results~~the ~~may~~critical accounting ~~differ~~policies ~~from~~as ~~these~~discussed ~~estimates~~in ~~under~~our ~~different~~Annual ~~assumptions~~Report ~~or conditions.~~on ~~Our~~Form ~~critical~~10-K ~~accounting~~for ~~policies~~the ~~are~~year ~~set~~ended ~~forth below~~April 1, 2007.

Revenue recognition. We derive our revenues from product 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 defer any payments we receive prior to the date we estimate the customer has received the goods. 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 $0.5 million, $0.5 million and $0.4 million as of July 3, 2005, April 3, 2005 and June 27, 2004, 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 fulfillment center expenses, are included in operating expenses — fulfillment. Handling costs included in operating expenses — fulfillment for the thirteen weeks ended July 3, 2005 and June 27, 2004 were $1.0 million and $1.2 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 with costs based on the first-in-first-out method. 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 year-end based on the results of our physical inventory count. The obsolescence reserve was $1.1 million, $0.8 million and $0.6 million as of July 3, 2005, April 3, 2005 and June 27, 2004, 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 April 3, 2005, we had recorded a valuation allowance of $29.6 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 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, production 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 three 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.

Results of Operations

The following table sets forth our statements of operations data for the thirteen weeks ~~ended~~ ended July 31, ~~2005~~2007 and ~~June~~July 272, ~~2004~~2006, ~~respectively,~~ expressed as a percentage of net revenues.

	Thirteen Weeks
	Thirteen Weeks Ended
	July 3,			June 27,
	July 1,			July 2,
	2005			2004
	2007			2006
Statements of Operation Data:
Statements of Operations Data:
Net revenues		100.0	%		100.0	%
Cost of sales		4749.08			46.89
Gross profit		5350.02			53.21
Operating expenses:
Fulfillment		13.67			1612.07
Marketing		2725.53			23.4
General and administrative		1926.23			1820.24
Total operating expenses		6065.3			5756.6
Loss from operations		(715.31	)		(43.45	)
Interest income		0.5			0.3
Interest income, net		0.6			0.1
Interest expense		(0.2	)		(0.4	)
Net loss		(14.5	)%		(3.4	)%
Net loss		(7.0	)%		(4.5	)%

Quarter Ended July 1, 2007 Compared to Quarter Ended July 2, 2006

Net Revenues

~~Our~~Net ~~net~~ revenues are comprised of product sales, shipping revenue, ~~and~~ gift-wrap revenue. and personalization 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 and personalization revenue consists of amounts we charge our customers for our signature red gift boxes and for personalization of products, respectively.

Net revenues were $2524.05 million and $2126.19 million for the thirteen weeks ended July 31, ~~2005~~2007 and ~~June~~July 272, ~~2004~~2006, respectively, representing aan 188.27% ~~increase~~decrease. The ~~increase~~decrease was ~~primarily~~mainly ~~due~~attributable to a 10.4% decrease in orders shipped in the first quarter of fiscal 2008 as compared to the first ~~increased~~quarter ~~demand~~of ~~for~~fiscal ~~our~~2007. ~~products~~The ~~resulting~~decrease ~~from~~in ~~additional~~orders ~~marketing~~shipped ~~efforts~~largely ~~through~~resulted ~~our~~from ~~online~~a reduction in ~~and~~marketing ~~catalog~~expenditures ~~campaigns.~~for ~~Both~~new ~~online~~customer ~~revenues,~~prospecting ~~through~~in ~~search,~~the ~~portals~~third and ~~affiliates,~~fourth ~~and~~quarters ~~revenues~~of fiscal ~~from~~2007, ~~customers~~which ~~who~~reduction ~~receive~~also ~~our~~resulted ~~catalogs,~~in ~~grew~~a ~~over~~6.4% decrease in new customer acquisitions in the first quarter of ~~the~~fiscal ~~prior~~2008 ~~fiscal~~as ~~year,~~compared ~~with~~ to the ~~online~~first ~~portion~~quarter of ~~the~~fiscal ~~business growing faster~~2007. During the first quarter of fiscal ~~2006~~2008, the Company experienced an ~~11.3%~~ increase in ~~orders~~the ~~shipped~~average ~~over~~number of items per order as compared to the first quarter of fiscal ~~2005~~2007 ~~from~~which ~~295,000~~was topartially ~~328,000~~offset ~~and~~by a ~~6.2%~~decrease ~~increase~~ in ~~revenue~~the ~~per~~average ~~order~~retail ~~shipped~~price ~~over~~per ~~the~~item ~~first~~sold. ~~quarter~~Although ofour ~~fiscal~~online ~~2005,~~and ~~from~~email ~~$72~~revenues ~~per~~declined ~~order~~by approximately 8.9% compared to ~~$76~~the ~~per~~first ~~order.~~quarter ~~Our customer~~of ~~base~~fiscal ~~increased~~2007, our revenues from ~~approximately~~customers ~~2.3 million~~who receive asour ofcatalog ~~April 3,~~increased ~~2005~~slightly toover ~~approximately~~the ~~2.5 million~~same asperiod of ~~July 3,~~the ~~2005~~prior year.

Our customer file increased by approximately 112,000 names from the end of the fourth quarter of fiscal 2007 to approximately 3.5 million as of July 1, 2007, compared with an increase of approximately 119,000 names in the same period of the prior year.

Cost of Sales

Cost of sales consists of the cost of the product sold, inbound and outbound freight and gift-wrap expense. Handling costs, which include fulfillment center expenses, are included in operating expenses — fulfillment.

Cost of sales was $1112.72 million and $912.96 million for the thirteen weeks ended July 31, ~~2005 and~~2007 ~~June~~and July 272, ~~2004~~2006, respectively, representing 4749.08% and 46.89% of net revenues, respectively. The ~~18.5%~~ increase in ~~costs~~cost of sales ~~was~~as ~~mainly~~a ~~attributable~~percentage toof ~~the~~net ~~18.2% increase~~revenues primarily reflects a shift in ~~net~~our ~~revenues.~~product mix ~~Gross~~to ~~profit~~include ~~per~~more ~~order~~market ~~increased~~product, ~~to approximately~~which ~~$40~~was ~~from~~partially ~~$38~~offset by a decrease in ~~the~~our ~~first~~shipping expenses ~~quarter~~due ofto ~~fiscal~~lower ~~2005~~shipping rates from carriers compared to the prior year.

1110

Operating Expenses

Fulfillment. Fulfillment expenses consist of wages and benefits for employees and seasonal hires working in our distribution center and customer sales and service facility, fees incurred to ~~process~~ process credit card transactions and certain fixed costs, such as rent and utilities, incurred ~~by our~~at our distribution center and customer sales and service facility.

Fulfillment expenses were $3.4 million ~~and $3.4 million~~ for the thirteen weeks ended July 31, ~~2005~~ 2007 and ~~June~~July 272, ~~2004~~ 2006, ~~respectively,~~ representing 13.67% and 1612.07% of net revenues, respectively. While we were able to maintain ~~The~~operating ~~decrease~~efficiencies asin warehouse management and maintain a ~~percentage~~consistent level of ~~net~~fixed ~~revenues~~expenses isin the ~~mainly~~first ~~attributable to~~quarter ~~operating~~of ~~efficiencies~~fiscal at2008 ~~both~~as compared to the ~~fulfillment~~ ~~center~~prior ~~and~~year, ~~the~~our ~~customer~~fulfillment ~~service~~expenses ~~facility.~~as ~~The~~a percentage ~~Company~~of ~~experienced~~net anrevenues 11increased by 1.30%. The increase in fulfillment expenses as a percentage of net revenues reflects the ~~number~~decrease of ~~orders~~8.7% ~~shipped~~in ~~over~~net revenues in the first quarter of fiscal ~~2005,~~2008 as ~~which~~compared ~~was~~to ~~handled~~the ~~without~~same ~~any related~~period ~~increase~~ in ~~fulfillment~~the ~~expenses,~~prior ~~mainly~~year. ~~due~~We tobelieve ~~improved~~that ~~processes~~we ~~and~~will ~~systems~~need ~~implemented~~to continue to make ~~over~~improvements ~~the~~in ~~past~~our ~~year,~~fulfillment ~~along~~processes ~~with~~and ~~successful~~capital ~~training~~infrastructure ~~programs~~in ~~and~~order ~~improved~~to ~~management~~efficiently meet market demand. If we are unable to ~~maintain~~continue to improve the efficiency of the ~~process at our~~ fulfillment ~~center~~process or if we are unable to service ~~effectively~~higher ~~our~~ order volumes in ~~fiscal~~the ~~2006~~event they are achieved, our business and 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 and advertising.

