Celebrate Express 10Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended November 30, 2005


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 000-50973

CELEBRATE EXPRESS, INC.

(Exact name of registrant as specified in its charter)


Washington (State or other jurisdiction of incorporation or organization)		91-1644428 (I.R.S. Employer Identification No.)

11220 – 120^thAvenue NE Kirkland, Washington (Address of principal executive offices)		98033 (Zip Code)

(425) 250-1061
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesþ Noo

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

Yeso Noþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yeso Noþ

As of December 31, 2005, there were 7,706,473 shares of the registrant’s common stock outstanding.

CELEBRATE EXPRESS, INC.

INDEX


	Page
PART I. FINANCIAL INFORMATION	2
Item 1. Financial Statements (unaudited)	2
Balance Sheets at November 30, 2005 and May 31, 2005	2
Statements of Income For the Three and Six Months Ended November 30, 2005 and November 30, 2004	3
Statement of Shareholders’ Equity For the Six Months Ended November 30, 2005	4
Statements of Cash Flows For the Six Months Ended November 30, 2005 and November 30, 2004.	5
Notes to Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	9
Item 3. Quantitative and Qualitative Disclosures About Market Risk	24
Item 4. Controls and Procedures	24
PART II. OTHER INFORMATION	24
Item 1. Legal Proceedings	24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 4. Submission of Matter to a Vote of Securityholders	25
Item 6. Exhibits	26
SIGNATURES
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

Cautionary Note Regarding Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements that involve many risks and uncertainties. These statements relate to future events and our future performance that are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. In some cases, you can identify forward-looking statements by terms such as “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “seek,” or “continue,” the negative of these terms or other variations of such terms. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business and other characterizations of future events or circumstances, are forward-looking statements. These statements are only predictions based upon assumptions made that are believed to be reasonable at the time and are subject to risk and uncertainties. Therefore, actual events or results may differ materially and adversely from those expressed in any forward-looking statement. In evaluating these statements, you should specifically consider the risks described under the caption “Factors that May Affect Future Operating Results” and elsewhere in this Form 10-Q. These factors may cause our actual results to differ materially from any forward-looking statements. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

CELEBRATE EXPRESS, INC.

BALANCE SHEETS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements


	November 30, 2005			May 31, 2005
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	33,698,164		$	30,768,694
Accounts receivable		328,923			213,365
Inventories		8,660,978			8,396,006
Prepaid expenses		3,273,186			3,461,381
Deferred income taxes		318,422			292,852

Total current assets		46,279,673			43,132,298

Fixed assets, net		2,978,290			2,517,352
Deferred income taxes		7,456,413			7,230,551
Other assets, net		168,079			176,633

Total assets	$	56,882,455		$	53,056,834


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3,134,739		$	2,968,546
Accrued liabilities		3,474,407			2,070,800
Current portion of capital leases		6,904			17,102

Total current liabilities		6,616,050			5,056,448

Commitments and contingencies		—			—

Shareholders’ equity:
Common stock, $0.001 par value and additional paid-in-capital - authorized, 10,000,000 shares; issued and outstanding, 7,703,136 shares at November 30, 2005; 7,522,712 shares at May 31, 2005		65,045,656			64,336,626
Unearned stock-based compensation		(296,440	)		(726,206	)
Accumulated deficit		(14,482,811	)		(15,610,034	)


Total shareholders’ equity		50,266,405			48,000,386


Total liabilities and shareholders’ equity	$	56,882,455		$	53,056,834

CELEBRATE EXPRESS, INC.

STATEMENTS OF INCOME

(unaudited)


	Three months ended						Six months ended
	November 30,			November 30,			November 30,			November 30,
	2005			2004			2005			2004
Net sales	$	26,129,057		$	18,770,139		$	44,056,761		$	33,292,961
Cost of sales		13,112,798			9,303,247			22,029,881			16,663,989

Gross margin		13,016,259			9,466,892			22,026,880			16,628,972

Operating expenses:
Fulfillment		2,857,537			1,945,353			5,168,039			3,765,912
Selling and marketing		6,403,209			4,578,786			10,424,778			7,971,362
General and administrative		2,246,806			1,719,026			4,066,394			3,149,966
Severance and related expenses		1,178,978			—			1,178,978			—


Total operating expenses		12,686,530			8,243,165			20,838,189			14,887,240


Income from operations		329,729			1,223,727			1,188,691			1,741,732

Other income (expense), net;

Interest income (expense), net		304,173			(143,885	)		545,898			(254,860	)


Income before income taxes		633,902			1,079,842			1,734,589			1,486,872

Income tax expense		(206,693	)		(395,020	)		(607,366	)		(561,080	)

Net income		427,209			684,822			1,127,223			925,792

Accretion to preferred stock redemption value		—			(35,795	)		—			(102,271	)


Net income available for common shareholders	$	427,209		$	649,027		$	1,127,223		$	823,521


Net income per share:
Basic	$	0.06		$	0.16		$	0.15		$	0.29

Diluted	$	0.05		$	0.11		$	0.14		$	0.17


Weighted average shares outstanding:
Basic		7,659,563			4,115,576			7,593,916			2,869,513
Diluted		7,911,568			6,251,935			7,937,122			5,601,759

CELEBRATE EXPRESS, INC.

STATEMENT OF SHAREHOLDERS’ EQUITY

(unaudited)



	Common stock and					Unearned						Total
	additional paid-in capital					stock-based			Accumulated			shareholders
	Shares		Amount			compensation			deficit			equity
BALANCE—May 31, 2005		7,522,712	$	64,336,626			($726,206	)		($15,610,034	)	$	48,000,386

Exercise of common stock options		175,897		133,192									133,192
Issuance of common stock in connection with employee stock purchase plan		4,527		53,872									53,872
Cancellation of stock options				(336,832	)		336,832						—
Tax effect of stock option exercises				858,798									858,798
Amortization of stock-based compensation							92,934						92,934
Net income										1,127,223			1,127,223


BALANCE—November 30, 2005		7,703,136	$	65,045,656			($296,440	)		($14,482,811	)	$	50,266,405

CELEBRATE EXPRESS, INC.

STATEMENT OF CASH FLOWS

(unaudited)


	Six months ended
	November 30, 2005			November 30, 2004
Cash flows from operating activities:
Net income	$	1,127,223		$	925,792
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes		607,366			561,080
Depreciation and amortization		568,077			313,239
Non-cash compensation expense—stock options		92,934			142,666
Amortization of deferred financing costs		—			23,958
Accretion of debt discount		—			70,012
Changes in operating assets and liabilities:
Accounts receivable		(115,558	)		(91,342	)
Inventories		(264,972	)		134,621
Prepaid expenses and other assets		188,195			(823,107	)
Accounts payable		166,193			(1,110,004	)
Accrued liabilities		1,403,607			871,245


Net cash provided by operating activities		3,773,065			1,018,160


Cash flows from investing activities:
Payments for purchases of fixed assets		(1,020,461	)		(899,095	)

Net cash used in investing activities		(1,020,461	)		(899,095	)

Cash flows from financing activities:
Principal payments on capital lease obligations		(10,198	)		(20,851	)
Principal payments on notes payable		—			(5,000,000	)
Net proceeds from sale of common stock, net of issuance costs		—			34,065,666
Proceeds from shares issued under the employee stock purchase plan		53,872			—
Proceeds from exercise of stock options		133,192			3,511


Net cash provided by financing activities		176,866			29,048,326


Net increase in cash and cash equivalents		2,929,470			29,167,391

Cash and cash equivalents:
Beginning of period		30,768,694			2,243,300

End of period	$	33,698,164		$	31,410,691

Supplemental disclosures of cash flow information:
Cash paid for interest	$	358		$	212,590


Supplemental disclosures of non-cash financing and investing activities:
Conversion of mandatorily redeemable convertible preferred stock				$	28,146,053
Net exercise of common stock warrants				$	72,795
Net exercise of preferred stock warrants				$	856,905
Cancellation of unvested stock options	$	336,832			—
Tax effect of stock option exercises	$	858,798			—

1. Organization of Business and Summary of Significant Accounting Policies

Description of Business —Celebrate Express, Inc. (the “Company”), a Washington corporation, is a provider of celebration products for families with young children, via the Internet and catalogs. The Company has three brands: Birthday Express, Storybook Heirlooms and Costume Express, which respectively offer children’s party products, girls’ special occasion and specialty apparel and children’s costumes and accessories.

Basis of Presentation —Management has prepared the accompanying financial statements in accordance with the accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities Exchange Commission. The financial information as of November 30, 2005 and for the three-and six-month periods ended November 30, 2005 and November 30, 2004 is unaudited. In the opinion of management, such information contains all adjustments, consisting of normal, recurring accruals, necessary for a fair presentation of the results for such periods. The results of operations for such interim periods are not necessarily indicative of the expected results of operations for the full fiscal year. These financial statements and related notes should be read in connection with the Company’s Notes to Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K filed for the year ended May 31, 2005. The balance sheet at May 31, 2005 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements.

