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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 Form 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended January 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 January 1, 2006
TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATION
    
    
    2Item 1.
    
    Financial Statements (Unaudited)
    
    
    2Condensed Balance Sheets as of January 1, 2006, April 3, 2005 and December 26, 2004
    
    
    2Condensed Statements of Operations for the thirteen weeks and thirty-nine weeks ended January 1, 2006
and December 26, 2004
    
    
    3Condensed Statements of Cash Flows for the thirty-nine weeks ended January 1, 2006 and December 26, 2004
    
    
    4Notes to Condensed Financial Statements
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    8Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    25Item 4.
    
    Controls and Procedures
    
    
    26PART II. OTHER INFORMATION
    
    II-1Item 1.
    
    Legal Proceedings
    
    II-1Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    II-1Item 3.
    
    Defaults up on Senior Securities
    
    II-1Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    II-1Item 5.
    
    Other Information
    
    II-1Item 6.
    
    Exhibits
    
    II-2EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 RedEnvelope, Inc.
 
 CONDENSED BALANCE SHEETS
 (Unaudited)
 January 1,
    
    
    April 3,
    
    
    December 26,2006
    
    
    2005
    
    
    2004(In thousands, except for share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,527
    
    
    $
    4,807
    
    
    $
    21,466Short-term investments
    
    
    18,326
    
    
    
    14,356
    
    
    
    6,022Accounts receivable, net
    
    
    2,705
    
    
    
    992
    
    
    
    4,397Inventory, net
    
    
    15,487
    
    
    
    14,048
    
    
    
    13,401Prepaid catalog costs and other current assets
    
    
    2,643
    
    
    
    3,905
    
    
    
    2,411Total current assets
    
    
    49,688
    
    
    
    38,108
    
    
    
    47,697Property and equipment, net
    
    
    7,499
    
    
    
    7,587
    
    
    
    7,987Other assets
    
    
    432
    
    
    
    573
    
    
    
    607Total assets
    
    $
    57,619
    
    
    $
    46,268
    
    
    $
    56,291LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    17,197
    
    
    $
    10,044
    
    
    $
    13,358Accrued expenses and other current liabilities
    
    
    8,025
    
    
    
    3,454
    
    
    
    7,501Accrued compensation
    
    
    1,207
    
    
    
    993
    
    
    
    954Capital lease obligations, current
    
    
    505
    
    
    
    579
    
    
    
    584Total current liabilities
    
    
    26,934
    
    
    
    15,070
    
    
    
    22,397Capital lease obligations, long-term
    
    
    168
    
    
    
    290
    
    
    
    436Deferred rent
    
    
    751
    
    
    
    874
    
    
    
    829Total liabilities
    
    
    27,853
    
    
    
    16,234
    
    
    
    23,662Common stock, $0.01 par value; 100 million shares
authorized; 9.1 million, 8.9 million, and 8.8 million
issued and outstanding as of January 1, 2006, April
3, 2005, and December 26, 2004, respectively
    
    
    91
    
    
    
    90
    
    
    
    89Additional paid-in capital
    
    
    114,674
    
    
    
    113,831
    
    
    
    113,354Deferred compensation
    
    
    (11
    )
    
    
    (43
    )
    
    
    (50
    )Notes receivable from stockholders
    
    
    (44
    )
    
    
    (44
    )
    
    
    (44
    )Accumulated deficit
    
    
    (84,944
    )
    
    
    (83,805
    )
    
    
    (80,723
    )Accumulated other comprehensive income
    
    
    
    
    
    
    5
    
    
    
    3Total stockholders equity
    
    
    29,766
    
    
    
    30,034
    
    
    
    32,629Total liabilities and stockholders equity
    
    $
    57,619
    
    
    $
    46,268
    
    
    $
    56,291
  2




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RedEnvelope, Inc.
 
 CONDENSED STATEMENTS OF OPERATIONS
 (Unaudited)
 Thirteen Weeks Ended
    
    
    Thirty-nine Weeks EndedJanuary 1,
    
    
    December 26,
    
    
    January 1,
    
    
    December 26,2006
    
    
    2004
    
    
    2006
    
    
    2004(In thousands, except for per share data)Net revenues
    
    $
    53,029
    
    
    $
    47,514
    
    
    $
    91,131
    
    
    $
    79,219Cost of sales
    
    
    25,308
    
    
    
    21,676
    
    
    
    43,983
    
    
    
    37,018Gross profit
    
    
    27,721
    
    
    
    25,838
    
    
    