Marketing expenses were $6.92 million and $46.93 million for the thirteen weeks ended July 31, ~~2005~~2007 and ~~June~~July 272, ~~2004~~2006, respectively, representing 2725.53% and 23.4% of net revenues, respectively. The ~~increase~~decrease in dollars ~~and~~primarily ~~percentage~~represents ofdecreased ~~net~~market ~~revenues~~research, ~~was~~partially ~~due~~offset ~~to additional spending in our online~~by ~~marketing~~increased ~~and~~ catalog ~~campaigns~~production ascosts ~~well~~ as ~~approximately~~compared ~~$0.8M~~to ~~spent on advertising and market research in~~ the ~~quarter. During the~~ first quarter of fiscal ~~2006,~~2007. weThe ~~increased~~increase ~~our catalog~~in ~~circulation~~marketing ~~over~~expenses ~~the~~as ~~same~~a ~~period~~percentage of ~~fiscal~~net ~~2005~~revenues ~~primarily~~reflects ~~due~~a toslight ~~the~~decrease ~~growth~~ in ~~our customer file to 2.5 million names and~~ the ~~addition~~efficiency of ~~a new jewelry catalog during the quarter. We do not expect~~ asour ~~significant~~online aand ~~spend~~email oncampaigns ~~traditional advertising~~ during the ~~last~~first ~~three~~quarter ~~quarters~~ of fiscal ~~year 2006,~~2008. asOur ~~during~~primary ~~the~~marketing vehicles ~~last~~are ~~three~~subject ~~quarters~~to ofincreasing ~~fiscal~~costs ~~2005~~and competition. If we are unsuccessful in efficiently generating sufficient revenues through our marketing vehicles, our operating results ~~could~~will be adversely affected.

General and Administrative. General and administrative expenses consist of wages and benefits for all of our employees, except for fulfillment and customer sales and service employees. These ~~expenses~~ expenses also include costs incurred for computer and communications technology, rent and utilities for our headquarters, travel, depreciation, stock-based compensation and other general corporate expenditures.

General and administrative expenses were $46.84 million and $35.85 million for the thirteen weeks ended July 31, ~~2005~~2007 and ~~June~~July 272, ~~2004~~2006, respectively, representing 1926.23% and 1820.24% of net revenues, respectively. The increase in general and administrative expenses in dollars and as a percentage of net ~~revenue~~revenues iswas ~~mainly~~primarily due to ~~being~~increased ~~fully staffed~~personnel ~~during~~costs, ~~the~~including ~~quarter~~bonus, ~~which~~severance, ~~was~~relocation costs, ~~not~~increased ~~the~~corporate ~~case~~consulting projects during the first quarter of fiscal ~~2005.~~2008 Inas ~~addition~~compared ~~depreciation~~to ~~expense~~the ~~increased~~same byperiod ~~approximately~~last ~~$0.2 million~~year, ~~due~~and toincreased ~~capital~~accruals ~~expenditures~~for ~~made~~state ~~in software equipment~~ and ~~facilities~~local intax ~~the prior year~~liabilities.

Liquidity and Capital Resources

~~We have funded our operations through July 3, 2005 primarily through 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 containing both our lowest level of cash for the year as we build inventory for the holiday selling season, and our highest level of cash upon conclusion of ~~the~~ this season. Throughout the fiscal year, we utilize our cash balances to build our inventory levels ~~with~~ 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 in place a revolving credit ~~facility~~ facility and the subordinated promissory note described more fully ~~below and~~ in Note 46 to the financial statements contained in this report.

Cash Flows From Operating Activities — Net cash flows used in operating activities were $21.2 million ~~for~~and ~~thirteen weeks ended July 3, 2005 as compared to~~ $31.8 million ~~of net cash flows provided by operating activities~~ for the thirteen weeks ended ~~June~~July 271, ~~2004.~~2007 Inand ~~the~~July 2, ~~first~~2006, ~~quarter~~respectively. ofThe ~~fiscal~~decrease ~~2006,~~in ~~net~~ cash flows used byin operating activities ~~increased~~represents favorable changes in working capital offset by the $62.07 million ~~from~~increase ~~the~~in ~~first quarter~~net ofloss. ~~fiscal~~The ~~2005,~~most ~~primarily~~significant ~~due~~of tothe favorable changes in working capital ~~and~~ ~~a higher net loss. Specifically, there~~ was a decrease in ~~our~~cash ~~accounts~~used ~~payable~~for asthe apayment ~~result~~ of ~~shorter~~accounts ~~payment~~payable ~~terms~~which ~~with~~was ~~certain~~due ofto ~~our~~timing ~~vendors~~of aspayments weand ~~move~~a tohigher ~~offshore~~accounts ~~sourcing~~payable ofbalance ~~product~~at ~~and~~the ~~make~~end ~~more~~of ~~timely~~fiscal ~~payment~~2006 as compared to ~~vendors.~~the Inend ~~addition,~~of ~~inventory~~fiscal ~~levels~~2007. ~~increased~~Further, asthe afavorable ~~result~~changes ofin ~~our~~working ~~overall~~capital ~~business~~also ~~growth as~~included ~~well~~an asincrease ain ~~change~~accounts receivable due to ~~stocking~~timing ~~more~~of ~~core~~receiving ~~inventory~~cash ~~items~~payment ~~for~~which ~~sale~~was partially offset by reduced inventory expenditures during the ~~upcoming~~first ~~Fall~~quarter ~~season~~of fiscal 2008.

Cash Flows From Investing Activities — Net cash flow used in investing activities was $2.3 million for the thirteen weeks ended July 1, 2007 and net cash provided by investing activities was $0.8 million for the thirteen weeks ended July 2, 2006. Cash (used in) provided by investing activities consisted of capital expenditures for property and equipment, as well as purchases and maturities of investments in fiscal 2007. Capital expenditures paid for during the first quarter of fiscal 2008 were approximately $2.3 million, of which $1.7 million was acquired during the quarter and approximately $0.6 million was acquired during the fourth quarter of fiscal 2007. These expenditures were for various investments in management systems, our call center and fulfillment center. We are currently investing in our fulfillment center and our technology, including our website, and we currently anticipate spending an additional $3.8 million during the remainder of fiscal 2008. We currently believe these investments 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, which could result in additional expenditures. Although we believe these estimates on expenditures which

could adversely affect our business 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 flow used in financing activities was $6,000 for the thirteen weeks ended July 1, 2007 and net cash provided by financing activities was $0.1 million for the thirteen weeks ended July 2, 2006. For both periods, net cash flows from financing activities consisted of proceeds from the exercises of stock options which were partially offset by payments on capital lease obligations. For the first quarter of fiscal 2007, net cash flows provided by financing activities also included payments for debt issuance costs of $0.1 million in connection with obtaining our revolving credit facility.

Revolving Credit Facility — We have in place a revolving credit facility with a lender, which is described more fully in Note 6 to the financial statements contained in this report. As of July 1, 2007, the borrowing base reflected an availability of $4.5 million and we had no borrowings under the revolving credit facility. On June 29, 2007, the Company executed a subordinated promissory note with a related party that provides for a term loan of up to $2.6 million, which is described more fully in Note 6 to the financial statements contained in this report. As of July 1, 2007, we had no borrowings under this promissory note.

We currently believe that the cash currently on hand and the cash available to us through our revolving credit facility and the subordinated promissory note 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 and cash available to us through our revolving credit facility to fund operations and capital expenditures. Additionally, equity and or additional debt financing may need to be obtained 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 would have a material adverse effect on our ability to continue as a going concern and to achieve our intended business objectives. For a discussion of these and other risks related to our capital resources, see “Part II, Item 1A — Risk Factors.”

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk— We have had a portfolio of fixed and variable 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 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.” We do not use derivative financial instruments in our investment portfolio.

