##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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Form 10-K



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|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended March 28,
    2004                                                
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the transition period
    from           to           .                                 

Commission file number: 0-50387

RedEnvelope, Inc.

(Exact name of Registrant as Specified in Its
Charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 33-0844285                              
|(State or Other Jurisdiction of
    Incorporation or Organization) |  | (I.R.S. 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)




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Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, par value $0.01 per share




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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 requirements for the
past
90 days.     Yes þ          No o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K (¶229.405 of this chapter) is not
contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the
Form 10-K or any amendment to this
Form 10-K.     Yes o          No þ

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

The aggregate market value of the voting stock
held by non-affiliates of the Registrant as of
September 26, 2003, was approximately $63.5 million
based upon the last sale price reported for such date on the
Nasdaq National Market. The Registrants common stock
commenced trading on September 25, 2003 and the
Registrants initial public offering closed on
September 30, 2003. For purposes of this disclosure, we
have assumed the conversion of all shares of the
Registrants preferred stock, which occurred in connection
with the closing of the initial public offering.

The number of outstanding shares of the
registrants common stock, $0.01 par value per share,
was 8,708,746 as of May 21, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this
Report, to the extent not set forth herein, is incorporated
herein by reference from the registrants definitive proxy
statement relating to the annual meeting of stockholders to be
held in 2004, which definitive proxy statement shall be filed
with the Securities and Exchange Commission within 120 days
after the end of the fiscal year to which this Report relates.



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RedEnvelope, Inc.

TABLE OF CONTENTS TO FORM 10-K

For Fiscal Year Ended March 28,
2004


|              |  |                                                                                           |    |      |    | 
|------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | -- | 
|              |  |                                                                                           |    | Page
|              |  |                                                                                           |    |     
|PART I       
|Item 1.       |  | Business                                                                                  |    |      | 2  | 
|Item 2.       |  | Properties                                                                                |    |      | 22 | 
|Item 3.       |  | Legal Proceedings                                                                         |    |      | 23 | 
|Item 4.       |  | Submission of Matters to a
    Vote of Security Holders                                   |    |      | 23 | 
|PART II      
|Item 5.       |  | Market for Registrants
    Common Equity and Related Stockholder Matters                 |    |      | 24 | 
|Item 6.       |  | Selected Financial Data                                                                   |    |      | 25 | 
|Item 7.       |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations |    |      | 26 | 
|Item 7A.      |  | Quantitative and Qualitative
    Disclosures About Market Risk                            |    |      | 37 | 
|Item 8.       |  | Financial Statements and
    Supplementary Data                                           |    |      | 38 | 
|Item 9.       |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure  |    |      | 58 | 
|Item 9A.      |  | Controls and Procedures                                                                   |    |      | 58 | 
|PART III     
|Item 10.      |  | Directors and Executive
    Officers of the Registrant                                    |    |      | 58 | 
|Item 11.      |  | Executive Compensation                                                                    |    |      | 58 | 
|Item 12.      |  | Security Ownership of
    Certain Beneficial Owners and Management                        |    |      | 58 | 
|Item 13.      |  | Certain Relationships and
    Related Transactions                                        |    |      | 58 | 
|Item 14.      |  | Principal Accountant Fees
    and Services                                                |    |      | 58 | 
|PART IV      
|Item 15.      |  | Exhibits, Financial
    Statement Schedules, and Reports on Form 8-K                      |    |      | 59 | 
|Signatures    |  |                                                                                           | 62 |     
|EXHIBIT 10.34
|EXHIBIT 10.35
|EXHIBIT 10.36
|EXHIBIT 10.37
|EXHIBIT 10.38
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 
|EXHIBIT 32.2 



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##### Table of Contents






PART I





|        |         
|------- | --------
|Item 1. | Business

This Annual Report on Form 10-K and the
documents incorporated herein by reference contain
forward-looking statements based on expectations, estimates and
projections as of the date of this filing. Actual results may
differ materially from those expressed in forward-looking
statements. See Item 7 of Part II 
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Forward-Looking
Statements.

Overview

RedEnvelope is an online retailer of upscale
gifts. RedEnvelopes goal is to make gift
giving  no matter what the occasion or
circumstance  easy and fun. RedEnvelope offers an
extensive collection of imaginative, original gifts for every
occasion, recipient and budget. We strive to maintain the
highest standards for customer service and gift delivery in an
effort to provide our customers with the best possible gift
giving experience and to encourage repeat business. We believe
that no other online gift retailer offers the combination of
ease of shopping, choice of unique, high-quality gifts and
superior customer service that we provide through our website
and catalog. A cornerstone of our business strategy has been to
develop, cultivate and satisfy an attractive and growing
customer base. We have developed an internal database of
approximately 1.8 million customer names, with
approximately 470,000 new customers added in fiscal 2004.

We strive to offer a wide assortment of
high-quality, thoughtful gifts, many of which are difficult to
find elsewhere and are not easily replicated. Our merchants
travel the world, sourcing unique products and often commission
artists and vendors to create exclusive gifts just for
RedEnvelope shoppers. Our gift wrap is distinctive and closely
associated with our brand. Gift-wrapped products are delivered
to the recipient in a branded, high-quality red box with a
hand-tied ivory ribbon. We offer a wide assortment of products
in fourteen categories, ranging from new baby to jewelry to
mens accessories to home and garden. Our price points
range from lower priced items in the $20 to $50 price range
intended for broader consumer appeal to higher priced items with
more targeted appeal. We believe that our merchandising strategy
and product quality enhance our ability to achieve attractive
margins on our products.

Through our website, www.redenvelope.com,
customers can search for gifts by occasion, recipient, product
category and price point. Our website generally features
approximately 650 products, increasing to approximately
800 products during the holiday shopping season. In
addition, through our website our customers can register for our
gift reminder service, sign up to receive email promotions, view
their order history, and request a catalog. In fiscal 2004,
approximately 72% of customer orders were placed through our
website with the remainder placed through telephone orders. We
also publish our full-color catalog several times during the
year. Each catalog generally features approximately
130 products, increasing to approximately 250 products
during the holiday shopping season, and also serves as the
primary advertising vehicle for our Internet operations. During
fiscal 2004 and 2003, we mailed approximately 18.8 million
and 18.7 million catalogs, respectively, to over
8 million individuals in each period.

We believe that substantial opportunities exist
to grow our business, increase our revenues and achieve
profitability by continuing to implement the following
strategies:



| |   |                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Improve marketing
    efficiency by focusing on
    the retention of existing customers and emphasizing various
    online marketing programs                       
|
| |  | Continue product
    innovation by maintaining
    our mix of 40-50% new products each year                                                                         
|
| |  | Seek to increase our scale to maximize cost
    efficiencies by striving
    to increase revenues while managing fixed costs and improving
    fulfillment processes
|
| |  | Acquire new
    customers by selective
    marketing campaigns geared towards capitalizing on our brand
    recognition                                             

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RedEnvelope, Inc. was incorporated in California
in June 1997 under the name Giftworks Online, Inc.
and changed its name to 911 Gifts, Inc. in December
1997. We reincorporated in the State of Delaware under the name
911 Gifts, Inc. in March 1999 and changed our name
to RedEnvelope, Inc. in September 1999. We made an
election to be treated as an S Corporation for federal and
state tax purposes, which remained in effect through February
1999, the day prior to our reincorporation in the State of
Delaware in September 1999. We completed our initial public
offering in September 2003, and our common stock is listed on
the Nasdaq National Market System under the symbol
REDE.

Merchandising and Sourcing

Our merchandising group has been designing and
developing new products since 2001, as well as finding new
product ideas from outside sources. Our merchandising group
meets regularly with our merchandise planning staff to review
product opportunities, product quality and customer feedback.
From these meetings, product ideas are put into design,
development and production. In addition, we work with vendors to
develop products focusing on unique and innovative features or
concepts that distinguish us from competitors. We believe that
the appeal of our exclusive products also serves as a key factor
in broadening our customer base and strengthening and enhancing
our brand appeal. Our goal is to continue to increase sales of
these products through the introduction of new, exclusive
RedEnvelope products.

Historically, approximately 50% of our products
can be characterized as proprietary. In fiscal year 2004, 61% of
the products in our holiday catalog were exclusive to
RedEnvelope and our proprietary products were some of our
strongest performing products. We currently intend to increase
the percentage of exclusive products to approximately 80% over
the next several years. We believe that by continually offering
innovative, proprietary products, we can better differentiate us
from our competitors and can provide a more satisfactory
gift-purchasing experience for our customers. In order to
provide these levels of proprietary products, our merchandising
group works directly with domestic manufacturers, importers and
overseas agents to design and manufacture our products. During
fiscal 2004, we sourced approximately 33% of our products from
overseas. In an effort to increase our proprietary product
offering, we will be increasing our overseas product sourcing.
We believe working directly with overseas agents and
manufacturers will allow us to effectively manage product
development and quality. Due to the complexities of overseas
sourcing, we have established and have begun staffing an
international sourcing group. Since we do not have long-term
arrangements with any vendor or distributor that guarantees the
availability of products, we do not have a predictable or
guaranteed supply of these products in the near future. In
addition, while our product development process includes
sampling products for quality, there remains the possibility
that final production runs will include products that do not
meet our quality standards. Due to the lead times of overseas
production, we may not be able to receive adequate levels of
product that meet our quality standards. If we are unable to
provide our customers with continued access to adequate levels
of proprietary products that meet our quality standards, our
operating results would be harmed. While products sourced
overseas typically have lower costs, our product margins may be
slightly offset by an increase in inbound freight costs. As
security measures around shipping ports increase, these
additional costs may result in higher inbound freight costs.
Furthermore, in recent years, U.S. companies were subject
to port strikes which delayed the delivery of goods. As we
increase our overseas sourcing, we face the risk of these delays
which could harm our business.

We cannot predict whether any of the countries in
which our merchandise currently is manufactured or may be
manufactured in the future will be subject to additional trade
restrictions imposed by the U.S. and other foreign governments,
including the likelihood, type or effect of any such
restrictions. Trade restrictions, including increased tariffs or
quotas, embargoes, and customs restrictions, against items that
we offer or intend to offer to our customers, as well as
U.S. or foreign labor strikes, work stoppages or boycotts,
could increase the cost or reduce the supply of items available
to us and adversely affect our business, financial condition and
results of operations. Our sourcing operations also may be
adversely affected by political and financial instability
resulting in the disruption of trade from exporting countries,
significant fluctuation in the value of the U.S. dollar
against foreign currencies, restrictions on the transfer of
funds and/or other trade disruptions.

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Marketing

We rely primarily on Internet-based online
programs and catalog advertising. Revenues to our customers
attributable to online Internet-based channels, specifically
portals, search, and affiliate derived sales, increased by 44%
over the prior fiscal year, which was less than we expected.
Revenues attributable to customers who received a catalog
increased approximately 9% over the prior fiscal year, even
though we mailed approximately the same number of catalogs.

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

We currently intend to use our catalog programs
to market our products and brand. However, increases in the cost
of catalogs may limit our ability to advertise and market our
business without reducing profitability. We plan on exploring
other ways to market our products and brand. For example, in the
third quarter of fiscal 2004, we launched a series of television
advertisements which we believe led to additional interest in
our products and catalogs. We are currently considering
utilizing other methods of advertising (e.g. print, television,
and/or radio). These marketing programs will result in an
increase in our marketing costs. Further, the results of
advertising will be less predictable than our online and catalog
programs. In addition, our limited experience with these methods
of advertising may cause us not to achieve the desired results.
If such efforts do not produce a sufficient level of sales to
cover their costs, it would harm our operating results.

Fulfillment and Distribution

We lease and operate an approximately
240,000 square foot warehouse and distribution facility in
Lockbourne, Ohio. We terminated our relationship with our
third-party fulfillment service provider and assumed control of
our fulfillment services in August 2003. In the third quarter of
fiscal 2004, we experienced delays and errors in the fulfillment
process at our distribution center, which prevented us from
fulfilling demand for our products. In addition, the anticipated
efficiencies from managing the distribution center ourselves did
not materialize. Improvements in managing our distribution
center will be a key objective in the ensuing months. We are
currently in the process of revising certain materials handling
processes and implementing new warehouse management software. We
believe that these changes will allow us to better manage our
fulfillment operations and scale our business. If we are unable
to improve the performance of the fulfillment process at our
distribution center, we may incur additional labor costs, fail
to satisfy demand for our products or experience customer
dissatisfaction, any of which could have an adverse affect on
our business, financial condition and operating results.

We do not have any long-term contracts with any
manufacturer or supplier and place all of our orders by purchase
order. If we fail to obtain sufficient quantities of inventory,
it would have a harmful effect on our business, financial
condition and results of operations. We have received in the
past, and may receive in the future, shipments of products from
manufacturers that fail to conform to our quality control
standards. In such event, unless we are able to obtain
replacement products in a timely manner, we may lose sales which
could harm our business and operating results. For a discussion
of these and other risks related to our fulfillment and
distribution operations, please see Factors That May
Affect Future Results.

Customer Service

We lease and operate an approximately
13,000 square foot customer service center in
San Diego, California. We are committed to providing our
customers with courteous, knowledgeable and prompt service
24 hours a day, seven days a week. Our customer service
group in San Diego provide personal attention to customers
who call toll free, use Internet chat, or send emails to place
orders or inquire about products. Our customer service group is
also responsible for addressing customer concerns promptly in an
attempt to achieve the customers complete satisfaction. We
seek to provide a great customer experience and therefore, if a
gift

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recipient is not satisfied with one of our
products (except, under certain circumstances, personalized
products), they can return the product for repair, replacement
or refund at any time.


We seek to hire and retain qualified customer
service representatives and train them thoroughly. Training for
customer service representatives focuses primarily on acquiring
a working knowledge of our products and of developing an
understanding of our high customer service standards.

Our customer service operations are subject to a
number of risks, including disruptions due to power outages,
telecommunications or computer system failures, natural
disasters and other catastrophic events or an inability to
maintain proper levels of competent staffing, the occurrence of
any of which could seriously harm our operations. For a
description of these and other risks related to our customer
service operations, please see Factors That May Affect
Future Results.

Competition

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,
    Bloomingdales, and Neiman Marcus                                                                                                                    
|
| |  | 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 establish more
robust online sales operations 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.

Intellectual Property and Proprietary
Rights

We regard our trademarks, copyrights, domain
names, trade secrets and other intellectual property as critical
to our success. We rely on various intellectual property laws
and contractual restrictions to protect our proprietary rights.
These include copyright and trade secret laws and
confidentiality, invention assignment and nondisclosure
agreements with our employees, contractors, suppliers and
strategic partners. Despite these precautions, it may be
possible for a third party to copy or otherwise obtain and use
our intellectual property without our authorization.
RedEnvelope, Inc. and certain other trademarks for
our business either have been registered or applications are
pending with United States Patent and Trademark Office and with
certain foreign registries. Effective intellectual property
protection may not be available in every country in which our

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products and services are made or will be made
available online. If we are unable to protect or preserve the
value of our intellectual property 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. For a discussion of risks
related to intellectual property, see Factors That May
Affect Future Results.

Information Technology and Systems

We use third party information technology systems
for order fulfillment, merchandising and financial reporting. In
addition, we internally developed our webstore and integrated it
with these other systems. We are continually making improvements
to the overall technology infrastructure to improve the shopping
experience and order fulfillment capabilities. We currently use
Mail Order and Catalog System (MACS) as our back-end order
and fulfillment system.

Our information technology systems are housed in
a leased third-party facility in Santa Clara, California.
Currently, we use 28 servers to run our website. Data is
stored in a database that runs on a redundant server and storage
array. We also have standby servers that can provide additional
capacity as necessary. The facility hosting our servers provides
redundant heating, ventilation, air conditioning, power and
Internet connectivity. In November of 2003, we created a
redundant data center in Cincinnati, Ohio. This back-up site is
engineered to provide recovery of data within 1 hour.

We are planning on implementing new software
programs for our website, financial, warehouse management, and
order entry functions in fiscal year 2005. We believe the
implementation of these software systems will support the needs
of our business and customers. Software implementation projects
entail significant technical and business risks. If we are
unsuccessful in implementing these systems, it may hinder our
ability to process and fulfill customer orders as well as
complete critical financial processing transactions. These
projects will result in uses of cash and will result in
additional depreciation expense.

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, terrorist
attacks, natural disasters and other catastrophic events, and
errors in usage by our employees and customers. In the event
that our service provider in Santa Clara has a disruption
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 alternate 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, distribution or communications systems for any
reason, particularly an interruption during the holiday season,
could seriously harm our business. For a discussion of these and
other risks related to our facilities and systems, see
Factors That May Affect Future Results.

Seasonality

Our business is highly seasonal, reflecting the
general patterns associated with the retail industry of peak
sales and earnings in late November and December during the
holiday shopping season. The secondary peak seasons for us are
in February and May, reflecting gift buying for Valentines
Day and Mothers Day. A substantial portion of our net
revenues occurs in the 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. In anticipation of increased
sales activity during the third fiscal quarter, we incur
significant additional expenses, including significantly higher
inventory and staffing costs. Due to the seasonality of our
sales, our quarterly results will

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fluctuate, perhaps significantly. In addition,
similar to many retailers, we make merchandising and inventory
decisions for the holiday season well in advance of the holiday
selling season. Accordingly, unfavorable economic conditions or
deviations from projected demand for products during the third
fiscal quarter could have a material adverse effect on our
business, financial condition or results of operations for the
entire fiscal year. For a discussion of these and other risks
related to the seasonality of our business, see Factors
That May Affect Future Results.


Employees

As of March 28, 2004, we employed
approximately 164 full-time people. We hire temporary
employees during the peak seasons. We have never had a work
stoppage, and none of our employees is represented by a labor
union. We consider our employee relationships to be positive. If
we are unable to retain our key employees or if we are unable to
maintain adequate staffing of qualified employees, particularly
during peak sales seasons, our business would be affected
adversely. For a discussion of these and other risks related to
our employees, see Factors That May Affect Future
Results.

Factors That May Affect Future
Results

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



| |                                                                              
| | -----------------------------------------------------------------------------
| | Our limited operating history makes
    evaluation of our business difficult.

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



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

We have a history of losses and we may continue
to incur losses for the foreseeable future. As of March 28,
2004, our accumulated deficit was $78.7 million. We have
not achieved profitability for a full fiscal year. If our
revenues grow more slowly than we anticipate, or if our
operating expenses exceed our expectations, we may not be able
to achieve profitability in the near future or at all. Even if
we do achieve profitability, we may not be able to sustain or
increase profitability on an annual basis in the future. If we
are unable to achieve profitability within a short period of
time, or at all, or if we are unable to sustain profitability at
satisfactory levels, our financial condition and stock price
could be adversely affected.



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

Our business is highly seasonal, reflecting the
general pattern of peak sales for the retail industry during the
holiday shopping season. Typically, a substantial portion of our
net revenues occur during our third fiscal 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 45% of net revenues in the fiscal
year ended March 28, 2004. We cannot predict with certainty
what percentage of our total net revenues for fiscal

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year 2005 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 affect 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 negative 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 more
    popular products by our competitors                                                                                     
|
| |  | Fluctuations in the level of our product returns                                                                                                                         
|
| |  | Termination of existing marketing relationships
    or failure to develop successful new marketing relationships                                                         
|
| |  | Fluctuations in shipping costs, particularly
    during the holiday season                                                                                               
|
| |  | Fluctuations in advertising, marketing or catalog
    production and distribution costs                                                                                  
|
| |  | Fluctuations in personalization and fulfillment
    costs                                                                                                                
|
| |  | The amount and timing of operating costs and
    capital expenditures relating to expansion or upgrade 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

8



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##### Table of Contents



outages, computer and telecommunications
failures, computer viruses, security breaches, catastrophic
events (such as natural disasters or terrorist attacks), 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 a wide range of consumers do not
find our products attractive or if we are required to reduce our
prices, our revenues and earnings may decline or fail to meet
expected levels and our stock price could be affected adversely.



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

Our fulfillment and distribution operation is
located in leased facilities in Lockbourne, Ohio. Our agreement
with the fulfillment services company that previously managed
the fulfillment and distribution operations at the Lockbourne,
Ohio facility expired in August 2003, at which point we assumed
direct control of fulfillment and distribution operations. We
have no prior experience managing fulfillment and distribution
operations and we cannot assure you that we will be successful
in this endeavor. We experienced significant difficulties
managing the fulfillment and distribution operations during the
2003 holiday season, including difficulties in inventory
management and timely gift personalization, and anticipated
efficiencies from managing the distribution center ourselves did
not materialize during that period. If we are unable to manage
successfully our fulfillment and distribution operations and to
meet our customers expectations regarding personalization,
presentation and delivery, our operations and financial
condition could be seriously harmed. Any difficulty in managing
our fulfillment and distribution operations could require us to
find one or more parties to provide these services for us. If we
are required to engage one or more service providers, we could
incur higher fulfillment expenses than anticipated or incur
additional costs for balancing merchandise inventories among
multiple distribution facilities. Further, we may need to expand
or upgrade our distribution operations in the future to
accommodate increases in customer orders, increased demand for
personalized products or changes in available technology. If we
fail to successfully manage, expand or make necessary upgrades
to our fulfillment and distribution operations in a timely and
cost-effective manner, 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

9



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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 would likely cause us to miss
revenue opportunities and could cause our customers to become
dissatisfied and look to our competitors for their gift items.
During the 2003 holiday season, some of our popular items were
not stocked in quantities sufficient to meet the demand for such
items, which likely led to missed sales opportunities. 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.




| |                                                
| | -----------------------------------------------
| | We may have difficulty in product
    sourcing.

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.

In addition, we may receive products from our
suppliers that do not meet our quality standards. From time to
time, we receive products from suppliers that are of
insufficient quality to provide to our customers. Generally the
supplier is able to quickly rectify the problem, but
occasionally we have been unable to obtain replacement product
quickly enough to fulfill all customer orders for such product
in a timely manner, particularly with respect to items sourced
overseas which tend to have longer delivery lead time
requirements. If we receive products from our suppliers that do
not meet our high quality standards and we are unable to obtain
suitable replacement products in a timely manner, our reputation
and our operating results could be harmed. Further, customers
who do not receive their products in a timely manner may look to
our competitors for their gift items.