New accounting pronouncements —On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Standard No. 123 (revised 2004),Share-Based Payment (“SFAS No.123R”).SFAS No. 123R would require the Company to measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. In addition, the adoption of SFAS No. 123R will require additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. In April 2005, the SEC deferred the effective date for SFAS No. 123R to the beginning of the first fiscal year that begins after June 15, 2005. Therefore, we will be required to comply with SFAS No. 123R effective the first quarter following our fiscal year ending May 31, 2006. The Company is currently evaluating the impact of adoption of this statement.

In March 2005, the SEC issued Staff Accounting Bulleting No. 107. SAB 107 expresses the views of the SEC staff regarding the interaction of FAS 123R and certain SEC rules and regulations and provides the SEC staff’s view regarding the valuation of share-based payment arrangements for public companies. We are assessing the impact of SAB 107 in conjunction with our evaluation of the impact of SFAS 123R.

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 at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of the more significant estimates include allowance for sales returns, lower of cost or market adjustments to inventory and deferred income taxes. Actual results could differ from those estimates.

Stock-Based Compensation —The Company measures compensation cost of stock options in accordance with Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees, under which no recognition of expense is required in accounting for stock options granted to employees for which the exercise price equals or exceeds the fair value of the stock at the grant date. For stock options granted to employees for which the exercise price is less than the fair value of the stock on the date of the grant, the intrinsic value of stock options is recorded as unearned compensation and amortized into the Statement of Operations over the vesting period of the option.

Had compensation cost been determined using Statement of Financial Accounting Standards (“SFAS”) No. 123,Accounting for Stock-Based Compensation, the impact on the Company’s net income for each period presented would have been as follows:


	Three Months Ended November 30,						Six Months Ended November 30,
	2005			2004			2005			2004
Net income available for common shareholders, as reported	$	427,209		$	649,027		$	1,127,223		$	823,521

Add: Stock-based employee compensation expense, as reported	$	32,874			49,486		$	92,934			94,160
Deduct: Stock-based employee compensation expense determined under the fair-value-based method		(113,384	)		(103,535	)		(222,853	)		(166,478	)

Pro forma net income available for common shareholders — basic	$	346,699		$	594,978		$	997,304		$	751,203

Add: Accretion to preferred stock redemption value		—			35,795			—			102,271

Pro Forma net income available for common shareholders — diluted	$	346,699		$	630,773		$	997,304		$	853,474

Total weighted average shares outstanding in computing pro forma net income per share
Basic		7,659,563			4,115,576			7,593,916			2,869,513
Diluted		7,845,331			6,139,847			7,871,022			5,481,509

Net income per share:
Basic — as reported	$	0.06		$	0.16		$	0.15		$	0.29

Diluted — as reported	$	0.05		$	0.11		$	0.14		$	0.17

Basic — SFAS No. 123 pro forma	$	0.05		$	0.14		$	0.13		$	0.26

Diluted — SFAS No. 123 pro forma	$	0.04		$	0.10		$	0.13		$	0.16

2. Inventories

Inventories are stated at the lower of market or weighted-average cost on a first-in first-out basis. The Company writes down inventory for estimated obsolescence or damage for the excess cost of the inventory over estimated market value based upon assumptions about future demand and market conditions.

The components of inventories were as follows (in thousands):


	November 30, 2005		May 31, 2005
Finished goods	$	8,250	$	7,877
Raw materials		411		519

	$	8,661	$	8,396

3. Income Per Share

Basic net income per share is based on the weighted-average number of common shares outstanding. Diluted net income per share is based on the weighted number of common shares and common share equivalents outstanding. Common shares and common share equivalents included in the computation represent shares issuable upon assumed exercise of outstanding stock options and warrants and the conversion of mandatorily redeemable convertible preferred stock, except when the effect of their inclusion would be antidilutive.

The following table sets forth the computation of basic and diluted net income per share:


	Three Months Ended				Six Months Ended
	November 30,				November 30,
	2005		2004		2005		2004
Net income available for common shareholders — basic	$	427,209	$	649,027	$	1,127,223	$	823,521

Add: Accretion to preferred stock redemption value		—		35,795		—		102,271

Net income available for common shareholders — diluted	$	427,209	$	684,822	$	1,127,223	$	925,792


Weighted average common shares outstanding		7,659,563		4,115,576		7,593,916		2,869,513

Basic net income per share	$	0.06	$	0.16	$	0.15	$	0.29

Common share equivalents:
Dilutive effect of common stock options		252,005		368,555		343,206		271,262
Dilutive effect of common and preferred stock warrants		—		9,047		—		8,749

Dilutive effect of mandatorily redeemable convertible preferred stock		—		1,758,757		—		2,452,235

Weighted average common shares and common share equivalents		7,911,568		6,251,935		7,937,122		5,601,759

Diluted net income per share	$	0.05	$	0.11	$	0.14	$	0.17

The following is a summary of the weighted average securities during the respective periods that have been excluded from the calculation because the effect on net income would be antidilutive:

Three Months Ended

Six Months Ended

November 30,

2005

2004

2005

2004

Common stock options

162,740

8,075

138,343

4,016

4. Severance and Related Costs

On October 17, 2005, the Company entered into settlement agreements with Ms. Lori Liddle, Chief Marketing and Merchandising Officer, Ms. Dina Alhadeff, Vice President, Storybook and a third individual, which agreements provide for, among other things, cash severance payments, agreements not to compete and agreements to dismiss a legal complaint by such individuals alleging wrongful termination. The $1.2 million of severance and related costs was incurred during the quarter ending November 30, 2005, at which time we agreed to settlement of all claims including claims of wrongful termination by these former employees, and is comprised of the cash severance payments and related payroll taxes, as well as legal fees incurred by the Company relating to the severance negotiations and the complaint of wrongful termination.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with our financial statements and the related notes contained elsewhere in this quarterly report on Form 10-Q and our annual report of Form 10-K filed for our fiscal year ended May 31, 2005. All statements in the following discussion that are not reports of historical information or descriptions of current accounting policy are forward-looking statements. Readers are urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation “Factors That May Affect Future Operating Results “ set forth in this Form 10-Q, and the audited financial statements and the notes thereto and disclosures made under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Factors That May Affect Future Operating Results,” “Financial Statements,” and “Notes to Financial Statements,” included in annual report of Form 10-K filed for our fiscal year ended May 31, 2005.

Overview

Celebrate Express is a leading provider of celebration products serving families with young children via the Internet and catalogs. We offer a broad assortment of proprietary and third party children’s party products, girls’ special occasion and specialty apparel and children’s costumes, complemented by a wide variety of accessories. Our centralized inventory management maximizes product availability and allows us to customize our product assortment to meet specific customer needs. We have designed our business infrastructure to share distribution, customer support, marketing, and technology resources across all of our brands. Our goal is to help busy parents celebrate the special moments in their children’s lives.

To date, we have derived our revenue primarily from the sale of party related products from our Birthday Express website and catalog. For the three months ended November 30, 2005, we generated $26.1 million in net sales, an increase of 39.2% from $18.8 million in the three months ended November 30, 2004. Our gross margin as a percentage of sales declined to 49.8% in the three months ended November 30, 2005 from 50.4% in the three months ended November 30, 2004. For the six months ended November 30, 2005, we generated $44.1 million in net sales, an increase of 32.3% from $33.3 million in the six months ended November 30, 2004. Our gross margin as a percentage of sales increased slightly to 50.0% in the six months ended November 30, 2005 compared with 49.9% in the six months ended November 30, 2004. For the three and six-month periods ended November 30, 2005, our net income was $427,000 and $1.1 million, respectively compared with $685,000 and $926,000 in the three and six-month periods ended November 30, 2004, respectively. Net income for the three and six months ended November 30, 2005 includes a charge of $1.2 million for severance and related costs previously estimated and reported on our current report on Form 8-K filed on October 21, 2005. No severance and related charges were included in the results for the same periods in the prior year.

