**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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

 

**For The Quarterly Period EndedMarch 27, 2004**

 

**OR**

 

**TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the TransitionPeriod from                  to                  **

 

**Commission FileNumber 0-25507**

 

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**iPARTY CORP.**

(Exact Name of Registrant as 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 mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes  ý  No  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 May 3, 2004, there were 21,014,910 shares of iParty Corp.’scommon stock outstanding.

 

 

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**iParty Corp.**

**Quarterly Report onForm 10-Q**

**Table of Contents**

 

 
|           |                                                                                               | **Page**       |
|----------------|----------------------------------------------------------------------------------------------------|----------------|
| PART 1         | FINANCIAL INFORMATION                                                                              |           |
|           |                                                                                               |           |
| Item 1.        | Financial Statements (Unaudited)                                                                   |           |
|           | Consolidated Balance Sheets – March 27, 2004 and December 27, 2003                            | 2              |
|           | Consolidated Statements of Operations –  Three months ended March 27, 2004 and March 29, 2003 | 3              |
|           | Consolidated Statements of Cash Flows –  Three months ended March 27, 2004 and March 29, 2003 | 4              |
|           | Notes to Consolidated Financial Statements                                                         | 5              |
|           |                                                                                               |           |
| Item 2.        | Management’s Discussion and Analysis of  Financial Condition and Results of Operations        | 8              |
|           |                                                                                               |           |
| Item 3.        | Quantitative and Qualitative Disclosures About  Market Risk                                        | 13             |
|           |                                                                                               |           |
| Item 4.        | Controls and Procedures                                                                            | 13             |
|           |                                                                                               |           |
| PART II        | OTHER INFORMATION                                                                                  |           |
|           |                                                                                               |           |
| Item 1.        | Legal Proceedings                                                                                  | Not applicable |
|           |                                                                                               |           |
| Item 2.        | Changes  in Securities, Use of Proceeds and Issuer Purchases of Equity Securities                  | Not applicable |
|           |                                                                                               |           |
| Item 3.        | Defaults upon Senior  Securities                                                                   | Not applicable |
|           |                                                                                               |           |
| Item 4.        | Submission  of Matters to a Vote of Security Holders                                               | Not applicable |
|           |                                                                                               |           |
| Item 5.        | Other Information                                                                                  | Not applicable |
|           |                                                                                               |           |
| Item 6.        | Exhibits and Reports  on Form 8-K                                                                  | 14             |
|           |                                                                                               |           |
| SIGNATURES     | 15                                                                                                 |
|           |                                                                                               |
| EXHIBIT  INDEX | 16                                                                                                 |
|           |                                                                                               |           |
| Ex. 31.1       | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act        | 17             |
|           |                                                                                               |           |
| Ex. 31.2       | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act        | 18             |
|           |                                                                                               |           |
| Ex. 32.1       | Certification  of Chief Executive Officer pursuant to 18 U.S.C. Section 1350                       | 19             |
|           |                                                                                               |           |
| Ex. 32.2       | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350                       | 20             |

 

1

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**PART I - FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

 

