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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(MARK ONE)

|  |  |                                                                                        
|- |  | ---------------------------------------------------------------------------------------
|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 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
(State or Other Jurisdiction of
Incorporation or Organization) |  | 33-0844285
(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
o      No x

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).

Yes o      No x

The number of outstanding shares of the registrants common stock, $0.01
par value per share, was 2,565,542 as of September 28, 2003.



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TABLE OF CONTENTS



|                              |                                                                                               |                                         |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | Condensed Balance Sheets               
|                              |                                                                                               | Condensed Statements of Operations     
|                              |                                                                                               | Statements of Cash Flows               
|                              |                                                                                               | 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 4. Submissions of Matters to a Vote of Security Holders                                 
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                   
|Exhibit Index                
|EXHIBIT 3.1                  
|EXHIBIT 3.2                  
|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 SEPTEMBER 28, 2003

TABLE OF CONTENTS

|                              |  |                                                                                       |  |  |                                                                                                                                |  |  |      |  | 
|----------------------------- |  | ------------------------------------------------------------------------------------- |  |  | ------------------------------------------------------------------------------------------------------------------------------ |  |  | ---- |  | 
|                              |  |                                                                                       |  |  |                                                                                                                                |  |  | Page
|                              |  |                                                                                       |  |  |                                                                                                                                |  |  |     
|PART I. FINANCIAL INFORMATION |  |                                                                                       |  | 
|Item 1.                       |  | Financial Statements (Unaudited)                                                      |  |  |                                                                                                                                | 
|                              |  |                                                                                       |  |  | Condensed Balance Sheets as of September 28, 2003, March 30, 2003
and September 29, 2002                                       |  |  | 3    | 
|                              |  |                                                                                       |  |  | Condensed Statements of Operations for the thirteen weeks and
twenty-six weeks ended September 28, 2003 and September 29, 2002 |  |  | 4    | 
|                              |  |                                                                                       |  |  | Condensed Statements of Cash Flows for the twenty-six weeks ended
September 28, 2003 and September 29, 2002                    |  |  | 5    | 
|                              |  |                                                                                       |  |  | Notes to Condensed Financial Statements                                                                                        |  |  | 6    | 
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of
Operations |  |  | 10                                                                                                                             | 
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |  | 27                                                                                                                             | 
|Item 4.                       |  | Controls and Procedures                                                               |  |  | 28                                                                                                                             | 
|PART II. OTHER INFORMATION    |  |                                                                                       |  | 
|Item 1.                       |  | Legal Proceedings                                                                     |  |  | 29                                                                                                                             | 
|Item 2.                       |  | Changes in Securities and Use of Proceeds                                             |  |  | 29                                                                                                                             | 
|Item 4.                       |  | Submissions of Matters to a Vote of Security Holders                                  |  |  | 31                                                                                                                             | 
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                      |  |  | 31                                                                                                                             | 

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##### Table of Contents






PART I. FINANCIAL INFORMATION




Item 1.Financial Statements




RedEnvelope, Inc.
Condensed Balance Sheets
(Unaudited)

