UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 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 February 29, 2008

For the quarterly period ended August 31, 2006

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to

For the transition period from to

Commission file number 000-50973

CELEBRATE EXPRESS, INC.

(Exact name of registrant as specified in its charter)

Washington (State or other jurisdiction of incorporation or organization)		91-1644428 (I.R.S. Employer Identification No.)
Washington		91-1644428
11220 – 120th Avenue NE
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)
11232 — 120th Avenue NE
Kirkland, Washington		98033
(Address of principal executive offices)		(Zip Code)

(425) 250-1061
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period than the registrant was required to file such reports), and (2) has been subject to such filing 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., or a smaller reporting company. See ~~definition~~the definitions of “large accelerated filer,” “accelerated filer” and ~~large~~“smaller ~~accelerated~~reporting ~~filer~~company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer þ (Do not check if a smaller reporting company) Smaller Reporting Company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

As of ~~September~~March 3031, ~~2006~~2008, there were 7,~~810~~981,~~401~~584 shares of the registrant’s common stock outstanding.

CELEBRATE EXPRESS, INC.

INDEX

	Page
PART I. FINANCIAL INFORMATION		1
Item 1. Financial Statements (unaudited)		1
Balance Sheets at August 31, 2006 and May 31, 2006		2
Balance Sheets at February 29, 2008 and May 31, 2007		2
Statements of Income For the Three Months Ended August 31, 2006 and August 31, 2005		3
Statements of Operations for the Three and Nine Months Ended February 29, 2008 and February 28, 2007		3
Statements of Shareholders’ Equity For the Three Months Ended August 31, 2006		4
Statement of Shareholders’ Equity for the Nine Months Ended February 29, 2008		4
Statements of Cash Flows For the Three Months Ended August 31, 2006 and August 31, 2005		5
Statements of Cash Flows for the Nine Months Ended February 29, 2008 and February 28, 2007		5
Notes to Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 3. Quantitative and Qualitative Disclosures About Market Risk		1418
Item 4. Controls and Procedures		1518
PART II. OTHER INFORMATION		1518
Item 1. Legal Proceedings		1518
Item 1A. Risk Factors		1518
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		2629
Item 6. Exhibits		2630
SIGNATURES		2731
EXHIBIT 10.1
EXHIBIT 3.6
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 10.4
EXHIBIT 10.5
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

****

We end our fiscal year on May 31. In this report, we refer to our fiscal periods as follows:


Reference in this report

		Fiscal years ending

Fiscal 2009		May 31, 2009

Fiscal 2008		May 31, 2008

Fiscal 2007		May 31, 2007

Fiscal 2006		May 31, 2006

		Interim fiscal period

Third quarter fiscal 2008		Three month period ended February 29, 2008

Third quarter fiscal 2007		Three month period ended February 28, 2007

Nine months fiscal 2008		Nine month period ended February 29, 2008

Nine months fiscal 2007		Nine month period ended February 28, 2007

Cautionary Note Regarding Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements that involve many risks and uncertainties. These statements relate to future events and our future performance that are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. In some cases, you can identify forward-looking statements by terms such as “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “seek,” or “continue,” the negative of these terms or other variations of such terms. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business and other characterizations of future events or circumstances, are forward-looking statements. These statements are only predictions based upon assumptions made that are believed to be reasonable at the time and are subject to risk and uncertainties. Therefore, actual events or results may differ materially and adversely from those expressed in any forward-looking statement. In evaluating these statements, you should specifically consider the risks described under Part II—Item 1A “Risk Factors” and elsewhere in this quarterly report on Form 10-Q. These factors may cause our actual results to differ materially from any forward-looking statements. If one or more of the factors affecting our forward-looking statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking statements contained in this report. Consequently, you should not place undue reliance on our forward-looking information and statements. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

CELEBRATE EXPRESS, INC.

BALANCE SHEETS

	August 31, 2006			May 31, 2006
	February 29, 2008			May 31, 2007
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	2914,~~271~~815,~~116~~992		$	3121,~~326~~224,~~804~~178
Accounts receivable		303,190			338,772
Accounts receivable, net		1,031,364			1,490,383
Inventories		10,~~296~~139,~~874~~849			89,~~333~~039,~~503~~029
Prepaid expenses		53,~~276~~104,~~708~~442			43,~~097~~692,~~548~~573
Deferred income taxes		~~308,703~~—			~~399~~347,~~627~~019
Total current assets		4529,~~456~~091,~~591~~647			4435,~~496~~793,~~254~~182
Fixed assets, net		45,~~640~~685,~~275~~545			4,~~662~~453,~~439~~476
Deferred income taxes		~~8,087,866~~—			7,~~939~~771,~~639~~657
Other assets, net		~~101~~100,~~716~~656			101,~~892~~186
Total assets	$	5834,~~286~~877,~~448~~848		$	5748,~~200~~119,~~224~~501
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	32,~~945~~026,~~838~~023		$	32,~~151~~751,~~082~~155
Accrued liabilities		43,~~270~~069,~~892~~501			3,~~971~~648,~~903~~457
Total current liabilities		8,216,730			7,122,985
Current portion of capital leases		21,837			—
Total current liabilities		5,117,361			6,399,612
Long-term captial lease obligations		37,312			—
Commitments and contingencies		—			—
Shareholders’ equity:
Common stock, $0.001 par value and additional paid-in capital — authorized, 10,000,000 shares; issued and outstanding, 7,799,144 shares at August 31, 2006; 7,785,899 shares at May 31, 2006		65,600,505			65,495,253
Common stock, $0.001 par value and additional paid-in capital — authorized, 10,000,000 shares; issued and outstanding, 7,981,584 shares at February 29, 2008; 7,953,724 shares at May 31, 2007		68,246,136			67,122,392
Unearned stock-based compensation		—			(213,206	)
Accumulated deficit		(38,522,961	)		(25,402,503	)
Accumulated deficit		(15,530,787	)		(15,204,808	)
Total shareholders’ equity		29,723,175			41,719,889
Total shareholders’ equity		50,069,718			50,077,239
Total liabilities and shareholders’ equity	$	34,877,848		$	48,119,501
Total liabilities and shareholders’ equity	$	58,286,448		$	57,200,224

See notes to financial statements.

CELEBRATE EXPRESS, INC.

STATEMENTS OF OPERATIONS
(unaudited)

	Three months ended						Nine months ended
	August 31, 2006			August 31, 2005
	February 29, 2008			February 28, 2007			February 29, 2008			February 28, 2007
Net sales	$	1913,~~941~~289,~~779~~434		$	1716,~~927~~680,~~704~~660		$	62,174,598		$	65,133,891
Cost of sales (1)		97,~~943~~262,~~903~~218			87,~~917~~582,~~084~~273			29,914,033			31,719,268
Gross margin		9,997,876			9,010,620
Gross profit		6,027,216			9,098,387			32,260,565			33,414,623
Operating expenses:
Fulfillment (1)		2,~~979~~567,~~005~~617			2,~~310~~495,~~502~~112			8,195,132			8,906,764
Selling and marketing (1)		5,~~317~~296,~~922~~776			4,~~021~~714,~~569~~073			20,501,478			17,783,541
General and administrative (1)		23,~~441~~072,~~521~~914			12,~~819~~490,~~588~~987			9,181,245			7,733,552
Total operating expenses		10,~~738~~937,~~448~~307			89,~~151~~700,~~659~~172			37,877,855			34,423,857
Income (loss) from operations		(740,572	)		858,961
Loss from operations		(4,910,091	)		(601,785	)		(5,617,290	)		(1,009,234	)
Other income, net;
Other income, net:
Interest income, net		~~382~~158,~~943~~663			~~241~~400,~~725~~004			640,962			1,209,638
Net income (loss) before income taxes		(~~357~~4,~~629~~751,428	)		1(201,~~100,686~~781	)		(4,976,328	)		200,404
Income tax benefit (expense)		31(8,~~650~~222,171	)		~~(400~~64,~~673~~403	)		(8,144,130	)		(95,747	)
Net income (loss)		(~~325~~12,~~979~~973,599	)		~~700~~(137,~~013~~378	)		(13,120,458	)		104,657
Net income (loss) per share:
Basic	$	(01.0463	)	$	(0.0902	)	$	(1.65	)	$	0.01
Diluted	$	(01.0463	)	$	(0.0902	)	$	(1.65	)	$	0.01
Weighted average shares outstanding:
Basic		7,~~789~~979,~~480~~199			7,~~528~~858,~~983~~484			7,970,749			7,821,698
Diluted		7,~~789~~979,~~480~~199			7,~~958~~858,~~999~~484			7,970,749			7,950,782

(1) Stock-based compensation is included in the expense line items above in the following amounts:


(1) Stock-based compensation is included in the expense line items above in the following amounts:

Cost of Sales	$	2,221	$	8,569	$	5,907	$	26,726
Fulfillment		11,730		15,740		38,979		46,943
Selling and marketing		25,835		43,349		117,848		148,133
General and administrative		240,594		284,218		812,312		741,667

	$	280,380	$	351,876	$	975,046	$	963,469

Cost of Sales	$	9,183	$	5,028
Fulfillment		13,432		4,902
Selling and marketing		61,323		33,792
General and administrative		195,334		16,338
	$	279,272	$	60,060

See notes to financial statements.

CELEBRATE EXPRESS, INC.

STATEMENT OF SHAREHOLDERS’ EQUITY
(unaudited)

	Common stock and											Total
	Common stock and additional								Total
	additional paid-in-capital					Unearned			Accumulated			shareholders
	paid-in-capital					Accumulated			shareholders’
	Shares		Amount			~~compensation~~deficit			~~deficit~~equity			~~equity~~
BALANCE—May 31, 2006		7,785,899	$	65,495,253			($213,206	)		($15,204,808	)	$	50,077,239
BALANCE—May 31, 2007		7,953,724	$	67,122,392			($25,402,503	)	$	41,719,889
Exercise of common stock options		13,245		13,532									13,532
Exercise of common stock options and issuance of restricted stock		23,345		95,505						95,505
Tax effect of stock option exercises				25,654									25,654
Issuance of common stock in connection with employee stock purchase plan		4,515		35,939						35,939
Stock-based compensation				279,272									279,272
Tax effect of stock option exercises				17,254						17,254
Reversal of unearned compensation				(213,206	)		213,206
Stock-based compensation				975,046						975,046
Net loss							(13,120,458	)		(~~325~~13,~~979~~120,458	)		~~(325,979~~	)
BALANCE—August 31, 2006		7,799,144	$	65,600,505		$	0			($15,530,787	)	$	50,069,718
BALANCE—February 29, 2008		7,981,584	$	68,246,136			($38,522,961	)	$	29,723,175

See notes to financial statements.

CELEBRATE EXPRESS, INC.

~~STATEMENT~~STATEMENTS OF CASH FLOWS (unaudited)

	Three months ended
	Nine months ended
	August 31, 2006			August 31, 2005
	February 29, 2008			February 28, 2007
Cash flows from operating activities:
Net income (loss)	$	(~~325~~13,~~979~~120,458	)	$	~~700~~104,~~013~~657
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Deferred income taxes		~~(31~~8,~~650~~135,930	)		~~400~~75,~~673~~942
Depreciation and amortization		~~380~~1,~~064~~609,851			~~255~~1,~~614~~182,184
Stock-based compensation		~~279~~975,~~272~~046			60963,~~060~~469
Excess tax benefit from exercise of stock options		~~(25,654~~—	)		—(205,283	)
Loss on disposal of fixed assets		12,187			—
Changes in operating assets and liabilities:
Accounts receivable		35459,~~582~~019			(~~176~~946,~~172~~331	)
Inventories		(1,~~963~~100,~~371~~820	)		(2148,~~088,170~~322	)
Prepaid expenses and other assets		(1588,~~179,160~~132	)		(138,~~136,372~~811	)
Accounts payable		~~794~~(725,~~756~~132	)		~~372~~(724,~~046~~773	)
Accrued liabilities		~~298~~(578,~~989~~956	)		1444,~~712,474~~085
Net cash provided by (used in) operating activities		(13,~~737~~745,~~151~~201	)		~~100~~1,~~166~~003,461
Cash flows from investing activities:
Payments for purchases of fixed assets		(~~357~~2,~~723~~781,411	)		(~~538~~675,~~724~~964	)
Net cash used in investing activities		(~~357~~2,~~723~~781,411	)		(~~538~~675,~~724~~964	)
Cash flows from financing activities:
Principal payments on capital lease obligations		—			(5,064	)
Principal payments on capital lease obligation		(13,018	)		—
Proceeds from exercise of stock options		13,532			14,511
Proceeds from shares issued under the employee stock purchase plan		35,939			24,524
Excess tax benefit from exercise of stock options		25,654			—
Proceeds from exercise of stock options		95,505			196,404
Net cash provided by financing activities		39,186			9,447
Excess tax benefit from exercise of stock options		—			205,283
Net decrease in cash and cash equivalents		(2,055,688	)		(429,111	)
Net cash provided by financing activities		118,426			426,211
Net increase (decrease) in cash and cash equivalents		(6,408,186	)		753,708
Cash and cash equivalents:
Beginning of year		31,326,804			30,768,694
Beginning of period		21,224,178			31,326,804
End of year	$	29,271,116		$	30,339,583
End of period	$	14,815,992		$	32,080,512
Supplemental disclosures of cash flow information:
Cash paid for interest	$	—3,929		$	~~214~~—
Supplemental disclosures of noncash financing activities:
Supplemental disclosures of noncash financing and investing activities:
Cancellation of unvested stock options		—		$	320,984
Purchase of fixed assets under capital leases	$	72,167		$	—
Tax effect of stock option exercises		—			279,126

See notes to financial statements.

Notes to Financial Statements

1. Organization of Business and Summary of Significant Accounting Policies

Description of Business — Celebrate Express, Inc. (the “Company”), a Washington corporation, is a provider of celebration products for families with ~~young~~ children, via the Internet and catalogs. The Company’s ~~operates~~primary ~~two~~ brands, are Birthday Express ~~and Costume Express~~, which ~~respectively offer~~offers children’s party products, and Costume Express, which features children’s and family costumes and accessories. Another brand, Storybook Heirlooms, was phased out during fiscal 2007. The Company ~~began~~ ~~winding~~also ~~down~~sells ~~the~~everyday ~~operations~~party supplies ofand ~~its~~seasonal ~~Storybook~~party ~~Heirlooms~~goods. ~~brand~~The inCompany ~~the~~sells ~~first~~both ~~quarter~~products ofit ~~fiscal~~produces and products that ~~2007~~it purchases for resale.

Basis of Presentation — Management has prepared the accompanying financial statements in accordance with the accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities Exchange Commission (the “SEC”). The financial information as of ~~August~~February 3129, ~~2006~~2008 and for the ~~three-~~fiscal quarters and nine month periods ended ~~August~~ February 3129, ~~2006~~2008 and ~~August~~February 3128, ~~2005~~2007 is unaudited. In the opinion of management, such information contains all adjustments, consisting of normal, recurring accruals, necessary for a fair presentation of the results for such periods. The results of operations for such interim periods are not necessarily indicative of the expected results of operations for the full fiscal year. These financial statements and related notes should be read in connection with the Company’s Notes to Financial Statements contained in the Company’s Annual Report on Form 10-K filed for the year ended May 31, ~~2006~~2007. ~~The~~Certain ~~balance~~information ~~sheet~~and atnote disclosures ~~May 31,~~normally ~~2006~~included ~~has~~in ~~been~~financial ~~derived~~statements ~~from~~prepared ~~the~~in ~~audited~~accordance ~~financial~~with generally ~~statements~~accepted ataccounting ~~that~~principles ~~date,~~have ~~but~~been ~~does~~condensed ~~not~~or ~~include~~omitted ~~all~~pursuant ofto the ~~information~~rules and ~~footnotes required by~~regulations ~~accounting~~of ~~principles generally accepted in~~ the ~~United States of America for complete financial statements~~SEC.

New ~~accounting~~Accounting ~~pronouncements~~Pronouncements — OnIn ~~December~~July 162006, ~~2004,~~ the ~~Financial Accounting Standards Board (~~FASB) issued ~~Statement~~Interpretation ~~of Financial Standard~~ No. ~~123 (revised 2004)~~48, ~~Share-Based Payment (“FAS~~ ~~123R”)~~Accounting ~~which~~for ~~requires~~Uncertainty ~~all~~in ~~entities~~Income toTaxes ~~recognize~~— ~~compensation expense in~~ an ~~amount~~interpretation ~~equal to the fair value~~ of ~~share-based~~FASB ~~payments,~~Statement ~~such~~No. 109 ~~as stock options granted to employees~~(“FIN 48”). WeThis ~~adopted~~interpretation ~~FAS~~clarifies ~~123R during~~ the ~~first~~accounting ~~quarter~~for ofuncertainty ~~fiscal~~in ~~2007.~~income Wetaxes ~~have~~recognized ~~elected~~in toan enterprise’s ~~apply~~financial ~~FAS~~statements ~~123R~~in onaccordance awith ~~modified prospective~~FAS ~~method~~No. ~~Under this method~~ 109, weAccounting ~~apply~~for ~~the~~Income ~~fair~~Taxes. ~~value~~This interpretation ~~method~~prescribes ina ~~fiscal~~recognition ~~2007~~threshold and domeasurement ~~not restate~~attribute ~~prior periods. Further, compensation expense~~ for ~~existing grants will be recorded for~~ the financial ~~unvested~~statement ~~portion~~recognition ofand ~~the~~measurement ~~fair value compensation expense~~ of ~~those~~a ~~grants~~tax ~~over~~position ~~the~~taken ~~remaining~~or ~~vesting periods.~~expected Weto ~~believe~~be ~~that~~taken ~~the compensation expense we recognize~~ in ~~fiscal~~a ~~2007 will increase~~tax ~~substantially~~return. ~~from~~This ~~what~~interpretation wealso ~~have~~provides ~~historically~~guidance ~~disclosed~~on asderecognition, ~~proforma~~classification, ~~compensation~~interest ~~expense under the~~and ~~fair value method~~penalties, ~~primarily~~accounting ~~due to the increased number of option grants issued~~ in ~~fiscal~~interim ~~2007. Also~~periods, ~~FAS~~disclosure, ~~123R~~and ~~requires~~transition. usWe toadopted ~~reflect~~ the ~~tax~~provisions ~~savings resulting from tax deductions in excess~~ of ~~expense~~FIN ~~reflected~~48 inon ~~our~~June 1, ~~financial~~2007. ~~statements~~The asadoption aof ~~financing~~this ~~cash~~statement ~~flow,~~did ~~which~~not ~~may~~ have aan ~~material~~ impact on our ~~future~~results ~~reported~~of operations ~~cash~~or ~~flows~~financial ~~from operating activities~~condition.