**iPARTY CORP.CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                                                                                   |   | **Mar 27,  2004** |       | **Dec 27,  2003** |       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------|-------------------|------------|
|                                                                                                                                                                                                                   |   | **(Unaudited)**   | ** ** |              | ** ** |
| **ASSETS**                                                                                                                                                                                                             |   |              |       |              |       |
| Current assets:                                                                                                                                                                                                        |   |              |       |              |       |
| Cash and cash equivalents                                                                                                                                                                                              |   | $                 | 1,547,248  |              | $          | 2,442,471 |   |
| Restricted cash                                                                                                                                                                                                        |   | 393,039           |       | 533,284           |       |
| Accounts receivable                                                                                                                                                                                                    |   | 435,470           |       | 487,934           |       |
| Inventory, net                                                                                                                                                                                                         |   | 9,733,049         |       | 9,423,463         |       |
| Prepaid expenses and other  assets                                                                                                                                                                                     |   | 1,037,332         |       | 483,925           |       |
| Total current assets                                                                                                                                                                                                   |   | 13,146,138        |       | 13,371,077        |       |
| Property and equipment,  net                                                                                                                                                                                           |   | 2,052,261         |       | 1,694,140         |       |
| Other assets                                                                                                                                                                                                           |   | 131,633           |       | 86,763            |       |
| Total assets                                                                                                                                                                                                           |   | $                 | 15,330,032 |              | $          | 15,151,980 |   |
|                                                                                                                                                                                                                   |   |              |       |              |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                          |   |              |       |              |       |
| Current liabilities:                                                                                                                                                                                                   |   |              |       |              |       |
| Accounts payable                                                                                                                                                                                                       |   | $                 | 4,550,060  |              | $          | 3,095,848 |   |
| Accrued expenses                                                                                                                                                                                                       |   | 1,769,207         |       | 2,306,902         |       |
| Current portion of capital  lease obligations                                                                                                                                                                          |   | 2,480             |       | 29,220            |       |
| Borrowings under line of  credit                                                                                                                                                                                       |   | 3,921,778         |       | 3,760,671         |       |
| Total current liabilities                                                                                                                                                                                              |   | 10,243,525        |       | 9,192,641         |       |
|                                                                                                                                                                                                                   |   |              |       |              |       |
| Long-term liabilities:                                                                                                                                                                                                 |   |              |       |              |       |
| Capital lease obligations,  net of current portion                                                                                                                                                                     |   | —            |       | 260               |       |
| Other liabilities                                                                                                                                                                                                      |   | 412,702           |       | 406,209           |       |
| Total long-term  liabilities                                                                                                                                                                                           |   | 412,702           |       | 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 in 2004 and 2003, respectively                                                                     |   | —            |       | 1,000,000         |       |
| Series B convertible  preferred stock - 1,150,000 shares authorized; 552,656 and 611,080 shares  issued and outstanding in 2004 and 2003, respectively (aggregate liquidation  value of $11,078,120 at March 27, 2004) |   | 8,223,521         |       | 9,092,870         |       |
| Series C convertible  preferred stock - 100,000 shares authorized, issued and outstanding  (aggregate liquidation value of $2,000,000 at March 27, 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 March 27, 2004)                                                               |   | 3,652,500         |       | 3,652,500         |       |
| Series E convertible  preferred stock - 533,333 shares authorized; 366,667 and 389,439 shares  issued and outstanding in 2004 and 2003, respectively (aggregate liquidation  value of $1,375,000 at March 27, 2004)    |   | 1,375,000         |       | 1,460,396         |       |
| Series F convertible  preferred stock - 114,286 shares authorized, issued and outstanding  (aggregate liquidation value of $500,000 at March 27, 2004)                                                                 |   | 500,000           |       | 500,000           |       |
| Total convertible  preferred stock                                                                                                                                                                                     |   | 15,243,021        |       | 17,197,766        |       |
|                                                                                                                                                                                                                   |   |              |       |              |       |
| Common stock - $.001 par  value; 150,000,000 shares authorized; 20,775,581 and 18,780,204 shares issued  and outstanding in 2004 and 2003, respectively                                                                |   | 20,776            |       | 18,780            |       |
|                                                                                                                                                                                                                   |   |              |       |              |       |
| Additional paid-in capital                                                                                                                                                                                             |   | 49,510,626        |       | 47,554,621        |       |
| Accumulated deficit                                                                                                                                                                                                    |   | (60,100,618       | )          | (59,218,297       | )          |
| Total stockholders’ equity                                                                                                                                                                                        |   | 4,673,805         |       | 5,552,870         |       |
|                                                                                                                                                                                                                   |   |              |       |              |       |
| Total liabilities and  stockholders’ equity                                                                                                                                                                       |   | $                 | 15,330,032 |              | $          | 15,151,980 |   |

 

The accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

2

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**iPARTYCORP.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                  |   | **For the  three months ended** |       |
|---------------------------------------|--------|---------------------------------|------------|
|                                  |   | **Mar 27, 2004**                |       | **Mar 29,  2003** |   |
| Revenues                              |   | $                               | 12,036,066 |   | $ | 10,287,577 |   |
| Operating costs:                      |   |                            |       |   |   |
| Cost of products sold                 |   | 7,017,645                       |       | 6,241,696 |   |
| Marketing and sales                   |   | 4,298,590                       |       | 3,860,425 |   |
| General and administrative            |   | 1,574,906                       |       | 1,297,496 |   |
|                                  |   |                            |       |   |   |
| Operating loss                        |   | (855,075                        | )          | (1,112,040 | ) |
|                                  |   |                            |       |   |   |
| Interest income                       |   | 180                             |       | 579 |   |
| Interest expense                      |   | (27,426                         | )          | (52,805 | ) |
|                                  |   |                            |       |   |   |
| Loss before income taxes              |   | (882,321                        | )          | (1,164,266 | ) |
|                                  |   |                            |       |   |   |
| Income taxes                          |   | —                          |       | — |   |
|                                  |   |                            |       |   |   |
| Net loss                              |   | $                               | (882,321   | ) | $ | (1,164,266 | ) |
|                                  |   |                            |       |   |   |
| Basic and diluted net loss  per share |   | $                               | (0.04      | ) | $ | (0.07 | ) |
|                                  |   |                            |       |   |   |
| Weighted-average shares  outstanding: |   |                            |       |   |   |
| Basic and diluted                     |   | 20,227,671                      |       | 16,999,935 |   |

