**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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 September 25,2004**

 

**OR**

 

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

 

**For theTransition Period from              to                **

 

**CommissionFile Number 0-25507**

 

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** **

**iPARTY CORP.**

(Exact Name of Registrant asSpecified 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 theregistrant:  (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ýNo o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act). Yes o No ý

 

As of November 1, 2004, there were22,087,331 shares of iParty Corp.’s common stock outstanding.

 

 

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**iPartyCorp.**

**QuarterlyReport on Form 10-Q**

**Table ofContents**

 
| PART 1        | FINANCIAL INFORMATION                                                                                                                 |   |
|---------------|---------------------------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                                                  |   |
| Item 1.       | Financial Statements (Unaudited)                                                                                                      |   |
|          | Consolidated Balance Sheets – September 25, 2004 and December 27,  2003                                                |   |
|          | Consolidated Statements of Operations –  Three months and nine months ended September 25, 2004 and September 27,  2003 |   |
|          | Consolidated Statements of Cash Flows –  Nine months ended September 25, 2004 and September 27, 2003                   |   |
|          | Notes to Consolidated Financial Statements                                                                                            |   |
|          |                                                                                                                                  |   |
| Item 2.       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                           |   |
|          |                                                                                                                                  |   |
| Item 3.       | Quantitative and Qualitative Disclosures  about Market Risk                                                                           |   |
|          |                                                                                                                                  |   |
| Item 4.       | Controls and Procedures                                                                                                               |   |
|          |                                                                                                                                  |   |
| PART II       | OTHER INFORMATION                                                                                                                     |   |
|          |                                                                                                                                  |   |
| Item 1.       | Legal Proceedings                                                                                                                     |   |
|          |                                                                                                                                  |   |
| Item  2.      | 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 and  Reports on Form 8-K                                                                                                     |   |
|          |                                                                                                                                  |   |
| 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 -FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**iPARTY CORP.**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                                  | ** ** | **Sep 25, 2004** | ** ** | **Dec 27, 2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                                                                  | ** ** | **(Unaudited)**  | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                  | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current  assets:                                                                                                                                                                                                                                            |       |             |       |             |       |
| Cash and  cash equivalents                                                                                                                                                                                                                                  |       | $                | 843,362    |             | $          | 2,442,471 |   |
| Restricted  cash                                                                                                                                                                                                                                            |       | 592,315          |       | 533,284          |       |
| Accounts  receivable                                                                                                                                                                                                                                        |       | 838,228          |       | 487,934          |       |
| Inventory,  net                                                                                                                                                                                                                                             |       | 14,971,738       |       | 9,423,463        |       |
| Prepaid  expenses and other assets                                                                                                                                                                                                                          |       | 833,949          |       | 483,925          |       |
| Total  current assets                                                                                                                                                                                                                                       |       | 18,079,592       |       | 13,371,077       |       |
| Property and  equipment, net                                                                                                                                                                                                                                |       | 4,129,013        |       | 1,694,140        |       |
| Other assets                                                                                                                                                                                                                                                |       | 106,737          |       | 86,763           |       |
| Total assets                                                                                                                                                                                                                                                |       | $                | 22,315,342 |             | $          | 15,151,980 |   |
|                                                                                                                                                                                                                                                        |       |             |       |             |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                              | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current  liabilities:                                                                                                                                                                                                                                       |       |             |       |             |       |
| Accounts  payable                                                                                                                                                                                                                                           |       | $                | 7,793,604  |             | $          | 3,095,848 |   |
| Accrued  expenses                                                                                                                                                                                                                                           |       | 3,119,325        |       | 2,306,902        |       |
| Current  portion of capital lease obligations                                                                                                                                                                                                               |       | 241,433          |       | 29,220           |       |
| Borrowings  under line of credit                                                                                                                                                                                                                            |       | 6,260,579        |       | 3,760,671        |       |
| Total  current liabilities                                                                                                                                                                                                                                  |       | 17,414,941       |       | 9,192,641        |       |
|                                                                                                                                                                                                                                                        |       |             |       |             |       |
| Long-term  liabilities:                                                                                                                                                                                                                                     |       |             |       |             |       |
| Capital  lease obligations, net of current portion                                                                                                                                                                                                          |       | 606,517          |       | 260              |       |
| Other  liabilities                                                                                                                                                                                                                                          |       | 444,932          |       | 406,209          |       |
| Total  long-term liabilities                                                                                                                                                                                                                                |       | 1,051,449        |       | 406,469          |       |
|                                                                                                                                                                                                                                                        |       |             |       |             |       |
| Commitments  and contingencies                                                                                                                                                                                                                              |       |             |       |             |       |
|                                                                                                                                                                                                                                                        |       |             |       |             |       |
| Stockholders’  equity:                                                                                                                                                                                                                                 |       |             |       |             |       |
| Convertible  preferred stock - $.001 par value; 10,000,000 shares authorized,                                                                                                                                                                               |       |             |       |             |       |
| Series A  convertible preferred stock - 1,000,000 shares authorized; 0 and 1,000,000  shares issued and outstanding at September 25, 2004 and Dec 27, 2003,  respectively (aggregate liquidation value of $0 at September 25, 2004)               |       | —           |       | 1,000,000        |       |
| Series B  convertible preferred stock - 1,150,000 shares authorized; 507,460 and  611,080 shares issued and outstanding at September 25, 2004 and Dec 27,  2003, respectively (aggregate liquidation value of $10,149,200 at September 25,  2004) |       | 7,551,002        |       | 9,092,870        |       |
| Series C  convertible preferred stock - 100,000 shares authorized, issued and  outstanding (aggregate liquidation value of $2,000,000 at September 25,  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 September 25,  2004)                                                                                          |       | 3,652,500        |       | 3,652,500        |       |
| Series E  convertible preferred stock - 533,333 shares authorized; 296,667 and 389,439  shares issued and outstanding at September 25, 2004 and Dec 27, 2003,  respectively (aggregate liquidation value of $1,112,500 at September 25,  2004)    |       | 1,112,500        |       | 1,460,396        |       |
| Series F  convertible preferred stock - 114,286 shares authorized, issued and  outstanding (aggregate liquidation value of $500,000 at September 25,  2004)                                                                                            |       | 500,000          |       | 500,000          |       |
| Total  convertible preferred stock                                                                                                                                                                                                                          |       | 14,308,002       |       | 17,197,766       |       |
|                                                                                                                                                                                                                                                        |       |             |       |             |       |
| Common stock  - $.001 par value; 150,000,000 shares authorized; 22,087,331 and 18,780,204  shares issued and outstanding at September 25, 2004 and Dec 27, 2003,  respectively                                                                         |       | 22,087           |       | 18,780           |       |
|                                                                                                                                                                                                                                                        |       |             |       |             |       |
| Additional  paid-in capital                                                                                                                                                                                                                                 |       | 50,445,607       |       | 47,554,621       |       |
| Accumulated  deficit                                                                                                                                                                                                                                        |       | (60,926,744      | )          | (59,218,297      | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                            |       | 3,848,952        |       | 5,552,870        |       |
|                                                                                                                                                                                                                                                        |       |             |       |             |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                            |       | $                | 22,315,342 |             | $          | 15,151,980 |   |