In ~~July~~September 2006, the FASB issued ~~Interpretation~~Statement ~~No. 48, Accounting for Uncertainty in Income Taxes — an interpretation~~ of ~~FASB~~Financial ~~Statement~~Accounting Standards No. ~~109~~157, Fair Value Measurements (“~~FIN~~FAS 48157”). ~~This~~FAS ~~interpretation~~157 ~~clarifies~~establishes ~~the accounting~~a ~~for~~common ~~uncertainty~~definition infor ~~income~~fair ~~taxes~~value, ~~recognized in an enterprise’s financial statements in~~establishes ~~accordance~~a ~~with~~framework ~~SFAS No. 109, Accounting~~ for ~~Income~~measuring ~~Taxes.~~fair ~~This~~value, ~~Interpretation prescribes a recognition threshold~~ and ~~measurement~~expands ~~attribute~~disclosure ~~for~~about ~~the~~such ~~financial~~fair ~~statement~~value ~~recognition and~~measurements. ~~measurement~~FAS of157 ais ~~tax~~effective ~~position~~for ~~taken~~fiscal oryears ~~expected~~beginning toafter beNovember 15, ~~taken in a tax return~~2008. ~~This~~We ~~Interpretation also~~will ~~provides~~apply this guidance onbeginning ~~derecognition~~June 1, ~~classification,~~2009. ~~interest~~We ~~and~~do ~~penalties,~~not ~~accounting~~expect ~~in interim~~that ~~periods,~~the ~~disclosure, and~~adoption ~~transition.~~of ~~FIN~~this 48statement will behave ~~effective for our fiscal year ending May 31, 2008. The Company~~a ismaterial ~~currently evaluating the~~ impact ~~of FIN 48~~ on ~~its~~our results of operations ~~and~~or financial condition.

~~Use~~In February 2007, the Financial Accounting Standards Board issued Statement of ~~Estimates~~Financial Accounting —Standards No. 159, The ~~preparation~~Fair ofValue ~~financial~~Option ~~statements~~for inFinancial ~~conformity~~Assets ~~with~~and ~~accounting~~Financial Liabilities, ~~principles~~(“FAS ~~generally~~159”). ~~accepted~~FAS in159 ~~the~~permits ~~United~~entities ~~States~~to ofchoose ~~America~~to ~~requires~~measure ~~management~~many tofinancial ~~make~~instruments ~~estimates~~ and ~~assumptions~~certain other items at fair value that ~~affect~~are ~~the~~not ~~reported~~currently ~~amounts~~required ofto ~~assets~~be ~~and~~measured ~~liabilities~~at ~~and~~fair ~~disclosure~~value. ofFAS 159 ~~contingent~~also ~~assets~~establishes presentation and ~~liabilities~~disclosure atrequirements ~~the~~designed ~~date~~to offacilitate ~~the~~comparisons between ~~financial~~entities ~~statements~~that ~~and~~choose ~~the~~different ~~reported~~measurement ~~amounts~~ attributes for similar types of ~~revenues~~assets and liabilities. ~~expenses~~FAS ~~during~~159 ~~the~~is ~~reporting~~effective ~~period.~~for ~~Some~~fiscal ofyears ~~the~~beginning ~~more~~after ~~significant~~November 15, ~~estimates include~~2007. ~~allowance~~We ~~for~~will ~~sales~~apply this ~~returns~~guidance beginning June 1, ~~lower~~2008. ofWe ~~cost~~do ornot ~~market~~expect ~~adjustments~~that tothe ~~inventory~~adoption ~~and~~of ~~deferred~~this statement will ~~income~~have ~~taxes.~~a ~~Actual~~material impact on our results ~~could~~of ~~differ~~operations ~~from~~or ~~those~~financial ~~estimates~~condition.

~~Summary~~In ofDecember 2007, ~~significant~~the ~~accounting~~Financial ~~policies~~Accounting —Standards ~~The~~Board ~~significant~~issued ~~accounting~~Statement ~~policies~~of ~~used~~Financial Accounting Standards No. 160, Noncontrolling Interests in ~~the~~Consolidated Financial Statements, (“FAS ~~preparation~~160”). ofFAS ~~our~~160 addresses the accounting and financial ~~statements~~reporting ~~are~~for ~~disclosed~~minority interests in consolidated ~~our~~subsidiaries. ~~Annual~~FAS ~~Report~~160 onis ~~Form~~effective ~~10-K~~ for ~~the year~~fiscal ~~ended~~years ~~May 31~~beginning on or after December 15, ~~2006.~~2008, ~~Updates~~with toearlier ~~our~~adoption ~~significant~~prohibited. ~~accounting~~We ~~policies~~will ~~for~~apply ~~fiscal~~this ~~2007~~guidance ~~include~~beginning June 1, 2009. ~~accounting~~We ~~for~~do ~~share-based~~not ~~payment~~expect ~~under~~that ~~FAS~~the ~~123R~~adoption asof ~~discussed~~this ~~above,~~statement ~~and~~will inhave ~~footnote~~a 5material ~~below~~impact on our results of operations or financial condition.

2. Use ~~Inventories~~of Estimates — 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

Inventories are stated at the lower of market or weighted-average cost on a first-in first-out basis. The Company writes down inventory for estimated obsolescence or damage for the excess cost of the inventory over estimated market value based upon assumptions about future demand and market conditions.

reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of the more significant estimates include allowance for sales returns, lower of cost or market adjustments to inventory and deferred income taxes. Actual results could differ from those estimates.

Summary of significant accounting policies — The significant accounting policies used in the preparation of our financial statements are disclosed in our Annual Report on Form 10-K for the year ended May 31, 2007.

2. Inventories

The components of inventories were as follows:

	August 31, 2006		May 31, 2006
	February 29, 2008		May 31, 2007
Finished goods	$	9,~~896~~925,~~155~~687	$	78,~~986~~706,~~237~~354
Raw materials		~~400~~214,~~719~~162		~~347~~332,~~267~~675
	$	10,~~296~~139,~~874~~849	$	89,~~333~~039,~~504~~029

3. Income Per Share

Basic net income (loss) per share is based on the weighted-average number of common shares outstanding. Diluted net income (loss) per share is based on the weighted number of common shares ~~and~~ and common share equivalents outstanding. Common shares and common share equivalents included in ~~the~~ the computation represent shares issuable upon assumed exercise of outstanding stock options, ~~except~~ except when the effect of their inclusion would be antidilutive.

The following table sets forth the computation of basic and diluted net income (loss) per share:

	Three Months Ended						Nine Months Ended
	August 31, 2006			August 31, 2005
	February 29, 2008			February 28, 2007			February 29, 2008			February 28, 2007
Net income (loss)	$	(~~325~~12,~~979~~973,599	)	$	~~700~~(137,~~013~~378	)	$	(13,120,458	)	$	104,657
Weighted average common shares outstanding		7,~~789~~979,~~480~~199			7,~~528~~858,~~983~~484			7,970,749			7,821,698
Basic net income (loss) per share	$	(01.0463	)	$	(0.0902	)	$	(1.65	)	$	0.01
Common share equivalents:
Dilutive effect of common stock options		—			~~430,016~~—			—			129,084
Weighted average common shares and common share equivalents		7,~~789~~979,~~480~~199			7,~~958~~858,~~999~~484			7,970,749			7,950,782
Diluted net income (loss) per share	$	(01.0463	)	$	(0.0902	)	$	(1.65	)	$	0.01

The following is a summary of the weighted average securities during the respective periods that have been excluded from the calculation because the effect on net income (loss) per share would be antidilutive:

Three Months Ended

Nine Months Ended

August 31, 2006

August 31, 2005

February 29, 2008

February 28, 2007

February 29, 2008

February 28, 2007

Restricted stock

9,824

—

Unvested restricted stock

3,794

5,886

2,868

1,003

Common stock options

~~458~~712,~~921~~629

~~138~~601,~~193~~961

671,404

602,783

4. Brand Revenues

The following table provides detail of our revenues by brand:

	Three months ended
	Three Months Ended				Nine Months Ended
	August 31, 2006		August 31, 2005
	February 29, 2008		February 28, 2007		February 29, 2008		February 28, 2007
Birthday Express	$	1712,~~947~~362,~~188~~009	$	15,~~571~~694,~~783~~759	$	42,323,477	$	49,528,409
Storybook Heirlooms		1,041,444		1,301,020
Costume Express		407,806		338,945		18,596,248		13,066,015
Costume Express		953,147		1,054,901
Holiday		331,571		—		577,782		—
Total Revenue	$	19,941,779	$	17,927,704
Storybook Heirlooms		—		467,048		—		2,150,655
Total Brand Revenue	$	13,101,386	$	16,500,752	$	61,497,507	$	64,745,079

In the fiscal quarter and nine month period ended February 29, 2008, the Company also had approximately $188,000 and $677,000 in other revenue, respectively. In the fiscal quarter and nine month period ended February 28, 2007, the Company had approximately $180,000 and $389,000 in other revenue, respectively.

5. Stock Based Compensation

Equity Incentive Plan — Our 2004 Amended and Restated Equity Incentive Plan (the “2004 Plan”) permits the grant of options to directors, officers, employees, consultants, and advisors. Options may be either incentive stock options or nonqualified stock options. The 2004 Plan also permits the grant of stock bonuses and rights to purchase restricted stock. There were ~~375,385~~ 434,339 shares remaining for future grant under the 2004 Plan as of ~~August~~February 3129, ~~2006~~2008. Generally, options vest at the rate of 25% on the first anniversary of the grant and 25% each successive year until fully vested. Options granted under the 2004 Plan are exercisable over a period of time, generally either 7 or 10 years, designated by the Company’s Board of Directors and are subject to other terms and conditions as determined by the Board. When a stock award expires or is terminated before it is exercised, the shares become available for issuance under the 2004 Plan.

7 Employee Stock Purchase Plan — Effective in October 2004, the Company adopted an Employee Stock Purchase Plan (the “ESPP”). Eligible employees may purchase common stock for a purchase price per share that is equal to 85% of the fair market value of a share on the offering date for the applicable offering period, or if lower, the fair market value of a share on the applicable purchase date in such a period. During the nine month period ended February 29, 2008, employees purchased 4,515 shares of our common stock under the ESPP in exchange for approximately $36,000.

~~Table~~Stock ofCompensation ~~Contents~~Expense

~~subject~~ We toaccount ~~other~~for ~~terms~~the 2004 Plan and ~~conditions~~the asESPP ~~determined~~under the recognition and measurement principles of byFASB Statement No. 123 (revised 2004), Share-Based Payment (“FAS 123R”), which requires measurement of compensation cost for all stock-based awards at fair value on the ~~Board~~date of grant and recognition of compensation over the service period for awards expected to vest. ~~When~~The afair value of stock-based awards is determined using the Black-Scholes option pricing model using the single option award approach. ~~expires~~This orfair value is ~~terminated~~then ~~before~~amortized iton isa ~~exercised~~straight-line basis over the requisite service periods of the awards, which is generally the ~~shares~~vesting ~~become~~period. As required by FAS 123R, management ~~available~~makes an estimate of expected forfeitures, and we are recognizing compensation costs only for ~~issuance~~those equity ~~under~~awards expected to vest. The estimation of stock awards that will ultimately vest requires judgment, and to the ~~2004~~extent ~~Plan~~actual results or updated estimates differ from our current estimates, we will record such amounts retrospectively as an increase or decrease in stock-based compensation in the period we revise the estimates. We consider many factors when estimating expected forfeitures, including historical voluntary termination behavior and actual option forfeitures. Actual results, and future changes in estimates, may differ substantially from our current estimates.

~~Employee~~As ~~Stock~~of ~~Purchase Plan — Effective in October~~February ~~2004~~29, ~~the~~2008, ~~Company adopted an Employee Stock Purchase Plan (~~the ~~“ESPP”).~~total ~~Eligible~~compensation ~~employees~~cost ~~may~~related ~~purchase~~to ~~common~~unvested ~~stock~~options ~~for a~~and ~~purchase~~restricted ~~price~~stock ~~per~~units ~~share~~granted ~~that is equal~~ to ~~85%~~employees oftotaled ~~the~~$2.4 million, ~~fair~~inclusive ~~market value~~ of ~~a share on the offering~~estimated ~~date~~forfeitures. ~~for~~This ~~the~~cost ~~applicable~~will ~~offering~~be ~~period,~~amortized oron ifa ~~lower,~~straight-line ~~the~~basis ~~fair~~over ~~market value of~~ a ~~share~~weighted-average onperiod ~~the~~of ~~applicable purchase date in such a period~~1. ~~During the three months ended August~~4 ~~31,~~years ~~2006,~~and ~~there were~~will nobe ~~common~~adjusted ~~stock~~for ~~purchases~~estimated ~~under the ESPP plan~~forfeitures.

Adoption of FASB Statement No. 123 (revised 2004)

Prior to June 1, 2006, we accounted for the 2004 Plan and the ESPP under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related Interpretations, as permitted by Financial Accounting Standards Board (FASB) Statement No. 123, Accounting for Stock-based Compensation (FAS 123). Under APB 25, no compensation expense was recognized when the exercise price of employee stock options equaled the fair value of the underlying stock on the date of grant. Deferred stock-based compensation was recorded for those situations where the exercise price of an option was lower than the fair value for financial reporting purposes of the underlying common stock on the date of grant. Deferred stock-based compensation was being amortized over the vesting period of the underlying options and the remaining balance of $213,000 was reversed against stockholders’ equity on June 1, 2006.

Effective June 1, 2006, we adopted the fair value recognition provisions of FAS 123R using the modified-prospective-transition method, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation over the service period for awards expected to vest. Under the modified-prospective-transition method, compensation cost recognized in fiscal 2007 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of June 1, 2006, which is based on the grant date fair value estimated in accordance with the original provisions of FAS 123, recognized over the vesting period of the underlying options, (b) compensation cost for all share-based payments granted after June 1, 2006, which is based on the grant-date fair value estimated in accordance with the provisions of FAS 123R, recognized over the requisite service period of the award on a straight-line basis, and (c) compensation cost for shares issued under the ESPP, which is based on the fair value estimated in accordance with the provisions of FAS 123R and is not considered material to our overall financial statements. In accordance with the modified-prospective-transition method, results for the three months ended August 31, 2005 have not been restated to reflect, and do not include, the impact of FAS 123R.

Determining Fair Value

We calculate the fair value of our stock options granted to employees using the Black-Scholes option pricing model using the single option award approach. This fair value is then amortized on a a straight-line basis over the requisite ~~service periods of the awards, which is generally the~~ ~~vesting period. The following weighted-average assumptions were used to compute fair value of the stock options granted for the three months ended August 31, 2006 and August 31, 2005:~~

	Three Months Ended
	August 31, 2006			August 31, 2005
Expected volatility		60.5	%		60.7	%
Expected term (in years)		5.9			4.0
Risk-free interest rate		5.1	%		3.8	%
Expected dividend		0	%		0	%
Weighted-average fair value	$	7.31		$	6.88

Expected Volatility. Our computation of expected volatility for the first quarter of fiscal 2007 is based on the limited historical volatility of our common stock and the experience of what we believe are peer companies based on the similar nature of our industry and option plan characteristics. We have used a volatility factor that considers the historical experience of these peer companies using a period commensurate with the expected life of the award.

Expected Term. Our expected life in fiscal 2007 was calculated using the simplified method outlined by SEC Staff Accounting Bulletin No. 107 (SAB 107). Under this method, our expected term is equal to the sum of the weighted

~~average~~service ~~vesting~~periods ~~term~~of ~~plus~~the awards, which is generally the ~~original~~vesting ~~contractual~~period. ~~term~~The ~~divided~~following byweighted-average ~~two.~~assumptions ~~Prior~~were used to ~~fiscal~~compute ~~2007,~~fair ~~our~~value ~~computation~~ of ~~expected~~the ~~life~~stock ~~was~~options ~~based~~granted onfor ~~vesting~~the three- ~~schedules~~ and ~~historical~~ ~~experience~~nine ofmonth ~~options~~periods ~~exercised.~~ended February 29, 2008 and February 28, 2007:

Risk- Free Interest Rate. We base the risk-free interest rate on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent term to the expected life of the award.


	Three months ended						Nine months ended
	February 29, 2008			February 28, 2007			February 29, 2008			February 28, 2007
Expected volatility		47.4	%		47.2	%		47.2	%		58.9	%
Expected term (in years)		4.6			4.6			4.6			5.7
Risk-free interest rate		2.5	%		4.8	%		3.3	%		5.1	%
Expected dividend		0	%		0	%		0	%		0	%
Weighted-average fair value	$	2.88		$	5.34		$	3.69		$	7.08

Expected Dividend. A dividend yield of 0% was considered appropriate as we have not issued and do not anticipate issuing dividends in the near future.

When estimating forfeitures, we considered historical termination behavior, in addition to analyzing actual option forfeitures. Our forfeiture rate is based on the weighted average termination behavior our employees and board members, which is approximately 10.9%. This forfeiture rate was applied to all options granted subsequent to June 1, 2006 and to the carryover amount for options granted prior to, but not vested as of June 1, 2006. Prior to adoption of FAS 123R, we recognized the impact of forfeitures when they occurred.

Stock Compensation Expense

We recognized stock-based compensation totaling $279,000 for the three months ended August 31, 2006. Our incremental stock-based compensation expense resulting from the adoption of FAS 123R totaled $235,000, which excludes stock-based compensation of $44,000 that would have been recognized prior to adoption for options granted with an exercise price below the market value on the date of grant. The adoption of FAS 123R increased our net loss by $215,000 and our basic and diluted net loss per share by $0.03. As required by FAS 123R, management made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest. Prior to June 1, 2006, we recognized stock-based compensation under the provisions of APB 25 and FAS 123 for options granted with exercise prices below market value on the date of grant. Such compensation expense totaled $60,000 for the three months ended August 31, 2005.

As of August 31, 2006, the total compensation cost related to unvested options and restricted stock units granted to employees totaled $3.3 million, inclusive of estimated forfeitures. This cost will be amortized on a straight-line basis over a weighted-average period of 1.8 years and will be adjusted for estimated forfeitures.

