** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

# ** **

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For TheQuarterly Period Ended June 26, 2004**

 

**OR**

 

**o****TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the Transition Period from               to               **

 

**Commission File Number 0-25507**

 

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**iPARTYCORP.**

(Exact Name of Registrantas Specified in Its Charter)

 
| **DELAWARE**                                                     | ** ** | **76-0547750**                     |
|------------------------------------------------------------------|------------|------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) |       | (IRS Employer  Identification No.) |
|                                                             |       |                               |
| **270  BRIDGE STREET, SUITE 301  DEDHAM, MASSACHUSETTS**         |       | **02026**                          |
| (Address of Principal  Executive Offices)                        |       | (Zip Code)                         |
|                                                             |       |                               |
| **(781)  329-3952**                                              |
| (Registrant’s Telephone  Number, Including Area Code)       |

 

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Indicate by check markwhether the registrant:  (1) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes ýNo o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes o No ý

 

As of August 2, 2004,there were 22,055,157 shares of iParty Corp.’s common stock outstanding.

 

 

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**iParty Corp.**

**Quarterly Report on Form 10-Q**

**Table of Contents**

 

 
| PART 1         | FINANCIAL INFORMATION                                                                                            |   |
|----------------|------------------------------------------------------------------------------------------------------------------|--------|
|           |                                                                                                             |   |
| Item 1.        | Financial Statements  (Unaudited)                                                                                |   |
|           | Consolidated Balance Sheets  – June 26, 2004 and December 27, 2003                                          |   |
|           | Consolidated  Statements of Operations – Three months and six months ended June 26, 2004  and June 28, 2003 |   |
|           | Consolidated  Statements of Cash Flows – Six months ended June 26, 2004 and June 28, 2003                   |   |
|           | Notes to  Consolidated Financial Statements                                                                      |   |
|           |                                                                                                             |   |
| Item  2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                      |   |
|           |                                                                                                             |   |
| Item  3.       | Quantitative  and Qualitative Disclosures About Market Risk                                                      |   |
|           |                                                                                                             |   |
| Item  4.       | Controls  and Procedures                                                                                         |   |
|           |                                                                                                             |   |
| PART  II       | OTHER  INFORMATION                                                                                               |   |
|           |                                                                                                             |   |
| Item  1.       | Legal  Proceedings                                                                                               |   |
|           |                                                                                                             |   |
| Item  2.       | Changes  in Securities, Use of Proceeds and Issuer Purchases of Equity Securities                                |   |
|           |                                                                                                             |   |
| Item  3.       | Defaults  upon Senior Securities                                                                                 |   |
|           |                                                                                                             |   |
| Item 4.        | Submission of Matters to a Vote of Security  Holders                                                             |   |
|           |                                                                                                             |   |
| Item  5.       | Other  Information                                                                                               |   |
|           |                                                                                                             |   |
| Item  6.       | Exhibits  and Reports on Form 8-K                                                                                |   |
|           |                                                                                                             |   |
| SIGNATURES     |                                                                                                             |
|           |                                                                                                             |   |
| EXHIBIT  INDEX |                                                                                                             |
|           |                                                                                                             |   |
| Ex. 10.1       | Amended and Restated Employment Agreement between  iParty Corp. and Sal Perisano                                 |   |
|           |                                                                                                             |   |
| Ex. 10.2       | Amended and Restated Employment Agreement between  iParty Corp. and Patrick Farrell                              |   |
|           |                                                                                                             |   |
| Ex. 10.3       | Amended and Restated Employment Agreement between  iParty Corp. and Dorice Dionne                                |   |
|           |                                                                                                             |   |
| Ex. 31.1       | Certification of Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act                      |   |
|           |                                                                                                             |   |
| Ex. 31.2       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act                      |   |
|           |                                                                                                             |   |
| Ex. 32.1       | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350                                     |   |
|           |                                                                                                             |   |
| Ex. 32.2       | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350                                     |   |

 

1

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**PART I - FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**iPARTYCORP.**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                        | ** ** | **Jun 26, 2004** | ** ** | **Dec 27, 2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                                                        | ** ** | **(Unaudited)**  | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                                                                                                                        |       |             |       |             |       |
| Current assets:                                                                                                                                                                                                                                   |       |             |       |             |       |
| Cash and cash  equivalents                                                                                                                                                                                                                        |       | $                | 2,398,317  |             | $          | 2,442,471 |   |
| Restricted cash                                                                                                                                                                                                                                   |       | 487,638          |       | 533,284          |       |
| Accounts  receivable                                                                                                                                                                                                                              |       | 666,608          |       | 487,934          |       |
| Inventory, net                                                                                                                                                                                                                                    |       | 9,805,681        |       | 9,423,463        |       |
| Prepaid expenses  and other assets                                                                                                                                                                                                                |       | 440,644          |       | 483,925          |       |
| Total current  assets                                                                                                                                                                                                                             |       | 13,798,888       |       | 13,371,077       |       |
| Property and  equipment, net                                                                                                                                                                                                                      |       | 3,309,982        |       | 1,694,140        |       |
| Other assets                                                                                                                                                                                                                                      |       | 146,545          |       | 86,763           |       |
| Total assets                                                                                                                                                                                                                                      |       | $                | 17,255,415 |             | $          | 15,151,980 |   |
|                                                                                                                                                                                                                                              |       |             |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                                                    |       |             |       |             |       |
| Current  liabilities:                                                                                                                                                                                                                             |       |             |       |             |       |
| Accounts payable                                                                                                                                                                                                                                  |       | $                | 3,558,453  |             | $          | 3,095,848 |   |
| Accrued expenses                                                                                                                                                                                                                                  |       | 2,976,402        |       | 2,306,902        |       |
| Current portion  of capital lease obligations                                                                                                                                                                                                     |       | 1,765            |       | 29,220           |       |
| Borrowings under  line of credit                                                                                                                                                                                                                  |       | 4,872,255        |       | 3,760,671        |       |
| Total current  liabilities                                                                                                                                                                                                                        |       | 11,408,875       |       | 9,192,641        |       |
|                                                                                                                                                                                                                                              |       |             |       |             |       |
| Long-term  liabilities:                                                                                                                                                                                                                           |       |             |       |             |       |
| Capital lease  obligations, net of current portion                                                                                                                                                                                                |       | —           |       | 260              |       |
| Other  liabilities                                                                                                                                                                                                                                |       | 422,166          |       | 406,209          |       |
| Total long-term  liabilities                                                                                                                                                                                                                      |       | 422,166          |       | 406,469          |       |
|                                                                                                                                                                                                                                              |       |             |       |             |       |
| Commitments and  contingencies                                                                                                                                                                                                                    |       |             |       |             |       |
|                                                                                                                                                                                                                                              |       |             |       |             |       |
| Stockholders’  equity:                                                                                                                                                                                                                       |       |             |       |             |       |
| Convertible  preferred stock - $.001 par value; 10,000,000 shares authorized,  Series A convertible preferred stock - 1,000,000 shares authorized; 0 and  1,000,000 shares issued and outstanding at Jun 26, 2004 and Dec 27, 2003,  respectively |       | —           |       | 1,000,000        |       |
| Series B  convertible preferred stock - 1,150,000 shares authorized; 527,204 and  611,080 shares issued and outstanding at Jun 26, 2004 and Dec 27, 2003,  respectively (aggregate liquidation value of $10,544,080 at Jun 26, 2004)              |       | 7,844,794        |       | 9,092,870        |       |
| Series C  convertible preferred stock - 100,000 shares authorized, issued and  outstanding (aggregate liquidation value of $2,000,000 at Jun 26, 2004)                                                                                            |       | 1,492,000        |       | 1,492,000        |       |
| Series D  convertible preferred stock - 250,000 shares authorized, issued and  outstanding (aggregate liquidation value of $5,000,000 at Jun 26, 2004)                                                                                            |       | 3,652,500        |       | 3,652,500        |       |
| Series E  convertible preferred stock - 533,333 shares authorized; 296,667 and 389,439  shares issued and outstanding at Jun 26, 2004 and Dec 27, 2003, respectively  (aggregate liquidation value of $1,112,500 at Jun 26, 2004)                 |       | 1,112,500        |       | 1,460,396        |       |
| Series F  convertible preferred stock - 114,286 shares authorized, issued and outstanding  (aggregate liquidation value of $500,000 at Jun 26, 2004)                                                                                              |       | 500,000          |       | 500,000          |       |
| Total  convertible preferred stock                                                                                                                                                                                                                |       | 14,601,794       |       | 17,197,766       |       |
|                                                                                                                                                                                                                                              |       |             |       |             |       |
| Common stock -  $.001 par value; 150,000,000 shares authorized; 21,833,227 and 18,780,204  shares issued and outstanding at Jun 26, 2004 and Dec 27, 2003, respectively                                                                           |       | 21,833           |       | 18,780           |       |
|                                                                                                                                                                                                                                              |       |             |       |             |       |
| Additional  paid-in capital                                                                                                                                                                                                                       |       | 50,152,069       |       | 47,554,621       |       |
| Accumulated  deficit                                                                                                                                                                                                                              |       | (59,351,322      | )          | (59,218,297      | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                  |       | 5,424,374        |       | 5,552,870        |       |
|                                                                                                                                                                                                                                              |       |             |       |             |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                  |       | $                | 17,255,415 |             | $          | 15,151,980 |   |

