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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 Form 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended July 2, 2006
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number: 0-50387
 RedEnvelope, Inc.
 (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    33-0844285(State or Other Jurisdiction of
    
    (IRS EmployerIncorporation or Organization)
    
    Identification No.)
 149 New Montgomery Street,
San Francisco, California 94105  (Address of Principal Executive Offices and Zip Code)
 (415) 371-9100  (Registrants Telephone Number, Including Area Code)
 þ o
  o o þ
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##### Table of Contents



RedEnvelope, Inc.
REPORT ON FORM 10-Q
For the Quarter Ended July 2, 2006
TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATION
    
    
    3Item 1.
    
    Financial Statements (Unaudited)
    
    
    3Condensed Balance Sheets as of July 2, 2006, April 2, 2006 and July 3, 2005
    
    
    3Condensed Statements of Operations for the thirteen weeks ended July 2, 2006 and July 3, 2005
    
    
    4Condensed Statements of Cash Flows for the thirteen weeks ended July 2, 2006 and July 3, 2005
    
    
    5Notes to Condensed Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    9Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    13Item 4.
    
    Controls and Procedures
    
    
    14PART II. OTHER INFORMATION
    
    
    14Item 1.
    
    Legal Proceedings
    
    
    14Item 1A.
    
    Risk Factors
    
    
    14Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25Item 3.
    
    Defaults Upon Senior Securities
    
    
    26Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    26Item 5.
    
    Other Information
    
    
    26Item 6.
    
    Exhibits
    
    
    26EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
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PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 RedEnvelope, Inc.
 
 CONDENSED BALANCE SHEETS
 (Unaudited)
 July 2,
    
    
    April 2,
    
    
    July 3,2006
    
    
    2006
    
    
    2005(In thousands, except for share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    2,311
    
    
    $
    3,277
    
    
    $
    2,172Short-term investments
    
    
    5,058
    
    
    
    6,762
    
    
    
    14,471Accounts receivable, net
    
    
    1,611
    
    
    
    1,054
    
    
    
    1,109Inventory
    
    
    19,209
    
    
    
    19,690
    
    
    
    11,794Prepaid catalog costs and other current assets
    
    
    2,430
    
    
    
    2,793
    
    
    
    2,243Total current assets
    
    
    30,619
    
    
    
    33,576
    
    
    
    31,789Property and equipment, net
    
    
    7,576
    
    
    
    7,255
    
    
    
    7,423Other assets
    
    
    258
    
    
    
    146
    
    
    
    538,Total assets
    
    $
    38,453
    
    
    $
    40,977
    
    
    $
    39,750LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    6,285
    
    
    $
    9,759
    
    
    $
    4,632Accrued expenses and other current liabilities
    
    
    2,904
    
    
    
    2,699
    
    
    
    3,716Accrued compensation
    
    
    1,737
    
    
    
    1,371
    
    
    
    1,148Capital lease obligations, current
    
    
    284
    
    
    
    312
    
    
    
    578Total current liabilities
    
    
    11,210
    
    
    
    14,141
    
    
    
    10,074Capital lease obligations, long-term
    
    
    507
    
    
    
    136
    
    
    
    141Deferred rent
    
    
    644
    
    
    
    710
    
    
    
    833Total liabilities
    
    
    12,361
    
    
    
    14,987
    
    
    
    11,048Stockholders equity:Common stock, $0.01 par value; 100 million
shares authorized; 9.4 million, 9.3
million, and 9.0 million issued and
outstanding as of July 2, 2006, April 2,
2006, and July 3, 2005, respectively
    
    
    96
    
    
    
    94
    
    
    
    90Additional paid-in capital
    
    
    116,367
    
    
    
    115,367
    
    
    
    114,216Notes receivable from stockholders
    
    
    (44
    )
    
    
    (44
    )
    
    
    (44
    )Accumulated deficit
    
    
    (90,327
    )
    
    
    (89,427
    )
    
    
    (85,560
    )Total stockholders equity
    
    
    26,092
    
    
    
    25,990
    
    
    
    28,702Total liabilities and stockholders equity
    
    $
    38,453
    
    
    $
    40,977
    
    
    $
    39,750
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RedEnvelope, Inc.
 
