UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 2006
OR
|_| TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Transition Period from _______________ to _______________
Commission File Number 0-25507
------------------------------
iPARTY CORP.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 76-0547750
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) 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)
----------------------------------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check
one).
Large accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|
Indicate by check mark whether the registrant is a shell company as defined
in Rule 12b-2 of the Exchange Act. Yes |_| No |X|
As of November 10, 2006 there were 22,564,487 shares of common stock, $.001
par value, outstanding.
iPARTY CORP.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets 2
Consolidated Statements of Operations 3
Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Item 4. Controls and Procedures 22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings Not applicable
Item 1A. Risk Factors 23
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds 23
Item 3. Defaults upon Senior Securities Not applicable
Item 4. Submission of Matters to a Vote of Security Holders Not applicable
Item 5. Other Information Not applicable
Item 6. Exhibits 23
SIGNATURES 24
EXHIBIT INDEX 25
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 -
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
iPARTY CORP.
CONSOLIDATED BALANCE SHEETS
Sep 30, 2006 Dec 31, 2005
-------------- --------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,045,214 $ 699,194
Restricted cash 797,428 651,617
Accounts receivable 971,586 1,246,545
Inventory, net 16,775,354 13,251,307
Prepaid expenses and other assets 2,103,304 548,114
-------------- --------------
Total current assets 21,692,886 16,396,777
Property and equipment, net 4,831,461 5,187,099
Intangible assets, net 2,267,986 -
Other assets 105,646 133,200
-------------- --------------
Total assets $ 28,897,979 $ 21,717,076
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 11,622,217 $ 4,695,094
Accrued expenses 2,844,659 2,532,238
Current portion of capital lease obligations 449,311 442,358
Current notes payable 541,514 -
Borrowings under line of credit 5,306,358 6,635,874
-------------- --------------
Total current liabilities 20,764,059 14,305,564
Long-term liabilities:
Capital lease obligations, net of current portion 65,867 426,995
Notes payable 3,781,254 -
Other liabilities 836,058 669,003
-------------- --------------
Total long-term liabilities 4,683,179 1,095,998
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock - $.001 par value; 10,000,000 shares authorized,
Series B convertible preferred stock - 1,150,000 shares authorized; 473,901
and 474,402 shares issued and outstanding at Sep 30, 2006 and Dec 31, 2005,
respectively (aggregate liquidation value of $9,478,024 at Sep 30, 2006) 7,051,650 7,059,101
Series C convertible preferred stock - 100,000 shares authorized, issued and
outstanding (aggregate liquidation value of $2,000,000 at Sep 30, 2006) 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 Sep 30, 2006) 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 Sep 30, 2006) 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 Sep 30, 2006) 500,000 500,000
-------------- --------------
Total convertible preferred stock 13,808,650 13,816,101
Common stock - $.001 par value; 150,000,000 shares authorized; 22,564,487 and
22,536,637 shares issued and outstanding at Sep 30, 2006 and Dec 31, 2005,
respectivley 22,564 22,537
Additional paid-in capital 51,623,060 50,971,656
Accumulated deficit (62,003,533) (58,494,780)
-------------- --------------
Total stockholders' equity 3,450,741 6,315,514
-------------- --------------
Total liabilities and stockholders' equity $ 28,897,979 $ 21,717,076
============== ==============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
- 2 -
iPARTY CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the three months ended For the nine months ended
---------------------------- ----------------------------
Sep 30, 2006 Sep 24, 2005 Sep 30, 2006 Sep 24, 2005
------------- ------------- ------------- -------------
Revenues $ 17,240,535 $ 14,839,051 $ 49,373,503 $ 44,516,336
Operating costs:
Cost of products sold and occupancy costs 10,266,805 9,042,165 29,662,875 26,752,342
Marketing and sales 6,583,780 6,204,540 17,931,894 16,316,817
General and administrative 1,639,993 1,852,047 4,737,681 5,187,189
------------- ------------- ------------- -------------
Operating loss (1,250,043) (2,259,701) (2,958,947) (3,740,012)
Interest expense, net (222,285) (150,960) (549,806) (382,540)
------------- ------------- ------------- -------------
Net loss $ (1,472,328) $ (2,410,661) $ (3,508,753) $ (4,122,552)
============= ============= ============= =============
Loss per share:
Basic and diluted $ (0.07) $ (0.11) $ (0.16) $ (0.19)
============= ============= ============= =============
Weighted-average shares outstanding:
Basic and diluted 22,555,333 22,147,063 22,549,026 22,123,289
============= ============= ============= =============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
- 3 -
iPARTY CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the nine months ended
-----------------------------
Sep 30, 2006 Sep 24, 2005
------------- -------------
Operating activities:
Net loss $ (3,508,753) $ (4,122,552)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization 938,038 785,693
Deferred rent 167,055 93,387
Non-cash stock based compensation 26,439 -
Non-cash warrant expense 17,046 -
Changes in operating assets and liabilities:
Accounts receivable 274,959 (244,456)
Inventory (3,226,634) (5,998,147)
Prepaid expenses and other assets (1,188,807) 56,431
Accounts payable 6,927,123 6,038,326
Accrued expenses and other liabilities (146,486) 45,830
------------- -------------
Net cash provided by (used in) operating activities 279,980 (3,345,488)
Investing activities:
Acquisition of retail store and non-compete agreement (1,869,115) -
Purchase of property and equipment (432,045) (1,480,824)
------------- -------------
Net cash used in investing activities (2,301,160) (1,480,824)
Financing activities:
Net borrowings under line of credit (1,329,516) 4,261,780
Proceeds from notes payable 4,319,373 -
Increase (decrease) in restricted cash (145,811) 109,532
Principal payments on capital lease obligations (354,175) (314,338)
Deferred financing costs (126,561) 9,804
Proceeds from exercise of stock options 3,890 3,598
------------- -------------
Net cash provided by financing activities 2,367,200 4,070,376
------------- -------------
Net increase in cash and cash equivalents 346,020 (755,936)
Cash and cash equivalents, beginning of period 699,194 1,757,157
------------- -------------
Cash and cash equivalents, end of period $ 1,045,214 $ 1,001,221
============= =============
Supplemental disclosure of non-cash financing activities:
Conversion of Series B convertible preferred stock to common stock $ 7,451 $ 66,958
============= =============
Acquisition of assets under capital lease $ - $ 132,968
============= =============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
- 4 -
iPARTY CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES:
Interim Financial Information
The interim consolidated financial statements as of September 30, 2006 have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (the "SEC") for interim financial reporting.
