##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, DC 20549


Form 10-Q

|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                 
|þ          |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR
    15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934 
|           |  | For the quarterly period ended
    December 28, 2003                                            
|          
|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
    Incorporation or Organization) |  | (IRS Employer
    Identification No.)

201 Spear Street, 3rd Floor,

San Francisco, California 94105


(Address of Principal Executive Offices and
Zip Code)


(415) 371-9100

(Registrants Telephone Number, Including
Area Code)


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

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

The number of outstanding shares of the
registrants common stock, $0.01 par value per share,
was 8,521,552 as of December 28, 2003.



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TABLE OF CONTENTS



|                                        |                                                                                               |  |  |  |  |  |  | 
|--------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION          
|                                        | Item 1. Financial Statements                                                                 
|CONDENSED BALANCE SHEETS (Unaudited)   
|NOTES TO CONDENSED FINANCIAL STATEMENTS
|                                        | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                        | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                                        | Item 4. Controls and Procedures                                                              
|PART II. OTHER INFORMATION             
|                                        | Item 1. Legal Proceedings                                                                    
|                                        | Item 2. Changes in Securities and Use of Proceeds                                            
|                                        | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                             
|EXHIBIT INDEX                          
|EXHIBIT 31.1                           
|EXHIBIT 31.2                           
|EXHIBIT 32.1                           
|EXHIBIT 32.2                           



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##### Table of Contents



REDENVELOPE, INC.

REPORT ON FORM 10-Q

For the Quarter Ended December 28,
2003


TABLE OF CONTENTS

|                              |  |                                                                                                                                       |  |      |      | 
|----------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ---- | 
|                              |  |                                                                                                                                       |  | Page
|                              |  |                                                                                                                                       |  |     
|PART I. FINANCIAL INFORMATION |  |                                                                                                                                       |  |     
|Item 1.                       |  | Financial Statements (Unaudited)                                                                                                      |  |      |      | 
|                              |  | Condensed Balance Sheets as of December 28,
    2003, March 30, 2003 and December 29, 2002                                            |  |      | 2    | 
|                              |  | Condensed Statements of Operations for the
    thirteen weeks and thirty-nine weeks ended December 28,
    2003 and December 29, 2002 |  |      | 3    | 
|                              |  | Condensed Statements of Cash Flows for the
    thirty-nine weeks ended December 28, 2003 and December 29,
    2002                    |  |      | 4    | 
|                              |  | Notes to Condensed Financial Statements                                                                                               |  |      | 5    | 
|Item 2.                       |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                                             |  |      | 10   | 
|Item 3.                       |  | Quantitative and Qualitative Disclosures About
    Market Risk                                                                        |  |      | 32   | 
|Item 4.                       |  | Controls and Procedures                                                                                                               |  |      | 32   | 
|PART II. OTHER INFORMATION    |  |                                                                                                                                       |  |     
|Item 1.                       |  | Legal Proceedings                                                                                                                     |  |      | II-1 | 
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                                                                             |  |      | II-2 | 
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                                                      |  |      | II-2 | 





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##### Table of Contents






PART I.

FINANCIAL INFORMATION






|        |                     
|------- | --------------------
|Item 1. | Financial Statements

REDENVELOPE, INC.






CONDENSED BALANCE SHEETS


(Unaudited)


|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |         |         |  
|-------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------- | ----- | --------- | ------ | ------------ | ------ | ------- | ------- | - | ------ | ------- | ------- | -
|                                                                                                               |                                                                                                                                                                                                               | December 28,                                                                                        |       | March 30, |        | December 29,
|                                                                                                               |                                                                                                                                                                                                               | 2003                                                                                                |       | 2003      |        | 2002        
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |             
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                    
|                                                                                                               |                                                                                                                                                                                                               | (In thousands, except per share data)                                                              
|ASSETS                                                                                                        
|Current assets:                                                                                                |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               | Cash and cash equivalents                                                                                                                                                                                     |                                                                                                     | $     | 34,756    |        |              | $      | 4,997   |         |   | $      | 14,154  |        
|                                                                                                               | Short term investments                                                                                                                                                                                        |                                                                                                     |       | 2,888     |        |              |        |        |         |   |        |        |        
|                                                                                                               | Accounts receivable, net                                                                                                                                                                                      |                                                                                                     |       | 5,803     |        |              |        | 286     |         |   |        | 595     |        
|                                                                                                               | Inventory                                                                                                                                                                                                     |                                                                                                     |       | 7,873     |        |              |        | 9,716   |         |   |        | 9,973   |        
|                                                                                                               | Prepaid advertising and other current assets                                                                                                                                                                  |                                                                                                     |       | 1,462     |        |              |        | 2,099   |         |   |        | 1,030   |        
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               |                                                                                                                                                                                                               | Total current assets                                                                                |       |           | 52,782 |              |        |         | 17,098  |   |        |         | 25,752  |  
|Property and equipment, net                                                                                    |                                                                                                                                                                                                               |                                                                                                     | 4,591 |           |        |              | 4,462  |         |         |   | 5,070  |        
|Other assets and restricted cash                                                                               |                                                                                                                                                                                                               |                                                                                                     | 1,165 |           |        |              | 566    |         |         |   | 400    |        
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               |                                                                                                                                                                                                               | Total assets                                                                                        |       | $         | 58,538 |              |        | $       | 22,126  |   |        | $       | 31,222  |  
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|LIABILITIES, MANDATORILY REDEEMABLE
    CONVERTIBLE
    PREFERRED STOCK AND STOCKHOLDERS
    EQUITY/(DEFICIT)
|Current liabilities:                                                                                           |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               | Accounts payable                                                                                                                                                                                              |                                                                                                     | $     | 12,705    |        |              | $      | 5,957   |         |   | $      | 10,679  |        
|                                                                                                               | Accrued expenses and other current liabilities                                                                                                                                                                |                                                                                                     |       | 7,268     |        |              |        | 1,443   |         |   |        | 3,403   |        
|                                                                                                               | Accrued compensation                                                                                                                                                                                          |                                                                                                     |       | 820       |        |              |        | 723     |         |   |        | 578     |        
|                                                                                                               | Short-term loan                                                                                                                                                                                               |                                                                                                     |       |          |        |              |        | 1,123   |         |   |        | 1,073   |        
|                                                                                                               | Capital lease obligations, current                                                                                                                                                                            |                                                                                                     |       | 732       |        |              |        | 673     |         |   |        | 565     |        
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               |                                                                                                                                                                                                               | Total current liabilities                                                                           |       |           | 21,525 |              |        |         | 9,919   |   |        |         | 16,298  |  
|Capital lease obligations, long-term                                                                           |                                                                                                                                                                                                               |                                                                                                     | 997   |           |        |              | 1,102  |         |         |   | 1,345  |        
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               |                                                                                                                                                                                                               | Total liabilities                                                                                   |       |           | 22,522 |              |        |         | 11,021  |   |        |         | 17,643  |  
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|Commitments and contingencies:                                                                                 |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|Mandatorily redeemable convertible preferred stock                                                             |                                                                                                                                                                                                               |                                                                                                     |      |           |        |              | 82,556 |         |         |   | 82,479 |        
|Stockholders deficit:                                                                                         |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               | Series A preferred stock, $0.01 par
    value; 2,000,000 shares authorized, none outstanding                                                                                                                  |                                                                                                     |       |          |        |              |        | 953     |         |   |        | 953     |        
|                                                                                                               | Common stock, $0.01 par value;
    100 million shares authorized; 8,521,552, 336,939, and
    336,378 issued and outstanding as of December 28, 2003,
    March 30, 2003, and December 29, 2002, respectively |                                                                                                     |       | 86        |        |              |        | 4       |         |   |        | 4       |        
|                                                                                                               | Additional paid-in capital                                                                                                                                                                                    |                                                                                                     |       | 113,006   |        |              |        | 1,322   |         |   |        | 1,320   |        
|                                                                                                               | Deferred compensation                                                                                                                                                                                         |                                                                                                     |       | (641      | )      |              |        | (162    | )       |   |        | (262    | )      
|                                                                                                               | Notes receivable from stockholders                                                                                                                                                                            |                                                                                                     |       | (44       | )      |              |        | (44     | )       |   |        | (44     | )      
|                                                                                                               | Accumulated deficit                                                                                                                                                                                           |                                                                                                     |       | (76,391   | )      |              |        | (73,524 | )       |   |        | (70,871 | )      
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               |                                                                                                                                                                                                               | Total stockholders equity/(deficit)                                                                |       |           | 36,016 |              |        |         | (71,451 | ) |        |         | (68,900 | )
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        
|                                                                                                               |                                                                                                                                                                                                               | Total liabilities, mandatorily redeemable
    convertible preferred stock and stockholders deficit |       | $         | 58,538 |              |        | $       | 22,126  |   |        | $       | 31,222  |  
|                                                                                                               |                                                                                                                                                                                                               |                                                                                                     |       |           |        |              |        |         |         |   |        |        

See accompanying notes to these condensed
financial statements.

2



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##### Table of Contents



REDENVELOPE, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)


|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |        |        | 
|------------------------------------------------- | -------------------------- | ----------------------------------------- | ------ | ----------------------- | ------ | ------------ | ------ | ------------ | ------ | - | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                  |                            |                                           |        |                        
|                                                  |                            | Thirteen Weeks Ended                      |        | Thirty-Nine Weeks Ended
|                                                  |                            |                                           |        |                        
|                                                  |                            | December 28,                              |        | December 29,            |        | December 28, |        | December 29,
|                                                  |                            | 2003                                      |        | 2002                    |        | 2003         |        | 2002        
|                                                  |                            |                                           |        |                         |        |              |        |             
|                                                  |                            |                                          
|                                                  |                            | (In thousands, except for per share data)
|Net revenues                                      |                            | $                                         | 35,922 |                         |        | $            | 34,290 |              |        | $ | 61,972 |        |        | $ | 54,943 |       
|Cost of sales                                     |                            |                                           | 18,149 |                         |        |              | 17,318 |              |        |   | 31,496 |        |        |   | 28,510 |       
|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|                                                  | Gross profit               |                                           |        | 17,773                  |        |              |        | 16,972       |        |   |        | 30,476 |        |   |        | 26,433 |       
|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|Operating expenses:                               |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|                                                  | Fulfillment                |                                           |        | 5,195                   |        |              |        | 4,485        |        |   |        | 9,446  |        |   |        | 8,272  |       
|                                                  | Marketing                  |                                           |        | 7,434                   |        |              |        | 7,593        |        |   |        | 12,860 |        |   |        | 12,106 |       
|                                                  | General and administrative |                                           |        | 3,929                   |        |              |        | 3,790        |        |   |        | 10,743 |        |   |        | 10,671 |       
|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|                                                  |                            | Total operating expenses                  |        |                         | 16,558 |              |        |              | 15,868 |   |        |        | 33,049 |   |        |        | 31,049 | 
|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|Income/(loss) from operations                     |                            |                                           | 1,215  |                         |        |              | 1,104  |              |        |   | (2,573 | )      |        |   | (4,616 | )     
|Interest income                                   |                            |                                           | 60     |                         |        |              | 21     |              |        |   | 75     |        |        |   | 138    |       
|Interest expense                                  |                            |                                           | (99    | )                       |        |              | (213   | )            |        |   | (369   | )      |        |   | (580   | )     
|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|Net income/(loss)                                 |                            | $                                         | 1,176  |                         |        | $            | 912    |              |        | $ | (2,867 | )      |        | $ | (5,058 | )     
|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|Net income/(loss) per share  basic               |                            | $                                         | 0.14   |                         |        | $            | 2.81   |              |        | $ | (0.41  | )      |        | $ | (16.01 | )     
|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|Net income/(loss) per share  diluted             |                            | $                                         | 0.13   |                         |        | $            | 0.14   |              |        | $ | (0.41  | )      |        | $ | (16.01 | )     
|                                                  |                            |                                           |        |                         |        |              |        |              |        |   |        |        |        |   |        |       
|Weighted average shares outstanding 
    basic   |                            |                                           | 8,522  |                         |        |              | 325    |              |        |   | 7,071  |        |        |   | 316    |       
|Weighted average shares outstanding 
    diluted |                            |                                           | 9,379  |                         |        |              | 6,296  |              |        |   | 7,071  |        |        |   | 316    |       

See accompanying notes to these condensed
financial statements.

