##### 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 October 1, 2006
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number: 0-50387
 RedEnvelope, Inc.
 (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    33-0844285(State or Other Jurisdiction of 
Incorporation or Organization)
    
    (IRS Employer
Identification No.)
 149 New Montgomery Street,
San Francisco, California 94105  (Address of Principal Executive Offices and Zip Code)
 (415) 371-9100  (Registrants Telephone Number, Including Area Code)
 þ o
  o o þ
 o þ




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##### Table of Contents



RedEnvelope, Inc.
REPORT ON FORM 10-Q
For the Quarter Ended October 1, 2006
TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATION
    
    
    3Item 1.
    
    Financial Statements (Unaudited)
    
    
    3Condensed Balance Sheets as of October 1, 2006, April 2, 2006 and October 2, 2005
    
    
    3Condensed Statements of Operations for the thirteen and twenty-six weeks ended
October 1, 2006 and October 2, 2005
    
    
    4Condensed Statements of Cash Flows for the twenty-six weeks ended October 1, 2006
and October 2, 2005
    
    
    5Notes to Condensed Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    14Item 4.
    
    Controls and Procedures
    
    
    15PART II. OTHER INFORMATION
    
    
    15Item 1.
    
    Legal Proceedings
    
    
    15Item 1A.
    
    Risk Factors
    
    
    15Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 3.
    
    Defaults Upon Senior Securities
    
    
    26Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    26Item 5.
    
    Other Information
    
    
    27Item 6.
    
    Exhibits
    
    
    27EXHIBIT 10.65EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 RedEnvelope, Inc.
 
 CONDENSED BALANCE SHEETS
 (Unaudited)
 October 1,
    
    
    April 2,
    
    
    October 2,2006
    
    
    2006
    
    
    2005(In thousands, except for share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    3,143
    
    
    $
    3,277
    
    
    $
    3,286Short-term investments
    
    
    
    
    
    
    6,762
    
    
    
    10,122Accounts receivable, net
    
    
    969
    
    
    
    1,054
    
    
    
    792Inventory
    
    
    22,928
    
    
    
    19,690
    
    
    
    13,976Prepaid catalog costs and other current assets
    
    
    3,883
    
    
    
    2,793
    
    
    
    3,879Total current assets
    
    
    30,923
    
    
    
    33,576
    
    
    
    32,055Property and equipment, net
    
    
    7,607
    
    
    
    7,255
    
    
    
    7,473Other assets
    
    
    200
    
    
    
    146
    
    
    
    503Total assets
    
    $
    38,730
    
    
    $
    40,977
    
    
    $
    40,031LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    10,499
    
    
    $
    9,759
    
    
    $
    8,913Accrued expenses and other current liabilities
    
    
    2,443
    
    
    
    2,699
    
    
    
    3,554Accrued compensation
    
    
    1,305
    
    
    
    1,371
    
    
    
    770Capital lease obligations, current
    
    
    207
    
    
    
    312
    
    
    
    549Total current liabilities
    
    
    14,454
    
    
    
    14,141
    
    
    
    13,786Capital lease obligations, long-term
    
    
    456
    
    
    
    136
    
    
    
    39Deferred rent
    
    
    594
    
    
    
    710
    
    
    
    792Total liabilities
    
    
    15,504
    
    
    
    14,987
    
    
    
    14,617Stockholders equity:Common stock, $0.01 par value; 100 million
shares authorized; 9.6 million, 9.3 million,
and 9.0 million issued and outstanding as of
October 1, 2006, April 2, 2006, and October 2,
2005, respectively
    
    
    97
    
    
    
    94
    
    
    
    91Additional paid-in capital
    
    
    117,188
    
    
    
    115,367
    
    
    
    114,413Notes receivable from stockholders
    
    
    (44
    )
    
    
    (44
    )
    
    
    (44
    )Accumulated deficit
    
    
    (94,015
    )
    
    
    (89,427
    )
    
    
    (89,046
    )Total stockholders equity
    
    
    23,226
    
    
    
    25,990
    
    
    
    25,414Total liabilities and stockholders equity
    
    $
    38,730
    
    
    $
    40,977
    
    
    $
    40,031
  3




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RedEnvelope, Inc.
 