Many of our products are sourced overseas. While
products sourced overseas typically have lower costs, our
product margins may be slightly offset by an increase in inbound
freight costs. As security measures around shipping ports
increase, these additional costs may result in higher inbound
freight costs. Furthermore, in recent years, U.S. companies
were subject to port strikes which delayed the delivery of
goods. As we increase our overseas sourcing, we face the risk of
these delays which could harm our business and results of
operations. We cannot predict whether any of the countries in
which our merchandise currently is manufactured or may be
manufactured in the future will be subject to additional trade
restrictions imposed by the U.S. and other foreign governments,
including the likelihood, type or effect of any such
restrictions. Trade restrictions, including increased tariffs or
quotas, embargoes, and customs restrictions, against items that
we offer or intend to offer to our customers, as well as
U.S. or foreign labor strikes, work stoppages or boycotts,
could increase the cost or reduce the supply of items available
to us and adversely affect our business, financial condition and
results of operations. Our sourcing operations also may be
adversely affected by political and financial instability
resulting in the disruption of trade from exporting countries,
significant fluctuation in the value of the U.S. dollar
against foreign currencies, restrictions on the transfer of
funds and/or other trade disruptions. Any disruption or delays
in, or increased costs of, importing our products could have an
adverse effect on our business, financial condition and
operating results.



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

10



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




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

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

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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 establish more
robust online sales operations in the future. Our competitors
may be able to secure products from vendors on more favorable
terms, provide popular products to which we do not have access,
fulfill customer orders more efficiently and adopt more
aggressive pricing or inventory availability policies than we
can.

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



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

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

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



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

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

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We also depend on temporary employees to
adequately staff our distribution facility during busy periods
such as the holiday shopping season, including individuals
responsible for gift personalization and packaging. 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 and other periods of
increased activity, 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 non-personalized 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. Also, returned merchandise that
is personalized, perishable, or damaged likely cannot be
re-sold, creating non-recoverable inventory costs which
detrimentally affects our operating results.



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

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



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

Catalog production and mailings entail
substantial paper, printing, postage and human labor costs.
Increases in the costs of producing and distributing the
RedEnvelope catalog, including increases in postage rates or
paper, photography, or printing costs, may reduce the margin on
sales derived from our catalog. The U.S. Postal Service is
likely to increase its postage rates in the future and other
delivery and overnight courier services that we utilize to
deliver our products also will likely raise their rates in the
future, which could significantly increase the aggregate cost of
mailing our catalogs . As we incur nearly all of the costs
associated with our catalogs prior to mailing, we are unable to
adjust the costs being incurred in connection with a particular
mailing to reflect the actual performance of the catalog. In
addition, response rates to our mailings and, as a result,
revenues generated by each mailing, are affected by factors such
as constantly changing consumer preferences and our ability to
include a product assortment that satisfies those 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.

13



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

Our revenues depend on our ability to advertise
and market our products effectively through the RedEnvelope
catalog and our other advertising and marketing efforts. If we
do not successfully advertise and market our products, our
operating results will be seriously harmed. 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. In addition, individuals are
increasingly using software programs that block certain email
marketing campaigns, and certain Federal and state laws and
regulations may restrict our ability to effectively utilize
email as a marketing tool. If we decrease our advertising or
marketing activities, or the effectiveness of such activities is
diminished, 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 per-shipment shipping revenues resulting from our
shipping rate policy change. We believe that this change in
shipping rate policy had an aggregate negative impact on our
revenues for the third fiscal quarter of 2004, which was the
first full quarter following the policy change, and it is
possible that the policy change could have a negative impact on
our revenues in future periods. 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 or adequately staff our
customer service operations would likely impair our reputation
and have an adverse effect on our business and operating results.

14



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

Our performance is substantially dependent on the
continued services and on the performance of our senior
management and other key personnel, particularly Alison L. May,
our President and Chief Executive Officer. One of our long-time
officers and directors, Hilary Billings, recently resigned from
RedEnvelope. While we believe that this will have no material
impact on our operations, we cannot assure you that disruptions
occasioned by her departure will not have an adverse impact on
our near-term operations. 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 or any
of our executive officers or other key employees for any reason
could harm our business, financial condition and operating
results. 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 I.
Item 3  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 substantially 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, or we may be prevented from providing features or
functionality on our website that our customers and potential
customers desire, any of 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 in the past received claims and have been a defendant
in a lawsuit alleging that our Internet marketing program and
website operations infringe patents held by third parties. For
additional information on this lawsuit, see Part I.
Item 3  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

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us, we may be required to pay monetary damages or
ongoing royalties. Further, as a result of infringement claims
either against us or against those who license technology to us,
we may be required to develop non-infringing intellectual
property or enter into costly royalty or licensing agreements.
Such royalty or licensing agreements, if required, may be
unavailable on terms that are acceptable to us, or at all. If a
third-party successfully asserts an infringement claim against
us and we are required to pay monetary damages or royalties or
we are unable to develop suitable non-infringing alternatives or
license the infringed or similar intellectual property on
reasonable terms on a timely basis, it could significantly harm
our business.




| |                                             
| | --------------------------------------------
| | We face the risk of inventory
    shrinkage.

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



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

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



| |                                                                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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. Since our inception, we
have experienced negative cash flow from operations on a fiscal
year basis and may experience negative cash flow from operations
on a fiscal year basis for the foreseeable future. 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.



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

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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
or financial damages to any of our customers or other
individuals, we could be vulnerable to product liability
lawsuits. If we are found liable under product liability claims,
we could be required to pay substantial monetary damages and our
reputation could suffer. 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 the claims could bring adverse
publicity to us, 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 and live plants, which
    may hurt our business.

We currently offer select food items and live
plants 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 products. In addition,
any inquiry or investigation from a 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, any of which could adversely affect our
business, financial condition and operating results.



| |                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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.

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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 commerce and communication.
Factors which could reduce the widespread use of the Internet
include:



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

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



| |                                                                  
| | -----------------------------------------------------------------
| | Customers may be unwilling to purchase
    goods on the Internet.

Approximately 72% 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 and information of our customers. 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. We may 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

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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 or elsewhere in the world 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 and operating results could be affected adversely.




| |                                                                      
| | ---------------------------------------------------------------------
| | Existing or future government regulation
    could harm our business.

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

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

The State of California recently enacted a law
that requires any company that does business in California and
possesses computerized data, in unencrypted form, containing
certain personal information about California residents to
provide prompt notice to such residents if that personal
information was, or is reasonably believed to have been,
obtained by an unauthorized person such as a computer hacker.
The law defines personal information as an individuals
name together with one or more of that individuals social
security number, drivers license number, California
identification card number, credit card number, debit card
number, or bank account information, including any necessary
passwords or access codes. As our customers, including
California residents, generally provide information to us that
is covered by this definition of personal information in
connection with their purchases via our website, our business
will be affected by this new law. As a result, we will need to
ensure that all computerized data containing the
previously-described personal information is sufficiently
encrypted or that we have implemented appropriate measures to
detect

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unauthorized access to our data and to notify our
California customers of any such access to the extent it
involves their personal information. Such measures will likely
increase the costs of doing business and, if we fail to detect
and provide prompt notice of unauthorized access as required by
the new law, we could be subject to potential claims for damages
and other remedies available to California residents whose
information was improperly accessed or, under certain
circumstances, the State of California could seek to enjoin our
business operations until appropriate corrective actions have
been taken. While we intend to comply fully with this new law,
we cannot assure you that we will be successful in avoiding all
potential liability or disruption of business resulting from
this law. If we were required to pay any significant amount of
money in satisfaction of claims under this new law, or any
similar law enacted by another jurisdiction, or if we were
forced to cease our business operations for any length of time
as a result of our inability to comply fully with any such law,
our business, operating results and financial condition could be
adversely affected. Further, complying with the applicable
notice requirements in the event of a security breach could
result in significant costs.


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

In addition, because our website is accessible
over the Internet in multiple states and other countries, we may
be subject to their laws and regulations or may be required to
qualify to do business in those locations. We are qualified to
do business only in California and Ohio at present. Our failure
to qualify in a state or country where we are required to do so
could subject us to taxes and penalties and we could be subject
to legal actions and liability in those jurisdictions. The
restrictions or penalties imposed by, and costs of complying
with, these laws and regulations could harm our business,
operating results and financial condition. Our ability to
enforce contracts and other obligations in states and countries
in which we are not qualified to do business could be hampered,
which could have a material adverse effect on our business.
Further, an important aspect of the new Internet-focused laws is
that where federal legislation is absent, states have begun to
enact consumer-protective laws of their own and these can vary
significantly from state to state. Thus, it is difficult for any
company to be sufficiently aware of the requirements of all
applicable state laws and it is also difficult or impossible for
any company to comply fully with the sometimes inconsistent
standards and requirements set by various states. In addition to
the consequences that could result from violating one or more
state laws, the costs of attempting to comply could be
considerable.



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

We are subject to increasing regulation relating
to privacy and the use of personal user information. For
example, we are subject to various telemarketing laws that
regulate the manner in which we may solicit future suppliers and
customers. Such regulations, along with increased governmental
or private enforcement, may increase the cost of growing our
business. California recently enacted a law, currently scheduled
to take effect on July 1, 2004, that will require all
commercial website operators that collect personal information
about California residents to adopt and post a privacy policy
that meets certain specified criteria. Any failure to comply
with this new law could subject us to civil penalties,
injunctions, and/or lawsuits. In addition, several states have
proposed legislation that would limit the uses of personal user
information gathered online or require online services to
establish privacy policies. The Federal Trade Commission has
adopted regulations regarding the collection and use of personal
identifying information obtained from children under
13 years of age. Bills proposed in Congress would extend
online privacy protections to adults. Moreover, proposed

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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 significant 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.



| |                                         
| | ----------------------------------------
| | Executive Officers of the
    Registrant

The following table sets forth certain
information regarding our executive officers and key employees
as of June 22, 2004.

|                         |  |     |    |             |  |                                                
|------------------------ |  | --- | -- | ----------- |  | -----------------------------------------------
|Name                     |  | Age |    | Position(s)
|                         |  |     |    |            
|Alison L. May            |  |     | 54 |             |  | Chief Executive Officer, President and Director
|Eric C. Wong             |  |     | 34 |             |  | Chief Financial Officer and Secretary          
|Kristine N. Dang         |  |     | 37 |             |  | General Merchandising Manager                  
|Kathy M. Herzog          |  |     | 39 |             |  | Vice President of Planning                     
|Christopher E. Nordquist |  |     | 38 |             |  | General Counsel                                
|John W. Roberts          |  |     | 43 |             |  | Senior Vice President of Information Technology
|Edward M. Schmults       |  |     | 41 |             |  | Senior Vice President of Operations            

Alison L. Mayhas
served as the President, Chief Executive Officer and a member of
our Board of Directors since April 2002. Prior to joining
RedEnvelope, from March 2001 to April 2002, Ms. May served
as the Chief Operating Officer at Gymboree Corporation, a
childrens specialty retailer. Ms. May held the
positions of President and Business Consultant at ALM Consulting
from February 2000 to March 2001. From January 1997 to February
2000, Ms. May served as the Chief Operating Officer at
Esprit de Corp., a clothing retailer. Ms. May served as the
President and Chief Financial Officer of Patagonia, Inc., an
outdoor clothing and equipment retailer, from December 1991 to
April 1996. Ms. May holds an MBA in Finance from the
University of Southern California and a BA in Spanish,
Education, and History from Purdue University.

Eric C. Wonghas
served as Chief Financial Officer of RedEnvelope since April
2003. Prior to that, Mr. Wong served as our Vice President
of Finance from February 2003 to April 2003 and as our Director
of Finance from November 2002 to February 2003. From February
2000 to July 2002, Mr. Wong served as the Director of
Finance at Network Associates, Inc., an enterprise software
company. From December 1997 to February 2000, Mr. Wong
served as a Finance Manager at Sanmina Corporation, an
electronics manufacturer.

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Mr. Wong is a certified public accountant
and received a BA in Economics from the University of California
at Santa Cruz.


Kristine N. Danghas
served as General Merchandising Manager at RedEnvelope since
April 2003. Prior to that, Ms Dang served as the Vice President
of Merchandising at RedEnvelope from March 2000 to April 2003
and served as the Director of Merchandising at RedEnvelope from
July 1998 to March 2000. Prior to joining RedEnvelope, from
April 1997 to June 1998, Ms. Dang served as an Assistant
Buyer at Williams-Sonoma, Inc., a specialty home furnishing
retailer. Ms. Dang studied fashion design at
San Francisco State University.

Kathy M. Herzoghas
served as our Vice President of Planning since April 2003 and
served as our Director of Merchandise Planning from January 2002
to April 2003. Prior to joining RedEnvelope, from August 2001 to
December 2001, Ms. Herzog served as a Project Manager with
GlobalNetXchange, a retail technology company. Ms. Herzog
also served as the Director of Planning at Bluelight.com L.L.C.,
an online retail unit of Kmart Corporation, from January 2001 to
July 2001. From March 2000 to December 2000, Ms. Herzog
served as a Group Manager at Escalate, Inc., a retail software
company. Ms. Herzog also served as a Project Manager at
Williams-Sonoma, Inc., a specialty home furnishing retailer,
from February 1999 to February 2000, a Planning and Inventory
Manager at Williams-Sonoma, Inc. from March 1998 to January 1999
and a Senior Planner at Williams-Sonoma, Inc. from August 1996
to February 1998. Ms. Herzog holds a BA in Business
Marketing and an MBA in Business Management from Pacific
Lutheran University.

Christopher E. Nordquisthas served as General Counsel of
RedEnvelope since October 2003. Prior to joining RedEnvelope,
from June 2001 to October 2003, Mr. Nordquist served as
Chief Operating Officer of Asset Management Business at Thomas
Weisel Partners, an investment bank, and from July 2000 to June
2001 as General Counsel of an asset management joint venture
between Thomas Weisel Partners and Scudder Investments. From
January 2000 to July 2000, Mr. Nordquist served as General
Counsel at WR Hambrecht, an investment bank. From July 1998 to
January 2000, Mr. Nordquist also served as Sr. Council at
Barclays Global Investors, an institutional asset management
firm. Mr. Nordquist received a BA in Economics from St.
Olaf College and a JD from Boalt Law School at University of
California at Berkeley.

John W. Robertshas
served as our Senior Vice President of Information Technology
since July 2003 and our Vice President of Information Technology
from March 2003 to July 2003. Prior to joining RedEnvelope, from
July 2002 to March 2003, Mr. Roberts served as Vice
President of Information Technology at Bridgespan, Inc., a
mortgage services company. From November 2000 to June 2002,
Mr. Roberts served as a Senior Director and Chief
Information Officer at DiCarta, Inc., an enterprise software
company. Mr. Roberts also served as a Director of
Information Technology Operations at Webvan Group, Inc., an
online retail grocer, from January 1998 to August 2000.
Mr. Roberts received a BA in English from
San Francisco State University and an MS in Systems
Management from the University of Denver.

Edward M. Schmultshas served as our Senior Vice
President of Operations since May 2004. Prior to joining
RedEnvelope, Mr. Schmults served as a consultant for YOOX,
an Italian web-based retailer of high fashion apparel and
footwear. From November 2000 to February 2003, Mr. Schmults
served as President of Global Accounts at Freeborders, an
enterprise software company. From November 1997 to March 2000,
Mr. Schmults served as President of Moonstone Mountain
Equipment, a high-end outdoor apparel company. From 1990-1997,
Mr. Schmults held several executive positions at Patagonia,
including COO, CIO, and Managing Director of Patagonia Japan,
where he oversaw all aspects of the retail, catalog and
wholesale business. Mr. Schmults holds a MBA from Harvard
University and a BA in Economics and Political Science from Yale
University.






|        |           
|------- | ----------
|Item 2. | Properties

As of March 28, 2004, we leased
approximately 16,500 square feet of headquarters office
space in San Francisco, California. This lease expires on
September 30, 2004, and we are currently negotiating a new
lease for our headquarters in San Francisco, California. Also,
as of March 28, 2004 we leased approximately
240,000 square feet of distribution space located in
Lockbourne, Ohio and approximately 13,000 square feet for
our customer service center located in San Diego,
California. We believe these facilities and the new

22



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headquarters space will be sufficient for our
needs for at least the next twelve months, although we can offer
no assurances in this regard or that our negotiations for the
new space will be successful. For a discussion of risks related
to our facilities, see Factors That May Affect Future
Results.


Our information technology systems are housed in
a leased third-party facility in Santa Clara, California.
Currently, we use 28 servers to run our website. Data is stored
in a database that runs on a redundant server and storage array.
We also have standby servers that can provide additional
capacity as necessary. The facility hosting our servers provides
redundant heating, ventilation, air conditioning, power and
Internet connectivity. In November of 2003, we created a
redundant data center in Cincinnati, Ohio. This back-up site is
engineered to provide recovery of data within 1 hour. For a
discussion of the risks related to disruption in services at our
third-party facility in Santa Clara and other
facility-related risks, see Factors That May Affect Future
Results.






|        |                  
|------- | -----------------
|Item 3. | 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 have been 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.

On September 3, 2003, Activ8now, LLC filed a
patent infringement lawsuit against the Company in the United
States District Court, Northern District of Georgia. The lawsuit
alleged a cause of action for infringement of U.S. Patent
Nos. 6,535,889 and 6,557,006 based on the theory that
certain of our website operations were covered by such patents.
On June 18, 2004, the Company and Activ8now, LLC entered
into a settlement agreement providing the Company with a
non-exclusive, irrevocable, paid-up, worldwide license to such
patents in exchange for a one-time fee and dismissal of the
lawsuit with prejudice. The settlement did not have a material
adverse effect on the Companys financial position or
results of operations.






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

There were no matters submitted to a vote of
security holders during the fourth quarter of the 2004 fiscal
year.

23



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##### Table of Contents






PART II





|        |                                                                                             
|------- | --------------------------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters Market Information

Our common stock began trading on the Nasdaq
National Market System on September 25, 2003 under the
symbol REDE. The following table sets forth the high and low
closing prices for the periods indicated.

|            |  |      |       |     |  |   |       | 
|----------- |  | ---- | ----- | --- |  | - | ----- | 
|Fiscal 2004 |  | High |       | Low
|            |  |      |       |    
|1st Quarter |  |      | N/A   |     |  |   | N/A   | 
|2nd Quarter |  | $    | 14.55 |     |  | $ | 14.35 | 
|3rd Quarter |  | $    | 16.85 |     |  | $ | 11.30 | 
|4th Quarter |  | $    | 16.70 |     |  | $ | 8.07  | 

On May 21, 2004, the closing sales price of
our common stock on the Nasdaq National Market System was $8.32.

On September 24, 2003, a Registration
Statement on Form S-1 (Commission File No. 333-106120)
relating to our initial public offering was declared effective
by the Securities and Exchange Commission. The net proceeds to
us from the offering were approximately $29.0 million after
deducting underwriting discounts of $1.8 million. We used
approximately $1.5 million of the net proceeds for fees
related to the offering (excluding banker fees). Since the
initial public offering, we have used approximately
$2.0 million for purchases of property and equipment. We
also use the net proceeds to fund our working capital
requirements throughout the year.

Stockholders

The number of stockholders of record as of
May 21, 2004 was approximately 137. This number excludes
beneficial stockholders whose stock is held in nominee or street
name by brokers.

Dividend Policy

We have never declared nor paid, and do not
currently intend to pay, a cash dividend on our common stock. We
currently expect to retain future earnings, if any, for use in
the operation and expansion of our business and do not
anticipate paying any cash dividends in the foreseeable future.
Our credit agreement with CapitalSource Finance LLC contains
covenants that limit our ability to pay dividends; see also
Item 7  Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Liquidity and Capital Resources.

Equity Compensation Plan Information

The information required hereunder is
incorporated by reference. Please refer to Exhibit 10.20:
1999 Stock Plan, as amended on April 11, 2003, and form
agreements thereunder, Exhibit 10.21:
2003 Directors Stock Option Plan and form agreements
thereunder, and Exhibit 10.22: 2003 Employee Stock Purchase
Plan and form agreements thereunder.