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

The following table lists our cash and cash equivalents and short-term investments at July 1, 2007:


	(In thousands)
Cash and cash equivalents	$	9,727
Short-term investments		—


Total	$	9,727

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 generally denominated in U.S. dollars. As of July 1, 2007, 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.

~~Cash Flows From Investing Activities — Net cash flows used in investing activities were $0.8 million and $14.4~~Item million for thirteen weeks ended July 3, 2005 and June 27, 2004, respectively. Uses of cash flows from investing activities consisted of capital expenditures for property and equipment and purchases of investments, offset by maturities of investments. In the first quarter of fiscal 2006, we spent $0.6 million for various investments in management systems, our call center, and fulfillment center. We currently anticipate spending an additional $2.4 ~~to $2~~.~~9 million~~ ~~during~~Controls ~~the remainder of fiscal 2006 related to these projects which we believe support the needs of our business~~ and ~~customers. Software implementation projects entail significant technical~~Procedures 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 may result in an increase in our depreciation expense. Although we believe these estimates of 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~~ Disclosure ~~Flows~~Controls ~~From~~and ~~Financing~~Procedures— ~~Activities~~The —Company ~~Net~~evaluated ~~cash~~the ~~flows~~design ~~provided~~and byoperation ~~financing~~of ~~activities~~its disclosure ~~were~~controls and procedures to determine whether they are effective in ensuring that the $0disclosure of required information is timely and made in accordance with the Exchange Act and the rules and forms of the Securities and Exchange Commission.~~3 million~~ This evaluation was made under the supervision and $0with the participation of management, including the Company’s principal executive officer and principal financial officer as of the end of the period being reported on in this Quarterly Report on Form 10-Q.~~3 million~~ ~~for~~The Company continues to formalize and document procedures already in place. Maintenance of disclosure controls and procedures is an ongoing process and controls and procedures may change over time. The Company has also established a Disclosure Committee, which consists of certain members of the ~~thirteen~~Company’s ~~weeks~~senior ~~ended~~management. ~~July 3~~Based on this evaluation, ~~2005~~the principal executive officer and ~~June~~the principal financial officer have concluded that our disclosure controls and procedures, as defined at Exchange Act Rules 2713a-15(e) and 15d-15(e), ~~2004~~are effective to ~~respectively.~~ensure ~~For~~that ~~both~~information ~~periods~~required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, ~~net~~processed, ~~cash~~summarized ~~flows~~and ~~from~~reported ~~financing~~within ~~activities~~the ~~consisted~~time ofperiods ~~proceeds~~specified ~~from~~in Securities and Exchange Commission rules and forms. During the ~~exercises~~fiscal ofquarter ~~stock~~ended ~~options~~July 1, ~~which~~2007, there ~~were~~have ~~slightly~~not ~~offset~~been byany ~~payments~~changes onto ~~capital~~the ~~lease~~Company’s ~~obligations~~internal control over financial reporting that have materially affected, or that are reasonably likely to materially affect, the Company’s internal control over financial reporting.

~~Revolving~~PART ~~Credit Facility — We have in place a revolving credit facility with a lender which is described more fully in Note 4 to the financial statements contained in this report~~II. ~~At July 3, 2005 we had no borrowings under the revolving credit facility. We can offer no~~ ~~assurances that this credit facility would be available to us under the current terms or at all should we need to borrow.~~

WeOTHER ~~currently believe that the cash and short-term investments currently on hand will be~~INFORMATION ~~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. Additionally, equity and or debt financing may be needed 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~~Item 1. ~~That~~Legal ~~May Affect Future Results~~Proceedings

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 1A. Risk Factors

There have been no material changes to the Risk Factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended April 1, 2007.

You should consider carefully the risks and uncertainties relating to our business including those described below, together with all of the other information included or incorporated by reference in this Quarterly Report on Form 10-Q. Additional risks and uncertainties not currently known to us or that we currently do not deem material could 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, and you could lose all or part of your investment.

~~Our~~If ~~limited~~we ~~operating~~fail ~~history~~to ~~makes~~meet ~~evaluation~~the ofborrowing requirements under our ~~business~~loan ~~difficult~~and security agreement, we may be unable to obtain necessary short-term financing and if we default on a secured loan, material assets of ours could be subject to forfeiture.

WeFrom ~~were~~time ~~originally~~to ~~incorporated~~time, inwe ~~1997~~may ~~and~~experience ~~began~~the ~~selling~~need ~~products~~to inobtain ~~September 1997.~~funding Asto ameet short-term cash ~~result~~requirements, wesuch ~~have~~as ~~limited~~the ~~historical~~acquisition ~~financial~~of ~~data~~inventory ~~upon~~prior ~~which~~ to ~~base~~our ~~planned~~holiday ~~operating~~selling ~~expenses~~season. orWe ~~forecast~~currently ~~accurately~~are ~~our~~party ~~future~~to ~~operating~~a ~~results.~~loan ~~Further,~~and ~~our~~security ~~limited~~agreement ~~operating~~which ~~history~~provides ~~will~~us ~~make it~~with ~~difficult~~a revolving credit facility for ~~investors~~the ~~and~~primary ~~securities~~purpose ~~analysts~~of enabling us to ~~evaluate~~satisfy ~~our~~any ~~business~~such ~~and~~funding ~~prospects~~needs. ~~You must~~However, ~~consider~~as ~~our~~is typical ~~business~~for ~~and~~agreements ~~prospects~~of inthis ~~light~~sort, of the ~~risks~~loan and ~~difficulties~~security weagreement ~~may~~requires ~~face~~us asto anmeet certain ~~early~~financial ~~stage~~conditions ~~company~~as ~~with~~a ~~limited~~prerequisite ~~operating~~to ~~history.~~obtaining ~~These~~and ~~risks~~maintaining loans thereunder and ~~difficulties~~we ~~include~~can ~~challenges~~offer inno ~~accurate~~assurances ~~financial~~that ~~planning~~we aswill be able to meet such conditions when a ~~result~~loan ofis ~~limited~~needed ~~historical~~or ~~data,~~continue to ~~operating~~meet such conditions when a loan is outstanding. If we are unable to meet the conditions for ~~experience~~borrowing under our loan and ~~the~~security ~~uncertainties~~agreement ~~resulting~~when ~~from~~funds ~~having~~are ~~had~~required aand ~~relatively~~we ~~limited~~are ~~time~~unable ~~period~~to inobtain ~~which~~necessary tofunds ~~implement~~from ~~and~~other ~~evaluate~~sources, ~~our~~we ~~business~~could ~~strategies~~be asprevented ~~compared~~from purchasing sufficient inventory to meet ~~older~~our ~~companies~~revenue ~~with~~and ~~longer~~profitability objectives or from meeting other payment obligations, which could have a material adverse effect on our business, financial condition and operating ~~histories~~results. Further, ~~Our~~if ~~failure~~we were to ~~successfully~~breach ~~address~~such ~~these~~financial ~~risks~~conditions while a loan is outstanding under the loan and ~~difficulties~~security ~~would~~agreement, it could constitute a default under that agreement which could require ~~seriously~~immediate ~~harm~~repayment ~~our~~of ~~business~~any amounts owed under the agreement.

We Further, ~~have~~our aobligations ~~history~~under the loan and security agreement are secured by substantially all of ~~significant~~our ~~losses~~tangible and intangible assets, including intellectual property. If we dodefault ~~not~~under ~~achieve~~our loan orand ~~sustain~~security ~~profitability~~agreement for any reason and are unable to cure the default pursuant to the terms of that agreement, our lenders could take possession of any or all of our assets in which they hold ~~financial~~a ~~condition~~security interest, including intellectual property, and ~~stock~~dispose ~~price~~of those assets to the extent necessary to pay off our debts, which could ~~suffer~~materially harm our business.