Stock Option Activity

Additional information regarding ~~options~~stock ~~outstanding~~option asactivity offor ~~August~~the nine-month period ended February 3129, ~~2006~~2008 is as follows:

						Weighted-
				Weighted-		average
				average		remaining		~~Aggregate~~
				exercise		contractual		~~Intrinsic Value~~Aggregate
	Shares			price		term		~~(in~~Intrinsic ~~thousands)~~Value
Outstanding at June 1, 2006		512,260		$	9.33
Outstanding at June 1, 2007		717,746		$	12.07
Granted		~~371~~216,~~492~~872			128.0925
Exercised		(1322,~~245~~308	)		14.1128
Cancelled or expired		(37109,~~843~~359	)		1311.8192
Outstanding at August 31, 2006		832,664			10.40		8.30	$	2,453
Outstanding at February 29, 2008		802,951		$	11.26		8.41	$	36,705
Exercisable at August 31, 2006		261,316			6.05		6.03	$	1,905
Exercisable at February 29, 2008		306,676		$	12.43		7.64	$	36,849

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the market price of our common stock for the shares subject to ~~options~~ options that were in-the-money at ~~August~~February 3129, ~~2006~~2008.

~~During~~Certain ~~fiscal 2006, certain~~ employees ~~were~~are granted restricted stock unit awards pursuant to the ~~Company’s~~ 2004 ~~Amended~~Plan. ~~and~~As ~~Restated~~of May 31, ~~Equity~~2007 ~~Incentive~~there ~~Plan.~~were A2,800 ~~total~~shares ofoutstanding 10and unvested. In fiscal 2008,~~600~~ an additional 3,000 shares were granted and were valued at the closing stock price of $119.9807 on the date of grant. During the ~~quarter~~ ~~ended~~nine ~~August 31~~months fiscal 2008, ~~2006~~1,250 ~~750~~ shares vested and 1,~~700~~175 shares were forfeited. As of ~~August~~ February 3129, ~~2006~~ 2008 there were 83,~~150~~375 unvested shares outstanding ~~and unvested~~. ~~There were no additional grants of~~ ~~restricted stock units during the quarter ended August 31, 2006.~~

6. Income Taxes

We record income taxes using the asset and liability method in accordance with SFAS No. 109, Accounting for Income Taxes. Deferred income taxes are recognized for temporary differences — the differences between the GAAP financial statement carrying amounts of assets and liabilities and those required for use in the tax return. The tax effect of these temporary differences are reported as deferred income tax assets and liabilities on the balance sheet, measured using enacted laws and income tax rates that are currently in effect.

In accordance with the Financial Accounting Standards Board’s Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, the Company has evaluated its deferred tax assets quarterly to determine if valuation allowances were required, and determined in prior periods during fiscal 2007 and fiscal 2008 that a valuation allowance was not necessary for its deferred tax assets. SFAS No. 109 requires that companies assess whether valuation allowances should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. A company’s current or previous losses are given more weight than its future outlook, and a recent three-year historical cumulative loss is considered a significant factor that is difficult to overcome for purposes of this analysis.

~~Pro~~ Based upon these SFAS No. 109 guidelines, we determined that a valuation allowance should now be established due to more recent events and developments during the third quarter fiscal 2008. While we believe that our long-~~forma~~term ~~Disclosures~~financial outlook remains positive, we concluded that our ability to rely on our long-term outlook as to future taxable income was limited due to uncertainty created by the weight of the negative evidence, particularly the Company’s three-year historical cumulative loss in the third quarter fiscal 2008, the recent and anticipated near term effects associated with the efforts to improve Company systems and staffing and the more challenging near-term economic conditions. Accordingly, based on our current circumstances and uncertainty regarding our future taxable income, we have recorded a full valuation allowance against these deferred tax assets during the third quarter fiscal 2008. If and when our operating performance improves on a sustained basis, our conclusion regarding the need for a full valuation allowance could change, resulting in the reversal of some or all of the valuation allowance in the future. This non-cash charge of approximately $8.2 million is reported as income tax expense for the third quarter fiscal 2008.

~~The~~As ~~following~~of ~~table~~February 29, ~~illustrates~~2008, the ~~effect~~Company onhad ~~net~~approximately $24.1 million in operating loss carryforwards for federal income tax purposes, which expire in varying amounts between 2020 and 2026, ~~net~~if unused. In addition, the Company has approximately $2.5 million of operating loss carryforwards for state income ~~per~~tax ~~share~~purposes, ~~had~~which weare scheduled to expire in varying amounts ~~applied~~between 2016 and 2021, if unused. Under the ~~fair~~Internal ~~value~~Revenue ~~recognition~~Code, ~~provisions~~the amounts of ~~FAS~~and ~~123~~benefits from net operating loss and tax credit carryforwards may be impaired or limited in certain circumstances. Events which could cause limitations in the amount of net operating losses that the Company may utilize in any one year, include, but are not limited to, ~~options~~a ~~granted~~cumulative ~~under~~ownership ~~our~~change of ~~2004~~more ~~Plan~~than ~~and~~50%, as defined, over a three year period. The Company evaluates whether changes in its stock ownership have resulted in annual limitations to the utilization of our ~~ESPP~~deferred ~~for~~tax assets. ~~all~~In ~~periods~~addition, ~~presented~~realization is dependent on generating sufficient taxable income prior to ~~June 1,~~the expiration ~~2006~~of the loss carryforwards.

	Three Months Ended
	August 31, 2005
Net income, as reported	$	700,013
Add: Stock-based employee compensation expense, as reported	$	60,060
Deduct: Stock-based employee compensation expense determined under the fair-value-based method		(109,469	)
Pro forma net income	$	650,604
Total weighted average shares outstanding in computing pro forma net income per share
Basic		7,528,983
Diluted		7,881,034
Net income per share:
Basic — as reported	$	0.09
Diluted — as reported	$	0.09
Basic — SFAS No. 123 pro forma	$	0.09
Diluted — SFAS No. 123 pro forma	$	0.08

In June 2006, the FASB issued FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN 48”) to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies income tax accounting by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting for interim periods, disclosure and transition, and clearly excludes uncertainty in income taxes from guidance prescribed by FASB No. 5, Accounting for Contingencies. We adopted the provisions of FIN 48, on June 1, 2007. The adoption had no impact on our financial condition or results of operations. There were no unrecognized tax benefits under FIN 48 as of June 1, 2007 or February 29, 2008.

~~Disclosure~~ The ~~for~~Company ~~the~~has ~~three~~adopted ~~months~~a ~~ended~~policy ~~August 31,~~whereby ~~2006~~penalties isincurred ~~not~~in ~~presented~~connection ~~because~~with ~~stock-based~~tax matters ~~payments~~will ~~were~~be ~~accounted~~classified ~~for~~as ~~under~~general ~~the~~and ~~fair~~administrative ~~value~~expenses, ~~method~~and ofinterest ~~FAS~~assessments ~~123R~~incurred in connection with tax matters will be classified as interest expense. No tax-related interest or penalties were recognized during ~~this~~the ~~period~~nine months February 29, 2008.

6 Tax years that remain open for examination by federal and state taxing authorities include fiscal 2004 through fiscal 2008. ~~Storybook~~In ~~Heirlooms~~addition, ~~Brand~~previous tax years may be subject to examination to the extent that the Company utilizes the NOLs from those years in its current year or future years’ tax returns.

On June 5, 2006, the Board of Directors of the Company authorized and directed management to immediately begin an orderly wind-down of its Storybook Heirlooms brand. The wind-down of Storybook Heirloom’s operations is in process and is expected to continue through the first 9 to 11 months of fiscal 2007. As of August 31, 2006, the Company has incurred all anticipated charges in connection with this closure of approximately $356,000, which includes approximately $30,000 in severance costs and $130,000 in contract termination charges and related costs.

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

The following discussion should be read in conjunction with our financial statements and the related notes contained elsewhere in this quarterly report on Form 10-Q as well as the audited financial statements and the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our annual report of on Form 10-K ~~filed~~ for ~~our~~the fiscal year ended May 31, ~~2006~~2007 filed with the SEC on August 17, 2007. ~~All~~This discussion and analysis contains “forward-looking statements” that involve risk, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in ~~the~~these ~~following~~forward-looking ~~discussion~~statements as ~~that~~a ~~are~~result of many factors, including, but not ~~reports~~limited to, general economic factors, successful execution of ~~historical~~our ~~information~~business orplans, ~~descriptions~~the impact of ~~current~~competition, ~~accounting~~the ~~policy~~effect ~~are~~of regulation and legal ~~forward-looking~~proceedings, ~~statements~~and others described in the “Risk Factors” section of our fiscal 2007 Form 10K and elsewhere in this report. Readers are urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the financial statements and the related notes contained elsewhere in this quarterly report, “Risk Factors” set forth in Part II—Item 1A of this ~~Form~~quarterly report and disclosures included in our annual report on Form 10-QK ~~and~~for the fiscal year ended May 31, 2007, including the audited financial statements and the notes thereto, ~~and~~“Risk ~~disclosures~~Factors,” ~~made under the~~and ~~captions~~ “Management’s Discussion and Analysis of Financial Condition and Results of Operations,.” ~~“Financial Statements,” and “Notes to Financial Statements,” included in annual report of Form 10-K filed for our fiscal year ended May 31, 2006.~~

Business developments

During fiscal 2007, the Company engaged in an eight month process, concluded in May 2007, to review strategic alternatives, including the possible sale of the Company. The conclusion of the strategic review permitted the Company to return its focus to business improvements.

Company management has determined that certain improvements to the Company’s systems and processes are essential to the business. We have pursued these improvements on an accelerated schedule in fiscal 2008. During the first three quarters of fiscal 2008, these business improvement efforts have resulted in increased costs and some short-term adverse effects on customers. Additionally, focusing on these important initiatives has led to distractions from other matters and to some execution issues. While pressuring short-term results, this important work is expected to produce future benefits through increased sales and cost efficiencies commencing in fiscal 2009.

The Company has achieved significant progress on a number of these initiatives during fiscal 2008:

	•		A new warehouse management system was implemented during the third quarter fiscal 2008, to better manage and track our distribution center operations and inventory,

	•		A new off-site data center was established with upgraded hardware and software during the third quarter fiscal 2008, to provide a more reliable and scalable operating and development environment, and we commenced the migration of applications to this data center,

	•		A data warehouse was established on new hardware and software,

	•		Our customer database was moved to the new data warehouse, and

	•		We recruited personnel to fill key positions, including our chief financial officer (January 2008) and our vice president, marketing (completed March 2008).

We also have sought to leverage our customer database, marketing and operating resources to increase sales outside of our core Birthday Express brand:

	•		We increased our marketing expenditures and merchandise purchases for the Costume Express brand, particularly for the 2007 Halloween season, to support increased sales and the addition of new customers, and

	•		A limited Holiday marketing test was conducted for Christmas and other seasonal merchandise during the second and third quarters of fiscal 2008.

Other initiatives are in earlier stages of assessment or implementation and are priorities for our fourth quarter and for fiscal 2009:

	•		Further integration of our new warehouse management system with our shipping manifest and enterprise systems,

	•		Selection and implementation of analytical tools to use with the new data warehouse,

	•		Installation and implementation of the new telephone system for our call center and general corporate operations,

	•		Migration of remaining legacy operations to the new data center,

	•		Design, development and implementation of a next generation website, and

	•		Recruitment of currently open key positions, including our vice president, merchandising.

The implementation of the new warehouse management system was a huge effort that we sought to complete in a relatively short time. During this implementation effort, we incurred extra fulfillment labor costs and extra shipping costs in order to minimize delivery delays and other adverse effects on customers. The implementation of our new data center and data warehouse also were significant initiatives that we sought to do rapidly in order to increase the reliability and stability of these resources. These efforts have resulted in additional costs for consultants, labor and depreciation. Management believes these necessary business improvement efforts sometimes had a short-term adverse effect on our customer service, and therefore in our third quarter, we introduced our new “Customer First!” initiative to reemphasize our focus on the customer in our day to day operations and our process improvements.

On April 9, 2008, the Company disclosed that it has been approached by third parties regarding a possible merger or acquisition involving the Company and that the Company has engaged a financial advisor in connection with these discussions. It is our objective, where possible, to complete this effort on an expeditious basis in order to minimize the potential distraction and disruption to our ongoing business and to our business improvement efforts.

Overview

Celebrate Express is a leading provider of celebration products serving families with young children via the Internet and catalogs. We offer a broad assortment of proprietary and third party children’s party products and children’s and family costumes, complemented by a wide variety of accessories. Our centralized inventory management maximizes product availability and allows us to customize our product assortment to meet specific customer needs. We have designed our business infrastructure to share distribution, customer support, marketing, and technology resources across our brands. Our goal is to help busy ~~parents~~families celebrate the special moments in their ~~children’s~~ lives.

We review our operations based on our financial results and various non-financial measures. We focus on several financial factors including net sales per order, gross margin, growth in net sales and the percentage of our sales generated by repeat customers. Among the key non-financial measures upon which we focus in reviewing performance are the frequency of purchase by our customers and the number of new customers added to our database.

To date, we have derived our revenue primarily from the sale of party related products and costumes from our ~~Birthday Express~~ website and ~~catalog~~catalogs. For the ~~three~~third ~~months~~quarter ~~ended~~fiscal ~~August 31~~2008, ~~2006,~~ we generated $1913.93 million in net sales, a andecrease ~~increase~~ of 1120.23% from $1716.97 million in the ~~three~~same ~~months~~period ~~ended~~last ~~August 31, 2005~~year. Our gross margin (our gross profit as a percentage of net sales) ~~declined~~decreased ~~slightly~~ to 5045.14% in the ~~three~~third quarter fiscal 2008 from 54.5% in the same period last year. For the third quarter fiscal 2008, our net loss before taxes was $4.8 million, compared with a net loss before income taxes of $202,000 in the same period last year. For the nine months ~~ended~~fiscal ~~August~~2008, we generated $62.2 31million in net sales, ~~2006~~a decrease of approximately 4.5% from 50$65.31 million in the same period last year. Our gross margin increased to 51.9% in the ~~three~~nine months ~~ended~~fiscal ~~August 31,~~2008 ~~2005~~from 51.3% ~~For~~in the ~~three~~same period last year. For the nine months ~~ended~~fiscal ~~August 31~~2008, ~~2006,~~we ~~our~~had a net loss before income taxes ~~was~~of $~~358~~5.0 million,~~000,~~ compared with ~~income~~net income before income taxes of $~~1.1 million~~200,000 in the ~~three~~same ~~months~~period ~~ended~~last ~~August 31, 2005~~year.

InWe ~~fiscal~~believe ~~2006,~~that wethe ~~installed~~decline ~~pick-to-light~~in ~~technology~~revenue in the ~~distribution~~third ~~center~~quarter tofiscal ~~pick~~2008 ~~Birthday Express~~resulted ~~orders.~~primarily ~~This~~from ~~investment,~~a combination ~~together~~of ~~with~~(1) intentional ~~the~~reductions ~~departure~~in ofthe a number of ~~company~~catalogs ~~executives~~circulated, to eliminate less ~~have~~productive ~~been~~mailings ~~disruptive~~in response to the ~~distribution~~increased ~~center~~costs for postage, printing and ~~caused~~paper, us(2) tosub-optimal ~~incur~~catalog ~~higher~~circulation ~~than~~selection ~~anticipated fulfillment~~and ~~costs.~~mailing, We(3) customer ~~have~~service ~~also~~issues, ~~observed~~and ~~some~~(4) the ~~erosion~~general weakness in ~~repeat~~consumer ~~buying~~spending ~~rates,~~during ~~which~~the wepast ~~attribute partially~~few months. The Company continues to ~~the~~focus ~~distribution~~on ~~center~~reducing unprofitable ~~problems~~mailings weand ~~have~~reevaluating ~~experienced~~circulation ~~over~~quantities ~~the~~in ~~past~~light ~~year.~~of Ascatalog wepostage, paper ~~anticipate~~and ~~further~~print ~~distribution~~costs. ~~center~~In ~~investments~~third ~~throughout~~quarter fiscal ~~2007~~2008, wecertain ~~expect~~circulation todecisions ~~incur~~and ~~high~~execution ~~costs~~problems ~~through~~resulted ~~the~~in ~~implementation~~catalog ~~period~~mailings ofto ~~the~~a ~~investment~~mix ~~initiatives.~~of Wecustomers ~~recently~~and ~~hired~~prospective acustomers which we ~~vice-president~~believe ofwas ~~operations~~less ~~and~~productive. ~~vice~~Further, ~~president~~we believe that the implementation of ~~information~~our ~~technology~~new ~~and~~warehouse management ~~believe~~system caused various temporary problems that ~~these~~impacted customer service and resulted in ~~additions~~lower tosales and lower gross margins in the ~~management~~third ~~team~~quarter fiscal 2008. Although we expect that certain of these factors will ~~enable~~affect usour results to ~~improve~~some extent in the ~~operations~~remainder of ~~our~~fiscal ~~distribution center~~2008 and future ~~show~~periods, ~~year-over-year~~we ~~improvement~~seek into ~~distribution~~improve ~~expenses~~our assales aand ~~percentage~~improve ofour ~~net~~operating ~~sales beginning~~efficiencies inthrough ~~the~~a number ~~fourth quarter~~ of ~~fiscal~~ongoing ~~2007.~~initiatives including:

~~Comparison~~• Improved analysis of ~~Three~~our ~~Months~~catalog ~~Ended~~circulation ~~August 31~~and online marketing efforts, ~~2006~~facilitated by our new data warehouse and ~~August 31~~the addition of new management and staff in our marketing team, ~~2005~~ • Improved customer service in our distribution and consumer call center, through the completion of our warehouse management system implementation and the expected implementation of our new phone system, • Introducing new products and improving catalog and online merchandising strategies, • Recent and anticipated future hiring of key management and staff,

	•		Implementing selective price changes,

	•		Utilization of the information within our growing customer database to better reach and serve our customers, and

	•		Improvements in our catalog and online marketing messaging.

Our business is somewhat seasonal, with the second quarter typically having a greater percentage of our sales and gross profits as a result of our Halloween costume business, and the third quarter typically having the lowest sales and gross profits as consumers have typically focused more on the holiday season rather than birthday celebrations during November and December.

Primarily as a result of these factors, we had a net loss before income taxes of $4,751,428 in the third quarter fiscal 2008 as compared to a net loss before income taxes of $201,781 in the same period last year. Additionally, in the third quarter fiscal 2008, the Company reevaluated its deferred tax assets and recorded a non-cash charge of approximately $8.2 million for the establishment of a valuation allowance against the deferred tax assets, as described below.