 

The accompanying notesare an integral part of these Consolidated Financial Statements.

 

2

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**iPARTYCORP.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                      | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|-------------------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **Jun 26, 2004**               | ** ** | **Jun 28, 2003**             | ** ** | **Jun 26, 2004** | ** ** | **Jun 28, 2003** | ** ** |
| Revenues                                        |       | $                              | 15,360,388 |                         | $          | 13,805,555 |   | $ | 27,396,454 |   | $ | 24,093,132 |   |
| Operating costs:                                |       |                           |       |                         |       |   |   |   |   |
| Cost of products  sold                          |       | 8,539,369                      |       | 7,849,863                    |       | 15,557,014 |   | 14,091,559 |   |
| Marketing and  sales                            |       | 4,792,713                      |       | 4,344,027                    |       | 9,091,303 |   | 8,204,452 |   |
| General and  administrative                     |       | 1,590,445                      |       | 1,203,423                    |       | 3,165,351 |   | 2,500,919 |   |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Operating income  (loss)                        |       | 437,861                        |       | 408,242                      |       | (417,214 | ) | (703,798 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Other income                                    |       | 354,500                        |       | —                       |       | 354,500 |   | — |   |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Income (loss)  before interest and income taxes |       | 792,361                        |       | 408,242                      |       | (62,714 | ) | (703,798 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Interest income                                 |       | 829                            |       | 409                          |       | 1,009 |   | 988 |   |
| Interest expense                                |       | (43,894                        | )          | (56,874                      | )          | (71,320 | ) | (109,679 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Income (loss)  before income taxes              |       | 749,296                        |       | 351,777                      |       | (133,025 | ) | (812,489 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Income taxes                                    |       | —                         |       | —                       |       | — |   | — |   |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Net income  (loss)                              |       | $                              | 749,296    |                         | $          | 351,777 |   | $ | (133,025 | ) | $ | (812,489 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Income (loss)  per share:                       |       |                           |       |                         |       |   |   |   |   |
| Basic                                           |       | $                              | 0.02       |                         | $          | 0.01 |   | $ | (0.01 | ) | $ | (0.05 | ) |
| Diluted                                         |       | $                              | 0.02       |                         | $          | 0.01 |   | $ | (0.01 | ) | $ | (0.05 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Weighted-average  shares outstanding:           |       |                           |       |                         |       |   |   |   |   |
| Basic                                           |       | 37,698,128                     |       | 36,678,920                   |       | 20,675,562 |   | 17,187,437 |   |
| Diluted                                         |       | 41,834,415                     |       | 37,747,614                   |       | 20,675,562 |   | 17,187,437 |   |

 

The accompanying notesare an integral part of these Consolidated Financial Statements.

 

3

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**iPARTYCORP.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **For the six months ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                 | ** ** | **Jun 26, 2004**             | ** ** | **Jun 28, 2003** | ** ** |
| **Operating  activities:**                                                                 |       |                         |       |   |   |
|                                                                                       |       |                         |       |   |   |   |
| Net loss                                                                                   |       | $                            | (133,025   | ) | $ | (812,489 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                         |       |   |   |
| Depreciation and  amortization                                                             |       | 207,743                      |       | 254,789 |   |
| Deferred rent                                                                              |       | 15,957                       |       | (16,603 | ) |
| Changes in  operating assets and liabilities:                                              |       |                         |       |   |   |
| Accounts  receivable                                                                       |       | (178,674                     | )          | 96,106 |   |
| Inventory                                                                                  |       | (382,218                     | )          | (190,276 | ) |
| Prepaid expenses  and other assets                                                         |       | 24,128                       |       | (346,920 | ) |
| Accounts payable                                                                           |       | 462,605                      |       | 668,822 |   |
| Accrued expenses  and other liabilities                                                    |       | 669,500                      |       | (94,040 | ) |
| Net cash  provided by (used in) operating activities                                       |       | 686,016                      |       | (440,611 | ) |
|                                                                                       |       |                         |       |   |   |
| **Investing  activity:**                                                                   |       |                         |       |   |   |
|                                                                                       |       |                         |       |   |   |
| Purchase of  property and equipment                                                        |       | (1,823,585                   | )          | (185,031 | ) |
| Net cash used in  investing activity                                                       |       | (1,823,585                   | )          | (185,031 | ) |
|                                                                                       |       |                         |       |   |   |
| **Financing  activities:**                                                                 |       |                         |       |   |   |
|                                                                                       |       |                         |       |   |   |
| Net borrowings  under line of credit                                                       |       | 1,111,584                    |       | 745,257 |   |
| Decrease in  restricted cash                                                               |       | 45,646                       |       | (11,666 | ) |
| Principal  payments on capital lease obligations                                           |       | (27,715                      | )          | (111,492 | ) |
| Deferred  financing costs                                                                  |       | (40,629                      | )          | 26,147 |   |
| Proceeds from  exercise of stock options                                                   |       | 4,529                        |       | 1,760 |   |
| Net cash  provided by financing activities                                                 |       | 1,093,415                    |       | 650,006 |   |
|                                                                                       |       |                         |       |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                                  |       | (44,154                      | )          | 24,364 |   |
|                                                                                       |       |                         |       |   |   |
| **Cash  and cash equivalents, beginning of period**                                        |       | 2,442,471                    |       | 2,326,343 |   |
|                                                                                       |       |                         |       |   |   |
| **Cash  and cash equivalents, end of period**                                              |       | $                            | 2,398,317  |   | $ | 2,350,707 |   |
|                                                                                       |       |                         |       |   |   |
| Supplemental  disclosure of non-cash financing activities:                                 |       |                         |       |   |   |
|                                                                                       |       |                         |       |   |   |
| Conversion of  Series A convertible preferred stock to common stock                        |       | $                            | 1,000,000  |   | $ | — |   |
| Conversion of  Series B convertible preferred stock to common stock                        |       | 1,248,077                    |       | 533,240 |   |
| Conversion of  Series E convertible preferred stock to common stock                        |       | 347,895                      |       | — |   |
| Total conversion  of convertible preferred stock to common stock                           |       | $                            | 2,595,972  |   | $ | 533,240 |   |

 

The accompanying notesare an integral part of these Consolidated Financial Statements.