3



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##### Table of Contents



REDENVELOPE, INC.

STATEMENTS OF CASH FLOWS

(Unaudited)


|                                                                                |                                                                        |                                                |                                           |              |        |        |        |        |        |        |  
|------------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ---------------------------------------------- | ----------------------------------------- | ------------ | ------ | ------ | ------ | ------ | ------ | ------ | -
|                                                                                |                                                                        |                                               
|                                                                                |                                                                        | Thirty-Nine Weeks Ended                       
|                                                                                |                                                                        |                                               
|                                                                                |                                                                        | December 28,                                   |                                           | December 29,
|                                                                                |                                                                        | 2003                                           |                                           | 2002        
|                                                                                |                                                                        |                                                |                                           |             
|                                                                                |                                                                        |                                               
|                                                                                |                                                                        | (In thousands)                                
|Cash Flows From Operating
    Activities:                                       |                                                                        |                                                |                                           |              |        |        |        |       
|                                                                                | Net loss                                                               |                                                | $                                         | (2,867       | )      |        | $      | (5,058 | )     
|Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                                        |                                                |                                           |              |        |        |        |       
|                                                                                | Depreciation and amortization                                          |                                                |                                           | 1,930        |        |        |        | 1,871  |       
|                                                                                | Amortization of deferred stock compensation                            |                                                |                                           | 201          |        |        |        | 261    |       
|                                                                                | Other non-cash charges                                                 |                                                |                                           | 35           |        |        |        | 335    |       
|                                                                                | Issuance of stock for services rendered                                |                                                |                                           | 9            |        |        |        |       |       
|                                                                                | Changes in current assets and liabilities:                             |                                                |                                           |              |        |        |        |        |       
|                                                                                |                                                                        | Accounts receivable                            |                                           |              | (5,517 | )      |        |        | (94    | )     
|                                                                                |                                                                        | Inventory                                      |                                           |              | 1,843  |        |        |        | (2,972 | )     
|                                                                                |                                                                        | Other assets                                   |                                           |              | 292    |        |        |        | 887    |       
|                                                                                |                                                                        | Accounts payable                               |                                           |              | 6,959  |        |        |        | 5,177  |       
|                                                                                |                                                                        | Accrued expenses and other current liabilities |                                           |              | 5,924  |        |        |        | 1,539  |       
|                                                                                |                                                                        |                                                |                                           |              |        |        |        |       
|                                                                                |                                                                        |                                                | Net cash provided by operating activities |              |        | 8,809  |        |        |        | 1,946  |  
|                                                                                |                                                                        |                                                |                                           |              |        |        |        |       
|Cash Flows From Investing
    Activities:                                       |                                                                        |                                                |                                           |              |        |        |        |       
|                                                                                | Purchase of investments                                                |                                                |                                           | (3,435       | )      |        |        |       |       
|                                                                                | Purchase of property and equipment                                     |                                                |                                           | (1,636       | )      |        |        | (1,468 | )     
|                                                                                |                                                                        |                                                |                                           |              |        |        |        |       
|                                                                                |                                                                        |                                                | Net cash used in investing activities     |              |        | (5,071 | )      |        |        | (1,468 | )
|                                                                                |                                                                        |                                                |                                           |              |        |        |        |       
|Cash Flows From Financing
    Activities:                                       |                                                                        |                                                |                                           |              |        |        |        |       
|                                                                                | Proceeds from exercise of common stock options
    and warrants        |                                                |                                           | 128          |        |        |        | 91     |       
|                                                                                | Repurchase of common stock                                             |                                                |                                           |             |        |        |        | (2     | )     
|                                                                                | Net proceeds from issuance of Series F
    convertible preferred stock |                                                |                                           |             |        |        |        | 13,743 |       
|                                                                                | Principal payments on capital lease obligations                        |                                                |                                           | (469         | )      |        |        | (279   | )     
|                                                                                | Repayment of loan                                                      |                                                |                                           | (1,123       | )      |        |        | (4,780 | )     
|                                                                                | Payment of loan costs and other                                        |                                                |                                           | (414         | )      |        |        | (7     | )     
|                                                                                | Payment of IPO costs                                                   |                                                |                                           | (1,053       | )      |        |        |       |       
|                                                                                | IPO proceeds                                                           |                                                |                                           | 28,952       |        |        |        |       |       
|                                                                                |                                                                        |                                                |                                           |              |        |        |        |       
|                                                                                |                                                                        |                                                | Net cash provided by financing activities |              |        | 26,021 |        |        |        | 8,766  |  
|                                                                                |                                                                        |                                                |                                           |              |        |        |        |       
|Net increase in cash and cash equivalents                                       |                                                                        |                                                | 29,759                                    |              |        |        | 9,244  |       
|Cash and cash equivalents at beginning of period                                |                                                                        |                                                | 4,997                                     |              |        |        | 4,910  |       
|                                                                                |                                                                        |                                                |                                           |              |        |        |        |       
|Cash and cash equivalents at end of period                                      |                                                                        | $                                              | 34,756                                    |              |        | $      | 14,154 |       
|                                                                                |                                                                        |                                                |                                           |              |        |        |        |       

See accompanying notes to these condensed
financial statements.

4



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##### Table of Contents



REDENVELOPE, INC.






NOTES TO CONDENSED FINANCIAL
STATEMENTS


(Unaudited)


1.     Financial
Statements  Basis of Presentation

The accompanying unaudited financial statements
include the accounts of RedEnvelope, Inc. (referred to as the
Company, we, us, and
our). The condensed balance sheets as of
December 28, 2003 and December 29, 2002, the condensed
statements of earnings for the thirteen and thirty-nine week
periods ended December 28, 2003 and December 29, 2002,
and the condensed statements of cash flows for the thirty-nine
week periods ended December 28, 2003 and December 29,
2002 have been prepared by us, without audit. In our opinion,
the financial statements include all adjustments (which include
only normal recurring adjustments) necessary to present fairly
the financial position at the balance sheet dates and the
results of operations for the thirteen and thirty-nine week
periods then ended. The balance sheet at March 30, 2003,
presented herein, has been derived from our audited balance
sheet included in our Amendment No. 8 of the Registration
Statement on Form S-1, declared effective by the Securities
and Exchange Commission on September 24, 2003.

Certain information and disclosures normally
included in the notes to the annual financial statements
prepared in accordance with accounting principles generally
accepted in the United States of America have been omitted.
These financial statements should be read in conjunction with
the condensed financial statements and notes thereto included in
our Amendment No. 8 of the Registration Statement on
Form S-1. Certain reclassifications have been made to the
prior period financial statements to conform to the presentation
used in the current period.

The results of operations for the thirteen and
thirty-nine weeks ended December 28, 2003 are not
necessarily indicative of the operating results of the full
year. Further, the preparation of condensed financial statements
requires management to make estimates and assumptions that
affect the recorded amounts reported therein. A change in facts
or circumstances surrounding the estimates could result in a
change to the estimates and impact future operating results.

Our fiscal year ends on the Sunday closest to
March 31, resulting in a 52 or 53 week year. Fiscal
year 2003 ended on March 30, 2003. Fiscal year 2004 will
end on March 28, 2004. Both fiscal year 2003 and fiscal
year 2004 are 52 weeks long. We report our interim results
on a fiscal quarter basis rather than on a calendar quarter
basis. Under the fiscal quarter basis, each of the first three
fiscal quarters is thirteen weeks long, ending on the Sunday
closest to the calendar quarter end, with the fourth fiscal
quarter covering the remaining part of the fiscal year.



|   |                    
|-- | -------------------
|2. | Accounting Policies

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

Stock Based
Compensation The Company
accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees(APB No. 25), and complies with the
disclosure provisions of Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123) as
amended by SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. Under
APB No. 25, compensation cost is recognized based on the
difference, if any, between the fair market value of the
Companys stock on the date of grant and the amount an
employee must pay to acquire the stock. Equity

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REDENVELOPE, INC.


NOTES TO CONDENSED
FINANCIAL STATEMENTS  (Continued)

instruments issued to non-employees are accounted
for in accordance with the provision of SFAS No. 123 and
Emerging Issues Task Force Issue No. 96-18.