Comparison of the Fiscal Quarters Ended February 29, 2008 and February 28, 2007

Net Sales

Our net sales are comprised of product sales and shipping revenue. Net sales ~~increased~~decreased 1120.23% to $1913.93 million in the ~~three~~third ~~months~~quarter ~~ended~~fiscal ~~August 31,~~2008 ~~2006~~ from $1716.97 million in the ~~three~~same ~~months~~period last year ~~ended~~mainly ~~August 31,~~due ~~2005~~to the factors described above. Total advertising spending for both online and offline direct marketing efforts such as catalog mailings, paid search and affiliate spending was $4.52 million during the ~~first~~third quarter of fiscal ~~2007~~2008, ~~compared~~up ~~with $3~~9.~~4 million~~2% ~~during~~from the ~~first quarter~~same ofperiod ~~fiscal~~last ~~2006~~year, anwhich totaled ~~increase of 32~~$3.6%9 million. The ~~increase~~decrease in net sales in the ~~three~~third ~~months~~quarter ~~ended August 31,~~fiscal ~~2006~~2008 over the same period in ~~2005~~fiscal 2007 reflects ana ~~increase~~decrease of approximately ~~12.9~~13% in the number of orders shipped, which ~~grew~~decreased to approximately ~~247~~178,000 orders in the ~~three~~third ~~months~~quarter ~~ended August 31,~~fiscal ~~2006~~2008 from approximately ~~219~~ 206,000 orders in the ~~three~~same ~~months~~period ~~ended~~in ~~August 31,~~the ~~2005~~prior year. Net sales per order for the ~~three~~third ~~months~~quarter fiscal ~~ended~~2008 ~~August 31, 2006~~ was $8073.8050, compared with net sales per order of $8280.0315 for the ~~three~~same ~~months~~period ~~ending~~last ~~August 31~~year. Our Birthday Express brand had net sales per order of $74.02 in the third quarter of fiscal 2008, down ~~2005~~8.1% from $80.57 in the same period of fiscal 2007. Our Costume Express brand had net sales per order of $65.56 in the third quarter of fiscal 2008, down 6.6% from $70.23 in the same period of fiscal 2007. We added approximately ~~133~~99,000 new customers to our database during the ~~first~~ third quarter, compared with 118,000 new customers added in the same quarter last year, ana ~~increase~~decrease of 13 16%. This brought our total customer database to approximately 3.9 million customers at February 29, 2008. Revenue from our repeat customers represented approximately 4544% of revenue during ~~three~~the ~~months~~third ~~ended~~quarter fiscal ~~August 31~~2008, ~~2006~~which ~~compared~~is consistent with 4744% ~~during~~in the ~~three~~ ~~months~~same ~~ended~~period ~~August 31,~~as ~~2005~~the prior year. Birthday Express net sales ~~increased~~decreased to $1712.94 million in the ~~first~~ third quarter of fiscal ~~2007~~2008 from $15.67 million in the third ~~first~~ quarter of fiscal ~~2006~~2007, ana ~~increase~~decrease of $23.3 million, or approximately 1521%. This decrease reflected a reduction in Birthday Express catalog circulation of approximately 17% from the same quarter in the prior year and the factors described above. Costume Express net sales ~~decreased~~increased to $~~953~~408,000 in the ~~first~~ third quarter of fiscal ~~2007~~2008 from $~~1.06 million~~339,000 in the ~~first~~third quarter of fiscal 2007, ~~2006~~an increase of $69,000 or approximately 20%. The Company also generated approximately $332,000 in Holiday revenue related to a test offering of Christmas season products in the third quarter fiscal 2008 as compared to none last year, while the third quarter of fiscal 2007 included approximately $467,000 in Storybook Heirlooms revenue with no comparable revenue in the current year.

11Gross Profit and Gross Margin

Our gross profit consists of net sales less cost of sales. Our cost of sales consists primarily of product costs, costs associated with our in-house production facility, including wages and depreciation, inbound and outbound shipping costs, and packaging materials for outbound shipments. Gross profit decreased 33.8% to $6.0 million in the third quarter fiscal 2008 from $9.1 million in the same period last year, reflecting the 20.3% reduction in net sales and a 4.2% decrease in cost of goods sold. Gross margin was 45.4% in the third quarter fiscal 2008, compared with 54.5% in the same period last year. The year over year decline in gross margin for the quarter just ended was driven primarily by increased shipping expense related to generally higher shipping rates and additional expedited shipping cost incurred by the Company to meet customer expectations and party dates. Approximately 65% of this decline in gross margin is attributed to this change in shipping expense. The implementation of our new warehouse management system was the principal factor in causing these excess expedited shipping costs, which we believe will improve in future months as the new warehouse management system moves from the implementation stage and provides the intended efficiencies. Our gross margin may fluctuate from quarter to quarter due to the mix of products sold, as well as the potential introduction of new brands. In the third quarter fiscal 2008, our margin was adversely affected by a lower margin associated with the Holiday

~~decrease~~product oftest ~~$102,000~~and orbenefited ~~approximately 10%. The decrease in Costume Express revenue is due primarily to less cross-selling of our Costume Express brand to our Storybook Heirlooms customers in the first quarter of fiscal 2007~~ compared ~~with the first quarter of fiscal 2006. Revenue from our Storybook Heirlooms brand decreased~~ to ~~$1.0 million~~last inyear’s ~~the~~third ~~first~~ quarter ofwhen ~~fiscal 2007, compared with $1.3 million in the first quarter of and fiscal 2006. In June 2006,~~ we ~~announced that we~~ were ~~beginning~~liquidating ~~an orderly wind-down of~~ our ~~Storybook Heirlooms brand. Throughout the~~ ~~remainder of fiscal 2007, our year-over-year revenue growth will be impacted by this decision. The~~ Storybook Heirlooms brand ~~accounted for $2~~.~~4 million, $2.5 million and $2.8 million of our net~~ ~~revenue in the second, third and fourth quarters of fiscal 2006 respectively. Revenue from our Storybook brand will be substantially less than these amounts in the comparable quarters of fiscal 2007.~~

Gross Margin

Our gross margin consists of net sales less cost of sales. Our cost of sales consists primarily of product costs, costs associated with our in-house production facility, including wages and depreciation, design and production costs for our apparel and costume brands, inbound and outbound shipping costs, and packaging materials for outbound shipments. Gross margin increased 11.0% to $10.0 million in the three months ended August 31, 2006 from $9.0 million in the three months ended August 31, 2005. Our gross margin as a percentage of net sales was 50.1% in the three months ended August 31, 2006, compared with 50.3% in the three months ended August 31, 2005. During fiscal 2007 the Company has been winding down the operations of the Storybook brand. This effort has included selling Storybook products at significantly discounted prices, which has had a negative impact on our gross margin. Our gross margin also includes the cost of shipping packages to our customers. We have seen increases in these outbound shipping costs as a result of increases in fuel surcharges and rates charged by our third party carriers. Further increases in these costs will have an impact on our gross margin. Our gross margin may fluctuate from quarter to quarter due to the mix of products sold, as well as the potential introduction of new brands.

Fulfillment

Our fulfillment expenses consist primarily of labor and other operating costs associated with our customer support ~~centers~~center inand ~~Kirkland,~~distribution ~~Washington~~center ~~and~~in Greensboro, North Carolina. ~~and~~Despite ~~our~~the lower ~~distribution~~orders ~~center~~and sales in ~~Greensboro,~~the ~~North~~quarter ~~Carolina.~~as ~~Our~~compared to last year, our fulfillment expenses increased 282.9% to to $32.06 million in the ~~three~~third ~~months~~quarter ~~ended~~fiscal ~~August 31,~~2008 ~~2006~~ from $2.35 million in the ~~three~~same ~~months~~period ~~ended August 31,~~last ~~2005~~year. As a percentage of net sales, these expenses increased to 1419.93% in the ~~three months~~third ~~ended~~quarter ~~August 31,~~fiscal ~~2006~~ 2008 from 1215.90% in the ~~three~~same ~~months~~period ~~ended~~last ~~August 31, 2005~~year. This quarter-over-quarter increase is was due primarily to additional ~~higher~~ labor required in connection with the implementation of our new warehouse management system, ~~overtime~~as ~~and~~discussed ~~temporary~~above, which resulted in increased labor ~~costs~~hours ~~incurred~~both in the warehouse and in our customer service call center in order to ~~ship~~meet customer service requirements, as well as other ~~orders~~related costs. We ~~anticipate~~believe ~~that~~these ~~additional~~costs ~~investments~~as ~~and~~a ~~procedural~~percentage ~~changes~~of sales will ~~continue~~improve toin befuture ~~made in~~months as the ~~distribution~~new ~~center~~warehouse ~~throughout~~management ~~fiscal~~system ~~2007,~~moves from the implementation stage and weprovides the intended efficiencies. We expect ~~that~~further weimprovements ~~will~~as our customers continue to ~~incur~~shift to the more ~~costs~~efficient ~~associated~~web ordering method, which represented 86% of total orders in the third quarter of fiscal 2008 as compared with ~~this~~80% ~~transition~~of ~~and~~total ~~implementation~~orders ~~over~~in the ~~next~~third ~~several~~quarter ~~quarters~~of fiscal 2007.

Selling and Marketing

Our selling and marketing expenses consist primarily of advertising costs, wages and related payroll benefits for our internal marketing and merchandising staff. Advertising costs include online marketing efforts, print advertising and other direct marketing strategies. Online advertising costs are generally expensed as incurred. Prepaid direct marketing expenses consist of third-party costs including paper, printing and mailing costs and are capitalized and amortized over their expected period of future benefit, which is generally from 90 to 120 days. Selling and marketing costs increased 3212.24% to $5.3 million in the ~~three~~third ~~months~~quarter ~~ended~~fiscal ~~August 31,~~2008 ~~2006~~ from $4.0 7 million in the ~~three~~same ~~months~~period ~~ended~~last ~~August 31, 2005, due primarily to increases in online advertising and direct marketing circulation costs of $1~~year.~~1 million.~~ As a percentage of net sales, selling and marketing expenses increased to 2639.79% in the ~~three~~third ~~months~~quarter ~~ended~~fiscal ~~August 31,~~2008 ~~2006~~ from 2228.43% in the ~~three~~ ~~months~~same ~~ended~~period ~~August 31,~~last ~~2005~~year. The change as a percentage of net sales is mainly due ~~primarily~~ to higher online advertising, including paid ~~reductions~~search inand significantly higher catalog ~~response~~postage ~~rates~~costs as compared to the same period in the prior year, ~~primarily~~in ~~from~~addition to the ~~customer~~lower ~~file~~sales as described above. We have experienced increases, and are potentially subject to further increases, in our online paid search costs, ~~and increases in~~ paper prices and postage rates ~~related to our direct marketing campaigns~~. We expect that marketing will continue to be ~~our~~a ~~largest~~major ~~operating~~ expense line item ~~and will increase in absolute dollars~~ as we ~~continue~~seek to expand sales and prospecting to new customers.

General and Administrative

Our general and administrative expenses consist primarily of wages and related payroll benefits for our administrative and technology employees. These expenses also include credit card fees, legal and accounting professional fees, insurance, network fees, ~~systems~~ depreciation, bad debt expense, ~~and~~ and other general corporate expenses. General and administrative expenses increased 3423.24% to $23.41 million in the ~~three~~third ~~months~~quarter ~~ended~~fiscal ~~August 31,~~2008 ~~2006~~ from $12.85 million in the ~~three~~same ~~months~~period ~~ended~~last year. As a ~~August 31~~percentage of net sales, ~~2005.~~our ~~Wages~~general and ~~benefits~~administrative ~~for~~expenses ~~our~~increased to 23.1% in the third quarter fiscal 2008 from 14.9% in the same period last year. The increase in general and administrative expenses year over year was driven primarily by an increase in depreciation associated with new systems and ~~technology~~systems-related ~~employees~~consulting ~~increased~~fees of $~~238~~299,000 and $314,000 respectively in the ~~three~~third ~~months~~quarter ~~ended~~fiscal ~~August 31~~2008, ~~2006,~~ compared with the ~~three~~same ~~months~~period ~~ended~~last ~~August 31, 2005~~year.

Stock compensation expense increased $179,000 in the current quarter, compared with the same quarter of the prior year, due primarily to the adoption of SFAS 123R. Professional fees, insurance premiums and other related costs increased $54,000 in the three months ended August 31, 2006, compared with the three months ended August 31, 2005. As a percentage of net sales, our general and administrative expenses increased to 12.2% in the three months ended August 31, 2006 from 10.2% in the three months ended August 31, 2005.

Other Income, Net

~~The~~Interest ~~improvement in other~~ income declined to $~~383~~159,000 in the ~~three~~third ~~months~~quarter ~~ended~~fiscal ~~August 31~~2008, ~~2006,~~from ~~compared with~~ $~~242~~400,000 in the ~~three~~same period ~~months~~last ~~ended~~year. ~~August 31,~~This ~~2005,~~change is due primarily to ~~increased~~the ~~interest~~lower average cash balance invested in the period in addition to a decrease in interest rates. ~~earned~~The onreduction ~~our~~in invested cash is largely due to the approximately $9.9 million dividend paid in April 2007 and other uses of cash ~~equivalents~~in the nine months fiscal 2008 as described below.

Income Taxes

In ~~the~~accordance ~~three~~with ~~months~~the ~~ended~~Financial ~~August 31,~~Accounting ~~2006,~~Standards weBoard’s ~~recognized~~Statement ~~an income tax benefit~~ of ~~$32,000~~Financial ~~on a net~~Accounting ~~loss~~Standards ~~before taxes of $358,000, an effective tax rate of 8~~(SFAS) No.~~9%. In the three months ended August~~ 31109, ~~2005,~~ weAccounting ~~recognized~~for anIncome ~~income tax expense of $401~~Taxes,~~000~~ ~~based on income before taxes of $1.1 million, an effective tax rate of 36.4%. In arriving at~~ the ~~current~~Company ~~8.9%~~has ~~effective~~evaluated ~~tax~~its ~~rate,~~deferred ~~we considered~~tax aassets ~~variety~~quarterly ofto ~~factors,~~determine ~~including~~if ~~estimated~~valuation ~~annual~~allowances ~~pre-tax~~were ~~results~~required, ~~the~~and ~~U.S.~~determined ~~federal~~in ~~rate of 35%,~~prior ~~estimated~~periods ~~annual~~that ~~nondeductible~~a ~~expenses~~valuation ~~and~~allowance ~~estimated~~was ~~state~~not ~~income~~necessary ~~taxes.~~for Weits ~~evaluate~~deferred ~~our~~ tax ~~rate each~~assets. ~~quarter~~SFAS ~~and make adjustments when necessary~~No. 109 requires ~~Our~~that ~~final~~companies ~~effective~~assess ~~tax~~whether ~~rate~~valuation ~~for~~allowances ~~the~~should ~~full year may~~ be ~~materially~~established ~~different~~against ~~than our current estimate and is highly dependent upon the level of~~their ~~pre-~~deferred tax ~~income~~assets orbased ~~loss,~~on the ~~magnitude~~consideration of ~~any~~all ~~nondeductible~~available ~~expenses~~evidence inusing ~~relation~~a to“more ~~that~~likely ~~pre-tax~~than ~~amount~~not” ~~and~~standard. ~~various~~In ~~other factors.~~making

such judgments, significant weight is given to evidence that can be objectively verified. A company’s current or previous losses are given more weight than its future outlook, and a recent three-year historical cumulative loss is considered a significant factor that is difficult to overcome.

Based upon these SFAS No. 109 guidelines, we determined that a valuation allowance should now be established due to more recent events and developments during the third quarter fiscal 2008. While we believe that our long-term financial outlook remains positive, we concluded that our ability to rely on our long-term outlook as to future taxable income was limited due to uncertainty created by the weight of the negative evidence, particularly the Company’s three-year historical cumulative loss in the third quarter fiscal 2008, the recent and anticipated near term effects associated with the efforts to improve Company systems and staffing and the more challenging near-term economic conditions. Accordingly, based on our current circumstances and uncertainty regarding our future taxable income, we recorded a full valuation allowance against these net deferred tax assets during the third quarter fiscal 2008. If and when our operating performance improves on a sustained basis, our conclusion regarding the need for a full valuation allowance could change, resulting in the reversal of some or all of the valuation allowance in the future. This non-cash charge of approximately $8.2 million is reported as income tax expense for the third quarter fiscal 2008.

In the same period last year, we recognized an income tax benefit of $64,000 based on a net loss before taxes of $202,000.

Comparison of Nine Months Ended February 29, 2008 and February 28, 2007

Net Sales

Net sales decreased approximately 4.5% to $62.2 million in the nine months fiscal 2008 from $65.1 million in the same period last year. The decrease in net sales is driven primarily by (1) reduction in Birthday catalog circulation in response to increased costs for postage, paper and printing and (2) the third quarter fiscal 2008 factors described above, partially offset by increased Costume Express net sales as described below. In addition, there was a $2.1 million decrease in revenue from our Storybook brand, whose wind-down was completed in the fourth quarter of fiscal 2007. Net sales decreased despite an increase of approximately 1.3% in the number of orders shipped, which grew to approximately 853,000 orders in the nine months fiscal 2008 from approximately 842,000 orders in the same period last year due to a reduction in the net sales per order. Net sales per order decreased to $72.07 in the nine months fiscal 2008 from $76.87 in the same period last year. Birthday Express net sales decreased to $42.3 million in the nine months fiscal 2008 from $49.5 million in the same period last year, a decrease of 14.5%. Costume Express net sales increased to $18.6 million in the nine months fiscal 2008 from $13.1 million in the same period last year, an increase of 42.3%, primarily as the result of our strong Halloween season growth this year. Storybook Heirlooms net sales were $2.1 million in the same period last year with no corresponding revenue in the current fiscal year due to the wind-down of this brand. The nine months fiscal 2008 also included $578,000 in revenue related to Holiday marketing test in the third quarter fiscal 2008.

Gross Profit and Gross Margin

Gross profit decreased 3.5% to $32.3 million in the nine months fiscal 2008 from $33.4 million in the same period last year, reflecting the 4.5% reduction in net sales and a 5.7% decrease in cost of goods sold. Our gross margin increased to 51.9% in the nine months fiscal 2008 from 51.3% in the same period last year. The improvement in gross margin is due to increases in the merchandise margin due to improved product sourcing, particularly in the Costume Express brand, which was somewhat offset by decreases in our shipping margin and by the third quarter fiscal 2008 factors described above. We had approximately $677,000 in advertising revenue during the nine months fiscal 2008 generated from web advertising sources, which have no corresponding cost of goods sold, as compared with $389,000 of advertising revenue during the same period in fiscal 2007.

Fulfillment

Our fulfillment expenses decreased 8.0% to $8.2 million in the nine months fiscal 2008 from $8.9 million in the same period last year. As a percentage of net sales, these expenses decreased to 13.2% in the nine months fiscal 2008 from 13.7% in the same period last year. This decrease is due primarily to operational efficiencies in customer service center during the first six months of fiscal 2008, partially offset by the third quarter fiscal 2008 factors described above. In the nine months fiscal 2008, the amount of our revenue coming from web orders (which are more efficient than telephone orders), as a percentage of total revenue, increased to approximately 82% as compared to approximately 75% in the same period last year.