 CONDENSED STATEMENTS OF OPERATIONS
 (Unaudited)
 Thirteen Weeks EndedJuly 2,
    
    
    July 3,2006
    
    
    2005(In thousands, except for per share data)Net revenues
    
    $
    26,858
    
    
    $
    24,978Cost of sales
    
    
    12,608
    
    
    
    11,729Gross profit
    
    
    14,250
    
    
    
    13,249Operating expenses:Fulfillment
    
    
    3,419
    
    
    
    3,405Marketing
    
    
    6,285
    
    
    
    6,863General and administrative
    
    
    5,489
    
    
    
    4,811Total operating expenses
    
    
    15,193
    
    
    
    15,079Loss from operations
    
    
    (943
    )
    
    
    (1,830
    )Interest income, net
    
    
    43
    
    
    
    78Net loss
    
    $
    (900
    )
    
    $
    (1,752
    )Net loss per share  basic and diluted
    
    $
    (0.10
    )
    
    $
    (0.20
    )Weighted average shares outstanding  basic and diluted
    
    
    9,377
    
    
    
    8,919
  4




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RedEnvelope, Inc.
 
 CONDENSED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Thirteen Weeks EndedJuly 2,
    
    
    July 3,2006
    
    
    2005(In thousands)Cash Flows From Operating Activities:Net loss
    
    $
    (900
    )
    
    $
    (1,752
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization
    
    
    837
    
    
    
    798Stock-based compensation
    
    
    593
    
    
    
    4Other non-cash charges
    
    
    (34
    )
    
    
    (7
    )Changes in current assets and liabilities:Accounts receivable, net
    
    
    (557
    )
    
    
    (118
    )Inventory
    
    
    481
    
    
    
    2,255Prepaid catalog costs and other current assets
    
    
    363
    
    
    
    1,661Accounts payable
    
    
    (3,192
    )
    
    
    (5,412
    )Accrued expenses and other current liabilities
    
    
    571
    
    
    
    414Net cash used in operating activities
    
    
    (1,838
    )
    
    
    (2,157
    )Cash Flows From Investing Activities:Maturities of short-term investments
    
    
    6,561
    
    
    
    1,300Purchases of short-term investments
    
    
    (4,857
    )
    
    
    (1,420
    )Purchases of property and equipment
    
    
    (945
    )
    
    
    (633
    )Net cash provided by (used in) investing activities
    
    
    759
    
    
    
    (753
    )Cash Flows From Financing Activities:Proceeds from issuance of common stock
    
    
    409
    
    
    
    424Principal payments on capital lease obligations
    
    
    (155
    )
    
    
    (149
    )Payment of debt issuance costs
    
    
    (141
    )
    
    
    Net cash provided by financing activities
    
    
    113
    
    
    
    275Net decrease in cash and cash equivalents
    
    
    (966
    )
    
    
    (2,635
    )Cash and cash equivalents at beginning of period
    
    
    3,277
    
    
    
    4,807Cash and cash equivalents at end of period
    
    $
    2,311
    
    
    $
    2,172Supplemental Cash Flow Information:Cash paid for interest
    
    $
    28
    
    
    $
    27Supplemental Non-Cash Investing and Financing Activities:Property and equipment acquired through capital lease transactions
    
    $
    498
    
    
    $
    
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RedEnvelope, Inc.
 