These consolidated statements are unaudited and, in the opinion of management,
include all adjustments (consisting of normal recurring adjustments and
accruals) necessary to present fairly the consolidated balance sheets,
consolidated operating results, and consolidated cash flows for the periods
presented in accordance with generally accepted accounting principles. The
consolidated balance sheet at December 31, 2005 has been derived from the
audited consolidated financial statements at that date. Operating results for
the Company on a quarterly 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 operating income have been experienced in the
second and fourth fiscal quarters, while the Company has generated losses in the
first and third quarters. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been omitted in accordance with the rules and
regulations of the SEC. These consolidated financial statements should be read
in conjunction with the audited consolidated financial statements, and
accompanying notes, included in the Company's Annual Report on Form 10-K, for
the year ended December 31, 2005.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries after elimination of all significant
intercompany transactions and balances.
Revenue Recognition
Revenues include 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 and such amounts have not been
significant.
Concentrations
The Company purchases its inventory from a diverse group of vendors. Three
suppliers account for approximately 30% of the Company's purchase of
merchandise, but the Company does not believe that it is overly dependent upon
any single source for its merchandise, often using more than one vendor for
similar kinds of products. The Company entered into a Supply Agreement with its
largest supplier on August 7, 2006 which will require the Company to increase
its purchases with that vendor by 2008.
Accounts receivable primarily represent amounts due from credit card
companies and vendors for inventory rebates. Management does not provide for
doubtful accounts as such amounts have not been significant to date; the Company
does not require collateral.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these estimates.
- 5 -
Cash and Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments with an original
maturity date of three months or less to be cash equivalents. Cash equivalents
consist primarily of money market accounts and are carried at cost plus accrued
interest, which approximates fair value.
The Company uses controlled disbursement banking arrangements as part of
its cash management program. Outstanding checks, which were included in accounts
payable, totaled $1,847,238 at September 30, 2006 and $627,269 at December 31,
2005. The Company had sufficient funds available to fund the outstanding checks
when they were presented for payment.
Restricted cash represents money deposited in blocked accounts established
for the benefit of and under the control of Wells Fargo Retail Finance II, LLC,
the Company's lender under its line of credit, and constitutes collateral for
amounts outstanding under the Company's line of credit.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, accounts receivable and
accounts payable approximate fair value because of the short-term nature of
these instruments. The fair value of borrowings under its line of credit
approximates carrying value because the debt bears interest at a variable market
rate. The fair value of the capital lease obligations approximates the carrying
value. The fair value of the notes payable approximates the carrying value. The
fair value of the warrants was determined by using the Black-Scholes model
(volatility of 108%, interest of 4.73% and expected life of five years).
Inventories
Inventories consist of party supplies and are valued at the lower of moving
weighted-average cost or market. Inventory has been reduced by an allowance for
obsolete and excess inventory, which is based on management's review of
inventories on hand compared to estimated future sales. The Company records
vendor rebates, discounts and certain other adjustments to inventory, including
freight costs, and these amounts are recognized in the income statement as the
related goods are sold.
The activity in the allowance for obsolete and excess inventory is as
follows:
Nine months ended Twelve months ended
Sep 30, 2006 Dec 31, 2005
------------ ------------
Beginning balance $ 1,098,974 $ 1,296,855
Increases to reserve 449,550 300,000
Write-offs against reserve (418,067) (497,881)
------------ ------------
Ending balance $ 1,130,457 $ 1,098,974
============ ============
Net Income (Loss) per Share
Net income (loss) per basic share is computed by dividing net income (loss)
by the weighted average number of common shares outstanding plus the common
share equivalents of Series B-F preferred stock. The common share equivalents of
Series B-F are included in the calculation of net income (loss) per basic share
in accordance with EITF Topic D-95, Effect of Participating Convertible
Securities on the Computation of Basic Earnings Per Share, since the preferred
stockholders are entitled to participate in dividends when and if declared by
the Board of Directors. For the periods with net losses, the Company excludes
those common share equivalents since their impact would be anti-dilutive.