|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |   |         |   | 
|----------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------- | ------- | - | ------------------------------------- | ------ | --------- | - | ------------- | ------ | ------- | - | ------- | - | 
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   | September 28,                         |        | March 30, |   | September 29,
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   | 2003                                  |        | 2003      |   | 2002         
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |              
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   | (in thousands, except per share data)
|Assets                                                                                    |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |       
|Current assets:                                                                           |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |        
|                                                                                          | Cash and cash equivalents                                                                                                                                                                           |  | $                                                                                               | 2,959   |   |                                       | $      | 4,997     |   |               | $      | 9,706   |  
|                                                                                          | Accounts receivable, net                                                                                                                                                                            |  |                                                                                                 | 309     |   |                                       |        | 286       |   |               |        | 120     |  
|                                                                                          | Receivable from underwriter, net IPO proceeds                                                                                                                                                       |  |                                                                                                 | 28,952  |   |                                       |        |          |   |               |        |        |  
|                                                                                          | Inventory                                                                                                                                                                                           |  |                                                                                                 | 10,749  |   |                                       |        | 9,716     |   |               |        | 9,478   |  
|                                                                                          | Prepaid advertising and other current assets                                                                                                                                                        |  |                                                                                                 | 1,582   |   |                                       |        | 2,099     |   |               |        | 1,550   |  
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  
|                                                                                          |                                                                                                                                                                                                     |  | Total current assets                                                                            |         |   | 44,551                                |        |           |   | 17,098        |        |         |   | 20,854  |  
|Property and equipment, net                                                               |                                                                                                                                                                                                     |  | 4,005                                                                                           |         |   |                                       | 4,462  |           |   |               | 5,308  |        
|Other assets and restricted cash                                                          |                                                                                                                                                                                                     |  | 653                                                                                             |         |   |                                       | 566    |           |   |               | 400    |        
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  
|                                                                                          |                                                                                                                                                                                                     |  | Total assets                                                                                    |         | $ | 49,209                                |        |           | $ | 22,126        |        |         | $ | 26,562  |  
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  
|Liabilities, Mandatorily Redeemable Convertible Preferred Stock and Stockholders Deficit |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |        
|Current liabilities:                                                                      |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |        
|                                                                                          | Accounts payable                                                                                                                                                                                    |  | $                                                                                               | 7,467   |   |                                       | $      | 5,957     |   |               | $      | 4,272   |  
|                                                                                          | Accrued expenses and other current liabilities                                                                                                                                                      |  |                                                                                                 | 2,809   |   |                                       |        | 1,443     |   |               |        | 1,154   |  
|                                                                                          | Accrued compensation                                                                                                                                                                                |  |                                                                                                 | 850     |   |                                       |        | 723       |   |               |        | 711     |  
|                                                                                          | Short-term loan                                                                                                                                                                                     |  |                                                                                                 | 1,242   |   |                                       |        | 1,123     |   |               |        | 5,919   |  
|                                                                                          | Capital lease obligations, current                                                                                                                                                                  |  |                                                                                                 | 762     |   |                                       |        | 673       |   |               |        | 433     |  
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  
|                                                                                          |                                                                                                                                                                                                     |  | Total current liabilities                                                                       |         |   | 13,130                                |        |           |   | 9,919         |        |         |   | 12,489  |  
|Capital lease obligations, long-term                                                      |                                                                                                                                                                                                     |  | 1,147                                                                                           |         |   |                                       | 1,102  |           |   |               | 1,628  |        
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  
|                                                                                          |                                                                                                                                                                                                     |  | Total liabilities                                                                               |         |   | 14,277                                |        |           |   | 11,021        |        |         |   | 14,117  |  
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  
|Commitments and contingencies                                                             |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |        
|Mandatorily redeemable convertible preferred stock                                        |                                                                                                                                                                                                     |  | 82,556                                                                                          |         |   |                                       | 82,556 |           |   |               | 82,372 |        
|Stockholders deficit:                                                                    |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |        
|Series A preferred stock, $0.01 par value; 657,114 shares authorized, 626,610
outstanding |                                                                                                                                                                                                     |  | 953                                                                                             |         |   |                                       | 953    |           |   |               | 953    |        
|                                                                                          | Common stock, $0.01 par value; 100 million shares
authorized; 2,565,542, 336,939, and 334,368 issued and
outstanding as of September 28, 2003, March 30, 2003,
and September 29, 2002, respectively |  |                                                                                                 | 26      |   |                                       |        | 4         |   |               |        | 4       |  
|                                                                                          | Additional paid-in capital                                                                                                                                                                          |  |                                                                                                 | 29,731  |   |                                       |        | 1,322     |   |               |        | 1,305   |  
|                                                                                          | Deferred compensation                                                                                                                                                                               |  |                                                                                                 | (723    | ) |                                       |        | (162      | ) |               |        | (362    | )
|                                                                                          | Notes receivable from stockholders                                                                                                                                                                  |  |                                                                                                 | (44     | ) |                                       |        | (44       | ) |               |        | (44     | )
|                                                                                          | Accumulated deficit                                                                                                                                                                                 |  |                                                                                                 | (77,567 | ) |                                       |        | (73,524   | ) |               |        | (71,782 | )
|                                                                                          | Accumulated other comprehensive income                                                                                                                                                              |  |                                                                                                 |        |   |                                       |        |          |   |               |        | (1      | )
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  
|                                                                                          |                                                                                                                                                                                                     |  | Total stockholders deficit                                                                     |         |   | (47,624                               | )      |           |   | (71,451       | )      |         |   | (69,927 | )
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  
|                                                                                          |                                                                                                                                                                                                     |  | Total liabilities,
mandatorily redeemable
convertible preferred
stock and stockholders
deficit |         | $ | 49,209                                |        |           | $ | 22,126        |        |         | $ | 26,562  |  
|                                                                                          |                                                                                                                                                                                                     |  |                                                                                                 |         |   |                                       |        |           |   |               |        |         |  

See accompanying notes to these condensed financial statements.

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RedEnvelope, Inc.
Condensed Statements of Operations
(Unaudited)