 

4

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**iPARTYCORP.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**June 26,2004**

**(Unaudited)**

 

**1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES**:

 

*InterimFinancial Information*

 

**The interim consolidated financialstatements as of June 26, 2004 have been prepared by the Company pursuant tothe rules and regulations of the Securities and Exchange Commission (the “SEC”)for interim financial reporting.  Theseconsolidated statements are unaudited and, in the opinion of management,include all adjustments (consisting of normal recurring adjustments andaccruals) necessary to present fairly the consolidated balance sheets,consolidated operating results, and consolidated cash flows for the periodspresented in accordance with generally accepted accounting principles.  The consolidated balance sheet at December27, 2003 has been derived from the audited consolidated financial statements atthat date.  Operating results for thethree months and six months ended June 26, 2004 and June 28, 2003 may not beindicative of the results for the entire year due, in part, to the seasonalityof the Company’s business.  Historically,higher revenues and operating income have been experienced in the second andfourth fiscal quarters.  Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles have beenomitted in accordance with the rules and regulations of the SEC.  These consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements, and accompanying notes, included in the Company’s Annual Report onForm 10-K for the year ended December 27, 2003.**

** **

*Principlesof Consolidation*

 

The consolidatedfinancial statements include the accounts of the Company and its wholly-ownedsubsidiaries after elimination of all significant intercompany transactions andbalances.

 

*Revenue Recognition*

 

Revenues include theselling price of party goods sold, net of returns and discounts, and arerecognized at the point of sale.  TheCompany estimates returns based upon historical return rates and such amountshave not been significant.

 

*Concentrations*

 

The Company purchases itsinventory from a diverse group of vendors and is not overly dependent upon anysingle source for its merchandise, often using more than one vendor for similarkinds of products.

 

Accounts receivableprimarily represent amounts due from credit card companies and vendors forinventory rebates.  Management does notprovide for doubtful accounts as such amounts have not been significant todate; the Company does not require collateral.

 

*Use ofEstimates*

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period.  Actual results coulddiffer from these estimates.

 

5

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*Cashand Cash Equivalents and Restricted Cash*

 

The Company considers allhighly liquid investments with an original maturity date of three months orless to be cash equivalents.  Cashequivalents consist primarily of money market accounts and are carried at cost plusaccrued interest, which approximates fair value.

 

The Company uses controlled disbursement banking arrangements as partof its cash management program. Outstanding checks, which were included in accounts payable, totaled$972,647 at June 26, 2004 and $989,816 at December 27, 2003.  The Company had sufficient funds available tofund the outstanding checks when they were presented for payment.

 

Restricted cash represents money deposited in blocked accountsestablished for the benefit of and under the control of Wells Fargo RetailFinance II, LLC, the Company’s lender under its lineof credit, and constitutes collateral for amounts outstanding under theCompany’s line of credit.

 

*Fair Value of Financial Instruments*

 

The carrying values ofcash and cash equivalents, accounts receivable and accounts payable approximatefair value because of the short-term nature of these instruments.  The fair value of borrowings under its lineof credit approximates carrying value because the debt bears interest at avariable market rate.

 

*Inventories*

 

Inventoriesconsist of party supplies and are valued at the lower of movingweighted-average cost or market. Inventory has been reduced by an allowance for obsolete and excessinventory, which is based on management’s review of inventories on handcompared to estimated future sales.  TheCompany records vendor rebates, discounts and certain other adjustments toinventory, including freight costs, and these amounts are recognized in theincome statement as the related goods are sold.

 

*Net Income (Loss) per Share*

 

Net income per basicshare is computed by dividing net income by the weighted-average number ofcommon shares outstanding plus the common share equivalents of all outstandingSeries B, C, D, E and F convertible preferred stock.  The common share equivalents of Series B, C,D, E and F convertible preferred stock are included in the calculation of netincome per basic share in accordance with EITF Topic D-95, Effect ofParticipating Convertible Securities on the Computation of Basic Earnings PerShare, since these convertible preferred stockholders are entitled toparticipate in dividends when and if declared by the Board of Directors.  For the periods with net losses, the Companyexcludes those common share equivalents since their impact would beanti-dilutive.

 

Net income per dilutedshare is computed by dividing net income by the weighted-average number ofcommon shares outstanding, plus the common share equivalents of all outstandingSeries A, B, C, D, E and F convertible preferred stock, plus the common shareequivalents of the “in the money” stock options and warrants as computed by thetreasury method.  For the periods withnet losses, the Company excludes those common share equivalents since theirimpact would be anti-dilutive.

 

The following table setsforth the computation of basic and diluted net income (loss) per shareavailable to common stockholders:

 

6

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| ** **                                                                      | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                                                                      | ** ** | **Jun 26, 2004**               | ** ** | **Jun 28, 2003**             | ** ** | **Jun 26, 2004** | ** ** | **Jun 28, 2003** | ** ** |
| Net  income (loss) available to common stockholders                             |       | $                              | 749,296    |                         | $          | 351,777 |   | $ | (133,025 | ) | $ | (812,489 | ) |
|                                                                            |       |                           |       |                         |       |   |   |   |   |
| Basic  and diluted net income (loss) per share available to common stockholders |       | $                              | 0.02       |                         | $          | 0.01 |   | $ | (0.01 | ) | $ | (0.05 | ) |
|                                                                            |       |                           |       |                         |       |   |   |   |   |
| Weighted-average  shares outstanding:                                           |       |                           |       |                         |       |   |   |   |   |
| Common  shares                                                                  |       | 21,123,453                     |       | 17,374,939                   |       | 20,675,562 |   | 17,187,437 |   |
| Common  share equivalents of Series B-F convertible preferred stock             |       | 16,574,675                     |       | 19,303,981                   |       | — |   | — |   |
| Basic  weighted-average shares outstanding                                      |       | 37,698,128                     |       | 36,678,920                   |       | 20,675,562 |   | 17,187,437 |   |
|                                                                            |       |                           |       |                         |       |   |   |   |   |
| Common  share equivalents of Series A convertible preferred stock               |       | —                         |       | 1,000,000                    |       | — |   | — |   |
| Common  share equivalents of “in the money” stock options             |       | 4,136,288                      |       | 61,339                       |       | — |   | — |   |
| Common  share equivalents of “in the money” warrants                  |       | —                         |       | —                       |       | — |   | — |   |
| Diluted  weighted-average shares outstanding                                    |       | 41,834,415                     |       | 37,740,259                   |       | 20,675,562 |   | 17,187,437 |   |

 

On January 13, 2004, all1,000,000 shares of Series A convertible stock were converted into 1,000,000shares of common stock.  The common shareequivalents of “out of the money” stock options and warrants which wereexcluded from the computation of diluted net income per share available to commonstockholders for the three months ended June 26, 2004 were 2,003,880 and13,561,216, respectively, because to do so would have been anti-dilutive.  The common share equivalents of “out of themoney” stock options and warrants which were excluded from the computation ofdiluted net income per share available to common stockholders for the threemonths ended June 28, 2003 were 7,910,808 and 13,563,212, respectively, becauseto do so would have been anti-dilutive.