 

The accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

3

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**iPARTYCORP.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
|                                                                         |   | **For the  three months ended** |      |
|------------------------------------------------------------------------------|--------|---------------------------------|-----------|
|                                                                         |   | **Mar 27,  2004**               |      | **Mar 29,  2003** |   |
| **Operating  activities:**                                                   |   |                            |      |   |   |
|                                                                         |   |                            |      |   |   |
| Net loss                                                                     |   | $                               | (882,321  | ) | $ | (1,164,266 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities: |   |                            |      |   |   |
| Depreciation and  amortization                                               |   | 98,326                          |      | 124,889 |   |
| Deferred rent                                                                |   | 6,493                           |      | (4,248 | ) |
| Changes in operating  assets and liabilities:                                |   |                            |      |   |   |
| Accounts receivable                                                          |   | 52,464                          |      | 150,311 |   |
| Inventory                                                                    |   | (309,586                        | )         | (581,214 | ) |
| Prepaid expenses and other  assets                                           |   | (553,408                        | )         | 3,121 |   |
| Accounts payable                                                             |   | 1,454,212                       |      | 618,880 |   |
| Accrued expenses and other  liabilities                                      |   | (537,695                        | )         | (276,506 | ) |
| Net cash used in operating  activities                                       |   | (671,515                        | )         | (1,129,033 | ) |
|                                                                         |   |                            |      |   |   |
| **Investing  activities:**                                                   |   |                            |      |   |   |
|                                                                         |   |                            |      |   |   |
| Purchase of property and  equipment                                          |   | (456,447                        | )         | (102,447 | ) |
| Net cash used in investing  activities                                       |   | (456,447                        | )         | (102,447 | ) |
|                                                                         |   |                            |      |   |   |
| **Financing  activities:**                                                   |   |                            |      |   |   |
|                                                                         |   |                            |      |   |   |
| Net borrowings under line  of credit                                         |   | 161,107                         |      | 363,509 |   |
| Decrease in restricted  cash                                                 |   | 140,245                         |      | 63,808 |   |
| Principal payments on  capital lease obligations                             |   | (27,000                         | )         | (58,256 | ) |
| Deferred financing costs                                                     |   | (44,869                         | )         | 13,073 |   |
| Proceeds from exercise of  stock options                                     |   | 3,256                           |      | — |   |
| Net cash provided by  financing activities                                   |   | 232,739                         |      | 382,134 |   |
|                                                                         |   |                            |      |   |   |
| **Net  decrease in cash and cash equivalents**                               |   | (895,223                        | )         | (849,346 | ) |
|                                                                         |   |                            |      |   |   |
| **Cash and  cash equivalents, beginning of period**                          |   | 2,442,471                       |      | 2,326,343 |   |
|                                                                         |   |                            |      |   |   |
| **Cash and  cash equivalents, end of period**                                |   | $                               | 1,547,248 |   | $ | 1,476,997 |   |
|                                                                         |   |                            |      |   |   |
| 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          |   | 869,349                         |      | 25,311 |   |
| Conversion of Series E  convertible preferred stock to common stock          |   | 85,396                          |      | — |   |
| Total conversion of  convertible preferred stock to common stock             |   | $                               | 1,954,745 |   | $ | 25,311 |   |

 

The accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

4

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**iPARTY CORP.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMEN****TS**

**March 27, 2004**

**(Unaudited)**

 

**1.  BASIS OF PRESENTATION AND SIGNIFICANTACCOUNTING POLICIES**:

 

*Interim Financial Information*

 

**The interim consolidated financialstatements as of March 27, 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 ended March 27, 2004 and March 29, 2003 may not be indicative ofthe results for the entire year due, in part, to the seasonality of theCompany’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.**

** **

*Principles of Consolidation*

 

The consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiaries after elimination of all significantintercompany transactions and balances.

 

*Revenue Recognition*

 

Revenues include the selling price of party goods sold, net of returnsand discounts, and are recognized at the point of sale.  The Company estimates returns based uponhistorical return rates and such amounts have 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 of Estimates*

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period.  Actualresults could differ from these estimates.