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 (Unaudited)
 1. Financial Statements  Basis of Presentation
     2. Certain Significant Accounting Policies
  Loss Per Share 
 Investments 
  New Accounting Pronouncements  Share-Based Payment
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How Taxes Collected from Customers and Remitted to Governmental Authorities Should
Be Presented in the Income Statement (that is, Gross versus Net Presentation)
 Accounting for Income Tax
Uncertainties Accounting
for Income Taxes
 3. Stock-Based Compensation
  Accounting for Stock Issued to Employees
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(In thousands, exceptper share data)Net loss  as reported
    
    $
    (1,752
    )Stock-based employee compensation included in reported net loss
    
    
    4Stock-based compensation expense determined under fair value method
    
    
    (456
    )Pro forma net loss
    
    $
    (2,204
    )Basic and diluted loss per shareAs reported
    
    $
    (0.20
    )Pro forma
    
    $
    (0.25
    )
 Stock Options
       Thirteen Weeks EndedWeighted average assumptions:
    
    July 2, 2006
    
    July 3, 2005Expected volatility
    
    56.8%
    
    59.3%Dividend yield
    
    0%
    
    0%Expected term
    
    3.8  5.7 years
    
    4.0 yearsRisk-free interest rate
    
    4.8%  5.2%
    
    3.9%
  8




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WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateOptions
    
    Exercise Price
    
    Contractual
    
    IntrinsicOutstanding
    
    per Share
    
    Term (Years)
    
    Value(in thousands)Balance, April 2, 2006
    
    
    1,560
    
    
    $
    8.65Granted
    
    
    53
    
    
    
    10.48Cancelled
    
    
    (68
    )
    
    
    12.13Exercised
    
    
    (170
    )
    
    
    1.97Balance, July 2, 2006
    
    
    1,375
    
    
    $
    9.36
    
    
    
    7.34
    
    
    $
    1,080Exercisable, July 2, 2006
    
    
    499
    
    
    $
    8.03
    
    
    
    5.84
    
    
    $
    1,060
  Employee Stock Purchase Plan
   Thirteen Weeks Ended
July 2, 2006Expected volatility
    
    32.6% - 40.5%Dividend yield
    
    0%Expected term
    
    0.5 yearsRisk-free interest rate
    
    4.1%  4.7%
  4. Borrowing Arrangements
  5. Legal Proceedings
  
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
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Forward-Looking Statements
 This report, together with the documents incorporated herein by reference, contains
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. Such statements
are based upon current expectations and involve risks and uncertainties. Any statements contained
in this report that are not purely statements of historical fact may be deemed to be
forward-looking statements. Such forward-looking statements may include but are not limited to
statements regarding our future operations and enhancements, product offerings, business, financial
condition, results of operations and prospects. Additionally, statements concerning possible
changes in applicable rules or legislation are forward-looking statements. Words such as expects,
anticipates, intends, plans, believes, seeks, estimate, may, should, would,
could and similar expressions or variations of such words are intended to identify
forward-looking statements, but are not the exclusive means of identifying forward-looking
statements in this report. All forward-looking statements in this report are based upon information
available to us as of the date hereof, and we assume no obligation to revise or update any such
forward-looking statements in order to reflect any event or circumstance that may arise after the
date of this report. Actual results and the timing of certain events could differ materially from
our current expectations. Factors that could cause or contribute to such differences include, but
are not limited to, those set forth in this report under Risk Factors, and elsewhere in this
report, and those contained from time to time in our other filings with the SEC. We caution
investors that our business and financial performance are subject to substantial risks and
uncertainties.
 Overview
 www.redenvelope.com
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Critical Accounting Policies
  New Accounting Standards
 Share-Based Payment
 Results of Operations
  Thirteen Weeks EndedJuly 2,
    
    July 3,2006
    
    2005Statements of Operations Data:Net revenues
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    46.9
    
    
    
    47.0Gross profit
    
    
    53.1
    
    
    
    53.0Operating expenses:Fulfillment
    
    
    12.7
    
    
    
    13.6Marketing
    
    
    23.4
    
    
    
    27.5General and administrative
    
    
    20.4
    
    
    
    19.3Total operating expenses
    
    
    56.6
    
    
    
    60.3Loss from operations
    
    
    (3.5
    )
    