 

*Stock Option Compensation Expense*

 

The Company accounts forits stock option compensation agreements with employees under the provisions ofAccounting Principles Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*. The Company has adopted the disclosure-only provisions of Statement ofFinancial Accounting Standards (“SFAS”) No. 123, *Accountingfor Stock-Based Compensation*.

 

The Company has computedthe value of options using the Black-Scholes option pricing model prescribed bySFAS No. 123.  The weighted-average fairvalue of the options granted was $0.78 per share during the second quarter offiscal 2004 and $0.19 per share during the second quarter of fiscal 2003, usingthe following assumptions:  no dividendyield, volatility of 117% to 118% in 2004 and 120% to 122% in 2003, a risk-freeinterest rate of 3.72% to 4.00% in the second quarter of fiscal 2004 and 2.13%to 2.88% in the second quarter of fiscal 2003 and an expected life of fiveyears from the date of the grant.  Hadcompensation cost for the Company’s stock option plan been determined basedupon the fair value at the grant date for awards under the plan consistent withthe methodology prescribed under SFAS 123, the Company’s net income (loss) andnet income (loss) per share would have been the following pro forma amounts:

 
| ** **                         | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **Jun 26, 2004**               | ** ** | **Jun 28, 2003**             | ** ** | **Jun 26, 2004** | ** ** | **Jun 28, 2003** | ** ** |
| Net  income (loss):                |       |                           |       |                         |       |   |   |   |   |
| Reported                           |       | $                              | 749,296    |                         | $          | 351,777 |   | $ | (133,025 | ) | $ | (812,489 | ) |
| Stock  option compensation expense |       | (386,935                       | )          | (108,170                     | )          | (535,285 | ) | (217,193 | ) |
| Pro  forma                         |       | $                              | 362,361    |                         | $          | 243,607 |   | $ | (668,310 | ) | $ | (1,029,682 | ) |
|                               |       |                           |       |                         |       |   |   |   |   |
| Net  income (loss) per share:      |       |                           |       |                         |       |   |   |   |   |
| Reported                           |       |                           |       |                         |       |   |   |   |   |
| Basic:                             |       | $                              | 0.02       |                         | $          | 0.01 |   | $ | (0.01 | ) | $ | (0.05 | ) |
| Diluted:                           |       | $                              | 0.02       |                         | $          | 0.01 |   | $ | (0.01 | ) | $ | (0.05 | ) |
| Pro  forma                         |       |                           |       |                         |       |   |   |   |   |
| Basic:                             |       | $                              | 0.01       |                         | $          | 0.01 |   | $ | (0.03 | ) | $ | (0.06 | ) |
| Diluted:                           |       | $                              | 0.01       |                         | $          | 0.01 |   | $ | (0.03 | ) | $ | (0.06 | ) |

 

7

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*Propertyand Equipment*

 

Propertyand equipment are stated at cost less accumulated depreciation and aredepreciated on the straight-line method over the estimated useful lives of theassets.  At the beginning of fiscal 2004the Company adopted a new policy for estimating the useful life of fixed assetswhich extended the useful life of equipment, furniture and fixtures andpoint-of-sale specific computer hardware and software.  Changing the estimated life of the assets inthese categories as of the beginning of the year reduced depreciation expensefor the second quarter and first six months of fiscal 2004 by approximately$29,000 and $69,000, respectively. Expenditures for maintenance and repairs are charged to operations asincurred.  A listing of the estimateduseful life of the various categories of property and equipment is as follows:

 
| **Asset Classification**                                                    | ** ** | **Estimated Useful Life**            | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------|------------|
| Computer  hardware and software                                             |       | 3 years                              |       |
| Equipment                                                                   |       | 5 years                              |       |
| Furniture  and fixtures                                                     |       | 7 years                              |       |
| Computer  hardware and software under capital leases                        |       | 3 years                              |       |
| Point-of-sale  specific computer hardware and software under capital leases |       | 5 years                              |       |
| Leasehold  improvements                                                     |       | Lesser of term of lease  or 10 years |       |

 

*Accountingfor the Impairment of Long-Lived Assets*

 

In accordance with SFASNo. 144, *Accounting for the Impairment orDisposal of Long-Lived Assets*,**the Company performs an impairmentreview quarterly.

 

*Reclassifications*

 

Certain reclassifications have been made to prior year’samounts to conform to the current year presentation.

 

**Item 2.**  Management’s Discussion and Analysis

** **

This information shouldbe read in conjunction with the unaudited consolidated financial statements andrelated notes included in Item 1 of this Quarterly Report on Form 10-Q and theaudited consolidated financial statements and related notes and Item 7,Management’s Discussion and Analysis, contained in our Annual Report on Form10-K for the fiscal year ended December 27, 2003.

 

**Forward Looking Statements**

 

This Quarterly Report onForm 10-Q, including this discussion and analysis by management, contains orincorporates forward-looking statements within the meaning of Section 27A ofthe Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended.  Theseforward-looking statements are based on current expectations, estimates,forecasts and projections about the industry and markets in which we operateand our management’s beliefs and assumptions. In addition, other written or oral statements that constituteforward-looking statements may be made by or on our behalf.  Words such as “expect”, “anticipate”,“intend”, “plan”, “believe”, “seek”, estimate”, variations of such words andsimilar expressions are intended to identify such forward-looking statements.These statements are not guarantees of future performance and involve certainrisks, uncertainties and assumptions that are difficult to predict.  We have included important factors in thecautionary statements below under the heading “Factors That May Affect FutureResults” that we believe could cause our actual results to differ materiallyfrom the forward-looking statements we make. We do not intend to update publicly any forward-looking statements,whether as a result of new information, future events or otherwise.