Selling and Marketing

Selling and marketing costs increased 15.3% to $20.5 million in the nine months fiscal 2008 from $17.8 million in the same period last year. The increase in selling and marketing expenses was due primarily to an increase in catalog costs and online advertising expenditures totaling approximately $2.0 million. In addition, professional services, wages and related payroll benefits for our internal marketing and merchandising staff increased over the prior year. As a percentage of net sales, selling and marketing expenses increased to 33.0% in the nine months fiscal 2008 from 27.3% in the same period last year. This was driven by multiple factors: increased online search fees due to higher website traffic, the increase in catalog postage rates and generally lower than anticipated response rates, particularly related to the third quarter fiscal 2008 factors described above.

General and Administrative

General and administrative expenses increased 18.7% to $9.2 million in the nine months fiscal 2008 from $7.7 million in the same period last year. The increase in general and administrative expenses is due primarily to higher levels of depreciation and systems related consulting fees related to the Company’s recent investments in capital projects. As a percentage of net sales, our general and administrative expenses increased to 14.8% in the nine months fiscal 2008 from 11.9% in the same period last year.

Other Income (Expense), Net

Interest income declined to $641,000 in the nine months fiscal 2008, compared with $1.2 million in the same period last year. This change is due primarily to the lower average cash balance invested in the period in addition to a decrease in interest rates. The reduction in invested cash is largely due to the approximately $9.9 million dividend paid in April 2007 and other uses of cash in the nine months fiscal 2008 as described below.

Income Taxes

Primarily as a result of the recognition of the non-cash charge for the establishment of a valuation reserve for deferred tax assets as described above, in the nine months of fiscal 2008, we recognized income tax expense of $8,144,000. In the same period last year, we recognized income tax expense of $96,000 on income before taxes of $200,000 for the same period based upon an effective tax rate of 47.8%.

Liquidity and Capital Resources

As of ~~August~~February 3129, ~~2006~~2008 we had working capital of $~~37.2~~24 million, including cash and cash equivalents of $2914.38 million. We believe that our current cash and cash equivalents, as well as cash flows from operations, will be sufficient to continue our operations and meet our capital needs for the foreseeable future.

Net cash ~~provided by (~~used in) operating activities was ($13.78 million) ~~and $100,000~~ for the ~~three~~ nine months ~~ended~~fiscal ~~August~~2008 and cash provided by operating activities was $1.0 ~~31,~~million ~~2006~~for ~~and~~the ~~2005,~~same ~~respectively~~period last year. Net cash used in operating activities in the ~~first~~ ~~quarter~~nine ofmonths fiscal ~~2007~~2008 ~~can~~reflects beapproximately ~~attributed to an increase in inventory of~~ $~~2.0~~3 million ~~during~~ from the ~~first~~nine month ~~quarter.~~operating ~~This~~loss ~~increase~~exclusive inof ~~inventory~~non-cash ~~was~~costs ~~primarily~~of ~~due~~depreciation, toamortization ~~higher~~and ~~Costume~~stock compensation, ~~Express~~and ~~inventory balances~~a $1.1 million increase in ~~anticipation~~inventories. ofAdditionally, ~~higher~~cash ~~demand~~was inused ~~the~~for decreased ~~second~~accounts ~~fiscal~~payable ~~quarter.~~and ~~Additionally,~~accrued ~~prepaid expenses~~liabilities ~~increased~~totaling $1.23 million. ~~during~~Cash ~~the~~was ~~first~~provided ~~quarter~~as prepaid ofexpenses ~~fiscal~~decreased ~~2007~~$588,000 ~~due~~and ~~primarily~~accounts toreceivable ~~an increase~~decreased in$459,000 ~~prepaid~~during ~~catalog~~the ~~and~~nine months ~~related~~fiscal ~~costs~~2008. ~~Net~~The $1.0 million of cash provided by operating activities in the ~~first~~ ~~quarter~~nine of months fiscal ~~2006~~2007 was attributed primarily to ~~net~~approximately ~~income~~$1.1 million ~~and~~from ~~increases~~the innine ~~accounts~~month operating ~~payable~~loss exclusive of non-cash costs of depreciation, amortization and stock compensation, and an increase in accrued liabilities,. ~~which~~These ~~was~~increases were partially offset by ~~increases~~an increase in ~~inventory~~accounts receivable and ~~prepaid expenses~~a decrease in accounts payable in the same period last year.

Net cash used in investing activities was ($~~357,723)~~2.8 million and ($~~538~~676,~~724)~~000 for the ~~three~~nine months ~~ended August 31,~~fiscal ~~2006~~ 2008 and ~~2005~~2007, respectively., ~~Cash~~representing cash used infor ~~investing~~capital ~~activities~~expenditures. The increased level of capital expenditures in the ~~first~~nine ~~quarters~~months of fiscal ~~2007~~2008 ~~and~~reflects ~~2006~~the ~~was~~resumed ~~used~~focus ~~for~~on business improvements after we completed the strategic review, as described above. Approximately $250,000 of the capital expenditures during the nine months fiscal 2008 represents costs related to in-process software development projects capitalized under Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use and the associated hardware purchases. We ~~expect~~anticipate that our capital expenditures for the full fiscal year ending May 31, ~~2007~~2008 will berange ~~approximately~~from $5.3 ~~million~~.5 ~~This~~million ~~estimate~~to ~~includes~~ $34.5 ~~million~~ ~~related to anticipated investments in our distribution center~~million.

~~Net cash provided by financing activities was $39,186 and $9,447 for the three months ended August~~16 31, 2006 and 2005, respectively. Cash provided by financing activities in the first quarter of fiscal 2007 was primarily due to proceeds from the exercise of stock options and the tax benefit associated with option exercises. Cash provided by financing activities in the first quarter of 2006 was related to proceeds from exercises of stock options, partially offset by principal payments on capital lease obligations.

The following table summarizes our contractual obligations as of August 31, 2006 and the effect these obligations are expected to have on our liquidity and cash flows in future periods.

	Payments Due by Period
	Total		Less than 1 year		1-3 years		3-5 years
	(in thousands)
Description of Contractual Obligations:
Operating lease obligations	$	1,482	$	830	$	627	$	25

These anticipated fiscal 2008 expenditures include our new warehouse management system, phone system, data center and other projects.

Net cash provided by financing activities was $118,000 and $426,000 for the nine months fiscal 2008 and 2007, respectively. Cash provided by financing activities was due primarily to proceeds from the exercise of stock options and proceeds from shares issued under the Celebrate Express employee stock purchase plan.

The following table summarizes our contractual obligations as of February 29, 2008 and the effect these obligations are expected to have on our liquidity and cash flows in future periods.


	Payments Due by Period
	Total		Less than 1 year		1-3 years		3-5 years
	(in thousands)
Description of Contractual Obligations:
Capital lease obligations	$	59	$	22	$	37	$	—
Operating lease obligations	$	972	$	604	$	368	$	—

Total	$	1,031	$	626	$	405	$	—

Critical Accounting Policies

Certain of our accounting policies require the application of management judgment in making estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes. Those estimates and assumptions are based on historical experience and various other factors deemed to be applicable and reasonable under the circumstances. The use of judgment in determining such estimates and assumptions is, by nature, subject to a degree of uncertainty. Accordingly, actual results could differ from the estimates made. The critical accounting policies used in the preparation of our financial statements are reported in the Management’s Discussion and Analysis section of our Annual Report on Form 10-K for the year ended May 31, ~~2006. Updates to our significant accounting policies for fiscal~~ 2007 ~~include accounting for share-based payment under FAS 123R~~. ~~Based on the adoption of SFAS 123R on~~ ~~June 1, 2006, we have modified our critical accounting policy relating to “Stock-based Compensation” as follows.~~

~~Stock~~New accounting pronouncements -~~based~~ ~~Compensation~~In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FAS No. 109, Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. We adopted the provisions of FIN 48 on June 1, 2007. The adoption of this statement did not have an impact on our results of operations or financial condition.

WeIn ~~account~~September 2006, ~~for stock-based compensation in accordance with~~ the ~~fair~~FASB ~~value~~issued ~~recognition~~Statement ~~provisions~~ of ~~SFAS~~ ~~123R.~~Financial WeAccounting ~~use~~Standards ~~the Black-Scholes-Merton option valuation model~~No. 157, ~~which~~Fair ~~requires the input of~~Value ~~highly~~Measurements ~~subjective~~(“FAS ~~assumptions~~157”). ~~These~~FAS ~~assumptions~~157 ~~include~~establishes ~~estimating~~a ~~the~~common ~~length~~definition offor ~~time~~fair ~~employees will~~value, ~~retain~~establishes ~~their~~a framework ~~vested~~for ~~stock~~measuring ~~options~~fair ~~before~~value, ~~exercising~~and ~~them~~expands ~~(“expected~~disclosure ~~term”),~~about ~~the~~such ~~estimated volatility~~fair ofvalue ~~the~~measurements. ~~Company’s~~FAS 157 ~~common~~is ~~stock~~effective ~~price~~for ~~over~~fiscal ~~the~~years ~~expected~~beginning ~~term~~after November 15, ~~and~~2008. ~~the~~We ~~number of options that~~ will ~~ultimately~~apply ~~not~~this ~~complete~~guidance beginning ~~their~~June 1, ~~vesting requirements (“forfeitures”)~~2009. ~~Changes~~We indo ~~these assumptions~~not ~~can~~expect ~~materially~~that ~~affect~~ the ~~estimate~~adoption of ~~the~~this ~~fair~~statement ~~value~~will ofhave ~~employee~~a ~~stock options and~~material ~~consequently,~~impact ~~the~~on ~~related~~our ~~amount~~results of ~~stock-based~~operations ~~compensation~~or ~~expense~~financial ~~recognized in the statement of operations~~condition.

~~New~~In ~~accounting pronouncements — On December~~February 162007, ~~2004,~~ the Financial Accounting Standards Board ~~(FASB)~~ issued Statement of Financial ~~Standard~~Accounting Standards No. ~~123~~159, ~~(revised~~The ~~2004),~~Fair ~~Share-Based~~Value ~~Payment~~Option for Financial Assets and Financial Liabilities, (“FAS ~~123R~~159”). ~~which~~FAS ~~requires~~159 ~~all~~permits entities to ~~recognize~~choose ~~compensation~~to ~~expense~~measure inmany anfinancial ~~amount~~instruments ~~equal~~and tocertain ~~the fair~~other ~~value~~items ofat ~~share-based~~fair ~~payments,~~value ~~such~~that asare ~~stock~~not ~~options~~currently ~~granted~~required to ~~employees.~~be Wemeasured ~~adopted~~at ~~FAS~~fair ~~123R during the first quarter of fiscal 2007~~value. ~~We have elected to apply~~ FAS ~~123R~~159 ~~on a modified~~also ~~prospective~~establishes ~~method.~~presentation ~~Under~~and ~~this~~disclosure ~~method,~~requirements wedesigned ~~apply~~to ~~the~~facilitate ~~fair~~comparisons ~~value method in fiscal 2007 and do not~~between ~~restate~~entities ~~prior~~that ~~periods.~~choose ~~Further,~~different ~~compensation~~measurement ~~expense~~attributes for ~~existing~~similar ~~grants~~types ~~will~~of beassets ~~recorded~~and ~~for the~~liabilities. ~~unvested~~FAS ~~portion~~159 ofis ~~the~~effective ~~fair~~for ~~value~~fiscal ~~compensation~~years ~~expense~~beginning ofafter ~~those~~November 15, ~~grants over the remaining vesting periods~~2007. We ~~believe that the compensation expense we recognize in fiscal 2007~~ will ~~increase substantially~~apply ~~from what we have historically disclosed as proforma compensation expense under the~~this ~~fair~~guidance ~~value~~beginning ~~method~~June 1, ~~due primarily to the increased number of option grants issued in fiscal 2007~~2008. ~~Also,~~ ~~FAS~~We ~~123R~~do ~~requires~~not usexpect tothat ~~reflect~~ the ~~tax~~adoption ~~savings resulting from tax deductions in excess~~ of ~~expense~~ ~~reflected~~this instatement ~~our~~will ~~financial statements as a financing cash flow, which may~~ have a ~~material~~ material impact on our ~~future~~results ~~reported~~of ~~cash~~operations ~~flows~~or ~~from~~financial ~~operating activities~~condition.

In ~~July~~December ~~2006~~2007, the ~~FASB~~Financial ~~issued Interpretation No. 48,~~ Accounting ~~for~~Standards ~~Uncertainty~~Board inissued ~~Income~~Statement ~~Taxes — an interpretation~~ of ~~FASB~~Financial ~~Statement~~Accounting Standards No. ~~109~~160, ~~(“FIN~~Noncontrolling ~~48”).~~Interests ~~This interpretation clarifies the accounting for uncertainty~~ in ~~income~~Consolidated ~~taxes~~Financial ~~recognized in an enterprise’s financial statements in accordance with SFAS No. 109~~Statements, ~~Accounting~~(“FAS ~~for Income Taxes~~160”). ~~This Interpretation prescribes a~~FAS ~~recognition~~160 ~~threshold~~addresses ~~and measurement attribute for~~ the ~~financial~~accounting ~~statement recognition~~ and ~~measurement~~ offinancial areporting ~~tax~~for ~~position~~minority ~~taken~~interests ~~or expected to be taken~~ in ~~a tax return. This Interpretation~~consolidated ~~also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition~~subsidiaries. ~~FIN~~FAS 48160 ~~will~~is be effective for ~~our~~ fiscal ~~year~~years ~~ending~~beginning ~~May~~on or after December 3115, 2008., ~~The~~with ~~Company~~earlier isadoption ~~currently~~prohibited. ~~evaluating~~We ~~the~~will ~~impact~~apply ofthis ~~FIN 48 on its results of operations~~guidance ~~and financial condition.~~beginning

June 1, 2009. We do not expect that the adoption of this statement will have a material impact on our results of operations or financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

The primary 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 rated securities. As of ~~August~~February 3129, ~~2006~~2008, we held short-term investments that have a ~~maturity~~ maturity date of three months or less at the time of purchase, and ~~consist~~consisted primarily of money ~~market~~ ~~accounts~~market ~~and commercial paper~~accounts. Because of the short-term nature of our investments, we believe that our exposure to market rate fluctuations on those investments is minimal. On ~~August~~February 3129, ~~2006~~2008, we had no long-term or short-term bank debt outstanding.

Foreign Currency Risk

Our revenue, expense and capital expenditures are transacted in U.S. dollars. We do source a portion of our product inventories from foreign vendors, primarily manufacturers in China. If the value of the U.S. dollar declines relative to the Chinese yuan, these foreign currency fluctuations could result in an increase in the cost of merchandise sourced from China through price increases. As a result of such fluctuations, we may experience fluctuations in our operating results on an annual or quarterly basis.

Item 4. Controls and Procedures.

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management, including our chief executive officer and chief financial officer (collectively, our “certifying officers”), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on their evaluation, our certifying officers concluded that these disclosure controls and procedures are effective in providing reasonable assurance that the information required to be disclosed by us in our periodic reports filed with the Securities and Exchange Commission (“SEC”) is recorded, processed, summarized, and reported within the time periods specified by the SEC’s rules and SEC reports.

We believe that a system of internal controls, no matter how well designed and operated, is based in part upon certain assumptions about the likelihood of future events, and therefore can only provide reasonable, not absolute, assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

We have reviewed our internal controls over financial reporting and have made no changes during the quarter ended ~~August~~February 3129, ~~2006~~2008 that our certifying officers concluded materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are not aware of any pending legal proceedings (other than routine litigation that is incidental to the business).

Item 1A. Risk Factors.

Factors That May Affect Future Operating Results

You should carefully consider the risks described below together with all of the other information included in this report. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline and you may lose all or part of your investment.

We have incurred net losses in ~~each~~recent ~~of the past three~~ quarters and may not be able to return to or sustain ~~profitably~~profitability in the future.

In ~~the~~7 ~~three~~of ~~months~~our ~~periods~~8 ~~ended~~most ~~August 31,~~recent ~~2006,~~fiscal ~~May 31,~~quarters ~~2006 and February 28, 2006~~ we ~~had~~ reported net losses ~~of $326,000, $324,000~~ and ~~$398,000, respectively, and~~ we expect to ~~have~~report ~~either~~ a net loss orin ~~small~~the ~~profit~~fourth ~~for~~quarter of fiscal ~~2007.~~2008 ~~While~~and wefor ~~were profitable from~~ fiscal ~~2004~~2008 ~~through~~as ~~fiscal 2006, prior to that we have had~~ a ~~history of losses~~whole. WeThough ~~may incur losses again in future fiscal years, especially if~~ we ~~introduce new brands or products, make investments in our systems or~~were ~~infrastructure,~~profitable ~~or continue to have difficulties~~ in ~~our~~fiscal ~~distribution~~2005 ~~center.~~through Wefiscal ~~expect our operating expenses to increase in the future~~2007, as we~~, among other things:~~

• expand into new product categories; • continue with our marketing efforts to build our brand names; • expand our customer base; • upgrade our operational and financial systems, procedures and controls; • invest in and upgrade our distribution center; and • retain existing personnel and hire additional personnel, including senior leadership.18

We may not be able to generate the required sales from our current or new product categories or reduce fulfillment and other operating expenses sufficiently to return to, sustain or increase profitability. If we have a shortfall in sales without a corresponding reduction to our expenses, our operating results will suffer. It is possible that results of operations may be below the expectations of public market analysts and investors, which could cause the trading price of our common stock to fall.

If we do not successfully expand sales into other product categories beyond party goods, we may not be able to achieve our desired revenue growth.

Wehave ~~were~~had ~~incorporated~~a ~~and~~history ~~began~~of ~~selling~~losses. ~~party~~We ~~products~~may ~~through our direct marketing catalog in~~incur ~~June 1994~~losses ~~and~~again ~~on our www.BirthdayExpress.com website~~ in ~~April 1996.~~future Infiscal ~~September 2003~~years, weespecially ~~launched our~~if ~~website~~we ~~www.Costumeexpress.com~~introduce ~~and~~new ~~catalog~~brands ~~for~~or ~~Costume Express~~products, ~~a provider of children’s and~~make ~~family~~investments ~~costumes.~~in ~~We have historically derived more than 75% of~~ our ~~annual~~systems ~~revenues~~or ~~from~~infrastructure, ~~the~~or ~~sale of~~continue ~~party products and accessories~~ to ~~families~~have ~~with~~difficulties ~~young children under our Birthday Express brand. In order to achieve the desired growth~~ in our ~~sales and business, we will need to expand into new~~distribution ~~product categories~~center. ~~Challenges~~We ~~that~~expect ~~may affect~~ our ~~ability~~operating expenses to ~~expand~~increase ~~into~~in ~~new~~the ~~product~~future, ~~categories include~~as ~~our~~we, ~~ability~~among toother things:

	•		expand into new product categories;

	•		continue with our marketing efforts to build our brand names;

	•		expand our customer base;

	•		upgrade our operational and financial systems, procedures and controls;

	•		invest in and upgrade our distribution center; and

	•		retain existing personnel and hire additional personnel, including senior management.