    
    (7.3
    )Interest income, net
    
    
    0.1
    
    
    
    0.3Net loss
    
    
    (3.4
    )%
    
    
    (7.0)
    %
 Quarter Ended July 2, 2006 Compared to Quarter Ended July 3, 2005
 Net Revenues
   11




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Cost of Sales
   Operating Expenses
 Fulfillment.
  Marketing.
  General and Administrative.
  Liquidity and Capital Resources
  Cash Flows From Operating Activities
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Cash Flows From Investing Activities
 Cash Flows From Financing Activities
 Revolving Credit Facility
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Interest Rate Risk
   (In thousands)Cash and cash equivalents
    
    $
    2,311Short-term investments
    
    
    5,058Total
    
    $
    7,369
  Foreign Currency Risk
 13




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Item 4. Controls and Procedures
 Disclosure Controls and Procedures
 
 PART II.
OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  You should consider carefully the risks and uncertainties relating to our business including
those described below, together with all of the other information included or incorporated by
reference in this Quarterly Report on Form 10-Q . Additional risks and uncertainties not currently
known to us or that we currently do not deem material could also become important factors that may
harm our business. The trading price of our common stock could decline due to any of these risks
and uncertainties, and you could lose all or part of your investment.
 Our limited operating history makes evaluation of our business difficult.
  We have a history of significant losses. If we do not achieve
or sustain profitability, our financial condition and stock price
could suffer.
  14




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Because we experience seasonal fluctuations in our net sales,
our quarterly results will fluctuate and our annual performance will
depend largely on results from one quarter.
  Our operating results are volatile and difficult to predict and may adversely affect our stock price.
  Our computer and communications hardware and software systems
are vulnerable to damage and interruption, which could harm our
business.
  If we fail to offer a broad selection of innovative merchandise
that consumers find attractive, our revenues could decline or fail to
reach anticipated levels and our stock price could be harmed.
  15




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Failure to successfully manage or expand our fulfillment and distribution operation would have a material adverse effect on us.
  If we do not manage our inventory levels successfully, our operating results may be adversely affected.
  We may have difficulty in product sourcing.
    16




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Our operating results could suffer if we fail to offer or sell sufficient quantities of proprietary products.
  Our facilities and systems are vulnerable to natural disasters or other catastrophic events.
  We have grown quickly and if we fail to manage our growth, our business will suffer.
  We experience intense competition in the rapidly changing retail gift market.
  17




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
    
    other online retailers, such as Amazon.com and eBay
    
    major department stores, such as Macys, Bloomingdales, Neiman Marcus and their online storefronts
    
    physical and online stores and catalog retailers that sell popular gift items such as Pottery Barn, Brookstone,
The Sharper Image, Tiffanys, Harry & David, J Crew, 1-800-Flowers and Williams-Sonoma
    
    Internet portals and online service providers and other comparison shopping sites, such as AOL, Yahoo! and Google.
   If we do not successfully expand our website and order
processing systems or respond to rapid technological changes, we
could lose customers and our net revenues could decline.
   Delivery of our merchandise could be delayed or disrupted by
factors beyond our control, and we could lose customers as a result.
  The loss of our senior management or other key personnel could harm our current and future operations and prospects.
  18




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We rely on seasonal and temporary employees during periods of
peak activity and any failure by such employees to adequately perform
their jobs could adversely affect our operations.
  Increased merchandise returns and a failure to accurately predict merchandise returns could harm our business.
  If we are unable to successfully manage the costs of our
catalog operations or our catalogs fail to produce sales at
satisfactory levels it could adversely affect our business.
  
    
    effective management of costs associated with the production and distribution of our catalog
    
    achievement of adequate response rates to our mailings
    
    displaying a mix of merchandise in our catalog that is attractive to our customers
    
    production of aesthetically appealing catalogs
    
    timely delivery of catalog mailings to our customers
  19




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We are dependent on the success of our advertising and marketing efforts which are costly and may not achieve desired results.
  If we are unable to provide satisfactory customer service, we could lose customers.
   If the protection of our trademarks and proprietary rights is
inadequate, our brand and reputation could be impaired and we could
lose customers.
   20




