** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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# **FORM 10-Q**

 

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

 

**For the quarterly period ended June 25, 2005**

 

**or**

 

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

 

**For the transition period from                 to                 **

 

**Commission File Number 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) |       | (I.R.S. 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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Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

Yes ý No o

 

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

Yes oNo ý

 

As of August 3,2005, there were 22,159,628 shares of common stock, $.001 par value, 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 25, 2005 and December 25, 2004                                          |   |
|               | Consolidated Statements of  Operations – Three months and six months ended June 25, 2005 and  June 26, 2004 |   |
|               | Consolidated Statements of  Cash Flows – Six months ended June 25, 2005 and June 26, 2004                   |   |
|               | 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.            | Unregistered Sales of Equity  Securities and Use of Proceeds                                                               |   |
|               |                                                                                                                       |   |
| Item 3.            | Defaults upon Senior  Securities                                                                                           |   |
|               |                                                                                                                       |   |
| Item 4.            | Submission of Matters to a  Vote of Security Holders                                                                       |   |
|               |                                                                                                                       |   |
| Item 5.            | Other Information                                                                                                          |   |
|               |                                                                                                                       |   |
| Item 6.            | Exhibits                                                                                                                   |   |
|               |                                                                                                                       |   |
| SIGNATURES         |                                                                                                                       |
|               |                                                                                                                       |   |
| EXHIBIT INDEX |                                                                                                                       |
|               |                                                                                                                       |   |
| 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 - FINANCIALINFORMATION**

 

**Item 1. Financial Statements**

**iPARTYCORP.**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                            | ** ** | **Jun 25, 2005** | ** ** | **Dec 25, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                                                            | ** ** | **(Unaudited)**  | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                                                                                                                            |       |             |       |             |       |
| Current assets:                                                                                                                                                                                                                                       |       |             |       |             |       |
| Cash and cash  equivalents                                                                                                                                                                                                                            |       | $                | 1,765,512  |             | $          | 1,757,157 |   |
| Restricted cash                                                                                                                                                                                                                                       |       | 471,572          |       | 561,407          |       |
| Accounts  receivable                                                                                                                                                                                                                                  |       | 674,820          |       | 700,961          |       |
| Inventory, net                                                                                                                                                                                                                                        |       | 11,827,434       |       | 11,400,971       |       |
| Prepaid expenses  and other assets                                                                                                                                                                                                                    |       | 461,561          |       | 476,046          |       |
| Total current  assets                                                                                                                                                                                                                                 |       | 15,200,899       |       | 14,896,542       |       |
| Property and  equipment, net                                                                                                                                                                                                                          |       | 4,648,781        |       | 4,483,705        |       |
| Other assets                                                                                                                                                                                                                                          |       | 87,141           |       | 99,690           |       |
| Total assets                                                                                                                                                                                                                                          |       | $                | 19,936,821 |             | $          | 19,479,937 |   |
|                                                                                                                                                                                                                                                  |       |             |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                         |       |             |       |             |       |
| Current  liabilities:                                                                                                                                                                                                                                 |       |             |       |             |       |
| Accounts payable                                                                                                                                                                                                                                      |       | $                | 4,147,476  |             | $          | 3,421,195 |   |
| Accrued expenses                                                                                                                                                                                                                                      |       | 2,100,135        |       | 2,615,835        |       |
| Current portion  of capital lease obligations                                                                                                                                                                                                         |       | 413,781          |       | 365,674          |       |
| Borrowings under  line of credit                                                                                                                                                                                                                      |       | 7,205,431        |       | 5,257,690        |       |
| Total current  liabilities                                                                                                                                                                                                                            |       | 13,866,823       |       | 11,660,394       |       |
|                                                                                                                                                                                                                                                  |       |             |       |             |       |
| Long-term  liabilities:                                                                                                                                                                                                                               |       |             |       |             |       |
| Capital lease  obligations, net of current portion                                                                                                                                                                                                    |       | 676,419          |       | 796,693          |       |
| Other  liabilities                                                                                                                                                                                                                                    |       | 525,879          |       | 471,759          |       |
| Total long-term  liabilities                                                                                                                                                                                                                          |       | 1,202,298        |       | 1,268,452        |       |
|                                                                                                                                                                                                                                                  |       |             |       |             |       |
| Commitments and  contingencies                                                                                                                                                                                                                        |       |             |       |             |       |
|                                                                                                                                                                                                                                                  |       |             |       |             |       |
| Stockholders’  equity:                                                                                                                                                                                                                           |       |             |       |             |       |
| Series B  convertible preferred stock - 1,150,000 shares authorized; 505,710 and 507,460  shares issued and outstanding at June 25, 2005 and Dec 25, 2004, respectively  (aggregate liquidation value of $10,114,200 at June 25, 2005) |       | 7,524,962        |       | 7,551,002        |       |
| Series C  convertible preferred stock - 100,000 shares authorized, issued and outstanding  (aggregate liquidation value of $2,000,000 at June 25, 2005)                                                                                     |       | 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 June 25, 2005)                                                                                     |       | 3,652,500        |       | 3,652,500        |       |
| Series E  convertible preferred stock - 296,667 shares authorized, issued and outstanding  (aggregate liquidation value of $1,112,500 at June 25, 2005)                                                                                     |       | 1,112,500        |       | 1,112,500        |       |
| Series F  convertible preferred stock - 114,286 shares authorized, issued and outstanding  (aggregate liquidation value of $500,000 at June 25, 2005)                                                                                       |       | 500,000          |       | 500,000          |       |
| Total  convertible preferred stock                                                                                                                                                                                                                    |       | 14,281,962       |       | 14,308,002       |       |
|                                                                                                                                                                                                                                                  |       |             |       |             |       |
| Common stock -  $.001 par value; 150,000,000 shares authorized; 22,115,239 and 22,092,717 shares  issued and outstanding at June 25, 2005 and Dec 25, 2004, respectively                                                                         |       | 22,115           |       | 22,093           |       |
|                                                                                                                                                                                                                                                  |       |             |       |             |       |
| Additional  paid-in capital                                                                                                                                                                                                                           |       | 50,502,618       |       | 50,448,100       |       |
| Accumulated  deficit                                                                                                                                                                                                                                  |       | (59,938,995      | )          | (58,227,104      | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                      |       | 4,867,700        |       | 6,551,091        |       |
|                                                                                                                                                                                                                                                  |       |             |       |             |       |
| Total liabilities  and stockholders’ equity                                                                                                                                                                                                      |       | $                | 19,936,821 |             | $          | 19,479,937 |   |