We may not be able to generate the required sales from our current or new product categories or reduce fulfillment and other operating expenses sufficiently to sustain or increase profitability. If we have a shortfall in sales without a corresponding reduction to our expenses, our operating results will suffer. It is possible that results of operations may be below the expectations of public market analysts and investors, which could cause the trading price of our common stock to fall.

If we do not successfully expand sales into other product categories beyond party goods, we may not be able to achieve our desired revenue growth.

We were incorporated and began selling party products through our direct marketing catalog in June 1994 and on our www.BirthdayExpress.com website in April 1996. In September 2003, we launched our Costume Express brand and became a provider of children’s and family costumes. We have historically derived more than 75% of our annual revenues from the sale of party products and accessories to families with young children under our Birthday Express brand. We conducted a small scale test of Holiday products in third quarter fiscal 2008, which resulted in an operating loss for the test. In order to achieve the desired growth in our sales and business, we may need to expand into new product categories. Challenges that may affect our ability to expand into new product categories include our ability to:

	•		improve the efficiency of our distribution center;

	•		successfully design, produce and market new products;

	•		identify and introduce new product categories;

	•		maintain our gross margins with respect to new product categories;

	•		provide a satisfactory mix of merchandise that is responsive to the needs of our customers;

	•		broaden consumer awareness of our existing and future brands;

	•		manage our selling, marketing and fulfillment costs; and

	•		manage our dual-channel direct marketing model.

Furthermore, we have not demonstrated the ability to expand into other product categories through acquisitions. In April 2001, we acquired certain assets of Storybook Inc., a direct marketer of girls’ specialty and special occasion apparel. ~~In February 2002, we re-launched the Storybook Heirlooms brand and the website www.Storybook.com.~~ Revenue growth from the Storybook Heirlooms brand, however, did not meet management expectations, which inwas ~~part,~~a ~~resulted~~significant ~~in the~~factor ~~Company’s~~leading ~~decision in June 2006~~ to our wind-down of the Storybook Heirlooms brand during fiscal 2007.

In addition, we may experience a higher degree of seasonality in our business as we expand our brands or expand into new brands or product categories that have seasonal significance. If we are unsuccessful in addressing these risks and uncertainties, our business, financial condition and results of operations may be harmed.

~~Our~~The ~~evaluation~~loss of ~~strategic~~our ~~alternatives~~senior ~~may~~management ~~negatively~~or ~~impact~~other ~~business~~key personnel could harm our current and future operations and ~~our~~prospect, ~~assets~~and newly hired personnel may not successfully integrate with the Company.

OnOur ~~August 21,~~performance ~~2006,~~is wesubstantially ~~announced~~dependent ~~that~~on wethe ~~engaged~~services anof ~~investment~~our ~~banker~~senior tomanagement ~~assist~~and ~~us in a review~~other ofkey ~~our~~personnel, ~~strategic~~particularly, ~~alternatives~~Kevin ~~including~~Green, aour ~~sale~~president ofand ~~the~~chief ~~company~~executive officer. AsOur ~~this~~senior management ~~review~~team is incomprised ~~its~~of ~~early stages~~several individuals, and we ~~are~~have ~~uncertain~~had asmany toof ~~what~~these ~~strategic~~positions ~~alternatives~~open ~~may~~at besome ~~available~~time toduring ~~us,~~the ~~whether~~past weseveral ~~will elect~~quarters. toThe ~~pursue~~loss ~~any~~of ~~such~~key ~~strategic~~personnel ~~alternatives~~has had, and ormay ~~what~~continue ~~impact~~to ~~any~~have, ~~particular~~an ~~strategic alternative~~adverse ~~will~~impact ~~have~~ on our ~~stock~~operations ~~price~~and iffinancial ~~pursued~~results. ~~There~~We ~~are~~have ~~various~~hired several ~~uncertainties~~members of our senior management team in fiscal 2007 and ~~risks relating~~2008, toincluding most recently our chief ~~exploration~~financial officer and vice president of ~~strategic~~marketing. ~~alternatives,~~We ~~including:~~are also currently engaged in a search for a

• exploration of strategic alternatives may distract management and disrupt operations, which could have a material adverse effect on our operating results; • we may not be able to successfully achieve the benefits of any strategic alternative undertaken by us; • the process of exploring strategic alternatives may be time consuming and expensive and may result in the loss of business opportunities; and • perceived uncertainties as to our future direction may result in increased difficulties in recruiting and retaining employees, particularly senior management.19

If the exploration of strategic alternatives does result in a transaction, we are unable to predict what the market prices of our common stock would be after the announcement of such a transaction. In addition, the market price of our stock could be highly volatile for several months as we explore strategic alternatives and may continue to be more volatile if and when a transaction is announced or we announce that we are no longer exploring strategic alternatives.

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 services of our senior management and other key personnel, particularly, Kevin Green, our Chief Executive Officer, and Darin White, our Vice President Finance. Several of our former officers, including Michael Jewell, former President and Chief Executive Officer, Louis Usarzewicz, Executive Vice President Operations, Lori Liddle, Chief Marketing and Merchandising Officer, and Allen McDowell, Vice President of Information Systems departed from Celebrate Express in the recent past. These departures have had an adverse impact on our operations and financial results. We have recently hired a vice president of operations and vice president of information technology. However, we cannot assure you that these new senior executives will successfully integrate with the company or that the continued absence of senior management in marketing and merchandising will not

~~further~~vice ~~adversely~~president ~~impact our business, financial condition and results~~ of ~~operations~~merchandising. ~~Recruiting~~ ~~new~~We ~~senior~~cannot ~~management~~assure ~~has~~you ~~taken~~that ~~longer than~~ we ~~would~~will ~~have~~find ~~anticipated,~~a ~~and~~qualified candidate wein ~~expect that~~a ~~recruiting~~timely ~~will~~manner, ~~become~~or ~~more~~that ~~difficult~~these ~~and~~new ~~expensive~~senior ~~given~~executives ~~our~~will ~~recent~~successfully ~~announcement~~integrate ~~concerning~~with ~~exploration~~the ~~of strategic alternatives~~Company.

Our performance also depends on our ability to retain and motivate our officers and key employees. We do not have employment agreements with our senior executives or other key personnel except MrKevin Green. In March ~~Green~~2008 ~~and~~we entered into agreements with our senior executives (other than Mr. ~~White~~Green),which provide for severance payments under certain circumstances in connection with a change in control of the Company, but we cannot assure you that these agreements will prevent the loss of any of these executives. The loss of the services of Mr. Green or ~~Mr. White or~~ any of our other senior executives or 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 senior management and other technical, managerial, editorial, merchandising, marketing, and customer support personnel. Competition for such personnel is intense and we cannot assure you that we will be able to successfully attract, assimilate or ~~retain~~ retain sufficiently qualified personnel.

Failure to successfully manage our fulfillment and distribution operations could cause us to incur increased costs or lose customers.

Our fulfillment and distribution operations are located in Greensboro, North Carolina. These operations are critical to the cost-effective and efficient fulfillment and shipment of customer orders. We are making modifications to our distribution center to accommodate more streamlined distribution procedures. The Company has incurred higher than anticipated costs in implementing these procedures, as well as, higher fulfillment costs related to the Company’s transition to a more automated order picking process. As a result, for the first quarter of fiscal 2007, fulfillment costs increased to 14.9% of net sales, compared with 12.9% in the same quarter last year. These increased costs contributed significantly to our net loss in the current quarter, and in the third and fourth quarters of fiscal 2006. We expect that we will continue to incur higher expenses and additional costs throughout fiscal 2007 as we make further improvements in our fulfillment and distribution operations. We have also observed some erosion in the repeat buying rates of our customers, which we attribute partially to the distribution center problems we have experienced over the past year. Failure to correct the issues in our distribution facility, or to successfully implement the new distribution processes, could continue to result in delays in fulfillment and shipment of customer orders, which will in turn increase our costs more than we anticipate and might hurt our reputation and discourage repeat sales. If we are unable to successfully remedy our fulfillment difficulties or manage our fulfillment and distribution operations, we could also incur increased costs to fulfill customer orders for longer than anticipated which may delay our return to profitability, or we may be required to find one or more parties to provide these services for us.

As our operations grow in size and scope, we will need to improve, upgrade and increase the capacity of our fulfillment and distribution center systems and infrastructure. The expansion of our fulfillment and distribution systems and infrastructure will require us to commit substantial financial, operational and technical resources before the volume of our business increases, with no assurance of a corresponding increase in sales. If we cannot expand our distribution center or move to a larger distribution center in advance of increased customer demand, we could experience increased expenses and lower customer satisfaction. Any of these problems could impair our reputation, damage our brands and cause our sales to decline.

We must compete with other party goods and costume retailers and mass merchandisers on the selection, quality and price of our products, and failure to do so successfully could negatively affect our stock price.

In order to meet our strategic goals, we must successfully offer, on a continuous basis, a broad selection of appealing products to families with young children. To successfully compete against other party goods retailers, costume retailers and mass merchandisers, our product offerings must be affordable, high-quality, innovative and attractive to a wide range of consumers whose preferences may change from time to time. We cannot predict with certainty that we will be successful in offering products that meet these requirements. If consumers do not find our products attractive or our products otherwise become less popular with consumers, we may see increased merchandise returns, inventory write-downs and increased costs. Any shortcomings in our merchandise strategy could adversely affect our operating results and cash flows.

Children’s tastes change and are often difficult to predict, and any failure by us to correctly identify and react appropriately to these changing preferences could hurt our sales and gross margins and render a portion of our inventory obsolete.

Our failure to anticipate, identify or react appropriately to changes in consumer demand could lead to excess inventories and significant markdowns or a shortage of products and lost sales. Our strategy, relations with our customers and margins are dependent, in part, on our identification and regular introduction of new designs that are appealing to our customers, especially children. We cannot assure you that we will be able to identify, obtain or license popular third-party designs or that our design personnel will be able to timely identify and introduce appealing designs in sufficient volume to support our strategy and operations.

popular third-party designs or that our design personnel will be able to timely identify and introduce appealing designs in sufficient volume to support our strategy and operations.

We must also anticipate changes in the tastes and preferences of consumers in order to compete for their business successfully. In particular, our ability to anticipate changes in the tastes and preferences of children, which change often and quickly, is crucial to our success, and we could misinterpret or fail to identify trends on a timely basis. Further, product orders must be placed with suppliers before we receive orders from our customers, and the demand for specific products can change between the time the products are ordered by us and the date we receive them. If we underestimate consumer demand, we may disappoint customers and lose potential sales to our competitors. If we overestimate consumer acceptance of our products, we may be required to take significant inventory markdowns or sell our products at discounted prices, which could reduce our sales and gross margins.

If we fail to promote and maintain our brands effectively, we may not be able to compete successfully with better-known competitors.

Building and maintaining recognition of our brands by families with young children is critical to expanding our customer base and competing successfully against other party goods retailers and mass merchandisers with greater brand recognition. In order to continue building consumer recognition of our brands, we will need to increase our financial commitment to creating and maintaining brand awareness in a manner targeted at families with young children. We cannot be certain that our marketing efforts will attract new customers, enable us to retain existing customers, or encourage repeat purchases. If these efforts are not successful, our sales may not grow to desired levels, or could even decline.

If we do not successfully maintain and expand our customer and prospect databases our sales volume could suffer and our marketing costs could increase.

We depend on our proprietary customer and prospect databases to facilitate repeat sales and attract new customers. If we fail to keep these databases current, or if the information in these databases is damaged or destroyed, our sales could stagnate or even decline. If we do not expand our databases of customers and prospects, or if we fail to enhance and refine our techniques for segmenting this information to maximize its usefulness, our sales volume could suffer and our marketing costs could increase. In addition, if federal or state governments enact privacy legislation resulting in the increased regulation of mailing lists, we could experience increased costs in complying with new regulations concerning the solicitation of consents or be unable to achieve the desired database and sales volume growth.

Our operating results could suffer if we are unable to successfully manage the costs of our catalog ~~operations~~and email marketing efforts or if our catalogs and emails fail to produce sales at satisfactory levels.

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

• effective management of costs associated with the production and distribution of our catalogs; • achievement of adequate response rates to our emails and catalog mailings; • displaying a mix of merchandise in our catalogs and emails that is attractive to our customers; ~~and~~ • timely delivery of catalog mailings to our customers; • maintaining adequate delivery rates of emails to our customers’ inboxes; • managing our email campaigns to avoid classification as SPAM by significant email service providers.

Catalog production and mailings entail substantial paper, printing, postage and labor costs. Increases in the costs of producing and distributing our catalogs, including increases in postage rates, or paper, photography or printing costs, may reduce the margin on sales derived from our catalogs. As we incur nearly all of the costs associated with our catalogs prior to mailing, we are unable to adjust the costs incurred in connection with a particular mailing to reflect the actual performance of the catalog. Further, in the third quarter the Company experienced issues in catalog circulation, which adversely affected catalog response rates. In addition, response rates to our mailings and, as a result, sales generated by each mailing are affected by factors such as consumer preferences, economic conditions, the timing and mix of our catalog mailings, the timely delivery of these mailings by the postal system, and changes in our merchandise assortment, some of which are outside of our control. A significant increase in the costs associated with producing or distributing our catalogs, a recurrence of the errors in catalog circulation tactics, or other failure of our catalogs to produce sales at satisfactory levels, could have a negative effect on our operating results.

~~Increased~~Capacity ~~product returns~~constraints, systems failures or asecurity ~~failure~~breaches bycould usprevent access to ~~accurately~~our ~~predict~~website, ~~the~~which ~~level of~~could ~~product~~lower ~~returns,~~our ~~could~~sales and harm our ~~business~~reputation.

18 Our service goals of performance, reliability and availability require that we have adequate capacity in our computer systems to cope with the volume of customers on our website. As our operations grow in size and scope, we will need to improve and upgrade our systems and infrastructure to maintain or improve the efficiency of our operations as well as to offer customers enhanced services, capacity, features and functionality. The expansion and/or upgrade of our systems and infrastructure will require us to commit substantial financial, operational and technical resources before the volume of our business increases and with no assurance of a corresponding increase in sales. If we cannot expand and/or upgrade our systems in a timely or efficient manner, we could experience increased costs, disruptions in service, slower response times, lower customer satisfaction and delays in the introduction of new products and services. Any of these problems could impair our reputation, damage our brands and cause our sales to decline.

Our ability to provide high-quality service depends on the efficient and uninterrupted operation of our computer and communications systems. Our systems and operations are vulnerable to damage or interruption from human error, natural disasters, power loss, telecommunication failures, break-ins, sabotage, computer viruses, design defects, vandalism, denial-of-service attacks and similar events. Our website has experienced system interruptions from time to

time and could experience periodic system interruptions in the future. We do not have a formal disaster recovery plan or alternate providers of web hosting services, and a natural disaster or other disruption at our data center could mean the temporary loss of the use of our website. Our business interruption insurance may not adequately compensate us for the associated losses. Any system failure or security breach that causes an interruption in service or decreases the responsiveness of our customer support center or website could impair our reputation, damage our brands and cause a decrease in sales.

If we are unable to provide satisfactory telephone-based customer support, we could lose customers.

Our ability to provide satisfactory levels of customer support also depends, to a large degree, on the efficient and uninterrupted operation of our customer support centers. Any material disruption or slowdown in our telephone order processing systems resulting from capacity constraints, labor disputes, telephone or Internet failures, power or service outages, natural disasters or other events could make it difficult or impossible to provide adequate telephone-based customer support. Further, we may be unable to attract and retain an adequate number of competent customer support representatives, which is essential in creating a favorable customer experience. If we are unable to continually provide adequate staffing for our customer support operations, our reputation could be seriously harmed. In addition, we cannot assure you that call volumes will not exceed our present system capacities. If this occurs, we could experience delays in accepting orders, responding to customer inquiries and addressing customer concerns. Also, we may be required to expand our customer support center in the near future. We cannot assure you that we will be able to find additional suitable facilities on acceptable terms or at all, which could seriously hinder our ability to provide satisfactory levels of customer support. Because our success depends in large part on keeping our customers satisfied, any failure to provide satisfactory levels of customer support would likely impair our reputation and we could lose customers.

Failure to successfully manage our fulfillment and distribution operations could cause us to incur increased costs or lose customers.

Increased product returns, or a failure by us to accurately predict the level of product returns, could harm our business.

As part of our customer support commitment, we maintain a product return policy that allows recipients to return most items received from us with which they are dissatisfied. We make allowances for product returns in our financial statements based on historical return rates. We cannot assure you that actual product 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 within existing or new product categories, increased sales over the Internet, changes in the habits of our customers or other factors will not cause actual returns to exceed return allowances, perhaps significantly. Any increase in product returns above our allowances could have a negative impact on our financial results and may, in turn, cause our stock price to decline.

We may not be able to compete successfully against current and future competitors.

We operate in several competitive markets including party goods and children’s and family costumes. Our primary competition comes from traditional retailers that offer a variety of products in the party goods and children’s and family costume markets. We believe our primary competition in party goods and costumes is from mass merchandisers such as Target and Wal-Mart, ~~and~~ party goods superstores such as Party City and Party America, and online retailers such as Oriental Trading and Buy Costumes. We also compete in these markets with a variety of other companies including: ~~online retailers of party goods; online retailers of costumes;~~ traditional card and gift specialty retailers; supermarkets and drugstores; and catalog retailers of novelty items.

Competitors can enter our market with little difficulty and can launch new websites or catalogs at a relatively low cost. Many of these current and potential competitors may have the ability to devote substantially more resources to marketing, customer support, product development and order fulfillment operations than we can. Some of our suppliers also may choose to compete with us directly and may in the future choose not to supply products to us. In addition, ~~larger or more~~ well-financed entities have acquired and may in the future acquire, invest in or form joint ventures with our competitors. Some of our competitors may be able to secure products from suppliers on more favorable terms, fulfill orders more efficiently or adopt more aggressive pricing than we can. If we are unable to compete effectively in our markets, our business, financial condition and operating results may suffer.