Had compensation cost for the Companys
stock options been determined based on the fair value of the
options at the date of grant for options granted in the thirteen
and thirty-nine weeks ended December 28, 2003 and December
29, 2002 consistent with the provisions of SFAS No. 123 the
Companys pro forma net income/(loss) would have been as
follows:

|                                                                             |                             |                                       |       |                         |  |              |      |              |  |   |        |        |   |   |        |        |  
|---------------------------------------------------------------------------- | --------------------------- | ------------------------------------- | ----- | ----------------------- |  | ------------ | ---- | ------------ |  | - | ------ | ------ | - | - | ------ | ------ | -
|                                                                             |                             |                                       |       |                        
|                                                                             |                             | Thirteen Weeks Ended                  |       | Thirty-Nine Weeks Ended
|                                                                             |                             |                                       |       |                        
|                                                                             |                             | December 28,                          |       | December 29,            |  | December 28, |      | December 29,
|                                                                             |                             | 2003                                  |       | 2002                    |  | 2003         |      | 2002        
|                                                                             |                             |                                       |       |                         |  |              |      |             
|                                                                             |                             |                                      
|                                                                             |                             | (In thousands, except per share data)
|Net income/(loss)  as reported                                              |                             | $                                     | 1,176 |                         |  | $            | 912  |              |  | $ | (2,867 | )      |   | $ | (5,058 | )     
|Stock-based employee compensation included in
    reported net income/(loss) |                             |                                       | 77    |                         |  |              | 100  |              |  |   | 212    |        |   |   | 260    |       
|Stock-based compensation expense determined under
    fair value base method |                             |                                       | (225  | )                       |  |              | (150 | )            |  |   | (533   | )      |   |   | (389   | )     
|                                                                             |                             |                                       |       |                         |  |              |      |              |  |   |        |        |   |   |        |       
|                                                                             | Pro forma net income/(loss) |                                       | $     | 1,028                   |  |              | $    | 862          |  |   | $      | (3,188 | ) |   | $      | (5,187 | )
|                                                                             |                             |                                       |       |                         |  |              |      |              |  |   |        |        |   |   |        |       
|Basic and diluted earnings per share:                                        |                             |                                       |       |                         |  |              |      |              |  |   |        |        |   |   |        |       
|                                                                             | As reported  basic         |                                       | $     | 0.14                    |  |              | $    | 2.81         |  |   | $      | (0.41  | ) |   | $      | (16.01 | )
|                                                                             | As reported  diluted       |                                       | $     | 0.13                    |  |              | $    | 0.14         |  |   | $      | (0.41  | ) |   | $      | (16.01 | )
|                                                                             | Pro forma  basic           |                                       | $     | 0.12                    |  |              | $    | 2.65         |  |   | $      | (0.45  | ) |   | $      | (16.41 | )
|                                                                             | Pro forma  diluted         |                                       | $     | 0.11                    |  |              | $    | 0.14         |  |   | $      | (0.45  | ) |   | $      | (16.41 | )
|                                                                             | Basic Shares                |                                       |       | 8,522                   |  |              |      | 325          |  |   |        | 7,071  |   |   |        | 316    |  
|                                                                             | Diluted Shares              |                                       |       | 9,379                   |  |              |      | 6,296        |  |   |        | 7,071  |   |   |        | 316    |  

Earnings Per
Share For the thirteen
weeks ended December 28, 2003 and December 29, 2003,
basic net income per share was greater than the diluted net
income per share because the effect of stock options, unvested
shares and warrants outstanding was dilutive. The number of
dilutive stock options, unvested shares, and warrants excluded
from the calculation for the thirty-nine weeks ended
December 28, 2003 and December 29, 2002, were
approximately 1.4 million and 0.9 million,
respectively.

Comprehensive
Income/(Loss) Comprehensive income/ (loss) equals net income/ (loss) for all
periods presented.

New Accounting
Pronouncements In May
2003, the Financial Accounting Standards Board
(FASB) issued SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. SFAS No. 150 requires
instruments that are mandatorily redeemable, among other
financial instruments, which embody an unconditional obligation
requiring the issuer to redeem them by transferring its assets
at a specified or determinable date or upon an event that is
certain to occur, be classified as liabilities. We adopted SFAS
No. 150 effective June 30, 2003. The adoption of this
statement did not have an impact on the Companys financial
statements.

3.     Initial Public
Offering

On September 30, 2003, we completed our
initial public offering, whereby we sold 2.2 million shares
of our common stock at $14 per share and received proceeds of
approximately $29.0 million (after underwriters
discounts of $1.8 million). Total related offering expenses
were $1.6 million.

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##### Table of Contents



REDENVELOPE, INC.


NOTES TO CONDENSED
FINANCIAL STATEMENTS  (Continued)

Immediately prior to the offering, the Company
effected a 1 for 11.71 reverse stock split. All shares and per
share calculations included in the accompanying unaudited
condensed financial statements have been adjusted to reflect
this split.

On September 30, 2003, the Companys
outstanding Preferred Stock was automatically converted into
approximately 6.0 million shares of common stock. Each
share of Series A and B preferred stock outstanding was
converted into common stock on a one-for-one exchange ratio of
common for preferred. Each share of Series C, D, E, and F
preferred stock outstanding was converted into common stock on
an exchange ratio of one share of preferred for approximately
1.58, 1.80, 1.27 and 0.99 shares of common, respectively, as
follows:

|                                     |                                                            |           |       |       | 
|------------------------------------ | ---------------------------------------------------------- | --------- | ----- | ----- | 
|                                     |                                                            | March 30,
|                                     |                                                            | 2003     
|                                     |                                                            |          
|Series A (conversion rate of 1.0)    |                                                            |           | 627   |      
|Series B (conversion rate of 1.0)    |                                                            |           | 385   |      
|Series C (conversion rate of 1.5816) |                                                            |           | 877   |      
|Series D (conversion rate of 1.7983) |                                                            |           | 350   |      
|Series E (conversion rate of 1.2720) |                                                            |           | 1,900 |      
|Series F (conversion rate of .9886)  |                                                            |           | 1,818 |      
|                                     |                                                            |           |       |      
|                                     | Total preferred shares outstanding converted to
    common |           |       | 5,957 | 
|                                     |                                                            |           |       |      

4.     Benefit
Plans

On September 30, 2003, the Company filed a
registration statement on Form S-8 to register shares
related to the Directors Stock Option Plan, the Employee Stock
Purchase Plan (the ESPP), and the 1999 Stock Plan.

The Directors Stock Option Plan is intended to be
a formula award plan providing for the grant of nonstatutory
stock options to non-employee members of our Board of Directors.
The Company registered 449,615 shares of $0.01 par value
common stock for the Directors Stock Option Plan.

The ESPP allows employees to purchase our common
stock at a discount to market price through payroll deductions.
The plan is structured through a series of consecutive six-month
offering periods. Except for the first offering period, these
offering periods generally start on the first trading day on or
after May 1st and November 1st of each year and end,
respectively, on the last trading day of the next October and
April. The Company registered 401,366 shares $0.01 par
value common stock for the ESPP.

The S-8 registered an additional
1,831,855 shares of $0.01 par value common stock related to
our 1999 Stock Plan.

5.     Borrowing
Arrangements

The Companys line of credit is provided by
CapitalSource Finance LLC pursuant to the terms of a revolving
credit and security agreement dated June 13, 2003. Per the
terms of this agreement, CapitalSource Finance LLC has made
available to the Company a credit facility under a revolving
promissory note with a maximum principal amount of
$11.0 million, subject to availability guidelines that
specify the amount that can be borrowed under the facility at
any given time. Amounts borrowed under this line of credit bear
interest at rates equal to the greater of 9.5% or the prime
lending rate plus 5.75%, for advances up to a fluctuating base
amount, and equal to the greater of 11.5% or the prime lending
rate plus 7.75% for advances in excess of that base amount.
Amounts borrowed under this line of credit are secured by
substantially all of the Companys assets. The line of
credit agreement provides for certain events of default, sets
forth a number of affirmative and negative covenants to which
the Company must adhere and expires on April 15, 2006,
unless extended,

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REDENVELOPE, INC.


NOTES TO CONDENSED
FINANCIAL STATEMENTS  (Continued)

renewed or terminated pursuant to the terms of
the agreement. The Company paid a non-refundable commitment fee
of approximately $0.2 million in connection with this line
of credit and must pay an unused line fee of up to
$0.05 million per year, which is payable monthly, based on
the unused portion of the loan commitment. The Company has
borrowed funds under this line of credit from time to time and
periodically repaid such borrowings with available cash. As of
December 28, 2003, the Company did not have an outstanding
balance under this line of credit.

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

Under the provisions of this credit agreement,
subject to exceptions in limited circumstances, the Company must
comply with certain covenants during the term of that agreement
including, but not limited to, financial covenants that require
the Company to obtain certain levels of minimum earnings before
interest, taxes, depreciation and amortization (EBITDA) for
the trailing four accounting quarters ending on the last day of
the applicable date.

The credit agreement requires us to pay and
deliver all collections to an account over which CapitalSource
Finance LLC has sole control. When we borrow under the credit
agreement, the borrowings are repaid through the funds in this
account. In a situation where we are not borrowing, we must
request the funds to be withdrawn from this account and
deposited into our bank account.

In addition, the credit agreement requires,
subject to exceptions in certain limited circumstances,
maintaining certain inventory ratios, which are determined by
dividing 115% of the cost of the Companys inventory at a
given date by the Companys projected net sales for the
subsequent three month period subject to certain maximums,
maintaining excess availability of a certain amount of capital
at certain specified times, covenants limiting the
Companys capital expenditures, a covenant which among
other things restricts the Companys ability to engage in
certain acquisition and investment transactions, and other
covenants which restrict or place limitations on the
Companys ability to incur indebtedness, issue securities,
create or allow to exist any liens on the Companys assets,
transfer the Companys assets, or declare or pay dividends.

As of December 28, 2003, the Company was not
in compliance with the EBITDA ratio covenant. On
January 22, 2004, we received a waiver from CapitalSource
Finance LLC for our non-compliance with such covenant.
Additionally, we were not in compliance with the inventory ratio
covenant for the months of October 2003 and November 2003, but
received a waiver of such non-compliance from CapitalSource
Finance LLC on November 11, 2003 and December 23,
2003, respectively. As of February 5, 2004, the Company was
not in compliance with the inventory ratio covenant for January.
We received a waiver of such non-compliance from CapitalSource
Finance LLC on February 5, 2004.

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REDENVELOPE, INC.


NOTES TO CONDENSED
FINANCIAL STATEMENTS  (Continued)

6.     Marketable
Securities

Cash
Equivalents and Investments

For purposes of the statements of cash flows, the
Company considers all highly liquid debt instruments purchased
with an original maturity of three months or less at the date of
purchase to be cash equivalents. Cash and cash equivalents
consist of demand accounts, government securities, and money
market funds. Short-term investments consist of government
securities and corporate bonds both with original maturities
beyond three months. Long term investments consist of corporate
bonds with original maturities of one year or longer.

All of the Companys cash equivalents and
investments are considered available-for-sale. Such securities
are carried at fair market value, which is equal to cost at
December 28, 2003. Fair value is based on market quotes.
Unrealized gains and losses, net of tax, on securities in this
category are reported as a separate component of
stockholders equity. There were no unrealized gains or
losses for the quarter ended December 28, 2003. The cost of
securities sold is based on the specific identification method.
Interest earned on securities is included in interest income.

Available-for-sale investments at
December 28, 2003 were as follows:

|                                     |  |                |       | 
|------------------------------------ |  | -------------- | ----- | 
|                                     |  | Cost/Estimated
|                                     |  | Fair Value    
|                                     |  |               
|                                     |  | (In thousands)
|Corporate bonds                      |  | $              | 2,888 | 
|Government securities (long-term)    |  |                | 546   | 
|                                     |  |                |       | 
|Total available-for-sale investments |  | $              | 3,434 | 
|                                     |  |                |       | 

There were no gross realized gains or losses for
quarter ending December 28, 2003 and the gross realized
gains or losses for the quarter ended December 29, 2002
were immaterial.