 

5

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*Cashand Cash Equivalents and Restricted Cash*

 

The Company considers all highly liquid investments with an originalmaturity date of three months or less to be cash equivalents.  Cash equivalents consist primarily of moneymarket accounts and are carried at cost plus accrued interest, whichapproximates fair value.

 

The Company uses controlled disbursement banking arrangements as partof its cash management program. Outstanding checks, which were included in accounts payable, totaled$1,606,558 at March 27, 2004 and $989,816 at December 27, 2003.  The Company had sufficient funds availableto fund 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 Loss per Share*

 

Net loss per basic share is computed by dividing net loss by theweighted-average number of common shares outstanding.  For periods with net income, net income per basic share iscomputed by dividing net income by the weighted-average number of common sharesoutstanding plus the common share equivalents of all outstanding Series B, C,D, E and F convertible preferred stock. The common share equivalents of Series B, C, D, E and F convertiblepreferred stock are included in the calculation of net income per basic sharein accordance with EITF Topic D-95, Effect of Participating ConvertibleSecurities on the Computation of Basic Earnings Per Share, since theseconvertible preferred stockholders are entitled to participate in dividendswhen and if declared by the Board of Directors.  For the periods with net losses, the Company excludes thosecommon share equivalents since their impact would be anti-dilutive.

 

Net loss per diluted share is computed by dividing net loss by theweighted-average number of common shares outstanding.  For periods with net income, net income per diluted share iscomputed by dividing net income by the weighted average number of common sharesoutstanding, plus the common share equivalents of all outstanding Series A, B,C, D, E and F convertible preferred stock, plus the common share equivalents ofthe “in the money” stock options and warrants as computed by the treasurymethod.  For the periods with netlosses, the Company excludes those common share equivalents since their impactwould be anti-dilutive.

 

On January 13, 2004, all 1,000,000 shares of Series A convertible stockwere converted into 1,000,000 shares of common stock.  As of March 27, 2004, there were 38,909,337 potential additionalcommon share equivalents outstanding, which were not included in the abovecalculation because their effect would be anti-dilutive.  These include 16,920,222 shares upon theconversion of immediately convertible preferred stock, 13,563,212 shares uponthe exercise of warrants with a weighted-average exercise price of $1.43 and 8,425,903shares upon the exercise of stock options with a weighted-average exerciseprice of $0.97.

 

6

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*Stock Option Compensation Expense*

 

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

 

The Company has computed the value of options using the Black-Scholesoption pricing model prescribed by SFAS No. 123.  The weighted-average fair value of the options granted was $0.82per share during the first quarter of fiscal 2004 and $0.17 per share duringthe first quarter of fiscal 2003, using the following assumptions:  no dividend yield, volatility of 119% in2004 and 122% to 125% in 2003, a risk-free interest rate of 2.71% to 3.02% inthe first quarter of fiscal 2004 and 2.61% to 3.11% in the first quarter offiscal 2003 and an expected life of five years from the date of the grant.  Had compensation cost for the Company’sstock option plan been determined based upon the fair value at the grant datefor awards under the plan consistent with the methodology prescribed under SFAS123, the Company’s net loss and net loss per share would have been thefollowing pro forma amounts:

 

|                                   |   | **For the  three months ended** |       |
|----------------------------------------|--------|---------------------------------|------------|
|                                   |   | **Mar 27,  2004**               |       | **Mar 29,  2003** |   |
| Net loss:                              |   |                            |       |   |   |
| Reported                               |   | $                               | (882,321   | ) | $ | (1,164,266 | ) |
| Stock option compensation  expense     |   | (148,350                        | )          | (109,023 | ) |
| Pro forma                              |   | $                               | (1,030,671 | ) | $ | (1,273,289 | ) |
|                                   |   |                            |       |   |   |
| Basic and diluted net loss  per share: |   |                            |       |   |   |
| Reported                               |   | $                               | (0.04      | ) | $ | (0.07 | ) |
| Pro forma                              |   | $                               | (0.05      | ) | $ | (0.07 | ) |

 

*Property and Equipment*

 

Property and equipment are stated at costless accumulated depreciation and are depreciated on the straight-line methodover the estimated useful lives of the assets. At the beginning of fiscal 2004 the Company adopted a new policy forestimating the useful life of fixed assets which extended the useful life ofequipment, furniture and fixtures and point-of-sale specific computer hardwareand software.  Changing the estimatedlife of the assets in these categories as of the beginning of the year reduceddepreciation expense by approximately $40,191. Expenditures for maintenance and repairs are charged to operations asincurred.  A listing of the estimated usefullife 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 |   |

 

*Accounting for the Impairment of Long-LivedAssets*

 

In accordance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*,**theCompany performs an impairment review quarterly.