 

The accompanying notes are anintegral part of these Consolidated Financial Statements.

 

2

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**iPARTY CORP.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                             | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **Sep 25, 2004**               | ** ** | **Sep 27, 2003**              | ** ** | **Sep 25, 2004** | ** ** | **Sep 27, 2003** | ** ** |
| Revenues                               |       | $                              | 13,157,546 |                          | $          | 11,878,460 |   | $ | 40,554,000 |   | $ | 35,971,592 |   |
| Operating  costs:                      |       |                           |       |                          |       |   |   |   |   |
| Cost of  products sold                 |       | 7,897,580                      |       | 7,060,170                     |       | 23,454,594 |   | 21,151,729 |   |
| Marketing  and sales                   |       | 5,276,532                      |       | 4,507,919                     |       | 14,367,835 |   | 12,712,371 |   |
| General and  administrative            |       | 1,509,548                      |       | 1,279,623                     |       | 4,674,898 |   | 3,780,542 |   |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Operating  loss                        |       | (1,526,114                     | )          | (969,252                      | )          | (1,943,327 | ) | (1,673,050 | ) |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Other income                           |       | 28,000                         |       | —                        |       | 382,500 |   | — |   |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Loss before  interest and income taxes |       | (1,498,114                     | )          | (969,252                      | )          | (1,560,827 | ) | (1,673,050 | ) |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Interest  income                       |       | 271                            |       | 273                           |       | 1,280 |   | 1,261 |   |
| Interest  expense                      |       | (77,580                        | )          | (65,748                       | )          | (148,900 | ) | (175,427 | ) |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Loss before  income taxes              |       | (1,575,423                     | )          | (1,034,727                    | )          | (1,708,447 | ) | (1,847,216 | ) |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Income taxes                           |       | —                         |       | —                        |       | — |   | — |   |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Net loss                               |       | $                              | (1,575,423 | )                             | $          | (1,034,727 | ) | $ | (1,708,447 | ) | $ | (1,847,216 | ) |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Basic and  diluted net loss per share  |       | $                              | (0.07      | )                             | $          | (0.06 | ) | $ | (0.08 | ) | $ | (0.11 | ) |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Weighted-average  shares outstanding:  |       |                           |       |                          |       |   |   |   |   |
| Basic and  diluted                     |       | 22,019,408                     |       | 17,687,448                    |       | 21,123,511 |   | 17,354,107 |   |

 

The accompanying notes are anintegral part of these Consolidated Financial Statements.

 