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Intellectual property claims against us could be costly and could impair our business.
  We may be subject to litigation proceedings that could adversely affect our business.
  We face the risk of inventory shrinkage.
  Poor economic conditions may constrain discretionary consumer spending on retail products such as ours.
  If we fail to meet the borrowing requirements under our loan
and security agreement, we may be unable to obtain necessary
short-term financing and if we default on a secured loan, material
assets of ours could be subject to forfeiture.
  21




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We may need additional financing and may not be able to raise
additional financing on favorable terms or at all, which could
increase our costs, limit our ability to grow and dilute the
ownership interests of existing stockholders.
  We may face product liability claims that are costly and create adverse publicity.
  We may incur significant costs or experience delays in product
availability due to regulations applicable to the sale of food
products and live plants, which may hurt our business.
  If we fail to comply with the laws regulating the sale of
tobacco products it may have a negative impact on our reputation and
make us vulnerable to liability claims.
  Our charter documents, Delaware law and third-party contractual
restrictions may make an acquisition of us more difficult, even if an
acquisition would be beneficial to our stockholders.
  22




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Our success is tied in large part to the continued use of the Internet by a large number of consumers.
  
    
    actual or perceived lack of privacy protection
    
    actual or perceived lack of security of credit card information
    
    possible disruptions or other damage to the Internet or telecommunications infrastructure
    
    increased governmental regulation and taxation
    
    decreased use of personal computers
  Customers may be unwilling to purchase goods on the Internet.
  The security risks of online commerce, including credit card fraud, may discourage customers from purchasing goods from us.
   Existing or future government regulation could harm our business.
  23




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Laws or regulations relating to privacy and data protection may
adversely affect the growth of our Internet business or our marketing
efforts.
  We may be subject to liability for the content that we publish.
  Our directors, executive officers and significant stockholders
hold a substantial portion of our stock, which may lead to conflicts
with other stockholders over corporate transactions and other
corporate matters.
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 $
 Purchases of Equity Securities by the Issuer and Affiliated Purchasers
  25




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Issuer Purchases of Equity Securities
 (d) Maximum Number(or Approximate(c) Total Number of
    
    DollarShares Purchased as
    
    Value) of Shares that(a) Total
    
    (b) Average
    
    Part of Publicly
    
    May Yet Be PurchasedNumber of Shares
    
    Price Paid
    
    Announced Plans or
    
    Under the Plans orPeriod
    
    Purchased
    
    per Share
    
    Programs
    
    Programs1/2/2006-1/28/2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1/29/2006-2/25/2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    2/26/2006-4/2/2006
    
    
    17,728
    (1)
    
    $
    9.30
    
    
    
    
    
    
    
    (2
    )Total
    
    
    17,728
    
    
    $
    9.30
    
    
    
    
    
    
    $
    
 
 (1)
    
    Represents shares of common stock delivered to RedEnvelope as consideration for the payment of
taxes upon the vesting of the restricted common stock granted to Ken Constable.(2)
    
    Additional shares of common stock will be delivered to RedEnvelope as payment of taxes then
due upon the vesting of the restricted common stock granted to Ken Constable, however such number
of shares cannot be determined until such vesting occurs. 
 Item 3. Defaults Upon Senior Securities.
 None.
 
 Item 4. Submission of Matters to a Vote of Security Holders.
 None.
 
 Item 5. Other Information.
 None.
 
 Item 6. Exhibits
 31.1
    
    Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)31.2
    
    Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)32.1
    
    Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002
 26




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SIGNATURES
  REDENVELOPE, INC.By:
    
    /s/ Polly Boe

Polly BoeChief Financial Officer
  27




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EXHIBIT INDEX
 31.1
    
    Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)31.2
    
    Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)32.1
    
    Certification required by 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification required by 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002
 28