24



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##### Table of Contents








|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The table below shows selected financial data
for our last five fiscal years. Our fiscal year is based on a 52
or 53 week year and ends on the Sunday closest to the last
day in March. The following selected financial data should be
read in conjunction with the financial statements and the notes
thereto on Item 8 of Part II, Financial
Statements and Supplementary Data, and the information
contained in Item 7 of Part II,
Managements Discussion and Analysis of Financial
Condition and Results of Operations. Historical results
are not necessarily indicative of future results.

|                                                  |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |        |        | 
|------------------------------------------------- | -------------------------- | ------------------------------------- | ------ | --------- | ------ | --------- | ------ | -------- | ------ | -------- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                  |                            |                                      
|                                                  |                            | Year Ended                           
|                                                  |                            |                                      
|                                                  |                            | March 28,                             |        | March 30, |        | March 31, |        | April 1, |        | April 2,
|                                                  |                            | 2004                                  |        | 2003      |        | 2002      |        | 2001     |        | 2000    
|                                                  |                            |                                       |        |           |        |           |        |          |        |         
|                                                  |                            |                                      
|                                                  |                            | (In thousands, except per share data)
|Statements of Operations Data:                    |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |       
|Net revenues                                      |                            | $                                     | 79,308 |           |        | $         | 70,059 |          |        | $        | 55,778  |        |        | $ | 32,565  |        |        | $ | 8,035   |       
|Cost of sales                                     |                            |                                       | 39,594 |           |        |           | 36,577 |          |        |          | 31,446  |        |        |   | 19,800  |        |        |   | 5,899   |       
|                                                  |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |       
|Gross profit                                      |                            |                                       | 39,714 |           |        |           | 33,482 |          |        |          | 24,332  |        |        |   | 12,765  |        |        |   | 2,136   |       
|Operating expenses:                               |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |       
|                                                  | Fulfillment                |                                       |        | 12,206    |        |           |        | 10,769   |        |          |         | 9,030  |        |   |         | 6,160  |        |   |         | 1,774  |       
|                                                  | Marketing                  |                                       |        | 16,680    |        |           |        | 15,280   |        |          |         | 13,411 |        |   |         | 21,613 |        |   |         | 18,077 |       
|                                                  | General and administrative |                                       |        | 15,677    |        |           |        | 14,598   |        |          |         | 15,423 |        |   |         | 11,741 |        |   |         | 5,832  |       
|                                                  |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |       
|                                                  |                            | Total operating expenses              |        |           | 44,563 |           |        |          | 40,647 |          |         |        | 37,864 |   |         |        | 39,514 |   |         |        | 25,683 | 
|                                                  |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |       
|Loss from operations                              |                            |                                       | (4,849 | )         |        |           | (7,165 | )        |        |          | (13,532 | )      |        |   | (26,749 | )      |        |   | (23,547 | )     
|Interest income                                   |                            |                                       | 170    |           |        |           | 160    |          |        |          | 459     |        |        |   | 1,424   |        |        |   | 510     |       
|Interest expense                                  |                            |                                       | (449   | )         |        |           | (706   | )        |        |          | (1,036  | )      |        |   | (1,124  | )      |        |   | (201    | )     
|                                                  |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |       
|Net loss                                          |                            | $                                     | (5,128 | )         |        | $         | (7,711 | )        |        | $        | (14,109 | )      |        | $ | (26,449 | )      |        | $ | (23,238 | )     
|                                                  |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |       
|Deemed preferred stock dividend                   |                            |                                       |       |           |        |           |       |          |        |          |        |        |        |   |        |        |        |   | (1,032  | )     
|                                                  |                            |                                       |        |           |        |           |        |          |        |          |         |        |        |   |         |        |        |   |         |       
|Net loss attributable to common stockholders      |                            | $                                     | (5,128 | )         |        | $         | (7,711 | )        |        | $        | (14,109 | )      |        | $ | (26,449 | )      |        | $ | (24,270 | )     
|Net loss per common share  basic and
    diluted |                            | $                                     | (1.16  | )         |        | $         | (24.48 | )        |        | $        | (53.04  | )      |        | $ | (126.55 | )      |        | $ | (128.41 | )     
|Weighted average shares  basic and
    diluted   |                            |                                       | 4,422  |           |        |           | 315    |          |        |          | 266     |        |        |   | 209     |        |        |   | 189     |       

|                                                   |  |                |        |           |  |           |         |          |  |          |         |   |  |   |         |   |  |   |         |  
|-------------------------------------------------- |  | -------------- | ------ | --------- |  | --------- | ------- | -------- |  | -------- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                   |  |               
|                                                   |  | As of         
|                                                   |  |               
|                                                   |  | March 28,      |        | March 30, |  | March 31, |         | April 1, |  | April 2,
|                                                   |  | 2004           |        | 2003      |  | 2002      |         | 2001     |  | 2000    
|                                                   |  |                |        |           |  |           |         |          |  |         
|                                                   |  |               
|                                                   |  | (In thousands)
|Balance Sheet Data:                                |  |                |        |           |  |           |         |          |  |          |         |   |  |   |         |   |  |   |         |  
|Cash and equivalents                               |  | $              | 18,409 |           |  | $         | 4,997   |          |  | $        | 4,910   |   |  | $ | 11,248  |   |  | $ | 14,842  |  
|Working capital                                    |  |                | 27,638 |           |  |           | 7,179   |          |  |          | 483     |   |  |   | 19,087  |   |  |   | 14,982  |  
|Total assets                                       |  |                | 45,176 |           |  |           | 22,126  |          |  |          | 18,482  |   |  |   | 32,951  |   |  |   | 21,237  |  
|Capital lease obligations                          |  |                | 1,412  |           |  |           | 1,775   |          |  |          | 477     |   |  |   | 661     |   |  |   | 776     |  
|Total indebtedness                                 |  |                |       |           |  |           | 1,123   |          |  |          | 6,000   |   |  |   | 6,797   |   |  |   | 6,614   |  
|Mandatorily redeemable convertible preferred stock |  |                |       |           |  |           | 82,556  |          |  |          | 68,410  |   |  |   | 68,162  |   |  |   | 34,158  |  
|Stockholders equity (deficit)                     |  |                | 33,917 |           |  |           | (71,451 | )        |  |          | (64,191 | ) |  |   | (51,439 | ) |  |   | (25,513 | )

25



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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion should be read in
conjunction with Item 1 of Part 1
Business  Factors That May Affect Future
Results and Item 8 of Part II, Financial
Statements and Supplementary Data.

Forward-Looking Statements

This report, together with the documents
incorporated herein by reference,contains forward-looking
statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the
Securities and Exchange Act of 1934, as amended. Such statements
are based upon current expectations and involve risks and
uncertainties. Any statements contained in this report that are
not purely statements of historical fact may be deemed to be
forward-looking statements. Such forward-looking statements may
include but are not limited to statements regarding our future
operations and enhancements, product offerings, business,
financial condition, results of operations and prospects.
Additionally, statements concerning possible changes in
applicable rules or legislation are forward-looking statements.
Words such as expects, anticipates,
intends, plans, believes,
seeks, estimate, may,
should, 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 above in this report under Factors That May Affect
Future Results, and elsewhere in this report, and those
contained from time to time in our other filings with the SEC.
We caution investors that our business and financial performance
are subject to substantial risks and uncertainties.

Overview

In fiscal year 2004, our net revenues increased
13.2% to $79.3 million. Gross margins increased to 50.1%
from 47.8% in fiscal year 2003. Our net loss decreased to
$5.1 million compared to $7.7 million in the prior
fiscal year. On September 30, 2003, we completed our
initial public offering whereby we sold 2.2 million shares
of our common stock at $14 per share and received proceeds
of approximately $29.0 million (after underwriters
discounts of $1.8 million). Total related offering expenses
were approximately $1.5 million, excluding
underwriters discounts.

As we attempt to grow our business, our marketing
campaigns are an integral part of accomplishing this goal. The
challenges associated with marketing include determining the
appropriate amount to spend in order to generate additional net
revenues, and the allocation of resources between our different
marketing channels. We constantly need to balance our efforts to
grow our net revenues with the impact on profitability. In
fiscal year 2004, we sought to improve the efficiency of our
marketing campaigns, by increasing our marketing spend for
online marketing programs which had lower marketing cost as a
percentage of revenues than our catalog programs. We also sought
to improve the performance of our catalogs. While we circulated
roughly the same number of catalogs as the prior fiscal year, we
introduced two new catalogs: one dedicated solely to jewelry
products which was introduced in the first quarter of fiscal
2004 and one featuring non-seasonal gifts for all occasions
which debuted in second quarter of fiscal 2004. We partially
offset the costs associated with these incremental catalogs by
reducing the prospecting for new customers through our Holiday
catalog by approximately 2.0 million catalogs.

We terminated our relationship with our
third-party fulfillment services provider and assumed control of
our fulfillment services in August 2003. In fiscal year 2004, we
experienced some operational execution issues. In the third
quarter of fiscal 2004, conservative inventory purchasing,
operational difficulties in our fulfillment center and sourcing
problems with respect to some of our products led to our
inability to satisfy customer demand. Specifically, we
experienced delays and errors in the fulfillment process at our
fulfillment center, which prevented us from fulfilling demand
for our products. In addition, the anticipated efficiencies from
managing the fulfillment center ourselves did not materialize.
Improvements in managing our fulfillment

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##### Table of Contents



center will be a key objective during the coming
months. Our current plans include revising certain materials
handling processes and implementing new warehouse management
software. We believe that these changes will allow us to better
manage our fulfillment operations and scale our business. If we
are unable to improve the performance of the fulfillment process
at our fulfillment center, we may incur additional labor and
shipping costs, fail to satisfy demand for our products or
experience customer dissatisfaction, any of which could have an
adverse affect on our business, financial condition, and
operating results. Achieving operational effectiveness at times
of peak demand and the appropriate mix and amount of inventory
will continue to be critical areas of management focus.


For fiscal year 2005, our efforts will be focused
largely around the following three strategic initiatives:
improving the operational execution throughout our supply chain
including our fulfillment center; expanding our marketing
campaigns, and continued development and expansion of our unique
and proprietary product assortment. We believe investment in
these initiatives will result in higher top line growth,
scalability, and increased efficiency of our operations.
Moreover, we believe these investments are vital to support the
future growth of the Company.

To improve our operational execution, we will
make investments in our warehouse management systems and
training programs at our fulfillment center. We are also in the
process of improving our materials handling processing by
implementing RF scanning, additional conveyors and layout
modifications at the fulfillment center. Additionally, to
support our increased overseas sourcing and more actively manage
our increasingly diverse manufacturing base, we have created an
internal sourcing team to improve the management of our supply
chain. We believe that these initiatives will increase our order
fulfillment rates, reduce customer return rates, and improve
inventory management.

In developing our expanded marketing strategy, we
identified the positives and negatives of online and catalog
marketing campaigns. Online marketing can be an efficient means
to acquire new customers. However, there are limitations under
this approach in communicating our brand image as online
marketing programs may be limited to key word search results or
banner advertisements that only display our logo. Moreover,
while e-mail campaigns can be an efficient program for acquiring
and retaining customers, the advent of spam filtering programs
and increased government regulation concerning e-mail marketing
may cause e-mail marketing campaigns to be less effective and/or
more expensive in the future. By circulating catalogs, we are
able, in general, to communicate our brand image more
effectively than online programs through the use of lifestyle
and product pictures. However, customer acquisition through
catalog campaigns can be less profitable than other marketing
channels. We expect to continue utilizing these types of
marketing campaigns while continually monitoring the
effectiveness of these campaigns.

As a result of these factors, we also plan to
compliment our existing marketing campaigns with other means of
advertising aimed at increasing brand awareness with new
customers as well as retention of existing customers. While we
have not finalized the methods of advertising, the campaigns
could include print, television, or radio. We anticipate the
costs of marketing through these methods will be higher than
catalog and online marketing alone. These marketing campaigns
are expected to occur in the second half of our fiscal year. In
addition, the costs to develop these marketing campaigns will be
made in advance of the expected revenue stream. We are also
currently developing a catalog for corporate gift-giving that
includes specific products and creative marketing designed for
the corporate customer.

In addition, to support the future growth of our
business, we will be making investments in areas such as
merchandising and product development. We believe investing in
these areas will provide customers with affordable upscale,
modern and unique gifts.

Fiscal year 2005 will be our first full year as a
public company and, as a result, we expect the costs of
compliance will be higher than in our prior fiscal year.

Although we are committed to our strategic
initiatives, there are inherent risks associated with our
business that may present challenges for us in the future and
could prevent us from achieving intended revenue growth,
scalability and increased efficiencies. We have outlined
currently identified risks within the Factors That May
Affect Future Results section of this Annual Report on
Form 10-K. In addition, the

27



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following discussion and analysis of financial
condition, results of operations, liquidity and capital
resources should be read in conjunction with our audited
financial statements and the notes thereto.


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. In particular, 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 $0.2 million and
$0.1 million as of March 28, 2004 and March 30,
2003, respectively.

Shipping and Handling
Costs.Shipping costs, which include
inbound and outbound freight costs 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 fiscal years
ended March 28, 2004, March 30, 2003 and
March 31, 2002 were $4.7 million, $3.8 million
and $2.8 million, respectively. Our gross profit may not be
comparable to other entities, which may allocate all shipping
and handling costs to either cost of sales, resulting in lower
gross profit, or operating expenses, resulting in higher gross
profit.

Inventory.Inventories, net of an allowance for excess quantities and
obsolescence, are stated at the lower of cost or market. We
estimate a provision for damaged, obsolete, excess and
slow-moving inventory based on inventory aging reports and
specific identification. If actual obsolescence is different
from our estimate, we will adjust our provision accordingly.
Specific reserves are recorded in the event the cost of the
inventory exceeds the fair market value. In addition, we
estimate a reserve for expected inventory shrinkage based on
historical shrinkage factors and our current inventory levels.
Actual shrinkage is recorded at year-end based on the results of
our physical inventory count. For the fiscal years ended
March 28, 2004, March 30, 2003, and March 31,
2002, we wrote down inventory of approximately
$0.3 million, $0.6 million, and $0.4 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 28, 2004, we had recorded
a valuation allowance of $28.0 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

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costs and are amortized over their expected
period of future benefit which generally does not exceed two
months. 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. Our
estimate of undiscounted future cash flows is based upon our
experience, historical operations, estimates of future
profitability and economic conditions. During fiscal 2002, we
recorded a $1.2 million impairment charge related to
certain software related to our website that was no longer being
utilized due to system enhancements completed during fiscal 2002.

Stock based
compensation.We account for stock
options granted to employees using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees.
Accordingly, no compensation expense has been recognized in the
financial statements for stock options. SFAS No. 123,
Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure,
however, requires the disclosure of pro forma net earnings and
earnings per share as if we had adopted the fair value method.
Under SFAS No. 123, the fair value of stock-based
awards to employees is calculated through the use of option
pricing models. These models require subjective assumptions,
including future stock price volatility and expected time to
exercise, which affect the calculated values. Our calculations
are based on a single option valuation approach and forfeitures
are recognized as they occur.

In fiscal 2000, we granted approximately
0.4 million options to employees at an exercise price that
was less than the fair market value of our stock on the date of
grant. We recorded $1.8 million of deferred compensation
related to these option grants, which is included as a separate
component of stockholders equity, and is being amortized
over the vesting period of the awards. We recorded amortization
expense of $132,000, $359,000, and $406,000 in fiscal 2004,
2003, and 2002, respectively, which is included in general and
administrative expenses in the statements of operations.

In fiscal 2004, we granted approximately
0.3 million options to employees at an exercise price that
was less than the fair market value of our stock on the date of
grant. We recorded $0.7 million of deferred compensation
related to these option grants, which is included as a separate
component of stockholders equity, and is being amortized
over the vesting period of the awards. We recorded amortization
expense of $130,000 in fiscal 2004, which is included in general
and administrative expenses in the statements of operations.

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Results of Operations

The following table sets forth our statements of
operations data expressed as a percentage of net revenues. Our
fiscal year is based on a 52 or 53-week year. The fiscal year
ends on the Sunday closest to March 31.

|                              |                            |                                 |       |           |      |           |       |      |      |  |       |      |      | 
|----------------------------- | -------------------------- | ------------------------------- | ----- | --------- | ---- | --------- | ----- | ---- | ---- |  | ----- | ---- | ---- | 
|                              |                            |                                
|                              |                            | Year Ended                     
|                              |                            |                                
|                              |                            | March 28,                       |       | March 30, |      | March 31,
|                              |                            | 2004                            |       | 2003      |      | 2002     
|                              |                            |                                 |       |           |      |          
|                              |                            |                                
|                              |                            | (As percentage of net revenues)
|Statements of Operation Data: |                            |                                 |       |           |      |           |       |      |      |  |       |     
|Net revenues                  |                            |                                 | 100.0 | %         |      |           | 100.0 | %    |      |  | 100.0 | %   
|Cost of sales                 |                            |                                 | 49.9  |           |      |           | 52.2  |      |      |  | 56.4  |     
|                              |                            |                                 |       |           |      |           |       |      |      |  |       |     
|Gross profit                  |                            |                                 | 50.1  |           |      |           | 47.8  |      |      |  | 43.6  |     
|Operating expenses:           |                            |                                 |       |           |      |           |       |      |      |  |       |     
|                              | Fulfillment                |                                 |       | 15.4      |      |           |       | 15.4 |      |  |       | 16.2 |     
|                              | Marketing                  |                                 |       | 21.0      |      |           |       | 21.8 |      |  |       | 24.0 |     
|                              | General and administrative |                                 |       | 19.8      |      |           |       | 20.8 |      |  |       | 27.7 |     
|                              |                            |                                 |       |           |      |           |       |      |      |  |       |     
|                              |                            | Total operating expenses        |       |           | 56.2 |           |       |      | 58.0 |  |       |      | 67.9 | 
|                              |                            |                                 |       |           |      |           |       |      |      |  |       |     
|Loss from operations          |                            |                                 | (6.1  | )         |      |           | (10.2 | )    |      |  | (24.3 | )   
|Interest income               |                            |                                 | 0.2   |           |      |           | 0.2   |      |      |  | 0.8   |     
|Interest expense              |                            |                                 | (0.6  | )         |      |           | (1.0  | )    |      |  | (1.8  | )   
|                              |                            |                                 |       |           |      |           |       |      |      |  |       |     
|Net loss                      |                            |                                 | (6.5  | )%        |      |           | (11.0 | )%   |      |  | (25.3 | )%  
|                              |                            |                                 |       |           |      |           |       |      |      |  |       |     

Comparison of Years Ended March 28,
2004 with March 30, 2003

Net Revenues

Our net revenues are comprised of product sales,
shipping revenue and gift-wrap revenue. Revenues are recorded
net of estimated returns, coupons redeemed by customers, and
other discounts. Our shipping revenue represents the amounts we
charge our customers for delivering the product. Our gift wrap
revenue consists of amounts we charge our customers for our
signature red gift boxes.

Net revenues were $79.3 million and
$70.1 million for fiscal 2004 and 2003, respectively,
representing a 13.2% increase. The increase was primarily due to
increased demand for our products resulting from additional
marketing efforts through our online and catalog campaigns.
During fiscal 2004, we increased our online marketing programs
compared to the prior year. Online revenues, through search,
portals, and affiliates, grew 44% over the prior year. Revenues
from customers who receive our catalogs, grew 9% over the prior
year. In the first quarter of fiscal 2004, we introduced a
catalog dedicated solely to jewelry products. Also, in the
second quarter of fiscal 2004, we introduced a new catalog that
featured non-seasonal gifts for all occasions. For the third
quarter of fiscal 2004, our Holiday catalog circulation
decreased by approximately 2.0 million catalogs, or 21.7%,
from the same period in the prior year. For fiscal 2004, we
circulated approximately the same number of catalogs as the
prior fiscal year. The number of orders increased approximately
12.2% over fiscal 2003. Net revenues per order decreased by
approximately 0.9% over fiscal 2003. This was primarily
attributable to lower shipping revenues for the third and fourth
quarters of fiscal 2004 in comparison to the third and fourth
quarters of fiscal 2003. As of March 28, 2004, we had
approximately 1.8 million customers which was an increase
of 0.5 million customers over fiscal 2003.

From the second quarter of fiscal 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. In
August of 2003, we changed the delivery charge for standard
ground delivery to a flat rate regardless of order value. For
expedited delivery methods, we charge a flat fee over the
standard delivery charge. Periodically, we offer shipping
discount promotions intended to increase order volume. The
change to

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flat rate shipping and shipping discount
promotions did not result in an increase in order volume to
offset the reduction in shipping revenues during fiscal 2004. In
addition, during the third quarter of fiscal 2004, we
experienced unexpectedly high demand for some new proprietary
products, which we had bought conservatively. The resulting
inventory deficiencies caused missed revenue opportunities. We
also ran into limitations in our ability to timely fulfill
certain personalized items in our assortment. Rather than
disappoint customers with late deliveries, in some cases we let
customers know that items would not arrive on time, and this led
to order cancellations. With additional and timely training of
the core staff, management changes at the warehouse, process
changes, and the expected implementation of new warehouse,
financial and order entry software, we believe that we will
improve the operating efficiency of the warehouse, although
there can be no assurance that we will be successful in this
endeavor. If we are unable to appropriately manage our inventory
levels, our customers may become dissatisfied and look to our
competitors for their gift items. Furthermore, if we are unable
to improve the performance of the fulfillment process at our
distribution center, this may result in unsatisfied customers
and order cancellations, which would adversely affect our
business.


Cost of Sales

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

Cost of sales were $39.6 million and
$36.6 million for fiscal 2004 and 2003, respectively,
representing 49.9% and 52.2% of net revenues, respectively. The
8.2% increase in cost of sales was mainly attributable to the
13.2% increase in net revenues as well as additional shipping
costs incurred during December 2003. During
December 2003, we expedited delivery of certain orders due
to delays in the fulfillment process at our distribution center.
The expedited delivery methods resulted in additional shipping
costs above our expectations. The decrease in cost of sales as a
percentage of net revenues was primarily attributable to higher
average product margins resulting from an increase in overseas
product sourcing, which typically have lower product costs. This
was slightly offset, however, by higher shipping costs as a
result of the aforementioned increase in expedited delivery. If
we are unable to improve the performance of the fulfillment
process at our distribution center, we may be required to
expedite delivery of products which will result in additional
shipping costs which would increase our cost of sales.

Operating Expenses

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

Fulfillment expenses were $12.2 million and
$10.8 million for fiscal 2004 and 2003, respectively,
representing in each year 15.4% of net revenues. The increase in
dollars was primarily attributable to the 12.2% increase in the
number of orders, specifically labor costs incurred at our
distribution center during the third quarter of fiscal 2004. In
addition, delays in the fulfillment process at our distribution
center, required us to utilize more seasonal employees and incur
more overtime hours than anticipated. To address the prior
delays, we are in the process of revising certain materials
handling processes, implementing new warehouse management
software, and effecting management changes. We believe that
these changes will allow us to better manage our fulfillment
operations and scale our business. If we are unable to improve
the performance of the fulfillment process at our distribution
center or if our planned modifications cost more than we
anticipate, our business and operating results could be
materially harmed.

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

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Marketing expenses were $16.7 million and
$15.3 million for fiscal 2004 and 2003, respectively,
representing 21.0% and 21.8% of net revenues, respectively. The
increase in dollars was primarily due to the additional spending
in our online marketing channels. In addition, we introduced
television advertising, which led to additional interest in our
products and catalogs. These increases were slightly offset by a
decrease in our catalog expenses. While we circulated
approximately the same number of catalogs as the prior fiscal
year, we were able to achieve certain costs efficiencies related
to paper and production. The cost efficiencies associated with
our catalog business resulted in a slight decrease in our
marketing expenses as a percentage of net revenues. Currently,
we plan to consider marketing opportunities through television,
radio, and print advertising to further enhance our brand. In
addition, we currently plan on increasing the number of catalogs
circulated. As of March 28, 2004, the number of existing
customers had increased approximately 0.5 million from the
end of fiscal 2003. We intend to increase the amount of catalog
prospecting in fiscal 2005 compared to fiscal 2004. If we are
unsuccessful in generating revenues through these marketing
vehicles, our operating results could be adversely affected.