~~We depend on search engines to attract customers to our websites, and losing~~22 ~~these customers would adversely affect our revenues and financial results.~~

ManyTable consumers access our websites by clicking through search results displayed by Internet search engines. Internet search engines typically provide two types of search results, algorithmic listings and purchased listings. Algorithmic listings cannot be purchased, and instead are determined and displayed solely by a set of formulas utilized by the search engine. Purchased listings can be bought by advertisers in order to attract users to their websites. We rely on both algorithmic and purchased listings to attract and direct consumers to our websites. Search engines revise their algorithms from time to time in an attempt to optimize their search results. If one or more of the search engines on which we rely for algorithmic listings were to modify its algorithms, resulting in fewer consumers clicking through to our websites, we would need to increase our marketing expenditures, which would adversely affect our financial results. In addition, the rates for purchased listings have significantly increased. If one or more of the search engines on which we rely for purchased listings modifies or terminates its relationship with us or if the rates for purchased listings continues to rise, our online marketing expenses as a percentage of revenue could rise, we could lose customers, we could be forced to look for other advertising avenues and traffic to our websites could decrease. Contents

larger or more well-financed entities have acquired and may in the future acquire, invest in or form joint ventures with our competitors. Some of our competitors may be able to secure products from suppliers on more favorable terms, fulfill orders more efficiently or adopt more aggressive pricing than we can. If we are unable to compete effectively in our markets, our business, financial condition and operating results may suffer.

We depend on search engines to attract customers to our website, and losing these customers would adversely affect our revenues and financial results.

Many consumers access our website by clicking through search results displayed by Internet search engines. Internet search engines typically provide two types of search results, algorithmic listings and purchased listings. Algorithmic listings cannot be purchased, and instead are determined and displayed solely by a set of formulas utilized by the search engine. Purchased listings can be bought by advertisers in order to attract users to their websites. We rely on both algorithmic and purchased listings to attract and direct consumers to our website. Search engines revise their algorithms from time to time in an attempt to optimize their search results. If one or more of the search engines on which we rely for algorithmic listings were to modify its algorithms, resulting in fewer consumers clicking through to our website, we would need to increase our marketing expenditures, which would adversely affect our financial results. In addition, the rates for purchased listings have significantly increased. If one or more of the search engines on which we rely for purchased listings modifies or terminates its relationship with us or if the rates for purchased listings continues to rise, our online marketing expenses as a percentage of revenue could rise, we could lose customers, we could be forced to look for other advertising avenues and traffic to our website could decrease.

Because we do not have long-term contracts for third-party products, we may not have continued access to popular products.

Our business depends significantly on the use of third-party proprietary products and our future success is contingent upon the continued availability of these products. We do not have long-term arrangements with any vendor or distributor that would guarantee the availability of third-party proprietary products and, as a result, we do not have a predictable or guaranteed supply of these products. We cannot assure you we will have access to any third-party products in sufficient quantities. If we are unable to provide our customers with continued access to popular or exclusive third-party products, our sales could decline.

If we are unable to maintain or acquire licenses to intellectual property, we may have fewer proprietary products and our sales may decline.

Many of our proprietary products are based on or incorporate intellectual property and other character or story rights licensed from third parties. These license agreements are limited in scope, typically have a two- or three-year term and lack renewal rights. We may not be able to renew key licenses when they expire or include new products in existing licenses. Moreover, most of these licenses may be terminated immediately if we breach their terms. If we are unable to maintain these licenses and obtain additional licenses with significant commercial value, or maintain them at reasonable costs, we will be unable to increase our revenue in the future unless we offset the loss of the products that depend on these licenses with an increase in sales of our independently created proprietary products.

maintain these licenses and obtain additional licenses with significant commercial value, or maintain them at reasonable costs, we will be unable to increase our revenue in the future unless we offset the loss of the products that depend on these licenses with an increase in sales of our independently created proprietary products.

Because we do not have long-term contracts with our suppliers, we may not have continued access to necessary materials and our sales may suffer.

Our financial performance depends on our ability to purchase our products in sufficient quantities at competitive prices. We purchase our products from over 250 foreign and domestic manufacturers and distributors. We have no long-term purchase contracts with any of these suppliers, and therefore, have no contractual assurances of continued supply, access to products or favorable pricing. Any vendor could increase prices or discontinue selling to us at any time. The lack of long-term contracts also exposes us to increased risks associated with changes in local economic conditions, trade issues and foreign currency fluctuations. In ~~our~~the ~~first~~third quarter of fiscal ~~2007~~2008 ended ~~August~~February 3129, ~~2006~~2008, products supplied by our ten largest suppliers represented approximately 4348.83% of inventory purchases, with our largest supplier representing 1119.78%. If we are unable to maintain these supplier relationships, our ability to offer high-quality, favorably-priced products to our customers may be impaired, and our sales and gross margins could decline.

Our reliance on smaller or independent vendors and suppliers and manufacturers located abroad exposes us to various risks including disruption in product supply.

Some of our smaller vendors have limited resources, production capacities and operating histories, which means that they may not be able to timely produce sufficient quantities of certain products demanded by our customers. In addition, our relationships with independent foreign suppliers and manufacturers are also subject to a number of risks, including:

	•		work stoppages;

	•		transportation delays and interruptions;

	•		political instability;

	•		foreign currency fluctuations;

	•		changing economic conditions;

	•		an increased likelihood of counterfeit, knock-off or gray market goods;

	•		product liability claims;

	•		expropriation, nationalization, imposition of tariffs, import and export controls and other non-tariff barriers, including quotas and restrictions on the transfer of funds;

	•		environmental regulation; and

	•		other changes in governmental policies.

Because of these factors, we may be subject to liability claims or may not be able to acquire desired products in sufficient quantities on terms acceptable to us. Any inability to acquire suitable products, the loss of one or more key vendors, or the settlement or outcome of a product liability suit could have a negative effect on our sales and operating results. We may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of lesser quality or more expensive than those we currently purchase. We cannot be certain that such factors will not prevent us from procuring manufactured products in a cost-effective or timely manner.

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

If any of the products that we sell causes harm or damages to any of our customers or other individuals, we could be vulnerable to product liability claims. We have in the past recalled, and may in the future recall, products that we sold. Although we maintain insurance against product liability claims, our coverage may be inadequate to cover any liabilities we may incur. We ~~also~~ work with experts to test some of our products for safety compliance, but our tests may not identify all potential product defects before products are sold. Even if we successfully defend ourselves against product liability claims, 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, we could be required to remove products from inventory, and we could suffer adverse publicity about the safety and fitness of our products, any of which could harm our business.

20Product safety regulations may restrict availability of products and reduce our sales or increase our costs.

Certain products that we sell are subject to government regulations related to product safety, and other products may become subject to such regulations in the future. During 2007, a number of consumer product companies had product issues, including product recalls which were widely reported. As a result, state and federal legislative bodies and regulatory agencies are considering modification of current laws and regulations or the adoption of further laws and regulations related to toys and other consumer products. The standards which may be adopted are not predictable and they may vary between jurisdictions. If such regulations are adopted, we may determine that certain products may not be in compliance with the new standards and it may become necessary to replace, modify or discontinue the products. Such regulations may restrict our ability to sell certain products within one or more localities or may result in higher costs for the products and for the administrative costs associated with compliance with the new laws and regulations, in amounts which cannot be predicted.

claims, we could be required to remove products from inventory, and we could suffer adverse publicity about the safety and fitness of our products, any of which could harm our business.

Failure of third parties to deliver our products efficiently and in a timely manner could cause us to lose customers.

We rely upon other parties for product shipments to and from our Greensboro, North Carolina fulfillment and distribution center. It is possible that events beyond our control, such as strikes, trucking shortages, the imposition of tariffs, rail disruption, or other disruption, could affect the ability of these parties to deliver inventory items to our facilities or merchandise to our customers. The failure of these parties to deliver goods to or from our facilities could result in delays in fulfillment of customer orders. Because our customer orders are often time-sensitive, delays by our third-party shipment providers could hurt our reputation and our ability to obtain repeat orders.

Fluctuations in commodity prices may increase our operating costs and make our expenses difficult to predict.

We are vulnerable to fluctuations in commodity prices, particularly the price of paper stock. Paper goods comprise a significant portion of our total inventory. In addition, a portion of our marketing expenditures are related to our direct marketing efforts which include our paper catalogs. If the price of paper increases significantly, we may be unable to pass the additional costs on to our customers, which could hurt our profitability. In addition, fluctuations in commodity prices could make it difficult for us to accurately forecast our expenses.

We ~~will~~may consider acquisitions as part of our growth strategy, and failure to adequately evaluate or integrate any acquisitions could harm our business.

We have limited experience in acquiring other businesses. In April 1997 we acquired the assets of Great Days Publishing, Inc., a product line that offers a variety of personalized date history scrolls that chronicle noteworthy events. This product line is marketed under our Birthday Express brand. In April 2001, we acquired the assets of Storybook Inc. Integration expenses were higher than anticipated and despite considerable effort and time spent, revenue growth from the Storybook brand did not meet management expectations. In June of 2006, we announced the wind-down of the Storybook brand. Wewhich ~~expect~~was completed toin ~~continue~~the tofourth quarter of fiscal 2007. We may consider opportunities to acquire other products and businesses that could enhance or complement our current products and services or expand the breadth of our product categories or customer base. Potential and completed acquisitions involve numerous risks, including unanticipated costs associated with the acquisition and risks associated with entering product categories in which we have no or limited prior experience. If we fail to properly evaluate and execute future acquisitions, our management team may be distracted from our day-to-day operations, our business may be disrupted, and our operating results may suffer.

The favorable impact of the income tax benefit in 2004 affects the comparability of our results, and utilization of our deferred tax assets is dependent on future taxable income.

In our fiscal year ended May 31, 2004, based on the information existing at that time including consideration of our forecasted book and tax income, we reduced the valuation allowance on our deferred tax assets by $9.0 million and recognized a corresponding tax benefit in our fiscal 2004 results of operations. This tax benefit causes our financial results for our fiscal year ended May 31, 2004 to appear significantly more favorable than they would in the absence of the tax benefit. The favorable impact of the $9.0 million tax benefit may distort the trends in our operating results and will impact the comparability of our results of operations with other periods. The tax benefit may also make our financial results appear more favorable than those of companies with similar results of operations that have not reduced a valuation allowance on their net deferred tax assets in the comparable period. In addition, should our operating results fall below expectations, we may need to evaluate the need to re-establish a valuation allowance against our deferred tax assets. If the valuation allowance were to be re-established it would negatively affect the financial results in the period in which it was re-established. Additionally, future changes in ownership of our common stock may restrict the ability to realize the benefit of our net operating loss carryforwards.

Our business involves the extensive use of intellectual property, and related claims against us could be costly or force us to abandon popular products.

Third parties have asserted, and may in the future assert, that our business or the products we make or use infringe upon their rights. We cannot predict whether third parties will assert claims of infringement against us, or whether any past or future assertions or prosecutions of infringement will harm our business. If we are forced to defend against any such claims, whether they are with or without merit and even if they are determined in our favor, we may face costly litigation, diversion of the attention of our technical and management personnel and product shipment delays. As a result of any infringement dispute, we may have to develop non-infringing products or enter into royalty or licensing agreements, which may be on unfavorable terms. If there is a successful claim of infringement against us, and we are unable to develop non-infringing products or license the infringed or similar product on a timely basis or at all, we will need to drop the infringed product from our offerings and our sales could suffer.

of any infringement dispute, we may have to develop non-infringing products or enter into royalty or licensing agreements, which may be on unfavorable terms. If there is a successful claim of infringement against us, and we are unable to develop non-infringing products or license the infringed or similar product on a timely basis or at all, we will need to drop the infringed product from our offerings and our sales could suffer.

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

The steps we take to protect our proprietary rights may be inadequate. 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 or license agreements with our employees, customers, partners and others to protect our proprietary rights. Birthday Express and BirthdayExpress.com are registered with the United States Patent and Trademark office, and we have filed federal trademark applications for Costume Express and Celebrate Express. We cannot be certain we will be able to obtain registration for our filed trademarks or for trademarks we submit applications for in the future. Effective trademark, service mark, copyright and trade secret protection may not be available in every country in which we will sell our products and services. Furthermore, the relationship between ~~regulations governing~~ domain names and laws protecting trademarks and similar proprietary rights is unclear. Therefore, we may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights and our brands and reputation could be impaired and we could lose customers.

~~If we cannot maintain and protect our existing domain names or acquire suitable~~25 ~~new domain names as needed, we may not be able to successfully build our brands.~~

We may be unable to acquire or maintain Internet domain names relating to our brands in the United States and other countries in which we may conduct business. As a result, we may be unable to prevent third parties from acquiring and using domain names relating to our brands. Such use could damage our brands and reputation and divert customers away from our websites. We currently hold various relevant domain names, including www.BirthdayExpress.com, www.CelebrateExpress.com, and www.CostumeExpress.com. The acquisition and maintenance of domain names generally is regulated by governmental agencies. Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names, any of which may affect our ability to maintain the domain names we need for our business. If we cannot prevent others from using similar domain names we may be unable to successfully build our brands.

Capacity constraints, systems failures or security breaches could prevent access to our websites, which could lower our sales and harm our reputation.

Our service goals of performance, reliability and availability require that we have adequate capacity in our computer systems to cope with the volume of customers on our websites. As our operations grow in size and scope, we will need to improve and upgrade our systems and infrastructure to maintain or improve the efficiency of our operations as well as to offer customers enhanced services, capacity, features and functionality. The expansion and/or upgrade of our systems and infrastructure will require us to commit substantial financial, operational and technical resources before the volume of our business increases and with no assurance of a corresponding increase in sales. If we cannot expand and/or upgrade our systems in a timely or efficient manner, we could experience increased costs, disruptions in service, slower response times, lower customer satisfaction and delays in the introduction of new products and services. Any of these problems could impair our reputation, damage our brands and cause our sales to decline.

Our ability to provide high-quality service depends on the efficient and uninterrupted operation of our computer and communications systems. Our website has experienced system interruptions from time to time and could experience periodic system interruptions in the future. Our systems and operations are also vulnerable to damage or interruption from human error, natural disasters, power loss, telecommunication failures, break-ins, sabotage, computer viruses, design defects, vandalism, denial-of-service attacks and similar events. We do not have a formal disaster recovery plan or alternate providers of web hosting services, and outages at our data centers could mean the temporary loss of the use of our websites. Our business interruption insurance may not adequately compensate us for the associated losses. Any system failure or security breach that causes an interruption in service or decreases the responsiveness of our customer support center or websites could impair our reputation, damage our brands and cause a decrease in sales.

If we are unable to provide satisfactory telephone-based customer support, we could lose customers.

~~processing~~regulations ~~systems~~governing ~~resulting~~domain ~~from~~names ~~capacity~~and ~~constraints,~~laws ~~labor~~protecting ~~disputes,~~trademarks ~~telephone~~and orsimilar ~~Internet failures,~~proprietary ~~power~~rights ~~or service outages, natural disasters or other events could make it difficult or~~is ~~impossible to provide adequate telephone-based customer support~~unclear. ~~Further~~Therefore, we may be unable to ~~attract~~ ~~and~~prevent ~~retain~~third anparties ~~adequate~~from ~~number~~acquiring ofdomain ~~competent~~names ~~customer~~that ~~support representatives, which is essential in creating a favorable customer experience. If we~~ are ~~unable to continually provide~~ ~~adequate~~similar ~~staffing for our customer support operations~~to, ~~our~~infringe ~~reputation~~upon ~~could~~or beotherwise ~~seriously~~decrease ~~harmed.~~the ~~In addition,~~value weof ~~cannot assure you that call volumes will not exceed~~ our ~~present~~trademarks ~~system~~and ~~capacities.~~other Ifproprietary ~~this~~rights ~~occurs, we could experience delays in accepting orders, responding to customer inquiries~~ and ~~addressing~~ ~~customer concerns. Also, we may be required to expand~~ our ~~customer~~brands ~~support~~and ~~centers~~reputation ~~in the~~could ~~near future. We cannot assure you that we will~~ be ~~able~~impaired to find additional suitable facilities on acceptable terms or at all, which could seriously hinder our ability to provide satisfactory levels of customer support. Because our success depends in large part on keeping our customers satisfied, any failure to provide satisfactory levels of customer support would likely impair our reputation and we could lose customers.

If we cannot maintain and protect our existing domain names or acquire suitable new domain names as needed, we may not be able to successfully build our brands.

We may be unable to acquire or maintain Internet domain names relating to our brands in the United States and other countries in which we may conduct business. As a result, we may be unable to prevent third parties from acquiring and using domain names relating to our brands. Such use could damage our brands and reputation and divert customers away from our website. We currently hold various relevant domain names, including www.CelebrateExpress.com, www.BirthdayExpress.com, and www.CostumeExpress.com. The acquisition and maintenance of domain names generally is regulated by governmental agencies. Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names, any of which may affect our ability to maintain the domain names we need for our business. If we cannot prevent others from using similar domain names we may be unable to successfully build our brands.

Temporary or permanent disruption at our fulfillment facility could prevent timely shipment of customer orders and hurt our sales.

We assemble, package, and ship our orders, and process all product returns, at our Greensboro, North Carolina fulfillment and distribution facility. In the future, we may be unable to fulfill our customers’ orders at this facility in a timely manner, or at all, due to a number of factors, including:

	•		a failure to maintain or renew our existing lease agreement;

	•		a power, telecommunications or other systems failure;

	•		an employee strike or other labor stoppage;

	•		terrorist attacks, acts of war or break-ins;

	•		a disruption in the transportation infrastructure including air traffic and roads; or

	•		fire, flood, hurricane or other disaster.

In the event that we are temporarily unable to timely fulfill our customers’ orders through our Greensboro facility, we will either upgrade the shipping or attempt to re-ship the orders from another source. However, we cannot guarantee that we will be able to fulfill all orders or that we will be able to deliver the affected orders in a timely manner. This could result in increased fulfillment costs or a decrease in sales, as well as the potential loss of repeat orders from affected customers. In addition, if operations at our Greensboro facility become permanently disrupted due to any of the above or other factors, we may not be able to secure a replacement fulfillment and distribution facility on terms acceptable to us or at all. We do not currently maintain back-up power systems at our Greensboro facility, nor do we have a formal disaster recovery plan and our business interruption insurance may be insufficient to compensate us for losses that occur in the event operations at our fulfillment and distribution center are interrupted.

We may incur significant costs or experience product availability delays in complying with regulations applicable to the sale of our manufactured products.