 

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 25, 2005**               | ** ** | **Jun 26, 2004**             | ** ** | **Jun 25, 2005** | ** ** | **Jun 26, 2004** | ** ** |
| Revenues                                        |       | $                              | 16,517,522 |                         | $          | 15,360,388 |   | $ | 29,677,285 |   | $ | 27,396,454 |   |
| Operating costs:                                |       |                           |       |                         |       |   |   |   |   |
| Cost of products  sold and occupancy costs      |       | 9,544,608                      |       | 8,539,369                    |       | 17,710,177 |   | 15,557,014 |   |
| Marketing and  sales                            |       | 5,276,430                      |       | 4,792,713                    |       | 10,112,277 |   | 9,091,303 |   |
| General and  administrative                     |       | 1,534,192                      |       | 1,590,445                    |       | 3,335,142 |   | 3,165,351 |   |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Operating income  (loss)                        |       | 162,292                        |       | 437,861                      |       | (1,480,311 | ) | (417,214 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Other income                                    |       | —                         |       | 354,500                      |       | — |   | 354,500 |   |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Income (loss)  before interest and income taxes |       | 162,292                        |       | 792,361                      |       | (1,480,311 | ) | (62,714 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Interest income                                 |       | 109                            |       | 829                          |       | 281 |   | 1,009 |   |
| Interest expense                                |       | (129,513                       | )          | (43,894                      | )          | (231,861 | ) | (71,320 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Income (loss)  before income taxes              |       | 32,888                         |       | 749,296                      |       | (1,711,891 | ) | (133,025 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Income taxes                                    |       | —                         |       | —                       |       | — |   | — |   |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Net income  (loss)                              |       | $                              | 32,888     |                         | $          | 749,296 |   | $ | (1,711,891 | ) | $ | (133,025 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Income (loss)  per share:                       |       |                           |       |                         |       |   |   |   |   |
| Basic                                           |       | $                              | 0.00       |                         | $          | 0.02 |   | $ | (0.08 | ) | $ | (0.01 | ) |
| Diluted                                         |       | $                              | 0.00       |                         | $          | 0.02 |   | $ | (0.08 | ) | $ | (0.01 | ) |
|                                            |       |                           |       |                         |       |   |   |   |   |
| Weighted-average  shares outstanding:           |       |                           |       |                         |       |   |   |   |   |
| Basic                                           |       | 37,706,143                     |       | 37,698,128                   |       | 22,111,403 |   | 20,675,562 |   |
| Diluted                                         |       | 39,937,184                     |       | 41,834,415                   |       | 22,111,403 |   | 20,675,562 |   |

 

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 25, 2005**             | ** ** | **Jun 26, 2004** | ** ** |
| **Operating  activities:**                                                                 |       |                         |       |   |   |
|                                                                                       |       |                         |       |   |   |
| Net Loss                                                                                   |       | $                            | (1,711,891 | ) | $ | (133,025 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                         |       |   |   |
| Depreciation and  amortization                                                             |       | 492,220                      |       | 207,743 |   |
| Deferred rent                                                                              |       | 54,120                       |       | 15,957 |   |
| Changes in  operating assets and liabilities:                                              |       |                         |       |   |   |
| Accounts  receivable                                                                       |       | 26,141                       |       | (178,674 | ) |
| Inventory                                                                                  |       | (426,463                     | )          | (382,218 | ) |
| Prepaid expenses  and other assets                                                         |       | 19,484                       |       | 24,128 |   |
| Accounts payable                                                                           |       | 726,281                      |       | 462,605 |   |
| Accrued expenses  and other liabilities                                                    |       | (487,200                     | )          | 669,500 |   |
| Net cash  provided by (used in) operating activities                                       |       | (1,307,308                   | )          | 686,016 |   |
|                                                                                       |       |                         |       |   |   |
| **Investing  activities:**                                                                 |       |                         |       |   |   |
|                                                                                       |       |                         |       |   |   |
| Purchase of  property and equipment                                                        |       | (524,328                     | )          | (1,823,585 | ) |
| Net cash used in  investing activities                                                     |       | (524,328                     | )          | (1,823,585 | ) |
|                                                                                       |       |                         |       |   |   |
| **Financing  activities:**                                                                 |       |                         |       |   |   |
|                                                                                       |       |                         |       |   |   |
| Net borrowings  under line of credit                                                       |       | 1,947,741                    |       | 1,111,584 |   |
| Increase in  restricted cash                                                               |       | 89,835                       |       | 45,646 |   |
| Principal  payments on capital lease obligations                                           |       | (205,135                     | )          | (27,715 | ) |
| Deferred  financing costs                                                                  |       | 7,550                        |       | (40,629 | ) |
| Proceeds from  exercise of stock options                                                   |       | —                       |       | 4,529 |   |
| Net cash  provided by financing activities                                                 |       | 1,839,991                    |       | 1,093,415 |   |
|                                                                                       |       |                         |       |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                                  |       | 8,355                        |       | (44,154 | ) |
|                                                                                       |       |                         |       |   |   |
| **Cash  and cash equivalents, beginning of period**                                        |       | 1,757,157                    |       | 2,442,471 |   |
|                                                                                       |       |                         |       |   |   |
| **Cash  and cash equivalents, end of period**                                              |       | $                            | 1,765,512  |   | $ | 2,398,317 |   |
|                                                                                       |       |                         |       |   |   |
| 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                   |       | 26,040                       |       | 1,248,077 |   |
| Conversion of  Series E convertible preferred stock to common stock                   |       | —                       |       | 347,895 |   |
| Total conversion  of convertible preferred stock to common stock                           |       | $                            | 26,040     |   | $ | 2,595,972 |   |
|                                                                                       |       |                         |       |   |   |
| Acquisition of  assets under capital lease                                                 |       | $                            | 132,968    |   | $ | — |   |

 

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

 

4

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**iPARTY CORP.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**June 25, 2005**

**(Unaudited)**

 

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

 

*Interim Financial Information*

 