3

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**iPARTY CORP.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                   | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                   | ** ** | **Sep 25, 2004**              | ** ** | **Sep 27, 2003** | ** ** |
| **Operating  activities:**                                                   |       |                          |       |   |   |
|                                                                         |       |                          |       |   |   |
| Net loss                                                                     |       | $                             | (1,708,447 | ) | $ | (1,847,216 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |       |                          |       |   |   |
| Depreciation  and amortization                                               |       | 406,576                       |       | 386,022 |   |
| Deferred  rent                                                               |       | 38,723                        |       | 5,691 |   |
| Changes in  operating assets and liabilities:                                |       |                          |       |   |   |
| Accounts  receivable                                                         |       | (350,294                      | )          | (100,463 | ) |
| Inventory                                                                    |       | (5,548,275                    | )          | (3,452,354 | ) |
| Prepaid  expenses and other assets                                           |       | 29,682                        |       | (33,501 | ) |
| Accounts  payable                                                            |       | 4,697,756                     |       | 3,517,920 |   |
| Accrued  expenses and other liabilities                                      |       | 143,980                       |       | (65,546 | ) |
| Net cash  used in operating activities                                       |       | (2,290,299                    | )          | (1,589,447 | ) |
|                                                                         |       |                          |       |   |   |
| **Investing  activities:**                                                   |       |                          |       |   |   |
|                                                                         |       |                          |       |   |   |
| Purchase of  property and equipment                                          |       | (1,648,300                    | )          | (714,292 | ) |
| Net cash  used in investing activities                                       |       | (1,648,300                    | )          | (714,292 | ) |
|                                                                         |       |                          |       |   |   |
| **Financing  activities:**                                                   |       |                          |       |   |   |
|                                                                         |       |                          |       |   |   |
| Net  borrowings under line of credit                                         |       | 2,499,908                     |       | 2,746,453 |   |
| Increase in  restricted cash                                                 |       | (59,031                       | )          | (281,837 | ) |
| Principal  payments on capital lease obligations                             |       | (72,995                       | )          | (167,772 | ) |
| Deferred  financing costs                                                    |       | (32,921                       | )          | 39,220 |   |
| Proceeds  from exercise of stock options                                     |       | 4,529                         |       | 1,760 |   |
| Net cash  provided by financing activities                                   |       | 2,339,490                     |       | 2,337,824 |   |
|                                                                         |       |                          |       |   |   |
| **Net  increase (decrease) in cash and cash equivalents**                    |       | (1,599,109                    | )          | 34,085 |   |
|                                                                         |       |                          |       |   |   |
| **Cash and  cash equivalents, beginning of period**                          |       | 2,442,471                     |       | 2,326,343 |   |
|                                                                         |       |                          |       |   |   |
| **Cash and  cash equivalents, end of period**                                |       | $                             | 843,362    |   | $ | 2,360,428 |   |
|                                                                         |       |                          |       |   |   |
| Supplemental  disclosure of non-cash financing activities:                   |       |                          |       |   |   |
|                                                                         |       |                          |       |   |   |
| Conversion  of Series A convertible preferred stock to common stock          |       | $                             | 1,000,000  |   | $ | — |   |
| Conversion  of Series B convertible preferred stock to common stock          |       | 1,541,869                     |       | 761,276 |   |
| Conversion  of Series E convertible preferred stock to common stock          |       | 347,895                       |       | 289,604 |   |
| Total  conversion of convertible preferred stock to common stock             |       | $                             | 2,889,764  |   | $ | 1,050,880 |   |
|                                                                         |       |                          |       |   |   |
| Acquisition  of assets under capital lease                                   |       | $                             | 891,465    |   | $ | — |   |
|                                                                              |            |                               |            |  |  |  |  |  |  |

 

The accompanying notes are anintegral part of these Consolidated Financial Statements.

 

4

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**iPARTYCORP.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**September 25,2004**

**(Unaudited)**

 

**1.  BASISOF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES**:

 

*Interim FinancialInformation*

 

**The interim consolidated financial statements as of September 25,2004 have been prepared by the Company pursuant to the rules and regulations ofthe Securities and Exchange Commission (the “SEC”) for interim financialreporting.  These consolidated statementsare unaudited and, in the opinion of management, include all adjustments(consisting of normal recurring adjustments and accruals) necessary to presentfairly the consolidated balance sheets, consolidated operating results, andconsolidated cash flows for the periods presented in accordance with generallyaccepted accounting principles.  Theconsolidated balance sheet at December 27, 2003 has been derived from theaudited consolidated financial statements at that date.  Operating results for the three months andnine months ended September 25, 2004 and September 27, 2003 may notbe indicative of the results for the entire year due, in part, to theseasonality of the Company’s business. Historically, higher revenues and operating income have been experiencedin the second and fourth fiscal quarters. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples have been omitted in accordance with the rules and regulations ofthe SEC.  These consolidated financialstatements should 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 ofConsolidation*

 

The consolidated financial statements includethe accounts of the Company and its wholly-owned subsidiaries after eliminationof all significant intercompany transactions and balances.

 

*RevenuesRecognition*

 

Revenues include the selling price of partygoods sold, net of returns and discounts, and are recognized at the point ofsale.  The Company estimates returnsbased upon historical return rates and such amounts have not been significant.

 

*Concentrations*

 

The Company purchases its inventory from a diverse group of vendors andis not overly dependent upon any single source for its merchandise, often usingmore than one vendor for similar kinds of products.

 

Accounts receivable primarily represent amounts due from credit cardcompanies and vendors for inventory rebates. Management does not provide for doubtful accounts as such amounts havenot been significant to date; the Company does not require collateral.

 

*Use of Estimates*

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period.  Actual results could differ from theseestimates.

 

5

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*Cashand Cash Equivalents and Restricted Cash*

 

The Company considers all highly liquidinvestments with an original maturity date of three months or less to be cashequivalents.  Cash equivalents consistprimarily of money market accounts and are carried at cost plus accruedinterest, 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 $768,145 at September 25,2004 and $989,816 at December 27, 2003. 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’s lender underits line of credit, and constitutes collateral for amounts outstanding underthe Company’s line of credit.

 

*FairValue of Financial Instruments*

 

The carrying values of cash and cash equivalents, accounts receivableand accounts payable approximate fair value because of the short-term nature ofthese instruments.  The fair value ofborrowings under its line of credit approximates carrying value because thedebt bears interest at a variable market rate. The fair value of capital lease obligations for point-of-sale equipmentand software approximates carrying value because the obligations were incurredduring the third quarter of fiscal 2004 at prevailing interest rates for suchleases.

 

*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 Company records vendor rebates, discountsand certain other adjustments to inventory, including freight costs, and theseamounts are recognized in the income statement as the related goods are sold.