WeThe ~~have~~loan aand ~~history~~security ofagreement ~~losses~~also ~~and~~contains wea ~~may~~covenant ~~continue~~that toprohibits ~~incur~~us ~~losses~~from ~~for~~paying ~~the foreseeable future.~~cash Asdividends ofto ~~July 3, 2005,~~ our ~~accumulated deficit was $85~~stockholders.~~6 million. We have not achieved profitability~~ ~~for a full fiscal year. If our revenues~~

~~grow~~We ~~more~~may ~~slowly~~need ~~than~~additional wefinancing ~~anticipate,~~and ~~or if our operating expenses exceed our expectations, we~~ may not be able to ~~achieve~~raise ~~full~~additional ~~fiscal~~financing ~~year~~on ~~profitability~~favorable terms ~~in the near future~~ or at all~~. Even if we do achieve full fiscal year profitability~~, wewhich ~~may~~could ~~not be able to sustain or~~ increase ~~profitability on~~our acosts, ~~quarterly~~limit orour ~~annual~~ability ~~basis in the future. If we are unable~~ to ~~achieve~~grow ~~full~~and ~~fiscal~~dilute ~~year~~the ~~profitability~~ownership ~~within~~interests ~~a short period~~ of ~~time,~~existing ~~or at all, or if we are unable to sustain profitability at satisfactory levels, our financial condition and stock price could be adversely affected~~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 through fiscal 2006, 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 in the future. We cannot be certain that we will be able to obtain additional financing on commercially reasonable terms or at all. 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 could experience dilution of their ownership interests. We may also be subject to high interest rates or substantial restrictive covenants. We currently are parties to a loan and security agreement and a subordinated promissory note, each as described in the notes to our financial statements contained in this report. Further, under the terms of our loan and security agreement, we are subject to certain contractual limitations with respect to raising additional capital during the term of that agreement. Any failure to obtain necessary capital on commercially reasonable terms could have severe adverse consequences on our business. Further, an inability to obtain additional financing could require us to scale back, or fail to address opportunities for expansion or enhancement of, our operations.

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 our catalog, online marketing programs and 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, the costs of online marketing and the costs of complying with applicable regulations, may limit our ability to advertise and market our business in a cost-effective manner. 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. 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.

Although the Company experienced an increase in the average number of items per order and an increase in the average revenue per order shipped, we experienced a 10.4% decrease in the number of orders shipped over the same period in the prior year. The decline in orders shipped in the first quarter of fiscal 2008 resulted from a reduction in marketing expenditures for new customer prospecting in the third and fourth quarters of fiscal 2007, which reduction also resulted in a 6.4% decrease in new customer acquisitions in the first quarter of fiscal 2008 as compared to the first quarter of fiscal 2007.

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 July 1, 2007, our accumulated deficit was $96.5 million and, during the first quarter of fiscal 2007, the Company incurred a net loss of $3.6 million. We have not achieved profitability for a full fiscal year since our inception. If our revenues grow more slowly than we anticipate, or if our operating expenses exceed our expectations, we may not be able to achieve full fiscal year profitability in the near future or at all. Even if we do achieve full fiscal year profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If we are unable to achieve full fiscal year 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.

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 47% of net revenues in the fiscal year ended April 31, ~~2005~~2007. We cannot predict with certainty what percentage of our total net revenues for fiscal year ~~2006~~2008 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, for whatever reason, then increased expenses may not be offset, ~~which~~and ~~would adversely affect our financial condition. If we were to experience lower than expected sales during 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 projections or 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 including those discussed in this report, 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 projections or the expectations of securities analysts and investors. In this event, the trading price of our common stock could decline significantly.

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, and we are currently in the process of moving them to another third-party service provider in San Francisco, California. Such a move could result in the loss of data and/or an interruption of service, either of which could seriously harm our business. In the event that these service providers experience any interruption in their operations or cease 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 loss of data or 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 and operating results.

Ifour weoperating ~~fail~~results may vary significantly from one quarter to ~~offer~~the next as part of our normal business cycle. As a ~~broad~~result, ~~selection~~we believe that quarterly comparisons of ~~innovative~~our ~~merchandise~~operating results are not necessarily meaningful and that ~~consumers~~you ~~find~~should ~~attractive,~~not rely on the results of one quarter as an indication of our ~~revenues~~future ~~could~~performance. ~~decline~~It is likely that in some future quarter our operating results may fall below projections or ~~fail~~the toexpectations ~~reach~~of ~~anticipated~~securities ~~levels~~analysts and ~~our~~investors. ~~stock~~In this event, the trading price of our common stock could ~~be harmed~~decline, perhaps significantly.

InOur ~~order~~computer ~~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~~communications ~~customers~~hardware ~~for a variety of gift-giving occasions. To be successful, our product offerings must be affordable, well made, innovative~~ and ~~attractive~~software tosystems 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~~vulnerable to ~~reduce~~damage ~~our prices, our revenues~~ and ~~earnings may decline or fail to meet~~ ~~expected~~interruption, ~~levels~~which ~~and our stock price~~ could beharm ~~affected~~our ~~adversely~~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. The uninterrupted operation of our computer and communications hardware and software systems may also be dependent upon the continued performance of third party vendors and/or service providers with whom we have contracted. In the event that one of our third party service providers fails for any reason to perform its obligations in a timely or efficient manner, or at all, our operations could be interrupted or adversely affected or we could be required to incur additional, unanticipated costs. Further, our servers are located at the facilities of, and hosted by, a third-party service provider in San Francisco, 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 could be forced to enter into a relationship with another service provider or take over hosting responsibilities ourselves. During fiscal 2007, we established a failover system at our primary data center for all of our production systems. 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 loss of data or 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 and operating results. And, any significant additional expenses incurred as a result of any failure by a third party to perform obligations in a timely or efficient manner or any significant costs associated with finding a new vendor or service provider or taking over responsibilities ourselves would have an adverse impact on our business, financial condition and operating results.

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.

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 competitively priced, 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 operating results would be adversely affected.

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~~In ~~agreement with~~ the ~~fulfillment services company that previously managed the fulfillment and distribution operations at the Lockbourne~~past, ~~Ohio facility expired in August 2003, at which point~~ we ~~assumed direct control of fulfillment and distribution operations. We~~ have ~~limited experience and have~~ encountered difficulties in the ~~past~~management ~~managing~~of our fulfillment and distribution operations, and we ~~cannot assure you that~~ we ~~will~~may beencounter ~~successful~~such difficulties in ~~this~~the ~~endeavor~~future. If we are unable to ~~manage~~ manage successfully our fulfillment and distribution operations and to meet our customers’ ~~expectations~~ expectations regarding personalization, presentation and delivery, our business reputation, operations and financial condition could be seriously harmed. Further, 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~~ higher fulfillment expenses than anticipated or incur additional costs for balancing merchandise inventories among multiple fulfillment facilities. Further, we currently anticipate that we will need to expand and upgrade our fulfillment 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 may be adversely affected.

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, which could also harm our business and reputation. In the past, 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.

A significant portion 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 will be harmed.

Inwidespread ~~addition~~consumer acceptance, we may ~~not~~be ~~receive~~required ~~products~~to ~~from~~take ~~our~~significant ~~suppliers~~inventory inmarkdowns, which acould ~~timely~~reduce ~~manner~~our ornet wesales ~~may receive~~and ~~products~~gross ~~from~~margins. ~~our~~This ~~suppliers~~risk ~~that~~may dobe ~~not~~greatest ~~meet~~in ~~our~~the ~~quality~~third ~~standards.~~fiscal quarter ~~From~~of ~~time~~each ~~to time~~year, after we ~~receive~~ ~~products~~have ~~from~~significantly ~~suppliers~~increased ~~that~~inventory ~~are~~levels offor ~~insufficient~~the ~~quality~~holiday shopping toseason. ~~provide~~In addition, to the extent that demand for our ~~customers. Generally~~products ~~the~~increases ~~supplier~~over istime, ~~able~~we may be forced to ~~quickly~~increase ~~rectify~~inventory ~~the~~levels. ~~problem,~~Any ~~but~~such ~~occasionally~~increase wewould ~~have~~require ~~been~~the ~~unable to~~use ~~obtain~~of ~~replacement~~additional working ~~product~~capital ~~quickly~~and ~~enough~~subject us to ~~fulfill~~additional ~~all~~inventory ~~customer~~risks. ~~orders~~Further, ~~for~~our ~~such~~failure ~~product~~to ~~in a~~stock ~~timely~~sufficient ~~manner,~~quantities ~~particularly~~of ~~with~~popular ~~respect~~products towould ~~items~~likely ~~sourced~~cause ~~overseas~~us ~~which~~to ~~tend~~miss torevenue ~~have~~opportunities ~~longer~~and ~~delivery~~could ~~lead~~cause ~~time~~our ~~requirements.~~customers Ifto webecome dodissatisfied ~~not~~and ~~receive~~look ~~products~~to ~~from~~ our ~~suppliers~~competitors infor atheir ~~timely~~gift items, ~~manner~~which orcould ifalso weharm ~~receive~~our ~~products~~business ~~from~~and ~~our~~reputation. ~~suppliers~~In ~~that~~prior doperiods, ~~not~~some ~~meet~~of our ~~high~~popular ~~quality~~items ~~standards and~~were wenot ~~are~~stocked ~~unable~~in toquantities ~~obtain~~sufficient ~~suitable~~to ~~replacement~~meet ~~products~~the indemand afor ~~timely~~such ~~manner~~items, ~~our~~which ~~reputation~~likely ~~and~~led ~~our~~to missed ~~operating~~sales ~~results~~opportunities. ~~could~~If bewe ~~harmed.~~fail ~~Further,~~to ~~customers~~stock ~~who~~popular doproducts ~~not~~in ~~receive~~sufficient ~~their~~quantities ~~products~~or inif awe ~~timely~~overstock ~~manner~~products, ~~may~~our ~~look~~business, tofinancial ~~our~~condition ~~competitors~~and ~~for~~operating ~~their~~results ~~gift~~would ~~items~~be affected adversely.