 

*Reclassifications*

 

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

 

7

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**Item2.  Management’s Discussion and Analysis**

** **

This information should be read in conjunction with the unauditedconsolidated financial statements and related notes included in Item 1 of thisQuarterly Report on Form 10-Q and the audited consolidated financial statementsand related notes and Item 7, Management’s Discussion and Analysis, containedin our Annual Report on Form 10-K for the fiscal year ended December 27, 2003.

 

**Forward Looking Statements**

 

This Quarterly Report on Form 10-Q, including this discussion andanalysis by management, contains or incorporates forward looking statementswithin the meaning of Section 27A of the Securities Act of 1933, as amended,and Section 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements are basedon current expectations, estimates, forecasts and projections about theindustry and markets in which we operate and our management’s beliefs andassumptions.  In addition, other writtenor oral statements that constitute forward-looking statements may be made by oron our behalf.  Words such as “expect”,“anticipate”, “intend”, “plan”, “believe”, “seek”, estimate”, variations ofsuch words and similar expressions are intended to identify suchforward-looking statements. These statements are not guarantees of futureperformance and involve certain risks, uncertainties and assumptions that aredifficult to predict.  We have includedimportant factors in the cautionary statements below under the heading “FactorsThat May Affect Future Results” that we believe could cause our actual resultsto differ materially from the forward-looking statements we make.  We do not intend to update publicly anyforward-looking statements, whether as a result of new information, futureevents 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 NewEngland, where 37 of our 40 retail stores are located, two of which have openedsince the end of the first quarter.  Wealso license the name “iparty.com” (at www.iparty.com) to a third party inexchange for royalties from Internet sales, which to date have not beensignificant.  The following table showsthe number of stores in operation at March 27, 2004 and March 29, 2003.

 

|                |   | **For the  three months ended** |   |
|---------------------|--------|---------------------------------|--------|
|                |   | **Mar 27,  2004**               |   | **Mar 29,  2003** |   |
| Beginning of period |   | 38                              |   | 35 |   |
| Openings            |   | —                          |   | — |   |
| Closings            |   | —                          |   | — |   |
| End of period       |   | 38                              |   | 35 |   |

 

Our stores feature over 20,000 products ranging from greeting cards andballoons to more unique merchandise such as piñatas, tiny toys, masquerade andHawaiian Luau items.  Our sales aredriven by the following events: Halloween, Christmas, Easter, Valentine’s Day, New Year’s, IndependenceDay, St. Patrick’s Day, Thanksgiving and Chanukah.  We also focus our business closely on lifetime events such asanniversaries, graduations, birthdays, and bridal or baby showers.  The following table shows a summary of ourrevenues and the increase (decrease) in revenues from the prior year period.

 

|                             |   | **For the  three months ended** |       |
|----------------------------------|--------|---------------------------------|------------|
|                             |   | **Mar 27,  2004**               |       | **Mar 29,  2003** |   |
| Revenues                         |   | $                               | 12,036,066 |   | $ | 10,287,577 |   |
|                             |   |                            |       |   |   |
| Increase (decrease) in  revenues |   | 17.0                            | %          | -2.8 | % |
|                                  |        |                                 |            |  |  |  |  |

 

Our business has a seasonal pattern whereby in the past two years wehave realized over one-third of our annual revenues in our fourth quarter,which includes Halloween and Christmas, and approximately 25% of our revenuesin the second 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.

 

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**Results of Operations**

** **

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

 

The first quarter of fiscal year 2004 had 13 weeks and ended on March27, 2004.  The first quarter of fiscalyear 2003 had 13 weeks and ended on March 29, 2003.

 

**Three Months Ended March27, 2004 Compared to Three Months Ended March 29, 2003**

 

*Revenues*

 

Our consolidated revenues for the first quarter of fiscal 2004 were$12,036,066, an increase of $1,748,489, or 17.0% from the first quarter of theprior fiscal year.  Revenues include theselling price of party goods sold, net of returns and discounts, and arerecognized at the point of sale.

 

Sales for the first quarter of fiscal 2004 included sales from threenew stores that opened in the second half of 2003, as well as an increase of10.6% in comparable store sales. Comparable store sales are defined as sales from those stores open forat least one full year.  Our increase incomparable store sales was largely due to a one-day longer selling period forNew Year’s Eve and an increase in parties and gatherings in the New Englandregion relating to the participation of the New England Patriots in theplayoffs and the Super Bowl.