 

**Overview**

** **

Webelieve we are a leading brand in the party industry in the markets we serveand a leading resource in those markets for consumers seeking party goods,party planning advice and relevant information. We are a party goods retailer operating stores throughout New England,where 37 of our 41 retail stores are located. Our other four stores are in Florida, one of which, in Citrus Park, FL,has opened since the end of the second quarter. We also license the name “iparty.com” (at www.iparty.com) to a thirdparty in exchange for royalties from Internet sales,

 

8

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whichto date have not been significant.  Thefollowing table shows the number of stores in operation at June 26, 2004 andJune 28, 2003.

 
| ** **           | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|----------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **           | ** ** | **Jun 26, 2004**               | ** ** | **Jun 28, 2003**             | ** ** | **Jun 26, 2004** | ** ** | **Jun 28, 2003** | ** ** |
| Beginning  of period |       | 38                             |       | 35                           |       | 38 |   | 35 |   |
| Openings             |       | 2                              |       | —                       |       | 2 |   | — |   |
| Closings             |       | —                         |       | —                       |       | — |   | — |   |
| End  of period       |       | 40                             |       | 35                           |       | 40 |   | 35 |   |

 

Our stores feature over20,000 products ranging from greeting cards and balloons to more uniquemerchandise such as piñatas, tiny toys, masquerade and Hawaiian Luauitems.  Our sales are driven by thefollowing events:  Halloween, Christmas,Easter, Valentine’s Day, New Year’s, Independence Day, St. Patrick’s Day,Thanksgiving and Chanukah.  We also focusour business closely on lifetime events such as anniversaries, graduations,birthdays, and bridal or baby showers. The following table shows a summary of our revenues and the increase inrevenues from the prior year periods.

 
| ** **            | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|-----------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **            | ** ** | **Jun 26, 2004**               | ** ** | **Jun 28, 2003**             | ** ** | **Jun 26, 2004** | ** ** | **Jun 28, 2003** | ** ** |
| Revenues              |       | $                              | 15,360,388 |                         | $          | 13,805,555 |   | $ | 27,396,454 |   | $ | 24,093,132 |   |
|                  |       |                           |       |                         |       |   |   |   |   |
| Increase  in revenues |       | 11.3                           | %          | 5.5                          | %          | 13.7 | % | 1.8 | % |
|                       |            |                                |            |                              |            |  |  |  |  |  |  |  |  |

 

Our business has a seasonalpattern.  In the past two years we haverealized over one-third of our annual revenues in our fourth quarter, whichincludes Halloween and Christmas, and approximately 25% of our revenues in thesecond quarter, which includes school graduations.  Also, during these past two years, we havehad net income in our second and fourth quarters and generated losses in ourfirst and third quarters.

 

**Results of Operations**

** **

Fiscal year 2004 has 52weeks and ends on December 25, 2004. Fiscal year 2003 had 52 weeks and ended on December 27, 2003.

 

The second quarter offiscal year 2004 had 13 weeks and ended on June 26, 2004.  The second quarter of fiscal year 2003 had 13weeks and ended on June 28, 2003.

 

**Three Months Ended June26, 2004 Compared to Three Months Ended June 28, 2003**

** **

*Revenues*

 

Our consolidated revenuesfor the second quarter of fiscal 2004 were $15,360,388, an increase of$1,554,833, or 11.3% from the second quarter of the prior fiscal year.  Revenues include the selling price of partygoods sold, net of returns and discounts, and are recognized at the point ofsale.

 

Sales for the secondquarter of fiscal 2004 included sales from five new stores that opened sincethe end of the second quarter of 2003, as well as an increase of 2.5% incomparable store sales.  Comparable storesales are defined as sales from those stores open for at least one fullyear.  Our increase in comparable storesales was led by the performance of our graduation and summer merchandisecategories, which are our two most important seasonal businesses during oursecond fiscal quarter.  We also generatedstrong sales increases during this period in our Halloween category, as we haveincreased our assortment of costumes and related accessories available for salethroughout the year in many of our stores.

 

9

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*Cost ofproducts sold*

 

Our cost of products soldfor the second quarter of fiscal 2004 was $8,539,369, or 55.6% of revenues, anincrease of $689,504 and a decrease of 1.3 percentage points, as a percentageof revenues, from the second quarter of the prior fiscal year.  Cost of products sold consists of the cost ofmerchandise sold to customers and the occupancy costs for our stores.  As a percentage of revenues, the decrease wasattributable to better terms with our vendors and reductions in inventoryreserves associated with reduced exposure to slow moving inventory.

 

*Marketingand sales expense*

 

Our consolidatedmarketing and sales expense for the second quarter of fiscal 2004 was$4,792,713, or 31.2% of revenues, an increase of $448,686 and a decrease of 0.3percentage points, as a percentage of revenues, from the second quarter of theprior fiscal year.  Marketing and salesexpense consists primarily of advertising and promotional expenditures, allstore payroll and related expenses for personnel engaged in marketing andselling activities and other non-payroll expenses associated with operating ourstores.  As a percentage of revenues, thedecrease in marketing and sales expense was primarily attributable to tightcontrol of store payroll and lower advertising costs, in absolute dollars, thanin the second quarter of 2003.

 

*Generaland administrative expense*

 

Our consolidated generaland administrative (“G&A”) expense for the second quarter of fiscal 2004was $1,590,445, or 10.4% of revenues, an increase of $387,022 and an increaseof 1.7 percentage points, as a percentage of revenues, from the second quarterof the prior fiscal year.  G&Aexpense consists of payroll and related expenses for executive, merchandising,finance and administrative personnel, as well as information technology,professional fees and other general corporate expenses.  The increase in G&A expense is largelyattributable to increased labor costs for positions added to support growth,higher benefits-related insurance costs, increased occupancy costs for our newcorporate office and increased training and other expenses associated withinstalling new point-of-sale equipment and software in all of our stores, whichwas completed in early July 2004.

 

*Otherincome*

 

In the second quarter offiscal 2004 we reached a settlement with a third party in connection with thespecial charge previously recorded in fiscal year 2002.  We recorded the net settlement of $354,500 asother income.

 

*Interestexpense*

 

Our interestexpense in the second quarter of fiscal 2004 was $43,894, a decrease of $12,980from the second quarter of fiscal 2003. Approximately $8,900 of the decrease in interest expense resulted fromthe expiration of capital leases during 2003. The interest rate on our borrowings under our line of credit declined to4.5% in the second quarter of fiscal 2004 compared to 6.5% in the secondquarter of fiscal 2003, which reduced interest expense by approximately $13,200.  Our average loan balance was approximately$3,750,000 during the second quarter of fiscal 2004 compared to $2,961,000 inthe second quarter of fiscal 2003, which increased interest expense byapproximately $9,200.

 

*Incometaxes*

 

We have not provided abenefit for income taxes for the first six months of fiscal 2004 or fiscal 2003due to the uncertainty of future taxable income.

 

At the end of fiscal 2003we had estimated net operating loss carryforwards of approximately $23.7million, which begin to expire in 2018. In accordance with Section 382 of the Internal Revenue Code, the use ofthese carryforwards will be subject to annual limitations based upon certainownership changes of our stock that have occurred or that may occur.

 

10

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*Netincome*

 

Our net income in thesecond quarter of fiscal 2004 was $749,296 or $0.02 per basic and dilutedshare, compared to a $351,777, or $0.01 per basic and diluted share, in thesecond quarter of fiscal 2003.

 

**Six months ended June 26,2004 compared to six months ended June 28, 2003**

** **

*Revenues*

 

Our consolidated revenuesfor the first six months of fiscal 2004 were $27,396,454, an increase of$3,303,322, or 13.7% from the first six months of the prior fiscal year.  Revenues include the selling price of partygoods sold, net of returns and discounts, and are recognized at the point ofsale.

 

Sales for the first sixmonths of fiscal 2004 included sales from five new stores that opened since theend of the second quarter of 2003, as well as an increase of 6.0% in comparablestore sales.  Comparable store sales aredefined as sales from those stores open for at least one full year.  Our increase in comparable store sales wasled by the performance of our Halloween, graduation, summer, Super Bowl relatedmerchandise and New Year’s categories. We generated strong sales increases during this period in our Halloweencategory, as we have increased our assortment of costumes and related accessoriesavailable for sale throughout the year in many of our stores.