**The interim consolidated financial statements as of June 25,2005 have been prepared by the Company pursuant to the rules andregulations of the Securities and Exchange Commission (the “SEC”) for interimfinancial reporting.  These consolidatedstatements are unaudited and, in the opinion of management, include alladjustments (consisting of normal recurring adjustments and accruals) necessaryto present fairly the consolidated balance sheets, consolidated operatingresults, and consolidated cash flows for the periods presented in accordancewith generally accepted accounting principles. The consolidated balance sheet at December 25, 2004 has beenderived from the audited consolidated financial statements at that date.  Operating results for the Company on aquarterly basis may not be indicative of the results for the entire year due,in part, to the seasonality of the party goods industry.  Historically, higher revenues and operatingincome have been experienced in the second and fourth fiscal quarters.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been omitted in accordance with the rules andregulations of the SEC.  Theseconsolidated financial statements should be read in conjunction with theaudited consolidated financial statements, and accompanying notes, included inthe Company’s Annual Report on Form 10-K, as amended, for the year ended December 25,2004.**

** **

*Principles of Consolidation*

 

Theconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiaries after elimination of all significant intercompanytransactions and balances.

 

*RevenuesRecognition*

 

Revenuesinclude the selling price of party goods sold, net of returns and discounts,and are recognized at the point of sale. The Company estimates returns based upon historical return rates andsuch amounts have not been significant.

 

*Concentrations*

 

The Companypurchases its inventory from a diverse group of vendors and is not overlydependent upon any single source for its merchandise, often using more than onevendor for similar kinds 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*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions 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 revenues and expenses during thereporting period.  Actual results coulddiffer from these estimates.

 

5

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*Cashand Cash Equivalents and Restricted Cash*

 

TheCompany considers all highly liquid investments with an original maturity dateof three months or less to be cash equivalents. Cash equivalents consist primarily of money market accounts and arecarried at cost plus accrued interest, which approximates fair value.

 

TheCompany uses controlled disbursement banking arrangements as part of its cashmanagement program.  Outstanding checks,which were included in accounts payable, totaled $853,945 at June 25, 2005and $950,156 at December 25, 2004. The Company had sufficient funds available to fund the outstandingchecks when they were presented for payment.

 

Restrictedcash represents money deposited in blocked accounts established for the benefitof and under the control of Wells Fargo Retail Finance II, LLC, the Company’slender under its line of credit, and constitutes collateral for amountsoutstanding under the Company’s line of credit.

 

*FairValue of Financial Instruments*

 

The carryingvalues of cash and cash equivalents, accounts receivable and accounts payableapproximate fair value because of the short-term nature of theseinstruments.  The fair value ofborrowings under its line of credit approximates carrying value because thedebt bears interest at a variable market rate.

 

*Inventories*

 

Inventories consistof party supplies and are valued at the lower of moving weighted-average costor market.  Inventory has been reduced byan allowance for obsolete and excess inventory, which is based on management’sreview of inventories on hand compared to estimated future sales.  The activity in the allowance for obsoleteand excess inventory is as follows:

 

| ** **                  | ** ** | **Jun 25, 2005** | ** ** | **Dec 25, 2004** | ** ** |
|-----------------------------|------------|------------------|------------|------------------|------------|
| Beginning  balance          |       | $                | 1,296,855  |             | $          | 1,400,262 |   |
| Increases to  reserve       |       | 121,477          |       | 200,000          |       |
| Write-offs  against reserve |       | (4,232           | )          | (303,407         | )          |
| Ending balance              |       | $                | 1,414,100  |             | $          | 1,296,855 |   |

 

The Company recordsvendor rebates, discounts and certain other adjustments to inventory, includingfreight costs, and these amounts are recognized in the income statement as therelated goods are sold.

 

*Net Income(Loss) per Share*

 

Net incomeper basic share is computed by dividing net income by the weighted-averagenumber of common shares outstanding plus the common share equivalents of alloutstanding Series 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 ofnet income per basic share in accordance with EITF Topic D-95, Effect of ParticipatingConvertible Securities on the Computation of Basic Earnings Per Share, sincethese convertible preferred stockholders are entitled to participate individends 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 incomeper diluted share is computed by dividing net income by the weighted-averagenumber of common shares outstanding, plus the common share equivalents of alloutstanding Series B, C, D, E and F convertible preferred stock, plus thecommon share equivalents of the “in the money” stock options and warrants ascomputed by the treasury method.  For theperiods with net losses, the Company excludes those common share equivalentssince their impact would be anti-dilutive.

 

6

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Thefollowing table sets forth the computation of basic and diluted net income(loss) per share available to common stockholders:

 
| ** **                                                                      | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                                                                      | ** ** | **Jun 25, 2005**               | ** ** | **Jun 26, 2004**             | ** ** | **Jun 25, 2005** | ** ** | **Jun 26, 2004** | ** ** |
| Net income  (loss) available to common stockholders                             |       | $                              | 32,888     |                         | $          | 749,296 |   | $ | (1,711,891 | ) | $ | (133,025 | ) |
|                                                                            |       |                           |       |                         |       |   |   |   |   |
| Basic and  diluted net income (loss) per share available to common stockholders |       | $                              | 0.00       |                         | $          | 0.02 |   | $ | (0.08 | ) | $ | (0.01 | ) |
|                                                                            |       |                           |       |                         |       |   |   |   |   |
| Weighted-average  shares outstanding:                                           |       |                           |       |                         |       |   |   |   |   |
| Common shares                                                                   |       | 22,115,239                     |       | 21,123,453                   |       | 22,111,403 |   | 20,675,562 |   |
| Common share  equivalents of Series B-F convertible preferred stock        |       | 15,590,904                     |       | 16,574,675                   |       | — |   | — |   |
| Basic  weighted-average shares outstanding                                      |       | 37,706,143                     |       | 37,698,128                   |       | 22,111,403 |   | 20,675,562 |   |
|                                                                            |       |                           |       |                         |       |   |   |   |   |
| Common share  equivalents of “in the money” stock options             |       | 2,231,041                      |       | 4,136,287                    |       | — |   | — |   |
| Common share  equivalents of “in the money” warrants                  |       | —                         |       | —                       |       | — |   | — |   |
| Diluted  weighted-average shares outstanding                                    |       | 39,937,184                     |       | 41,834,415                   |       | 22,111,403 |   | 20,675,562 |   |

 

Thecommon share equivalents of “out of the money” stock options and warrants wereexcluded from the computation of diluted net income per share available tocommon stockholders since their impact would have been anti-dilutive.  A total of 5,198,447 common share equivalentsassociated with stock options and 13,011,216 common share equivalentsassociated with warrants were excluded from the computation of diluted netincome per share available to common stockholders for the three months ended June 25,2005. A total of 2,003,880 common share equivalents associated with stockoptions and 13,561,216 common share equivalents associated with warrants wereexcluded from the computation of diluted net income per share available tocommon stockholders for the three months ended June 26, 2004.