 

*NetIncome (Loss) per Share*

 

Net income per basic share is computed bydividing net income by the weighted-average number of common shares outstandingplus the common share equivalents of all outstanding Series B, C, D, E and Fconvertible preferred stock.  The commonshare equivalents of Series B, C, D, E and F convertible preferred stock areincluded in the calculation of net income per basic share in accordance withEITF Topic D-95, Effect of Participating Convertible Securities on theComputation of Basic Earnings Per Share, since these convertible preferredstockholders are entitled to participate in dividends when and if declared bythe Board of Directors.  For the periodswith net losses, the Company excludes those common share equivalents sincetheir impact would be anti-dilutive.

 

Net income per diluted share is computed bydividing 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 net losses,the Company excludes those common share equivalents since their impact would beanti-dilutive.

 

On January 13, 2004, all 1,000,000shares of Series A convertible stock were converted into 1,000,000 shares ofcommon stock.  As of September 25,2004, there were 38,832,488 potential additional common share equivalentsoutstanding, which were not included in the above calculation because theireffect would be anti-dilutive.  Theseinclude 15,613,425 shares upon the conversion of immediately convertiblepreferred stock, 13,561,216 shares upon the exercise of warrants with aweighted-average exercise price of $1.43 and 9,657,847 shares upon the exerciseof stock options with a weighted-average exercise price of $0.97.

 

6

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*StockOption Compensation Expense*

 

The Company accounts for its stock optioncompensation agreements with employees under the provisions of AccountingPrinciples Board (“APB”) Opinion No. 25, *Accounting for StockIssued to Employees*.  TheCompany has adopted the disclosure-only provisions of Statement of FinancialAccounting Standards (“SFAS”) No. 123, *Accounting for Stock-BasedCompensation*.

 

The Company has computed the value of optionsusing the Black-Scholes option pricing model prescribed by SFAS No. 123.  The weighted-average fair value of theoptions granted was $0.59 per share during the third quarter of fiscal 2004 and$0.33 per share during the third quarter of fiscal 2003, using the followingassumptions:  no dividend yield,volatility of 117% in 2004 and 119% to 121% in 2003, a risk-free interest rateof 3.26% in the third quarter of fiscal 2004 and 2.49% to 3.51% in the thirdquarter of fiscal 2003 and an expected life of five years from the date of thegrant.  Had compensation cost for theCompany’s stock option plan been determined based upon the fair value at thegrant date for awards under the plan consistent with the methodology prescribedunder SFAS 123, the Company’s net loss and net loss per share would have beenthe following pro forma amounts:

 
| ** **                             | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **                             | ** ** | **Sep 25, 2004**               | ** ** | **Sep 27, 2003**              | ** ** | **Sep 25, 2004** | ** ** | **Sep 27, 2003** | ** ** |
| Net loss:                              |       |                           |       |                          |       |   |   |   |   |
| Reported                               |       | $                              | (1,575,423 | )                             | $          | (1,034,727 | ) | $ | (1,708,447 | ) | $ | (1,847,216 | ) |
| Stock option  compensation expense     |       | (117,460                       | )          | (144,324                      | )          | (652,745 | ) | (361,517 | ) |
| Pro forma                              |       | $                              | (1,692,883 | )                             | $          | (1,179,051 | ) | $ | (2,361,192 | ) | $ | (2,208,733 | ) |
|                                   |       |                           |       |                          |       |   |   |   |   |
| Basic and  diluted net loss per share: |       |                           |       |                          |       |   |   |   |   |
| Reported                               |       | $                              | (0.07      | )                             | $          | (0.06 | ) | $ | (0.08 | ) | $ | (0.11 | ) |
| Pro forma                              |       | $                              | (0.08      | )                             | $          | (0.07 | ) | $ | (0.11 | ) | $ | (0.13 | ) |

 

*Property andEquipment*

 

Propertyand equipment are stated at cost less accumulated depreciation and aredepreciated on the straight-line method over the estimated useful lives of theassets.  At the beginning of fiscal 2004the Company adopted a new policy for estimating the useful life of fixed assetswhich extended the useful life of equipment, furniture and fixtures andpoint-of-sale specific computer hardware and software.  Changing the estimated life of the assets inthese categories as of the beginning of the year reduced depreciation expensefor the third quarter and first nine months of fiscal 2004 by approximately$31,840 and $100,753, respectively.  Thenet loss per share on the basic and diluted would have been $.07 for the thirdquarter and $.09 for the nine months of fiscal 2004 if this change inestimating the useful life of fixed assets had not been adopted.  Expenditures for maintenance and repairs arecharged to operations as incurred.  Alisting of the estimated useful life of the various categories of property andequipment 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 theImpairment of Long-Lived Assets*

 

In accordance with SFAS No. 144, *Accounting for the Impairment or Disposal ofLong-Lived Assets*,**the Company performs an impairmentreview quarterly.

 

7

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*Reclassifications*

 

Certainreclassifications have been made to prior year’s amounts to conform to thecurrent year presentation.

 

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

 

This information should be read inconjunction with the unaudited consolidated financial statements and relatednotes included in Item 1 of this Quarterly Report on Form 10-Q and the auditedconsolidated financial statements and related notes and Item 7, Management’sDiscussion and Analysis, contained in our Annual Report on Form 10-K for thefiscal year ended December 27, 2003.

 

**Forward Looking Statements**

 

This Quarterly Report on Form 10-Q, includingthis discussion and analysis by management, contains or incorporatesforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended.  Theseforward-looking statements are based on current expectations, estimates,forecasts and projections about the industry and markets in which we operateand our management’s beliefs and assumptions. In addition, other written or oral statements that constituteforward-looking statements may be made by or on our behalf.  Words such as “expect”, “anticipate”, “intend”,“plan”, “believe”, “seek”, estimate”, variations of such words 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 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, future eventsor otherwise.