The amortized cost, which equals the estimated
fair value of investments in debt securities at
December 28, 2003, by contractual maturity were as follows:

|                      |  |                |       | 
|--------------------- |  | -------------- | ----- | 
|                      |  | Fair Value    
|                      |  |               
|                      |  | (In thousands)
|Due in 1 year or less |  | $              | 2,888 | 
|Due in 1-2 years      |  |                | 546   | 
|                      |  |                |       | 
|                      |  | $              | 3,434 | 
|                      |  |                |       | 

7.     Contingencies

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

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

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

Forward-Looking Statements

This report 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, estimates, may,
should, could and similar expressions or
variations of such words are intended to identify
forward-looking statements, but are not the exclusive means of
identifying forward-looking statements in this report. All
forward-looking statements in this report are based upon
information available to us as of the date hereof, and we assume
no obligation to revise or update any such forward-looking
statements in order to reflect any event or circumstance that
may arise after the date of this report. Actual results and the
timing of certain events could differ materially from our
current expectations. Factors that could cause or contribute to
such differences include, but are not limited to, those set
forth under Factors That May Affect Future Operating
Results below in this report, and elsewhere in this
report, the section entitled Risk Factors contained in our
Prospectus dated September 24, 2003 as filed with the
Securities and Exchange Commission 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

We are an online retailer of upscale gifts. Our
fourteen product categories provide customers with a wide
assortment of choices for all gift-giving occasions. Product
revenues consist of sales made to individual consumers and
businesses. We market our products through our website and our
catalogs. Customers place orders with us through our website or
the telephone. Telephone orders are taken at our customer
service center. At the time an order is taken, we obtain the
customers credit card information. When the order is
shipped, the customers credit card is charged. We
recognize revenue on the date on which we estimate that the
product has been received by the customer. Product sales are
recorded net of discounts and estimated returns.

Historically, revenues have been seasonal.
Revenues have been higher in our third fiscal quarter,
reflecting higher consumer holiday spending. Our strategy
includes offering a product assortment for all gift occasions
throughout the year, and thereby increasing the percentage of
revenues in the first, second and fourth fiscal quarters. For
example, in the first and second quarters of fiscal 2004, we
introduced two new catalogs. In the first quarter of fiscal
2004, we introduced a catalog dedicated solely to jewelry
products. In the second quarter of fiscal 2004, we introduced a
new catalog that featured non-seasonal gifts for all occasions.
While we are focused on reducing the seasonality of the third
fiscal quarter, we anticipate higher revenues in our third
fiscal quarter than in our other three fiscal quarters to
continue in the foreseeable future. As a result, promptly
obtaining sufficient volumes and an appropriate mix of product
inventory is especially important in our third fiscal quarter.
In the third fiscal quarter of fiscal 2004, conservative
inventory purchasing, operational difficulties in our
distribution center and sourcing problems with respect to some
of our products led to our inability to satisfy customer demand.
Achieving operational effectiveness at times of peak demand and
the appropriate mix and amount of inventory will continue to be
critical areas of management focus.

We believe our gift assortment provides an
opportunity for corporate gift giving, and we will look at
opportunities to grow our corporate sales channel. For example,
some corporations are implementing policies which do not allow
for the acceptance of gifts valued at more than one hundred
dollars. We believe our

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assortment includes unique and innovative
products within that price range. We also intend to consider
potential partnerships with companies that possess similar brand
qualities and/or alternative channels of distribution. We have
funded our operations through December 28, 2003 primarily
through private sales of equity securities, borrowings, and our
recently completed initial public offering.


On September 30, 2003, we completed our
initial public offering whereby we sold 2.2 million shares
of our common stock at $14 per share and received proceeds of
approximately $29.0 million (after underwriters
discounts of $1.8 million). Total related offering expenses
were $1.6 million.

Our revenues are comprised of product sales,
shipping revenue and gift-wrap revenue. Our shipping revenue
represents the amounts we charge our customers for delivering
the product. From the second quarter of fiscal year 2003 until
August 25, 2003, the delivery charge to our customers was
based on the order value and the method of delivery. As the
order value increased, the delivery charge increased as well.
However, after August 25, 2003, we changed the delivery
charge for standard ground delivery to a flat rate regardless of
the order value. For expedited delivery methods, we charge a
flat fee over the standard delivery charge. We believe the flat
rate delivery charge allows us to better compete with other
online retailers. We want our customers to focus on the product
rather than the cost of delivery. The change to flat rate
shipping and shipping discount promotions did not result in an
increase in order volume to offset the reduction in shipping
revenues. Our gift wrap revenue consists of amounts we charge
our customers for our signature red gift boxes. The customer has
the option to purchase gift wrap if the product is offered with
our special gift wrapping. The gift wrapping process occurs as
part of order fulfillment at the distribution center. No single
customer accounts for more than 1% of our net revenues. To date,
we have achieved our growth from internal operations rather than
through acquisitions.

Our merchandising strategy is based on providing
unique and innovative products. Historically, approximately 50%
of our products can be characterized as proprietary. For the
third quarter of fiscal year 2004, 61% of the products in our
holiday catalog were exclusive to RedEnvelope and our
proprietary products were some of our strongest performing
products. We currently intend to increase the percentage of
exclusive products to approximately 80% over the next several
years. We believe that by continually offering innovative,
proprietary products, we can better differentiate us from our
competitors and can provide a more satisfactory gift-purchasing
experience for our customers. In order to provide these levels
of proprietary products, our merchandising group works directly
with domestic manufacturers, importers and overseas agents to
design and manufacture our products. During our fiscal year
2003, we sourced approximately 25% of our products from
overseas. In an effort to increase our proprietary product
offering, we will be increasing our overseas product sourcing.
We believe working directly with overseas agents and
manufacturers will allow us to effectively manage product
development and quality. Due to the complexities of overseas
sourcing, we plan on creating an international sourcing group.
In addition, since we do not have long-term arrangements with
any vendor or distributor that guarantees the availability of
products, we do not have a predictable or guaranteed supply of
these products in the near future. In addition, while our
product development process includes sampling products for
quality, there remains the possibility that final production
runs will include products that do not meet our quality
standards. Due to the lead times of overseas production, we may
not be able to receive adequate levels of product that meet our
quality standards. If we are unable to provide our customers
with continued access to adequate levels of proprietary products
that meet our quality standards, our operating results would be
harmed. While products sourced overseas typically have lower
costs, our product margins may be slightly offset by an increase
in inbound freight costs. As security measures around shipping
ports increase, these additional costs may result in higher
inbound freight costs. Furthermore, in recent years,
U.S. companies were subject to port strikes which delayed
the delivery of goods. As we increase our overseas sourcing, we
face the risk of these delays which could harm our business.

We terminated our relationship with our
third-party fulfillment service provider and assumed control of
our fulfillment services in August 2003. In the third quarter of
fiscal 2004, we experienced delays and errors in the fulfillment
process at our distribution center, which prevented us from
fulfilling demand for our products. In addition, the anticipated
efficiencies from managing the distribution center ourselves did
not materialize. Improvements in managing our distribution
center will be a key objective in the ensuing months. Our
current plans include revising certain materials handling
processes, implementing new warehouse management

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software, and effecting management changes. We
believe that these changes will allow us to better manage our
fulfillment operations and scale our business. If we are unable
to improve the performance of the fulfillment process at our
distribution center, we may incur additional labor costs, fail
to satisfy demand for our products or experience customer
dissatisfaction, any one of which could have an adverse affect
on our operating results.


We rely primarily on Internet-based online
programs and catalog advertising. Revenues to our customers
attributable to online Internet-based channels, specifically
portals, search, and affiliate derived sales, increased by 42%
over the third quarter of the prior fiscal year, which was less
than we expected. Additionally, the catalog business generated
similar levels of revenue for the quarter ended
December 28, 2003 compared to the same period last year,
even though we mailed 2.0 million fewer catalogs this year.

Currently, we believe the increase in commerce
over the Internet will continue for the foreseeable future.
However, if consumers are unwilling to use the Internet to
purchase retail products, our business will be harmed. In
addition, if competitors increase the utilization of online
marketing campaigns, the cost of online marketing programs may
increase. Moreover, software programs that block certain email
marketing campaigns have gained in popularity with individuals.
The federal government and certain states have enacted
legislation specifically prohibiting or placing significant
restrictions on email marketing campaigns. These trends could
negatively impact our ability to market to customers through
email campaigns.

We currently intend to use our catalog programs
to market our products and brand. However, increases in the cost
of catalogs may limit our ability to advertise and market our
business without reducing profitability. We plan on exploring
other ways to market our products and brand. For example, in the
third fiscal quarter of 2004, we launched a series of television
advertisements. We are currently considering running additional
television advertisements as well as radio and print
advertisements. These marketing programs may result in an
increase in our marketing costs.

We are planning on implementing new software
programs for our financial, warehouse management, and order
entry functions in fiscal year 2005. These projects will result
in uses of cash and will result in additional depreciation
expense. In addition, the reporting and regulatory requirements
associated with being a publicly-traded company will likely
increase our accounting and legal expenses.

Critical Accounting Policies

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

Revenue recognition.We derive our revenues from
merchandise sales made to consumers and businesses. We generally
require payment by credit card prior to shipment. We recognize
revenue on the date on which we estimate that the product has
been received by the customer and any payments received prior to
the estimated date of receipt of the goods by the customer are
deferred. We use our third-party freight carrier information to
estimate when delivery has occurred. Revenues are recorded net
of estimated returns, coupons redeemed by customers, and other
discounts. Significant management judgments and estimates must
be made and used in connection with determining revenue
recognized in any accounting period. Our management must make
estimates of potential future product returns related to current
period revenue. We analyze historical returns, current economic
trends and changes in customer demand and acceptance of our
products when evaluating the adequacy of the sales returns and
other allowances in any accounting period. Actual returns may
differ materially from our estimated reserve. As a result, our
operating results and financial condition could be affected
adversely. The reserve for returns was $1.4 million as of
December 28, 2003.

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Shipping and Handling Costs.Shipping costs, which include inbound
and outbound freight and the cost of gift wrap, are included in
cost of sales. Handling costs, which include fees paid to our
former third-party fulfillment service provider and distribution
center expenses, are included in operating expenses 
fulfillment. Handling costs included in operating
expenses  fulfillment for the thirteen weeks ended
December 28, 2003 and December 29, 2002 were
$2.4 million and $1.8 million, respectively. Our gross
profit may not be comparable to other entities, which may
allocate all shipping and handling costs to either cost of
sales, resulting in lower gross profit, or operating expenses,
resulting in higher gross profit.