General and
Administrative.General and
administrative expenses consist of wages and benefits for 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.

General and administrative expenses were
$15.7 million and $14.6 million for fiscal 2004 and
2003, respectively, representing 19.8% and 20.8% of net
revenues, respectively. The increase in dollars was primarily
due to severance costs related to former employees of
$0.6 million and higher costs associated with being a
public company. As a percentage of net revenues, the decrease
was primarily due to similar costs allocated over a larger
revenue base. As of March 28, 2004, we had a total of
approximately $0.3 million in deferred compensation expense
as a result of stock options issued in fiscal 2000 and fiscal
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 $65,000 in each of
the fiscal 2005-2008, less any cancellations or forfeitures of
stock options subject to the deferred compensation. The planned
implementation of new software systems in fiscal 2005 will
result in additional depreciation expense. In addition, the
regulatory requirements associated with being a public company
will likely increase our accounting and legal expenses. We
currently plan on slightly increasing our general employee
headcount (i.e., employees other than fulfillment and customer
service employees) in order to support future business needs,
which will add to general and administrative expenses.

Other Income and Expenses

Interest Income.Interest income was $0.2 million for each of fiscal 2004
and 2003.

Interest Expense.Interest expense was $0.4 million and $0.7 million for
fiscal 2004 and 2003, respectively. The decrease was
attributable to lower amounts of debt outstanding.

Income Taxes.As of
March 28, 2004, we had $100.5 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.

Comparison of Years Ended March 30,
2003 with March 31, 2002

Revenues

During fiscal 2003, net revenues increased 25.6%
from $55.8 million to $70.1 million relative to the
prior year. This was primarily due to increased demand for our
products resulting from additional marketing efforts through our
catalog campaigns. During fiscal 2003, we increased our catalog
circulation by approximately 3.6 million catalogs, or
23.3%. The number of orders increased approximately 17% and the
revenue per order increased approximately 7%. Our customer base
increased from approximately 853,000 to approximately
1.3 million. In addition, in the second quarter of fiscal
2003, we began to base our delivery charge on the order

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value of the transaction. Prior to this change,
the amount charged to the customer was a flat rate regardless of
the order value. As a result of this change, our average
shipping revenue per order increased approximately 24%.


Cost of Sales

Cost of sales were $36.6 million and
$31.4 million for fiscal 2003 and 2002, respectively,
representing 52.2% and 56.4% of net revenues, respectively. The
increase in dollars was mainly attributable to the 25.6%
increase in net revenues. The decrease in cost of sales as a
percentage of net revenues in fiscal 2003 compared to fiscal
2002 was primarily a result of our improved cost leverage with
vendors due to increased volumes of merchandise that we
purchased and the sale of higher margin products on average.

Operating Expenses

Fulfillment.Fulfillment expenses were $10.8 million and
$9.0 million for fiscal 2003 and 2002, respectively. As a
percentage of net revenues, fulfillment was 15.4% in fiscal 2003
and 16.2% in fiscal 2002. The increase in dollars was primarily
attributable to the 17% increase in the number of orders. The
cost to fulfill orders through our third party distribution
center increased approximately $0.9 million. There was an
increase of approximately $0.2 million in salaries at our
customer service center for additional employees hired to
accommodate the increase in sales transactions. Our credit card
processing fees increased approximately $0.3 million due to
the increase in revenues. In addition, rent and utilities at our
third party distribution center and our customer service
facility increased approximately $0.4 million. The decrease
in fulfillment expenses as a percentage of net revenues was
primarily attributable to economies of scale achieved through an
increased number of sales transactions and higher average order
value.

Marketing.Marketing
expenses were $15.3 million and $13.4 million for
fiscal 2004 and 2003, respectively As a percentage of net
revenues, marketing expenses were 21.8% in fiscal 2003 and 24.0%
in fiscal 2002. The increase in dollars was primarily due to the
increase in catalog circulation. We mailed approximately
15.1 million catalogs in fiscal 2002 and 18.7 million
in fiscal 2003. As a result, costs for catalog printing, postage
and lists increased approximately $2.4 million. This
increase was partially offset by decreases in spending related
to online marketing programs of approximately $0.6 million.

General and
Administrative.General and
administrative expenses were $14.6 million and
$15.4 million for fiscal 2003 and 2002, respectively. As a
percentage of net revenues, general and administrative expenses
were 20.8% in fiscal 2003 and 27.7% in fiscal 2002. The
decreases were primarily due to an impairment charge of
approximately $1.2 million incurred in fiscal 2002, as well
as reductions in bonuses, travel, depreciation and recruiting
costs of approximately $0.8 million. These decreases were
offset in part by increases in salaries of approximately
$1.0 million due to additional employees hired and
severance paid to former employees. During fiscal 2002, due to
system enhancements completed during fiscal 2002, the Company
determined that certain software related to our website was no
longer being utilized. As a result, the Company identified
$1.2 million of unamortized costs associated with the
unused software and wrote off these costs during fiscal 2002.

Other Income and Expenses

Interest Income.Interest income was $0.2 million and $0.5 million in
fiscal 2003 and 2002, respectively. The decrease was primarily
due to lower average interest rates earned in fiscal 2003.

Interest Expense.Interest expense was $0.7 million and $1.0 million in
fiscal 2003 and 2002, respectively. The decrease was primarily
due to a reduction of approximately $4.8 million in our
outstanding debt.

Liquidity and Capital Resources

We have funded our operations through
March 28, 2004 primarily through private sales of equity
securities, borrowings, and the completion of our initial public
offering which resulted in net offering proceeds of
approximately $29.0 million. Historically, revenues have
been seasonal. Revenues have been higher in the

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third fiscal quarter, reflecting higher consumer
holiday spending. As a result, our cash balances are seasonal in
nature, with the third fiscal quarter representing a
significantly higher level of cash than other periods.
Throughout the fiscal year, we utilize our cash balances to
build our inventory levels with the most significant use of
working capital occurring immediately prior to the month of
December. In addition to our current cash balances on-hand, we
have an $11.0 million revolving credit facility which
allows us to borrow funds for working capital purposes, subject
to certain provisions.


Cash Flows From Operating
Activities Net cash flows
used in operating activities was $0.7 million,
$6.9 million and $11.5 million for fiscal 2004, 2003,
and 2002, respectively. In fiscal 2004, net cash used in
operating activities decreased by $6.1 million from fiscal
2003, resulting primarily from revenue growth of 13% and related
higher gross profit, partially offset by higher operating
expenses and by changes in working capital. Specifically, there
was an increase in our accrued expenses and other current
liabilities for accrued severance, shipping, legal, and salary
expenses. Our merchandise inventories remained consistent with
the prior fiscal year balance. This was primarily due to
improved inventory management and slightly lower number of
products compared to fiscal 2003. In fiscal 2003, net cash used
in operating activities decreased by $4.6 million from
fiscal 2002, resulting primarily from revenue growth of 26% and
related higher gross profit, partially offset by higher
operating expenses and by changes in working capital.
Specifically, there was an increase in our merchandise
inventories in anticipation of higher sales as well as our
decision to maintain higher levels of inventory for core
merchandise.

Cash Flows From Investing
Activities Net cash flows
(used in) provided by investing activities was
($11.3) million, ($1.5) million and $6.3 million
for fiscal 2004, 2003, and 2002, respectively. Uses of cash flow
for investing activities were for purchases of investments as
well as capital expenditures for property and equipment.
Currently, we are planning capital expenditures for software
systems to support our financial, warehouse management, and
order management functions. We believe the implementation of
these software systems will support the needs of our business
and customers. Software implementation projects entail
significant technical and business risks. If we are unsuccessful
in implementing these systems, it may hinder our ability to
process and fulfill customer orders as well as complete critical
financial processing transactions. These capital expenditures
may result in an increase in our depreciation expense. We
currently estimate spending between $1.2 million and
$1.5 million over the next twelve months on the financial
and warehouse management systems. In addition, we are
considering projects for an order management system and other
warehouse upgrades which we estimate may range between $1.5 to
$2.0 million. Although we believe these estimates on
expenditures to be reasonable given the current facts and
circumstances available to us, we can offer no assurance that
the actual amounts expended will not be greater.

Cash Flows From Financing
Activities Net cash flows
provided by (used in) financing activities were
$25.4 million, $8.5 million and ($1.2) million
for fiscal years 2004, 2003, and 2002, respectively. For fiscal
2004, net cash provided by financing activities consisted of the
net proceeds from our initial public offering whereby we sold
2.2 million shares of our common stock at $14 per
share and received proceeds of approximately $29.0 million
(after underwriters discount of $1.8 million)
slightly offset by payments on an existing line of credit as
well as a $1.1 million repayment of a loan, plus our
initial public offering related expenses of approximately
$1.5 million. For fiscal 2003, net cash provided by
financing activities consisted primarily of approximately
$13.6 million of net proceeds from the issuance of
Series F convertible preferred stock slightly offset by a
$4.8 million repayment of a loan. For fiscal 2002, cash
used in financing activities consisted of payments of
$1.2 million on an outstanding working capital line of
credit and capital lease obligations.

Revolving Credit Facility We also have funds available of up to
$11 million pursuant to its revolving credit facility with
CapitalSource Finance LLC, which is described more fully in
Note 6 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 March 28, 2004,
we were not in compliance with the EBITDA, Inventory Ratio, and
Change in Control covenants contained in the credit agreement
and such breach constituted an event of default under the credit
agreement, and we have failed to comply with such covenants in
prior months during the term of the credit facility. On
April 29, 2004, CapitalSource Finance LLC agreed to waive
such non-compliance with such covenants which was designated as
the First Amendment to the credit facility

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agreement. CapitalSource Finance LLC previously
has waived non-compliance with such covenants as of prior dates.
At March 28, 2004, we had no borrowings under the revolving
credit facility.


On June 21, 2004, the Company amended the
terms of its credit facility with CapitalSource Finance LLC.
Under the terms of this Second Amendment, certain covenants for
inventory ratios and capital expenditure limitations were
eliminated. The minimum earnings before interest, taxes,
depreciation and amortization (EBITDA) covenant was modified,
and quarterly minimum unrestricted cash balance levels were
established. Further, under this Second Amendment, the EBITDA
and minimum unrestricted cash balance covenants were modified
such that they are not applicable unless borrowings are
outstanding.

In advance of any borrowings, the Company is
required to deliver to CapitalSource Finance LLC written
notification of its intent to borrow, certain consents from the
Companys landlords and credit card processing firm, a list
of domain name registrations, evidence of compliance with EBITDA
and minimum unrestricted cash balance levels on a prospective
basis, and historical and prospective financial statements. In
addition, CapitalSource Finance LLC may perform due diligence on
the Companys financial projections.

We believe that the cash currently on hand will
be sufficient to continue operations through at least the next
twelve months. Our assessment is based on historical working
capital needs, operating loss trends, and current business
outlook. Beyond the next twelve months, we intend to utilize the
cash generated from operations to fund operations and capital
expenditures. Additionally, equity and or debt financing may
need to be obtained to support our long-term obligations and
needs. However, there can be no assurance that if additional
financing is necessary it will be available, or if available,
that such financing can be obtained on satisfactory terms or
without undue dilution to, or an adverse impact on the rights
of, our existing stockholders. Failure to generate sufficient
revenues or raise additional capital could have a material
adverse effect on our ability to continue as a going concern and
to achieve our intended business objectives.

Contractual Obligations

The following table summarizes significant
contractual obligations as of March 28, 2004:

|                     |  |                        |        |           |  |           |        |           |  |               |       |  |  |   |   |  |  |   |   | 
|-------------------- |  | ---------------------- | ------ | --------- |  | --------- | ------ | --------- |  | ------------- | ----- |  |  | - | - |  |  | - | - | 
|                     |  |                       
|                     |  | Payments Due by Period
|                     |  |                       
|                     |  |                        |        | Less Than |  |          
|                     |  | Total                  |        | 1 Year    |  | 1-3 Years |        | 4-5 Years |  | After 5 Years
|                     |  |                        |        |           |  |           |        |           |  |              
|                     |  |                       
|                     |  | (In thousands)        
|Capital leases       |  | $                      | 1,556  |           |  | $         | 691    |           |  | $             | 865   |  |  | $ |  |  |  | $ |  | 
|Operating leases     |  |                        | 2,140  |           |  |           | 1,174  |           |  |               | 966   |  |  |   |  |  |  |   |  | 
|Purchase obligations |  |                        | 10,140 |           |  |           | 10,126 |           |  |               | 14    |  |  |   |  |  |  |   |  | 
|                     |  |                        |        |           |  |           |        |           |  |               |       |  |  |   |   |  |  |   |   | 
|Total                |  | $                      | 13,836 |           |  | $         | 11,991 |           |  | $             | 1,845 |  |  | $ |  |  |  | $ |  | 
|                     |  |                        |        |           |  |           |        |           |  |               |       |  |  |   |   |  |  |   |   | 

Capital
Leases Our
$1.6 million of capital lease obligations consist primarily
of equipment used at our fulfillment center. The terms of these
leases extends into our fiscal year 2007. At the end of the
lease term, we have the option to purchase the equipment for $1.

Operating
Leases At March 28,
2004, we had operating lease obligations of approximately
$2.1 million. Our operating lease obligations primarily
consist of payments related to properties that we occupy for our
headquarters, customer service center and fulfillment center.
The lease terms expire in September 2004, March 2005,
and July 2006, respectively. We are currently negotiating a
lease for new headquarters space in San Francisco, California,
but there are no assurances these negotiations will be
successful.

Purchase
Obligations Amounts
represent estimated commitments at March 28, 2004 to
purchase inventory and other goods and services in the normal
course of business to meet operational requirements. These
obligations are expected to be paid in future periods as stated
in the table.

Other Contractual
Arrangements In our normal
course of business, we are party to a variety of contractual
agreements under which we may be obligated to indemnify the
other party for certain matters. These contracts primarily
relate to our commercial partnerships, supply agreements,
operating leases, license agreements, financial agreements and
various other agreements. Under these contracts, we may provide

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certain routine indemnifications relating to
representations and warranties, property damage or personal
injury matters. The terms of these indemnifications range in
duration and may not be explicitly defined. Historically, we
have not made significant payments for these indemnifications.
We believe that if we were to incur a loss in any of these
matters, the loss could have a material adverse effect on our
financial condition or results of operations.


Commercial Commitments

The following table provides summary information
concerning our outstanding commercial commitments as of
March 28, 2004:

|                          |  |                        |     |           |  |           |     |           |  |               |   |  |  |   |   |  |  |   |   | 
|------------------------- |  | ---------------------- | --- | --------- |  | --------- | --- | --------- |  | ------------- | - |  |  | - | - |  |  | - | - | 
|                          |  |                       
|                          |  | Payments Due by Period
|                          |  |                       
|                          |  |                        |     | Less Than |  |          
|                          |  | Total                  |     | 1 Year    |  | 1-3 Years |     | 4-5 Years |  | After 5 Years
|                          |  |                        |     |           |  |           |     |           |  |              
|                          |  |                       
|                          |  | (In thousands)        
|Revolving credit facility |  | $                      |    |           |  | $         |    |           |  | $             |  |  |  | $ |  |  |  | $ |  | 
|Letters of credit         |  |                        | 130 |           |  |           | 130 |           |  |               |  |  |  |   |  |  |  |   |  | 
|                          |  |                        |     |           |  |           |     |           |  |               |   |  |  |   |   |  |  |   |   | 
|Total                     |  | $                      | 130 |           |  | $         | 130 |           |  | $             |  |  |  | $ |  |  |  | $ |  | 
|                          |  |                        |     |           |  |           |     |           |  |               |   |  |  |   |   |  |  |   |   | 

Revolving Credit
Facility We have available
up to $11 million pursuant to its revolving credit facility
with CapitalSource Finance LLC, which is described more fully in
Note 6 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 March 28, 2004,
we were not in compliance with the EBITDA, Inventory Ratio, and
Change in Control covenants contained in the credit agreement
and such breach constituted an event of default under the credit
agreement. On April 29, 2004, CapitalSource Finance LLC
agreed to waive such non-compliance with such covenants which
was designated as the First Amendment to the credit facility
agreement. We are currently able to draw down funds under this
credit facility. At March 28, 2004, we had no borrowings
under the revolving credit facility.

On June 21, 2004, the Company amended the
terms of its credit facility with CapitalSource Finance LLC.
Under the terms of this Second Amendment, certain covenants for
inventory ratios and capital expenditure limitations were
eliminated. The minimum earnings before interest, taxes,
depreciation and amortization (EBITDA) covenant was modified,
and quarterly minimum unrestricted cash balance levels were
established. Further, under this Second Amendment, the EBITDA
and minimum unrestricted cash balance covenants were modified
such that they are not applicable unless borrowings are
outstanding.

In advance of any borrowings, the Company is
required to deliver to CapitalSource Finance LLC written
notification of its intent to borrow, certain consents from the
Companys landlords and credit card processing firm, a list
of domain name registrations, evidence of compliance with EBITDA
and minimum unrestricted cash balance levels on a prospective
basis, and historical and prospective financial statements. In
addition, CapitalSource Finance LLC may perform due diligence on
the Companys financial projections.

Letters of
Credit We have letters of
credit outstanding associated with our headquarters office space
in San Francisco and a marketing agreement. Both letters of
credit will expire in fiscal 2005 and are classified as
restricted cash on the balance sheets of our financial
statements.

Recently Issued Accounting Standards

In January 2003, the FASB (Financial Accounting
Standards Board) issued FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51(FIN 46). FIN 46 requires certain
variable interest entities to be consolidated by the primary
beneficiary of the entity under certain conditions. The Company
does not have any involvement in variable interest entities. The
adoption of FIN 46 did not have a material impact on the
Companys results of operations, financial position or cash
flows.

In May 2003, the 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

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redeemable, among other financial instruments,
which embody an unconditional obligation requiring the issuer to
redeem them by transferring its assets at a specified or
determinable date or upon an event that is certain to occur, be
classified as liabilities. We adopted SFAS No. 150
effective June 30, 2003. The adoption of this statement did
not have an impact on the Companys financial statements.







|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Interest Rate RiskWe currently maintain a portfolio of fixed and variable
investments consisting of cash equivalents, short-term
marketable securities and long-term marketable securities, which
can be affected by changes in market interest rates. The
objective of our investment activities is to preserve principal,
while at the same time maximizing yields without significantly
increasing risk. To achieve this objective, we invest in highly
liquid, investment grade and government debt securities. Our
investments in debt securities are subject to interest rate
risk. According to our investment policy, we may invest in
taxable and tax exempt instruments. In addition, the policy
establishes limits on credit quality, maturity, issuer and type
of instrument. Marketable securities are classified as
available for sale. Marketable securities are
comprised of government securities and corporate bonds. We do
not use derivative financial instruments in our investment
portfolio. (See Note 3 of Notes to Financial Statements)

All highly liquid investments with maturity of
three months or less at the date of purchase are considered to
be cash equivalents. The remaining investments in marketable
securities are considered short-term investments if original
maturities range over three months but less than one year, or
long term investments if original maturities are one year or
longer.

The following table lists our cash and cash
equivalents, short-term investments and long-term investments at
March 28, 2004:

|                          |  |                |        | 
|------------------------- |  | -------------- | ------ | 
|                          |  | March 28, 2004
|                          |  |               
|                          |  | (In thousands)
|Cash and cash equivalents |  | $              | 18,409 | 
|Short-term investments    |  |                | 6,971  | 
|Long-term investments     |  |                | 1,844  | 
|                          |  |                |        | 
|Total                     |  | $              | 27,224 | 
|                          |  |                |        | 

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

Foreign Currency
RiskWe purchase a significant amount
of inventory from vendors outside of the U.S. in
transactions that are denominated in U.S. dollars. As of
March 28, 2004, any currency risks related to these
transactions were not significant to us. A decline in the
relative value of the U.S. dollar to other foreign
currencies could, however, lead to increased purchasing costs.

37



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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

|                                                                        |  |      |    | 
|----------------------------------------------------------------------- |  | ---- | -- | 
|                                                                        |  | Page
|                                                                        |  |     
|Report of Independent Registered Public
    Accounting Firm             |  |      | 39 | 
|Balance Sheets                                                          |  |      | 40 | 
|Statements of Operations                                                |  |      | 41 | 
|Statements of Stockholders Equity (Deficit)
    and Comprehensive Loss |  |      | 42 | 
|Statements of Cash Flows                                                |  |      | 43 | 
|Notes to Financial Statements                                           |  |      | 44 | 

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REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors and Stockholders of 
 RedEnvelope, Inc.

We have audited the accompanying balance sheets
of RedEnvelope, Inc. as of March 28, 2004 and
March 30, 2003 and the related statements of operations,
stockholders equity/(deficit) and comprehensive loss, and
cash flows for each of the three years in the period ended
March 28, 2004. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with
standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present
fairly, in all material respects, the financial position of
RedEnvelope, Inc. as of March 28, 2004 and March 30,
2003 and the results of its operations and its cash flows for
each of the three years in the period ended March 28, 2004,
in conformity with accounting principles generally accepted in
the United States of America.

/s/ DELOITTE & TOUCHE LLP

San Francisco, California

June 21, 2004


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RedEnvelope, Inc.