 

*StockOption Compensation Expense*

 

TheCompany accounts for its stock option compensation agreements with employeesunder the provisions of Accounting Principles Board (“APB”) Opinion No. 25,*Accounting for Stock Issued to Employees*.  The Company has adopted the disclosure-onlyprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123,*Accounting for Stock-Based Compensation*.

 

TheCompany has computed the value of options using the Black-Scholes optionpricing model prescribed by SFAS No. 123. The weighted-average fair value of the options granted was $0.42 pershare during the second quarter of fiscal 2005 and $0.78 per share during the secondquarter of fiscal 2004, using the following assumptions:  no dividend yield, volatility of 111% in 2005and 117-118% in 2004, a risk-free interest rate of 3.73% in the second quarterof fiscal 2005 and 3.72-4.00% in the second quarter of fiscal 2004 and anexpected life of five years from the date of the grant.  Had compensation cost for the Company’s stockoption plan been determined based upon the fair value at the grant date forawards 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** | ** ** | **For the six months ended** | ** ** |
|------------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **Jun 25, 2005**               | ** ** | **Jun 26, 2004**             | ** ** | **Jun 25, 2005** | ** ** | **Jun 26, 2004** | ** ** |
| Net income  (loss):                |       |                           |       |                         |       |   |   |   |   |
| Reported                           |       | $                              | 32,888     |                         | $          | 749,296 |   | $ | (1,711,891 | ) | $ | (133,025 | ) |
| Stock option  compensation expense |       | (94,938                        | )          | (386,935                     | )          | (209,651 | ) | (535,285 | ) |
| Pro forma                          |       | $                              | (62,050    | )                            | $          | 362,361 |   | $ | (1,921,542 | ) | $ | (668,310 | ) |
|                               |       |                           |       |                         |       |   |   |   |   |
| Net income  (loss) per share:      |       |                           |       |                         |       |   |   |   |   |
| Reported                           |       |                           |       |                         |       |   |   |   |   |
| Basic and  diluted:                |       | $                              | 0.00       |                         | $          | 0.02 |   | $ | (0.08 | ) | $ | (0.01 | ) |
| Pro forma                          |       |                           |       |                         |       |   |   |   |   |
| Basic and  diluted:                |       | $                              | 0.00       |                         | $          | 0.01 |   | $ | (0.09 | ) | $ | (0.03 | ) |

 

7

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*Property and Equipment*

 

Property and equipment are stated at cost lessaccumulated depreciation and are depreciated on the straight-line method overthe estimated useful lives of the assets. 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**           | ** ** |
|---------------------------------|------------|-------------------------------------|------------|
| Leasehold improvements          |       | Lesser of term of lease or 10 years |       |
| Furniture and  fixtures         |       | 7 years                             |       |
| Computer  hardware and software |       | 3 years                             |       |
| Equipment                       |       | 5 years                             |       |

 

*Accounting for the Impairment of Long-Lived Assets*

 

Inaccordance with SFAS No. 144, Accounting for the Impairment or Disposal ofLong-Lived Assets, the Company reviews each store for impairment indicatorswhenever events and changes in circumstances suggest that the carrying amountsmay not be recoverable from estimated future store cash flows.  Our reviewconsiders store operating results, future sales growth and cash flows.

 

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

** **

Thisinformation should be read in conjunction with the unaudited consolidatedfinancial statements and related notes included in Item 1 of this QuarterlyReport on Form 10-Q and the audited consolidated financial statements andrelated notes and Item 7, Management’s Discussion and Analysis of FinancialCondition and Results of Operations, contained in our Annual Report on Form 10-K,as amended, for the fiscal year ended December 25, 2004.

 

**ForwardLooking Statements**

 

ThisQuarterly Report on Form 10-Q, including this discussion and analysis bymanagement, contains or incorporates forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended.  These forward-looking statements are based oncurrent expectations, estimates, forecasts and projections about the industryand markets in which we operate and our management’s beliefs and assumptions.  In addition, other written or oral statementsthat constitute forward-looking statements may be made by or on our behalf.  Words such as “expect”, “anticipate”, “intend”,“plan”, “believe”, “seek”, estimate”, variations of such words and similarexpressions are intended to identify such forward-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 actualresults to 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**

** **

We believe we are a leading brand in the party industry in the marketswe serve and a leading resource in those markets for consumers seeking partygoods, party planning advice and party-related information.  We are a party goods retailer operatingstores throughout New England, where 42 of our 47 retail stores are located.  Our other five stores are located in Florida.  We opened two new stores after the secondquarter; one in Port Richey, Florida; and another in Seekonk, Massachusetts.  We also license the name “iparty.com” (atwww.iparty.com) to a third party in exchange for royalties from Internet sales,which to date have not been significant.

 

8

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The following table shows the number of stores in operation:

 
| ** **           | ** ** | **For the three months ended** | ** ** | **For the six months ended** | ** ** |
|----------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **           | ** ** | **Jun 25, 2005**               | ** ** | **Jun 26, 2004**             | ** ** | **Jun 25, 2005** | ** ** | **Jun 26, 2004** | ** ** |
| Beginning of  period |       | 45                             |       | 38                           |       | 44 |   | 38 |   |
| Openings             |       | —                         |       | 2                            |       | 1 |   | 2 |   |
| Closings             |       | —                         |       | —                       |       | — |   | — |   |
| End of period        |       | 45                             |       | 40                           |       | 45 |   | 40 |   |

 

Ourstores feature over 20,000 products ranging from greeting cards and balloons tomore unique merchandise such as piñatas, tiny toys, masquerade and HawaiianLuau items.  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 25, 2005**               | ** ** | **Jun 26, 2004**             | ** ** | **Jun 25, 2005** | ** ** | **Jun 26, 2004** | ** ** |
| Revenues              |       | $                              | 16,517,522 |                         | $          | 15,360,388 |   | $ | 29,677,285 |   | $ | 27,396,454 |   |
|                  |       |                           |       |                         |       |   |   |   |   |
| Increase in  revenues |       | 7.5                            | %          | 11.3                         | %          | 8.3 | % | 13.7 | % |
|                       |            |                                |            |                              |            |  |  |  |  |  |  |  |  |

 

Ourbusiness has a seasonal pattern.  In thepast three years we have realized over one-third of our annual revenues in ourfourth quarter, which includes Halloween and Christmas, and approximately 25%of our revenues in the second quarter, which includes school graduations.  Also, during the past three years, we havehad net income in our second and fourth quarters and generated losses in ourfirst and third quarters.