Inventory.We write
down inventory for estimated obsolescence or damage equal to the
difference between the cost of inventory and the estimated
market value based upon assumptions about future demand and
market conditions. If actual market conditions or demand for our
products are less favorable than projected by management,
additional inventory write-downs may be required. For the
quarters ended December 28, 2003 and December 29,
2002, we wrote down inventory of approximately $0.8 million
and $0.7 million, respectively.

Accounting for income taxes.Significant management judgment is
required in determining our deferred tax assets and liabilities
and any valuation allowance recorded against our net deferred
tax assets. As of March 30, 2003, we had recorded a
valuation allowance of $25.9 million against our net
deferred tax asset balance due to uncertainties related to our
deferred tax assets as a result of our history of operating
losses. The valuation allowance is based on our estimates of
taxable income by jurisdiction in which we operate and the
period over which our deferred tax assets will be recoverable.
In the event that actual results differ from these estimates or
we adjust these estimates in future periods, we may need to
change the valuation allowance, which could materially impact
our financial position and results of operations.

Catalog Amortization.Prepaid catalog costs consist of
third-party costs including paper, printing, postage and mailing
costs for all of our direct response catalogs. Such costs are
capitalized as prepaid catalog costs and are amortized over
their expected period of future benefit. Such amortization is
based upon the ratio of actual revenues to the total of actual
and estimated future revenues on an individual catalog basis.
Prepaid catalog costs are evaluated for realizability at each
reporting period by comparing the carrying amount associated
with each catalog to the estimated probable remaining future net
benefit of the catalog (defined as net revenues less merchandise
cost of goods sold, selling expenses and catalog completion
costs) associated with that catalog. If the carrying amount is
in excess of the estimated probable remaining future net benefit
of the catalog, the excess is expensed in the reporting period.

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

13



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##### Table of Contents



Results of Operations

The following table sets forth our statements of
operations data for the thirteen weeks and thirty-nine weeks
ended December 28, 2003 and December 29, 2002,
respectively, expressed as a percentage of net revenues.

|                              |                            |                          |       |                   |      |              |       |              |      |  |       |      |      |  |       |      |      | 
|----------------------------- | -------------------------- | ------------------------ | ----- | ----------------- | ---- | ------------ | ----- | ------------ | ---- |  | ----- | ---- | ---- |  | ----- | ---- | ---- | 
|                              |                            |                          |       |                  
|                              |                            | Thirteen Weeks           |       | Thirty-Nine Weeks
|                              |                            |                          |       |                  
|                              |                            | December 28,             |       | December 29,      |      | December 28, |       | December 29,
|                              |                            | 2003                     |       | 2002              |      | 2003         |       | 2002        
|                              |                            |                          |       |                   |      |              |       |             
|Statements of Operation Data: |                            |                          |       |                   |      |              |       |              |      |  |       |      |      |  |       |     
|Net revenues                  |                            |                          | 100.0 | %                 |      |              | 100.0 | %            |      |  | 100.0 | %    |      |  | 100.0 | %   
|Cost of sales                 |                            |                          | 50.5  |                   |      |              | 50.5  |              |      |  | 50.8  |      |      |  | 51.9  |     
|                              |                            |                          |       |                   |      |              |       |              |      |  |       |      |      |  |       |     
|Gross profit                  |                            |                          | 49.5  |                   |      |              | 49.5  |              |      |  | 49.2  |      |      |  | 48.1  |     
|Operating expenses:           |                            |                          |       |                   |      |              |       |              |      |  |       |      |      |  |       |     
|                              | Fulfillment                |                          |       | 14.5              |      |              |       | 13.1         |      |  |       | 15.2 |      |  |       | 15.1 |     
|                              | Marketing                  |                          |       | 20.7              |      |              |       | 22.1         |      |  |       | 20.8 |      |  |       | 22.0 |     
|                              | General and administrative |                          |       | 10.9              |      |              |       | 11.1         |      |  |       | 17.3 |      |  |       | 19.4 |     
|                              |                            |                          |       |                   |      |              |       |              |      |  |       |      |      |  |       |     
|                              |                            | Total operating expenses |       |                   | 46.1 |              |       |              | 46.3 |  |       |      | 53.3 |  |       |      | 56.5 | 
|Income (loss) from operations |                            |                          | 3.4   |                   |      |              | 3.2   |              |      |  | (4.1  | )    |      |  | (8.4  | )   
|Interest income               |                            |                          | 0.2   |                   |      |              | 0.1   |              |      |  | 0.1   |      |      |  | 0.3   |     
|Interest expense              |                            |                          | (0.3  | )                 |      |              | (0.6  | )            |      |  | (0.6  | )    |      |  | (1.1  | )   
|                              |                            |                          |       |                   |      |              |       |              |      |  |       |      |      |  |       |     
|Net income (loss)             |                            |                          | 3.3   | %                 |      |              | 2.7   | %            |      |  | (4.6  | )%   |      |  | (9.2  | )%  
|                              |                            |                          |       |                   |      |              |       |              |      |  |       |      |      |  |       |     



| |         
| | --------
| | Revenues

Net revenues were $35.9 million and
$34.3 million for the thirteen weeks ended
December 28, 2003 and December 29, 2002, respectively,
representing a 4.8% increase. The number of orders increased by
approximately 7.1% over the third quarter of fiscal 2003. The
increase in both revenues and number of orders was primarily due
to increased demand for our products resulting from additional
marketing efforts through our online marketing campaigns. Online
revenues, through search, portals, and affiliates, grew 42% over
the same quarter in the prior year. Although there was an
increase in online sales, it fell short of management
expectations for such period. While we reduced our catalog
circulation by 21.7%, we generated similar levels of revenues
from customers who receive our catalogs as the same quarter in
the prior year.

Net revenues per order decreased by approximately
2.2% over the third quarter of fiscal 2003. This was primarily
attributable to shipping revenues for the third quarter of
fiscal 2004 that were 18.9% lower than shipping revenue from the
third quarter of fiscal 2003. In August of 2003, we changed the
delivery charge for standard ground delivery to a flat rate
regardless of order value, and for expedited delivery methods,
we charge a flat fee over the standard delivery charge.
Periodically, we offer shipping discount promotions intended to
increase order volume. The change to flat rate shipping and
shipping discount promotions did not result in an increase in
order volume to offset the reduction in shipping revenues. In
addition, we experienced unexpectedly high demand for some new
proprietary products, which we bought conservatively. The
resulting inventory deficiencies caused missed revenue
opportunities. We also ran into limitations in our ability to
fulfill in a timely manner personalized items in our assortment.
Rather than disappoint customers with late deliveries, in some
cases we let customers know that items would not arrive on time,
and this led to order cancellations. With additional and timely
training of the core staff, management changes at the warehouse,
process changes, and the implementation of new warehouse,
financial and order entry software, we believe that we will
improve the operating efficiency of the warehouse, although
there can be no assurance that we will be successful in this
endeavor. If we are unable to appropriately manage our inventory
levels of certain items, our customers may become dissatisfied
and look to our competitors for their gift items. Furthermore,
if we are unable to improve the performance of the fulfillment
process at our distribution center, this may result in
unsatisfied customers and order cancellations, which would
adversely affect our business.

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Net revenues were $62.0 million and
$54.9 million for the thirty-nine weeks ended
December 28, 2003 and December 29, 2002, respectively,
representing a 12.8% increase. The increase was primarily due to
increased demand for our products resulting from additional
marketing efforts through our online and catalog campaigns.
During the first thirty-nine weeks of fiscal year 2004, we
increased our online marketing programs compared to the same
period in the prior year. Online revenues, through search,
portals, and affiliates, grew 57% over the same period in the
prior year. Revenues from customers who receive our catalogs,
grew 8% over the same period in the prior year. In the first
quarter of fiscal 2004, we introduced a catalog dedicated solely
to jewelry products. Also, in the second quarter of fiscal 2004,
we introduced a new catalog that featured non-seasonal gifts for
all occasions. For the third quarter of fiscal 2004, our Holiday
catalog circulation decreased by approximately 2.0 million
catalogs, or 21.7%. The number of orders increased approximately
15.0% over the thirty-nine weeks of fiscal 2003. Net revenues
per order decreased by approximately 2.0% over the thirty-nine
weeks of fiscal 2003. This was primarily attributable to lower
shipping revenues for the third quarter of fiscal 2004 in
comparison to the third quarter of fiscal 2003. As of
December 28, 2003, we had approximately 1.7 million
customers which was an increase of 0.5 million customers
over the third quarter of fiscal 2003.



| |              
| | -------------
| | Cost of Sales

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

Cost of sales were $18.1 million and
$17.3 million for the thirteen weeks ended
December 28, 2003 and December 29, 2002, respectively,
representing 50.5% of net revenues for both periods. For the
thirteen weeks ended December 28, 2003 and
December 29, 2002, the increase in dollars was mainly
attributable to the 4.8% increase in net revenues as well as
additional shipping costs. During December 2003, we expedited
delivery of certain orders due to delays in the fulfillment
process at our distribution center. The expedited delivery
methods resulted in additional shipping costs above our
expectations. As a percentage of net revenues, we accomplished
higher product margins resulting from an increase in product
sourcing overseas, which typically have lower product costs.
This was offset, however, by higher shipping costs as a result
of expedited delivery methods.

Cost of sales were $31.5 million and
$28.5 million for the thirty-nine weeks ended
December 28, 2003 and December 29, 2002, respectively,
representing 50.8% and 51.9% of net revenues, respectively. The
increase in cost of sales was mainly attributable to the 12.8%
increase in net revenues as well as additional shipping costs
incurred during December 2003. If we are unable to improve the
performance of the fulfillment process at our distribution
center, we may be required to expedite delivery of products
which will result in additional shipping costs that would
increase our cost of sales.



| |                   
| | ------------------
| | Operating Expenses

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

Fulfillment expenses were $5.2 million and
$4.5 million for the thirteen weeks ended December 28,
2003 and December 29, 2002, respectively, representing
14.5% and 13.1% of net revenues, respectively. The increase in
dollars and percentage of net revenues was primarily
attributable to the 7.1% increase in the number of orders,
specifically labor costs incurred at our distribution center.
Due to delays in the fulfillment process at our distribution
center, we utilized more seasonal employees and incurred more
overtime hours than anticipated.

15



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Fulfillment expenses were $9.4 million and
$8.3 million for the thirty-nine weeks ended
December 28, 2003 and December 29, 2002, respectively,
representing 15.2% and 15.1% of net revenues, respectively. The
increase in dollars and percentage of net revenues was primarily
attributable to the 15.0% increase in the number of orders,
specifically labor costs incurred at our distribution center.
Our current plans include revising certain materials handling
processes, implementing new warehouse management software, and
effecting management changes. We believe that these changes will
allow us to better manage our fulfillment operations and scale
our business. If we are unable to improve the performance of the
fulfillment process at our distribution center or if our planned
modifications cost more than we anticipate, our operating
results could be materially harmed.