Comparison of Three Months Ended November 30, 2005 and November 30, 2004

Net Sales

Our net sales are comprised of product sales and shipping revenue. Net sales increased 39.2% to $26.1 million in the three months ended November 30, 2005 from $18.8 million in the three months ended November 30, 2004. The increase in net sales is driven primarily by our expanded direct marketing efforts. These efforts included paid search, email marketing and other online marketing programs, as well as catalog circulation. The increase in net sales in the three months ended November 30, 2005 reflects an increase of approximately 38% in the number of orders shipped, which grew to approximately 327,000 orders in the three months ended November 30, 2005 from approximately 237,000 orders in the three months ended November 30, 2004. Net sales per order for the three months ended November 30, 2005 was $79.90, compared with net sales per order of $79.16 for the three months ending November 30, 2004, an increase of 0.9%. We added approximately 163,000 new customers to our database during the second quarter, compared with 108,000 new customers added in the same quarter last year, an increase of approximately 51%. Primarily as a result of the more significant growth in new customers during the quarter, compared with the second quarter of fiscal 2005, revenue from our repeat customers decreased to approximately 47% of revenue during three months ended November 30, 2005, compared with approximately 52% during the three months ended November 30, 2004. Birthday Express net sales increased to $15.7 million in the second quarter of fiscal 2006 from $11.9 million in the second quarter of fiscal 2005, an increase of approximately 31%. Costume Express net sales increased to $8.0 million in the second quarter of fiscal 2006 from $4.4 million in the second quarter of fiscal 2005, an increase of approximately 82%. Storybook Heirlooms net sales increased 0.4% during the quarter to $2.4 million.

Gross Margin

Our gross margin consists of net sales less cost of sales. Our cost of sales consists primarily of product costs, costs associated with our in-house production facility, including wages and depreciation, design and production costs for our apparel and costume brands, inbound and outbound shipping costs, and packaging materials for outbound shipments. Gross margin increased 37.5% to $13.0 million in the three months ended November 30, 2005 from $9.5 million in the three months ended November 30, 2004, due primarily to increased sales driven by our Birthday Express and Costume Express brands. Our gross margin percentage was 49.8% of net sales in the three months ended November 30, 2005, compared with 50.4% in the three months ended November 30, 2004. The change in gross margin as a percent of revenue is due primarily to an increase in outbound shipping costs as a percentage of revenue caused by a greater number of expedited shipments during the quarter. The increase in expedited shipments was driven primarily by demand in excess of our expectations requiring upgrades from ground to air shipping methods to meet customer expectations.

Fulfillment

Our fulfillment expenses consist primarily of labor and other operating costs associated with our customer support and distribution centers. Our fulfillment expenses increased 46.9% to $2.9 million in the three months ended November 30, 2005 from $1.9 million in the three months ended November 30, 2004. As a percentage of net sales, these expenses increased to 10.9% in the three months ended November 30, 2005 from 10.4% in the three months ended November 30, 2004. The increase in fulfillment expenses as a percentage of revenue is due primarily to an increase in labor and related costs in the distribution center. Order volumes during the quarter exceeded expectations and the Company hired temporary labor to accommodate the additional demand. The increase in fulfillment costs can also be attributed to an increase in rent, utilities and depreciation as a percentage of revenue, due to the expansion of our warehouse and customer service areas in the second and third quarters of fiscal 2005. Our long-term target for fulfillment expenses remains at 10% of net sales.

Selling and Marketing

Our selling and marketing expenses consist primarily of advertising costs, wages and related payroll benefits for our internal marketing and merchandising staff. Advertising costs include online marketing efforts, print advertising and other direct marketing strategies. Online advertising costs are generally expensed as incurred. Prepaid direct marketing expenses consist of third-party costs including paper, printing and mailing costs and are capitalized and amortized over their expected period of future benefit, which is generally from 90 to 120 days. Selling and marketing expenses increased 39.8% to $6.4 million in the three months ended November 30, 2005 from $4.6 million in the three months ended November 30, 2004, due primarily to increases in online advertising and direct marketing circulation costs of $1.5 million. As a percentage of net sales, selling and marketing expenses remained constant at 24.5% in the three months ended November 30, 2005, compared with 24.4% in the three months ended November 30, 2004. Long-term, we continue to target sales and marketing costs between 23% and 25% of net sales.

General and Administrative

Our general and administrative expenses consist primarily of wages and related payroll benefits for our administrative and technology employees. These expenses also include credit card fees, legal and accounting professional fees, insurance, network fees, systems depreciation, bad debt expense, and other general corporate expenses. General and administrative expenses increased 30.7% to $2.2 million in the three months ended November 30, 2005 from $1.7 million in the three months ended November 30, 2004. Professional fees, insurance premiums and other related costs increased $212,000 in the three months ended November 30, 2005, compared with the three months ended November 30, 2004, primarily as a result of operating for a full quarter in fiscal 2006 as a public company. Credit card fees increased by $175,000 in the three months ended November 30, 2005, compared with the three months ended November 30, 2004, due to the increase in net sales. As a percentage of net sales, our general and administrative expenses decreased to 8.6% in the three months ended November 30, 2005 from 9.2% in the three months ended November 30, 2004.

Severance and Related Costs

Severance and related costs incurred during the three months ended November 30, 2005 relate to employee terminations that took place on July 22, 2005. Included in the $1.2 million severance and related cost balance is approximately $985,000 in cash severance payments and related payroll taxes. The remainder of the balance is composed of legal fees incurred by the company relating to the severance negotiations and the terminated employees’ legal complaint for wrongful termination. The expense related to these terminations was taken in the second quarter of fiscal 2006, at which

time we agreed to settlement of all claims including claims of wrongful termination by these former employees. There were no severance and related costs in the three-month period ended November 30, 2004.

Other Income (Expense), Net

The improvement in other income to $304,000 in the three months ended November 30, 2005, compared with other expense of ($144,000) in the three months ended November 30, 2004, is due primarily to interest earned from the proceeds from our initial public offering and the repayment of our $5.0 million term loan.

Income Taxes

In the three months ended November 30, 2005, we recognized income tax expense of $207,000 on income before taxes of $634,000, an effective tax rate of 32.6%. In the three months ended November 30, 2004, we recognized an income tax expense of $395,000 based on income before taxes of $1.1 million, an effective tax rate of 36.6%.

Comparison of Six Months Ended November 30, 2005 and November 30, 2004

Net Sales

Net sales increased 32.3% to $44.1 million in the six months ended November 30, 2005 from $33.3 million in the six months ended November 30, 2004. The increase in net sales is driven primarily by our expanded direct marketing efforts. These efforts included paid search, email marketing and other online marketing programs, as well as catalog circulation. The increase in net sales reflects an increase of approximately 30% in the number of orders shipped, which grew to approximately 546,000 orders in the six months ended November 30, 2005 from approximately 419,000 orders in the six months ended November 30, 2004. Our increase in net sales in the six months ended November 30, 2005 over the comparable period in 2004 also reflects a 1.6% increase in net sales per order to $80.75 from $79.44. Birthday Express net sales increased to $31.2 million in the six months ending November 30, 2005 $24.7 million in the six months ending November 30, 2004, an increase of 26.3%. Costume Express net sales increased to $9.1 million in the six months ending November 30, 2005 from $4.8 million in the six months ending November 30, 2004, an increase of 88.0%. Storybook Heirlooms net sales remained consistent with the prior period at $3.7 million.

Gross Margin

Gross margin increased 32.5% to $22.0 million in the six months ended November 30, 2005 from $16.6 million in the six months ended November 30, 2004 due primarily to increased sales. Our gross margin as a percentage of net sales increased slightly to 50.0% of net sales in the six months ended November 30, 2005 from 49.9% in the six months ended November 30, 2004. The change in gross margin percentage is composed of reduced costs of sales due to increases in revenue from higher margin proprietary products in our Birthday Express brand and better volume discounts, offset by increased outbound shipping costs as a percentage of revenue.

Fulfillment

Our fulfillment expenses increased 37.2% to $5.2 million in the six months ended November 30, 2005 from $3.8 million in the six months ended November 30, 2004. As a percentage of net sales, these expenses increased to 11.7% in the six months ended November 30, 2005 from 11.3% in the six months ended November 30, 2004. The increase in fulfillment expenses as a percentage of revenue is due primarily to an increase in labor and related costs in the distribution center. The increase can also be attributed to an increase in rent, utilities and depreciation as a percentage of revenue, due to the expansion of our warehouse and customer service areas in the second and third quarters of fiscal 2005.

Selling and Marketing

Selling and marketing costs increased 30.8% to $10.4 million in the six months ended November 30, 2005 from $8.0 million in the six months ended November 30, 2004. The increase in selling and marketing expenses was due primarily to increases in online advertising and direct marketing circulation costs of $2.1 million. As a percentage of net sales, selling and marketing expenses decreased slightly to 23.7% in the six months ended November 30, 2005 from 23.9% in the six months ended November 30, 2004. The decline as a percentage of net sales can be attributed primarily to leverage of fixed costs included in selling and marketing expenses such as personnel and related costs.

General and Administrative

General and administrative expenses increased 29.1% to $4.1 million in the six months ended November 30, 2005 from $3.1 million in the six months ended November 30, 2004. Credit card fees increased by $270,000 in the six months ended November 30, 2005 over the six months ended November 30, 2004, due to the increase in net sales. Professional fees, insurance premiums and other related costs increased $451,000 in the six months ended November 30, 2005 over the six months ended November 30, 2004, primarily as a result of operating as a public company. As a percentage of net sales, our general and administrative expenses decreased to 9.2% in the six months ended November 30, 2005 from 9.5% in the six months ended November 30, 2004.