 

*Cost of products sold*

 

Our cost of products sold for the first quarter of fiscal 2004 was$7,017,645, or 58.3% of revenues, an increase of $775,949 and a decrease of 2.4percentage points, as a percentage of revenues, from the first quarter of theprior fiscal year.  Cost of productssold consists of the cost of merchandise sold to customers and the occupancycosts for our stores.  As a percentageof revenues, the decrease was primarily attributable to better pricing from ourvendors and leverage gained on fixed occupancy costs from our increase incomparable store sales.

 

*Marketing and sales expense*

 

Our consolidated marketing and sales expense for the first quarter offiscal 2004 was $4,298,590, or 35.7% of revenues, an increase of $438,165 and adecrease of 1.8 percentage points, as a percentage of revenues, from the firstquarter of the prior fiscal year. Marketing and sales expense consists primarily of advertising andpromotional expenditures, all store payroll and related expenses for personnelengaged in marketing and selling activities and other non-payroll expensesassociated with operating our stores. As a percentage of revenues, the decrease in marketing and sales expensewas primarily attributable to leverage on store payroll costs associated withour increase in comparable store sales.

 

*General and administrative expense*

 

Our consolidated general and administrative (“G&A”) expense for thefirst quarter of fiscal 2004 was $1,574,906, or 13.1% of revenues, an increaseof $277,410 and an increase of 0.5 percentage points, as a percentage ofrevenues, from the first quarter of the prior fiscal year.  G&A expense consists of payroll andrelated expenses for executive, merchandising, finance and administrativepersonnel, as well as information technology, professional fees and othergeneral corporate expenses.  Theincrease in G&A expense is largely attributable to increased labor costsfor positions added to support growth and higher benefits-related insurancecosts.

 

*Interest expense*

 

Our interestexpense in the first quarter of fiscal 2004 was $27,426, a decrease of $25,379from the first quarter of fiscal 2003. Approximately $12,100 of the decrease in interest expense resulted fromthe expiration of capital leases during 2003. Approximately $10,800 of the decrease in interest expense wasattributable to a reduction in the interest rate on our borrowings under ourline of credit, which declined to 4.5% in the first quarter of fiscal 2004compared to 6.5% in the first quarter of fiscal 2003.

 

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*Incometaxes*

 

We have not provided a benefit for income taxes for the first quarterof fiscal 2004 or fiscal 2003 due to the uncertainty of future taxable income.

 

At the end of fiscal 2003 we had estimated net operating losscarryforwards of approximately $23.7 million, which begin to expire in2018.  In accordance with Section 382 ofthe Internal Revenue Code, the use of these carryforwards will be subject toannual limitations based upon certain ownership changes of our stock that haveoccurred or that may occur.

 

*Netloss*

 

Our net loss in the firstquarter of fiscal 2004 was $882,321 or $0.04 per basic and diluted share,compared to a loss of $1,164,266, or $0.07 per basic and diluted share, in thefirst quarter of fiscal 2003.

 

**Liquidity and CapitalResources**

 

Our operating activitiesused $671,515 in cash in the first quarter of fiscal 2004 compared to$1,129,033 in the first quarter of fiscal 2003, a decrease of $457,518.  Our reduction in net loss, which was$882,321 in the first quarter of fiscal 2004 compared to $1,164,266 in 2003,represented $281,945 of this decrease.

 

We used $456,447 of netcash in investing activities in the first quarter of fiscal 2004 compared to$102,447 in the first quarter of 2003. The cash invested in the first quarter of 2004 was predominantly forfixed assets associated with two new stores that were under construction duringthe period.  The cash invested in thefirst quarter of fiscal 2003 included the purchase of personal computersoftware licenses.

 

We provided $232,739 innet cash by financing activities in the first quarter of 2004 compared to$382,134 in the first quarter of 2003. We increased our borrowings under our line of credit by $161,107 in thefirst quarter of 2004 compared to $363,509 in the first quarter of 2003.

 

We have a line of credit (the “line”) with Wells Fargo Retail FinanceII, LLC, which was amended on January 2, 2004. The amendment extended the maturity date of the line to January 2, 2007,eliminated the minimum interest rate of 6.5%, established a new interest rateat the bank’s base rate plus 50 basis points and added the option to increasethe 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 incompliance with all debt covenants and the other provisions of the loanagreement.  Our inventory and accountsreceivable secure our line of credit.