We use a variety of water-based inks, paper and coatings in the manufacture of our paper party products. We are required to maintain our manufacturing operations in compliance with United States federal, state and local laws and regulations, including but not limited to rules and regulations associated with consumer protection and safety, the Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, the Food and Drug Administration and the Occupational Safety and Health Administration, or OSHA. Changes in laws and regulations applicable to our business could significantly increase our costs of goods sold and we may not be able to pass these increases on to our customers. If we fail to comply with current laws and regulations applicable to our business, or to pass annual inspections of our facilities by regulatory bodies, we could be subject to fines and penalties or even ~~interruptions of our operations. In addition, failure to~~ ~~comply with applicable laws and regulations could subject us to the risk of private lawsuits and damages.~~

~~If use of the Internet, particularly with respect to online commerce, does not~~26 ~~continue to increase as rapidly as we anticipate, our sales may not grow to desired levels.~~

For the quarter ended August 31, 2006, our online sales represented approximately 73% of our total sales. Our future sales and profits are substantially dependent upon the continued use of the Internet as an effective medium of business and communication by our customers. Internet use may not continue to develop at historical rates and consumers may

~~not~~interruptions ~~continue~~of toour ~~use~~operations. ~~the~~In ~~Internet~~addition, ~~and~~failure ~~other~~to ~~online~~comply ~~services~~with asapplicable alaws ~~medium for commerce.~~and ~~Highly-publicized~~regulations ~~failures of some online retailers in meeting consumer demands~~ could ~~result~~subject ~~in consumer~~us ~~reluctance~~ to ~~adopt~~ the ~~Internet~~risk asof aprivate ~~means~~lawsuits ~~for commerce,~~ and ~~thereby damage our reputation and brands and reduce our revenues and results of operations~~damages.

If use of the Internet, particularly with respect to online commerce, does not continue to increase as rapidly as we anticipate, our sales may not grow to desired levels.

For the quarter ended February 29, 2008, our online sales represented approximately 86% of our total sales. Our future sales and profits are substantially dependent upon the continued use of the Internet as an effective medium of business and communication by our customers. Internet use may not continue to develop at historical rates and consumers may not continue to use the Internet and other online services as a medium for commerce. Highly-publicized failures of some online retailers in meeting consumer demands could result in consumer reluctance to adopt the Internet as a means for commerce, and thereby damage our reputation and brands and reduce our revenues and results of operations.

In addition, the Internet may not be accepted as a viable long-term commercial marketplace for a number of reasons, including:

	•		actual or perceived lack of security of information or privacy protection;

	•		possible disruptions, computer viruses or other damage to the Internet servers or to users’ computers; and

	•		excessive governmental regulation.

If the Internet fails to continue growing as a commercial marketplace, our sales may not increase as much as desired by our shareholders, or at all.

Risks related to the Internet, including security and reliability issues, are largely outside our control and may hurt our reputation or sales.

Our online business is subject to numerous risks, many of which are outside our control. In addition to changing consumer preferences and buying trends relating to Internet usage, we are vulnerable to additional risks and uncertainties associated with the Internet. These risks include changes in required technology interfaces, website downtime or slowdowns and other technical failures or human errors, changes in applicable federal and state regulation, security breaches, and consumer privacy concerns. Our failure to respond successfully to these risks and uncertainties might adversely affect the sales through our online business, as well as damage our reputation and increase our selling and marketing and general and administrative expenses. In addition, our success will depend, in large part, upon third parties maintaining the Internet infrastructure to provide a reliable network backbone with the speed, data capacity, security and hardware necessary for reliable Internet access and services. Our business, which relies on a graphically-rich ~~websites~~website that ~~require~~requires the transmission of substantial data, is also significantly dependent upon the availability and adoption of broadband Internet access and other high-speed Internet connectivity technologies. Any significant reliability, data capacity or connectivity problems experienced by the Internet or its users could harm our sales and profitability.

Government regulation of database use in direct marketing and Internet and online commerce is evolving. Unfavorable changes in these regulations could substantially harm our business and results of operations.

We are subject to general business regulations and laws, as well as regulations and laws that specifically govern database use in direct marketing and Internet and online commerce. Existing and future regulations and laws may impede the growth of database direct marketing, Internet or other online services. These regulations and laws may cover taxation, restrictions on imports and exports, customs, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, email restrictions, the provision of online payment services, broadband residential Internet access and the characteristics and quality of products and services. It is not clear how existing laws and regulations governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to database direct marketing, the Internet and online commerce. Unfavorable resolution of these issues may slow the growth of database direct marketing, online commerce and, in turn, our business.

Our failure to protect confidential information of our customers and our network against security breaches could damage our reputation and brands and subject us to legal liability.

A significant barrier to online commerce and communications is the secure transmission of confidential information over public networks. Currently, a majority of our sales are billed to our customers’ credit card accounts directly. We ~~rely on encryption and authentication technology~~ licensed from third parties to effect secure transmission of confidential information, including credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology we use to protect customer transaction data. Any compromise of our security could damage our reputation and brands and expose us to a risk of lost sales, or litigation and possible legal liability. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.

~~Our failure to address risks associated with credit card fraud could damage our reputation and brands.~~27

~~Under~~rely ~~current~~on ~~credit~~encryption ~~card~~and ~~practices,~~authentication wetechnology ~~are~~licensed ~~liable~~from ~~for~~third ~~fraudulent~~parties ~~credit~~to ~~card~~effect ~~transactions~~secure ~~because~~transmission weof doconfidential ~~not~~information, ~~obtain~~including acredit ~~cardholder’s~~card ~~signature~~numbers. WeAdvances doin ~~not~~computer capabilities, ~~currently~~new ~~carry~~discoveries ~~insurance~~in ~~against~~the ~~this risk.~~field Toof ~~date,~~cryptography weor ~~have~~other ~~experienced~~developments ~~minimal~~may ~~losses~~result ~~from~~in ~~credit~~a compromise ~~card~~or ~~fraud,~~breach ~~but~~of wethe ~~face~~technology ~~the~~we ~~risk~~use ~~of significant~~to ~~losses~~protect ~~from~~customer ~~this~~transaction ~~type~~data. Any compromise of ~~fraud~~our assecurity could damage our ~~net~~reputation ~~sales~~and ~~increase.~~brands ~~Such~~and ~~losses~~expose ~~could~~us ~~impair~~to ~~our results~~a risk of ~~operations~~lost sales, or litigation and possible legal liability. In addition, ~~any~~anyone ~~failure~~who tois ~~adequately~~able ~~control~~to ~~fraudulent~~circumvent ~~credit~~our ~~card~~security ~~transactions~~measures could ~~damage~~misappropriate ~~our~~proprietary ~~reputation~~information ~~and~~or ~~brands,~~cause ~~and~~interruptions ~~reduce~~in our ~~sales~~operations. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.

Our failure to address risks associated with credit card fraud and bad debt could damage our reputation, brands and results of operations.

Under current credit card practices, we are liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature. We do not currently carry insurance against this risk. To date, we have experienced minimal losses from credit card fraud, but we face the risk of significant losses from this type of fraud as our net sales increase. Losses incurred from fraudulent transactions or bad debt associated with the extension of credit to our customers could impair our results of operations. In addition, any failure to adequately control fraudulent credit card transactions could damage our reputation and brands, and reduce our sales.

Our sales may decrease if we are required to collect taxes on purchases.

We do not collect or have imposed upon us sales, use or other taxes related to the products we sell, except for certain corporate-level taxes and sales taxes with respect to purchases by customers located in the states of North Carolina and Washington. However, one or more states may seek to impose sales, use or other tax collection obligations on us in the future. A successful assertion by one or more states that we should be collecting sales, use or other taxes on the sale of our products could result in substantial tax liabilities and penalties in connection with past sales. In addition, if we are required to collect these taxes we will lose one of our current cost advantages, which may decrease our ability to compete with traditional retailers and substantially harm our sales.

We have based our policies for sales and use tax collection on our interpretation of certain ~~decisions~~ decisions of the U.S. Supreme Court that restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made through catalogs or over the Internet. However, implementation of the restrictions imposed by these Supreme Court decisions is subject to interpretation by state and local taxing authorities. While we believe that these Supreme Court decisions currently restrict state and local taxing authorities outside the states of North Carolina and Washington from requiring us to collect sales and use taxes from purchasers located within their jurisdictions, taxing authorities outside of North Carolina and Washington could disagree with our interpretation of these decisions. Moreover, a number of states, as well as the U.S. Congress, have been considering various initiatives that could limit or supersede the Supreme Court’s position regarding sales and use taxes on Internet sales. If any state or local taxing jurisdiction were to disagree with our interpretation of the Supreme Court’s current position regarding state and local taxation of Internet sales, or if any of these initiatives were to address the Supreme Court’s constitutional concerns and result in a reversal of its current position, we could be required to collect sales and use taxes from purchasers located in states other than North Carolina and Washington. The imposition byof ~~state~~additional ~~and~~tax ~~local~~obligations ~~governments~~on ~~of various~~our ~~taxes~~business ~~upon~~by ~~Internet~~state ~~commerce~~and local governments could create ~~administrative~~significant administration burdens for us ~~and could~~ , decrease our future sales and harm our cash flow and operating results.

Failure to rapidly respond to technological change could result in our services or systems becoming obsolete.

As the Internet and online commerce industries evolve, we may be required to license emerging technologies useful to our business, enhance our existing services, develop new services and technologies that address the increasingly sophisticated and varied needs of our prospective customers and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. We may not be able to successfully implement these new services and technologies or adapt our ~~websites~~website, telephone and transaction-processing systems to customer requirements or emerging industry standards. Some of our computer systems use antiquated software that is no longer supported by the vendor. If we were to encounter problems with these systems it could be costly and time consuming to correct, and may disrupt operations. If we fail to respond to these issues in a timely manner, we may lose existing customers and be unable to attract sufficient numbers of new customers.

Future sales of our common stock may depress our stock price.

If our shareholders sell substantial amounts of common stock in the public market, or if the market perceives that these sales may occur, the market price of our common stock may decline. Our former chief executive officer and president has in the past established, and he and other officers or directors may in the future establish, programmed selling plans under Rule 10b5-1 for the purpose of effecting sales of common stock. We have ~~also~~ registered all shares of common stock that we may issue under our employee benefits plans. As a result, these shares can be freely sold in the public market upon issuance, subject to restrictions under the securities laws. The holders of a significant portion of our common stock have rights, subject to some conditions, to require us to file registration statements covering the resale of their shares or to include their shares in registration statements that we may file for ourselves or other shareholders. These registration rights of our shareholders could impair our ability to raise capital by depressing the price at which we could sell our common stock.

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

Our directors and current beneficial holders of 5% or more of our outstanding common stock own a significant portion of our stock. These individuals, acting together, are able to control or influence significantly all matters requiring shareholder 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 and limit the ability of smaller shareholders to influence corporate matters.

We will need to implement additional finance and accounting systems, procedures and controls as we grow our business and organization and to satisfy new reporting requirements.

As a public reporting company, we are required to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, including expanded disclosures and accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements will increase our costs and require additional management time and resources. We may need to continue to implement additional finance and accounting systems, procedures and controls to satisfy new reporting requirements. If our internal controls over financial reporting are determined to be ineffective, investors could lose confidence in the reliability of our internal controls over financial reporting, which could adversely affect our stock price.

complex accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements will increase our costs and require additional management time and resources. We may need to continue to implement additional finance and accounting systems, procedures and controls to satisfy new reporting requirements. Compliance with Section 404 may first apply to our fiscal year ending May 31, 2007. If our internal controls over financial reporting are determined to be ineffective, investors could lose confidence in the reliability of our internal controls over financial reporting, which could adversely affect our stock price.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

On October 19, 2004 (the “registration effective date”), the Company’s registration statement on Form S-1 (Registration ~~Nos~~No. 333-117459) was declared effective for the Company’s initial public offering. Net proceeds to the Company after all expenses ~~was~~were approximately $34 million. From the registration effective date ~~of the registration statement~~ through ~~August~~February 3129, ~~2006~~2008, the Company has used the net proceeds from ~~the~~ the offering for repayment of the Company’s $5.0 million term loan. Through February 29, 2008, we estimate that approximately $9.6 million of the proceeds have been used to purchase fixed assets and approximately $5.0 million of proceeds have been used for working capital purposes. ~~The~~On April 26, 2007, approximately $9.9 million was paid to shareholders in the form of a one time special dividend. The remaining proceeds from the offering are invested in ~~commercial paper, auction rate securities and~~ money market securities.

Item 6. Exhibits.

Exhibit No.		Description
3.1(1)		Amended and Restated Articles of Incorporation of Celebrate Express, Inc.
3.2(2)		Articles of Amendment of the Amended and Restated Articles of Incorporation of Celebrate Express, Inc. (Series A Participating Preferred Stock).
3.3(1)		Amended and Restated Bylaws of the Celebrate Express, Inc.
3.4(3)		Amendments to Sections 2.1, 2,2 and 3.3 of the Amended and Restated Bylaws of Celebrate Express, Inc.
3.5(4)		Amendments to Sections 3.9 and 11.1 of the Amended and Restated Bylaws of Celebrate Express, Inc.
3.6		Articles of Amendment of the Amended and Restated Articles of Incorporation of Celebrate Express, Inc.
4.1(1)		Specimen Common Stock Certificate.
4.2(1)		Amended and Restated Investor’s Rights Agreement dated November 15, 2001, by and among Celebrate Express, Inc. and the investors named therein.
4.3(2)		Preferred Shares Rights Agreement, dated July 25, 2005.
4.4(2)		Form of Preferred Shares Rights Certificate.
10.1		Employment offer letter with Mr. Dennis Everhart, dated July 28, 2006.
10.1(5)		Lease Amendment No. 7 between Registrant and Queen Investment Company LLC dated October 4, 2007.
10.2		Employment offer letter with MsMr. ~~Lisa~~Harold ~~Tuttle~~Egler, dated ~~August~~March 307, ~~2006~~2008.
10.3		~~Severance~~Employment ~~and~~offer ~~Change~~letter ~~in Control Agreement~~ with Mr. ~~Darin~~Kristopher ~~White~~Galvin, dated ~~September~~January 1810, ~~2006~~2008.
10.4(5)		Lease agreement between Celebrate Express, Inc. and Queen Investment Company, dated June 8, 2006.
10.4		Severance and Change in Control Agreement with Mr. Harold Egler, dated March 13, 2008.
10.5(6)		Settlement Agreement between Celebrate Express, Inc. and the shareholders named therein, dated August 17, 2006.
10.5		Form of Severance and Change in Control Agreement with Mr. Kristopher Galvin, Ms. Lisa Tuttle, and Mr. Dennis Everhart, dated March 13, 2008
31.1		Certification of Chief Executive Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.
31.2		Certification of ~~Principal~~Chief Financial Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.
32.1		Certification of Chief Executive Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.
32.2		Certification of ~~Principal~~Chief Financial Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.

(1)		Incorporated by reference to Registrant’s Registration Statement on Form S-1 (File No. 333-117459), as amended, initially filed with the Securities and Exchange Commission on July 16, 2004.
(2)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 25, 2006.
(3)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 11, 2006.
(4)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 20, 2006.
(5)		Incorporated by reference to Registrant’s ~~Annual~~Current Report on Form 108-K ~~for~~filed with the ~~year~~Securities ~~ended~~and ~~May~~Exchange 31Commission on October 10, ~~2006~~2007.
(6)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 22, 2006.

2630

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.

	CELEBRATE EXPRESS, INC.	~~CELEBRATE EXPRESS, INC.~~
Date: October 13, 2006		By:	/s/ Kevin A. Green
Date: April 11, 2008	By:	/s/ Kevin A. Green
		Kevin A. Green	~~Kevin A. Green~~
			Chief Executive Officer and President
		Chief Executive Officer and President (Principal Executive Officer)
			(Principal Executive Officer)
Date: April 11, 2008	By:	/s/ Kristopher S. Galvin
Date: October 13, 2006		By:	/s/ Darin L. White
		Kristopher S. Galvin
			Darin L. White
		Chief Financial Officer (Principal Financial and Accounting Officer)
			Vice President, Finance
			(Principal Financial and Accounting Officer)

2731

EXHIBIT INDEX

Exhibit No.		Description
3.1(1)		Amended and Restated Articles of Incorporation of Celebrate Express, Inc.
3.2(2)		Articles of Amendment of the Amended and Restated Articles of Incorporation of Celebrate Express, Inc. (Series A Participating Preferred Stock).
3.3(1)		Amended and Restated Bylaws of the Celebrate Express, Inc.
3.4(3)		Amendments to Sections 2.1, 2,2 and 3.3 of the Amended and Restated Bylaws of Celebrate Express, Inc.
3.5(4)		Amendments to Sections 3.9 and 11.1 of the Amended and Restated Bylaws of Celebrate Express, Inc.
3.6		Articles of Amendment of the Amended and Restated Articles of Incorporation of Celebrate Express, Inc.
4.1(1)		Specimen Common Stock Certificate.
4.2(1)		Amended and Restated Investor’s Rights Agreement dated November 15, 2001, by and among Celebrate Express, Inc. and the investors named therein.
4.3(2)		Preferred Shares Rights Agreement, dated July 25, 2005.
4.4(2)		Form of Preferred Shares Rights Certificate.
10.1		Employment offer letter with Mr. Dennis Everhart, dated July 28, 2006.
10.1(5)		Lease Amendment No. 7 between Registrant and Queen Investment Company LLC dated October 4, 2007.
10.2		Employment offer letter with MsMr. ~~Lisa~~Harold ~~Tuttle~~Egler, dated ~~August~~March 307, ~~2006~~2008.
10.3		~~Severance~~Employment ~~and~~offer ~~Change~~letter ~~in Control Agreement~~ with Mr. ~~Darin~~Kristopher ~~White~~Galvin, dated ~~September~~January 1810, ~~2006~~2008.
10.4(5)		Lease agreement between Celebrate Express, Inc. and Queen Investment Company, dated June 8, 2006.
10.4		Severance and Change in Control Agreement with Mr. Harold Egler, dated March 13, 2008.
10.5(6)		Settlement Agreement between Celebrate Express, Inc. and the shareholders named therein, dated August 17, 2006.
10.5		Form of Severance and Change in Control Agreement with Mr. Kristopher Galvin, Ms. Lisa Tuttle, and Mr. Dennis Everhart, dated March 13, 2008
31.1		Certification of Chief Executive Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.
31.2		Certification of ~~Principal~~Chief Financial Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.
32.1		Certification of Chief Executive Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.
32.3		Certification of Principal Financial Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.
32.2		Certification of Chief Financial Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.

(1)		Incorporated by reference to Registrant’s Registration Statement on Form S-1 (File No. 333-117459), as amended, initially filed with the Securities and Exchange Commission on July 16, 2004.
(2)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 25, 2006.
(3)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 11, 2006.
(4)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 20, 2006.
(5)		Incorporated by reference to Registrant’s ~~Annual~~Current Report on Form 108-K ~~for~~filed with the ~~year~~Securities ~~ended~~and ~~May~~Exchange 31Commission on October 10, ~~2006~~2007.
(6)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 22, 2006.

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