 

**Results of Operations**

** **

Fiscalyear 2005 has 53 weeks and ends on December 31, 2005.  Fiscal year 2004 had 52 weeks and ended on December 25,2004.

 

The secondquarter of fiscal year 2005 had 13 weeks and ended on June 25, 2005.  The second quarter of fiscal year 2004 had 13weeks and ended on June 26, 2004.

 

**Three Months Ended June 25, 2005 Compared toThree Months Ended June 26, 2004**

** **

*Revenues*

 

Ourconsolidated revenues for the second quarter of fiscal 2005 were $16,517,522,an increase of $1,157,134, or 7.5% from the second quarter of the prior fiscalyear.  Revenues include the selling priceof party goods sold, net of returns and discounts, and are recognized at thepoint of sale.

 

Salesfor the second quarter of fiscal 2005 included sales from five new stores thatopened subsequent to the second quarter of 2004, as well as a decrease of 0.5%in comparable store sales.  Comparablestore sales are defined as sales from those stores open for at least one fullyear.  The decrease in comparable storesales was primarily due to the impact of the Easter season falling in the firstquarter in 2005 compared to the second quarter in 2004.

 

*Cost of goods sold and occupancy costs*

 

Ourcost of goods sold and occupancy costs for the second quarter of fiscal 2005was $9,544,608, or 57.8% of revenues, an increase of $1,005,239 and an increaseof 2.2 percentage points, as a percentage of revenues, from the second quarterof the prior fiscal year.  Cost of goods soldand occupancy costs consists of the cost of merchandise sold to customers andthe occupancy costs for our stores.  As apercentage of revenues, the increase was attributable

 

9

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to our new stores, whichoperate at a higher occupancy to sales ratio until they reach maturity, and increasesin our product costs charged to us by certain key vendors.

 

*Marketing and sales expense*

 

Ourconsolidated marketing and sales expense for the second quarter of fiscal 2005was $5,276,430, or 31.9% of revenues, an increase of $483,717 and an increaseof 0.7 percentage points, as a percentage of revenues, from the second quarterof the 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, theincrease in marketing and sales expense was primarily due to an increase indepreciation expense related to the acquisition of fixed assets for new storesand our new point-of-sale system.

 

*General and administrative expense*

 

Ourconsolidated general and administrative (“G&A”) expense for the second quarterof fiscal 2005 was $1,534,192, or 9.3% of revenues, a decrease of $56,253 and 1.1percentage points, as a percentage of revenues, from the second quarter offiscal 2004.  G&A expense consists ofpayroll and related expenses for executive, merchandising, finance andadministrative personnel, as well as information technology, professional feesand other general corporate expenses.  Thenature and magnitude of G&A expense for the second quarter of fiscal 2005 didnot differ materially from our G&A expense in the second quarter of fiscal 2004.

 

*Otherincome*

 

In thesecond quarter of fiscal 2004 we reached a settlement with a third party inconnection with the special charge pertaining to our preferred stock previouslyrecorded in fiscal year 2002.  Werecorded the net settlement of $354,500 as other income.

 

*Interest expense*

 

Our interest expense in thesecond quarter of fiscal 2005 was $129,513, an increase of $85,619 from the secondquarter of fiscal 2004.  The increase wasdue to a higher average loan balance in the second quarter of 2005 andadditional interest expense resulting from capital leases associated with our newpoint-of-sale system that were executed in the third quarter of fiscal 2004.

 

*Incometaxes*

 

Wehave not provided for income taxes for the second quarter of fiscal 2005 orfiscal 2004 due to the uncertainty of future taxable income.

 

*NetIncome*

 

Our net income in the second quarter of fiscal 2005was $32,888, or $0.00 per basic and diluted share, compared to net income of $749,296,or $0.02 per basic and diluted share, in the second quarter of fiscal 2004.

 

**Six months ended June 25, 2005 compared to sixmonths ended June 26, 2004**

** **

*Revenues*

 

Ourconsolidated revenues for the first six months of fiscal 2005 were $29,677,285,an increase of $2,280,831, or 8.3% from the first six months of the priorfiscal year.  Revenues include theselling price of party goods sold, net of returns and discounts, and arerecognized at the point of sale.

 

Salesfor the first six months of fiscal 2005 included sales from five new storesthat opened since the end of the second quarter of 2004, as well as a decreaseof 0.5% in comparable store sales. Comparable store sales are

 

10

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defined as sales fromthose stores open for at least one full year. The decrease in comparable store sales was primarily due to severeweather that impacted our New England region stores during the first quarter of2005.

 

*Cost of goods sold and occupancy costs*

 

Ourcost of products sold and occupancy costs for the first six months of fiscal2005 was $17,710,177, or 59.7% of revenues, an increase of $2,153,163 and anincrease of 2.9 percentage points, as a percentage of revenues, from the firstsix months of the prior fiscal year. Cost of products sold and occupancy costs consists of the cost ofmerchandise sold to customers and the occupancy costs for our stores.  As a percentage of revenues, the increase wasattributable to our new stores, which operate at a higher occupancy to salesratio until they reach maturity, and increases in our product costs charged tous by certain key vendors.

 

*Marketing and sales expense*

 

Our consolidatedmarketing and sales expense for the first six months of fiscal 2005 was $10,112,277,or 34.1% of revenues, an increase of $1,020,974 and an increase 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, theincrease in marketing and sales expense was primarily due to an increase indepreciation expense related to the acquisition of fixed assets for new storesand our new point-of-sale system.