 

**Overview**

 

We believe we are a leading brand in theparty industry in the markets we serve and a leading resource in those marketsfor consumers seeking party goods, party planning advice and party-relatedinformation.  We are a party goodsretailer operating stores throughout New England, where 40 of our 44 retailstores are located.  Our other fourstores are located in Florida.  Two newstores were opened during the third quarter, in Citrus Park (Tampa), Floridaand Augusta, Maine.  Two new stores wereopened subsequent to the end of the third quarter, in Sturbridge, Massachusettsand Plymouth, Massachusetts.  We alsolicense the name “iparty.com” (at www.iparty.com) to a third party in exchangefor royalties from Internet sales, which to date have not beensignificant.  The following table showsthe number of stores in operation at September 25, 2004 and September 27,2003.

 
| ** **           | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|----------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **           | ** ** | **Sep 25, 2004**               | ** ** | **Sep 27, 2003**              | ** ** | **Sep 25, 2004** | ** ** | **Sep 27, 2003** | ** ** |
| Beginning of  period |       | 40                             |       | 35                            |       | 38 |   | 35 |   |
| Openings             |       | 2                              |       | 2                             |       | 4 |   | 2 |   |
| Closings             |       | —                         |       | —                        |       | — |   | — |   |
| End of  period       |       | 42                             |       | 37                            |       | 42 |   | 37 |   |

 

Our stores feature over 20,000 productsranging from greeting cards and balloons to more unique merchandise such aspiñatas, tiny toys, masquerade and Hawaiian Luau items.  Our sales are driven by the followingevents:  Halloween, Christmas, Easter,Valentine’s Day, New Year’s, Independence Day, St. Patrick’s Day, Thanksgivingand Chanukah.  We also focus our businessclosely on lifetime events such as anniversaries, graduations, birthdays, andbridal or baby showers.  The followingtable shows a summary of our revenues and the increase in revenues from theprior year periods.

 
| ** **            | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|-----------------------|------------|--------------------------------|------------|-------------------------------|------------|
| ** **            | ** ** | **Sep 25, 2004**               | ** ** | **Sep 27, 2003**              | ** ** | **Sep 25, 2004** | ** ** | **Sep 27, 2003** | ** ** |
| Revenues              |       | $                              | 13,157,546 |                          | $          | 11,878,460 |   | $ | 40,554,000 |   | $ | 35,971,592 |   |
|                  |       |                           |       |                          |       |   |   |   |   |
| Increase in  revenues |       | 10.8                           | %          | 9.0                           | %          | 12.7 | % | 4.0 | % |
|                       |            |                                |            |                               |            |  |  |  |  |  |  |  |  |

 

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Our business has a seasonal pattern.  In the past two years we have realized overone-third of our annual revenues in our fourth quarter, which includesHalloween and Christmas, and approximately 25% of our revenues in the secondquarter, which includes school graduations. Also, during these past two years, we have had net income in our secondand fourth quarters and generated losses in our first and third quarters.

 

**Results of Operations**

 

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

 

The third quarter of fiscal year 2004 had 13weeks and ended on September 25, 2004. The third quarter of fiscal year 2003 had 13 weeks and ended on September 27,2003.

 

**Three Months Ended September 25, 2004 Compared toThree Months Ended September 27, 2003**

 

*Revenues*

 

Our consolidated revenues for the thirdquarter of fiscal 2004 were $13,157,546, an increase of $1,279,086, or 10.8%from the third quarter of the prior fiscal year.  Revenues include the selling price of partygoods sold, net of returns and discounts, and are recognized at the point ofsale.

 

Sales for the third quarter of fiscal 2004included sales from five new stores that we opened since the end of the thirdquarter of 2003, as well as an increase of 0.8% in comparable store sales.  Comparable store sales are defined as salesfrom those stores open for at least one full year.  Comparable store sales were up slightly thisyear following a 6.2% increase in the third quarter of last year.  Hurricanes in Florida caused some disruptionto our business during the third quarter of 2004 but we believe that weatherdid not have a material effect on our reported sales for the quarter.

 

*Cost of productssold*

 

Our cost of products sold for the thirdquarter of fiscal 2004 was $7,897,580, or 60.0% of revenues, an increase of$837,410 and an increase of 0.6 percentage points, as a percentage of revenues,from the third quarter of the prior fiscal year.  Cost of products sold consists of the cost ofmerchandise sold to customers and the occupancy costs for our stores.  We had higher occupancy costs, as apercentage of sales, primarily due to the five new stores we opened since theend of the third quarter of 2003.

 

*Marketing and salesexpense*

 

Our consolidated marketing and sales expensefor the third quarter of fiscal 2004 was $5,276,532, or 40.1% of revenues, anincrease of $768,613 and an increase of 2.1 percentage points, as a percentageof revenues, from the third quarter of fiscal 2003.  Marketing and sales expense consistsprimarily of advertising and promotional expenditures, all store payroll andrelated expenses for personnel engaged in marketing and selling activities andother non-payroll expenses associated with operating our stores.  Most of this increase, as a percentage ofrevenues, was due to higher store payroll and related fringe benefit expensesresulting from increased labor hours associated with preparing for the upcomingHalloween season and for training of our store associates on our newpoint-of-sale system.  We completed theinitial roll-out of the new system to all of our stores in July 2004.