|                                                        |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |       |        | 
|------------------------------------------------------- | -------------------------- | ------------------------ | ------ | ----------------------------------------- | ----- | ---------------------- | ------ | ------------- | ----- | ------------- | ------ | ------ | ------ | - | ------ | ----- | ------ | 
|                                                        |                            |                          |        | Thirteen Weeks Ended                      |       | Twenty-six Weeks Ended
|                                                        |                            |                          |        |                                           |       |                       
|                                                        |                            |                          |        | September 28,                             |       | September 29,          |        | September 28, |       | September 29,
|                                                        |                            |                          |        | 2003                                      |       | 2002                   |        | 2003          |       | 2002         
|                                                        |                            |                          |        |                                           |       |                        |        |               |       |              
|                                                        |                            |                          |        | (in thousands, except for per share data)
|Net revenues                                            |                            | $                        | 8,329  |                                           |       | $                      | 5,366  |               |       | $             | 26,050 |        |        | $ | 20,653 |      
|Cost of sales                                           |                            |                          | 4,297  |                                           |       |                        | 3,005  |               |       |               | 13,347 |        |        |   | 11,192 |      
|                                                        |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |      
|                                                        | Gross profit               |                          |        | 4,032                                     |       |                        |        | 2,361         |       |               |        | 12,703 |        |   |        | 9,461 |       
|                                                        |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |      
|Operating expenses:                                     |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |      
|                                                        | Fulfillment                |                          |        | 1,538                                     |       |                        |        | 1,386         |       |               |        | 4,251  |        |   |        | 3,787 |       
|                                                        | Marketing                  |                          |        | 1,679                                     |       |                        |        | 983           |       |               |        | 5,426  |        |   |        | 4,513 |       
|                                                        | General and administrative |                          |        | 3,545                                     |       |                        |        | 3,535         |       |               |        | 6,814  |        |   |        | 6,881 |       
|                                                        |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |      
|                                                        |                            | Total operating expenses |        |                                           | 6,762 |                        |        |               | 5,904 |               |        |        | 16,491 |   |        |       | 15,181 | 
|                                                        |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |      
|Loss from operations                                    |                            |                          | (2,730 | )                                         |       |                        | (3,543 | )             |       |               | (3,788 | )      |        |   | (5,720 | )    
|Interest income                                         |                            |                          | 5      |                                           |       |                        | 58     |               |       |               | 15     |        |        |   | 117    |      
|Interest expense                                        |                            |                          | (101   | )                                         |       |                        | (191   | )             |       |               | (270   | )      |        |   | (367   | )    
|                                                        |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |      
|Net loss                                                |                            | $                        | (2,826 | )                                         |       | $                      | (3,676 | )             |       | $             | (4,043 | )      |        | $ | (5,970 | )    
|                                                        |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |      
|Net loss per share  basic and diluted                  |                            | $                        | (6.56  | )                                         |       | $                      | (11.60 | )             |       | $             | (10.39 | )      |        | $ | (19.70 | )    
|                                                        |                            |                          |        |                                           |       |                        |        |               |       |               |        |        |        |   |        |      
|Weighted average shares outstanding  basic and diluted |                            |                          | 431    |                                           |       |                        | 317    |               |       |               | 389    |        |        |   | 303    |      

See accompanying notes to these condensed financial statements.

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RedEnvelope, Inc.
Statements of Cash Flows
(Unaudited)

|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |               |        |        |        |  
|--------------------------------------------------------------------------- |  | ------------------------------------------------------------------ | ---------------------------------------------- | --------------------------------------------------- | ------ | ---------------------- | ------ | ------------- | ------ | ------ | ------ | -
|                                                                            |  |                                                                    |                                                |                                                     |        | Twenty-six Weeks Ended
|                                                                            |  |                                                                    |                                                |                                                     |        |                       
|                                                                            |  |                                                                    |                                                |                                                     |        | September 28,          |        | September 29,
|                                                                            |  |                                                                    |                                                |                                                     |        | 2003                   |        | 2002         
|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |              
|                                                                            |  |                                                                    |                                                |                                                     |        | (in thousands)        
|Cash Flows From Operating Activities:                                       |  |                                                                    |                                                |                                                     |        |                        |        |              
|                                                                            |  | Net loss                                                           |                                                | $                                                   | (4,043 | )                      |        | $             | (5,970 | )     
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                                                    |                                                |                                                     |        |                        |        |              
|                                                                            |  | Depreciation and amortization                                      |                                                |                                                     | 1,309  |                        |        |               | 1,164  |       
|                                                                            |  | Amortization of deferred stock compensation                        |                                                |                                                     | 124    |                        |        |               | 161    |       
|                                                                            |  | Other non-cash charges                                             |                                                |                                                     |       |                        |        |               | 293    |       
|                                                                            |  | Issuance of stock for services rendered                            |                                                |                                                     | 9      |                        |        |               |       |       
|                                                                            |  | Changes in current assets and liabilities:                         |                                                |                                                     |        |                        |        |               |        |       
|                                                                            |  |                                                                    | Accounts receivable                            |                                                     |        | (23                    | )      |               |        | 381    |       
|                                                                            |  |                                                                    | Inventory                                      |                                                     |        | (1,033                 | )      |               |        | (2,478 | )     
|                                                                            |  |                                                                    | Other assets                                   |                                                     |        | 234                    |        |               |        | 368    |       
|                                                                            |  |                                                                    | Accounts payable                               |                                                     |        | 1,510                  |        |               |        | (1,231 | )     
|                                                                            |  |                                                                    | Accrued expenses and other current liabilities |                                                     |        | 1,492                  |        |               |        | (575   | )     
|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |               |        |       
|                                                                            |  |                                                                    |                                                | Net cash used in operating activities               |        |                        | (421   | )             |        |        | (7,887 | )
|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |               |        |       
|Cash Flows From Investing Activities Purchase of property and equipment    |  |                                                                    | (428                                           | )                                                   |        |                        | (995   | )            
|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |               |        |       
|Cash Flows From Financing Activities:                                       |  |                                                                    |                                                |                                                     |        |                        |        |              
|                                                                            |  | Proceeds from exercise of common stock options and warrants        |                                                |                                                     | 128    |                        |        |               | 77     |       
|                                                                            |  | Repurchase of common stock                                         |                                                |                                                     |       |                        |        |               | (2     | )     
|                                                                            |  | Net proceeds from issuance of Series F convertible preferred stock |                                                |                                                     |       |                        |        |               | 13,743 |       
|                                                                            |  | Principal payments on capital lease obligations                    |                                                |                                                     | (289   | )                      |        |               | (140   | )     
|                                                                            |  | Proceeds from inventory line of credit, net                        |                                                |                                                     | 1,242  |                        |        |               |       |       
|                                                                            |  | Repayment of loan                                                  |                                                |                                                     | (1,123 | )                      |        |               |       |       
|                                                                            |  | Payment of loan costs and other                                    |                                                |                                                     | (305   | )                      |        |               |       |       
|                                                                            |  | Payment of IPO costs                                               |                                                |                                                     | (842   | )                      |        |               |       |       
|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |               |        |       
|                                                                            |  |                                                                    |                                                | Net cash provided by (used in) financing activities |        |                        | (1,189 | )             |        |        | 13,678 |  
|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |               |        |       
|Net increase (decrease) in cash and cash equivalents                        |  |                                                                    | (2,038                                         | )                                                   |        |                        | 4,796  |              
|Cash and cash equivalents at beginning of period                            |  |                                                                    | 4,997                                          |                                                     |        |                        | 4,910  |              
|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |               |        |       
|Cash and cash equivalents at end of period                                  |  | $                                                                  | 2,959                                          |                                                     |        | $                      | 9,706  |              
|                                                                            |  |                                                                    |                                                |                                                     |        |                        |        |               |        |       
|Supplemental Noncash Investing and Financing Activities:                    |  |                                                                    |                                                |                                                     |        |                        |        |              
|                                                                            |  | Receivable from underwriter, net IPO proceeds                      |                                                | $                                                   | 28,952 |                        |        | $             |       |       