~~Many~~We ofmay ~~our products are sourced overseas. While products sourced overseas typically~~ have ~~lower~~ ~~costs,~~difficulty ~~our~~in product margins may be 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 seriously 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~~ A ~~operating~~significant ~~results~~portion ~~could~~of ~~suffer~~our ifproducts are unique designs manufactured by third-parties. However, since we ~~fail~~do tonot ~~offer~~have long-term arrangements with any manufacturer, vendor or ~~sell~~distributor that ~~sufficient~~would ~~quantities~~guarantee the availability of products from year to year, we do not have a predictable ~~proprietary~~or guaranteed supply of these products in the future. If we are unable to provide our customers with continued access to popular products, our operating results will be harmed.

In ~~recent periods~~addition, ~~the~~we ~~majority~~may ofnot receive products from our ~~most~~suppliers ~~popular~~in a timely manner or we may receive products ~~has~~from ~~been~~our ~~designed~~suppliers ~~in-house~~that ordo ~~was~~not meet our quality standards. From time to time, we ~~otherwise~~receive ~~exclusive~~products from suppliers that are of insufficient quality to ~~RedEnvelope~~provide to our customers. Generally Asthe ~~proprietary~~supplier ~~products~~is ~~generally~~able ~~carry~~to ~~higher~~quickly ~~gross~~rectify ~~margins~~the problem, but occasionally we have been unable ~~than~~to ~~widely~~obtain ~~available~~replacement products, ~~any~~quickly ~~failure~~enough to ~~offer~~fulfill ~~and~~all ~~sell~~customer ~~large~~orders ~~numbers~~for ofsuch ~~proprietary~~product ~~products~~in a ~~could~~timely ~~prevent~~manner, usparticularly ~~from~~with ~~achieving~~respect ~~our~~to ~~gross~~items ~~margin~~sourced ~~objectives~~overseas which tend to have longer delivery lead time requirements. If we ~~are~~do ~~unable~~not ~~for~~receive ~~any~~products ~~reason~~from toour suppliers in a timely ~~design~~manner or ~~source~~if ~~popular~~we ~~proprietary~~receive products orfrom ifour suppliers that do not meet our high quality standards and we are unable to ~~sell~~obtain ~~sufficient~~suitable ~~quantities~~replacement ~~of proprietary~~ products ~~during~~in ~~any~~a ~~future~~timely ~~period~~manner, our reputation and our operating results ~~will~~could be ~~adversely~~harmed. ~~affected~~Further, customers who do not receive their products in a timely manner may look to our competitors for their gift items.

Many of our products are sourced overseas. While products sourced overseas typically have lower costs, our product margins may be 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. Increasing competition for overseas production resources, particularly in China, may result in higher than anticipated product costs and lower product margins. Furthermore, in recent years, U.S. companies were subject to port strikes which delayed the delivery of goods. 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 would 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 San Francisco, California, an area that is susceptible to earthquakes and other ~~natural~~ 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 orders are shipped and our customer sales and service facility is located in San Diego, California. 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 inventory and/or 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 in the past experienced severe wildfires. The occurrence of any such wildfires in the future 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~~ 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 could be seriously harmed.

If we fail to manage our growth and successfully integrate our management team, our business will suffer.

We anticipate that future expansion, including the possible acquisition of third-party assets, technologies or businesses, may be required to address market opportunities and desired growth in our customer base. Prior expansion has placed, and any future expansion would likely place, a significant strain on our management, operational and financial resources. Some of our officers and senior management personnel have no prior senior management experience at public companies. We have experienced significant turnover among our executive officers in recent years and several of our executive officers have only been with the Company for a

Weshort period of time. In addition, we have ~~grown~~hired ~~quickly~~a number of key managerial, merchandising, technical, finance, accounting and operations personnel in the recent past. As a result, key members of our management and employee team are still in the process of being 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 Sarbanes Oxley Act of 2002. Moreover, if we ~~fail~~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 ~~manage~~ours. Any such investment or acquisition may further strain our financial and managerial controls and reporting systems and procedures. These difficulties could disrupt or make it more difficult to plan and forecast our business, distract our management and employees or increase our costs. If we are unable to manage growth effectively, including integration of new personnel, implement proper controls and systems in an efficient manner, or successfully integrate any assets, technologies or businesses that we may acquire, or if we acquire assets, technologies or business that do not prove complimentary to us, our business, ~~will~~financial ~~suffer~~condition and results of operations would be affected adversely.

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 and senior management personnel have no prior senior management experience at public companies. Our new employees include key officers, including our Chief Financial Officer, as well as a number of key managerial, technical, finance, accounting 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 or make it more difficult to plan and forecast 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, or if we acquire assets, technologies or business that do not prove complimentary to us, our business, financial condition and results of operations would be affected adversely.

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~~merchants that ~~offer~~ 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~~ because current and new competitors can enter our market with little difficulty and can launch new ~~websites~~ 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, ~~Gifts.com, Shopping.com~~ and eBay • major department stores, such as Macy’s, Bloomingdale’s, Neiman Marcus and their online storefronts • physical and online stores and catalog retailers that sell popular gift items such as Pottery Barn, Brookstone, The Sharper Image, Tiffany’s, Harry & David, J Crew, ~~and~~ 1-800-Flowers and Williams-Sonoma • Internet portals and online service providers and other comparison shopping sites, such as AOL, ~~and~~ Yahoo! and Google.

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 effectively 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 affected adversely.

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 any potential growth in customer orders successfully. As a result, we could lose customers and our net revenues could decline. 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 and enhancing 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.

We are currently in the process of implementing new website and inventory planning software systems. 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 ~~expand~~and cost-effectively ~~our~~implement ~~website~~one ~~and~~or ~~order~~more ~~processing~~of ~~systems~~these intended upgrades or ~~respond~~modified toprocesses ~~rapid~~or if we do ~~technological~~not achieve desired efficiencies or cost savings as a result of these changes, weor ~~could~~if ~~lose~~attempts ~~customers~~to enhance ~~and~~our website are unsuccessful or are not appealing to our ~~net~~customers, ~~revenues~~our business and operating results could ~~decline~~be harmed, perhaps significantly.

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.

We recently implemented certain system enhancements and upgrades, including a new warehouse management system and an updated financial software package. We are currently in the process of implementing new website and inventory planning software systems. 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 disruption or inaccuracy in order, fulfillment, ~~and~~personalization, ~~shipping~~or delivery for any reason, particularly during the holiday shopping season, could cause us to lose customers and negatively affect our business and reputation. 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~~delays ~~costs~~ due to factors that are beyond our control, including employee strikes, ~~inclement weather~~ and ~~increased~~inclement ~~fuel costs~~weather.

