Red Flag for Red Envelope?

Feb 16, 2008 4:46 AM  By

Gifts cataloger Red Envelope is falling further into the red. Shares of the San Francisco-based company sank to an all-time low Thursday ($1.63) after officials declared they have only enough money to operate the business through June.

For its fiscal third quarter, Red Envelope reported a loss of $4.3 million, compared with a net income of $5.3 million for the same period last year. Revenue plummeted to $45.2 million, from $57 million a year ago. Order shipments during the third quarter dropped about 20% compared with last year.

As of Dec. 30, 2007, Red Envelope had $12.3 million in cash and cash equivalents and no debt. The company has a credit facility of up to $12.5 million (of which only $3.8 million was available as of Dec. 30), the availability of which is subject to an inventory-based formula, and a stand-by subordinated, unsecured credit arrangement for up to $2.6 million.

Company officials said in a release that the cash on hand and available under its lending arrangements will be sufficient to fund operations and anticipated capital expenditures through the quarter ending June 2008.

CEO John Pound said in a release that the company is focused on its financial condition and capital needs and “is evaluating various options for addressing these challenges immediately. However, there can be no assurance that additional financing or other alternatives will be available when necessary, or if available, that such alternatives will not result in undue dilution to, or an adverse impact on the rights of, the company’s existing stockholders.”

Although the nine-year-old company entered the third quarter with a “significantly freshened creative message,” Pound said: “Revenue came in at the low end of our preseason forecasts. Margins were also affected by promotional activity necessary to drive revenue in holiday.”

While Red Envelope’s Web business performed well through holiday catalog response rates were low through both fall and holiday–and particularly low in prospecting, Pound said. “We increased prospecting circulation in holiday in hopes of beginning to rebuild our customer file, but did not achieve our goals.”

He said the company was in discussions with several potential partners, and that it hoped to have a resolution to the balance sheet situation in the next 90 days.

Red Envelope’s situation “will not be an uncommon story in the catalog market,” says Chris Shannon, managing director for New York-based investment bank Berkery, Noyes & Co. “Many good companies are experiencing regression in their specific segments.”

Says Lee Helman, managing director with New York-based investment bank Financo: “The business environment doesn’t bode well for them, even though many Wall Street analysts are thinking the second half of 2008 will be fine.”

Helman does not see consumer spending rebounding much for holiday ’08, “and this could crush Red Envelope–which has a huge reliance on the fourth quarter. I don’t think they will be forced to close, but they might be forced to raise capital or sell.”

Stuart Rose, managing director for Wellesley, MA-based investment bank Tully & Holland, says: “Eventually companies need to make money. Red Envelope is in deep trouble and has been for a while. It never built a profitable business model.”

The company grew to a size where it should be profitable, he notes, “but somewhere along the line someone missed the point that businesses are supposed to be profitable.”

The third quarter looks “disastrous” for Red Envelope, Rose added. What might happen to the company? “Someone will pick them up at a distressed price, consolidate their operations, and use the name and list in a method to build a profitable division of a larger company,” he says.