    47,148
    
    
    
    42,201Operating expenses:Fulfillment
    
    
    6,939
    
    
    
    6,386
    
    
    
    12,577
    
    
    
    12,079Marketing
    
    
    12,090
    
    
    
    12,258
    
    
    
    21,680
    
    
    
    19,401General and administrative
    
    
    4,617
    
    
    
    4,419
    
    
    
    14,208
    
    
    
    12,798Total operating expenses
    
    
    23,646
    
    
    
    23,063
    
    
    
    48,465
    
    
    
    44,278Income (loss) from operations
    
    
    4,075
    
    
    
    2,775
    
    
    
    (1,317
    )
    
    
    (2,077
    )Interest income (expense), net
    
    
    27
    
    
    
    (7
    )
    
    
    178
    
    
    
    6Net income (loss)
    
    $
    4,102
    
    
    $
    2,768
    
    
    $
    (1,139
    )
    
    $
    (2,071
    )Net income (loss) per share  basic
    
    $
    0.45
    
    
    $
    0.32
    
    
    $
    (0.13
    )
    
    $
    (0.24
    )Net income (loss) per share  diluted
    
    $
    0.43
    
    
    $
    0.30
    
    
    $
    (0.13
    )
    
    $
    (0.24
    )Weighted
average shares outstanding  basic
    
    
    9,025
    
    
    
    8,770
    
    
    
    8,981
    
    
    
    8,694Weighted
average shares outstanding  diluted
    
    
    9,500
    
    
    
    9,330
    
    
    
    8,981
    
    
    
    8,694
  3




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RedEnvelope, Inc.
 
 CONDENSED STATEMENTS OF CASH FLOWS
 (Unaudited)
 Thirty-nine Weeks EndedJanuary 1,
    
    
    December 26,2006
    
    
    2004(In thousands)Cash Flows From Operating Activities:Net loss
    
    $
    (1,139
    )
    
    $
    (2,071
    )Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization
    
    
    2,352
    
    
    
    1,996Amortization of deferred stock compensation
    
    
    8
    
    
    
    18Loss on disposal of property and equipment
    
    
    
    
    
    
    61Other non-cash charges
    
    
    (20
    )
    
    
    233Changes in current assets and liabilities:Accounts receivable
    
    
    (1,605
    )
    
    
    (3,343
    )Inventory
    
    
    (1,439
    )
    
    
    (3,792
    )Prepaid catalog and other assets
    
    
    1,299
    
    
    
    (579
    )Accounts payable
    
    
    6,930
    
    
    
    7,819Accrued expenses and other current liabilities
    
    
    4,785
    
    
    
    4,151Net cash provided by operating activities
    
    
    11,171
    
    
    
    4,493Cash Flows From Investing Activities:Maturities of short-term investments
    
    
    30,764
    
    
    
    26,344Purchases of short-term investments
    
    
    (34,739
    )
    
    
    (7,789
    )Purchases of property and equipment
    
    
    (1,730
    )
    
    
    (4,543
    )Net cash (used in) provided by investing activities
    
    
    (5,705
    )
    
    
    14,012Cash Flows From Financing Activities:Proceeds from exercise of common stock options
    
    
    761
    
    
    
    757Principal payments on capital lease obligations
    
    
    (507
    )
    
    
    (449
    )Net cash provided by financing activities
    
    
    254
    
    
    
    308Net increase in cash and cash equivalents
    
    
    5,720
    
    
    
    18,813Cash and cash equivalents at beginning of period
    
    
    4,807
    
    
    
    2,653Cash and cash equivalents at end of period
    
    $
    10,527
    
    
    $
    21,466Supplemental Cash Flow Information:Cash paid for interest
    
    $
    88
    
    
    $
    109Supplemental Non cash Investing and Financing Activities:Property and equipment acquired through capital lease transactions
    
    $
    311
    
    
    $
    Common stock option exercise receivable
    
    $
    108
    
    
    $
    
  4




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RedEnvelope, Inc.
 