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

Marketing expenses were $7.4 million and
$7.6 million for the thirteen weeks ended December 28,
2003 and December 29, 2002, respectively, representing
20.7% and 22.1% of net revenues, respectively. The decrease in
dollars and percentage of net revenues was primarily due to
approximately 2.0 million fewer catalogs circulated
compared to the third quarter of fiscal 2003. This resulted in a
decrease in our catalog expenses by approximately
$1.6 million compared to the third quarter of fiscal 2003.
This decrease was offset by increases in our online marketing
spend. In addition, we introduced television advertising during
the holiday season, which led to additional interest in our
products and catalogs. Currently, we plan on increasing the
circulation of our Valentines Day and Spring catalogs.
This increased circulation will increase marketing expenses by
approximately $0.6 million from the original projection.

Marketing expenses were $12.9 million and
$12.1 million for the thirty-nine weeks ended
December 28, 2003 and December 29, 2002, respectively,
representing 20.8% and 22.0% of net revenues, respectively. The
decrease in dollars and percentage of net revenues was primarily
due to approximately 1.3 million fewer catalogs circulated
compared to the thirty-nine weeks of fiscal 2003. This resulted
in a decrease in our catalog expenses by approximately
$1.2 million compared to the thirty-nine weeks ended
December 29, 2002, which was partially offset by increases
in our online marketing campaigns. Currently, we plan to further
consider marketing opportunities through television, radio, and
print advertising to further enhance our brand. If we are
unsuccessful in generating revenues through these marketing
vehicles, our operating results could be adversely affected.

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

General and administrative expenses were
$3.9 million and $3.8 million for the thirteen weeks
ended December 28, 2003 and December 29, 2002,
respectively, representing 10.9% and 11.1% of net revenues,
respectively. General and administrative expenses were
$10.8 million and $10.7 million for the thirty-nine
weeks ended December 28, 2003 and December 29, 2002,
respectively, representing 17.3% and 19.4% of net revenues,
respectively. As a percentage of net revenues, the decrease was
primarily due to similar costs allocated over a larger revenue
base. As of December 28, 2003, we had a total of
approximately $0.6 million in deferred compensation expense
as a result of stock options issued in fiscal year 2000 and the
first and second quarter of fiscal year 2004 at exercise prices
that were less than the fair market value of our common stock at
the time of grant. The amounts to be amortized are expected to
be approximately $0.2 million in each of the fiscal years
2004-2007, less any cancellations or forfeitures of stock
options subject to the deferred compensation. The planned
implementation of new software systems in fiscal year 2005 will
result in additional depreciation expense. In addition, the
reporting and regulatory requirements associated with being a
publicly-traded company will likely increase our accounting and
legal expenses.



| |                          
| | -------------------------
| | Other Income and Expenses

Interest Income.Interest income was $0.06 million
and $0.02 million in the thirteen weeks ended
December 28, 2003 and December 29, 2002, respectively.
The increase is primarily due to higher average cash

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balances. Interest income was $0.08 million
and $0.1 million for the thirty-nine weeks ended
December 28, 2003 and December 29, 2002, respectively.
The decrease was primarily due to lower average interest rates.


Interest Expense.Interest expense was $0.1 million
and $0.2 million in the thirteen weeks ended
December 28, 2003 and December 29, 2002, respectively.
Interest expense was $0.4 million and $0.6 million for
the thirty-nine weeks ended December 28, 2003 and
December 29, 2002, respectively. The decreases for both the
thirteen and thirty-nine week periods were attributable to lower
amounts of debt outstanding.

Income Taxes.We
have not recorded a provision for federal and state income taxes
since inception. As of March 30, 2003, we had
$96.3 million of net operating loss carryforwards, which
may be impaired or limited in certain circumstances. These net
operating loss carryforwards will begin to expire in 2007. We
have provided a valuation allowance on our deferred tax assets,
consisting primarily of net operating loss carryforwards,
because of the uncertainty regarding their realizability.



| |                                    
| | -----------------------------------
| | Liquidity and Capital
    Resources

We have funded our operations through
December 28, 2003 primarily through private sales of equity
securities, borrowings, and the completion of our initial public
offering which resulted in net offering proceeds of
approximately $29.0 million.

Net cash flows provided by operating activities
was $8.8 million and $1.9 million for the thirty-nine
weeks ended December 28, 2003 and December 29, 2002,
respectively. Net cash provided by operating activities resulted
from changes in working capital that was slightly offset by net
losses. Specifically, the increase in our accounts payable and
accrued expenses contributed to our ability to generate cash
flows from operations. The increase was due primarily to higher
inventory, marketing and shipping related costs from our holiday
sales.

Net cash flows used in investing activities was
$5.1 million and $1.5 million for the thirty-nine
weeks ended December 28, 2003 and December 29, 2002,
respectively. Uses of cash flow for investing activities were
for purchases of investments as well as capital expenditures for
property and equipment. Currently, we are planning capital
expenditures for software systems to support our financial,
warehouse management, and order management functions. We believe
the implementation of these software systems will support the
needs of our business and customers. Software implementation
projects entail significant technical and business risks. If we
are unsuccessful in implementing these systems, it may hinder
our ability to process and fulfill customer orders as well as
complete critical financial processing transactions. These
capital expenditures will result in an increase in our
depreciation expense. We currently estimate spending between
$1.2 million and $1.5 million over the next twelve
months on the financial and warehouse management systems. In
addition, we are considering projects for an order management
system and other warehouse upgrades which we estimate may range
between $1.5 to $2.0 million.

Net cash flows provided by financing activities
was $26.0 million and $8.8 million for the thirty-nine
weeks ended December 28, 2003 and December 29, 2002,
respectively. For the thirty-nine weeks ended December 28,
2003, net cash provided by financing activities consisted of the
net initial public offering proceeds (after underwriters
discount of $1.8 million) of approximately
$29.0 million slightly offset by payments on an existing
line of credit as well as a $1.1 million repayment of a
loan. For the thirty-nine weeks ended December 29, 2002,
net cash provided by financing activities consisted primarily of
approximately $13.7 million of net proceeds from the
issuance of Series F convertible preferred stock slightly
offset by a $4.8 million repayment of a loan.

On September 30, 2003, we completed our
initial public offering, whereby we sold 2.2 million shares
of our common stock at $14 per share and received proceeds of
approximately $29.0 million (after underwriters
discounts of $1.8 million). Total related offering expenses
were $1.6 million.

The Company also has available up to
$11 million pursuant to its revolving credit facility with
CapitalSource Finance LLC, which is described more fully in
Note 5 to the financial statements contained in this
report. The Companys ability to borrow under this credit
facility is subject to compliance with its terms. As of
December 28, 2003, the Company was not in compliance with
the EBITDA covenant contained in the credit agreement and such
breach constituted an event of default under the credit
agreement. On January 21,

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2004, CapitalSource Finance LLC agreed to waive
such non-compliance with such covenant for December 2003. The
Company is currently able to draw down funds under this credit
facility.


Based on our current revenue projections, we may
not be in compliance with certain EBITDA and inventory
covenants. If we are not in compliance, we will seek waivers
from our lender. Because we have zero borrowing outstanding and
have no current plans to borrow, we believe that we can obtain
waivers. If we are unable to obtain waivers, we believe the
credit facility could be terminated without a material adverse
impact on our ability to meet our currently projected capital
needs.

Management believes that the cash currently on
hand will be sufficient to continue operations through at least
the next twelve months. Managements assessment is based on
historical working capital needs, operating loss trends, and
current business outlook. Beyond the next twelve months,
management intends to utilize the cash generated from operations
to fund operations and capital expenditures. Additionally,
equity and or debt financing may need to be obtained to support
our long-term obligations and needs. However, there can be no
assurance that if additional financing is necessary it will be
available, or if available, that such financing can be obtained
on satisfactory terms. Failure to generate sufficient revenues
or raise additional capital could have a material adverse effect
on our ability to continue as a going concern and to achieve our
intended business objectives

Factors That May Affect Future Operating
Results

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

Our limited operating history makes evaluation
of our business difficult.

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

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

We have a history of losses and we may continue
to incur losses for the foreseeable future, although we incurred
net income of $1.2 million and $0.9 million for the
thirteen weeks ended December 28, 2003 and
December 29, 2002, respectively. As of December 28,
2003, our accumulated deficit was $76.4 million. We have
not achieved profitability for a full fiscal year. If our
revenues grow more slowly than we anticipate, or if our
operating expenses exceed our expectations, we may not be able
to achieve profitability in the near future or at all. Even if
we do achieve profitability, we may not be able to sustain or
increase profitability on an annual basis in the future. If we
are unable to achieve profitability within a short period of
time, or at all, or if we are unable to sustain profitability at
satisfactory levels, our financial condition and stock price
could be adversely affected.

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

Our business is highly seasonal, reflecting the
general pattern of peak sales for the retail industry during the
holiday shopping season. Typically, a substantial portion of our
net revenues occur during our third fiscal

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quarter ending around December 31. We
generally experience lower net revenues during the first, second
and fourth fiscal quarters and, as is typical in the retail
industry, have incurred and may continue to incur losses in
these quarters. The third fiscal quarter accounted for
approximately 49% of net revenues in the fiscal year ended
March 30, 2003. We cannot predict with certainty what
percentage of our total net revenues for fiscal year 2004 will
be represented by our third fiscal quarter revenues. In
anticipation of increased sales activity during the third fiscal
quarter, we incur significant additional expenses, including
significantly higher inventory and staffing costs. If sales for
the third fiscal quarter do not meet anticipated levels, then
increased expenses may not be offset, which would adversely
effect our financial condition. If we were to experience lower
than expected sales during one of our third fiscal quarters, for
whatever reason, it would have a disproportionately large impact
on our annual operating results and financial condition for that
fiscal year. If our net revenues during our third fiscal quarter
were to fall below the expectations of securities analysts, our
stock price could decline, perhaps significantly.