See accompanying notes to these condensed financial statements.

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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 September 28, 2003 and September 29, 2002, the
condensed statements of earnings for the thirteen and twenty-six week periods
ended September 28, 2003 and September 29, 2002, and the condensed statements
of cash flows for the twenty-six week periods ended September 28, 2003 and
September 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
twenty-six 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 twenty-six weeks ended
September 28, 2003 are not necessarily indicative of the operating results of
the full 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. Comprehensive
loss approximates net loss for all periods presented.

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 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 twenty-six weeks ended September 28, 2003 and September 29,
2002 consistent with the provisions of SFAS No. 123 the Companys pro forma net
loss would have been as follows:

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|                                                                         |                    |   |                                       |        |                        |   |               |        |               |   |        |        |   |   |        |        |  
|------------------------------------------------------------------------ | ------------------ | - | ------------------------------------- | ------ | ---------------------- | - | ------------- | ------ | ------------- | - | ------ | ------ | - | - | ------ | ------ | -
|                                                                         |                    |   | Thirteen Weeks Ended                  |        | Twenty-six Weeks Ended
|                                                                         |                    |   |                                       |        |                       
|                                                                         |                    |   | September 28,                         |        | September 29,          |   | September 28, |        | September 29,
|                                                                         |                    |   | 2003                                  |        | 2002                   |   | 2003          |        | 2002         
|                                                                         |                    |   |                                       |        |                        |   |               |        |              
|                                                                         |                    |   | (in thousands, except per share data)
|Net loss  as reported                                                   |                    | $ | (2,826                                | )      |                        | $ | (3,676        | )      |               | $ | (4,043 | )      |   | $ | (5,970 | )     
|Stock-based employee compensation
included in reported net loss          |                    |   | 96                                    |        |                        |   | 53            |        |               |   | 135    |        |   |   | 160    |       
|Stock-based compensation expense
determined under fair value base
method |                    |   | (195                                  | )      |                        |   | (79           | )      |               |   | (308   | )      |   |   | (239   | )     
|                                                                         |                    |   |                                       |        |                        |   |               |        |               |   |        |        |   |   |        |       
|                                                                         | Pro forma net loss |   | $                                     | (2,925 | )                      |   | $             | (3,702 | )             |   | $      | (4,216 | ) |   | $      | (6,049 | )
|                                                                         |                    |   |                                       |        |                        |   |               |        |               |   |        |        |   |   |        |       
|Basic and diluted earnings per share                                     |                    |   |                                       |        |                        |   |               |        |               |   |        |        |   |   |        |       
|                                                                         | As reported        |   | $                                     | (6.56  | )                      |   | $             | (11.60 | )             |   | $      | (10.39 | ) |   | $      | (19.70 | )
|                                                                         | Pro forma          |   | $                                     | (6.79  | )                      |   | $             | (11.68 | )             |   | $      | (10.84 | ) |   | $      | (19.96 | )

Earnings Per Share For all periods presented, basic net loss per share
equals diluted net loss per share because the effect of stock options, unvested
shares and warrants outstanding would have been antidilutive. The number of
antidilutive stock options, unvested shares, and warrants excluded from the
calculation for the first twenty-six weeks ended September 28, 2003 and
September 29, 2002, were approximately 1.0 million and 0.9 million,
respectively.

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. SFAS No.
150 is effective for financial instruments entered into or modified after May
31, 2003 and is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of this statement did not have an
impact on the Companys financial statements.

3. INITIAL PUBLIC OFFERING

On
September 24, 2003, our registration statement on Form S-1 was declared
effective for RedEnvelopes initial public offering, pursuant to which
RedEnvelope sold 2.2 million shares of common stock at $14 per
share. Our common stock commenced trading on September 25, 2003.
Our initial public offering closed on September 30, 2003, and,
as a result, the net offering
proceeds of approximately $29.0 million were received subsequent to quarter-end
(after underwriters discounts of $1.8 million). The Company
incurred additional related offering expenses of $1.4 million
through September 28, 2003.