 

*Cost ofproducts sold*

 

Our cost of products soldfor the first six months of fiscal 2004 was $15,557,014, or 56.8% of revenues,an increase of $1,465,455 and a decrease of 1.7 percentage points, as apercentage of revenues, from the first six months of the prior fiscalyear.  Cost of products sold consists ofthe cost of merchandise sold to customers and the occupancy costs for ourstores.  As a percentage of revenues, thedecrease was attributable to better terms with our vendors and lower inventorycharges resulting from reduced exposure to slow moving inventory.

 

*Marketingand sales expense*

 

Our consolidatedmarketing and sales expense for the first six months of fiscal 2004 was$9,091,303, or 33.2% of revenues, an increase of $886,851 and a decrease of 0.9percentage points, as a percentage of revenues, from the first six months ofthe prior fiscal year.  Marketing andsales expense consists primarily of advertising and promotional expenditures,all store payroll and related expenses for personnel engaged in marketing andselling activities and other non-payroll expenses associated with operating ourstores.  As a percentage of revenues, thedecrease in marketing and sales expense was primarily attributable to tightcontrol of store payroll and lower advertising costs, in absolute dollars, thanin the first six months of 2003.

 

*Generaland administrative expense*

 

Our consolidated generaland administrative (“G&A”) expense for the first six months of fiscal 2004was $3,165,351, or 11.6% of revenues, an increase of $664,432 and an increaseof 1.2 percentage points, as a percentage of revenues, from the first sixmonths of the prior fiscal year.  G&Aexpense consists of payroll and related expenses for executive, merchandising,finance and administrative personnel, as well as information technology,professional fees and other general corporate expenses.  The increase in G&A expense is largelyattributable to increased labor costs for positions added to support growth,higher benefits-related insurance costs, increased occupancy costs for our newcorporate office and increased training and other expenses associated withinstalling new point-of-sale equipment and software in all of our stores, whichwas completed in early July 2004.

 

*Otherincome*

 

In the second quarter offiscal 2004 we reached a settlement with a third party in connection with thespecial charge previously recorded in fiscal year 2002.  We recorded the net settlement of $354,500 asother income.

 

11

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*Interestexpense*

 

Our interestexpense in the first six months of fiscal 2004 was $71,320, a decrease of$38,359 from the first six months of fiscal 2003.  Approximately $21,000 of the decrease ininterest expense resulted from the expiration of capital leases during2003.  The interest rate on ourborrowings under our line of credit declined to 4.5% in the first six months offiscal 2004 compared to 6.5% in the first six months of fiscal 2003, whichreduced interest expense by approximately $24,000.  Our average loan balance was approximately$3,003,000 during the first six months of fiscal 2004 compared to $2,619,000 inthe first six months of fiscal 2003, which increased interest expense byapproximately $9,000.

 

*Incometaxes*

 

We have not provided abenefit for income taxes for the first six months of fiscal 2004 or fiscal 2003due to the uncertainty of future taxable income.

 

At the end of fiscal 2003we had estimated net operating loss carryforwards of approximately $23.7 million,which begin to expire in 2018.  Inaccordance with Section 382 of the Internal Revenue Code, the use of thesecarryforwards will be subject to annual limitations based upon certainownership changes of our stock that have occurred or that may occur.

 

*Netloss*

 

Our net loss in the firstsix months of fiscal 2004 was $133,025 or $0.01 per basic and diluted share,compared to $812,489, or $0.05 per basic and diluted share, in the first sixmonths of fiscal 2003.

 

**Liquidity and CapitalResources**

** **

Our operating activitiesprovided $686,016 in cash in the first six months of fiscal 2004 compared tousing $440,611 in the first six months of fiscal 2003, an increase of$1,126,627.  Our reduction in net loss,which was $133,025 in the first six months of fiscal 2004 compared to $812,489in the first six months of 2003, represented $679,464 of this increase.  We also reduced prepaid inventory in thefirst six months of fiscal 2004 by $420,887, associated with early deliveriesof Halloween merchandise, compared to the first six months of fiscal 2003.

 

We used $1,823,585 of netcash in investing activities in the first six months of fiscal 2004 compared to$185,031 in the first six months of 2003. The cash invested in the first six months of 2004 included $849,328 forour new point-of-sale equipment and software and $763,432 for fixed assetsassociated with new stores.  The cashinvested in the first six months of fiscal 2003 included the purchase ofpersonal computer software licenses and new fixtures for existing stores.

 

We provided $1,093,415 innet cash by financing activities in the first six months of 2004 compared to$650,006 in the first six months of 2003. We increased our borrowings under our line of credit by $1,111,584 in thefirst six months of 2004, largely to fund our fixed asset additions, comparedto $745,257 in the first six months of 2003.

 

We have a line of credit(the “line”) with Wells Fargo Retail Finance II, LLC, which was amended onJanuary 2, 2004.  The amendment extendedthe maturity date of the line to January 2, 2007, eliminated the minimuminterest rate of 6.5%, established a new interest rate at the bank’s base rateplus 50 basis points and added the option to increase the line in increments of$2,500,000 beyond the previous limit of $7,500,000, to a limit of $12,500,000,upon 15 days written notice, as long as we are in compliance with all debtcovenants and the other provisions of the loan agreement.  Our inventory and accounts receivable secure ourline of credit.

 

The amended agreementincludes a financial covenant requiring us to maintain a minimum availabilityunder the line in the amount of 5% of the credit limit, which at the currentlimit of $7,500,000, is $375,000.  If weadjust the credit limit in the future, the minimum availability would be 5% ofthe adjusted credit limit.  The amendedagreement also has a covenant that requires us to limit our capitalexpenditures to within 110% of those amounts included in our business plan,which may be updated from time to time.

 

12

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The amounts outstandingunder our line were $4,872,255 as of June 26, 2004 and $3,760,671 as ofDecember 27, 2003.  The outstandingbalances under our line are classified as current liabilities in theaccompanying consolidated balance sheets since we are required to apply dailylock-box receipts to reduce the amount outstanding.  At June 26, 2004, we had approximately$905,100 of additional availability under the line of credit.  Subsequent to the end of the quarter, weestablished a letter of credit for $356,000 with Wells Fargo Bank, N.A.associated with the leasing of our new point-of-sale equipment and software.

 

Our prospectivecash flows are subject to certain trends, events and uncertainties, includingdemands for capital to support growth, economic conditions, and contractualmatters.  We expect our capitalexpenditures for 2004 to be primarily related to new stores, a new retailpoint-of-sale computer system, store improvements and other technology advancementsin support of growth and operational enhancement.