BALANCE SHEETS

|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |         |         |  
|---------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | ----- | --------- | ------ |  | ------ | ------- | ------- | -
|                                                                                                           |                                                                                                                                                                                       | March 28,                                                                                                        |       | March 30,
|                                                                                                           |                                                                                                                                                                                       | 2004                                                                                                             |       | 2003     
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |          
|Assets                                                                                                    
|Current assets:                                                                                            |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           | Cash and cash equivalents                                                                                                                                                             |                                                                                                                  | $     | 18,409    |        |  | $      | 4,997   |        
|                                                                                                           | Short-term investments                                                                                                                                                                |                                                                                                                  |       | 6,971     |        |  |        |        |        
|                                                                                                           | Accounts receivable, net                                                                                                                                                              |                                                                                                                  |       | 1,055     |        |  |        | 286     |        
|                                                                                                           | Inventory                                                                                                                                                                             |                                                                                                                  |       | 9,609     |        |  |        | 9,716   |        
|                                                                                                           | Prepaid catalog costs, other current assets and
    restricted cash                                                                                                                   |                                                                                                                  |       | 2,037     |        |  |        | 2,099   |        
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           |                                                                                                                                                                                       | Total current assets                                                                                             |       |           | 38,081 |  |        |         | 17,098  |  
|Property and equipment, net                                                                                |                                                                                                                                                                                       |                                                                                                                  | 4,746 |           |        |  | 4,462  |        
|Long-term investments                                                                                      |                                                                                                                                                                                       |                                                                                                                  | 1,844 |           |        |  |       |        
|Other assets                                                                                               |                                                                                                                                                                                       |                                                                                                                  | 505   |           |        |  | 566    |        
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           |                                                                                                                                                                                       | Total assets                                                                                                     |       | $         | 45,176 |  |        | $       | 22,126  |  
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|Liabilities, Mandatorily Redeemable
    Convertible Preferred Stock and Stockholders Equity
    (Deficit)
|Current liabilities:                                                                                       |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           | Accounts payable                                                                                                                                                                      |                                                                                                                  | $     | 5,539     |        |  | $      | 5,957   |        
|                                                                                                           | Accrued expenses and other current liabilities                                                                                                                                        |                                                                                                                  |       | 2,706     |        |  |        | 1,443   |        
|                                                                                                           | Accrued compensation                                                                                                                                                                  |                                                                                                                  |       | 1,602     |        |  |        | 723     |        
|                                                                                                           | Short-term loan                                                                                                                                                                       |                                                                                                                  |       |          |        |  |        | 1,123   |        
|                                                                                                           | Capital lease obligations, current                                                                                                                                                    |                                                                                                                  |       | 596       |        |  |        | 673     |        
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           |                                                                                                                                                                                       | Total current liabilities                                                                                        |       |           | 10,443 |  |        |         | 9,919   |  
|Capital lease obligations, long-term                                                                       |                                                                                                                                                                                       |                                                                                                                  | 816   |           |        |  | 1,102  |        
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           |                                                                                                                                                                                       | Total liabilities                                                                                                |       |           | 11,259 |  |        |         | 11,021  |  
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|Commitments and contingencies                                                                              |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|Mandatorily redeemable convertible preferred
    stock (Note 8)                                            |                                                                                                                                                                                       |                                                                                                                  |      |           |        |  | 82,556 |        
|Stockholders equity/ (deficit):                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           | Series A preferred stock, $0.01 par
    value; 2,000,000 shares authorized, none and
    0.6 million issued and outstanding as of March 28,
    2004 and March 30, 2003, respectively |                                                                                                                  |       |          |        |  |        | 953     |        
|                                                                                                           | Common stock, $0.01 par value;
    100 million shares authorized; 8.5 million and
    0.3 million issued and outstanding as of March 28,
    2004 and March 30, 2003, respectively    |                                                                                                                  |       | 86        |        |  |        | 4       |        
|                                                                                                           | Additional paid-in capital                                                                                                                                                            |                                                                                                                  |       | 112,728   |        |  |        | 1,322   |        
|                                                                                                           | Deferred compensation                                                                                                                                                                 |                                                                                                                  |       | (197      | )      |  |        | (162    | )      
|                                                                                                           | Notes receivable from stockholders                                                                                                                                                    |                                                                                                                  |       | (44       | )      |  |        | (44     | )      
|                                                                                                           | Accumulated deficit                                                                                                                                                                   |                                                                                                                  |       | (78,652   | )      |  |        | (73,524 | )      
|                                                                                                           | Accumulated other comprehensive loss                                                                                                                                                  |                                                                                                                  |       | (4        | )      |  |        |        |        
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           |                                                                                                                                                                                       | Total stockholders equity/ (deficit)                                                                            |       |           | 33,917 |  |        |         | (71,451 | )
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        
|                                                                                                           |                                                                                                                                                                                       | Total liabilities, mandatorily redeemable
    convertible preferred stock and stockholders
    equity/(deficit) |       | $         | 45,176 |  |        | $       | 22,126  |  
|                                                                                                           |                                                                                                                                                                                       |                                                                                                                  |       |           |        |  |        |        

See accompanying notes to these financial
statements.

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RedEnvelope, Inc.

STATEMENTS OF OPERATIONS

|                                                            |                            |                                       |        |           |        |           |        |        |        |   |         |        |        | 
|----------------------------------------------------------- | -------------------------- | ------------------------------------- | ------ | --------- | ------ | --------- | ------ | ------ | ------ | - | ------- | ------ | ------ | 
|                                                            |                            |                                      
|                                                            |                            | Fiscal Year Ended                    
|                                                            |                            |                                      
|                                                            |                            | March 28,                             |        | March 30, |        | March 31,
|                                                            |                            | 2004                                  |        | 2003      |        | 2002     
|                                                            |                            |                                       |        |           |        |          
|                                                            |                            |                                      
|                                                            |                            | (In thousands, except per share data)
|Net revenues                                                |                            | $                                     | 79,308 |           |        | $         | 70,059 |        |        | $ | 55,778  |       
|Cost of sales                                               |                            |                                       | 39,594 |           |        |           | 36,577 |        |        |   | 31,446  |       
|                                                            |                            |                                       |        |           |        |           |        |        |        |   |         |       
|                                                            | Gross profit               |                                       |        | 39,714    |        |           |        | 33,482 |        |   |         | 24,332 |       
|                                                            |                            |                                       |        |           |        |           |        |        |        |   |         |       
|Operating expenses:                                         |                            |                                       |        |           |        |           |        |        |        |   |         |       
|                                                            | Fulfillment                |                                       |        | 12,206    |        |           |        | 10,769 |        |   |         | 9,030  |       
|                                                            | Marketing                  |                                       |        | 16,680    |        |           |        | 15,280 |        |   |         | 13,411 |       
|                                                            | General and administrative |                                       |        | 15,677    |        |           |        | 14,598 |        |   |         | 15,423 |       
|                                                            |                            |                                       |        |           |        |           |        |        |        |   |         |       
|                                                            |                            | Total operating expenses              |        |           | 44,563 |           |        |        | 40,647 |   |         |        | 37,864 | 
|                                                            |                            |                                       |        |           |        |           |        |        |        |   |         |       
|Loss from operations                                        |                            |                                       | (4,849 | )         |        |           | (7,165 | )      |        |   | (13,532 | )     
|Interest income                                             |                            |                                       | 170    |           |        |           | 160    |        |        |   | 459     |       
|Interest expense                                            |                            |                                       | (449   | )         |        |           | (706   | )      |        |   | (1,036  | )     
|                                                            |                            |                                       |        |           |        |           |        |        |        |   |         |       
|Net loss                                                    |                            | $                                     | (5,128 | )         |        | $         | (7,711 | )      |        | $ | (14,109 | )     
|                                                            |                            |                                       |        |           |        |           |        |        |        |   |         |       
|Net loss per share  basic and diluted                      |                            | $                                     | (1.16  | )         |        | $         | (24.48 | )      |        | $ | (53.04  | )     
|                                                            |                            |                                       |        |           |        |           |        |        |        |   |         |       
|Weighted average shares outstanding 
    basic and diluted |                            |                                       | 4,422  |           |        |           | 315    |        |        |   | 266     |       

See accompanying notes to these financial
statements.

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##### Table of Contents



REDENVELOPE, INC.

STATEMENTS OF STOCKHOLDERS
EQUITY/(DEFICIT) AND COMPREHENSIVE LOSS

|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------------------------------- |  | --------- | ---- | ------------ |  | ---------- | ---- | -------- |  | ------------------------------------- | ----- | ------------ |  | ------------- | -- | ------------- |  | ------------- | ------- | --------- |  | ---- | ------ | - |  | - | --- | - |  | - | ------- | - |  | - | --- | - |  | - | ------- | - |  | - | ------- | -
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |          
|                                                                                               |  | Series A  |      |              |  |            |      |          |  | Notes                                 |       |              |  |               |    |               |  |              
|                                                                                               |  | Preferred |      | Common Stock |  | Additional |      |          |  | Receivable                            |       |              |  | Other         |    | Stockholders |  |              
|                                                                                               |  |           |      |              |  | Paid-In    |      | Deferred |  | from                                  |       | Accumulated  |  | Comprehensive |    | Equity/       |  | Comprehensive
|                                                                                               |  | Shares    |      | Amount       |  | Shares     |      | Amount   |  | Capital                               |       | Compensation |  | Stockholder   |    | Deficit       |  | Loss          |         | (Deficit) |  | Loss
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |     
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |              
|                                                                                               |  |           |      |              |  |            |      |          |  | (In thousands, except per share data) |       |              |  |               |    |               |  |              
|Balance at April 1, 2001                                                                       |  |           | 627  |              |  |            | 953  |          |  |                                       | 322   |              |  |               | 4  |               |  |               | 1,345   |           |  |      | (1,062 | ) |  |   | (68 | ) |  |   | (51,704 | ) |  |   | 46  |   |  |   | (50,486 | ) |  |   |        |  
|Exercise of common stock options                                                               |  |           |     |              |  |            |     |          |  |                                       | 5     |              |  |               |   |               |  |               | 24      |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 24      |   |  |   |        |  
|Exercise of common stock warrants                                                              |  |           |     |              |  |            |     |          |  |                                       | 2     |              |  |               |   |               |  |               | 1       |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 1       |   |  |   |        |  
|Issuance of options for services                                                               |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               | 19      |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 19      |   |  |   |        |  
|Amortization of deferred stock compensation                                                    |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |        |           |  |      | 406    |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 406     |   |  |   |        |  
|Reversal of deferred compensation related to
    canceled options                              |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               | (29     | )         |  |      | 29     |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   |        |   |  |   |        |  
|Unrealized loss on available for sale investments                                              |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |        |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   | (46 | ) |  |   | (46     | ) |  |   | (46     | )
|Net loss                                                                                       |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |        |           |  |      |       |   |  |   |    |   |  |   | (14,109 | ) |  |   |    |   |  |   | (14,109 | ) |  |   | (14,109 | )
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  
|Comprehensive loss                                                                             |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   | (14,155 | )
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  
|Balance at March 31, 2002                                                                      |  |           | 627  |              |  |            | 953  |          |  |                                       | 329   |              |  |               | 4  |               |  |               | 1,360   |           |  |      | (627   | ) |  |   | (68 | ) |  |   | (65,813 | ) |  |   |    |   |  |   | (64,191 | ) |  |   |        |  
|Exercise of common stock options                                                               |  |           |     |              |  |            |     |          |  |                                       | 13    |              |  |               |   |               |  |               | 70      |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 70      |   |  |   |        |  
|Exercise of common stock warrants                                                              |  |           |     |              |  |            |     |          |  |                                       | 15    |              |  |               |   |               |  |               | 10      |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 10      |   |  |   |        |  
|Repurchase of common stock                                                                     |  |           |     |              |  |            |     |          |  |                                       | (20   | )            |  |               |   |               |  |               | (12     | )         |  |      |       |   |  |   | 12  |   |  |   |        |   |  |   |    |   |  |   |        |   |  |   |        |  
|Repayment of note receivable                                                                   |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |        |           |  |      |       |   |  |   | 12  |   |  |   |        |   |  |   |    |   |  |   | 12      |   |  |   |        |  
|Stock compensation charge                                                                      |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               | 19      |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 19      |   |  |   |        |  
|Amortization of deferred stock compensation                                                    |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |        |           |  |      | 340    |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 340     |   |  |   |        |  
|Reversal of deferred compensation                                                              |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               | (125    | )         |  |      | 125    |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   |        |   |  |   |        |  
|Net loss                                                                                       |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |        |           |  |      |       |   |  |   |    |   |  |   | (7,711  | ) |  |   |     |   |  |   | (7,711  | ) |  |   | (7,711  | )
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  
|Comprehensive loss                                                                             |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   | (7,711  | )
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  
|Balance at March 30, 2003                                                                      |  |           | 627  |              |  |            | 953  |          |  |                                       | 337   |              |  |               | 4  |               |  |               | 1,322   |           |  |      | (162   | ) |  |   | (44 | ) |  |   | (73,524 | ) |  |   |    |   |  |   | (71,451 | ) |  |   |        |  
|Exercise of common stock options                                                               |  |           |     |              |  |            |     |          |  |                                       | 51    |              |  |               |   |               |  |               | 239     |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 239     |   |  |   |        |  
|Issuance of common stock in connection with
    initial public offering, net of issuance costs |  |           |     |              |  |            |     |          |  |                                       | 2,200 |              |  |               | 22 |               |  |               | 27,419  |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 27,441  |   |  |   |        |  
|Conversion of preferred stock to common stock in
    connection with initial public offering   |  |           | (627 | )            |  |            | (953 | )        |  |                                       | 5,956 |              |  |               | 60 |               |  |               | 83,444  |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 82,551  |   |  |   |        |  
|Stock compensation charge                                                                      |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               | 9       |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 9       |   |  |   |        |  
|Recognition of deferred stock                                                                  |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  
|compensation                                                                                   |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               | 693     |           |  |      | (693   | ) |  |   |    |   |  |   |        |   |  |   |    |   |  |   |        |   |  |   |        |  
|Amortization of deferred stock compensation                                                    |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |         |           |  |      | 260    |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   | 260     |   |  |   |        |  
|Reversal of deferred compensation                                                              |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               | (398    | )         |  |      | 398    |   |  |   |    |   |  |   |        |   |  |   |    |   |  |   |        |   |  |   |        |  
|Unrealized loss on available for sale investments                                              |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |        |           |  |      |       |   |  |   |    |   |  |   |        |   |  |   | (4  | ) |  |   | (4      | ) |  |   | (4      | )
|Net loss                                                                                       |  |           |     |              |  |            |     |          |  |                                       |      |              |  |               |   |               |  |               |        |           |  |      |       |   |  |   |    |   |  |   | (5,128  | ) |  |   |    |   |  |   | (5,128  | ) |  |   | (5,128  | )
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  
|Comprehensive loss                                                                             |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  | $ | (5,132  | )
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  
|Balance at March 28, 2004                                                                      |  |           |     |              |  |            |     |          |  |                                       | 8,544 |              |  | $             | 86 |               |  | $             | 112,728 |           |  | $    | (197   | ) |  | $ | (44 | ) |  | $ | (78,652 | ) |  | $ | (4  | ) |  | $ | 33,917  |   |  |   |        |  
|                                                                                               |  |           |      |              |  |            |      |          |  |                                       |       |              |  |               |    |               |  |               |         |           |  |      |        |   |  |   |     |   |  |   |         |   |  |   |     |   |  |   |         |   |  |   |         |  

See accompanying notes to these financial
statements.

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RedEnvelope, Inc.

STATEMENTS OF CASH FLOWS

|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |         |        |         |  
|------------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ------------------------------------------------------- | ------------------------------------------------------- | --------- | ------- | --------- | ----- | ------ | ------ | ------ | ------ | ------- | ------ | ------- | -
|                                                                                |                                                                        |                                                        
|                                                                                |                                                                        | Fiscal Year Ended                                      
|                                                                                |                                                                        |                                                        
|                                                                                |                                                                        | March 28,                                               |                                                         | March 30, |         | March 31,
|                                                                                |                                                                        | 2004                                                    |                                                         | 2003      |         | 2002     
|                                                                                |                                                                        |                                                         |                                                         |           |         |          
|                                                                                |                                                                        |                                                        
|                                                                                |                                                                        | (In thousands)                                         
|Cash Flows From Operating
    Activities:                                       |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|                                                                                | Net loss                                                               |                                                         | $                                                       | (5,128    | )       |           | $     | (7,711 | )      |        | $      | (14,109 | )     
|Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|                                                                                | Depreciation and amortization                                          |                                                         |                                                         | 2,523     |         |           |       | 2,543  |        |        |        | 2,716   |       
|                                                                                | Amortization of deferred stock compensation                            |                                                         |                                                         | 260       |         |           |       | 359    |        |        |        | 406     |       
|                                                                                | Other non-cash charges                                                 |                                                         |                                                         | 191       |         |           |       | 64     |        |        |        | 316     |       
|                                                                                | Issuance of stock for services and other                               |                                                         |                                                         | 9         |         |           |       | 400    |        |        |        | 152     |       
|                                                                                | Property and equipment impairment                                      |                                                         |                                                         |          |         |           |       |       |        |        |        | 1,199   |       
|                                                                                | Changes in operating assets and liabilities:                           |                                                         |                                                         |           |         |           |       |        |        |        |        |         |       
|                                                                                |                                                                        | Accounts receivable                                     |                                                         |           | (769    | )         |       |        | 215    |        |        |         | (74    | )      
|                                                                                |                                                                        | Inventory                                               |                                                         |           | 107     |           |       |        | (2,715 | )      |        |         | (2,016 | )      
|                                                                                |                                                                        | Other assets                                            |                                                         |           | (327    | )         |       |        | (347   | )      |        |         | (19    | )      
|                                                                                |                                                                        | Accounts payable                                        |                                                         |           | 251     |           |       |        | 455    |        |        |         | (87    | )      
|                                                                                |                                                                        | Accrued expenses and other current liabilities          |                                                         |           | 2,142   |           |       |        | (118   | )      |        |         | 56     |        
|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|                                                                                |                                                                        |                                                         | Net cash used in operating activities                   |           |         | (741      | )     |        |        | (6,855 | )      |         |        | (11,460 | )
|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|Cash Flows From Investing
    Activities:                                       |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|                                                                                | Proceeds from sale of investments                                      |                                                         |                                                         | 1,000     |         |           |       |       |        |        |        | 11,390  |       
|                                                                                | Purchase of investments                                                |                                                         |                                                         | (9,815    | )       |           |       |       |        |        |        | (2,922  | )     
|                                                                                | Purchase of property and equipment                                     |                                                         |                                                         | (2,441    | )       |           |       | (1,532 | )      |        |        | (2,152  | )     
|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|                                                                                |                                                                        | Net cash (used in) provided by investing
    activities |                                                         |           | (11,256 | )         |       |        | (1,532 | )      |        |         | 6,316  |        
|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|Cash Flows From Financing
    Activities:                                       |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|                                                                                | Proceeds from exercise of common stock options
    and warrants        |                                                         |                                                         | 239       |         |           |       | 80     |        |        |        | 25      |       
|                                                                                | Net proceeds from issuance of Series F
    convertible preferred stock |                                                         |                                                         |          |         |           |       | 13,585 |        |        |        |        |       
|                                                                                | Principal payments on capital lease obligations                        |                                                         |                                                         | (733      | )       |           |       | (423   | )      |        |        | (219    | )     
|                                                                                | Repayment of loan                                                      |                                                         |                                                         | (1,123    | )       |           |       | (4,780 | )      |        |        | (1,000  | )     
|                                                                                | Payment of loan costs and other                                        |                                                         |                                                         | (415      | )       |           |       | 12     |        |        |        |        |       
|                                                                                | Payment of IPO costs                                                   |                                                         |                                                         | (1,511    | )       |           |       |       |        |        |        |        |       
|                                                                                | IPO proceeds                                                           |                                                         |                                                         | 28,952    |         |           |       |       |        |        |        |        |       
|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|                                                                                |                                                                        |                                                         | Net cash provided by (used in) financing
    activities |           |         | 25,409    |       |        |        | 8,474  |        |         |        | (1,194  | )
|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|Net increase (decrease) in cash and cash
    equivalents                        |                                                                        |                                                         | 13,412                                                  |           |         |           | 87    |        |        |        | (6,338 | )      
|Cash and cash equivalents at beginning of period                                |                                                                        |                                                         | 4,997                                                   |           |         |           | 4,910 |        |        |        | 11,248 |        
|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        
|Cash and cash equivalents at end of period                                      |                                                                        | $                                                       | 18,409                                                  |           |         | $         | 4,997 |        |        | $      | 4,910  |        
|                                                                                |                                                                        |                                                         |                                                         |           |         |           |       |        |        |        |        |        

|                                                              |                                                           |  |   |        |  |  |   |       |  |  |   |     | 
|------------------------------------------------------------- | --------------------------------------------------------- |  | - | ------ |  |  | - | ----- |  |  | - | --- | 
|Supplemental Cash Flow Information:                           |                                                           |  |   |        |  | 
|                                                              | Cash paid for interest                                    |  | $ | 240    |  |  | $ | 639   |  |  | $ | 919 | 
|                                                              | Cash paid for income taxes                                |  |   | 1      |  |  |   | 1     |  |  |   | 1   | 
|Supplemental Non cash Investing and Financing
    Activities: |                                                           |  |   |        |  |  |   |       |  |  |   |    
|                                                              | Warrants issued in conjunction with debt agreement        |  | $ |       |  |  | $ | 161   |  |  | $ | 134 | 
|                                                              | Equipment acquired through capital lease
    transactions |  |   | 393    |  |  |   | 1,721 |  |  |   |    | 
|                                                              | Conversion of preferred stock to common stock             |  |   | 83,504 |  |  |   |      |  |  |   |    | 

See accompanying notes to these financial
statements.

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RedEnvelope, Inc.

NOTES TO FINANCIAL STATEMENTS



|   |                                                 
|-- | ------------------------------------------------
|1. | Financial Statements  Basis of
    Presentation

Description of
Business RedEnvelope,
Inc. (the Company) is an internet and catalog
retailer of upscale gifts. The Company publishes full-color
catalogs several times during the year. The Company operates as
a single business segment.

Fiscal
Year The
Companys fiscal year ends on the Sunday closest to
March 31, based on a 52/53-week year. Fiscal years 2004,
2003 and 2002, all 52-week periods, ended on March 28,
2004, March 30, 2003 and, March 31, 2002, respectively.