 

*General andadministrative expense*

 

Our consolidated general and administrative (“G&A”)expense for the third quarter of fiscal 2004 was $1,509,548, or 11.5% ofrevenues, an increase of $229,925 and an increase of 0.7 percentage points, asa percentage of revenues, from the third 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.  The increasein G&A expense is largely attributable to increased labor costs forpositions added to support growth, higher benefits-related insurance costs,increased occupancy costs for our

 

9

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new corporate office and increased expenses associated with supportingthe installation of and enhancements to our new point-of-sale equipment andsoftware.

 

*Otherincome*

 

In the second quarter of fiscal 2004 wereached a settlement with a third party in connection with the special chargepreviously recorded in fiscal year 2002. We had recorded a net settlement of $354,500 in the second quarter andwe recorded a final adjustment of $28,000, relating to this previously recordedamount, in the third quarter of fiscal 2004 as other income.

 

*Interest expense*

 

Our interest expense inthe third quarter of fiscal 2004 was $77,580, an increase of $11,832 from thethird quarter of fiscal 2003. Approximately $8,500 of the increase in interest expense resulted frominterest on capital leases for our new point-of-sale system.  The interest rate on our borrowings under ourline of credit declined to 5.0% in the third quarter of fiscal 2004 compared to6.5% in the third quarter of fiscal 2003, which reduced interest expense byapproximately $15,600.  Our average loanbalance was approximately $4,881,000 during the third quarter of fiscal 2004compared to $3,450,000 in the third quarter of fiscal 2003, which increasedinterest expense by approximately $18,000.

 

*Incometaxes*

 

We have not provided a benefit for incometaxes for the first nine months of fiscal 2004 or fiscal 2003 due to theuncertainty of future taxable income.

 

At the end of fiscal 2003 we had estimatednet operating loss carryforwards of approximately $23.7 million, which begin toexpire in 2018.  In accordance with Section 382of the 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.

 

*Netincome*

 

Our net loss in the third quarter of fiscal 2004was $1,575,423 or $.07 per basic and diluted share, compared to a net loss of$1,034,727, or $.06 per basic and diluted share, in the third quarter of fiscal2003.

 

**Nine months ended September 25, 2004 compared tonine months ended September 27, 2003**

 

*Revenues*

 

Our consolidated revenues for the first ninemonths of fiscal 2004 were $40,554,000, an increase of $4,582,408, or 12.7%from the first nine months of the prior fiscal year.  Revenues include the selling price of partygoods sold, net of returns and discounts, and are recognized at the point ofsale.

 

Sales for the first nine months of fiscal2004 included sales from five new stores that we opened since the end of thethird quarter of 2003, as well as an increase of 4.3% in comparable storesales.  Comparable store sales are definedas sales from those stores open for at least one full year.  Our increase in comparable store sales wasled by the performance of our juvenile birthday, Halloween, graduation, summer,Super Bowl related merchandise and New Year’s categories.

 

*Cost of productssold*

 

Our cost of products sold for the first ninemonths of fiscal 2004 was $23,454,594, or 57.8% of revenues, an increase of$2,302,865 and a decrease of 1.0 percentage point, as a percentage of revenues,from the first nine months of the prior fiscal year.  Cost of products sold consists of the cost ofmerchandise sold to customers and the occupancy costs for our stores.  As a percentage of revenues, the decrease wasattributable to better terms with our vendors and lower inventory chargesresulting from reduced exposure to slow moving inventory.

 

10

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*Marketing and salesexpense*

 

Our consolidated marketing and sales expensefor the first nine months of fiscal 2004 was $14,367,835, or 35.4% of revenues,an increase of $1,655,464 and an increase of 0.1 percentage point, as apercentage of revenues, from the first nine months of the prior fiscalyear.  Marketing and sales expenseconsists primarily of advertising and promotional expenditures, all store payrolland related expenses for personnel engaged in marketing and selling activitiesand other non-payroll expenses associated with operating our stores.  Lower advertising costs, in absolute dollarsand as a percentage of revenues, were offset by higher store payroll andrelated fringe benefits expenses and higher pre-opening expenses from openingfour stores this year compared with two stores in the prior fiscal year.

 

*General andadministrative expense*

 

Our consolidated general and administrative (“G&A”)expense for the first nine months of fiscal 2004 was $4,674,898, or 11.5% ofrevenues, an increase of $894,356 and an increase of 1.0 percentage point, as apercentage of revenues, from the first nine months of the prior fiscalyear.  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. The increase in G&A expense is largely attributable to increasedlabor costs for positions added to support growth, higher benefits-relatedinsurance costs, increased occupancy costs for our new corporate office andincreased expenses associated with supporting the installation of andenhancements to our new point-of-sale equipment and software.  We completed the initial roll-out of the newsystem to all of our stores in July 2004.

 

*Otherincome*

 

In the second quarter of fiscal 2004 wereached a settlement with a third party in connection with the special chargepreviously recorded in fiscal year 2002. We recorded the net settlement of $382,500 as other income.

 

*Interest expense*

 

Our interest expense inthe first nine months of fiscal 2004 was $148,900, a decrease of $26,527 fromthe first nine months of fiscal 2003.  Adecrease of approximately $12,500 in interest expense resulted from theexpiration of capital leases during 2003, which was partially offset byinterest on capital leases for our new point-of-sale system.  The interest rate on our borrowings under ourline of credit declined to 4.7% in the first nine months of fiscal 2004compared to 6.5% in the first nine months of fiscal 2003, which reducedinterest expense by approximately $40,000. Our average loan balance was approximately $3,641,000 during the firstnine months of fiscal 2004 compared to $2,896,000 in the first nine months offiscal 2003, which increased interest expense by approximately $27,000.

 

*Incometaxes*

 

We have not provided a benefit for incometaxes for the first nine months of fiscal 2004 or fiscal 2003 due to theuncertainty of future taxable income.