Severance and Related Costs

Severance and related costs incurred during the six months ended November 30, 2005 relate to employee terminations that took place on July 22, 2005. Included in the $1.2 million severance and related cost balance is approximately $985,000 in cash severance payments and related payroll taxes. The remainder of the balance is composed of legal fees incurred by the company relating to the severance negotiations and the terminated employees’ legal complaint for wrongful termination. There were no severance and related costs in the six-month period ended November 30, 2004.

Other Income (Expense), Net

The improvement in other income to $546,000 in the six months ended November 30, 2005, compared with other expense of ($255,000) in the six months ended November 30, 2004, is due primarily to interest income earned on the proceeds from our initial public offering in October 2004.

Income Taxes

In the six months ended November 30, 2005, we recognized income tax expense of $607,000 on income before taxes of $1.7 million for the same period based upon an effective tax rate of 35.0%. In the six months ended November 30, 2004, we recognized income tax expense of $561,000 on income before taxes of $1.5 million for the same period based upon an effective tax rate of 37.7%.

Liquidity and Capital Resources

As of November 30, 2005 we had working capital of $39.7 million, including cash and cash equivalents of $33.7 million. We believe that our current cash and cash equivalents, as well as cash flows from operations, will be sufficient to continue our operations and meet our capital needs for the foreseeable future.

Net cash provided by operating activities was $3.8 million and $1.0 million for the six months ended November 30, 2005 and 2004, respectively. Net cash provided by operating activities in the first six months of fiscal 2006 can be attributed primarily to net income, utilization of $607,000 of our deferred tax asset, depreciation and amortization of $568,000 and an increase in accrued liabilities of $1.4 million. The increase in accrued liabilities of $1.4 million was driven primarily by an increase of $565,000 in deferred revenue and an increase of $504,000 in online search fees payable. Net cash provided by operating activities in the first six months of fiscal 2005 was attributed primarily to net income, utilization of our deferred tax asset, and an increase in accrued liabilities.

Net cash used in investing activities was ($1.0 million) and ($899,000) for the six months ended November 30, 2005 and 2004, respectively. Cash used in investing activities in the six months ended November 30, 2005 and 2004 was used for capital expenditures.

Net cash provided by financing activities was $177,000 and $29.1 million for the six months ended November 30, 2005 and 2004, respectively. Cash provided by financing activities in the first quarter of fiscal 2006 was primarily due to proceeds from the exercise of stock options. Cash provided by financing activities in the six months ended November 30, 2005 was due to the net proceeds from our initial public offering, offset by the repayment of our term loan.

The following table summarizes our contractual obligations as of November 30, 2005 and the effect these obligations are expected to have on our liquidity and cash flows in future periods.


	Payments Due by Period
	Total		Less than 1 year		1-3 years		3-5 years
	(in thousands)
Description of Contractual Obligations:
Capital lease obligations	$	7	$	7	$	—	$	—
Operating lease obligations		1,963		800		1,127		36


	$	1,970	$	807	$	1,127	$	36

Critical Accounting Policies

Certain of our accounting policies require the application of management judgment in making estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes. Those estimates and assumptions are based on historical experience and various other factors deemed to be applicable and reasonable under the circumstances. The use of judgment in determining such estimates and assumptions is, by nature, subject to a degree of uncertainty. Accordingly, actual results could differ from the estimates made. Management believes there have been no material changes during the six months ended November 30, 2005 to the critical accounting policies reported in the Management’s Discussion and Analysis section of our Annual Report on Form 10-K for the year ended May 31, 2005.

New accounting pronouncements- On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 123 (revised 2004),Share-Based Payment (“SFAS No.123R”).SFAS No. 123R would require us to measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. In addition, the adoption of SFAS No. 123R will require additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. In April 2005, the SEC deferred the effective date for SFAS No. 123R to the beginning of the first fiscal year that begins after June 15, 2005. Therefore, we will be required to comply with SFAS No. 123R effective the first quarter following our fiscal year ending May 31, 2006. The Company is currently evaluating the impact of adoption of this statement.

Factors That May Affect Future Operating Results

You should carefully consider the risks described below together with all of the other information included in this report. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline and you may lose all or part of your investment.

We achieved annual net income for the first time during our fiscal year ended May 31, 2004 and we cannot assure you that we will continue to operate profitably.

We achieved an annual net income for the first time in our corporate history during our fiscal year ended May 31, 2004. Prior to fiscal 2004 we have had a history of losses. We may incur losses again in our current or future fiscal years, especially as we introduce new products. We expect our operating expenses to increase in the future, as we, among other things:

	•		expand into new product categories;

	•		continue with our marketing efforts to build our brand names;

	•		expand our customer base;

	•		upgrade our operational and financial systems, procedures and controls;

	•		retain existing personnel and hire additional personnel.

In order to maintain profitability as we expand into new product categories, we will need to generate sales exceeding historical levels and/or reduce relative operating expenditures. We may not be able to generate the required sales from our current or new product categories or reduce operating expenses sufficiently to sustain or increase operating profitability. If we have a shortfall in sales without a corresponding reduction to our expenses, our operating results will suffer. It is possible that results of operations may be below the expectations of public market analysts and investors, which could cause the trading price of our common stock to fall.

If we do not successfully expand sales into other product categories beyond party goods, we may not be able to achieve our desired revenue growth.

We were incorporated and began selling party products through our direct marketing catalog in June 1994 and on our www.BirthdayExpress.com website in April 1996. In April 2001, we acquired certain assets of Storybook Inc., a direct marketer of girls’ specialty and special occasion apparel. In February 2002, we re-launched the Storybook Heirlooms brand and the website www.Storybook.com. Revenue growth from our Storybook Heirlooms brand has regularly not met management expectations, which in part, resulted in the Company’s decision in July 2005 to reposition the brand. In September 2003, we launched our website www.Costumeexpress.com and catalog for Costume Express, a provider of children’s and family costumes. We have historically derived more than 80% of our annual revenues from the sale of party products and accessories to families with young children under our Birthday Express brand. In order to achieve the desired growth in our sales and business, we will need to expand into new product categories. Challenges that may affect our ability to expand into new product categories include our ability to:

	•		successfully design, produce and market new products;

	•		identify and introduce new product categories;

	•		maintain our gross margins with respect to new product categories;

	•		provide a satisfactory mix of merchandise that is responsive to the needs of our customers;

	•		broaden consumer awareness of our existing and future brands;

	•		manage our online and offline marketing costs; and

	•		manage our dual-channel direct marketing model.

In addition, we may experience a higher degree of seasonality in our business as we expand our brands or expand into new brands or product categories that have seasonal significance. If we are unsuccessful in addressing these risks and uncertainties, our business, financial condition and results of operations may be harmed.

We must compete with other party goods retailers and mass merchandisers on the selection, quality and price of our products, and failure to do so successfully could negatively affect our stock price.

In order to meet our strategic goals, we must successfully offer, on a continuous basis, a broad selection of appealing products to families with young children. To successfully compete against other party goods retailers and mass merchandisers, our product offerings must be affordable, high-quality, innovative and attractive to a wide range of consumers whose preferences may change from time to time. We cannot predict with certainty that we will be successful in offering products that meet these requirements. If consumers do not find our products attractive or our products otherwise become less popular with consumers, we may see increased merchandise returns, inventory write-downs and increased costs. Any shortcomings in our merchandise strategy could adversely affect our operating results and cash flows. This may, in turn, cause our stock price to fall.

Children’s tastes change and are often difficult to predict, and any failure by us to correctly identify and react appropriately to these changing preferences could hurt our sales and gross margins and render a portion of our inventory obsolete.

Our failure to anticipate, identify or react appropriately to changes in consumer demand could lead to excess inventories and significant markdowns or a shortage of products and lost sales. Our strategy, relations with our customers and margins are dependent, in part, on our identification and regular introduction of new designs that are appealing to our customers, especially children. We cannot assure you that we will be able to identify, obtain or license popular third-party designs or that our design personnel will be able to timely identify and introduce appealing designs in sufficient volume to support our strategy and operations.

We must also anticipate changes in the tastes and preferences of consumers in order to compete for their business successfully. In particular, our ability to anticipate changes in the tastes and preferences of children, which change often and quickly, is crucial to our success, and we could misinterpret or fail to identify trends on a timely basis. Further, product orders must be placed with suppliers before we receive orders from our customers, and the demand for specific products can change between the time the products are ordered by us and the date we receive them. If we underestimate consumer demand, we may disappoint customers and lose potential sales to our competitors. If we overestimate consumer acceptance of our products, we may be required to take significant inventory markdowns or sell our products at discounted prices, which could reduce our sales and gross margins.

If we fail to promote and maintain our brands effectively, we may not be able to compete successfully with better-known competitors.