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 5.9 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:

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|                                                       |                                      |  |           |       | 
|------------------------------------------------------ | ------------------------------------ |  | --------- | ----- | 
|                                                       |                                      |  | 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, to refinance the Companys existing indebtedness and provide
working capital. 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, 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 September 28, 2003, the outstanding
balance under this line of credit was approximately $1.2 million.

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

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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.

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 September 28, 2003, the Company was not in compliance with the
inventory ratio covenant. On October 17, 2003, we received a
written 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 month of
October 2003, but received a written waiver of such non-compliance
from CapitalSource Finance LLC on November 11, 2003.

6. 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. We
anticipate this trend will continue in the foreseeable future. We have achieved
our historical growth from internal operations rather than through
acquisitions. We have funded our operations through September 28, 2003
primarily through private sales of equity securities and borrowings.

On September 24, 2003, the registration statement was declared effective
for our initial public offering, pursuant to which we sold
2.2 million shares of common stock at $14 per share. The Companys common
stock commenced trading on September 25, 2003. The offering
closed on September 30, 2003, just following the end of the
second fiscal quarter, and, as a result, the net offering proceeds of
approximately $29.0 million were received subsequent to
quarter-end.

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. 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.

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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.

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. We terminated our relationship with our third-party fulfillment
service provider and assumed control of our fulfillment services in August
2003.

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

General and administrative expenses consist of wages and benefits for all
of our employees, except for fulfillment and customer service employees. These
expenses also include costs incurred for computer and communications
technology, rent and utilities for our headquarters, travel, depreciation, and
other general corporate expenditures. As of September 28, 2003,
we had a total
of approximately $0.7 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.

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.

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 $0.1 million
as of September 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
September 28, 2003 and September 29, 2002 were $0.4 million and $0.3 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 September 28, 2003 and September 29, 2002, we wrote down
inventory of approximately $0.6 million and $0.3 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.

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Results Of Operations

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

|                              |                            |                          |       |                |      |                  |       |               |       |               |       |      |      |  |       |      |      | 
|----------------------------- | -------------------------- | ------------------------ | ----- | -------------- | ---- | ---------------- | ----- | ------------- | ----- | ------------- | ----- | ---- | ---- |  | ----- | ---- | ---- | 
|                              |                            |                          |       | Thirteen weeks |      | Twenty-six weeks
|                              |                            |                          |       |                |      |                 
|                              |                            |                          |       | September 28,  |      | September 29,    |       | September 28, |       | September 29,
|                              |                            |                          |       | 2003           |      | 2002             |       | 2003          |       | 2002         
|                              |                            |                          |       |                |      |                  |       |               |       |              
|Statements of Operation Data: |                            |                          |       |                |      |                  |       |               |       |               |       |      |      |  |       |     
|Net revenues                  |                            |                          | 100.0 | %              |      |                  | 100.0 | %             |       |               | 100.0 | %    |      |  | 100.0 | %   
|Cost of sales                 |                            |                          | 51.6  |                |      |                  | 56.0  |               |       |               | 51.2  |      |      |  | 54.2  |     
|                              |                            |                          |       |                |      |                  |       |               |       |               |       |      |      |  |       |     
|Gross profit                  |                            |                          | 48.4  |                |      |                  | 44.0  |               |       |               | 48.8  |      |      |  | 45.8  |     
|Operating expenses:           |                            |                          |       |                |      |                  |       |               |       |               |       |      |      |  |       |     
|                              | Fulfillment                |                          |       | 18.5           |      |                  |       | 25.8          |       |               |       | 16.3 |      |  |       | 18.3 |     
|                              | Marketing                  |                          |       | 20.2           |      |                  |       | 18.3          |       |               |       | 20.8 |      |  |       | 21.9 |     
|                              | General and administrative |                          |       | 42.6           |      |                  |       | 65.9          |       |               |       | 26.2 |      |  |       | 33.3 |     
|                              |                            |                          |       |                |      |                  |       |               |       |               |       |      |      |  |       |     
|                              |                            | Total operating expenses |       |                | 81.3 |                  |       |               | 110.0 |               |       |      | 63.3 |  |       |      | 73.5 | 
|Loss from operations          |                            |                          | (32.9 | )              |      |                  | (66.0 | )             |       |               | (14.5 | )    |      |  | (27.7 | )   
|Interest income               |                            |                          | 0.1   |                |      |                  | 1.1   |               |       |               | 0.1   |      |      |  | 0.6   |     
|Interest expense              |                            |                          | (1.2  | )              |      |                  | (3.6  | )             |       |               | (1.0  | )    |      |  | (1.8  | )   
|                              |                            |                          |       |                |      |                  |       |               |       |               |       |      |      |  |       |     
|Net loss                      |                            |                          | (34.0 | )%             |      |                  | (68.5 | )%            |       |               | (15.4 | )%   |      |  | (28.9 | )%  
|                              |                            |                          |       |                |      |                  |       |               |       |               |       |      |      |  |       |     

Revenues

Net revenues were $8.3 million and $5.4 million for the thirteen weeks
ended September 28, 2003 and September 29, 2002, respectively, representing a
55.2% increase. The increase was primarily due to increased demand for our
products resulting from additional marketing efforts through our catalog
campaigns. We introduced and circulated approximately 1.0 million new catalogs
that featured non-seasonal gifts for all occasions. The number of orders
increased by approximately 57.3% over the second quarter of fiscal 2002. Net
revenues per order were consistent with the thirteen weeks ended September 29,
2002. As of September 28, 2003, we had approximately 1.5 million customers
which was an increase of 0.5 million customers over the second quarter of
fiscal 2003.