 

The amended agreement includes a financial covenant requiring us tomaintain a minimum availability under the line in the amount of 5% of thecredit limit, which at the current limit of $7,500,000, is $375,000.  If we adjust the credit limit in the future,the minimum availability would be 5% of the adjusted credit limit.  The amended agreement also has a covenantthat requires us to limit our capital expenditures to within 110% of thoseamounts included in our business plan, which may be updated from time to time.

 

The amounts outstanding under our line were $3,921,778 as of March 27,2004 and $3,760,671 as of December 27, 2003. The outstanding balances under our line are classified as currentliabilities in the accompanying consolidated balance sheets since we arerequired to apply daily lock-box receipts to reduce the amount outstanding.  At March 27, 2004, we had approximately$1,566,000 of additional availability under the line of credit.

 

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 retailstores point-of-sale computer system, store improvements and other technologyadvancements in support of growth and operational enhancement.

 

Contractualobligations at March 27, 2004, including leases signed for stores yet to open,were as follows:

 

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|                                              |   | **Payments  Due By Period** |       |
|---------------------------------------------------|--------|-----------------------------|------------|
|                                              |   | **1 Year**                  |       | **2 - 3  Years** |   | **4 - 5  Years** |   | **After   5 Years** |   | **Total** |   |
| Line of credit                                    |   | $                           | 3,921,778  |   | $ | — |   | $ | — |   | $ | — |   | $ | 3,921,778 |   |
| Capital lease obligations                         |   | 2,480                       |       | — |   | — |   | — |   | 2,480 |   |
| Operating leases  (including retail space leases) |   | 6,411,040                   |       | 11,703,333 |   | 6,993,677 |   | 11,283,016 |   | 36,391,066 |   |
| Total contractual  obligations                    |   | $                           | 10,335,298 |   | $ | 11,703,333 |   | $ | 6,993,677 |   | $ | 11,283,016 |   | $ | 40,315,324 |   |

 

**Seasonality**

 

**Due to the seasonality of our business, sales and operatingincome are typically higher in our second and fourth quarters.  Our business is highly dependent upon salesof Easter, graduation and summer merchandise in the second quarter and sales ofHalloween and Christmas merchandise in the fourth quarter.**

 

**GeographicConcentration**

 

**At May 3, 2004 we operated a totalof 40 stores, 37 of which are located in New England.  As a result, a severe or prolonged regional recession or regionalchanges in demographics, employment levels, population, weather patterns, realestate market conditions or other factors specific to the New England regionmay adversely affect us more than a company that is more geographicallydiverse.**

 

**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 actualresults, performance or achievements to differ materially from those expressedin, or implied by, statements contained in this Quarterly Report on Form 10-Q,including, but not limited to, the following:

 

•                  the success orfailure of our efforts to implement our business strategy, including successfulsite location of new stores and implementation of our new point-of-sale system;

•                  our ability orinability to obtain additional financing, if required;

•                  third-partysuppliers’ failure to fulfill their obligations to us;

•                  unseasonableweather;

•                  intensecompetition;

•                  the availabilityof retail store space on reasonable lease terms;

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

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

•                  compliance withevolving federal securities, accounting, and stock exchange rules andregulations applicable to publicly-trade companies listed on the American StockExchange.

 

**CriticalAccounting Policies and Estimates**

 

Our financial statements are based on the application of significantaccounting policies, many of which require management to make significantestimates and assumptions (see Note 1 to the consolidated financialstatements).  We believe the followingaccounting policies to be those most important to the portrayal of ourfinancial condition and those that require the most subjective judgment.  If actual results differ significantly frommanagement’s estimates and projections, there could be a material effect on ourfinancial statements.

 

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*Inventory and Related Allowance forObsolete and Excess Inventory*

 

Our inventoryconsists of party supplies and is valued at the lower of moving weighted-averagecost or market.  We record vendorrebates, discounts and certain other adjustments to inventory, includingfreight costs, and we recognize these amounts in the income statement as therelated goods are sold.

 

*Revenue Recognition*

 

Revenues include the selling price of party goods sold, net of returnsand discounts, and are recognized at the point of sale.  We estimate returns based upon historicalreturn rates and such amounts have not been significant.

 

*Impairment ofLong-Lived Assets*

 

In accordance with SFAS No. 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.

 

*Income Taxes*

 

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 Financial Information and BalanceSheet Presentation of Series A-F Convertible Preferred Stock*

 

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 March 27, 2004 and December 27,2003 at its respective carrying values, as the redemption is solely within ourcontrol.