Building and maintaining recognition of our brands by families with young children is critical to expanding our customer base and competing successfully against other party goods retailers and mass merchandisers with greater brand recognition. In order to continue building consumer recognition of our brands, we will need to increase our financial commitment to creating and maintaining brand awareness in a manner targeted at families with young children. We cannot be certain that our marketing efforts will attract new customers, enable us to retain existing customers, or encourage repeat purchases. If these efforts are not successful, our sales may not grow to desired levels, or could even decline.

If we do not successfully maintain and expand our customer and prospect databases our sales volume could suffer and our marketing costs could increase.

We depend on our proprietary customer and prospect databases to facilitate repeat sales and attract new customers. If we fail to keep these databases current, or if the information in these databases is damaged or destroyed, our sales could stagnate or even decline. If we do not expand our databases of customers and prospects, or if we fail to enhance and refine our techniques for segmenting this information to maximize its usefulness, our sales volume could suffer and our marketing costs could increase. In addition, if federal or state governments enact privacy legislation resulting in the increased regulation of mailing lists, we could experience increased costs in complying with new regulations concerning the solicitation of consents or be unable to achieve the desired database and sales volume growth.

Failure to successfully manage our fulfillment and distribution operations could cause us to incur increased costs or lose customers.

Our fulfillment and distribution operations are located in Greensboro, North Carolina. These operations are critical to the cost-effective and efficient fulfillment and shipment of customer orders. If we are unable to successfully manage our fulfillment and distribution operations, we could incur increased costs to fulfill customer orders, or be would be required to find one or more parties to provide these services for us. This could cause us to incur significantly higher expenses or result in additional costs related to balancing inventories among multiple distribution facilities. We have recently expanded, and as our business grows we may need to further expand our fulfillment and distribution operations to accommodate increases in customer orders. We are also making modifications to our distribution center to accommodate more streamlined distribution procedures. Failure to manage our expanded facilities or to implement the new distribution processes could result in delays in fulfillment and shipment of customer orders, which might in turn increase our costs, hurt our reputation and discourage repeat sales.

Our operating results could suffer if we are unable to successfully manage the costs of our catalog operations or if our catalogs fail to produce sales at satisfactory levels.

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

	•		effective management of costs associated with the production and distribution of our catalogs;

	•		achievement of adequate response rates to our mailings;

	•		displaying a mix of merchandise in our catalogs that is attractive to our customers; and

	•		timely delivery of catalog mailings to our customers.

Catalog production and mailings entail substantial paper, printing, postage and labor costs. Increases in the costs of producing and distributing our catalogs, including increases in postage rates, or paper, photography or printing costs, may

reduce the margin on sales derived from our catalogs. As we incur nearly all of the costs associated with our catalogs prior to mailing, we are unable to adjust the costs 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, sales generated by each mailing are affected by factors such as consumer preferences, economic conditions, the timing and mix of our catalog mailings, the timely delivery of these mailings by the postal system, and changes in our merchandise assortment, some of which are outside of our control. A significant increase in the costs associated with producing or distributing our catalogs, or failure of our catalogs to produce sales at satisfactory levels, could have a negative effect on our operating results.

We will consider acquisitions as part of our growth strategy, and failure to adequately evaluate or integrate any acquisitions could harm our business.

We have limited experience in acquiring other businesses. In April 1997 we acquired the assets of Great Days Publishing, Inc., a product line that offers a variety of personalized date history scrolls that chronicle noteworthy events. This product line is marketed under our Birthday Express brand. In April 2001, we acquired the assets of Storybook Inc. We expect to continue to consider opportunities to acquire other products and businesses that could enhance or complement our current products and services or expand the breadth of our product categories or customer base. Potential and completed acquisitions involve numerous risks, including:

	•		problems assimilating the purchased products or business operations;

	•		problems maintaining uniform standards, procedures, controls and policies;

	•		unanticipated costs associated with the acquisition, including accounting charges and transaction expenses;

	•		diversion of management’s attention from our existing brands;

	•		adverse effects on existing business relationships with suppliers and customers;

	•		risks associated with entering product categories in which we have no or limited prior experience; and

	•		potential loss of key employees of acquired organizations.

For example, in the acquisition of Storybook Heirlooms, we incurred higher than expected customer returns, saleable product inventory was lower than expected, integration expenses were higher than forecasted and we have yet to achieve revenue levels meeting managements expectations. If we fail to properly evaluate and execute future acquisitions, our management team may be distracted from our day-to-day operations, our business may be disrupted, and our operating results may suffer.

Increased product returns, or a failure by us to accurately predict the level of product returns, could harm our business.

As part of our customer support commitment, we maintain a product return policy that allows recipients to return most items received from us with which they are dissatisfied. We make allowances for product returns in our financial statements based on historical return rates. We cannot assure you that actual product 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 within existing or new product categories, increased sales over the Internet, changes in the habits of our customers or other factors will not cause actual returns to exceed return allowances, perhaps significantly. Any increase in product returns above our allowances could have a negative impact on our financial results and may, in turn, cause our stock price to decline.

We may not be able to compete successfully against current and future competitors.

We operate in several highly competitive markets including party goods, girls’ specialty apparel and children’s costumes. Our primary competition comes from traditional retailers that offer a variety of products in the party goods and apparel markets. We believe our primary competition in party goods and costumes is from mass merchandisers such as Target and Wal-Mart, and party goods superstores such as Party City and Party America. We also compete in these markets with a variety of other companies including: online retailers of party goods; traditional card and gift specialty retailers; supermarkets and drugstores; and catalog retailers of novelty items. Additionally, we compete in the girls’ apparel market with department stores and specialty apparel catalogs and retailers.

Competitors can enter our market with little difficulty and can launch new websites or catalogs at a relatively low cost. Many of these current and potential competitors may have the ability to devote substantially more resources to

marketing, customer support, product development and order fulfillment operations than we can. Some of our suppliers also may choose to compete with us directly and may in the future choose not to supply products to us. In addition, larger or more well-financed entities may acquire, invest in or form joint ventures with our competitors. Some of our competitors may be able to secure products from suppliers on more favorable terms, fulfill orders more efficiently or adopt more aggressive pricing than we can. If we are unable to compete effectively in our markets, our business, financial condition and operating results may suffer.

We depend on search engines to attract customers to our websites, and losing these customers would adversely affect our revenues and financial results.

Many consumers access our websites by clicking through search results displayed by Internet search engines. Internet search engines typically provide two types of search results, algorithmic listings and purchased listings. Algorithmic listings cannot be purchased, and instead are determined and displayed solely by a set of formulas utilized by the search engine. Purchased listings can be bought by advertisers in order to attract users to their websites. We rely on both algorithmic and purchased listings to attract and direct consumers to our websites. Search engines revise their algorithms from time to time in an attempt to optimize their search results. If one or more of the search engines on which we rely for algorithmic listings were to modify its algorithms, resulting in fewer consumers clicking through to our websites, we would need to increase our marketing expenditures, which would adversely affect our financial results. In addition, the rates for purchased listings have significantly increased. If one or more of the search engines on which we rely for purchased listings modifies or terminates its relationship with us or if the rates for purchased listings continues to rise, our online marketing expenses as a percentage of revenue could rise, we could lose customers, we could be forced to look for other advertising avenues and traffic to our websites could decrease.

Because we do not have long-term contracts for third-party products, we may not have continued access to popular products.

Our business depends significantly on the use of third-party products and our future success is contingent upon the continued availability of these products. We do not have long-term arrangements with any vendor or distributor that would guarantee the availability of third-party products and, as a result, we do not have a predictable or guaranteed supply of these products. We cannot assure you we will have access to any third-party products in sufficient quantities. If we are unable to provide our customers with continued access to popular or exclusive third-party products, our sales could decline.

If we are unable to maintain or acquire licenses to intellectual property, we may have fewer proprietary products and our sales may decline.

Many of our proprietary products are based on or incorporate intellectual property and other character or story rights licensed from third parties. These license agreements are limited in scope, typically have a two- or three-year term and lack renewal rights. We may not be able to renew key licenses when they expire or include new products in existing licenses. Moreover, most of these licenses may be terminated immediately if we breach their terms. If we are unable to maintain these licenses and obtain additional licenses with significant commercial value, or maintain them at reasonable costs, we will be unable to increase our revenue in the future unless we offset the loss of the products that depend on these licenses with an increase in sales of our independently created proprietary products.

Because we do not have long-term contracts with our suppliers, we may not have continued access to necessary materials and our sales may suffer.