Net revenues were $26.1 million and $20.7 million for the twenty-six weeks
ended September 28, 2003 and September 29, 2002, respectively, representing a
26.1% 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 twenty-six weeks of fiscal year 2004, we
increased our online marketing programs compared to the same period in the
prior year. In addition, our catalog circulation increased by approximately 0.7
million catalogs, or 13.9%. The increase in circulation reflects mailings to a
larger customer base as well as the introduction of two new catalogs. 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. The number of
orders increased approximately 26.1% and the net revenues per order were
consistent with the twenty-six weeks ended September 29, 2002.

Cost of Sales

Cost of sales were $4.3 million and $3.0 million for the thirteen weeks
ended September 28, 2003 and September 29, 2002, respectively, representing
51.6% and 56.0% of net revenues, respectively. For the thirteen weeks ended
September 28, 2003 and September 29, 2002, the increase in dollars was mainly
attributable to the 55.2% increase in net revenues. As a percentage of net
revenues, the decrease in cost of sales was due to slightly

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higher product
margins, shipping credits provided to the Company from our third-party
fulfillment provider due to resolution of disputed charges, and lower outbound
shipping costs.

Cost of sales were $13.3 million and $11.2 million for the twenty-six
weeks ended September 28, 2003 and September 29, 2002, respectively,
representing 51.2% and 54.2% of net revenues, respectively. The increase in
cost of sales was mainly attributable to the 26.1% increase in net revenues. As
a percentage of net revenues, the decrease in cost of sales was a result of the
increase in jewelry sales during the first quarter of fiscal 2004, which have
higher margins, slightly higher product margins from other sales, shipping
credits from our third-party fulfillment provider, and lower outbound shipping
costs in the second quarter of fiscal 2004.

Operating Expenses

Fulfillment.Fulfillment expenses were $1.5 million and $1.4 million for
the thirteen weeks ended September 28, 2003 and September 29, 2002,
respectively, representing 18.5% and 25.8% of net revenues, respectively. The
increase in dollars was primarily attributable to the 57.3% increase in the
number of orders. Fulfillment expenses were $4.3 million and $3.8 million for
the twenty-six weeks ended September 28, 2003 and September 29, 2002,
respectively, representing 16.3% and 18.3% of net revenues, respectively. The
increase in dollars was primarily attributable to the 26.1% increase in the
number of orders. The decrease as a percentage of net revenues was primarily
attributable to economies of scale achieved through an increased number of
sales transactions.

Marketing.Marketing expenses were $1.7 million and $1.0 million for the
thirteen weeks ended September 28, 2003 and September 29, 2002, respectively,
representing 20.2% and 18.3% of net revenues, respectively. The
increase in dollars was primarily due to the introduction and circulation
of approximately 1.0 million new catalogs that featured non-seasonal gifts for
all occasions. Marketing expenses were $5.4 million and $4.5 million for the
twenty-six weeks ended September 28, 2003 and September 29, 2002, respectively,
representing 20.8% and 21.9% of net revenues, respectively. The increase in
dollars was primarily due to the introduction of the new catalog which featured
non-seasonal gifts for all occasions, as mentioned above, as well as an
increase in spending related to online marketing programs by approximately $0.5
million.

General
and Administrative.General and administrative expenses were
$3.5 million for each of the thirteen weeks ended
September 28, 2003 and September 29, 2002, representing 42.6% and 65.9% of net revenues, respectively.
General and administrative expenses were $6.8 million and $6.9 million for the
twenty-six weeks ended September 28, 2003 and September 29, 2002, respectively,
representing 26.2% and 33.3% of net revenues, respectively. As a percentage of
net revenues, the decrease was primarily due to similar costs allocated over a
larger revenue base.

Other Income and Expenses

Interest Income.Interest income was $0.005 million and $0.06 million in
the thirteen weeks ended September 28, 2003 and September 29, 2002,
respectively. Interest income was $0.02 million and $0.1 million for the
twenty-six weeks ended September 28, 2003 and September 29, 2002, respectively.
The decreases for both the thirteen and twenty-six week periods were primarily
due to lower cash balances.

Interest Expense.Interest expense was $0.1 million and $0.2 million in
the thirteen weeks ended September 28, 2003 and September 29, 2002,
respectively. Interest expense was $0.3 million and $0.4 million for the
twenty-six weeks ended September 28, 2003 and September 29, 2002, respectively.
The decreases for both the thirteen and twenty-six week periods were
attributable to lower amounts of debt outstanding.

Liquidity and Capital Resources

We have funded our operations through September 28, 2003 primarily through
private sales of equity securities and borrowings.

Net cash
flow used in operating activities was $0.4 million and $7.9 million for the twenty-six weeks ended September 28, 2003 and September 29,
2002, respectively. Uses of cash were primarily to fund net losses and changes
in working capital.

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Net cash flow used in investing activities was $0.4 million and $1.0
million for the twenty-six weeks ended September 28, 2003 and September 29,
2002, respectively. Uses of cash flow for investing activities is for capital
expenditures for property and equipment.