Use of
Estimates The
preparation of financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date
of the financial statements and reported amounts of revenues and
expenses during the reporting period. Actual results could
differ from those estimates and such differences could affect
the results of operations reported in future periods. Our
significant accounting policies are set forth below.

Cash
Equivalents The
Company considers all highly liquid investments purchased with
an original or remaining maturity of three months or less to be
cash equivalents.

Marketable
Securities The
Companys marketable securities are categorized as
available-for-sale securities, as defined by the Statement of
Financial Accounting Standards (SFAS) No. 115,
Accounting for Certain Investments in Debt and Equity
Securities. The Companys investment objectives
include: preserving principal, meeting liquidity needs,
delivering yields in relationship to risk tolerance and market
conditions, avoiding inappropriate concentrations of
investments, and providing direct fiduciary control of all cash
and investments. Unrealized marketable securities gains and
losses are reflected as a net amount under the caption of
accumulated other comprehensive loss within the statements of
stockholders equity/ (deficit) and comprehensive loss.
Realized gains and losses are recorded within the statements of
operations. For the purpose of computing realized gains and
losses, cost is identified on a specific identification basis.

Concentration of Credit
Risk Financial
instruments that potentially subject the Company to a
concentration of credit risk consist of cash, cash equivalents,
marketable debt securities and accounts receivable. Cash and
cash equivalents are deposited with high credit quality
financial institutions. The Companys accounts receivable
are derived from credit card purchases from customers and are
typically settled within two to three days.

Allowance for Doubtful
Accounts The Company
reviews the aging of its accounts receivable balances to
specifically identify accounts for uncollectibility. A summary
of changes in the allowance for doubtful accounts is as follows:

|                                          |                            |                |    |           |   |           |    |     |   |   |    |     |  
|----------------------------------------- | -------------------------- | -------------- | -- | --------- | - | --------- | -- | --- | - | - | -- | --- | -
|                                          |                            | March 28,      |    | March 30, |   | March 31,
|                                          |                            | 2004           |    | 2003      |   | 2002     
|                                          |                            |                |    |           |   |          
|                                          |                            |               
|                                          |                            | (In thousands)
|Beginning allowance for doubtful accounts |                            | $              | 9  |           |   | $         | 71 |     |   | $ | 11 |    
|                                          | Amounts charged to expense |                |    | 21        |   |           |    | 18  |   |   |    | 71  |  
|                                          | Amounts written-off        |                |    | (9        | ) |           |    | (80 | ) |   |    | (11 | )
|                                          |                            |                |    |           |   |           |    |     |   |   |    |    
|Ending allowance for doubtful accounts    |                            | $              | 21 |           |   | $         | 9  |     |   | $ | 71 |    
|                                          |                            |                |    |           |   |           |    |     |   |   |    |    

Inventory
Inventories consist of acquired finished goods for resale.
Inventories are stated at the lower of cost or market. We
estimate a provision for damaged, obsolete, excess and
slow-moving inventory based on inventory aging reports and
specific identification. If actual obsolescence is different
from our estimate, we will adjust our provision accordingly.

44



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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

Prepaid Catalog
Costs Prepaid catalog
costs consist of paper, printing, postage and mailing costs for
all Company catalogs. These costs are capitalized and are
amortized over their expected period of future benefit. Each
catalog is generally fully amortized within two months. At
March 28, 2004 and March 30, 2003, the Company had
prepaid catalog costs of $1.0 million and
$1.2 million, respectively, recorded as prepaid catalog
costs and other current assets.

Property and
Equipment,including leasehold
improvements, are stated at historical cost, less accumulated
depreciation and amortization. Depreciation and amortization are
computed using the straight-line method over the estimated
useful lives of these assets, ranging from three to seven years,
or, in the case of leasehold improvements, over the lease period
or estimated useful life, whichever is shorter.

Capitalized Software and Website
Development Costs The
Company capitalizes internally developed software costs and
website development costs in accordance with the provisions of
Statement of Position (SOP) 98-1, Accounting for
Costs of Computer Software Developed or Obtained for Internal
Useand Emerging Issues Task Force (EITF)
No. 00-2, Accounting for Website Development Costs.
Capitalized costs are amortized on a straight-line basis over
the useful life of the software once it is available for use.

Long-Lived Assetsheld and used by the Company are
reviewed for impairment whenever events or changes in
circumstances indicate that their net book value may not be
recoverable. An impairment loss is recognized if the sum of the
expected future cash flows (undiscounted and before interest)
from the 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. Our estimate of undiscounted
future cash flows is based upon our experience, historical
operations, estimates of future profitability and economic
conditions. During fiscal year 2002, the Company recorded a
$1.2 million impairment charge related to abandoned
software and website development costs, which is included in
general and administrative expenses in the statements of
operations.

Revenue
Recognition Net
revenues, which consist primarily of products sold via the
Internet and through catalogs, including shipping revenue, are
recognized at the estimated time of receipt by the customer.
Shipping revenues for fiscal years 2004, 2003, and 2002 were
$9.9 million, $10.4 million, and $7.1 million,
respectively.

Revenues are recorded net of estimated returns
and promotional discounts. The Companys policy is to
record a sales return allowance for anticipated future returns
in the period of sale. The Company generally does not extend
credit to customers, except through third-party credit cards.
Credit card sales account for the majority of net revenues.

Shipping costs, which include inbound and
outbound freight, and the cost of gift wrap is included in Cost
of Sales. Handling costs, which include fees that were paid to
our former third party fulfillment service provider and our
distribution center expenses, are included in Operating
Expenses  Fulfillment. Handling costs included in
Operating Expenses  Fulfillment for fiscal 2004,
2003, and 2002 were $4.7 million, $3.8 million and
$2.8 million, respectively. Our gross profit may not be
comparable to other entities, which may allocate all shipping
and handling costs to either Cost of Sales or Operating Expenses.

Provision for Sales Returns and
Allowances The
provision for sales returns and allowances consists of our
estimates of potential future product returns related to current
period product revenue. Management analyzes historical returns,
current economic trends, and changes in customer demand and
acceptance of our products when evaluating the adequacy of the
sales returns and allowances. Significant management judgments
and estimates must be made and used in connection with
establishing the sales returns and allowances in any accounting
period. Material differences may result in the amount and timing
of our revenue for any period if management made different
judgments or utilized different estimates.

45



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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

A summary of changes in the Reserve for Sales
Returns and Allowances is as follows:

|                                                           |  |                |     |               |  |             |       |            |  |   |        |   |  |   |     | 
|---------------------------------------------------------- |  | -------------- | --- | ------------- |  | ----------- | ----- | ---------- |  | - | ------ | - |  | - | --- | 
|                                                           |  |                |     | Provision for |  |             |       |           
|                                                           |  | Balance at     |     | Sales Returns |  | Actual      |       | Balance at
|                                                           |  | Beginning of   |     | and Other     |  | Returns and |       | End of    
|                                                           |  | Period         |     | Allowances    |  | Allowances  |       | Period    
|                                                           |  |                |     |               |  |             |       |           
|                                                           |  |               
|                                                           |  | (In thousands)
|Year Ended March 28, 2004 Sales Returns and
    Allowances |  | $              | 140 |               |  | $           | 4,767 |            |  | $ | (4,726 | ) |  | $ | 181 | 
|Year Ended March 30, 2003 Sales Returns and
    Allowances |  | $              | 49  |               |  | $           | 4,435 |            |  | $ | (4,345 | ) |  | $ | 140 | 
|Year Ended March 31, 2002 Sales Returns and
    Allowances |  | $              | 9   |               |  | $           | 3,129 |            |  | $ | (3,089 | ) |  | $ | 49  | 

Advertising
Expense The Company
expenses the costs of producing advertisements at the time
production occurs and expenses the cost of communicating
advertising in the period in which the advertising space or
airtime is used. Internet advertising expenses are recognized
either on a straight-line basis over the term of the contract or
in accordance with the actual number of clicks-through to the
RedEnvelope website. Advertising expenses for fiscal years 2004,
2003, and 2002 were $6.9 million, $4.1 million, and
$4.7 million, respectively, and are included in marketing
expenses,

Income
Taxes The Company
accounts for income taxes under the asset and liability approach
whereby the expected future tax consequences of temporary
differences between the book and tax basis of assets and
liabilities are recognized as deferred tax assets and
liabilities. A valuation allowance is established for any
deferred tax assets for which realization is uncertain.

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 SFAS No. 123,
Accounting for Stock-Based Compensation
(SFAS No. 123). 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.

46



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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

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 fiscal years
2001, 2002, and 2003 consistent with the provisions of
SFAS No. 123 the Companys pro forma net loss
would have been as follows:

|                                                                        |                    |                                       |        |        |   |      |        |        |   |   |         |         |  
|----------------------------------------------------------------------- | ------------------ | ------------------------------------- | ------ | ------ | - | ---- | ------ | ------ | - | - | ------- | ------- | -
|                                                                        |                    |                                      
|                                                                        |                    | Fiscal Year Ended                    
|                                                                        |                    |                                      
|                                                                        |                    | 2004                                  |        | 2003   |   | 2002
|                                                                        |                    |                                       |        |        |   |     
|                                                                        |                    |                                      
|                                                                        |                    | (In thousands, except per share data)
|Net loss  as reported                                                  |                    | $                                     | (5,128 | )      |   | $    | (7,711 | )      |   | $ | (14,109 | )      
|Stock-based employee compensation included in
    reported net loss     |                    |                                       | 260    |        |   |      | 359    |        |   |   | 406     |        
|Stock-based compensation expense determined under
    fair value method |                    |                                       | (716   | )      |   |      | (538   | )      |   |   | (571    | )      
|                                                                        |                    |                                       |        |        |   |      |        |        |   |   |         |        
|                                                                        | Pro forma net loss |                                       | $      | (5,584 | ) |      | $      | (7,890 | ) |   | $       | (14,274 | )
|                                                                        |                    |                                       |        |        |   |      |        |        |   |   |         |        
|Basic and diluted earnings per share                                    |                    |                                       |        |        |   |      |        |        |   |   |         |        
|                                                                        | As reported        |                                       | $      | (1.16  | ) |      | $      | (24.48 | ) |   | $       | (53.04  | )
|                                                                        | Pro forma          |                                       | $      | (1.26  | ) |      | $      | (25.05 | ) |   | $       | (53.66  | )

Loss 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 fiscal years 2004, 2003, and
2002 were approximately 1.3 million, 0.8 million, and
0.6 million, respectively.

The effect of convertible preferred stock has
been excluded from the computation of earnings per share for
fiscal years 2003 and 2002 as the effect is antidilutive. The
weighted average shares of common stock issuable from conversion
of convertible preferred stock for fiscal years 2003 and 2002
were approximately 5.9 million, and 3.4 million,
respectively.

Comprehensive
Loss Comprehensive
loss consists of two components, net loss and other
comprehensive loss. Other comprehensive loss refers to revenue,
expenses, gains and losses that under generally accepted
accounting principles are recorded as an element of
stockholders equity but are excluded from net loss. The
Companys other comprehensive loss is comprised of
unrealized losses on marketable securities categorized as
available-for-sale.

New Accounting
Pronouncements In
January 2003, the FASB (Financial Accounting Standards Board)
issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51(FIN 46). FIN 46 requires certain
variable interest entities to be consolidated by the primary
beneficiary of the entity under certain conditions. The Company
does not have any involvement in variable interest entities. The
adoption of FIN 46 did not have a material impact on the
Companys results of operations, financial position or cash
flows.

In May 2003, the 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. The adoption of this statement during
fiscal 2004 did not have an impact on the Companys
financial statements.



|   |                        
|-- | -----------------------
|2. | Initial Public Offering

On September 30, 2003, we completed our
initial public offering, whereby we sold 2.2 million shares
of our common stock at $14 per share and received proceeds
of approximately $29.0 million (after underwriters

47



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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

discounts of $1.8 million). Total related
offering expenses were approximately $1.5 million
(excluding underwriters discounts).

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

On September 30, 2003, the Companys
outstanding Preferred Stock was automatically converted into
approximately 6.0 million shares of common stock. (See
Note 8)



|   |            
|-- | -----------
|3. | Investments

Short-term investments consist of government
securities and corporate bonds both with original maturities
beyond three months but less than one year. Long term
investments consist of corporate bonds with original maturities
of one year or longer.

All of the Companys investments are
considered available-for-sale. Such securities are carried at
fair market value. Fair value is based on market quotes.
Unrealized gains and losses, net of tax, on securities in this
category are reported as a separate component of
stockholders equity. The cost of securities sold is based
on the specific identification method. Interest earned on
securities is included in interest income.

Available-for-sale investments at March 28,
2004 were as follows (in thousands):

|                                                             |  |   |       | 
|------------------------------------------------------------ |  | - | ----- | 
|Corporate bonds and auction preferred stock
    (short-term) |  | $ | 3,962 | 
|Government securities (short-term)                           |  |   | 3,009 | 
|Corporate bonds (long-term)                                  |  |   | 1,844 | 
|                                                             |  |   |       | 
|Total available-for-sale investments                         |  | $ | 8,815 | 
|                                                             |  |   |       | 

There were no gross realized gains or losses the
fiscal year ending March 28, 2004 and the gross realized
gains or losses for the fiscal year ended March 30, 2003
were immaterial.

The contractual maturity of investments were as
follows (in thousands):

|                        |  |   |       | 
|----------------------- |  | - | ----- | 
|Due in less than 1 year |  | $ | 6,971 | 
|Due in 1-2 years        |  |   | 1,844 | 
|Due thereafter          |  |   |      | 
|                        |  |   |       | 
|                        |  | $ | 8,815 | 
|                        |  |   |       | 

48



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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)



|   |                       
|-- | ----------------------
|4. | Property and Equipment

Property and equipment consists of the following
(including the useful lives):

|                                                          |       |                |        |           |  |   |        |       | 
|--------------------------------------------------------- | ----- | -------------- | ------ | --------- |  | - | ------ | ----- | 
|                                                          |       | March 28,      |        | March 30,
|                                                          |       | 2004           |        | 2003     
|                                                          |       |                |        |          
|                                                          |       |               
|                                                          |       | (In thousands)
|Computer equipment (3 years)                              |       | $              | 5,262  |           |  | $ | 4,107  |      
|Software (3 years)                                        |       |                | 4,688  |           |  |   | 3,578  |      
|Fulfillment equipment under capital lease
    (3-7 years) |       |                | 1,917  |           |  |   | 1,547  |      
|Furniture and fixtures (5 years)                          |       |                | 388    |           |  |   | 353    |      
|Leasehold improvements (3-5 years)                        |       |                | 528    |           |  |   | 391    |      
|                                                          |       |                |        |           |  |   |        |      
|                                                          | Total |                |        | 12,783    |  |   |        | 9,976 | 
|Less: accumulated depreciation and amortization           |       |                | (8,037 | )         |  |   | (5,514 | )    
|                                                          |       |                |        |           |  |   |        |      
|                                                          | Total |                | $      | 4,746     |  |   | $      | 4,462 | 
|                                                          |       |                |        |           |  |   |        |      

The cost of property and equipment under capital
leases was $3.0 million and $2.6 million at
March 28, 2004 and March 30, 2003, respectively.
Accumulated depreciation for assets under capital leases was
$1.5 million and $1.1 million, at March 31, 2004
and March 30, 2003, respectively.



|   |             
|-- | ------------
|5. | Income Taxes

The Company has not recorded a tax benefit in any
period presented due to losses incurred and uncertainty of
realizing the net operating loss carryforwards. A reconciliation
of the statutory federal income tax rate with the Companys
effective income tax rate is as follows:

|                       |  |      |     |      |  |      |     |    |  |  |     |   
|---------------------- |  | ---- | --- | ---- |  | ---- | --- | -- |  |  | --- | --
|                       |  | 2004 |     | 2003 |  | 2002
|                       |  |      |     |      |  |     
|Federal statutory rate |  |      | (34 | )%   |  |      | (34 | )% |  |  | (34 | )%
|State taxes and other  |  |      | (6  | )    |  |      | (6  | )  |  |  | (1  | ) 
|Valuation allowance    |  |      | (40 | )    |  |      | 40  |    |  |  | 35  |   
|                       |  |      |     |      |  |      |     |    |  |  |     |   
|                       |  |      | 0   | %    |  |      | 0   | %  |  |  | 0   | % 
|                       |  |      |     |      |  |      |     |    |  |  |     |   

Deferred tax assets are summarized as follows:

|                          |                                  |                |         |           |        |   |         |        |        | 
|------------------------- | -------------------------------- | -------------- | ------- | --------- | ------ | - | ------- | ------ | ------ | 
|                          |                                  | March 28,      |         | March 30,
|                          |                                  | 2004           |         | 2003     
|                          |                                  |                |         |          
|                          |                                  |               
|                          |                                  | (In thousands)
|Deferred tax assets:      |                                  |                |         |           |        |   |         |       
|                          | Net operating loss carryforwards |                | $       | 25,723    |        |   | $       | 24,641 |       
|                          | Allowance and accruals           |                |         | 2,281     |        |   |         | 1,297  |       
|                          |                                  |                |         |           |        |   |         |       
|                          |                                  | Total          |         |           | 28,004 |   |         |        | 25,938 | 
|Less: valuation allowance |                                  |                | (28,004 | )         |        |   | (25,938 | )     
|                          |                                  |                |         |           |        |   |         |       
|Net deferred tax assets   |                                  | $              |        |           |        | $ |        |       
|                          |                                  |                |         |           |        |   |         |       

The Company believes that, based on a number of
factors, the available objective evidence creates sufficient
uncertainty regarding the realizability of the deferred tax
assets such that a full valuation allowance has been recorded. A
valuation allowance is provided when it is more likely than not
that some portion of the deferred tax asset will not be
realized. The Company established a 100% valuation allowance at
March 28,

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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

2004, and March 30, 2003 due to the
uncertainty of realizing future tax benefits from its net
operating loss carryforward and other deferred tax assets.

At March 28, 2004, the Company had net
operating loss carryforwards for federal and state income tax
purposes of approximately $70.5 million and
$30.1 million respectively, which expire at various dates
through 2019 and 2007, respectively. Under the Tax Reform Act of
1986, the amounts of and benefits from net operating loss and
tax carryforwards may be impaired or limited in certain
circumstances. Events which could cause limitations in the
amount of net operating losses that the Company may utilize in
any one year include, but are not limited to, a cumulative
ownership change of more than 50%, as defined, over a three year
period. The Companys preferred stock issuances have
created an ownership change of more than 50% which caused annual
limitations in the amount of net operating losses that the
Company may utilize for both federal and state purposes.



|   |                       
|-- | ----------------------
|6. | Borrowing Arrangements

The Company has a line of credit from
CapitalSource Finance LLC. Per the terms of this agreement,
CapitalSource Finance LLC has made available to the Company a
credit facility under a revolving promissory note with a maximum
principal amount of $11.0 million, subject to availability
guidelines that specify the amount that can be borrowed under
the facility at any given time. Amounts borrowed under this line
of credit bear interest at rates equal to the greater of 9.5% or
the prime lending rate plus 5.75%, for advances up to a
fluctuating base amount, and equal to the greater of 11.5% or
the prime lending rate plus 7.75% for advances in excess of that
base amount. Amounts borrowed under this line of credit are
secured by substantially all of the Companys assets. The
line of credit agreement provides for certain events of default,
sets forth a number of affirmative and negative covenants to
which the Company must adhere and expires on April 15,
2006, unless extended, renewed or terminated pursuant to the
terms of the agreement. The Company 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 credit facility from time to time
and periodically repaid such borrowings with available cash. As
of March 28, 2004, the Company did not have an outstanding
balance under this credit facility.

On June 21, 2004, the Company amended the
terms of its credit facility with CapitalSource Finance LLC.
Under the terms of this Second Amendment, certain covenants for
inventory ratios and capital expenditure limitations were
eliminated. The minimum earnings before interest, taxes,
depreciation and amortization (EBITDA) covenant was modified,
and quarterly minimum unrestricted cash balance levels were
established. Further, under this Second Amendment, the EBITDA
and minimum unrestricted cash balance covenants were modified
such that they are not applicable unless borrowings are
outstanding.

In advance of any borrowings, the Company is
required to deliver to CapitalSource Finance LLC written
notification of its intent to borrow, certain consents from the
Companys landlords and credit card processing firm, a list
of domain name registrations, evidence of compliance with EBITDA
and minimum unrestricted cash balance levels on a prospective
basis, and historical and prospective financial statements.
In addition, CapitalSource Finance LLC may perform due diligence
on the Companys financial projections.

Events of default under this credit agreement
include, subject to grace periods and notice periods in certain
circumstances, failure to pay any amount owed under the line of
credit when due, breach of representations contained in the
agreement, failure to perform covenants contained in the
agreement, termination of any loan document or security interest
created under the agreement, a judgment against the Company in
excess of certain amounts, failure to pay certain amounts of
indebtedness due under, or another default under, debt or other
agreements to which the Company is party, insolvency or petition
for bankruptcy or dissolution, certain defined change of control
transactions, the termination of the employment of the
Companys Chief Executive Officer or Brand Strategist if
not timely replaced by suitable successors, a material adverse
effect on the Companys business or material adverse change
in the validity of the credit

50



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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

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.

The credit agreement requires us to pay and
deliver all collections to an account over which CapitalSource
Finance LLC has sole control. When we borrow under the credit
agreement, the borrowings are repaid through the funds in this
account. In a situation where we are not borrowing, we must
request the funds to be withdrawn from this account and
deposited into our bank account. Under the terms of the Second
Amendment, if the Company is not borrowing, this account will
not be utilized. As a result, funds settled from our net
revenues will be deposited directly into our bank account.

In addition, the credit agreement requires,
subject to exceptions in certain limited circumstances,
maintaining excess availability of a certain amount of capital
at certain specified times, 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 March 28, 2004, the Company was not in
compliance with the EBITDA, Inventory Ratio, and Change in
Control covenants contained in the credit agreement and such
breach constituted an event of default under the credit
agreement. On April 29, 2004, CapitalSource Finance LLC
agreed to waive such non-compliance with such covenants which
was designated as the First Amendment to the credit facility
agreement.