 

*General and administrative expense*

 

Ourconsolidated general and administrative (“G&A”) expense for the first sixmonths of fiscal 2005 was $3,335,142, or 11.2% of revenues, an increase of$169,791 and a decrease of 0.4 percentage points, as a percentage of revenues,from the first six months 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.  The increasein G&A expense is largely attributable to professional fees related tocompliance with Section 404 of Sarbanes-Oxley Act and enhancements to ournew point-of-sale system.

 

*Otherincome*

 

In thesecond quarter of fiscal 2004 we reached a settlement with a third party inconnection with the special charge pertaining to our preferred stock previouslyrecorded in fiscal year 2002.  Werecorded the net settlement of $354,500 as other income.

 

*Interest expense*

 

Our interest expense inthe first six months of fiscal 2005 was $231,861, an increase of $160,541 fromthe first six months of fiscal 2004.  Theincrease during the first six months of fiscal 2005 was due to an increase ininterest rates, a higher average loan balance and additional interest expenseresulting from capital leases associated with our new point-of-sale system.

 

*Incometaxes*

 

Wehave not provided a benefit for income taxes for the first six months of fiscal2005 or fiscal 2004 due to the uncertainty of future taxable income.

 

At theend of fiscal 2004 we had estimated net operating loss carryforwards ofapproximately $23.0 million, which begin to expire in 2018.  In accordance with Section 382 of theInternal Revenue Code, the use of these carryforwards will be subject to annuallimitations based upon certain ownership changes of our stock that haveoccurred or that may occur.

 

11

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*Net Loss*

 

Our net loss in the first six months of fiscal2005 was $1,711,891 or $0.08 per basic and diluted share, compared to a netloss of $133,025, or $0.01 per basic and diluted share, in the first six monthsof fiscal 2004.

 

**Liquidity and Capital Resources**

** **

Our operatingactivities used $1,307,308 in the first six months of fiscal 2005 compared to providing$686,016 in the first six months of fiscal 2004, a decrease of $1,993,324.  Our net loss of $1,711,891 in the first sixmonths of fiscal 2005 compared to a loss of $133,025 in the first sixmonths of fiscal 2004,represented $1,578,866 of this decrease. Accrued expenses related to new point-of-sale equipment decreased by approximately$850,000 in the first six months of 2005 as compared to the same period in 2004since these costs were financed as capital leases during the third quarter offiscal 2004.  These decreases in cashused in operating activities were partially offset by the increases indepreciation expense and the change in accounts receivable.

 

We used $524,328in investing activities in the first six months of fiscal 2005 compared to $1,823,585in the first six months of 2004.  Thecash invested in the first six months of 2005 was primarily for fixed assetsassociated with new stores, an existing store expansion and point-of-salesystem enhancements.  The cash investedin the first six months of fiscal 2004 was predominantly for fixed assetsassociated with new stores and the new point-of-sale system.

 

We provided $1,839,991by financing activities in the first six months of 2005 compared to $1,093,415in the first six months of 2004.  We increasedour borrowings under our line of credit by $1,947,741 in the first six monthsof 2005 compared to a $1,111,584 increase in the first six months of 2004.  This increase was primarily used to fund thenet operating loss for the first six months of fiscal 2005.

 

Wehave a line of credit (the “line”) with Wells Fargo Retail Finance II, 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 interestrate at the bank’s base rate plus 50 basis points and added the option toincrease 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 aswe are in compliance with all debt covenants and the other provisions of theloan agreement.  Our inventory andaccounts receivable secure our line of credit. We borrow against these assetsat agreed upon advance rates, which may vary at different times of the year.

 

On April 11,2005, we increased our line of credit limit to $10,000,000 to help finance ourpresent operations and current year new store expansion plans.

 

Ourinventory consists of party supplies which are valued at the lower ofweighted-average cost or market and are reduced by an allowance for obsoleteand excess inventory and other adjustments, including vendor rebates, discountsand freight costs.  Our line of creditavailability calculation allows us to borrow against “acceptable inventory at cost,”which takes our inventory at cost and reflects adjustments that our lender hasapproved which may be different than adjustments we use for valuing ourinventory in our financial statements, such as the adjustment to reserve forinventory shortage.  The amount of “acceptableinventory at cost” was $13,516,940 at June 25, 2005.

 

Ouraccounts receivable consists primarily of vendor rebates receivables and creditcard receivables.  Our line of creditavailability calculation allows us to borrow against “eligible credit card receivables,”which are the credit card receivables for the previous three days ofbusiness.  The amount of “eligible creditcard receivables” was $425,454 at June 25, 2005.

 

Thetotal borrowing base is then determined by adding the “acceptable inventory at cost”times an agreed upon advance rate plus the “eligible credit card receivables”times an agreed upon advance rate but not to exceed our established creditlimit.  The total borrowing base at June 25,2005 was at a credit limit of $10,000,000. Under the terms of our line of credit, this amount was then furtherreduced by (1) a minimum availability block, (2) customer deposits, (3) giftcertificates, (4) merchandise credits and (5) outstanding letters ofcredit.  Therefore, our additionalavailability at June 25, 2005 was approximately $272,000.

 

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Theamounts outstanding under our line were $7,205,431 as of June 25, 2005 and$5,257,690 as of December 25, 2004. 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.

 

On April 27,2005, we amended our agreement to allow for a “special subline” that would increaseour borrowing base by $500,000.  Uponactivation of the “special subline”, the interest rate on the line of creditwill be the bank’s base rate plus 75 basis points through the “special subline”termination date.  The “special subline”can be activated upon 5 days written notice and terminates as of November 1,2005 or earlier upon written notice.  Wehave not activated the “special subline”.