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. Three of our former officers, Gary Korotzer, our former Chief Marketing Officer, Polly Boe, our former Chief Financial Officer and Ken Constable, our former President and Chief Executive Officer each resigned from RedEnvelope during fiscal 2007. Following Mr. Constable’s departure, John Pound, who has been a Director since August 2005 and Chairman of the Board since February 2007, has assumed the role of Executive Chairman. The role of Chief Financial Officer has been filled by William Gochnauer, who is a Member of Tatum LLC, a national firm that provides such executive services. We are not currently engaged in a search for a full-time Chief Financial Officer. In April 2007, we hired Scott Sanborn as our Chief Marketing Officer to fill the position formerly held by Gary Korotzer. In June 2007, Scott Loly resigned as Vice President of Merchandising and this role has been filled by Suzanne Ellis, who was formerly a Director of Merchandising for the Company. We currently believe that these management changes will have no material adverse impact on our operations. We do not have long-term employment agreements with any of our key personnel. Our performance depends on our ability to retain and motivate other officers and key employees. The loss of the services of key personnel 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 sales and 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 sales and service personnel would harm our business, financial condition and results of operations. Moreover, competition is particularly intense for highly-qualified senior officers in our industry, and a variety of factors could make it difficult for us to attract the right candidates in the near term or at all. In the event that we cannot hire and retain qualified senior officers in a timely manner, our business could be adversely affected.

We rely on seasonal and temporary employees during periods of peak activity and any failure by such employees to adequately perform their jobs could adversely affect our operations.

We depend on temporary and seasonal employees to adequately staff our fulfillment facility and customer sales and service facilities during busy periods such as the holiday shopping season, ~~including~~ including individuals responsible for gift personalization and packaging and responding to ~~customer and~~consumer ~~potential customer~~ inquiries. Temporary employees may not have the same levels of training or commitment as full-time employees and, as a result, may be more likely to provide unsatisfactory service. 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 fulfillment and customer ~~service~~sales and service facilities, particularly during the holiday shopping season and other periods of increased activity or if our temporary and seasonal employees do not provide satisfactory service, our operations and sales during such ~~period~~periods 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 ~~• production of aesthetically appealing catalogs • timely delivery of catalog mailings to our customers~~

~~Catalog production and mailings entail substantial paper, printing, postage and human labor~~18 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 delivering our catalogs or a delay in distributing our catalogs or if 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 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, the costs of online marketing and the costs of complying with applicable regulations, may limit our ability to advertise and market our business in a cost-effective manner. 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. 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.

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 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. If we are unable to continually provide adequate staffing for our customer service operations, our reputation could be seriously harmed.

In• ~~addition,~~production weof ~~cannot~~aesthetically ~~assure~~appealing ~~you~~catalogs ~~that~~• ~~email~~timely ~~and~~delivery ~~telephone~~of ~~call~~catalog ~~volumes~~mailings ~~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. Although we are currently implementing plans to expand its capacity,~~ our ~~customer service facility currently accommodates customer service representatives at close to its capacity during our peak sales period. 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~~ Producing ~~loss~~and mailing our catalog entails substantial creative, paper, printing, postage and human labor costs. Increases in the costs of producing and distributing our ~~senior~~catalog, ~~management~~including increases in postage rates or ~~other~~paper, ~~key~~photography, ~~personnel~~or ~~could~~printing ~~harm~~costs, may reduce the margin on sales derived from our ~~current~~catalog. The U.S. Postal Service has recently increased its postage rates and is likely to continue to increase its postage rates in the future, which could significantly increase ~~operations~~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, ~~prospects~~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. In recent periods, we have experienced slower growth in revenues from our catalog channel than in our online channels and we expect this trend towards slower catalog growth to continue. If we were to experience an increase in the costs associated with producing or delivering our catalogs or a delay in distributing our catalogs or if our catalogs fail to produce sales at satisfactory levels, our operating results would be adversely affected.

~~Our~~If performance is substantially dependent on the continued services and on the performance of our senior management and other key personnel. Three of our former officers, Eric Wong, our former Chief Financial Officer, John Roberts, our former Vice President of Information Technology and Kathy Herzog, our former Vice President of Merchandise Operations, each resigned from RedEnvelope in the recent past. While we ~~believe~~are ~~that~~unable this will have no material impact on our operations, we cannot assure you that disruptions occasioned by their departures will not have an adverse impact on our near-term operations. Our performance also depends on our ability to ~~retain~~provide ~~and~~satisfactory 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, Ms. Boe 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~~could ~~assure~~lose ~~you that we may be able to successfully attract, assimilate or retain sufficiently qualified personnel~~customers. ~~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 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 creating a favorable interactive customer experience. 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. Because our success depends in large part on keeping our customers satisfied, any failure to provide high levels of customer sales and service or adequately staff our customer sales and service operations would likely impair our reputation and have an adverse effect on our business and operating results.

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,~~In ~~effective trademark~~addition, ~~service~~in ~~mark,~~many ~~copyright~~jurisdictions ~~and trade~~trademark ~~secret~~law ~~protection~~does ~~may~~ not ~~be available in every country in~~ ~~which~~protect wethe ~~may~~trademark ~~sell~~owner ~~our~~from ~~products and~~third ~~offer~~parties ~~our~~using ~~services~~domain innames ~~the~~that ~~future.~~are Insimilar ~~addition,~~to the ~~relationship between regulations governing~~trademark ~~domain~~owner’s ~~names~~registered ~~and laws protecting~~ trademarks and ~~similar proprietary rights is unclear~~logos. Therefore, we may be unable to prevent third parties from acquiring and using 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.

Intellectual property and other 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 been subject to claims or received notices from third parties alleging that our trademarks or product offerings and business processes infringe proprietary rights held by them. From time to time we also receive claims, and ~~become~~have previously been a defendant in ~~lawsuits~~ a lawsuit alleging that our Internet marketing program and website operations infringe patents held by third parties. 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 third-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

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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 In ~~face~~addition, it is possible that, in the ~~risk~~course of ~~inventory~~our ~~shrinkage~~business, we could be subject to legal claims or proceedings involving consumer, employment, stockholder, contract, product liability or other matters. If we are required to defend against a legal claim or deem it necessary or advisable to initiate a legal proceeding to protect our rights, the expense and distraction of such a claim or proceeding, whether or not resolved in our favor, could adversely affect our business. Further, if a claim or proceeding were resolved against us or if we were to settle any such dispute, we could be required to pay damages or refrain from certain activities, which could have an adverse impact on our business, financial condition and operating results. Additionally, any product liability claims could negatively affect our brand and our reputation.

We are subject to the risk of inventory loss and theft. 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. Our business and revenues have been, and in the future could 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, weany ~~may~~extended recession ~~not~~or ~~be able~~sluggish toeconomy ~~survive~~could anhave ~~extended~~a ~~recession~~material oradverse ~~sluggish~~effect ~~economy~~on us.

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 in the future. We cannot be certain that we will be able to obtain additional financing on commercially reasonable terms or at all. Any failure to obtain necessary capital on commercially reasonable terms could have severe consequences on our business. 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 would experience dilution of their ownership interests. Further, under the terms of our credit agreement, 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 would dilute the ownership interests, and possibly affect the rights, preferences and privileges 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 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 comply with a range of regulatory requirements, including age verification in connection with the sale of our tobacco products. If we fail to comply with such regulations or are unable to properly identify the age of our purchasers, we could face substantial penalties and legal liability. 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. In addition, several state and federal regulatory agencies are taking steps to further limit or prohibit direct sales of tobacco products. The success of such efforts could reduce our revenues.

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~~Also, the Board of Directors may determine at some point in the future that it is in the best interests of the Company and its stockholders to enact additional measures to protect the Company against unsolicited takeovers or stock accumulation. Such provisions or the enactment of additional protective measures 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~~loan and security agreement, 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~~loan and security agreement, even if such acquisition would be beneficial to our stockholders.

Our ~~success~~directors, isexecutive ~~tied~~officers inand ~~large~~significant ~~part~~stockholders tohold ~~the~~a ~~continued~~substantial ~~use~~portion of ~~the~~our stock, ~~Internet~~which bymay alead ~~large~~to ~~number~~conflicts ofwith other stockholders over corporate transactions and other ~~consumers~~corporate matters.