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

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

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



| |   |                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The seasonality of our business                                                                                                                                          
|
| |  | Decreases in the number of visitors to our
    website or our inability to convert those visitors into customers                                                         
|
| |  | Technical difficulties, including system or
    Internet failures                                                                                                        
|
| |  | Fluctuations in the demand for our products                                                                                                                              
|
| |  | The number of prior customers that make repeat
    purchases                                                                                                             
|
| |  | Overstocking or understocking of our merchandise                                                                                                                         
|
| |  | Offering of new or enhanced services or products
    by our competitors                                                                                                  
|
| |  | Fluctuations in the level of our product returns                                                                                                                         
|
| |  | Termination of existing marketing relationships
    or failure to develop successful new marketing relationships                                                         
|
| |  | Fluctuations in shipping costs, particularly
    during the holiday season                                                                                               
|
| |  | Fluctuations in advertising, marketing or catalog
    production and distribution costs                                                                                  
|
| |  | The amount and timing of operating costs and
    capital expenditures relating to expansion of our operations                                                            
|
| |  | Changes in government regulations and taxation
    related to use of the Internet or otherwise applicable to our
    business                                            
|
| |  | Economic conditions generally or economic
    conditions specific to the Internet, online commerce, the retail
    industry, the mail order industry or the gift industry
|
| |  | Changes in the mix of products that we sell                                                                                                                              
|
| |  | Fluctuations in levels of inventory theft, damage
    or obsolescence                                                                                                    

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

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

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

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

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

Our fulfillment and distribution operation is
located in leased facilities in Lockbourne, Ohio. Our agreement
with the fulfillment services company that previously managed
the fulfillment and distribution operations at the Lockbourne,
Ohio facility expired in August 2003, at which point we assumed
direct control of fulfillment and distribution operations. We
have no prior experience managing fulfillment and distribution
operations and we cannot assure you that we will be successful
in this endeavor. We experienced significant difficulties
managing the fulfillment and distribution operations during the
2003 holiday season. If we are unable to successfully manage our
fulfillment and distribution operations or if we experience any
significant disruptions in connection with the transition from
our prior service provider, our operations and financial
condition could be seriously harmed. Any failure in managing our
fulfillment and distribution operations would require us to find
one or more parties to provide these services for us. If we are
required to engage one or more service providers, we could incur
higher fulfillment expenses than anticipated or incur additional
costs for balancing merchandise inventories among multiple
distribution facilities. Further, we may need to expand our
distribution operations in the future to accommodate increases
in customer orders. If we fail to successfully manage or expand
our fulfillment and distribution operations it would have a
material adverse effect on our business.

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

We must maintain sufficient inventory levels to
operate our business successfully. Rapidly changing trends in
consumer tastes for gift items expose us to significant
inventory risks, particularly during our third fiscal quarter
when inventory levels are highest due to the holiday shopping
season. Consumer preferences can change between the time we
order a product and the time it is available for sale. We base
our product selection

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on our projections of consumer tastes and
preferences in a future period, and we cannot guarantee that our
projections of consumer tastes and preferences will be accurate.
It is critical to our success that we accurately predict
consumer tastes and stock our product offerings in appropriate
quantities. In the event that one or more products do not
achieve widespread consumer acceptance, we may be required to
take significant inventory markdowns, which could reduce our net
sales and gross margins. This risk may be greatest in the third
fiscal quarter of each year, after we have significantly
increased inventory levels for the holiday shopping season. In
addition, to the extent that demand for our products increases
over time, we may be forced to increase inventory levels. Any
such increase would require the use of additional working
capital and subject us to additional inventory risks. Further,
our failure to stock sufficient quantities of popular products
could cause our customers to become dissatisfied and look to our
competitors for their gift items. If we fail to stock popular
products in sufficient quantities or if we overstock products,
our business, financial condition and operating results would be
affected adversely.


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

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

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

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

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

We have rapidly and significantly expanded our
operations, and anticipate that further significant expansion,
including the possible acquisition of third-party assets,
technologies or businesses, will be required to address
potential growth in our customer base and market opportunities.
This expansion has placed, and is expected to continue to place,
a significant strain on our management, operational and
financial resources. Some of our officers or senior management
personnel have no prior senior management experience at public
companies. Our new employees include key officers as well as a
number of key managerial, technical and operations personnel who
have not yet been fully integrated into our operations.
Additionally, we need to

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properly implement and maintain our financial and
managerial controls, reporting systems and procedures, including
the increased internal controls and procedures required by the
recently enacted Sarbanes Oxley Act of 2002. Moreover, if we are
presented with appropriate opportunities, we may in the future
make investments in, or possibly acquire, assets, technologies
or businesses that we believe are complementary to ours. Any
such investment or acquisition may further strain our financial
and managerial controls and reporting systems and procedures.
These difficulties could disrupt our business, distract our
management and employees or increase our costs. If we are unable
to manage growth effectively or successfully integrate any
assets, technologies or businesses that we may acquire, our
business, financial condition and results of operations would be
affected adversely.


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

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



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

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

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

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

If we fail to upgrade our website in a timely
manner to accommodate higher volumes of traffic, our website
performance could suffer and we may lose customers. In addition,
if we fail to expand the computer systems that we use to process
and ship customer orders and process customer payments, we may
not be able to fulfill customer orders successfully. As a
result, we could lose customers and our net revenues could be
reduced. Further, to remain competitive, we must continue to
enhance and improve the functionality and features of our online
store. The Internet and the online commerce industry are subject
to rapid technological change. If competitors introduce new
features and website enhancements embodying new technologies, or
if new industry standards and practices emerge, our existing
website and systems may become obsolete or

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unattractive. Developing our website and other
systems entails significant technical and business risks. We may
use new technologies ineffectively or we may fail to adapt our
website, our transaction processing systems and our computer
network to meet customer requirements or emerging industry
standards. If we are unsuccessful in upgrading our systems to
accommodate higher traffic or developing or implementing new
technologies that enable us to meet evolving industry standards
and remain competitive, our operating results would be seriously
harmed.


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

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

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

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

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

As part of our customer service commitment, we
maintain a merchandise return policy that allows recipients to
return most merchandise items received from us if they are
dissatisfied with those items. We make allowances for
merchandise returns in our financial statements based on
historical return rates. We cannot assure you that actual
merchandise returns will not significantly exceed our allowances
for returns. In addition, because our allowances are based on
historical return rates, we cannot assure you that the
introduction of new merchandise in our catalogs, the
introduction of new catalogs, increased sales over the Internet,
changes in our merchandise mix, changes in the habits of our
gift item recipients, or other factors will not cause actual
returns to exceed return allowances, perhaps significantly. Any
increase in merchandise returns that exceed our allowances would
affect our business adversely.

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

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



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

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

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

Our revenues depend on our ability to advertise
and market our products effectively through the RedEnvelope
catalog and our other advertising and marketing efforts.
Increases in the cost of advertising and marketing, including
paper and postage costs and the costs of complying with
applicable regulations, may limit our ability to advertise and
market our business without reducing our profitability. If we
decrease our advertising or marketing activities due to
increased costs, restrictions enacted by regulatory agencies or
for any other reason, our future operating results could be
significantly harmed. We expect to increase spending on
advertising and marketing in the future, and if such efforts do
not produce a sufficient level of sales to cover their costs, it
would harm our operating results.

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

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

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

Our ability to provide satisfactory levels of
customer service depends, to a large degree, on the efficient
and uninterrupted operation of our call center. Any material
disruption or slowdown in our order processing systems resulting
from labor disputes, telephone or Internet failures, power or
service outages, natural disasters

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


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

Our performance is substantially dependent on the
continued services and on the performance of our senior
management and other key personnel, particularly Alison L. May,
our President and Chief Executive Officer, and Hilary Billings,
our Brand Strategist. Our performance also depends on our
ability to retain and motivate other officers and key employees.
We do not have long-term employment agreements with any of our
key personnel. The loss of the services of Ms. May,
Ms. Billings, any of our executive officers or other key
employees for any reason could harm our business, financial
condition and operating result. Our future success also depends
on our ability to identify, attract, hire, train, retain and
motivate other highly-skilled technical, managerial, editorial,
merchandising, marketing and customer service personnel.
Competition for such personnel is intense, particularly in the
San Francisco Bay Area, and we cannot assure you that we will be
able to successfully attract, assimilate or retain sufficiently
qualified personnel. Our failure to attract and retain the
necessary technical, managerial, editorial, merchandising,
marketing and customer service personnel would harm our
business, financial condition and results of operations.

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

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

We also rely on technologies that we license from
third parties. These licenses may not continue to be available
to us on commercially reasonable terms, or at all, in the
future. As a result, we may be required to

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develop or obtain substitute technology of lower
quality or at greater cost, which could materially adversely
affect our business, operating results and financial condition.


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

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

We face the risk of inventory
shrinkage.

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

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

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

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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 anticipate that we may need to raise
additional capital in the future to facilitate long-term
expansion, to respond to competitive pressures or to respond to
unanticipated financial requirements. We cannot be certain that
we will be able to obtain additional financing on commercially
reasonable terms or at all. If we raise additional funds through
the issuance of equity, equity-related or debt securities, such
securities may have rights, preferences or privileges senior to
those of the rights of our common stock and our stockholders
will experience dilution of their ownership interests. Further,
under the terms of our credit agreement with CapitalSource
Finance LLC, we are subject to certain contractual limitations
with respect to raising additional capital during the term of
that agreement. A failure to obtain additional financing or an
inability to obtain financing on acceptable terms could require
us to incur indebtedness that has high rates of interest or
substantial restrictive covenants, issue equity securities that
will dilute the ownership interests of existing stockholders, or
scale back, or fail to address opportunities for expansion or
enhancement of, our operations. Since our inception, we have
experienced negative cash flow from operations on a fiscal year
basis and may experience negative cash flow from operations on a
fiscal year basis for the foreseeable future.

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

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

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

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

We may face difficulty expanding into
international markets.

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

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

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

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

We are required to verify the age of purchasers
of our tobacco products. If we fail to request or are unable to
properly identify the age of our purchasers, we could face
substantial penalties and legal liability for sales of tobacco
products to underage persons. Any inquiry or investigation from
a regulatory authority could have a negative impact on our
reputation and any liability claims could subject us to fines,
mandatory damages or require us to spend significant time and
money in litigation.

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

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

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

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

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



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

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

Customers may be unwilling to purchase goods
on the Internet.

Approximately 70% of our products currently are
purchased through our website. Our long-term prospects therefore
depend upon the general publics increasing willingness to
use the Internet as a means to purchase goods. The failure of
the Internet to continue to develop into an effective and
reliable tool for consumer purchases would seriously damage our
future operations. Online commerce is a relatively new concept,
and online purchases may decline or fail to increase as
projected. The future of online commerce is highly uncertain,
many online commerce companies have ceased operations in recent
years and most existing online commerce companies have a
relatively short operating history. If consumers are unwilling
to use the Internet to purchase retail products, our business
will be harmed.

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

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

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

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

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

Existing or future government regulation could
harm our business.

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

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commercial use of e-mail (popularly known as
CAN-SPAM), are only beginning to be interpreted by
the courts and their applicability and reach are therefore
uncertain. The restrictions imposed by, and costs of complying
with, current and possible future laws and regulations related
to our business could harm our business, operating results and
financial condition.