Net cash
flow used in financing activities was $1.2 million for the
twenty-six weeks ended September 28, 2003 compared to net cash
flow provided by financing activities of $13.7 million for the
twenty-six weeks ended September 29, 2002. For the twenty-six weeks ended September 28, 2003, net cash
used in financing activities consisted of the net payments on an existing line
of credit as well as a $1.1 million repayment of a loan. For the twenty-six
weeks ended September 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.

On September 24, 2003, the registration statement was declared effective
for our initial public offering, pursuant to which we sold
2.2 million shares of common stock at $14 per share. Our common stock
commenced trading on September 25, 2003. The initial public offering closed on
September 30, 2003, just following the end of the second fiscal quarter. The
net offering proceeds of approximately $29.0 million were received subsequent to
quarter-end.

We also
have available up to $11 million pursuant to our revolving
credit facility with CapitalSource Finance LLC, which is described more fully in
Note 5 to the financial statements contained in this report. Our
ability to borrow under this credit facility is subject to compliance with its
terms. As of September 28,
2003, we were not in compliance with the inventory ratio covenant
contained in the credit agreement and such non-compliance constituted an event of
default under the credit agreement. On October 17, 2003, we
received a written 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 month of
October 2003, but received a written waiver of such non-compliance
from CapitalSource Finance LLC on November 11, 2003. Seasonal
fluctuations in our business, including higher inventory build-up
requirements for the holiday season, could make it difficult for us
to meet the inventory ratio covenant or other financial covenants
under the credit facility in the coming months. If we are unable to
meet these financial covenants, we would need to obtain a waiver from
CapitalSource Finance LLC to avoid being in breach of the terms of
the credit facility, which breach could prevent us from obtaining
additional funds, or require us to repay existing amounts borrowed,
under the credit facility. As of the date of this report, we are able
to draw down funds under this credit facility.

Management believes that the cash currently on hand, the line of credit
obtained on June 13, 2003, and the net proceeds from our initial public
offering will be sufficient to continue operations through at least the next
twelve months. However, we cannot be certain that our planned levels
of revenue, costs and expenses will be achieved. If our operating
results do not meet our expectations, or if we become unable to
borrow additional funds, or are required to repay existing
borrowings, under our current credit facility, we could be required
to seek additional funding through public or private financings or
other arrangements. In such event, we may be unable to obtain
adequate additional funds on commercially acceptable terms, or at
all, which could have an adverse affect on our business, financial
condition and results of operations.

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 address these risks and difficulties
successfully 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. We incurred net losses of $4.0 million and $6.0 million for
the twenty-six weeks ended September 28, 2003 and September 29, 2002,
respectively. As of September 28, 2003, our accumulated deficit was $77.6
million. We have not achieved profitability. 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

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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 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                                      

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| |  | 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                                                                                                

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 Lockbourne, Ohio,
the facilities for which are leased from a third-party. 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. 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

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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 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 recently. 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

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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 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

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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 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.

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.

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,

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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 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 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.

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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 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.

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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 have 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 and 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.

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 and expect to
experience negative cash flow from operations 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

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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.

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
|- |  | ----------------------------------------------

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| |  | 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.

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.

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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, user privacy, fraud, quality of products and services, taxation,
advertising, intellectual property rights and information security.
Applicability of existing laws to the Internet relating to issues such as
property ownership, 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,
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 may be subject to significant fines or other payments for any past failures
to comply with these requirements.

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.

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 laws and regulations could harm our business,
operating results and financial condition. Our ability to enforce contracts and
other

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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.

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. 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.

Our current stockholders hold a substantial number of shares, which they
will be able to sell in the public market in the near future. A significant
portion of the shares of our common stock will continue to be restricted in the
near term as a result of securities laws and lock-up agreements. 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 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 do not use derivative financial instruments in our investment portfolio
and have no foreign exchange contracts. Our financial instruments consist of
cash and cash equivalents, trade accounts receivable, accounts payable and
long-term obligations. We consider investments in highly-liquid instruments
purchased with a remaining maturity of 90 days or less at the date of purchase
to be cash equivalents. Our exposure to market risk for

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changes in interest
rates relates primarily to our short-term investments and short-term
obligations; thus, fluctuations in interest rates would not have a material
impact on the fair value of these securities.

At September 28, 2003, we had approximately $3.0 million in cash and cash
equivalents. At that same date, we had an outstanding balance under our line of
credit of approximately $1.2 million. A hypothetical 10% increase or
decrease in interest rates would not have a material impact on our earnings or
loss, or the fair market value or cash flows of these instruments.




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.