As of March 30, 2003, the Company had a loan
and security agreement, as amended, for borrowings, under which
it had outstanding $1.1 million at March 30, 2003.
Borrowings bear interest at 10.5% and are secured by
substantially all of the Companys assets. The Company
repaid $1.1 million in June 2003 in connection with the
Company obtaining the revolving line of credit and security
agreement from CapitalSource Finance LLC.

The original loan amount of $7.0 million was
obtained in March 2000 and was originally due on March 31,
2002. As consideration for the loan, the lender received a
warrant to purchase 17,079 shares of common stock at
$5.86 per share. The fair value of these warrants of
$386,000, as determined using the Black-Scholes option pricing
method, was recorded as debt discount and was amortized as
interest expense over the life of the debt ($182,000 was
expensed in fiscal year 2001 and $204,000 was expensed in fiscal
year 2002). The Company repaid $1.0 million in March 2002.

In September 2002, the loan was amended to extend
the maturity date of $4.8 million of principal to
December 31, 2002. The $4.8 million was repaid in
December 2002. As consideration for the extension of the
maturity of this $4.8 million, the lender received a
warrant to purchase 20,075 shares of Series F
Preferred Stock at an exercise price of $7.47 per share.
The value of this warrant ($80,000, using the Black-Scholes
option pricing method) was recorded as interest expense during
fiscal 2003. For the remaining principal amount of
$1.2 million, the lender had the choice of
(i) converting the $1.2 million, but not less than the
$1.2 million, into Series F Preferred Stock on or
before October 15, 2002 at a per share price equal to $7.47
or (ii) extending the maturity date to December 31,
2003 and receiving a warrant to purchase 20,075 shares of
Series F Preferred Stock at an exercise price of
$7.47 per share. The lender elected to extend the maturity
date and receive the warrant. The value of this warrant
($80,000, using the Black-Scholes option pricing method) was
being amortized as interest expense through December 31,
2003. In addition, the exercise price of the warrant originally
issued to the lender for the purchase of 17,079 common shares of
common stock was reduced to $1.64 per share.

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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)



|   |                              
|-- | -----------------------------
|7. | Commitments and Contingencies

Leases
The Company leases office space and equipment under
noncancelable operating and capital leases with various
expiration dates through 2005. Rent expense for the fiscal years
2004, 2003, and 2002 was approximately $1.9 million,
$2.4 million, and $2.0 million, respectively, net of
sub-rental income of $0, $0, and $146,0000, respectively. Future
minimum lease payments under noncancelable operating and capital
leases as of March 28, 2004 are as follows:

|                                                   |  |                |       |           |  |   |       | 
|-------------------------------------------------- |  | -------------- | ----- | --------- |  | - | ----- | 
|                                                   |  | Capital        |       | Operating
|                                                   |  | Leases         |       | Leases   
|                                                   |  |                |       |          
|                                                   |  |               
|                                                   |  | (In thousands)
|Fiscal 2005                                        |  | $              | 691   |           |  | $ | 1,174 | 
|Fiscal 2006                                        |  |                | 614   |           |  |   | 715   | 
|Fiscal 2007                                        |  |                | 251   |           |  |   | 251   | 
|Fiscal 2008 and thereafter                         |  |                |      |           |  |   |      | 
|                                                   |  |                |       |           |  |   |       | 
|Total minimum lease payments                       |  |                | 1,556 |           |  | $ | 2,140 | 
|                                                   |  |                |       |           |  |   |       | 
|Less: Amount representing interest                 |  |                | (144  | )         |  |   |       | 
|                                                   |  |                |       |           |  |   |       | 
|Present value of capital lease obligations         |  |                | 1,412 |           |  |   |       | 
|Less: Current portion of capital lease obligations |  |                | (596  | )         |  |   |       | 
|                                                   |  |                |       |           |  |   |       | 
|Long-term portion of capital lease obligations     |  | $              | 816   |           |  |   |       | 
|                                                   |  |                |       |           |  |   |       | 

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 have been 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.

On September 3, 2003, Activ8now, LLC filed a
patent infringement lawsuit against the Company in the United
States District Court, Northern District of Georgia. The lawsuit
alleged a cause of action for infringement of U.S. Patent
Nos. 6,535,889 and 6,557,006 based on the theory that
certain of our website operations were covered by such patents.
On June 18, 2004, the Company and Activ8now, LLC entered
into a settlement agreement providing the Company with a
non-exclusive, irrevocable, paid-up, worldwide license to

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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

such patents in exchange for a one-time fee and
dismissal of the lawsuit with prejudice. The settlement did not
have a material adverse effect on the Companys financial
position or results of operations.

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.



|   |                                                                                    
|-- | -----------------------------------------------------------------------------------
|8. | Mandatorily Redeemable Convertible Preferred
    Stock and Series A Preferred Stock

Changes in mandatorily redeemable convertible
preferred stock are as follows:

|                                                                   |  |                |      |          |  |          |      |          |  |          |      |          |  |        |        |        |  |        |      |        |  |        |         |        |  |   |      |   |  |   |         |   |  |   |        |   |  |   |         |   |  |   |        |   |  |   |         |  
|------------------------------------------------------------------ |  | -------------- | ---- | -------- |  | -------- | ---- | -------- |  | -------- | ---- | -------- |  | ------ | ------ | ------ |  | ------ | ---- | ------ |  | ------ | ------- | ------ |  | - | ---- | - |  | - | ------- | - |  | - | ------ | - |  | - | ------- | - |  | - | ------ | - |  | - | ------- | -
|                                                                   |  |                |      |          |  |          |      |          |  |          |      |         
|                                                                   |  | Series A       |      | Series B |  | Series C |      | Series D |  | Series E |      | Series F
|                                                                   |  |                |      |          |  |          |      |          |  |          |      |         
|                                                                   |  | Shares         |      | Amount   |  | Shares   |      | Amount   |  | Shares   |      | Amount   |  | Shares |        | Amount |  | Shares |      | Amount |  | Shares |         | Amount
|                                                                   |  |                |      |          |  |          |      |          |  |          |      |          |  |        |        |        |  |        |      |        |  |        |         |       
|                                                                   |  |               
|                                                                   |  | (In thousands)
|Balance at April 1, 2001                                           |  |                | 627  |          |  | $        | 953  |          |  |          | 385  |          |  | $      | 2,195  |        |  |        | 554  |        |  | $      | 20,921  |        |  |   | 195  |   |  | $ | 11,042  |   |  |   | 1,470  |   |  | $ | 34,004  |   |  |   |       |   |  | $ |        |  
|Issuance of preferred stock warrants in
    connection with a loan |  |                |     |          |  |          |     |          |  |          |     |          |  |        |       |        |  |        |     |        |  |        |        |        |  |   |     |   |  |   |        |   |  |   |       |   |  |   | 115     |   |  |   |       |   |  |   |        |  
|Issuance of preferred stock, net of issuance cost
    of $13       |  |                |     |          |  |          |     |          |  |          |     |          |  |        |       |        |  |        |     |        |  |        |        |        |  |   |     |   |  |   |        |   |  |   | 6      |   |  |   | 133     |   |  |   |       |   |  |   |        |  
|                                                                   |  |                |      |          |  |          |      |          |  |          |      |          |  |        |        |        |  |        |      |        |  |        |         |        |  |   |      |   |  |   |         |   |  |   |        |   |  |   |         |   |  |   |        |   |  |   |         |  
|Balance at March 31, 2002                                          |  |                | 627  |          |  | $        | 953  |          |  |          | 385  |          |  |        | 2,195  |        |  |        | 554  |        |  |        | 20,921  |        |  |   | 195  |   |  |   | 11,042  |   |  |   | 1,476  |   |  |   | 34,252  |   |  |   |       |   |  |   |        |  
|Reclass of warrant value                                           |  |                |      |          |  |          |      |          |  |          |     |          |  |        |       |        |  |        |     |        |  |        |        |        |  |   |     |   |  |   |        |   |  |   |       |   |  |   | (115    | ) |  |   |       |   |  |   | 115     |  
|Issuance of preferred stock, for services
    performed            |  |                |     |          |  |          |     |          |  |          |     |          |  |        |       |        |  |        |     |        |  |        |        |        |  |   |     |   |  |   |        |   |  |   | 17     |   |  |   | 400     |   |  |   |       |   |  |   |        |  
|Issuance of preferred stock warrants in
    connection with a loan |  |                |     |          |  |          |     |          |  |          |     |          |  |        |       |        |  |        |     |        |  |        |        |        |  |   |     |   |  |   |        |   |  |   |       |   |  |   |        |   |  |   |       |   |  |   | 161     |  
|Issuance of preferred stock, net of issuance cost
    of $158      |  |                |     |          |  |          |     |          |  |          |     |          |  |        |       |        |  |        |     |        |  |        |        |        |  |   |     |   |  |   |        |   |  |   |       |   |  |   |        |   |  |   | 1,839  |   |  |   | 13,585  |  
|                                                                   |  |                |      |          |  |          |      |          |  |          |      |          |  |        |        |        |  |        |      |        |  |        |         |        |  |   |      |   |  |   |         |   |  |   |        |   |  |   |         |   |  |   |        |   |  |   |         |  
|Balance at March 30, 2003                                          |  |                | 627  |          |  |          | 953  |          |  |          | 385  |          |  |        | 2,195  |        |  |        | 554  |        |  |        | 20,921  |        |  |   | 195  |   |  |   | 11,042  |   |  |   | 1,493  |   |  |   | 34,537  |   |  |   | 1,839  |   |  |   | 13,861  |  
|Conversion of preferred stock into common stock                    |  |                | (627 | )        |  |          | (953 | )        |  |          | (385 | )        |  |        | (2,195 | )      |  |        | (554 | )      |  |        | (20,921 | )      |  |   | (195 | ) |  |   | (11,042 | ) |  |   | (1,493 | ) |  |   | (34,537 | ) |  |   | (1,839 | ) |  |   | (13,861 | )
|                                                                   |  |                |      |          |  |          |      |          |  |          |      |          |  |        |        |        |  |        |      |        |  |        |         |        |  |   |      |   |  |   |         |   |  |   |        |   |  |   |         |   |  |   |        |   |  |   |         |  
|Balance at March 28, 2004                                          |  | $              |     |          |  | $        |     |          |  | $        |     |          |  | $      |       |        |  | $      |     |        |  | $      |        |        |  | $ |     |   |  | $ |        |   |  | $ |       |   |  | $ |        |   |  | $ |       |   |  | $ |        |  
|                                                                   |  |                |      |          |  |          |      |          |  |          |      |          |  |        |        |        |  |        |      |        |  |        |         |        |  |   |      |   |  |   |         |   |  |   |        |   |  |   |         |   |  |   |        |   |  |   |         |  

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

|                                                           |  |                |       | 
|---------------------------------------------------------- |  | -------------- | ----- | 
|                                                           |  | (In thousands)
|                                                           |  |               
|Series A (conversion rate of 1.0)                          |  |                | 627   | 
|Series B (conversion rate of 1.0)                          |  |                | 385   | 
|Series C (conversion rate of 1.5816)                       |  |                | 876   | 
|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 |  |                | 5,956 | 
|                                                           |  |                |       | 

53



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##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

Preferred Stock
Warrants In connection
with an unused credit facility, in November 2001 the Company
issued a Series F preferred stock purchase warrant
entitling the holder to purchase 21,349 shares of
preferred stock, at $7.47 per share. The warrants are fully
exercisable and expire upon the earlier of November 13,
2011 or two years after the closing of the Companys
initial public offering. The fair value of the warrants,
$115,000, as determined using the Black-Scholes option pricing
method, was recognized as interest expense over the term of the
credit facility in 2001.

As discussed in Note 6, as consideration for
the extension of the maturity date, the lender received warrants
to purchase 40,150 shares of Series F preferred
stock at an exercise price of $7.47 per share. The fair
value of the warrants was $161,000.

The assumptions used to calculate the fair value
of warrants as determined using the Black-Scholes option pricing
model are as follows:

|                        |  |             |      |      |  |  |       |  
|----------------------- |  | ----------- | ---- | ---- |  |  | ----- | -
|                        |  |            
|                        |  | Fiscal Year
|                        |  |            
|                        |  | 2003        |      | 2002
|                        |  |             |      |     
|Expected dividend rate  |  |             | 0    | %    |  |  | 0     | %
|Expected volatility     |  |             | 60   | %    |  |  | 60    | %
|Risk-free interest rate |  |             | 2.94 | %    |  |  | 3.63  | %
|Expected lives (years)  |  |             | 5.00 |      |  |  | 10.00 |  



|   |             
|-- | ------------
|9. | Common Stock

The Companys Amended and Restated
Certificate of Incorporation authorizes the Company to issue
100,000,000 shares of $0.01 par value common stock.
During fiscal years 2003 and 2002, the Company repurchased
20,875 and 244 shares, respectively, at an average price of
$0.59 per share.

As of March 28, 2004, the Company has
reserved the following number of shares of common stock for
future issuance in connection with:

|                                              |       |            |       |       | 
|--------------------------------------------- | ----- | ---------- | ----- | ----- | 
|                                              |       | March 28, 
|                                              |       | 2004      
|                                              |       |           
|                                              |       | (In       
|                                              |       | thousands)
|Exercise of Series F preferred stock warrants |       |            | 61    |      
|Exercise of common stock warrants             |       |            | 18    |      
|Options available for future grants           |       |            | 1,062 |      
|Options outstanding                           |       |            | 1,189 |      
|                                              |       |            |       |      
|                                              | Total |            |       | 2,330 | 
|                                              |       |            |       |      

Common Stock
Warrants In connection
with a line of credit (Note 6), the Company issued
detachable warrants to purchase 17,079 shares of
common stock in March 2000 with an exercise price of
$5.86 per share, later reduced to $1.64 per share. The
warrants are fully exercisable and expire on (a) March 2007
or (b) upon sale, conveyance or disposal of all or
substantially all of the Companys property or business or
any other transaction or series of transactions in which 50% of
the voting power of the Company is disposed of, whichever is
earlier. The fair value of the warrants of $386,000, as
determined using Black-Scholes option pricing model, was
recorded as a discount on notes payable and was amortized as
additional interest expense using the effective interest rate
method over the term of the note.

54



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##### Table of Contents



RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)



|    |              
|--- | -------------
|10. | Benefit Plans



| |                       
| | ----------------------
| | 1999 Stock Option Plan

The Company maintains a stock option plan, as
amended (the 1999 Plan), which authorizes the Board
of Directors to grant incentive stock options and nonstatutory
stock options to employees, directors and consultants. The
maximum aggregate number of shares that may be sold under the
Plan is 2,228,864 shares of common stock, plus an annual
increase on the first day of each of the Companys fiscal
years beginning in each of 2005 through 2009 equal to the lesser
of (a) 426,985 shares, (b) 4% of the shares
outstanding on the last day of the immediately preceding fiscal
year, or (c) such lesser number of shares as the Board
shall determine; provided however that the maximum number of
shares that may be added in any year pursuant to this sentence
shall not result in the 1999 Plans having available for
issuance an aggregate number of shares that exceeds 4% of the
fully diluted shares of outstanding common stock as of the last
day of the immediately preceding fiscal year.

Generally, options vest 25% on the first
anniversary of the date of grant and thereafter become
exercisable in equal monthly installments over the remaining
36 months. Options are exercisable for a term of ten years
after the date of grant. No options will be granted to any
individual who owns more than 10% of total combined voting power
of all classes of stock.

The 1999 Plan also provides for early exercise of
options prior to vesting. Any unvested shares purchased are
subject to repurchase by the Company upon occurrence of certain
events or conditions, such as employment termination, at the
original purchase price. As of March 28, 2004 and
March 30, 2003, there were 0 and 4,795 shares
outstanding, respectively, subject to repurchase rights.

In fiscal year 2000, the Company granted
approximately 0.4 million options to employees at an
exercise price that was less than the fair market value of the
Companys stock on the date of grant. The Company recorded
$1.8 million of deferred compensation related to these
option grants, which is included as a separate component of
stockholders equity, and is being amortized over the
vesting period of the awards. The Company recorded amortization
expense of $132,000, $359,000, and $406,000 in the fiscal years
2004, 2003, and 2002, respectively, which is included in general
and administrative expenses in the statements of operations.

In fiscal year 2004, the Company granted
approximately 0.3 million options to employees at an
exercise price that was less than the fair market value of the
Companys stock on the date of grant. The Company recorded
$0.7 million of deferred compensation related to these
option grants, which is included as a separate component of
stockholders equity, and is being amortized over the
vesting period of the awards. The Company recorded amortization
expense of $130,000 in fiscal 2004, which is included in general
and administrative expenses in the statements of operations.



| |                            
| | ---------------------------
| | Directors Stock Option 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.

55



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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

The following table summarizes activity under the
Companys stock option plans:

|                                            |  |                |       |             |  |           |       |   |  |   |      | 
|------------------------------------------- |  | -------------- | ----- | ----------- |  | --------- | ----- | - |  | - | ---- | 
|                                            |  |                |       |             |  | Weighted 
|                                            |  | Shares         |       |             |  | Average  
|                                            |  | Available      |       |             |  | Exercise 
|                                            |  | for            |       | Options     |  | Price Per
|                                            |  | Grant          |       | Outstanding |  | Share    
|                                            |  |                |       |             |  |          
|                                            |  |               
|                                            |  | (In thousands)
|Balance at April 1, 2001                    |  |                | 114   |             |  |           | 350   |   |  | $ | 5.62 | 
|Granted (weighted average fair value $0.94) |  |                | (176  | )           |  |           | 176   |   |  |   | 5.86 | 
|Cancelled                                   |  |                | 97    |             |  |           | (97   | ) |  |   | 5.74 | 
|Exercised                                   |  |                |      |             |  |           | (5    | ) |  |   | 4.92 | 
|                                            |  |                |       |             |  |           |       |   |  |   |      | 
|Balance at March 31, 2002                   |  |                | 35    |             |  |           | 424   |   |  | $ | 5.74 | 
|Additional shares authorized                |  |                | 639   |             |  |           |      |   |  |   |     | 
|Granted (weighted average fair value $0.23) |  |                | (572  | )           |  |           | 572   |   |  |   | 1.64 | 
|Cancelled                                   |  |                | 189   |             |  |           | (189  | ) |  |   | 4.33 | 
|Exercised                                   |  |                |      |             |  |           | (13   | ) |  |   | 5.39 | 
|                                            |  |                |       |             |  |           |       |   |  |   |      | 
|Balance at March 30, 2003                   |  |                | 291   |             |  |           | 794   |   |  | $ | 3.16 | 
|Additional shares authorized                |  |                | 1,217 |             |  |           |      |   |  |   |     | 
|Granted (weighted average fair value $5.02) |  |                | (681  | )           |  |           | 681   |   |  |   | 8.50 | 
|Cancelled                                   |  |                | 235   |             |  |           | (235  | ) |  |   | 3.47 | 
|Exercised                                   |  |                |      |             |  |           | (51   | ) |  |   | 4.27 | 
|                                            |  |                |       |             |  |           |       |   |  |   |      | 
|Balance at March 28, 2004                   |  |                | 1,062 |             |  |           | 1,189 |   |  | $ | 6.09 | 
|                                            |  |                |       |             |  |           |       |   |  |   |      | 
|Exercisable, March 31, 2002                 |  |                | 195   |             |  |           |       |   |  | $ | 5.62 | 
|Exercisable, March 30, 2003                 |  |                | 340   |             |  |           |       |   |  | $ | 4.45 | 
|Exercisable, March 28, 2004                 |  |                | 552   |             |  |           |       |   |  | $ | 3.53 | 

The following table summarizes information about
stock options outstanding at March 28, 2004:

|                                 |                 |                     |  |                     |        |           |  |             |     |           |  |   |       |  |  |  |     |  |  |   |       | 
|-------------------------------- | --------------- | ------------------- |  | ------------------- | ------ | --------- |  | ----------- | --- | --------- |  | - | ----- |  |  |  | --- |  |  | - | ----- | 
|                                 |                 |                     |  |                    
|                                 |                 | Options Outstanding |  | Options Exercisable
|                                 |                 |                     |  |                    
|                                 |                 |                     |  | Weighted            |        | Weighted  |  |             |     | Weighted 
|                                 |                 |                     |  | Average             |        | Average   |  |             |     | Average  
|                                 |                 |                     |  | Remaining           |        | Exercise  |  |             |     | Exercise 
|                                 |                 | Number              |  | Contractual         |        | Price Per |  | Number      |     | Price Per
|Exercise Price                   |                 | Outstanding         |  | Life (Years)        |        | Share     |  | Outstanding |     | Share    
|                                 |                 |                     |  |                     |        |           |  |             |     |          
|                                
|(in 000s except per share data)
|                                 | $ 0.59 - $ 4.   |                     |  |                     | 10 579 |           |  |             | 6.1 |           |  | $ | 1.79  |  |  |  | 341 |  |  | $ | 1.83  | 
|                                 | 5.86 - 11.26    |                     |  |                     | 293    |           |  |             | 4.6 |           |  |   | 7.02  |  |  |  | 197 |  |  |   | 5.86  | 
|                                 | $12.19 - $16.85 |                     |  |                     | 317    |           |  |             | 8.9 |           |  |   | 13.07 |  |  |  | 14  |  |  |   | 12.19 | 
|                                 |                 |                     |  |                     |        |           |  |             |     |           |  |   |       |  |  |  |     |  |  |   |       | 
|                                 |                 |                     |  |                     | 1,189  |           |  |             | 6.5 |           |  | $ | 6.09  |  |  |  | 552 |  |  | $ | 3.53  | 
|                                 |                 |                     |  |                     |        |           |  |             |     |           |  |   |       |  |  |  |     |  |  |   |       | 

The fair value of each option grant is estimated
on the date of grant using the Black-Scholes Method assuming an
expected life of four years, dividend yield of 0%, volatility of
60% and a weighted average risk-free interest rate of 2.3% to
3.4%.

See Note 1 for pro forma effect of
accounting for stock options using the fair value method.

Employee Stock Purchase Plan
(ESPP) 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

56



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RedEnvelope, Inc.


NOTES TO
FINANCIAL STATEMENTS  (Continued)

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.