 

Our prospective cashflows are subject to certain trends, events and uncertainties, includingdemands for capital to support growth, economic conditions, and contractualmatters.  We expect our capitalexpenditures for 2005 to be primarily related to new stores, store improvementsand other technology advancements in support of growth and operationalenhancement.

 
| ** **                                        | ** ** | **Payments Due By Period** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|
| ** **                                        | ** ** | ** **                 | ** ** | **Within** | ** ** | **Within** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **Within**                 | ** ** | **2 - 3** | ** ** | **4 - 5** | ** ** | **After** | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | **1 Year**                 | ** ** | **Years** | ** ** | **Years** | ** ** | **5 Years** | ** ** | **Total** | ** ** |
| Line of credit                                    |       | $                          | 7,205,431  |   | $ | — |   | $ | — |   | $ | — |   | $ | 7,205,431 |   |
| Capital lease  obligations                        |       | 413,781                    |       | 676,419 |   |   |   |   |   | 1,090,200 |   |
| Operating leases  (including retail space leases) |       | 7,663,315                  |       | 12,313,827 |   | 9,259,353 |   | 14,537,623 |   | 43,774,118 |   |
| Total  contractual obligations                    |       | $                          | 15,282,527 |   | $ | 12,990,246 |   | $ | 9,259,353 |   | $ | 14,537,623 |   | $ | 52,069,749 |   |

 

**Seasonality**

 

**Due to the seasonality of our business, sales andoperating income 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.**

 

**Geographic Concentration**

** **

**As of August 2, 2005 we operated a total of 47 stores,42 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**

 

Variousrisks, uncertainties and contingencies could cause our actual results,performance or achievements to differ materially from those expressed in, orimplied by, statements contained in this Quarterly Report on Form 10-Q,including, but not limited to, the following:

 

•                  the success or failure of our effortsto implement our business strategy

•                  our inability to obtain additionalfinancing, if required

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

•                  unseasonable weather, particularly inthe New England area

•                  intense competition

•                  the availability of retail storespace on reasonable lease terms

 

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•                  the failure of any of our systems,including, without limitation, our newly-installed point-of-sale system and ourmerchandise management system, the latter of which was developed by a vendorwho is no longer in business

•                  general economic and otherdevelopments affecting consumer confidence or spending patterns, particularlyin the New England region and particularly during the Halloween season, whichis our single most important season and

•                  compliancewith evolving federal securities, accounting, and stock exchange rules andregulations applicable to publicly-traded companies listed on the AmericanStock Exchange.

 

**Critical Accounting Policies andEstimates**

 

Ourfinancial statements are based on the application of significant accountingpolicies, many of which require management to make significant estimates andassumptions (see Note 1 to the consolidated financial statements).  We believe the following accounting policiesto be those most important to the portrayal of our financial condition andthose 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.

 

*Inventory and Related Allowancefor Obsolete and Excess Inventory*

 

Our inventory consistsof party supplies and is valued at the lower of moving weighted-average cost ormarket.  We record vendor rebates,discounts and certain other adjustments to inventory, including freight costs,and we recognize these amounts in the income statement as the related goods aresold.

 

*RevenuesRecognition*

 

Revenuesinclude the selling price of party goods sold, net of returns and discounts,and are recognized at the point of sale. We estimate returns based upon historical return rates and such amountshave not been significant.

 

*Impairmentof Long-Lived Assets*

 

Inaccordance with SFAS No. 144, *Accounting for theImpairment or Disposal of Long-Lived Assets*, we perform a review ofeach store for impairment indicators whenever events and changes incircumstances suggest that the carrying amounts may not be recoverable fromestimated future store cash flows.  Ourreview considers store operating results, future sales growth and cashflows.  The conclusion regardingimpairment may differ from current estimates if underlying assumptions orbusiness strategies change.

 

*Income Taxes*

 

Historically, we havenot 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.  In determining if a valuation allowanceagainst our deferred tax asset is appropriate, we consider both positive andnegative evidence.  The positive evidencethat we considered included (1) we were profitable for the last two yearsdue to the success of our Halloween seasons and (2) we have achievedpositive comparable store sales growth and improved merchandise margins duringthese two years of profitability.  Thenegative evidence that we considered included (1) our comparable storesales and merchandise margins decreased during the first six months of 2005, (2) wehave been profitable for only two years and we have been unprofitable for thefirst nine months of those years, (3) our future profitability isvulnerable to certain risks, including (a) the risk that we may not beable to generate significant taxable income to fully utilize our net operatingloss carryforwards of approximately $23.0 million, (b) the risk ofunseasonable weather and other factors in a single geographic region, NewEngland, where our stores are concentrated, (c) the risk of being sodependent upon a single season, Halloween, for a significant amount of annual salesand profitability and (d) the risk of rising prices for petroleumproducts, which are a key raw material for much of our merchandise and whichaffect our freight costs, (4) the costs of opening new stores will putpressure on our profit margins until these stores reach maturity (5) theinvestment in infrastructure required to support our store expansion plan willincrease our costs and (6) the expected costs of increased regulatorycompliance, including, without limitation, those associated with Section 404of the Sarbanes-Oxley Act , will likely have a negative impact on our profitability.

 

14

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The negative evidence isstrong enough for us to conclude that the level of our future profitability isuncertain at this time. We believe that it is prudent for us to maintain avaluation allowance until we have a longer track record of profitability and wecan reduce our exposure to the risks described above.  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.

 

*StockOption Compensation Expense*

 

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

 

*Property and Equipment*

 

Property and equipment are stated at cost lessaccumulated depreciation and are depreciated on the straight-line method overthe estimated useful lives of the assets. Expenditures for maintenance and repairs are charged to operations asincurred.

 

*Use of Estimates*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires us 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 revenues and expenses during thereporting period.  Our actual resultscould differ from our estimates.

 

**NewAccounting Pronouncements**

 

On December 16,2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 123(revised 2004), *Share-Based Payment*,which is a revision of FASB Statement No. 123, *Accounting for Stock-Based Compensation*.  Statement 123(R) supersedes APB Opinion No. 25,*Accounting for Stock Issued to Employees*,and amends FASB Statement No. 95, *Statementof Cash Flows*.  Generally, theapproach in Statement 123(R) is similar to the approach described in Statement123.  However, Statement 123(R) requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the income statement based on their fairvalues.  Pro forma disclosure is nolonger an alternative.

 

On April 14,2005, the SEC announced that it would provide for a phased-in implementationprocess for Statement 123(R) for public companies.  As a result, we will not be required to adoptStatement 123(R) until January 1, 2006 (a delay of six months).  Early adoption will be permitted in periods inwhich financial statements have not yet been issued.  We expect to adopt Statement 123(R) on January 1,2006.