 CONDENSED STATEMENTS OF OPERATIONS
 (Unaudited)
 Thirteen Weeks Ended
    
    
    Twenty-six Weeks EndedOctober 1,
    
    
    October 2,
    
    
    October 1,
    
    
    October 2,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands, except for per share data)Net revenues
    
    $
    15,531
    
    
    $
    13,124
    
    
    $
    42,389
    
    
    $
    38,102Cost of sales
    
    
    7,804
    
    
    
    6,946
    
    
    
    20,412
    
    
    
    18,675Gross profit
    
    
    7,727
    
    
    
    6,178
    
    
    
    21,977
    
    
    
    19,427Operating expenses:Fulfillment
    
    
    2,787
    
    
    
    2,233
    
    
    
    6,206
    
    
    
    5,638Marketing
    
    
    3,165
    
    
    
    2,727
    
    
    
    9,450
    
    
    
    9,590General and administrative
    
    
    5,507
    
    
    
    4,780
    
    
    
    10,996
    
    
    
    9,591Total operating expenses
    
    
    11,459
    
    
    
    9,740
    
    
    
    26,652
    
    
    
    24,819Loss from operations
    
    
    (3,732
    )
    
    
    (3,562
    )
    
    
    (4,675
    )
    
    
    (5,392
    )Interest income, net
    
    
    44
    
    
    
    73
    
    
    
    87
    
    
    
    151Net loss
    
    $
    (3,688
    )
    
    $
    (3,489
    )
    
    $
    (4,588
    )
    
    $
    (5,241
    )Net loss per share, basic and diluted
    
    $
    (0.39
    )
    
    $
    (0.39
    )
    
    $
    (0.49
    )
    
    $
    (0.59
    )Weighted average shares outstanding,
basic and diluted
    
    
    9,424
    
    
    
    8,996
    
    
    
    9,325
    
    
    
    8,958
  4




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RedEnvelope, Inc.
 
 CONDENSED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Twenty-six Weeks EndedOctober 1,
    
    
    October 2,2006
    
    
    2005(In thousands)Cash Flows From Operating Activities:Net loss
    
    $
    (4,588
    )
    
    $
    (5,241
    )Adjustments to reconcile net loss to net cash used in operating activities:Depreciation
    
    
    1,600
    
    
    
    1,596Stock-based compensation
    
    
    1,234
    
    
    
    6Other non-cash charges
    
    
    (75
    )
    
    
    (12
    )Changes in current assets and liabilities:Accounts receivable, net
    
    
    85
    
    
    
    200Inventory
    
    
    (3,238
    )
    
    
    72Prepaid catalog costs and other current assets
    
    
    (1,039
    )
    
    
    26Accounts payable
    
    
    877
    
    
    
    (1,131
    )Accrued expenses and other current liabilities
    
    
    (321
    )
    
    
    (123
    )Net cash used in operating activities
    
    
    (5,465
    )
    
    
    (4,607
    )Cash Flows From Investing Activities:Maturities of short-term investments
    
    
    11,619
    
    
    
    17,544Purchases of short-term investments
    
    
    (4,857
    )
    
    
    (13,315
    )Purchases of property and equipment
    
    
    (1,594
    )
    
    
    (1,447
    )Net cash provided by investing activities
    
    
    5,168
    
    
    
    2,782Cash Flows From Financing Activities:Proceeds from issuance of common stock
    
    
    590
    
    
    
    621Principal payments on capital lease obligations
    
    
    (283
    )
    
    
    (317
    )Payment of debt issuance costs
    
    
    (144
    )
    
    
    Net cash provided by financing activities
    
    
    163
    
    
    
    304Net decrease in cash and cash equivalents
    
    
    (134
    )
    
    
    (1,521
    )Cash and cash equivalents at beginning of period
    
    
    3,277
    
    
    
    4,807Cash and cash equivalents at end of period
    
    $
    3,143
    
    
    $
    3,286Supplemental Cash Flow Information:Cash paid for interest
    
    $
    49
    
    
    $
    51Supplemental Non-Cash Investing and Financing Activities:Property and equipment acquired through capital lease transactions
    
    $
    498
    
    
    $
    36
  5




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##### Table of Contents



RedEnvelope, Inc.
 