401(k) Savings
Plan The Company
sponsors a 401(k) Savings Plan which allows all employees to
make salary deferral contributions ranging from 1% to 15% of
their eligible earnings. The Company can make discretionary
matching contributions to the Plan. During fiscal years 2004,
2003, and 2002, the Company contributed $66,000, $69,000, and
$98,000, respectively, to the Plan.



|    |                           
|--- | --------------------------
|11. | Related Party Transactions

Notes Receivable from
Stockholders Notes
receivable from stockholders represent amounts owed to the
Company from the exercise of stock options. These full recourse
notes are collateralized by common stock and bear interest at a
rate of 5.74% per annum. Interest and principal is due and
payable on July 10, 2003 through 2007. At March 28,
2004 and March 30, 2003 , notes receivable were
approximately $44,000.



|    |                                                
|--- | -----------------------------------------------
|12. | Quarterly Financial Information
    (Unaudited)

The quarterly financial information presented
below reflects all adjustments, which, in the opinion of
management, are of a normal and recurring nature necessary to
present fairly the results of operations for the periods
presented.

|                                |  |                                          |        |               |  |              |        |           |  |       |        |  |  |   |        |   |  |   |        |  
|------------------------------- |  | ---------------------------------------- | ------ | ------------- |  | ------------ | ------ | --------- |  | ----- | ------ |  |  | - | ------ | - |  | - | ------ | -
|                                |  |                                          |        |              
|                                |  | Fiscal 2004 Quarter Ended                |        |              
|                                |  |                                          |        |              
|                                |  | June 29,                                 |        | September 28, |  | December 28, |        | March 28, |  | 2004 
|                                |  | 2003                                     |        | 2003          |  | 2003         |        | 2004      |  | Total
|                                |  |                                          |        |               |  |              |        |           |  |      
|                                |  |                                         
|                                |  | (In thousands, except per share amounts)
|Net revenues                    |  | $                                        | 17,721 |               |  | $            | 8,329  |           |  | $     | 35,922 |  |  | $ | 17,336 |   |  | $ | 79,308 |  
|Gross profit                    |  |                                          | 8,671  |               |  |              | 4,032  |           |  |       | 17,773 |  |  |   | 9,238  |   |  |   | 39,714 |  
|Operating income (loss)         |  |                                          | (1,058 | )             |  |              | (2,730 | )         |  |       | 1,215  |  |  |   | (2,276 | ) |  |   | (4,849 | )
|Net income (loss)               |  |                                          | (1,217 | )             |  |              | (2,826 | )         |  |       | 1,176  |  |  |   | (2,261 | ) |  |   | (5,128 | )
|Basic income (loss) per share   |  | $                                        | (3.52  | )             |  | $            | (6.56  | )         |  | $     | 0.14   |  |  | $ | (0.27  | ) |  | $ | (1.16  | )
|Diluted income (loss) per share |  | $                                        | (3.52  | )             |  | $            | (6.56  | )         |  | $     | 0.13   |  |  | $ | (0.27  | ) |  | $ | (1.16  | )

|                                |  |                                          |        |               |  |              |        |           |  |       |        |  |  |   |        |   |  |   |        |  
|------------------------------- |  | ---------------------------------------- | ------ | ------------- |  | ------------ | ------ | --------- |  | ----- | ------ |  |  | - | ------ | - |  | - | ------ | -
|                                |  |                                          |        |              
|                                |  | Fiscal 2003 Quarter Ended                |        |              
|                                |  |                                          |        |              
|                                |  | June 30,                                 |        | September 29, |  | December 29, |        | March 30, |  | 2003 
|                                |  | 2002                                     |        | 2002          |  | 2002         |        | 2003      |  | Total
|                                |  |                                          |        |               |  |              |        |           |  |      
|                                |  |                                         
|                                |  | (In thousands, except per share amounts)
|Net revenues                    |  | $                                        | 15,287 |               |  | $            | 5,366  |           |  | $     | 34,290 |  |  | $ | 15,116 |   |  | $ | 70,059 |  
|Gross profit                    |  |                                          | 7,100  |               |  |              | 2,361  |           |  |       | 16,972 |  |  |   | 7,049  |   |  |   | 33,482 |  
|Operating income (loss)         |  |                                          | (2,177 | )             |  |              | (3,543 | )         |  |       | 1,104  |  |  |   | (2,549 | ) |  |   | (7,165 | )
|Net income (loss)               |  |                                          | (2,294 | )             |  |              | (3,676 | )         |  |       | 912    |  |  |   | (2,653 | ) |  |   | (7,711 | )
|Basic income (loss) per share   |  | $                                        | (7.88  | )             |  | $            | (11.60 | )         |  | $     | 2.81   |  |  | $ | (7.99  | ) |  | $ | (24.48 | )
|Diluted income (loss) per share |  | $                                        | (7.88  | )             |  | $            | (11.60 | )         |  | $     | 0.14   |  |  | $ | (7.99  | ) |  | $ | (24.48 | )

57



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|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

None.






|         |                        
|-------- | -----------------------
|Item 9A. | 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 Annual Report on Form 10-K. The Company continues
to implement minor changes primarily to formalize and document
procedures already in place. Maintenance of disclosure controls
and procedures is an ongoing process and controls and procedures
may change over time. 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.




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

Information regarding our Executive Officers
required hereunder is set forth in Item 1 of Part 1
Business  Executive Officers of the
Registrant. The information required hereunder regarding
our Directors is incorporated by reference from our Proxy
Statement to be filed in connection with our 2004 annual meeting
of stockholders. The information required hereunder regarding
Compliance with Section 16(a) of the Securities Exchange
Act and our Code of Ethics is incorporated by reference from our
Proxy Statement to be filed in connection with our 2004 annual
meeting of stockholders.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our 2004 annual meeting of stockholders.






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our 2004 annual meeting of stockholders.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our 2004 annual meeting of stockholders.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The information required hereunder is
incorporated by reference from our Proxy Statement to be filed
in connection with our 2004 annual meeting of stockholders.

58



---



##### Table of Contents






PART IV






|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules,
    and Reports on Form 8-K

List the following documents filed as a part of
the report:

1. Financial Statements

The following consolidated financial statements
of the Company are included in Item 8:



| |                                                                        
| | -----------------------------------------------------------------------
| | Report of Independent Registered Public
    Accounting Firm            
| | Balance Sheets                                                         
| | Statements of Operations                                               
| | Statements of Stockholders Equity (Deficit)
    and Comprehensive Loss
| | Statements of Cash Flows                                               
| | Notes to Financial Statements                                          

2. Financial Statement Schedule

All schedules have been omitted because they are
inapplicable, not required or the information is included in the
Consolidated Financial Statements or Notes thereto.

3. Exhibits

|       |    |             |  |                                                                                                                                                                                                    
|------ | -- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 3  | .1          |  | Amended and Restated Certificate of Incorporation
    of the Registrant currently in effect.(1)                                                                                                    
|       | 3  | .2          |  | Amended and Restated Certificate of Incorporation
    of the Registrant(1)                                                                                                                         
|       | 3  | .4          |  | Form of Amended and Restated Bylaws of the
    Registrant to be in effect after the closing of the offering
    made pursuant to this Registration Statement.(1)                                   
|       | 4  | .1          |  | Specimen stock certificate for the
    Registrants common stock.(1)                                                                                                                               
|       | 4  | .2          |  | Amended and Restated Investors Rights
    Agreement dated April 17, 2002 between the Registrant and
    certain investors.(1)                                                                     
|       | 4  | .3          |  | Omnibus Amendment to Investors Rights
    Agreement, Right of First Refusal and Co-Sale Agreement and
    Voting Agreement dated May 29, 2003 between the Registrant
    and certain investors.(1)
|       | 4  | .4          |  | Common Stock Purchase Warrant dated March 9,
    2000 issued to Lighthouse Capital Partners III, L.P.(1)                                                                                           
|       | 4  | .5          |  | Series F Preferred Stock Purchase Warrant
    dated September 6, 2002 issued to Lighthouse Capital
    Partners III, L.P.(1)                                                                       
|       | 4  | .6          |  | Series F Preferred Stock Purchase Warrant
    dated October 15, 2002 issued to Lighthouse Capital
    Partners III, L.P.(1)                                                                        
|       | 4  | .7          |  | Warrant Purchase Agreement dated
    November 13, 2001 between the Registrant and Camelot
    Ventures, LLC.(1)                                                                                    
|       | 4  | .8          |  | Preferred Stock Purchase Warrant dated
    November 13, 2002 issued to Camelot Ventures, LLC.(1)                                                                                                   
|       | 4  | .9          |  | Warrant Agreement dated February 10, 2000
    issued to Comdisco, Inc.(1)                                                                                                                          
|       | 10 | .1          |  | Form of Indemnification Agreement between the
    Registrant and each of its officers and directors.(1)                                                                                            
|       | 10 | .7          |  | Office Lease dated September 1, 1999 between
    the Registrant and the Equitable Life Assurance Society of the
    United States.(1)                                                              
|       | 10 | .8          |  | Assignment of Lease dated April 18, 2000
    between RedEnvelope and Mission Valley Christian Fellowship of
    San Diego.(1)                                                                      

59



---



##### Table of Contents



|       |    |             |  |                                                                                                                                                                                               
|------ | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 10 | .9          |  | Assignment of Lease dated April 18, 2000
    between RedEnvelope and Mission Valley Christian Fellowship of
    San Diego.(1)                                                                 
|       | 10 | .10         |  | Lease dated March 28, 2000 between
    RedEnvelope and Four Amigos.(1)                                                                                                                        
|       | 10 | .11         |  | Sublease Agreement dated June 18, 2002
    between 3PF.Com, Inc. and RedEnvelope.(1)                                                                                                          
|       | 10 | .12         |  | Offer Letter to Alison May dated March 12,
    2002.(1)                                                                                                                                       
|       | 10 | .13         |  | Indemnification Agreement between RedEnvelope and
    Alison May dated April 8, 2002.(1)                                                                                                      
|       | 10 | .15         |  | Promissory Note issued by Hilary Billings, dated
    July 21, 1999.(1)                                                                                                                        
|       | 10 | .16         |  | Promissory Note issued by Hilary Billings dated
    July 21, 1999.(1)                                                                                                                         
|       | 10 | .17         |  | Amendment to Promissory Notes issued by Hilary
    Billings dated May 21, 2002.(1)                                                                                                            
|       | 10 | .19         |  | Offer Letter to John Roberts dated
    February 18, 2003.(1)                                                                                                                                  
|       | 10 | .20         |  | 1999 Stock Plan, as amended on April 11,
    2003, and form agreements thereunder.(1)                                                                                                         
|       | 10 | .21         |  | 2003 Directors Stock Option Plan and
    form agreements thereunder.(1)                                                                                                                      
|       | 10 | .22         |  | 2003 Employee Stock Purchase Plan and form
    agreements thereunder.(1)                                                                                                                      
|       | 10 | .32*        |  | Revolving Credit and Security Agreement dated
    June 13, 2003 between the Registrant and CapitalSource
    Finance, LLC.(1)                                                                 
|       | 10 | .33*        |  | Internet Data Center Services Agreement dated
    October 23, 1998 between the Registrant and Exodus
    Communications, Inc.(1)                                                              
|       | 10 | .34         |  | Offer Letter to Edward Schmults dated
    April 22, 2004.                                                                                                                                     
|       | 10 | .35         |  | Waivers under and Amendment dated April 29,
    2004 of the Revolving Credit and Security Agreement dated as of
    June 13, 2003 between RedEnvelope, Inc. and CapitalSource
    Finance LLC.
|       | 10 | .36         |  | Amendment No. 2 dated June 21, 2004 to
    the Revolving Credit and Security Agreement dated as of
    June 13, 2003 between RedEnvelope, Inc. and CapitalSource
    Finance LLC.             
|       | 10 | .37**       |  | Software License, Services, Support and
    Enhancements Agreement dated December 29, 2003 between
    RedEnvelope, Inc. and Manhattan Associates, Inc.                                       
|       | 10 | .38**       |  | Sales Agreement dated April 30, 2004 between
    RedEnvelope, Inc. and Vargo Material Handling, Inc.                                                                                          
|       | 23 | .1          |  | Consent of Independent Registered Public
    Accounting Firm.                                                                                                                                 
|       | 24 | .1          |  | Power of Attorney (See Page 62).                                                                                                                                                              
|       | 31 | .1          |  | Alison Mays Certification pursuant to
    13a-14(a) as adopted pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                
|       | 31 | .2          |  | Eric Wongs Certification pursuant to
    13a-14(a) as adopted pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                 
|       | 32 | .1          |  | Alison Mays Certification pursuant to
    18 U.S.C. 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                          
|       | 32 | .2          |  | Eric Wongs Certification pursuant to
    18 U.S.C. 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                                                           



---



|    |                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to identically numbered
    exhibits to the Registrants previously filed Registration
    Statement on Form S-1, which became effective on
    September 24, 2003.
|   
|*   | Confidential treatment granted with respect to
    certain portions of this Exhibit.                                                                                                         



|   |                                                                                                                                                                             
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|** | Material has been omitted pursuant to a request
    for confidential treatment. Omitted portions have been filed
    separately with the Securities and Exchange Commission.

60



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##### Table of Contents



Reports on Form 8-K

On January 9, 2004, the Company filed a
Current Report on Form 8-K reporting the departure of one
of its officers and announcing its anticipated revenue and net
income for the fiscal quarter ended December 28, 2004.

On January 27, 2004, the Company filed a
Current Report of Form 8-K reporting its financial results
for the fiscal quarter ended December 28, 2004.

On March 19, 2004, the Company filed a
Current Report on Form 8-K announcing the departure of one
of its officers and directors.

61



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



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



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

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

Date: June 22, 2004

KNOW ALL MEN BY THESE PRESENTS, that each person
whose signature appears below constitutes and appoints
Alison L. May and Eric C. Wong, and each of them, his
or her attorney-in-fact with power of substitution for him or
her in any and all capacities, to sign any amendments,
supplements or other documents relating to this Annual Report on
Form 10-K he deems necessary or appropriate, and to file
the same, with exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that such
attorney-in-fact or his substitute may do or cause to be done by
virtue hereof.

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|                                       |  |                                                                                       |  |               |  | 
|-------------------------------------- |  | ------------------------------------------------------------------------------------- |  | ------------- |  | 
|                                       |  |                                                                                       |  |              
|Signature                              |  | Title                                                                                 |  | Date         
|                                       |  |                                                                                       |  |              
|                                      
|/s/ MICHAEL MORITZMichael Moritz       |  | Chairman of the Board                                                                 |  | June 22, 2004
|                                      
|/s/ ALISON L. MAYAlison L. May         |  | Director, President and
    Chief Executive Officer
    (Principal Executive Officer) |  | June 22, 2004
|                                      
|/s/ ERIC C. WONGEric C. Wong           |  | Chief Financial Officer
    (Principal Financial and Accounting Officer)              |  | June 22, 2004
|                                      
|/s/ MICHAEL E. DUNNMichael E. Dunn     |  | Director                                                                              |  | June 22, 2004
|                                      
|/s/ KAREN EDWARDSKaren Edwards         |  | Director                                                                              |  | June 22, 2004
|                                      
|/s/ SCOTT GALLOWAYScott Galloway       |  | Director                                                                              |  | June 22, 2004
|                                      
|/s/ CHARLES HEILBRONNCharles Heilbronn |  | Director                                                                              |  | June 22, 2004
|                                      
|/s/ DANIEL R. LYLEDaniel R. Lyle       |  | Director                                                                              |  | June 22, 2004

62



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##### Table of Contents



EXHIBIT INDEX

|       |    |             |  |                                                                                                                                                                                                    
|------ | -- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 3  | .1          |  | Amended and Restated Certificate of Incorporation
    of the Registrant currently in effect.(1)                                                                                                    
|       | 3  | .2          |  | Amended and Restated Certificate of Incorporation
    of the Registrant(1)                                                                                                                         
|       | 3  | .4          |  | Form of Amended and Restated Bylaws of the
    Registrant to be in effect after the closing of the offering
    made pursuant to this Registration Statement.(1)                                   
|       | 4  | .1          |  | Specimen stock certificate for the
    Registrants common stock.(1)                                                                                                                               
|       | 4  | .2          |  | Amended and Restated Investors Rights
    Agreement dated April 17, 2002 between the Registrant and
    certain investors.(1)                                                                     
|       | 4  | .3          |  | Omnibus Amendment to Investors Rights
    Agreement, Right of First Refusal and Co-Sale Agreement and
    Voting Agreement dated May 29, 2003 between the Registrant
    and certain investors.(1)
|       | 4  | .4          |  | Common Stock Purchase Warrant dated March 9,
    2000 issued to Lighthouse Capital Partners III, L.P.(1)                                                                                           
|       | 4  | .5          |  | Series F Preferred Stock Purchase Warrant
    dated September 6, 2002 issued to Lighthouse Capital
    Partners III, L.P.(1)                                                                       
|       | 4  | .6          |  | Series F Preferred Stock Purchase Warrant
    dated October 15, 2002 issued to Lighthouse Capital
    Partners III, L.P.(1)                                                                        
|       | 4  | .7          |  | Warrant Purchase Agreement dated
    November 13, 2001 between the Registrant and Camelot
    Ventures, LLC.(1)                                                                                    
|       | 4  | .8          |  | Preferred Stock Purchase Warrant dated
    November 13, 2002 issued to Camelot Ventures, LLC.(1)                                                                                                   
|       | 4  | .9          |  | Warrant Agreement dated February 10, 2000
    issued to Comdisco, Inc.(1)                                                                                                                          
|       | 10 | .1          |  | Form of Indemnification Agreement between the
    Registrant and each of its officers and directors.(1)                                                                                            
|       | 10 | .7          |  | Office Lease dated September 1, 1999 between
    the Registrant and the Equitable Life Assurance Society of the
    United States.(1)                                                              
|       | 10 | .8          |  | Assignment of Lease dated April 18, 2000
    between RedEnvelope and Mission Valley Christian Fellowship of
    San Diego.(1)                                                                      
|       | 10 | .9          |  | Assignment of Lease dated April 18, 2000
    between RedEnvelope and Mission Valley Christian Fellowship of
    San Diego.(1)                                                                      
|       | 10 | .10         |  | Lease dated March 28, 2000 between
    RedEnvelope and Four Amigos.(1)                                                                                                                             
|       | 10 | .11         |  | Sublease Agreement dated June 18, 2002
    between 3PF.Com, Inc. and RedEnvelope.(1)                                                                                                               
|       | 10 | .12         |  | Offer Letter to Alison May dated March 12,
    2002.(1)                                                                                                                                            
|       | 10 | .13         |  | Indemnification Agreement between RedEnvelope and
    Alison May dated April 8, 2002.(1)                                                                                                           
|       | 10 | .15         |  | Promissory Note issued by Hilary Billings, dated
    July 21, 1999.(1)                                                                                                                             
|       | 10 | .16         |  | Promissory Note issued by Hilary Billings dated
    July 21, 1999.(1)                                                                                                                              
|       | 10 | .17         |  | Amendment to Promissory Notes issued by Hilary
    Billings dated May 21, 2002.(1)                                                                                                                 
|       | 10 | .19         |  | Offer Letter to John Roberts dated
    February 18, 2003.(1)                                                                                                                                       
|       | 10 | .20         |  | 1999 Stock Plan, as amended on April 11,
    2003, and form agreements thereunder.(1)                                                                                                              
|       | 10 | .21         |  | 2003 Directors Stock Option Plan and
    form agreements thereunder.(1)                                                                                                                           
|       | 10 | .22         |  | 2003 Employee Stock Purchase Plan and form
    agreements thereunder.(1)                                                                                                                           
|       | 10 | .32*        |  | Revolving Credit and Security Agreement dated
    June 13, 2003 between the Registrant and CapitalSource
    Finance, LLC.(1)                                                                      
|       | 10 | .33*        |  | Internet Data Center Services Agreement dated
    October 23, 1998 between the Registrant and Exodus
    Communications, Inc.(1)                                                                   
|       | 10 | .34         |  | Offer Letter to Edward Schmults dated
    April 22, 2004.                                                                                                                                          
|       | 10 | .35         |  | Waivers under and Amendment dated April 29,
    2004 of the Revolving Credit and Security Agreement dated as of
    June 13, 2003 between RedEnvelope, Inc. and CapitalSource
    Finance LLC.     
|       | 10 | .36         |  | Amendment No. 2 dated June 21, 2004 to
    the Revolving Credit and Security Agreement dated as of
    June 13, 2003 between RedEnvelope, Inc. and CapitalSource
    Finance LLC.                  



---



##### Table of Contents



|       |    |             |  |                                                                                                                                                        
|------ | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
|Number |    | Description
|       |    |            
|       | 10 | .37**       |  | Software License, Services, Support and
    Enhancements Agreement dated December 29, 2003 between
    RedEnvelope, Inc. and Manhattan Associates, Inc.
|       | 10 | .38**       |  | Sales Agreement dated April 30, 2004 between
    RedEnvelope, Inc. and Vargo Material Handling, Inc.                                                   
|       | 23 | .1          |  | Consent of Independent Registered Public
    Accounting Firm.                                                                                          
|       | 24 | .1          |  | Power of Attorney (See Page 62).                                                                                                                       
|       | 31 | .1          |  | Alison Mays Certification pursuant to
    13a-14(a) as adopted pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                         
|       | 31 | .2          |  | Eric Wongs Certification pursuant to
    13a-14(a) as adopted pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                          
|       | 32 | .1          |  | Alison Mays Certification pursuant to
    18 U.S.C. 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                   
|       | 32 | .2          |  | Eric Wongs Certification pursuant to
    18 U.S.C. 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002.                    



---



|    |                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to identically numbered
    exhibits to the Registrants previously filed Registration
    Statement on Form S-1, which became effective on
    September 24, 2003.
|   
|*   | Confidential treatment granted with respect to
    certain portions of this Exhibit.                                                                                                         



|   |                                                                                                                                                                             
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|** | Material has been omitted pursuant to a request
    for confidential treatment. Omitted portions have been filed
    separately with the Securities and Exchange Commission.