 

Statement 123(R)permits public companies to adopt its requirements using one of two methods:

 

•                  A “modified prospective” method in whichcompensation cost is recognized beginning with the effective date (a) basedon the requirements of Statement 123(R) for all share-based payments grantedafter the effective date and (b) based on the requirements of Statement123 for all awards granted to employees prior to the effective date ofStatement 123(R) that remain unvested on the effective date.

 

•                  A “modified retrospective” method which includesthe requirements of the modified prospective method described above, but alsopermits entities to restate based on the amounts previously recognized underStatement 123 for purposes of pro forma disclosures either (a) all priorperiods presented or (b) prior interim periods of the year of adoption.

 

We have not yetdetermined which method we will use.

 

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As permitted byStatement 123, we currently account for share-based payments to employees usingOpinion 25’s intrinsic value method and, as such, generally recognize nocompensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s fair value method willhave a significant impact on our results of operations, although it will haveno impact on our overall financial position. The impact of adoption of Statement 123(R) cannot be predicted at thistime because it will depend on levels of share-based payments granted in thefuture.  However, had we adoptedStatement 123(R) in prior periods, the impact of that standard would haveapproximated the impact of Statement 123 as described in the disclosure of proforma net loss and net loss per share discussed above.

 

InFebruary 2005, the Chief Accountant of the SEC issued a letter clarifyinghis staff’s interpretation of certain accounting issues and their applicationunder generally accepted accounting principles (“GAAP”) relating to operatingleases.  In summary, their interpretationis that (1) leasehold improvements should be amortized by the lessee overthe shorter of their economic lives or the lease term, which could includelease renewal terms when the renewals are “reasonably assured,” (2) freeor reduced rents should be recognized by the lessee on a straight-line basisover the lease term (including any free or reduced rent period) and (3) thestatement of cash flows should reflect cash received from the lessor that isaccounted for as a lease incentive within operating activities and theacquisition of leasehold improvements for cash within investingactivities.  These positions are basedupon existing accounting literature.  Ourpresent accounting policies are consistent with positions described by theChief Accountant and his staff in this letter.  Our policy is to amortize leaseholdimprovements for 10 years or the life of the lease, whichever period isshorter.  Our policy is to amortize freeor reduced rent on a straight-line basis over the lease term (including anyfree or reduced rent periods).  Wegenerally do not enter into agreements that involve receiving cash fromlessors/landlords.

 

**Item 3.  Quantitativeand Qualitative Disclosures about Market Risk**

 

There has been no material change in our marketrisk exposure since the filing of our Annual Report on Form 10-K, as amended.

 

**Item 4.  Controls andProcedures**

 

(a) *Evaluationof Disclosure 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) underthe Securities Exchange Act) as of June 25, 2005.  In designing and evaluating our disclosurecontrols and procedures, our management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable 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 June 25, 2005,our disclosure controls and procedures were (1) designed to ensure thatmaterial information relating to us, including our consolidated subsidiaries,is made known to our CEO and CFO by others within those entities, particularlyduring the period in which this report was being prepared and (2) effective,in that they provide reasonable assurance that information required to bedisclosed by us in the reports that we file or submit under the SecuritiesExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms.

 

(b) *Changes in Internal Controls.  *No change in our internal controlsover financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) underthe Securities Exchange Act) occurred during the fiscal quarter ended June 25,2005 that has materially affected, or is reasonably likely to materiallyaffect, our internal controls over financial reporting.

 

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PART II– OTHER INFORMATION

 

**Item1.  Legal Proceedings**

 

Not applicable.

 

**Item2.  Unregistered Sales of Equity andSecurities and Use of Proceeds**

 

Not applicable.

 

**Item3.  Defaults upon Senior Securities**

 

Not applicable.

 

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

 

On June 8, 2005, we held our Annual Meeting ofStockholders.  There were a total of37,093,157 votes entitled to be cast at the meeting.  Of this total, 33,441,879, or approximately90.2% of the total number of votes eligible to be cast, were represented eitherin person or by proxy.  At the meeting,the stockholders elected seven (7) Directors to our Board ofDirectors.  The holder of Series Dconvertible preferred stock was entitled to vote alone for the election of a Series DDirector.  Christina Weaver-Vest was thedesignee of the holder of the Series D convertible preferred stock.  Set forth below are (i) the names of thepersons elected to serve on our Board of Directors until the next AnnualMeeting 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           |       | 33,356,228    |       | 99.7           | %          | 85,651 |   | 0.3 | % |
| Lorenzo Roccia         |       | 33,350,343    |       | 99.7           | %          | 91,536 |   | 0.3 | % |
| Daniel De Wolf         |       | 33,363,176    |       | 99.8           | %          | 78,703 |   | 0.2 | % |
| Frank Haydu            |       | 33,363,276    |       | 99.8           | %          | 78,603 |   | 0.2 | % |
| Eric Schindler         |       | 33,362,828    |       | 99.8           | %          | 79,051 |   | 0.2 | % |
| Joseph  Vassalluzzo    |       | 33,357,995    |       | 99.7           | %          | 83,884 |   | 0.3 | % |
| Christina  Weaver-Vest |       | 3,500,000     |       | 100.0          | %          | — |   | 0.0 | % |

 

The stockholders also ratified the appointment ofErnst & Young LLP as our independent public auditors for the currentfiscal year ending December 31, 2005. Set forth below is the results of that vote.

 
| ** **                                                                                   | ** ** | **Number** | ** ** | **% of Total** | ** ** | **Number** | ** ** | **% of Total** | ** ** | **Number** | ** ** | **% of Total** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|------------|------------|----------------|------------|------------|------------|----------------|------------|
| Ratification of  appointment of Ernst & Young LLP as our independent public auditor |       | 33,412,381 |       | 99.9           | %          | 26,398     |       | 0.1            | %          | 3,100      |       | 0.0            | %          |

 

**Item5.  Other Information**

 

Not applicable.

 

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**Item 6. Exhibits**

 

The exhibits listed in the Exhibit Indeximmediately preceding the exhibits are filed as part of this Quarterly Reporton Form 10-Q.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,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:  August 8, 2005 |         |

 

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**EXHIBIT INDEX**

 
| **EXHIBIT** | ** ** | ** **                                                                                        |
|-------------|------------|---------------------------------------------------------------------------------------------------|
| **NUMBER**  | ** ** | **DESCRIPTION**                                                                                   |
| 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                 |

 

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