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

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

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

In addition, because our website is accessible
over the Internet in multiple states and other countries, we may
be subject to their laws and regulations or may be required to
qualify to do business in those locations. We are qualified to
do business only in California and Ohio at present. Our failure
to qualify in a state or country where we are required to do so
could subject us to taxes and penalties and we could be subject
to legal actions and liability in those jurisdictions. The
restrictions or penalties imposed by, and costs of complying
with, these

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laws and regulations could harm our business,
operating results and financial condition. Our ability to
enforce contracts and other obligations in states and countries
in which we are not qualified to do business could be hampered,
which could have a material adverse effect on our business.
Further, an important aspect of the new Internet-focused laws is
that where federal legislation is absent, states have begun to
enact consumer-protective laws of their own and these can vary
significantly from state to state. Thus, it is difficult for any
company to be sufficiently aware of the requirements of all
applicable state laws and it is also difficult or impossible for
any company to comply fully with the sometimes inconsistent
standards and requirements set by various states. In addition to
the consequences that could result from violating one or more
state laws, the costs of attempting to comply could be
considerable.


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

We are subject to increasing regulation relating
to privacy and the use of personal user information. For
example, we are subject to various telemarketing laws that
regulate the manner in which we may solicit future suppliers and
customers. Such regulations, along with increased governmental
or private enforcement, may increase the cost of growing our
business. California recently enacted a law, currently scheduled
to take effect on July 1, 2004, that will require all
commercial website operators that collect personal information
about California residents to adopt and post a privacy policy
that meets certain specified criteria. Any failure to comply
with this new law could subject us to civil penalties,
injunctions, and/or lawsuits. In addition, several states have
proposed legislation that would limit the uses of personal user
information gathered online or require online services to
establish privacy policies. The Federal Trade Commission has
adopted regulations regarding the collection and use of personal
identifying information obtained from children under
13 years of age. Bills proposed in Congress would extend
online privacy protections to adults. Moreover, proposed
legislation in the United States and existing laws in other
countries require companies to establish procedures to notify
users of privacy and security policies, obtain consent from
users for collection and use of personal information, and/or
provide users with the ability to access, correct and delete
personal information stored by companies. These data protection
regulations and enforcement efforts may restrict our ability to
collect demographic and personal information from users, which
could be costly or harm our marketing efforts. Further, any
violation of privacy or data protection laws and regulations may
subject us to fines, penalties and damages and may otherwise
have a material adverse effect on our business, results of
operations and financial condition.

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

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

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

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

The large number of shares eligible for future
public sale could cause our stock price to fall.

A large portion of the shares of our common stock
is currently subject to lock-up agreements that will expire in
the near future. The lock-up agreements restrict holders
ability to transfer their stock until March 23, 2004. Of
our outstanding shares, 2,200,000 are freely tradable as of the
date of this report, an

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additional 6,300,963 will be available for sale
in the public market on March 23, 2004 (or earlier in the
event that all or some of the holders of such stock are released
from their lock-up restrictions prior to such date), and the
remaining 3,605 shares will be available for sale in the public
market in March 2004, in each case subject to the
requirements of Rule 144 promulgated under the Securities
Act of 1933, as amended. Sales of a substantial number of shares
of our common stock within a short period of time, or after the
expiration of applicable lock-up periods, could cause our stock
price to fall. In addition, the sale of these shares could
impair our ability to raise capital through the sale of
additional stock.







|        |                                                               
|------- | --------------------------------------------------------------
|Item 3. | Quantitative and Qualitative Disclosures
    About Market Risk

We currently maintain a portfolio of fixed and
variable investments consisting of cash equivalents, short-term
marketable securities and long-term marketable securities, which
can be affected by changes in market interest rates. According
to our investment policy, we may invest in taxable and tax
exempt instruments. In addition, the policy establishes limits
on credit quality, maturity, issuer and type of instrument.
Marketable securities are classified as available for
sale. Marketable securities are comprised of government
securities and corporate bonds. We do not use derivative
financial instruments in our investment portfolio.

All highly liquid investments with a maturity of
three months or less at the date of purchase are considered to
be cash equivalents. The remaining investments are considered
short-term marketable securities if maturities range between
four and twelve months or long term marketable securities if
maturities are over twelve months.

The following table lists our cash equivalents,
short-term marketable securities and long-term marketable
securities at December 28, 2003:

|                       |  |                |        | 
|---------------------- |  | -------------- | ------ | 
|                       |  | December 28,  
|                       |  | 2003          
|                       |  |               
|                       |  | (In thousands)
|Cash and equivalents   |  | $              | 34,756 | 
|Short-term investments |  |                | 2,888  | 
|Long-term investments  |  |                | 565    | 
|                       |  |                |        | 
|Total                  |  | $              | 38,209 | 
|                       |  |                |        | 

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






|        |                        
|------- | -----------------------
|Item 4. | Controls and Procedures

The Company evaluated the design and operation of
its disclosure controls and procedures to determine whether they
are effective in ensuring that the disclosure of required
information is timely and made in accordance with the Exchange
Act and the rules and forms of the Securities and Exchange
Commission. This evaluation was made under the supervision and
with the participation of management, including the
Companys principal executive officer and principal
financial officer as of the end of the period being reported on
in this Quarterly Report on Form 10-Q. The Company
continues to implement minor changes primarily to formalize and
document procedures already in place. The Company also has
established a Disclosure Committee, which consists of certain
members of the Companys senior management. Based on this
evaluation, our chief executive officer and our chief financial
officer have concluded that our disclosure controls and
procedures, as defined at Exchange Act Rules 13a-15(e) and
15d-15(e), are effective to ensure that information required to
be disclosed by the Company in reports that it files under the
Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange
Commission rules and forms. Since the date of the evaluation of
internal controls, no significant changes have been made that
could significantly affect these controls.

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PART II.

OTHER INFORMATION






|        |                  
|------- | -----------------
|Item 1. | Legal Proceedings

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

In a letter dated May 23, 2003, counsel for
Activ8Now, LLC offered us a license to U.S. Patents
6,557,006 and 6,535,889 and certain patent applications. In a
letter dated July 10, 2003, Activ8Now asserted that we were
using the patented technology of Activ8Now. In a letter dated
September 3, 2003 and in response to an inquiry from our
counsel, counsel for Activ8Now reasserted that certain of
Activ8Nows patents covered certain aspects of our website
operations and provided their analysis of how such Activ8Now
patented technologies apply to our website operations, and again
offered to license such patents to us. On September 5,
2003, our counsel discovered that Activ8Now had filed suit
against RedEnvelope in the United States District Court for the
Northern District of Georgia on September 3, 2003 alleging
infringement of the two patents referenced above arising out of
certain aspects of our website operations, and seeking the
following relief: actual damages for the alleged infringement
(including interest) in an unspecified amount, but no less than
a reasonable royalty amount; permanent injunctive relief from
further alleged acts of infringement; costs and reasonable
attorneys fees related to the lawsuit; and triple damages
in the event that Activ8Now can show infringement that was
willful and intentional. On October 17, 2003, RedEnvelope
was served with the complaint. Counsel for RedEnvelope is in the
process of evaluating the merits of this claim and we intend to
pursue any and all available defenses to these allegations
vigorously. We currently believe that this lawsuit will not have
a material adverse effect on us. However, because this
litigation matter is in its early stages, we do not have
sufficient information to assess whether the allegations could
lead to liability on the part of RedEnvelope or the amount of
potential damages. We cannot guarantee that this lawsuit will
not result in costly settlement arrangements, royalty payments,
statutory damages, significant attorneys fees and/or
require us to modify our website or our methods of conducting
business.

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|        |                                              
|------- | ---------------------------------------------
|Item 2. | Changes in Securities and Use of
    Proceeds

(c) During the quarterly period ended
December 29, 2003, we issued the following securities that
were not registered under the Securities Act of 1933.

On September 29, 2003, we granted options to
purchase an aggregate of 426 shares of common stock with an
exercise price of $14.04 per share to a number of our employees
for an aggregate exercise price of $5,981.04. These transactions
were exempt from registration under the Securities Act pursuant
to Rule 701 promulgated under Section 3(b) thereof on
the basis that the transactions were pursuant to a compensation
benefit plan and contracts relating to employment or pursuant to
Section 4(2) thereof on the basis that the transactions did
not involve a public offering.

The recipients of securities in the transactions
listed above represented their intentions to acquire the
securities for investment only and not with a view to or for
sale in connection with any distribution thereof. All recipients
had adequate access to information about RedEnvelope through
their relationships with RedEnvelope. None of the foregoing
transactions involved any underwriters, underwriting discounts
or commissions, or any public offerings.

(d) The Securities and Exchange Commission
declared our registration statement, which we filed on
Form S-1 (Registration No. 333-106120) under the
Securities Act of 1933 in connection with the initial public
offering of our common stock, effective on September 24,
2003. Under this registration statement, we registered
2,200,000 shares of our common stock, and another
330,000 shares subject to the underwriters
over-allotment option. The shares of common stock registered
under the registration statement, not including the
330,000 shares of common stock covered by the
over-allotment option which expired on October 24, 2003 and
was not exercised, were sold at a price to the public of $14.00
per share. All of the shares of common stock were sold by us and
there were no selling stockholders in the offering. The offering
closed on September 30, 2003. The underwriters were WR
Hambrecht+Co, LLC and Pacific Crest Securities, Inc.

The aggregate proceeds to us from the offering
were approximately $29.0 million (after underwriters
discounts of $1.8 million). We will use approximately
$1.6 million for fees related to the offering (excluding
banker fees) and approximately $3.9 million to fund
operations. We invested approximately $23.5 million of the
remaining net proceeds in short and long term investments and
the balance in cash and cash equivalents.






|        |                                     
|------- | ------------------------------------
|Item 6. | Exhibits and Reports on
    Form 8-K

(a) 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 2002
|32.2 |  | Certification required by 18 U.S.C.§1350, as
    adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K

|                 |  |                                                                                                                                   
|---------------- |  | ----------------------------------------------------------------------------------------------------------------------------------
|Date:            |  | Item Reported On:                                                                                                                 
|                 |  |                                                                                                                                   
|October 28, 2003 |  | Item 12: On October 28, 2003,
    RedEnvelope announced its financial results for the fiscal
    quarter ended September 28, 2003.

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SIGNATURES

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



| |                  
| | -----------------
| | REDENVELOPE, INC.



| |     |                 
| | --- | ----------------
| | By: | /s/ ERIC C. WONG

| |                        
| | -----------------------
| |                        
| | Eric C. Wong           
| | Chief Financial Officer

Date: February 11, 2004

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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 2002
|32.2 |  | Certification required by 18 U.S.C.
    § 1350, as adopted pursuant to § 906 of the
    Sarbanes-Oxley Act of 2002