 

At the end of fiscal 2003 we had estimatednet operating loss carryforwards of approximately $23.7 million, which begin toexpire in 2018.  In accordance with Section 382of the 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 first nine months of fiscal2004 was $1,708,447 or $0.08 per basic and diluted share, compared to $1,847,216,or $0.11 per basic and diluted share, in the first nine months of fiscal 2003.

 

**Liquidity and Capital Resources**

 

Our operating activities used $2,290,299 in cash in the first ninemonths of fiscal 2004 compared to using $1,589,447 in the first nine months offiscal 2003, an increase of $700,852. The increase was primarily related to the increase in inventory, due tonew store openings.

 

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In the third quarter of fiscal 2004, we financed $309,000 of premiumsrelated to property and casualty insurance at a fixed interest rate of 4.25%with a maturity date of May 2005.  Duringthe period we also financed $129,200 of premiums related to directors andofficers insurance at a fixed interest rate of 5.62% with a maturity date of January 2005.  The remaining insurance premium payments andannual insurance expenses are recorded in accrued expenses and prepaidexpenses.

 

We used $1,648,300 of net cash in investing activities in the firstnine months of fiscal 2004 compared to $714,292 in the first nine months of2003.  The cash invested in the firstnine months of 2004 included approximately $1,144,000 for fixed assetsassociated with new stores, $291,000 in store improvements and $156,000 for ournew point-of-sale system.

 

We provided $2,339,490 in net cash by financing activities in the firstnine months of 2004 compared to $2,337,824 in the first nine months of2003.  Net borrowings under our line ofcredit in the first nine months of fiscal 2004 were consistent with fiscal2003.

 

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

 

The amended agreement includes a financialcovenant requiring us to maintain a minimum availability under the line in theamount of 5% of the credit limit, which at the current limit of $7,500,000, is$375,000.  If we adjust the credit limitin the future, the minimum availability would be 5% of the adjusted creditlimit.  The amended agreement also has acovenant that requires us to limit our capital expenditures to within 110% ofthose amounts included in our business plan, which may be updated from time totime.

 

The amounts outstanding under our line were$6,260,579 as of September 25, 2004 and $3,760,671 as of December 27,2003.  The outstanding balances under ourline are classified as current liabilities in the accompanying consolidatedbalance sheets since we are required to apply daily lock-box receipts to reducethe amount outstanding.  At September 25,2004, we had approximately $397,000 of additional availability under the lineof credit.  Our seasonal build-up ofHalloween inventory led to this relatively low level of additional availabilityat September 25, 2004.  In the thirdquarter of fiscal 2004, we established a letter of credit for $356,000 withWells Fargo Bank, N.A. associated with the leasing of our new point-of-salesystem.

 

As of September 25,2004, we recorded additions to property plant and equipment of approximately$1,349,000 for new point-of-sale equipment and software for our stores.  We invested approximately $156,000 of cash inthese fixed assets, financed $891,465 of these fixed assets under capitalleases and accrued approximately $302,000 for fixed assets whose capital leaseswere not yet signed as of September 25, 2004.

 

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 the remainder of 2004 and for 2005 to be primarily related tonew stores, store improvements and other technology advancements in support ofgrowth and operational enhancement.

 

Contractual obligationsat September 25, 2004, including leases signed for stores yet to open,were as follows:

 

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| ** **                                        | ** ** | **Payments Due By Period** | ** **       |
|---------------------------------------------------|------------|----------------------------|------------------|
| ** **                                        | ** ** | **Within  1 Year**         | ** **       | **Within  2 - 3  Years** | ** ** | **Within  4 - 5  Years** | ** ** | **After  5 Years** | ** ** | **Total** | ** ** |
| Line of  credit                                   |       | $                          | 6,260,579        |   | $ | — |   | $ | — |   | $ | — |   | $ | 6,260,579 |   |
| Capital  lease obligations                        |       | 241,433                    |             | 606,517 |   | — |   | — |   | 847,950 |   |
| Financed insurance  premiums                      |       | 366,759                    |             | — |   | — |   | — |   | 366,759 |   |
| Operating  leases (including retail space leases) |       | 6,899,485                  |             | 11,653,508 |   | 7,521,777 |   | 13,587,003 |   | 39,661,773 |   |
| Total  contractual obligations                    |       | $                          |  13,768,256 |   | $ |  12,260,025 |   | $ | 7,521,777 |   | $ | 13,587,003 |   | $ |  47,137,061 |   |

 

**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 sales ofEaster, graduation and summer merchandise in the second quarter and sales ofHalloween and Christmas merchandise in the fourth quarter.**

 

**Geographic Concentration**

 

**At November 9, 2004 we operated a total of 44stores, 40 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 the effects of inflation to have a material effect uponour business.

 

# **Factors That May AffectFuture Results**

 

Various risks, uncertainties andcontingencies could cause our actual results, performance or achievements todiffer materially from those expressed in, or implied by, statements containedin this Quarterly Report on Form 10-Q, including, but not limited to, the following:

 

•                  thesuccess or failure of our efforts to implement our business strategy, includingsuccessful site location of new stores and implementation of our newpoint-of-sale system;

•                  ourability or inability to obtain additional financing, if required;

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

•                  unseasonableweather;

•                  intensecompetition;

•                  theavailability of retail store space on reasonable lease terms;

•                  thefailure of our systems or those of our third-party suppliers;

•                  generaleconomic and other developments affecting consumer confidence or spendingpatterns, particularly in the New England region; and

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

 

**CriticalAccounting Policies and Estimates**

 

Our financial statements are based on theapplication of significant accounting policies, many of which requiremanagement to make significant estimates and assumptions (see Note 1 to theconsolidated financial statements).  Webelieve the following accounting policies to be those most important to theportrayal of our financial condition and those that require the most subjectivejudgment.  If actual results differsignificantly from management’s estimates and projections, there could be amaterial effect on our financial statements.