Our financial performance depends on our ability to purchase our products in sufficient quantities at competitive prices. We purchase our products from over 250 foreign and domestic manufacturers and distributors. We have no long-term purchase contracts with any of these suppliers, and therefore, have no contractual assurances of continued supply, access to products or favorable pricing. Any vendor could increase prices or discontinue selling to us at any time. The lack of long-term contracts also exposes us to increased risks associated with changes in local economic conditions, trade issues and foreign currency fluctuations. In our quarter ended November 30, 2005, products supplied by our ten largest suppliers represented approximately 43.7% of inventory purchases, with our largest supplier representing 14.1%. If we are unable to maintain these supplier relationships, our ability to offer high-quality, favorably-priced products to our customers may be impaired, and our sales and gross margins could decline.

Our reliance on smaller or independent vendors and suppliers and manufacturers located abroad exposes us to various risks including disruption in product supply.

Some of our smaller vendors have limited resources, production capacities and operating histories, which means that they may not be able to timely produce sufficient quantities of certain products demanded by our customers. In addition, our relationships with independent foreign suppliers and manufacturers are also subject to a number of risks, including:

	•		work stoppages;

	•		transportation delays and interruptions;

	•		political instability;

	•		foreign currency fluctuations;

	•		changing economic conditions;

	•		an increased likelihood of counterfeit, knock-off or gray market goods;

	•		product liability claims;

	•		expropriation, nationalization, imposition of tariffs, import and export controls and other non-tariff barriers, including quotas and restrictions on the transfer of funds;

	•		environmental regulation; and

	•		other changes in governmental policies.

Because of these factors, we may be subject to liability claims or may not be able to acquire desired products in sufficient quantities on terms acceptable to us. Any inability to acquire suitable products, the loss of one or more key vendors, or the settlement or outcome of a product liability suit could have a negative effect on our sales and operating results. We may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of lesser quality or more expensive than those we currently purchase. We cannot be certain that such factors will not prevent us from procuring manufactured products in a cost-effective or timely manner.

We may face product liability claims that are costly and create adverse publicity.

If any of the products that we sell causes harm or damages to any of our customers or other individuals, we could be vulnerable to product liability claims. Although we maintain insurance against product liability claims, our coverage may be inadequate to cover any liabilities we may incur. We also work with experts to test some of our products for safety compliance, but our tests may not identify all potential product defects before products are sold. Even if we successfully defend ourselves against product liability claims, 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, we could be required to remove products from sales inventory, and we could suffer adverse publicity about the safety and fitness of our products, any of which could harm our business.

Failure of third parties to deliver our products efficiently and in a timely manner could cause us to lose customers.

We rely upon other parties for product shipments to and from our Greensboro, North Carolina fulfillment and distribution center. It is possible that events beyond our control, such as strikes, trucking shortages, the imposition of tariffs, rail disruption, or other disruption, could affect the ability of these parties to deliver inventory items to our facilities or merchandise to our customers. The failure of these parties to deliver goods to or from our facilities could result in delays in fulfillment of customer orders. Because our customer orders are often time-sensitive, delays by our third-party shipment providers could hurt our reputation and our ability to obtain repeat orders.

Fluctuations in commodity prices may increase our operating costs and make our expenses difficult to predict.

We are vulnerable to fluctuations in commodity prices, particularly the price of paper stock. Paper goods comprise a significant portion of our total inventory. In addition, a portion of our marketing expenditures are related to our direct marketing efforts which include our paper catalogs. If the price of paper increases significantly, we may be unable to pass the additional costs on to our customers, which could hurt our profitability. In addition, fluctuations in commodity prices could make it difficult for us to accurately forecast our expenses.

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 services of our senior management and other key personnel, particularly, our executive officers, Michael Jewell, our President and Chief Executive Officer, Darin White, our Vice President Finance and Louis S. Usarzewicz, our Executive Vice President Operations. Two of our former officers, Ms. Lori Liddle, Chief Marketing and Merchandising Officer and Ms. Dina Alhadeff, Vice President, Storybook, departed from Celebrate Express in the recent past. While we believe that this will have no material impact on our operations, we cannot assure you that disruptions occasioned by their departures will not have an adverse impact on our near-term operations. Our performance also depends on our ability to retain and motivate our officers and key employees. We do not have employment agreements with any of our key personnel. The loss of the services of Mr. Jewell, Mr. White, Mr. Usarzewicz or any of our 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 support personnel. Competition for such personnel is intense and we cannot assure you that we will be able to successfully attract, assimilate or retain sufficiently qualified personnel.

The favorable impact of the income tax benefit in 2004 affects the comparability of our results, and utilization of our deferred tax assets is dependent on future taxable income.

In our fiscal year ended May 31, 2004, based on the information existing at that time including consideration of our forecasted book and tax income, we reduced the valuation allowance on our deferred tax assets by $9.0 million and recognized a corresponding tax benefit in our fiscal 2004 results of operations. This tax benefit causes our financial results for our fiscal year ended May 31, 2004 to appear significantly more favorable than they would in the absence of the tax benefit. The favorable impact of the $9.0 million tax benefit may distort the trends in our operating results and will impact the comparability of our results of operations with other periods. The tax benefit may also make our financial results appear more favorable than those of companies with similar results of operations that have not reduced a valuation allowance on their net deferred tax assets in the comparable period. In addition, should our operating results fall below expectations, we may need to evaluate the need to re-establish a valuation allowance against our deferred tax assets. If the valuation allowance were to be re-established it would negatively affect the financial results in the period in which it was re-established. Additionally, future changes in ownership of our common stock may restrict the ability to realize the benefit of our net operating loss carryforwards.

Our business involves the extensive use of intellectual property, and related claims against us could be costly or force us to abandon popular products.

Third parties have asserted, and may in the future assert, that our business or the products we make or use infringe upon their rights. We cannot predict whether third parties will assert claims of infringement against us, or whether any past or future assertions or prosecutions of infringement will harm our business. If we are forced to defend against any such claims, whether they are with or without merit and even if they are determined in our favor, we may face costly litigation, diversion of the attention of our technical and management personnel and product shipment delays. As a result of any infringement dispute, we may have to develop non-infringing products or enter into royalty or licensing agreements, which may be on unfavorable terms. If there is a successful claim of infringement against us, and we are unable to develop non-infringing products or license the infringed or similar product on a timely basis or at all, we will need to drop the infringed product from our offerings and our sales could suffer.

If the protection of our trademarks and proprietary rights is inadequate, our brands and reputation could be impaired and we could lose customers.

The steps we take to protect our proprietary rights may be inadequate. 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 or license agreements with our employees, customers, partners and others to protect our proprietary rights. Birthday Express, BirthdayExpress.com and Storybook Heirlooms are registered with the United States Patent and Trademark office, and we have filed federal trademark applications for Costume Express and Celebrate Express. We cannot be certain we will be able to obtain registration for our filed trademarks or for trademarks we submit applications for in the future. Effective trademark, service mark, copyright and trade secret protection may not be available in every country in which we will sell our products and services. Furthermore, 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 and our brands and reputation could be impaired and we could lose customers.

If we cannot maintain and protect our existing domain names or acquire suitable new domain names as needed, we may not be able to successfully build our brands.

We may be unable to acquire or maintain Internet domain names relating to our brands in the United States and other countries in which we may conduct business. As a result, we may be unable to prevent third parties from acquiring and using domain names relating to our brands. Such use could damage our brands and reputation and divert customers away from our websites. We currently hold various relevant domain names, including www.BirthdayExpress.com, www.Storybook.com, www.CelebrateExpress.com, and www.CostumeExpress.com. The acquisition and maintenance of domain names generally is regulated by governmental agencies. Governing bodies may establish additional top-level domains, appoint additional domain name registrars or modify the requirements for holding domain names, any of which may affect our ability to maintain the domain names we need for our business. If we cannot prevent others from using similar domain names we may be unable to successfully build our brands.

Capacity constraints, systems failures or security breaches could prevent access to our websites, which could lower our sales and harm our reputation.

Our service goals of performance, reliability and availability require that we have adequate capacity in our computer systems to cope with the volume of customers on our websites. As our operations grow in size and scope, we will need to improve and upgrade our systems and infrastructure to offer customers enhanced services, capacity, features and functionality. The expansion of our systems and infrastructure will require us to commit substantial financial, operational and technical resources before the volume of our business increases, with no assurance of a corresponding increase in sales. If we cannot expand our systems in a timely manner to cope with increased customer usage, we could experience disruptions in service, slower response times, lower customer satisfaction and delays in the introduction of new products and services. Any of these problems could impair our reputation, damage our brands and cause our sales to decline.

Our ability to provide high-quality service depends on the efficient and uninterrupted operation of our computer and communications systems. Our website has experienced system interruptions from time to time and could experience periodic system interruptions in the future. Our systems and operations are also vulnerable to damage or interruption from human error, natural disasters, power loss, telecommunication failures, break-ins, sabotage, computer viruses, design defects, vandalism, denial-of-service attacks and similar events. We do not have a formal disaster recovery plan or alternate providers of web hosting services, and outages at our data centers could mean the temporary loss of the use of our websites. Our business interruption insurance may not adequately compensate us for the associated losses. Any system failure or security breach that causes an interruption in service or decreases the responsiveness of our customer support center or websites could impair our reputation, damage our brands and cause a decrease in sales.