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 (Unaudited)
 1. Financial Statements  Basis of Presentation
     2. Certain Significant Accounting Policies
  Loss Per Share 
 Investments 
  6




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New Accounting Pronouncements  Share-Based Payment
    Accounting for Income Tax
Uncertainties
 3. Stock-Based Compensation
  Accounting for Stock Issued to Employees
   7




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Thirteen Weeks
    
    
    Twenty-six WeeksEnded
    
    
    Ended(In thousands, except per share data)Net loss  as reported
    
    $
    (3,489
    )
    
    $
    (5,241
    )Stock-based employee compensation included in reported net loss
    
    
    2
    
    
    
    6Stock-based compensation expense determined under fair value method
    
    
    (420
    )
    
    
    (876
    )Pro forma net loss
    
    $
    (3,907
    )
    
    $
    (6,111
    )Basic and diluted loss per shareAs reported
    
    $
    (0.39
    )
    
    $
    (0.59
    )Pro forma
    
    $
    (0.43
    )
    
    $
    (0.68
    )
 Stock Options
       Thirteen Weeks Ended
    
    Twenty-six Weeks EndedStock Option Valuation Assumptions:
    
    October 1, 2006
    
    October 2, 2005
    
    October 1, 2006
    
    October 2, 2005Expected volatility
    
    
    55.7
    %
    
    
    59.3
    %
    
    
    55.7%  56.8
    %
    
    
    59.3
    %Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Expected term
    
    3.8  5.7 years
    
    
    4.0 years
    
    
    3.8  5.7 years
    
    

4.0 yearsRisk-free interest rate
    
    
    4.5%  5.1
    %
    
    
    4.0
    %
    
    
    4.5%  5.2
    %
    
    
    4.0
    %
 8




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WeightedWeighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    AggregateOptions
    
    
    Exercise Price
    
    
    Contractual
    
    
    IntrinsicOutstanding
    
    
    per Share
    
    
    Term (Years)
    
    
    Value(in thousands)
    
    
    
    
    
    
    
    
    
    
    (in thousands)Balance, April 2, 2006
    
    
    1,560
    
    
    $
    8.65Granted
    
    
    438
    
    
    
    8.61Cancelled
    
    
    (135
    )
    
    
    11.76Exercised
    
    
    (280
    )
    
    
    1.85Balance, October 1, 2006
    
    
    1,583
    
    
    $
    9.55
    
    
    
    8.59
    
    
    $
    424Exercisable, October 1, 2006
    
    
    534
    
    
    $
    9.73
    
    
    
    7.60
    
    
    $
    258
  Employee Stock Purchase Plan
   Expected volatility
    
    
    32.6%  40.5
    %Dividend yield
    
    
    0%Expected term
    
    0.5 yearsRisk-free interest rate
    
    
    4.1%  4.7
    %
  4. Borrowing Arrangements
  5. Legal Proceedings
  9




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Forward-Looking Statements
 This report, together with the documents incorporated herein by reference, contains
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. Such statements
are based upon current expectations and involve risks and uncertainties. Any statements contained
in this report that are not purely statements of historical fact may be deemed to be
forward-looking statements. Such forward-looking statements may include but are not limited to
statements regarding our future operations and enhancements, product or service offerings,
business, financial condition, results of operations and prospects. Additionally, statements
concerning possible changes in applicable rules or legislation are forward-looking statements.
Words such as expects, anticipates, intends, plans, believes, seeks, estimate, may,
should, would, could and similar expressions or variations of such words are intended to
identify forward-looking statements, but are not the exclusive means of identifying forward-looking
statements in this report. All forward-looking statements in this report are based upon information
available to us as of the date hereof, and we assume no obligation to revise or update any such
forward-looking statements in order to reflect any event or circumstance that may arise after the
date of this report. Actual results and the timing of certain events could differ materially from
our current expectations. Factors that could cause or contribute to such differences include, but
are not limited to, those set forth in this report under Risk Factors, and elsewhere in this
report, and those contained from time to time in our other filings with the SEC. We caution
investors that our business and financial performance are subject to substantial risks and
uncertainties.
 Overview
 www.redenvelope.com
       10




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Critical Accounting Policies
  New Accounting Pronouncements
 Share-Based Payment
  Results of Operations
  Thirteen Weeks Ended
    
    Twenty-six Weeks EndedOctober 1,
    
    October 2,
    
    October 1,
    
    October 2,2006
    
    2005
    
    2006
    
    2005Statements of Operations Data:Net revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    50.2
    
    
    
    52.9
    
    
    
    48.2
    
    
    
    49.0Gross profit
    
    
    49.8
    
    
    
    47.1
    
    
    
    51.8
    
    
    
    51.0Operating expenses:Fulfillment
    
    
    17.9
    
    
    
    17.0
    
    
    
    14.6
    
    
    
    14.8Marketing
    
    
    20.4
    
    
    
    20.8
    
    
    
    22.3
    
    
    
    25.2General and administrative
    
    
    35.5
    
    
    
    36.4
    
    
    