 

Contractualobligations at June 26, 2004, including leases signed for stores yet to open,were as follows:

 
| ** **                                        | ** ** | **Payments Due By Period** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|
| ** **                                        | ** ** | **Within  1 Year**         | ** ** | **Within  2 - 3  Years** | ** ** | **Within  4 - 5  Years** | ** ** | **After  5 Years** | ** ** | **Total** | ** ** |
| Line  of credit                                   |       | $                          | 4,872,255  |   | $ | — |   | $ | — |   | $ | — |   | $ | 4,872,255 |   |
| Capital  lease obligations                        |       | 1,765                      |       | — |   | — |   | — |   | 1,765 |   |
| Operating  leases (including retail space leases) |       | 6,816,971                  |       | 12,202,153 |   | 7,585,915 |   | 13,441,792 |   | 40,046,831 |   |
| Total  contractual obligations                    |       | $                          | 11,690,991 |   | $ | 12,202,153 |   | $ | 7,585,915 |   | $ | 13,441,792 |   | $ | 44,920,851 |   |

 

**Seasonality**

** **

**Due to the seasonality of ourbusiness, sales and operating income are typically higher in our second andfourth quarters.  Our business is highlydependent upon sales of Easter, graduation and summer merchandise in the secondquarter and sales of Halloween and Christmas merchandise in the fourth quarter.**

** **

**GeographicConcentration**

** **

**At August2, 2004 we operated a total of 41 stores, 37 of which are located in NewEngland.  As a result, a severe orprolonged regional recession or regional changes in demographics, employmentlevels, population, weather patterns, real estate market conditions or otherfactors specific to the New England region may adversely affect us more than acompany that is more geographically diverse.**

** **

**Effects of Inflation**

** **

We do not view theeffects of inflation to have a material effect upon our business.

 

# **Factors That May Affect Future Results**

# ** **

Various risks,uncertainties and contingencies could cause our actual results, performance orachievements to differ materially from those expressed in, or implied by,statements contained in this Quarterly Report on Form 10-Q, including, but notlimited to, the following:

 

•                  the success or failure of our effortsto implement our business strategy, including successful site location of newstores and implementation of our new point-of-sale system;

•                  our ability or inability to obtainadditional financing, if required;

•                  third-party suppliers’ failure tofulfill their obligations to us;

•                  unseasonable weather;

•                  intense competition;

•                  the availability of retail storespace on reasonable lease terms;

•                  the failure of our systems or thoseof our third-party suppliers;

•                  general economic and otherdevelopments affecting consumer confidence or spending patterns, particularlyin the New England region; and

 

13

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•                  compliance with evolving federalsecurities, accounting, and stock exchange rules and regulations applicable topublicly-trade companies listed on the American Stock Exchange.

 

**Critical Accounting Policies and Estimates**

 

Our financial statementsare based on the application of significant accounting policies, many of whichrequire management to make significant estimates and assumptions (see Note 1 tothe consolidated financial statements). We believe the following accounting policies to be those most importantto the portrayal of our financial condition and those that require the mostsubjective judgment.  If actual resultsdiffer significantly from management’s estimates and projections, there couldbe a material effect on our financial statements.

 

*Inventoryand Related Allowance for Obsolete and Excess Inventory*

 

Our inventoryconsists of party supplies and is valued at the lower of movingweighted-average cost or market.  Werecord vendor rebates, discounts and certain other adjustments to inventory,including freight costs, and we recognize these amounts in the income statementas the related goods are sold.

 

*Revenue Recognition*

 

Revenues include theselling price of party goods sold, net of returns and discounts, and arerecognized at the point of sale.  Weestimate returns based upon historical return rates and such amounts have notbeen significant.

 

*Impairment of Long-Lived Assets*

 

In accordance with SFASNo. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*, we perform an impairment review quarterly.  If actual market conditions are lessfavorable than our projections, future write-offs may be necessary.

 

*IncomeTaxes*

 

Historically, wehave not recognized an income tax benefit for our losses.  Accordingly we record a valuation allowanceagainst our deferred tax assets because of the uncertainty of future taxableincome and the realizability of the deferred tax assets.  Should we determine that we will be able torealize our deferred tax assets in the future, an adjustment to our deferredtax assets would increase income in the period we made such a determination.

 

*Previous Restatement of FinancialInformation and Balance Sheet Presentation of Series A-F Convertible PreferredStock*

 

The holders of our SeriesA-F convertible preferred stock have the right to a liquidation preference,which previously could have been exercised under certain events not within ourcontrol.  In accordance with EITF TopicD-98, we included the respective equity securities outside of permanentstockholders’ deficit in our restated balance sheet as of December 28, 2002,and in our balance sheets through September 27, 2003, at their respectivecarrying values.

 

During the fourth quarterof 2003, the composition of our Board of Directors changed such that holders ofour convertible preferred stock or the designates of our preferred stockholdersno longer constituted a majority of our Board members.  This change in the composition of our Boardof Directors has permitted us to present our convertible preferred stock inequity in the accompanying balance sheets as of June 26, 2004 and December 27,2003 at its respective carrying values, as the redemption is deemed under EITFTopic D-98 to be solely within our control under these changed circumstances.

 

We will continue toreview and consider the criteria in EITF Topic D-98 at the reporting of eachbalance sheet.

 

14

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*Stock Option Compensation Expense*

 

We account for our stockoption compensation agreements with employees under the provisions ofAccounting Principles Board (“APB”) Opinion No. 25, *Accounting forStock Issued to Employees*.  Wehave adopted the disclosure-only provisions of SFAS No. 123, *Accounting for Stock-Based Compensation*, as amended by SFASNo. 148, *Accounting for Stock-Based Compensation –Transition and Disclosure, an amendment of Financial Accounting Standards Board(“FASB”) Statement No. 123*.

 

*Use ofEstimates*

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires us to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reporting period.  Our actual results could differ from ourestimates.

 

At the beginning offiscal 2004 we adopted a new policy for estimating the useful life of fixedassets which extended the useful life of equipment, furniture and fixtures andpoint-of-sale specific computer hardware and software.  Had we not made this change to the estimatedlife of the assets in these categories as of the beginning of the year we wouldhave had approximately a $69,000 greater operating loss and net loss in thefirst six months of 2004.  There wouldhave been no impact on basic and diluted loss per share for the period.

 

**New Accounting Pronouncements**

 

In January 2003,the FASB issued Interpretation No. 46, *Consolidationof Variable Interest Entities, an Interpretation of Accounting ResearchBulletin (“ARB”) No. 51*(“FIN 46”)*.*  FIN 46 requires certain variable interestentities to be consolidated by the primary beneficiary of the entity if theequity investors in the entity do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties.  FIN 46 is effective forall new variable interest entities created or acquired after January 31, 2003.  For variable interest entities created oracquired prior to February 1, 2003, the provisions of FIN 46 must be appliedfor the first interim or annual period beginning after June 15, 2003.  However, in October 2003, the FASB deferredthe effective date of FIN 46 to the end of the first interim or annual periodending after December 15, 2003 for those arrangements involving special purposeentities entered into prior to February 1, 2003.  All other arrangements within the scope ofFIN 46 are subject to its provisions beginning in 2004.  We adopted FIN 46, as required, with nomaterial impact to our consolidated financial position or results ofoperations.  We do not believe that theadoption of the remaining provisions of FIN 46 in 2004 will have a materialimpact on our financial position or results of operations.

 

On March 31, 2004, theFinancial Accounting Standards Board (FASB) issued its Exposure Draft, *Share-Based Payment*, which is a proposed amendment to FASBStatement No. 123, *Accounting for Stock-BasedCompensation*.  Generally, theapproach in the Exposure Draft is similar to the approach described inStatement 123.  However, the ExposureDraft would require all share-based payments to employees, including grants ofemployee stock options, to be recognized in the income statement based on theirfair values.  The FASB expects to issue afinal standard late in 2004 that would be effective for public companies (andfor nonpublic companies that currently use the fair value method, rather thanthe minimum value method, for recognition or disclosure purposes) for fiscalyears beginning after December 15, 2004. We are presently studying the Exposure Draft in anticipation of itsadoption next year, the impact of which is not known or reasonably estimable atthis time.