If we are unable to provide satisfactory telephone-based customer support, we could lose customers.

Our ability to provide satisfactory levels of customer support also depends, to a large degree, on the efficient and uninterrupted operation of our customer support center. Any material disruption or slowdown in our telephone 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 telephone-based customer support. Further, we may be unable to attract and retain an adequate number of competent customer support representatives, which is essential in creating a favorable customer experience. If we are unable to continually provide adequate staffing for our customer support operations, our reputation could be seriously harmed. In addition, we cannot assure you that call volumes will not exceed our present system capacities. If this occurs, we could experience delays in accepting orders, responding to customer inquiries and addressing customer concerns. Also, we may be required to expand our customer support center in the near future. We cannot assure you that we will be able to find additional suitable facilities on acceptable terms or at all, which could seriously hinder our ability to provide satisfactory levels of customer support. Because our success depends in large part on keeping our customers satisfied, any failure to provide satisfactory levels of customer support would likely impair our reputation and we could lose customers.

Temporary or permanent disruption at our fulfillment facility could prevent timely shipment of customer orders and hurt our sales.

We assemble, package, and ship our orders, and process all product returns, at our Greensboro, North Carolina fulfillment and distribution facility. In the future, we may be unable to fulfill our customers’ orders at this facility in a timely manner, or at all, due to a number of factors, including:

	•		a failure to maintain or renew our existing lease agreement;

	•		a power failure;

	•		an employee strike or other labor stoppage;

	•		telecommunications failure, terrorist attacks, acts of war or break-ins;

	•		a disruption in the transportation infrastructure including air traffic and roads; or

	•		fire, flood, hurricane or other disaster.

In the event that we are temporarily unable to timely fulfill our customers’ orders through our Greensboro facility, we will either upgrade the shipping or attempt to re-ship the orders from another source. However, we cannot guarantee that we will be able to fulfill all orders or that we will be able to deliver the affected orders in a timely manner. This could result in increased fulfillment costs or a decrease in sales,as well as the potential loss of repeat orders from affected customers. In addition, if operations at our Greensboro facility become permanently disrupted due to any of the above or other factors, we may not be able to secure a replacement fulfillment and distribution facility on terms acceptable to us or at all. We do not currently maintain back-up power systems at our Greensboro facility, nor do we have a formal disaster recovery plan and our business interruption insurance may be insufficient to compensate us for losses that occur in the event operations at our fulfillment and distribution center are interrupted.

We may incur significant costs or experience product availability delays in complying with regulations applicable to the sale of our manufactured products.

We use a variety of water-based inks, paper and coatings in the manufacture of our paper party products. We are required to maintain our manufacturing operations in compliance with United States federal, state and local laws and regulations, including but not limited to rules and regulations associated with consumer protection and safety, the Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, the Food and Drug Administration and the Occupational Safety and Health Administration, or OSHA. Changes in laws and regulations applicable to our business could significantly increase our costs of goods sold and we may not be able to pass these increases on to our customers. If we fail to comply with current laws and regulations applicable to our business, or to pass annual inspections of our facilities by regulatory bodies, we could be subject to fines and penalties or even interruptions of our operations. In addition, failure to comply with applicable laws and regulations could subject us to the risk of private lawsuits and damages.

If use of the Internet, particularly with respect to online commerce, does not continue to increase as rapidly as we anticipate, our sales may not grow to desired levels.

For the quarter ended November 30, 2005, our online sales represented approximately 70% of our total sales. Our future sales and profits are substantially dependent upon the continued use of the Internet as an effective medium of business and communication by our customers. Internet use may not continue to develop at historical rates and consumers may not continue to use the Internet and other online services as a medium for commerce. Highly-publicized failures of some online retailers in meeting consumer demands could result in consumer reluctance to adopt the Internet as a means for commerce, and thereby damage our reputation and brands and reduce our revenues and results of operations.

In addition, the Internet may not be accepted as a viable long-term commercial marketplace for a number of reasons, including:

	•		actual or perceived lack of security of information or privacy protection;

	•		possible disruptions, computer viruses or other damage to the Internet servers or to users’ computers; and

	•		excessive governmental regulation.

If the Internet fails to continue growing as a commercial marketplace, our sales may not increase as much as desired by our shareholders, or at all.

Risks related to the Internet, including security and reliability issues, are largely outside our control and may hurt our reputation or sales.

Our online business is subject to numerous risks, many of which are outside our control. In addition to changing consumer preferences and buying trends relating to Internet usage, we are vulnerable to additional risks and uncertainties associated with the Internet. These risks include changes in required technology interfaces, website downtime or slowdowns and other technical failures or human errors, changes in applicable federal and state regulation, security breaches, and consumer privacy concerns. Our failure to respond successfully to these risks and uncertainties might adversely affect the sales through our online business, as well as damage our reputation and increase our selling and marketing and general and administrative expenses. In addition, our success will depend, in large part, upon third parties maintaining the Internet infrastructure to provide a reliable network backbone with the speed, data capacity, security and hardware necessary for reliable Internet access and services. Our business, which relies on graphically-rich websites that require the transmission of substantial data, is also significantly dependent upon the availability and adoption of broadband Internet access and other high-speed Internet connectivity technologies. Any significant reliability, data capacity or connectivity problems experienced by the Internet or its users could harm our sales and profitability.

Government regulation of database use in direct marketing and Internet and online commerce is evolving. Unfavorable changes in these regulations could substantially harm our business and results of operations.

We are subject to general business regulations and laws, as well as regulations and laws that specifically govern database use in direct marketing and Internet and online commerce. Existing and future regulations and laws may impede the growth of database direct marketing, Internet or other online services. These regulations and laws may cover taxation, restrictions on imports and exports, customs, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, the provision of online payment services, broadband residential Internet access and the characteristics and quality of products and services. It is not clear how existing laws and regulations governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to database direct marketing, the Internet and online commerce. Unfavorable resolution of these issues may slow the growth of database direct marketing, online commerce and, in turn, our business.

Our failure to protect confidential information of our customers and our network against security breaches could damage our reputation and brands and subject us to legal liability.

A significant barrier to online commerce and communications is the secure transmission of confidential information over public networks. Currently, a majority of our sales are billed to our customers’ credit card accounts directly. We rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology we use to protect customer transaction data. Any compromise of our security could damage our reputation and brands and expose us to a risk of lost sales, or litigation and possible legal liability. In addition, anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches.

Our failure to address risks associated with credit card fraud could damage our reputation and brands.

Under current credit card practices, we are liable for fraudulent credit card transactions because we do not obtain a cardholder’s signature. We do not currently carry insurance against this risk. To date, we have experienced minimal losses from credit card fraud, but we face the risk of significant losses from this type of fraud as our net sales increase. Such losses could impair our results of operations. In addition, any failure to adequately control fraudulent credit card transactions could damage our reputation and brands, and reduce our sales.

Our sales may decrease if we are required to collect taxes on purchases.

We do not collect or have imposed upon us sales, use or other taxes related to the products we sell, except for certain corporate-level taxes and sales taxes with respect to purchases by customers located in the states of North Carolina and Washington. However, one or more states may seek to impose sales, use or other tax collection obligations on us in the future. A successful assertion by one or more states that we should be collecting sales, use or other taxes on the sale of our products could result in substantial tax liabilities and penalties in connection with past sales. In addition, if we are required to collect these taxes we will lose one of our current cost advantages, which may decrease our ability to compete with traditional retailers and substantially harm our sales.

We have based our policies for sales tax collection on our interpretation of certain decisions of the U.S. Supreme Court that restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made through catalogs or over the Internet. However, implementation of the restrictions imposed by these Supreme Court decisions is subject to interpretation by state and local taxing authorities. While we believe that these Supreme Court decisions currently restrict state and local taxing authorities outside the states of North Carolina and Washington from requiring us to collect sales and use taxes from purchasers located within their jurisdictions, taxing authorities outside of

North Carolina and Washington could disagree with our interpretation of these decisions. Moreover, a number of states, as well as the U.S. Congress, have been considering various initiatives that could limit or supersede the Supreme Court’s position regarding sales and use taxes on Internet sales. If any state or local taxing jurisdiction were to disagree with our interpretation of the Supreme Court’s current position regarding state and local taxation of Internet sales, or if any of these initiatives were to address the Supreme Court’s constitutional concerns and result in a reversal of its current position, we could be required to collect sales and use taxes from purchasers located in states other than North Carolina and Washington. The imposition by state and local governments of various taxes upon Internet commerce could create administrative burdens for us and could decrease our future sales.

Failure to rapidly respond to technological change could result in our services or systems becoming obsolete.