Item 2. Changes in Securities and Use of Proceeds



| | (a) |  | Not applicable.                                                                                                                                             
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (b) |  | Not applicable.                                                                                                                                             
|
| | (c) |  | During the quarterly period ended September 28, 2003, we issued and
sold the following securities that were not registered under the
Securities Act of 1933:

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| |     |  | From June 30, 2003 through September 28, 2003, we granted options to
purchase an aggregate of 17,019 shares of common stock with a weighted
average exercise price of $8.97 per share to a number of our employees and
directors for an aggregate exercise price of $152,719.58. 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.                                                                                                                                                                                                                                                                                                                                                                                                                      
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | From June 30, 2003 through
September 28, 2003, we issued 17,123
shares of common stock upon exercise of stock options granted under our
1999 Stock Plan at a weighted average exercise price of $3.62 per share
for an aggregate exercise price of $62,034.66. 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 each transaction 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
and appropriate legends were affixed to the share certificates issued in
such transactions. 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 offering.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| | (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 offering did not terminate until after the sale of all of the
securities registered on the registration statement provided, however,
that the underwriters over-allotment option to purchase 330,000 shares
expired prior to its exercise. The aggregate gross proceeds from the
shares of common stock sold by us were $30.8 million. The aggregate net
proceeds to us from the offering were $29.0 million after deducting an
aggregate of $1.8 million in underwriting discounts and commissions paid
to the underwriters. Additionally, the Company incurred $1.4 million in other expenses
as of September 28, 2003 in connection with the offering. As the offering closed on
September 30, 2003, the net offering proceeds were
received subsequent to the ending of this reporting period. The
Company intends to use the net proceeds from the offering to fund working
capital, including the build up of inventory prior to the holiday season,
to fund new capital equipment and information technology projects and for
other general corporate purposes.
|
| |     |  | Effective upon the closing of our initial public offering, all previously
outstanding Series A, Series B, Series C, Series D, Series E and Series F
preferred stock converted into common stock. We filed an amended and
restated certificate of incorporation, a copy of which is filed as an
exhibit to this report, in September of 2003.
This amendment and restatement, among other things, increased the
authorized shares of common stock, authorized undesignated shares of
preferred stock, and eliminated the ability of stockholders to take
action by written consent and cumulate votes at any election of
directors. At the same time, we adopted amended and restated bylaws,
a copy of which is filed as an exhibit to this report, that, among other things, eliminated the ability of
stockholders to take actions by written consent and established certain
procedures for advance notice of stockholder proposals and director
nominations.                                                                                                           
|
| |     |  | Under the terms of our credit
agreement with CapitalSource Finance LLC, our ability to pay
dividends on our common stock is contractually prohibited during the
term of that agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

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Item 4. Submissions of Matters to a Vote of Security Holders

In August 2003, we sent a written consent to our stockholders
requesting approval to the taking of the following actions in connection with
the initial public offering of our common stock: (1) the approval and adoption
of our amended and restated certificate of incorporation to effect a reverse
stock split to be effective prior to our initial public offering, (2) the
approval and adoption of our amended and restated certificate of incorporation
to increase the authorized shares of common stock and to authorize shares of
undesignated preferred stock to become effective upon the completion of our
initial public offering, (3) the approval and adoption of our amended and
restated bylaws to become effective and contingent upon the completion of our
initial public offering, (4) the approval of the amended and restated 1999
Stock Plan, (5) the approval and adoption of our 2003 Directors Stock Plan to
become effective and contingent upon the closing of our initial public
offering, (6) the approval and adoption of our 2003 Employee Stock Purchase
Plan to become effective and contingent upon the closing of our initial public
offering, (7) the election of the following 8 nominees to serve as members of
the board of directors: Alison L. May, Hilary Billings, Michael Moritz,
Michael E. Dunn, Scott Galloway, Charles Heilbronn, Daniel R. Lyle and
Jacqueline A. Macdonald; and (8) the appointment of Deloitte & Touche LLP as
our independent auditors for the fiscal year ending March 30, 2003. All such
actions were effected pursuant to an action by written consent of our
stockholders in compliance with Section 228 of the Delaware General Corporation
Law. We received the requisite consents on September 5, 2003.

A total of 5,017,025 shares of our stock out of 6,309,841 shares issued
and outstanding (or an as-converted to common stock basis) voted in favor of
these matters.




Item 6.Exhibits and Reports on Form 8-K

(a)  Exhibits

|     |  |                                                                                                        
|---- |  | -------------------------------------------------------------------------------------------------------
|3.1  |  | Amended and Restated Certificate of Incorporation of the Registrant currently in effect.*              
|     |  |                                                                                                        
|3.2  |  | Amended and Restated Bylaws of the Registrant currently in effect.*                                    
|     |  |                                                                                                        
|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

*             The form of this exhibit was filed with RedEnvelope, Inc.s Registration
Statement on Form S-1 (Registration Statement No. 333-106120) as declared
effective by the Securities and Exchange Commission on September 24, 2003.

(b)  Reports on Form 8-K

None.

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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.
|                        |  |                   |  |                                     
|Date: November 12, 2003 |  | By:               |  | /s/ ERIC C. WONG                    
|                        |  |                   |  |                                     
|                        |  |                   |  | Eric C. Wong
Chief Financial Officer

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Exhibit Index

|                                                                                                                                                                                                                                |  |                                                                                                        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------
|3.1                                                                                                                                                                                                                             |  | Amended and Restated Certificate of Incorporation of the Registrant currently in effect.*              
|                                                                                                                                                                                                                                |  |                                                                                                        
|3.2                                                                                                                                                                                                                             |  | Amended and Restated Bylaws of the Registrant currently in effect.*                                    
|                                                                                                                                                                                                                                |  |                                                                                                        
|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
|                                                                                                                                                                                                                                |  |                                                                                                        
|* The
form of this exhibit was filed with RedEnvelope, Inc.s
Registration Statement on Form S-1 (Registration Statement
No. 333-106120) as declared effective by the Securities and
Exchange Commission on September 24, 2003.