 

**Item3.****  Quantitative and QualitativeDisclosures About Market Risk**

 

There has been nomaterial change in our market risk exposure since the filing of our AnnualReport on Form 10-K.

 

**Item4.**** Controls andProcedures**

 

(a) *Evaluation ofDisclosure Controls and Procedures.** *Our management, with theparticipation of our Chief Executive Officer, or CEO, and Chief FinancialOfficer, or CFO, evaluated the effectiveness of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act) as of

 

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June 26, 2004. In designing and evaluating our disclosure controls and procedures, ourmanagement recognized that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives, and our management necessarily applied its judgment in evaluatingthe cost-benefit relationship of possible controls and procedures.  Based on this evaluation, our CEO and CFOconcluded that, as of June 26, 2004, our disclosure controls and procedureswere (1) designed to ensure that material information relating to us, includingour consolidated subsidiaries, is made known to our CEO and CFO by otherswithin those entities, particularly during the period in which this report wasbeing prepared and (2) effective, in that they provide reasonable assurancethat information required to be disclosed by us in the reports that we file orsubmit under the Securities Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

(b) *Changes in Internal Controls.*No change inour internal controls over financial reporting (as defined in Rules 13a-15(f)and 15d-15(f) under the Securities Exchange Act) occurred during the fiscalquarter ended June 26, 2004 that has materially affected, or is reasonablylikely to materially affect, our internal controls over financial reporting.

 

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PART II – OTHER INFORMATION

 

**Item1.  Legal Proceedings**

 

Not applicable.

 

**Item2.  Changes inSecurities, Use of Proceeds and Issuer Purchases of Equity Securities**

 

Not applicable.

 

**Item3.  Defaults uponSenior Securities**

 

Not applicable.

 

**Item4.  Submission ofMatters to a Vote of Security Holders**

 

On June 10, 2004, theCompany held its Annual Meeting of Stockholders.  There were a total of 37,033,124 votesentitled to be cast at the meeting.  Ofthis total, 33,267,121, or approximately 89.8% of the total number of voteseligible to be cast, were represented either in person or by proxy.  At the meeting, the stockholders electedseven (7) Directors to the Company’s Board of Directors.  The holder of Series D convertible preferredstock was entitled to vote alone for the election of a Series D Director.  Christine Weaver-Vest was the designee of theholder of the Series D convertible preferred stock.  Set forth below are (i) the names of thepersons elected to serve on the Company’s Board of Directors until the nextAnnual Meeting of Stockholders and until their successors are duly elected andqualified and (ii) the results of the voting for the nominees.

 
| ** **             | ** ** | **Votes For** | ** ** | **Withheld**   | ** ** |
|------------------------|------------|---------------|------------|----------------|------------|
| **Director**           | ** ** | **Number**    | ** ** | **% of Total** | ** ** | **Number** | ** ** | **% of Total** | ** ** |
| Sal  Perisano          |       | 33,233,986    |       | 99.9           | %          | 33,135 |   | 0.1 | % |
| Lorenzo  Roccia        |       | 33,232,486    |       | 99.9           | %          | 34,635 |   | 0.1 | % |
| Daniel  De Wolf        |       | 33,233,986    |       | 99.9           | %          | 33,135 |   | 0.1 | % |
| Frank  Haydu           |       | 33,234,486    |       | 99.9           | %          | 32,635 |   | 0.1 | % |
| Eric  Schindler        |       | 33,234,486    |       | 99.9           | %          | 32,635 |   | 0.1 | % |
| Joseph  Vassalluzzo    |       | 33,233,986    |       | 99.9           | %          | 33,135 |   | 0.1 | % |
| Christina  Weaver-Vest |       | 3,500,000     |       | 100.0          | %          | — |   | 0.0 | % |

 

The stockholders alsoratified the appointment of Ernst & Young LLP as the Company’s independentpublic auditors for the current fiscal year ending December 25, 2004.  Set forth below is the results of that vote.

 
| ** **                                                                                          | ** ** | **Votes For** | ** ** | **Votes Against** | ** ** | **Votes Abstained** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------|------------|-------------------|------------|---------------------|------------|
| ** **                                                                                          | ** ** | **Number**    | ** ** | **% of Total**    | ** ** | **Number**          | ** ** | **% of Total** | ** ** | **Number** | ** ** | **% of Total** | ** ** |
| Ratification  of appointment of Ernst & Young LLP as Company’s independent public  auditor |       | 33,192,863    |       | 99.8              | %          | 62,208              |       | 0.2 | % | 12,050 |   | 0.0 | % |

 

**Item5.  Other Information**

 

Not applicable.

 

**Item 6.  Exhibits and Reports onForm 8-K**

 

(a) Exhibits

 

The exhibits listed inthe Exhibit Index immediately preceding the exhibits are filed as part of thisQuarterly Report on Form 10-Q.

 

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(b) Reports on Form 8-K

 

On April 28, 2004, wefurnished a Current Report on Form 8-K under Item 12 containing a press releaseannouncing our financial results for the fiscal quarter ended March 27, 2004.

 

On July 28, 2004, wefurnished a Current Report on Form 8-K under Item 12 containing a press releaseannouncing our financial results for the fiscal quarter ended June 26, 2004.

 

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**SIGNATURES**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                          | iPARTY CORP. |
|-------------------------------|--------------|
|                          |         |   |
|                          | By:          |   | /s/ SAL PERISANO |   |   |
|                          |         | Sal Perisano |   |
|                          |         | Chairman of the Board  and Chief Executive Officer |   |
|                          |         | (Principal Executive  Officer) |   |
|                          |         |   |
|                          | By:          |   | /s/ PATRICK FARRELL |   |   |
|                          |         | Patrick Farrell |   |
|                          |         | President and Chief  Financial Officer |   |
|                          |         | (Principal Financial  and Accounting Officer) |   |
|                          |         |   |
| Dated:  August  10, 2004 |         |   |

 

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**EXHIBIT****INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                             |
|-----------------|------------|---------------------------------------------------------------------------------------------|
|            |       |                                                                                        |
| Ex. 10.1        |       | Amended and Restated Employment Agreement between  iParty Corp. and Sal Perisano            |
|            |       |                                                                                        |
| Ex. 10.2        |       | Amended and Restated Employment Agreement between  iParty Corp. and Patrick Farrell         |
|            |       |                                                                                        |
| Ex. 10.3        |       | Amended and Restated Employment Agreement between  iParty Corp. and Dorice Dionne           |
|            |       |                                                                                        |
| Ex. 31.1        |       | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act (Chief Executive Officer). |
|            |       |                                                                                        |
| Ex. 31.2        |       | Certification pursuant to Section 302 of the  Sarbanes-Oxley Act (Chief Financial Officer). |
|            |       |                                                                                        |
| Ex. 32.1        |       | Certification pursuant to 18 U.S.C. Section 1350  (Chief Executive Officer).                |
|            |       |                                                                                        |
| Ex. 32.2        |       | Certification pursuant to 18 U.S.C. Section 1350 (Chief  Financial Officer)                 |

 

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