As the Internet and online commerce industries evolve, we may be required to license emerging technologies useful to our business, enhance our existing services, develop new services and technologies that address the increasingly sophisticated and varied needs of our prospective customers and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. We may not be able to successfully implement these new services and technologies or adapt our websites and transaction-processing systems to customer requirements or emerging industry standards. If we fail to respond to these issues in a timely manner, we may lose existing customers and be unable to attract sufficient numbers of new customers.

Future sales of our common stock may depress our stock price.

If our shareholders sell substantial amounts of common stock in the public market, or if the market perceives that these sales may occur, the market price of our common stock may decline. Our chief executive officer and president has in the past established, and he and other officers or directors may in the future establish, programmed selling plans under Rule 10b5-1 for the purpose of effecting sales of common stock. We have also registered all shares of common stock that we may issue under our employee benefits plans. As a result, these shares can be freely sold in the public market upon issuance, subject to restrictions under the securities laws. The holders of a significant portion of our common stock have rights, subject to some conditions, to include their shares in registration statements that we may file for ourselves or other shareholders. These registration rights of our shareholders could impair our ability to raise capital by depressing the price at which we could sell our common stock.

We will need to implement additional finance and accounting systems, procedures and controls as we grow our business and organization and to satisfy new reporting requirements.

As a public reporting company, we are required to comply with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC, including expanded disclosures and accelerated reporting requirements and more complex accounting rules. Compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and other requirements will increase our costs and require additional management time and resources. We may need to continue to implement additional finance and accounting systems, procedures and controls to satisfy new reporting requirements. Compliance with Section 404 may first apply to our fiscal year ending May 31, 2007. If our internal controls over financial reporting are determined to be ineffective, investors could lose confidence in the reliability of our internal controls over financial reporting, which could adversely affect our stock price.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

The primary 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 rated securities. As of November 30, 2005 we held short-term investments that had maturity dates of three months or less at the time of purchase, and consist primarily of money market accounts and commercial paper. Because of the short-term nature of our investments, we believe that our exposure to market rate fluctuations on those investments is minimal. On November 30, 2005, we had no long-term or short-term bank debt outstanding.

Foreign Currency Risk

Our revenue, expense and capital expenditures are transacted in U.S. dollars. We do source a portion of our product inventories from foreign vendors, primarily manufacturers in China. If the value of the U.S. dollar declines relative to the Chinese yuan, these foreign currency fluctuations could result in an increase in the cost of merchandise sourced from China through price increases. As a result of such fluctuations, we may experience fluctuations in our operating results on an annual or quarterly basis.

Item 4. Controls and Procedures.

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management, including our chief executive officer and principal financial officer (collectively, our “certifying officers”), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on their evaluation, our certifying officers concluded that these disclosure controls and procedures are effective in providing reasonable assurance that the information required to be disclosed by us in our periodic reports filed with the Securities and Exchange Commission (“SEC”) is recorded, processed, summarized, and reported within the time periods specified by the SEC’s rules and SEC reports.

We believe that a system of internal controls, no matter how well designed and operated, is based in part upon certain assumptions about the likelihood of future events, and therefore can only provide reasonable, not absolute, assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

We have reviewed our internal controls over financial reporting and have made no changes during the six months ended November 30, 2005 that our certifying officers concluded materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In connection with the termination of three senior level employees in July 2005, including the Company’s Chief Merchandising and Marketing Officer and Vice President, Storybook, in September 2005 the Company received a complaint alleging, among other things, that these employees were wrongfully terminated in violation of public policy. In their prayer for relief, the plaintiffs sought front pay, back pay, value of lost benefits, value of lost stock options, unpaid wages, and double damages. On October 17, 2005, the Company entered into settlement agreements with the individuals terminated, which agreements provide for among other things cash severance payments including payroll taxes of $985,000, agreement not to compete and agreement to dismiss the complaint.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

(b) On October 19, 2004, the Company’s registration statement on Form S-1 (Registration No. 333-117459) was declared effective for the Company’s initial public offering, pursuant to which the Company registered 3,200,000 shares of common stock to be sold by us (2,057,081 shares) and certain of the Company’s shareholders (1,142,919 shares). The stock was offered at $15.50 per share or an aggregate of $31.9 million for the Company and $17.7 million for the selling shareholders. The Company’s common stock commenced trading on October 20, 2004. The offering closed on October 25, 2004, and, as a result, the Company received net proceeds of approximately $29.7 million (after underwriters’ discounts of $2.2 million). In November 2004, the underwriter’s over-allotment option was exercised whereby 480,000 shares of the Company’s common stock were sold at an offering price of $15.50 per share. Of the

480,000 shares sold, 408,570 were sold by the Company and an aggregate of 71,430 shares were sold by selling shareholders. The over-allotment closed on November 2, 2004, and, as a result, the Company received net proceeds of approximately $5.9 million (after underwriters’ discounts of $443,000). The underwriters of the offering were SG Cowen & Co., LLC, CIBC World Markets Corp. and Pacific Crest Securities, Inc. The Company incurred additional, related expenses of approximately $1.5 million, which together with the underwriters’ discount, totaled $4.2 million in expenses related to the offering. Net proceeds after all estimated expenses approximated $34 million. None of the Company’s net offering proceeds were paid, directly or indirectly, to: (i) directors or officers of the Company, or their associates; (ii) persons owning ten percent or more of any class of equity securities of the Company; or (iii) affiliates of the Company.

From the effective date of the registration statement through November 30, 2005, the Company has used the net proceeds from the offering for repayment of the Company’s $5.0 million term loan. The remaining proceeds from the offering are invested in commercial paper and money market securities.

Item 4. Submission of Matter to a Vote of Securityholders.

The following is a description of matters submitted to a vote of our shareholders at an annual meeting of shareholders held on October 20, 2005:

A. Tim McGarvey, Keith Crandell and Estelle DeMuesy were elected as directors to hold office until the annual meeting in the expiration year detailed below and until their successors are elected and qualified. Votes cast for and votes withheld with respect to each nominee were as follows:


	New Term		Votes		Votes
	Expiration		For		Withheld
Tim McGarvey		2008		5,530,735		1,735,772

Keith Crandell		2008		6,985,034		281,473

Estelle DeMuesy		2006		7,015,937		250,570

B. A brief description of each other matter voted upon at the annual meeting and the votes cast for, votes cast against, abstentions and broker non-votes as to each such matter is as follows:

Votes

Broker

For

Against

Abstained

Non-votes

Proposal to ratify the selection of Grant Thornton LLP as Celebrate Express’ independent registered public accounting firm for the year ending May 31, 2006

5,139,440

2,123,685

3,375

—

Item 6. Exhibits.


Exhibit No.		Description
3.1(1)		Amended and Restated Articles of Incorporation of Celebrate Express, Inc.

3.2(1)		Bylaws of the Registrant — Celebrate Express, Inc.

4.1(1)		Specimen Common Stock Certificate.

10.1(2)		Severance Agreement with Dina Alhadeff, effective as of October 17, 2005.

10.2(2)		Severance Agreement with Lori Liddle, effective as of October 17, 2005.

31.1		Certification of Chief Executive Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

31.2		Certification of Principal Financial Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1		Certification of Chief Executive Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.

32.2		Certification of Principal Financial Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.


(1)		Incorporated by reference to Registrant’s Registration Statement on Form S-1 (File No. 333-117459), as amended, initially filed with the Securities and Exchange Commission on July 16, 2004.

(2)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities Exchange Commission on October 21, 2005.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	CELEBRATE EXPRESS, INC.
Date: January 13, 2006	By:	/s/ Michael K. Jewell
		Michael K. Jewell
		Chief Executive Officer and President (Principal Executive Officer)



Date: January 13, 2006	By:	/s/ Darin L. White
		Darin L. White
		Vice President, Finance (Principal Financial and Accounting Officer)

EXHIBIT INDEX


Exhibit No.		Description
3.1(1)		Amended and Restated Articles of Incorporation of Celebrate Express, Inc.

3.2(1)		Bylaws of the Registrant — Celebrate Express, Inc.

4.1(1)		Specimen Common Stock Certificate.

10.1(2)		Severance Agreement with Dina Alhadeff, effective as of October 17, 2005.

10.2(2)		Severance Agreement with Lori Liddle, effective as of October 17, 2005.

31.1		Certification of Chief Executive Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

31.2		Certification of Principal Financial Officer Required Under Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

32.1		Certification of Chief Executive Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.

32.2		Certification of Principal Financial Officer Required Under Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350.


(1)		Incorporated by reference to Registrant’s Registration Statement on Form S-1 (File No. 333-117459), as amended, initially filed with the Securities and Exchange Commission on July 16, 2004.

(2)		Incorporated by reference to Registrant’s Current Report on Form 8-K filed with the Securities Exchange Commission on October 21, 2005.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman V good

Celebrate Express (BDAY) Inactive 10-Q2006 Q3 Quarterly report

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