    25.9
    
    
    
    25.2Total operating expenses
    
    
    73.8
    
    
    
    74.2
    
    
    
    62.9
    
    
    
    65.1Loss from operations
    
    
    (24.0
    )
    
    
    (27.1
    )
    
    
    (11.0
    )
    
    
    (14.2
    )Interest income, net
    
    
    0.3
    
    
    
    0.6
    
    
    
    0.2
    
    
    
    0.4Net loss
    
    
    (23.7
    )%
    
    
    (26.6
    )%
    
    
    (10.8
    )%
    
    
    (13.8
    )%
 11




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Quarter Ended October 1, 2006 Compared to Quarter Ended October 2, 2005
 Net Revenues
   Cost of Sales
   Operating Expenses
 Fulfillment.
  Marketing.
  General and Administrative.
  12




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Twenty-six Weeks Ended October 1, 2006 Compared to Twenty-six Weeks Ended October 2, 2005
 Net Revenues
  Cost of Sales
  Operating Expenses
 Fulfillment.
 Marketing.
 General and Administrative.
 Liquidity and Capital Resources
  Cash Flows From Operating Activities
 Cash Flows From Investing Activities
 13




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Cash Flows From Financing Activities
 Revolving Credit Facility
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Interest Rate Risk
   (In thousands)Cash and cash equivalents
    
    $
    3,143Short-term investments
    
    
    Total
    
    $
    3,143
  Foreign Currency Risk
 14




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Item 4. Controls and Procedures
 Disclosure Controls and Procedures
 
 PART II.
 OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 1A. Risk Factors
  You should consider carefully the risks and uncertainties relating to our business including
those described below, together with all of the other information included or incorporated by
reference in this Quarterly Report on Form 10-Q . Additional risks and uncertainties not currently
known to us or that we currently do not deem material could also become important factors that may
harm our business. The trading price of our common stock could decline due to any of these risks
and uncertainties, and you could lose all or part of your investment.
 Our limited operating history makes evaluation of our business difficult.
  We have a history of significant losses. If we do not achieve or sustain profitability, our
financial condition and stock price could suffer.
  15




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Because we experience seasonal fluctuations in our net sales, our quarterly results will fluctuate
and our annual performance will depend largely on results from one quarter.
  Our operating results are volatile and difficult to predict and may adversely affect our stock
price.
  Our computer and communications hardware and software systems are vulnerable to damage and
interruption, which could harm our business.
  If we fail to offer a broad selection of innovative merchandise that consumers find attractive, our
revenues could decline or fail to reach anticipated levels and our stock price could be harmed.
  16




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Failure to successfully manage or expand our fulfillment and distribution operation would have a
material adverse effect on us.
  If we do not manage our inventory levels successfully, our operating results may be adversely
affected.
  We may have difficulty in product sourcing.
    17




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Our operating results could suffer if we fail to offer or sell sufficient quantities of proprietary
products.
  Our facilities and systems are vulnerable to natural disasters or other catastrophic events.
  We have grown quickly and if we fail to manage our growth, our business will suffer.
  We experience intense competition in the rapidly changing retail gift market.
  18




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##### Table of Contents




    
    other online retailers, such as Amazon.com and eBay
    
    major department stores, such as Macys, Bloomingdales, Neiman Marcus and their online storefronts
    
    physical and online stores and catalog retailers that sell popular gift items such as Pottery Barn, Brookstone,
The Sharper Image, Tiffanys, Harry & David, J Crew, 1-800-Flowers and Williams-Sonoma
    
    Internet portals and online service providers and other comparison shopping sites, such as AOL, Yahoo! and Google.
   If we do not successfully expand our website and order processing systems or respond to rapid
technological changes, we could lose customers and our net revenues could decline.
   Delivery of our merchandise could be delayed or disrupted by factors beyond our control, and we
could lose customers as a result.
  The loss of our senior management or other key personnel could harm our current and future
operations and prospects.
  19




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We rely on seasonal and temporary employees during periods of peak activity and any failure by such
employees to adequately perform their jobs could adversely affect our operations.
  Increased merchandise returns and a failure to accurately predict merchandise returns could harm
our business.
  If we are unable to successfully manage the costs of our catalog operations or our catalogs fail to
produce sales at satisfactory levels it could adversely affect our business.
  