 

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

 

*Stock Option Compensation Expense*

 

We account for our stock option compensation agreements with employeesunder the provisions of Accounting Principles Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*. We have adopted the disclosure-only provisions of SFAS No. 123, *Accountingfor Stock-Based Compensation*, as amended by SFAS No. 148, *Accountingfor Stock-Based Compensation – Transition and Disclosure, an amendment ofFinancial Accounting Standards Board (“FASB”) Statement No. 123*.

 

*Use of Estimates*

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period.  Our actualresults could differ from our estimates.

 

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At the beginning of fiscal 2004 we adopted a new policy for estimatingthe useful life of fixed assets which extended the useful life of equipment,furniture and fixtures and point-of-sale specific computer hardware andsoftware.  Had we not made this changeto the estimated life of the assets in these categories as of the beginning ofthe year we would have had a $40,191 greater operating loss and net loss in thefirst quarter of 2004.  There would havebeen 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 entitiescreated or acquired prior to February 1, 2003, the provisions of FIN 46 must beapplied for 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 of FIN 46 are subject toits provisions beginning in 2004.  Weadopted FIN 46, as required, with no material impact to our consolidatedfinancial position or results of operations. We do not believe that the adoption of the remaining provisions of FIN46 in 2004 will have a material impact on our financial position or results ofoperations.

 

On March 31, 2004, theFinancial Accounting Standards Board (FASB) issued its Exposure Draft, *Share-BasedPayment*, which is a proposed amendment to FASB Statement No. 123, *Accountingfor Stock-Based Compensation*. Generally, the approach in the Exposure Draft is similar to the approachdescribed in Statement 123.  However,the Exposure Draft would require all share-based payments to employees,including grants of employee stock options, to be recognized in the incomestatement based on their fair values. The FASB expects to issue a final standard late in 2004 that would beeffective for public companies (and for nonpublic companies that currently usethe fair value method, rather than the minimum value method, for recognition ordisclosure purposes) for fiscal years beginning after December 15, 2004.  We are presently studying the Exposure Draftin anticipation of its adoption next year, the impact of which is not known orreasonably estimable at this time.

 

**Item 3.  Quantitative andQualitative Disclosures About Market Risk**

 

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

 

**Item 4.  Controls and Procedures**

 

(a) *Evaluation ofDisclosure Controls and Procedures.** *Our management, with the participation of ourChief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluatedthe effectiveness of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of March27, 2004.  In designing and evaluatingour disclosure controls and procedures, our management recognized that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving their objectives, and our managementnecessarily applied its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.  Basedon this evaluation, our CEO and CFO concluded that, as of March 27, 2004, ourdisclosure controls and procedures were (1) designed to ensure that materialinformation relating to us, including our consolidated subsidiaries, is madeknown to our CEO and CFO by others within those entities, particularly duringthe period in which this report was being prepared and (2) effective, in thatthey provide reasonable assurance that information required to be disclosed byus in the reports that we file or submit under the Securities Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.

 

(b) *Changes in Internal Controls.*Nochange in our internal controls over financial reporting (as defined in Rules13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during thefiscal quarter ended March 27, 2004 that has materially affected, or isreasonably likely to materially affect, our internal controls over financialreporting.

 

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PARTII – OTHER INFORMATION

 

**Item1.  LegalProceedings**

 

Not applicable.

 

**Item2.  Changes in Securities, Use ofProceeds and Issuer Purchases of Equity Securities**

 

Not applicable.

 

**Item3.  Defaults upon Senior Securities**

 

Not applicable.

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

Not applicable.

 

**Item 5.  Other Information**

 

Not applicable.

 

**Item 6. Exhibits and Reports on Form 8-K**

 

(a) Exhibits

 

The exhibits listed in the Exhibit Index immediately preceding theexhibits are filed as part of this Quarterly Report on Form 10-Q.

 

(b) Reports on Form 8-K

 

On January 28, 2004, we furnished a Current Report on Form 8-K underItem 9 containing a press release announcing the election of one new member toour Board of Directors.

 

On January 29, 2004, we furnished a Current Report on Form 8-K underItem 9 announcing an amendment to our existing line of credit agreement withWells Fargo Retail Finance II, LLC.

 

On February 25, 2004, we furnished a Current Report on Form 8-K underItem 9 containing a press release announcing our financial results for thefourth quarter and year ended December 27, 2003.

 

On April 28, 2004, we furnished a Current Report on Form 8-K under Item12 containing a press release announcing our financial results for the fiscalquarter ended March 27, 2004.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly 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:  May 10, 2004 |         |   |
|                           |              |  |  |  |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** |   | **Description**                                                                             |
|-----------------|--------|---------------------------------------------------------------------------------------------|
|            |   |                                                                                        |
| 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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