Our ~~future~~directors, ~~revenues~~executive officers and ~~profits,~~current ifbeneficial ~~any,~~holders ~~substantially~~of ~~depend~~5% ~~upon~~or ~~the~~more ~~continued~~of ~~widespread~~our ~~use~~outstanding common stock own a significant portion of ~~the~~our ~~Internet~~stock. asThese anstockholders, ~~effective~~acting together, ~~medium~~are able to control or influence significantly all matters requiring stockholder approval, including the election of ~~commerce~~directors and ~~communication~~significant corporate transactions such as mergers or other business combinations. ~~Factors~~This ~~which~~control ~~could~~may delay, deter or prevent a third-party from ~~reduce~~acquiring ~~the~~or ~~widespread~~merging ~~use~~with ofus and limit the ~~Internet~~ability ~~include:~~of smaller stockholders to influence corporate matters.

• 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 computers20

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.

During the first quarter of fiscal 2006, approximately 75% of our products were 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 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 significantly harmed.

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

As of July 1, 2007, approximately 79% of our customer orders were placed through our website. In order for the online commerce market to function and 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, any of which could adversely affect our business.

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 and 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.

WeThere are ~~subject~~an toincreasing ~~the~~number ~~same~~of ~~federal,~~laws ~~state~~specifically ~~and~~directed ~~local~~at ~~laws~~the asconduct ~~other~~of ~~companies conducting~~ business on the Internet. Moreover, ~~including~~due ~~consumer~~to ~~protection~~the ~~laws~~increasing use of the Internet, ~~user~~many ~~privacy~~additional laws and regulations relating to the Internet are being debated at the state and federal levels. These laws and regulations ~~prohibiting~~could ~~unfair~~cover ~~and~~issues ~~deceptive~~such ~~trade~~as ~~practices.~~freedom Inof ~~particular~~expression, ~~under~~pricing, ~~federal~~consumer privacy, fraud, quality of products and services, taxation, advertising, adult-oriented content, defamation, ~~state~~intellectual ~~financial~~property ~~privacy~~rights, ~~laws~~identity theft and ~~regulations,~~information wesecurity. ~~must~~Applicability ~~provide~~of ~~notice~~existing laws to ~~our~~the ~~customers~~Internet ofrelating ~~our~~to ~~policies~~issues such as trademarks, copyrights and ~~practices~~other ~~regarding~~intellectual property ~~non-public~~issues, taxation, libel, obscenity and personal ~~information~~privacy ~~that~~could also harm our business. For weexample, ~~collect~~United States and ~~use,~~international ~~including~~laws ~~whether~~regulate weour ~~share~~ability ~~that~~to ~~information~~use ~~with~~customer ~~third~~information ~~parties~~and to develop, ~~must~~buy ~~provide advance~~and ~~notice~~sell mailing lists. Many of ~~any~~these ~~changes~~laws are only beginning to ~~our~~be ~~privacy~~interpreted ~~policies~~by the courts and ~~must~~their ~~inform~~applicability ~~our~~and ~~customers~~reach ~~about~~are ~~how~~therefore ~~they~~uncertain. The restrictions imposed by, ~~can~~and ~~review~~costs of complying with, current and~~/or~~ ~~correct~~possible ~~the~~future ~~non-public~~laws ~~personal~~and regulations related to our business could harm our business, operating results and financial condition.

23 States and the federal government are increasingly enacting laws and regulations to protect consumers against identity theft, loss of privacy and misuse of personal user information. These measures impose various and inconsistent requirements on companies collecting and maintaining personal information about consumers. We collect personal information from consumers in the course of doing business. These multiple laws and regulations introduce a considerable measure of uncertainty to our compliance efforts. Such measures will likely increase the costs of doing business and, if we fail to implement appropriate safeguards or we fail to detect and provide prompt notice of unauthorized access as required by some of the new laws, we could be subject to potential claims for damages and other remedies. If we were required to pay any significant amount of money in satisfaction of claims under these laws, 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.

Several states have enacted several new laws that require all commercial website operators that collect personal information about residents in their states to adopt and post a privacy policy that meets certain specified criteria. Any failure to comply with these new laws could subject us to civil penalties, injunctions, and/or lawsuits. 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, 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, 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 federal 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

~~information~~so wecould ~~possess~~subject ~~about~~us ~~them.~~to ~~Further,~~taxes ~~the growth~~and ofpenalties ~~online~~and ~~commerce~~we could ~~result~~be insubject ~~more~~to ~~stringent~~legal ~~consumer~~actions ~~protection laws that impose~~and ~~additional~~liability ~~compliance~~in ~~burdens~~those ~~on us~~jurisdictions. ~~Today~~The ~~there~~restrictions ~~are~~or anpenalties ~~increasing~~imposed ~~number of laws specifically directed at the conduct of business on the Internet. Moreover~~by, ~~due~~and tocosts ~~the increasing use~~ of ~~the~~complying ~~Internet~~with, ~~many~~these ~~additional~~ laws and regulations ~~relating to the Internet are being debated at the state and federal levels. These laws and regulations~~ could ~~cover~~harm ~~issues~~our ~~such as freedom of expression~~business, ~~pricing,~~operating ~~consumer~~results ~~privacy, fraud, quality of products~~ and ~~services, taxation,~~financial ~~advertising, adult-oriented content, intellectual property rights and information security~~condition. ~~Applicability~~ ofOur ~~existing~~ability ~~laws~~ to ~~the~~enforce ~~Internet~~contracts ~~relating to issues such as trademarks, copyrights~~ and other ~~intellectual~~obligations ~~property~~in ~~issues,~~states ~~taxation, libel, obscenity~~ and ~~personal~~countries ~~privacy~~in ~~could also~~which ~~harm~~we ~~our~~are ~~business.~~not ~~For~~qualified ~~example, United States and international laws regulate our ability~~ to ~~use customer~~do ~~information~~business ~~and~~could tobe ~~develop~~hampered, ~~buy~~which ~~and~~could ~~sell~~have ~~mailing~~a ~~lists.~~material ~~Many~~adverse ~~of these laws were adopted~~effect ~~prior~~on toour ~~the~~business. ~~advent of the Internet~~Further, ~~and~~an doimportant ~~not~~aspect ~~contemplate~~of ~~or address~~ the ~~unique~~new ~~issues raised by the~~ Internet.-focused ~~Those~~ laws is that ~~do reference the Internet, such as the Digital Millennium Copyright~~where ~~Act and the recent~~ federal ~~law~~legislation ~~regulating~~is ~~the commercial use of e-mail (popularly known as “CAN-SPAM”)~~absent, ~~are~~states ~~only~~have ~~beginning~~begun to beenact ~~interpreted~~consumer-protective bylaws ~~the~~of ~~courts and~~ their ~~applicability~~own and ~~reach~~ ~~are~~these ~~therefore~~can ~~uncertain.~~vary ~~The~~significantly ~~restrictions~~from ~~imposed~~state ~~by,~~to ~~and~~state ~~costs of complying with, current~~ (and ~~possible~~ ~~future~~country ~~laws and regulations related~~ to ~~our~~country). ~~business~~Thus, ~~could~~it ~~harm~~is ~~our business, operating~~difficult ~~results~~for ~~and~~any ~~financial~~company ~~condition.~~to ~~Tax~~be ~~authorities~~sufficiently inaware ~~a number~~ of ~~states, as well as a Congressional advisory commission, are currently reviewing~~ the ~~appropriate~~requirements ~~tax treatment~~ of ~~companies~~all ~~engaged~~applicable ~~in online commerce, and new~~ state ~~tax~~laws ~~regulations may subject us to additional state sales~~ and ~~income taxes,~~it ~~which could have an adverse effect on our cash flows and results of operations. Further,~~is ~~there~~also isdifficult aor ~~possibility~~impossible ~~that~~for weany ~~could~~company ~~be subject~~ to ~~significant~~comply ~~fines~~fully orwith ~~other~~the ~~payments~~sometimes ~~for any past~~inconsistent ~~failures~~standards toand ~~comply~~requirements ~~with~~set ~~these~~by ~~requirements~~various states. In ~~its~~addition ~~most~~to ~~recent~~the ~~session,~~consequences ~~Congress~~that ~~refused~~could ~~to extend~~result ~~the~~from ~~U.S.~~violating ~~Internet~~one ~~tax~~or ~~moratorium.~~more ~~Consequently,~~state ~~states~~laws ~~are~~(or ~~free~~the tolaws ~~impose~~of ~~new~~any ~~taxes~~other ~~on Internet access~~country), ~~which could slow~~ the ~~growth~~costs of ~~Internet~~attempting to ~~use~~comply ~~and~~could ofbe ~~electronic commerce transactions over the Internet~~considerable.