 NOTES TO CONDENSED FINANCIAL STATEMENTS
 (Unaudited)
 1. Financial Statements  Basis of Presentation
     2. Certain Significant Accounting Policies
  Stock Based Compensation  Accounting for Stock Issued to Employees Accounting for
Stock-Based Compensation
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Thirteen Weeks Ended
    
    
    Thirty-nine Weeks EndedJanuary 1,
    
    
    December 26,
    
    
    January 1,
    
    
    December 26,2006
    
    
    2004
    
    
    2006
    
    
    2004(In thousands, except for per share data)Net income (loss)  as reported
    
    $
    4,102
    
    
    $
    2,768
    
    
    $
    (1,139
    )
    
    $
    (2,071
    )Stock-based employee compensation
included in reported net income
(loss)
    
    
    2
    
    
    
    5
    
    
    
    8
    
    
    
    18Stock-based compensation expense
determined under fair value based
method
    
    
    (430
    )
    
    
    (75
    )
    
    
    (1,306
    )
    
    
    (749
    )Pro forma net income (loss)
    
    $
    3,674
    
    
    $
    2,698
    
    
    $
    (2,437
    )
    
    $
    (2,802
    )Basic and diluted earnings (loss)
per share:As reported  basic
    
    $
    0.45
    
    
    $
    0.32
    
    
    $
    (0.13
    )
    
    $
    (0.24
    )As reported  diluted
    
    $
    0.43
    
    
    $
    0.30
    
    
    $
    (0.13
    )
    
    $
    (0.24
    )Pro forma  basic
    
    $
    0.41
    
    
    $
    0.31
    
    
    $
    (0.27
    )
    
    $
    (0.32
    )Pro forma  diluted
    
    $
    0.39
    
    
    $
    0.29
    
    
    $
    (0.27
    )
    
    $
    (0.32
    )
 Loss Per Share 
 Comprehensive Income (Loss) 
 6




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Thirteen Weeks Ended
    
    
    Thirty-nine Weeks EndedJanuary 1,
    
    
    December 26,
    
    
    January 1,
    
    
    December 26,2006
    
    
    2004
    
    
    2006
    
    
    2004(In thousands, except for per share data)Net income (loss)  as reported
    
    $
    4,102
    
    
    $
    2,768
    
    
    $
    (1,139
    )
    
    $
    (2,071
    )Other
comprehensive (loss) income 
unrealized (loss) gain on
marketable securities
    
    
    
    
    
    
    (1
    )
    
    
    (5
    )
    
    
    7Comprehensive income (loss)
    
    $
    4,102
    
    
    $
    2,767
    
    
    $
    (1,144
    )
    
    $
    (2,064
    )
 New Accounting Pronouncements 
  3. Investments
    4. Borrowing Arrangements
  7




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5. Legal Proceedings
  
 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 offerings, business, financial
condition, results of operations and prospects. Additionally, statements concerning possible
changes in applicable rules or legislation are forward-looking statements. Words such as expects,
anticipates, intends, plans, believes, seeks, estimate, may, should, would,
could and similar expressions or variations of such words are intended to identify
forward-looking statements, but are not the exclusive means of identifying forward-looking
statements in this report. All forward-looking statements in this report are based upon information
available to us as of the date hereof, and we assume no obligation to revise or update any such
forward-looking statements in order to reflect any event or circumstance that may arise after the
date of this report. Actual results and the timing of certain events could differ materially from
our current expectations. Factors that could cause or contribute to such differences include, but
are not limited to, those set forth in this report under Factors That May Affect Future Results,
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.
 8




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Overview
 www.redenvelope.com
        Critical Accounting Policies
  Revenue recognition.
 9




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Shipping and Handling Costs.
 Inventory.
 Accounting for income taxes.
 Catalog Amortization.
 Valuation of long-lived assets.
 Stock based compensation.
 10




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Results of Operations
  Thirteen Weeks Ended
    
    
    Thirty-nine Weeks EndedJanuary 1,
    
    
    December 26,
    
    
    January 1,
    
    
    December 26,2006
    
    
    2004
    
    
    2006
    
    
    2004Statements of Operations Data:Net revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    47.7
    
    
    
    45.6
    
    
    
    48.3
    
    
    
    46.7Gross profit
    
    
    52.3
    
    
    
    54.4
    
    
    
    51.7
    
    
    
    53.3Operating expenses:Fulfillment
    
    
    13.1
    
    
    
    13.4
    
    
    
    13.8
    
    
    
    15.2Marketing
    
    
    22.8
    
    
    
    25.8
    
    
    
    23.8
    
    
    
    24.5General and administrative
    
    
    8.7
    
    
    
    9.3
    
    
    
    15.6
    
    
    
    16.2Total operating expenses
    
    
    44.6
    
    
    
    48.5
    
    
    
    53.2
    
    
    
    55.9Income (loss) from operations
    
    
    7.7
    
    
    
    5.8
    
    
    
    (1.5
    )
    
    
    (2.6
    )Interest income (expense), net
    
    
    