 

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*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*

 

Revenues include the selling price of partygoods sold, net of returns and discounts, and are recognized at the point ofsale.  We estimate returns based uponhistorical return rates and such amounts have not been significant.

 

*Impairment of Long-Lived Assets*

 

In accordance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,we perform an impairment review quarterly. If actual market conditions are less favorable than our projections,future write-offs may be necessary.

 

*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.  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 andBalance Sheet Presentation of Series A-F Convertible Preferred Stock*

 

The holders of our Series A-F convertiblepreferred stock have the right to a liquidation preference, which previouslycould have been exercised under certain events not within our control.  In accordance with EITF Topic D-98, weincluded the respective equity securities outside of permanent stockholders’deficit in our restated balance sheet as of December 28, 2002, and in ourbalance sheets through September 27, 2003, at their respective carryingvalues.

 

During the fourth quarter of 2003, thecomposition of our Board of Directors changed such that holders of ourconvertible preferred stock or the designates of our preferred stockholders nolonger 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 September 25, 2004 and December 27,2003 at its respective carrying values, as the redemption is deemed under EITFTopic D-98 to be solely within our control under these changed circumstances.

 

We will continue to review and consider thecriteria in EITF Topic D-98 at the reporting of each balance sheet.

 

*StockOption Compensation Expense*

 

We account for our stock option compensationagreements with employees under the provisions 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 andEquipment*

 

Propertyand equipment are stated at cost less accumulated depreciation and aredepreciated on the straight-line method over the estimated useful lives of theassets.  At the beginning of fiscal 2004we adopted a new policy for estimating the useful life of fixed assets whichextended the useful life of equipment, furniture and fixtures and

 

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point-of-sale specific computer hardware andsoftware.  Expenditures for maintenanceand repairs are charged to operations as incurred.

 

*Use of Estimates*

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires us to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting period. Our actual results could differ from our estimates.

 

**NewAccounting Pronouncements**

 

In January 2003,the FASB issued Interpretation No. 46, *Consolidationof Variable Interest Entities, an Interpretation of Accounting ResearchBulletin (“ARB”) No. 51* (“FIN46”)*.*  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 46must be applied for the first interim or annual period beginning after June 15,2003.  However, in October 2003, theFASB deferred the effective date of FIN 46 to the end of the first interim orannual period ending after December 15, 2003 for those arrangementsinvolving special purpose entities entered into prior to February 1,2003.  All other arrangements within thescope of FIN 46 are subject to its provisions beginning in 2004.  We adopted FIN 46, as required, with nomaterial impact to our consolidated financial position or results ofoperations.  We do not believe that theadoption of the remaining provisions of FIN 46 in 2004 will have a materialimpact on our financial position or results of operations.

 

On March 31, 2004, the Financial AccountingStandards Board (FASB) issued its Exposure Draft, *Share-BasedPayment*, which is a proposed amendment to FASB Statement No. 123, *Accounting for Stock-Based Compensation*.  Generally, the approach in the Exposure Draftis similar to the approach described in Statement 123.  However, the Exposure Draft would require allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values.  The FASB expects to issue a final standardlate in 2004 that would be effective for public companies (and for nonpubliccompanies that currently use the fair value method, rather than the minimumvalue method, for recognition or disclosure purposes) for interim or annualfiscal periods beginning after June 15, 2005.  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 no material change in our marketrisk exposure since the filing of our Annual Report on Form 10-K.

 

**Item 4.  Controls andProcedures**

 

(a) *Evaluation of 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) under the SecuritiesExchange Act) as of September 25, 2004. In designing and evaluating our disclosure controls and procedures, ourmanagement recognized that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving theirobjectives, and our management necessarily applied its judgment in evaluatingthe cost-benefit relationship of possible controls and procedures.  Based on this evaluation, our CEO and CFOconcluded that, as of September 25, 2004, our disclosure controls andprocedures were (1) designed to ensure that material information relating tous, including our consolidated subsidiaries, is made known to our CEO and CFOby others within those entities, particularly during the period in which thisreport was being prepared and (2) effective, in that they provide reasonableassurance that information required to be disclosed by us in the reports thatwe file or submit under the Securities Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms.

 

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(b) *Changesin 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 September 25, 2004 that has materially affected, oris reasonably likely to materially affect, our internal controls over financialreporting.

 

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PART II – OTHER INFORMATION

 

**Item1.  Legal Proceedings**

 

Not applicable.

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

 

Not applicable.

 

**Item3.  Defaults upon Senior Securities**

 

Not applicable.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

Not applicable.

 

**Item5.  Other Information**

 

Not applicable.

 

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

 

(a) Exhibits

 

The exhibitslisted in the Exhibit Index immediately preceding the exhibits are filed aspart of this Quarterly Report on Form 10-Q.

 

(b) Reports on Form 8-K

 

On July 28,2004, we furnished a Current Report on Form 8-K under Item 12 containing apress release announcing our financial results for the fiscal quarter ended June 26,2004.

 

On November 3,2004, we furnished a Current Report on Form 8-K under Item 2.02 containing apress release announcing our financial results for the fiscal quarter ended September 25,2004 and sales for October 2004.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe 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:   November 9, 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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