    
    effective management of costs associated with the production and distribution of our catalog
    
    achievement of adequate response rates to our mailings
    
    displaying a mix of merchandise in our catalog that is attractive to our customers
    
    production of aesthetically appealing catalogs
    
    timely delivery of catalog mailings to our customers
  20




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We are dependent on the success of our advertising and marketing efforts which are costly and may
not achieve desired results.
  If we are unable to provide satisfactory customer service, we could lose customers.
   If the protection of our trademarks and proprietary rights is inadequate, our brand and reputation
could be impaired and we could lose customers.
   21




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Intellectual property claims against us could be costly and could impair our business.
  We may be subject to litigation proceedings that could adversely affect our business.
  We face the risk of inventory shrinkage.
  Poor economic conditions may constrain discretionary consumer spending on retail products such as
ours.
  If we fail to meet the borrowing requirements under our loan and security agreement, we may be
unable to obtain necessary short-term financing and if we default on a secured loan, material
assets of ours could be subject to forfeiture.
   22




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We may need additional financing and may not be able to raise additional financing on favorable
terms or at all, which could increase our costs, limit our ability to grow and dilute the ownership
interests of existing stockholders.
  We may face product liability claims that are costly and create adverse publicity.
  We may incur significant costs or experience delays in product availability due to regulations
applicable to the sale of food products and live plants, which may hurt our business.
  If we fail to comply with the laws regulating the sale of tobacco products it may have a negative
impact on our reputation and make us vulnerable to liability claims.
  Our charter documents, Delaware law and third-party contractual restrictions may make an
acquisition of us more difficult, even if an acquisition would be beneficial to our stockholders.
  23




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Our success is tied in large part to the continued use of the Internet by a large number of
consumers.
  
    
    actual or perceived lack of privacy protection
    
    actual or perceived lack of security of credit card information
    
    possible disruptions or other damage to the Internet or telecommunications infrastructure
    
    increased governmental regulation and taxation
    
    decreased use of personal computers
  Customers may be unwilling to purchase goods on the Internet.
  The security risks of online commerce, including credit card fraud, may discourage customers from
purchasing goods from us.
   Existing or future government regulation could harm our business.
  24




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##### Table of Contents



Laws or regulations relating to privacy and data protection may adversely affect the growth of our
Internet business or our marketing efforts.
 25




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We may be subject to liability for the content that we publish.
  Our directors, executive officers and significant stockholders hold a substantial portion of our
stock, which may lead to conflicts with other stockholders over corporate transactions and other
corporate matters.
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 None.
 
 Item 3. Defaults Upon Senior Securities.
 None.
 
 Item 4. Submission of Matters to a Vote of Security Holders.
   (I)
    
    The stockholders elected each of the following persons by the vote
indicated to serve as a director of the company until the next Annual
Meeting of Stockholders or until his or her successor is elected and
qualified, or until their earlier removal, resignation or
disqualification:
 26




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Name
    
    For
    
    WithheldKen Constable
    
    
    7,361,133
    
    
    
    8,766Michael Dunn
    
    
    6,485,102
    
    
    
    884,797Karen Edwards
    
    
    6,483,991
    
    
    
    885,908Scott Galloway
    
    
    6,485,102
    
    
    
    884,797Joseph Gandolfo
    
    
    6,485,102
    
    
    
    884,797Greggory Hammann
    
    
    6,485,102
    
    
    
    884,797Brett Hendrickson
    
    
    7,362,294
    
    
    
    7,605Daniel R. Lyle
    
    
    6,485,102
    
    
    
    884,797John Pound
    
    
    6,483,941
    
    
    
    885,958
 (II)
    
    The stockholders ratified, by the vote indicated below, the selection
of Deloitte & Touche LLP as the independent registered public
accounting firm for the Companys fiscal year ending April 1, 2007:
 For
    
    Against
    
    Abstain
    
    Broker Non-vote7,365,807
    
    
    4,093
    
    
    
    4,093
    
    
    
    0
 
 Item 5. Other Information.
   
 Item 6. Exhibits
 10.65
    
    First Amendment to Lease Agreement
effective August 1, 2006 between DCT Creekside III LLC and RedEnvelope, Inc.31.1
    
    Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)31.2
    
    Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)32.1
    
    Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002
 27




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##### Table of Contents



SIGNATURES
  REDENVELOPE, INC.By:
    

/s/ Polly BoePolly BoeChief Financial Officer
  28




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##### Table of Contents



EXHIBIT INDEX
 10.65
    
    First Amendment to Lease Agreement
effective August 1, 2006 between DCT Creekside III LLC and RedEnvelope, Inc.31.1
    
    Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)31.2
    
    Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)32.1
    
    Certification required by 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification required by 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002