In 2003, the California legislature enacted new sections of the Civil Code that require any company that does business in California and possesses computerized data, in unencrypted form, containing certain personal information about California residents to (i)Item 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 and (ii) implement and maintain reasonable security procedures and practices to protect that information from unauthorized access, destruction, use, modification or disclosure2. ~~The~~Unregistered ~~law~~Sales ~~defines personal information as an individual’s name together with one or more~~ of ~~that~~Equity ~~individual’s~~Securities 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. In 2004, the California legislature enacted another new section of the Civil Code that requires any company that owns or licenses personal information about California residents to implement and ~~maintain “reasonable~~Use security procedures and practices” to protect that information from unauthorized access, destruction, use, modification or disclosure. The law also requires that any company that discloses personal information about California residents to a nonaffiliated third party must require by contract that that party also implement and maintain “reasonable security procedures and practices.” 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 these new laws~~Proceeds. ~~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 protect the integrity and security of that information and to notify our California customers of any unauthorized access or misappropriation. In addition, the code section requiring us to implement and maintain “reasonable security procedures and practices” provides no guidelines as to what may be deemed reasonable but leaves that determination to future court cases. This introduces a considerable measure of uncertainty to our compliance efforts. Such measures will likely increase the costs of doing business and, if we fail to implement appropriate safeguards or 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 methodsNone. ~~The CAN-SPAM Act, for example,~~ ~~requires every commercial e-mail message to~~

24Item 3. Defaults Upon Senior Securities.

~~Table of Contents~~None.

~~include an “opt-out” mechanism and requires all senders to comply with their recipients “opt out” requests~~Item 4. ItSubmission ~~also requires senders to label all commercial e-mail messages as advertisements or solicitations. These requirements may reduce the effectiveness~~ of ~~our~~Matters ~~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~~Vote of anSecurity ~~inadvertent violation of such a law~~Holders. ~~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 (and country to country). 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 (or the laws of any other country), the costs of attempting to comply could be considerable.

~~Laws or regulations relating to privacy and data protection may adversely affect the growth of our Internet business or our marketing efforts~~None.

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 several new laws that 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. As mentioned above, California recently enacted new sections of its Civil Code that require companies maintaining personal information about California residents to take reasonable measures to protect against identity theft and other unauthorized uses of such information and to notify California residents in the event that such information has been (or is likely to have been) misappropriated, inappropriately modified or destroyed. The new laws provide no standards for satisfactory compliance, so it is impossible to know for certainty what steps the Company needs to take to comply with them. Compliance could require the Company to implement procedures that would require it to change the way it does business and such procedures may be expensive. 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 13Item ~~years of age~~5. ~~Bills~~Other ~~proposed in Congress would extend online privacy protections to adults~~Information. ~~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 On ~~may~~July 23, be2007, ~~subject~~RedEnvelope, Inc. (the “Company”) and DCT Creekside III LLC entered into a Second Amendment to ~~liability~~Lease ~~for~~Agreement, effective as of August 1, 2007 (the ~~content~~“Second Lease Amendment”). This Second Lease Amendment further amended the Lease Agreement with Creekside III LLC effective as of April 1, 2004, under which the Company leases approximately 238,674 square feet of space where it houses its distribution center. The Second Lease Amendment extended the term of this Lease by 36 months until July 31, 2010 at a monthly base rent of $66,629.83 during the first year of the extension, $68,618.78 during the second year of the extension and $70,607.73 during the third year of the extension. Additionally, the Second Lease Amendment provides that wethe ~~publish~~landlord will contribute up to an aggregate of $179,005.50 for certain tenant improvements, which contributions will be available through March 31, 2008.

AsThe aforegoing ~~publisher~~description of ~~catalogs~~the ~~and~~Second ~~online~~Lease ~~content,~~Amendment weis ~~face~~qualified ~~potential~~in ~~liability~~its ~~for~~entirety ~~defamation,~~by ~~negligence,~~reference ~~intellectual~~to ~~property~~the ~~infringement,~~provisions orof ~~other claims based on~~ the ~~information~~Second ~~and~~Amendment ~~other content~~to ~~contained~~Lease inAgreement ~~our~~between ~~catalogs~~DCT ~~and~~Creekside ~~website. In the past, parties have brought these types of~~III ~~claims~~LLC and ~~sometimes~~RedEnvelope, ~~successfully~~Inc. ~~litigated~~attached ~~them~~as ~~against online services~~Exhibit 10.73 Ifto wethis ~~incur~~Quarterly ~~liability~~Report ~~for our~~on ~~catalog~~Form ~~or online content, our financial condition could be affected adversely and our reputation could suffer~~10-Q.

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, short-term marketable securities, and long-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 original maturities range over three months but less than one year.

The following table lists our cash and cash equivalents and short-term investments at July 3, 2005:

	(In thousands)
Cash and cash equivalents	$	2,172
Short-term investments		14,471
Total	$	16,643

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 primarily denominated in U.S. dollars. As of July 3, 2005, 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

Disclosure 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 under the supervision and with the participation of management, including the Company’s principal executive officer and principal financial officer as of the end of the period being reported on in this Quarterly Report on Form 10-Q. The Company continues to implement minor changes primarily to formalize and document procedures already in place. 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. Since the date of the evaluation of internal controls, no significant changes have been made that could significantly affect these controls.

Changes in Internal Control Over Financial Reporting— On April 18, 2005 Polly Boe joined the Company as its new Chief Financial Officer, and on June 20, 2005 the Company hired a new Controller. On June 28, 2005, Ms. Boe discovered an overstatement of an inventory-related component of the Company’s accounts payable liability, which the Company believes occurred as the result of inadequate closing and reconciliation procedures for that account. The resolution of this issue is reflected in the Company’s financial statements included in its fiscal year 2005 Annual Report on Form 10-K. The Company subsequently implemented new closing and reconciliation procedures for such account that are designed to prevent such an error in the future.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

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. Recent Sales of Unregistered Securities; Use of Proceeds from Registered 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 $7.6 million for purchases of property and equipment. We also use the net proceeds to fund our working capital requirements throughout the year.

Item 5. Other Information

Beginning August 15, 2005, RedEnvelope entered into indemnification agreements with its officers and directors based on a revised Company standard form. The Company anticipates that all of its current officers and continuing directors will execute this new form. These agreements contain provisions that may require RedEnvelope, among other things, to indemnify its officers and directors against certain liabilities that may arise by reason of their status or service as officers or directors (other than liabilities arising from willful misconduct and other than as limited by Delaware law) and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. The foregoing description of these agreements is qualified in its entirety by reference to the Company’s Form of Indemnification Agreement for Executive Officers and Directors attached to this report as Exhibit 10.53.

Item 6. Exhibits

	10.53		RedEnvelope, Inc. Form of Indemnification Agreement for Executive Officers and Directors (in use from August 15, 2005)
10.73		Second Amendment to Lease Agreement between Creekside III LLC and RedEnvelope, Inc. dated as of July 23, 2007.
31.1	~~31.1~~	Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)	~~Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)~~
31.2	~~31.2~~	Certification of Interim Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)	~~Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)~~
32.1	~~32.1~~	Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002	~~Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002~~
32.2	~~32.2~~	Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002	~~Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002~~

~~II - 1~~22

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/ ~~Polly~~William ~~Boe~~T. ~~Polly~~Gochnauer ~~Boe~~Interim Chief Financial Officer

Date: ~~August 17~~September 14, ~~2005~~2007

~~II - 2~~23

EXHIBIT INDEX

10.53		RedEnvelope, Inc. Form of Indemnification Agreement for Executive Officers and Directors (in use from August 15, 2005)
10.73		Second Amendment to Lease Agreement between Creekside III LLC and RedEnvelope, Inc. dated as of July 23, 2007.
31.1		Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)
31.2		Certification of Interim 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

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