    
    
    
    
    
    
    
    0.2
    
    
    
    Net income (loss)
    
    
    7.7
    %
    
    
    5.8
    %
    
    
    (1.3
    )%
    
    
    (2.6
    )%
 11




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Results of Operations
 Quarter Ended January 1, 2006 Compared to Quarter Ended December 26, 2004
 Net Revenues
  Cost of Sales
  Operating Expenses
 Fulfillment.
 Marketing.
 General and Administrative.
 12




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Thirty-nine Weeks Ended January 1, 2006 Compared to Thirty-nine Weeks Ended December 26, 2004
 Net Revenues
  Cost of Sales
  Operating Expenses
 Fulfillment.
 Marketing.
 General and Administrative.
 13




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Liquidity and Capital Resources
  Cash Flows From Operating Activities
 Cash Flows From Investing Activities
 Cash Flows From Financing Activities
 Revolving Credit Facility
  Factors That May Affect Future Results
 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.
  14




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We have a history of significant losses. If we do not achieve or sustain profitability, our
financial condition and stock price could suffer.
  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.
  15




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




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Our operating results could suffer if we fail to offer or sell sufficient quantities of proprietary
products.
  Our facilities and systems are vulnerable to natural disasters or other catastrophic events.
  We have grown quickly and if we fail to manage our growth, our business will suffer.
  17




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We experience intense competition in the rapidly changing retail gift market.
  
    
    other online retailers, such as Amazon.com, Gifts.com, Shopping.com and eBay
    
    major department stores, such as Macys, Bloomingdales, Neiman Marcus and their online storefronts
    
    physical and online stores and catalog retailers that sell popular gift items such as Pottery Barn, Brookstone,
The Sharper Image, Tiffanys, Harry & David, J Crew, and 1-800-Flowers
    
    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.
  18




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We rely on seasonal and temporary employees during periods of peak activity and any failure by such
employees to adequately perform their jobs could adversely affect our operations.
  Increased merchandise returns and a failure to accurately predict merchandise returns could harm
our business.
  If we are unable to successfully manage the costs of our catalog operations or our catalogs fail to
produce sales at satisfactory levels it could adversely affect our business.
  
    
    effective management of costs associated with the production and distribution of our catalog
    
    achievement of adequate response rates to our mailings
    
    displaying a mix of merchandise in our catalog that is attractive to our customers
    
    production of aesthetically appealing catalogs
    
    timely delivery of catalog mailings to our customers
  We are dependent on the success of our advertising and marketing efforts which are costly and may
not achieve desired results.
  19




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If we are unable to provide satisfactory customer service, we could lose customers.
   The loss of our senior management or other key personnel could harm our current and future
operations and prospects.
  If the protection of our trademarks and proprietary rights is inadequate, our brand and reputation
could be impaired and we could lose customers.
  20




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Intellectual property claims against us could be costly and could impair our business.
  We face the risk of inventory shrinkage.
  Poor economic conditions may constrain discretionary consumer spending on retail products such as
ours.
  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.
  If we default on any secured loan, all or a portion of our assets could be subject to forfeiture.
  21




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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.
   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
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
    
    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.
   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.
  Existing or future government regulation could harm our business.
  23




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24




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Laws or regulations relating to privacy and data protection may adversely affect the growth of our
Internet business or our marketing efforts.
  We may be subject to liability for the content that we publish.
  Our directors, executive officers and significant stockholders hold a substantial portion of our
stock, which may lead to conflicts with other stockholders over corporate transactions and other
corporate matters.
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Interest Rate Risk
  25




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(In thousands)Cash and cash equivalents
    
    $
    10,527Short-term investments
    
    
    18,326Total
    
    $
    28,853
  Foreign Currency Risk
 
 Item 4. Controls and Procedures
 Disclosure Controls and Procedures
 26




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PART II.
OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 $
 
 Item 3. Defaults up on Senior Securities. None.
 
 Item 4. Submission of Matters to a Vote of Security Holders. None.
 
 Item 5. Other Information. None.
 II-1




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Item 6. Exhibits
 31.1
    
    Certification of Chief Executive Officer required by Exchange Act Rules 13a-14(a) (Section 302)31.2
    
    Certification of Chief Financial Officer required by Exchange Act Rules 13a-14(a) (Section 302)32.1
    
    Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification required by 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002
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SIGNATURES
  REDENVELOPE, INC.By:
    
    /s/ Polly BoePolly BoeChief Financial OfficerDate: February 15, 2006
 II-3




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