Net income (loss) per diluted share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding, plus the
common share equivalents of Series B-F preferred stock, plus the common share
equivalents of the "in the money" stock options and warrant as computed by the
treasury method. For the periods with net losses, the Company excludes those
common share equivalents since their impact would be anti-dilutive.
- 6 -
As of September 30, 2006, there were 28,503,956 potential additional common
share equivalents outstanding, which were not included in the calculation of
diluted net loss per share because their effect would be anti-dilutive. These
included 15,623,799 shares upon the conversion of immediately convertible
preferred stock, 2,083,334 shares upon the exercise of warrant with an exercise
price of $0.475, 528,210 shares upon the exercise of warrant with a weighted
average exercise price of $3.79 and 10,268,613 shares upon the exercise of stock
options with a weighted average exercise price of $0.95.
Stock Option Compensation Expense
On January 1, 2006, the Company adopted the Financial Accounting Standards
Board ("FASB") Statement No. 123(R), Share-Based Payments, using the modified
prospective method. Under this method, stock based compensation expense is
recognized for new grants beginning this fiscal year and any unvested grants
prior to the adoption of Statement No. 123(R). Prior to fiscal 2006, the Company
accounted for share-based payments to employees using the Accounting Principles
Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and the
disclosure-only provisions of Statement No. 123, Accounting for Stock-Based
Compensation. Because the Company granted stock options to employees at exercise
prices equal to fair market value on the date of grant, no stock based
compensation cost was recognized for option grants in periods prior to fiscal
2006.
In response to Statement No. 123(R), on September 21, 2005, the Company's
Board of Directors approved an acceleration of the vesting of certain unvested
and "out-of-the-money" stock options previously awarded to employees and
officers with exercise prices equal to or greater than $0.69 per share. Options
held by non-employee directors were excluded from the vesting acceleration. As a
result, options to purchase approximately 1.0 million shares of iParty stock
became exercisable immediately. Based upon the Company's closing stock price of
$0.46 on September 21, 2005, none of these options had intrinsic value on the
date of acceleration.
In making the decision to accelerate these options, the Company's Board of
Directors considered the interest of the stockholders as it would reduce the
Company's reported stock based compensation expense in future periods following
the effectiveness of Statement No. 123(R). The future stock based compensation
expense that was eliminated was approximately $508,000 on a pre-tax basis and is
reflected in the pro forma footnote disclosure for the year ended December 31,
2005.
Under Statement No. 123(R), the Company will continue to use the
Black-Scholes option pricing model to determine the fair value of stock based
compensation. The Black-Scholes model requires the Company to make several
subjective assumptions, including the estimated length of time employees will
retain their vested stock options before exercising them ("expected term"), and
the estimated volatility of the Company's common stock price over the expected
term, which is based on historical volatility of the Company's common stock over
a time period equal to the expected term. The Black-Scholes model also requires
a risk-free interest rate, which is based on the U.S. Treasury yield curve in
effect at the time of the grant, and the dividend yield on the Company's common
stock, which is assumed to be zero since the Company does not pay dividends and
has no current plans to do so in the future. Changes in these assumptions can
materially affect the estimate of fair value of stock based compensation and
consequently, the related expense recognized on the consolidated statement of
operations. Under the modified prospective method, stock based compensation
expense is recognized for new grants beginning this fiscal year and any unvested
grants prior to the adoption of Statement No. 123(R). The Company recognizes
stock based compensation expense on a straight-line basis over the employee's
vesting period.
The Company recognized stock based compensation expense of $11,862 and $0
in the three months ended September 30, 2006 and September 24, 2005,
respectively. The Company recognized stock based compensation expense of $26,439
and $0 for the nine months ended September 30, 2006 and September 24, 2005,
respectively. Stock based compensation expense is included in general and
administrative expense. The adoption of Statement No. 123(R) had no impact on
cash flow from operations and cash flow from financing activities for the nine
months ended September 30, 2006.
In accordance with Statement No. 123(R), the results for the nine months
ended September 24, 2005 have not been restated. If the stock based compensation
expenses for the Company's stock option plan had been determined based upon the
fair value at the grant date for awards made prior to fiscal 2006 under the plan
consistent with the methodology prescribed under Statement No. 123, the
Company's net loss would have been increased by $717,743 for the three months
ended September 24, 2005 and $927,744 for the nine months ended September 24,
2005. Basic and diluted loss per share would have increased by $0.03 for the
three months ended September 24, 2005 and $0.04 for the nine months ended
September 24, 2005.
- 7 -
Three months Nine months
ended ended
Sep 24, 2005 Sep 24, 2005
------------- -------------
Net loss:
Reported $ (2,410,661) $ (4,122,552)
Deduct: Total stock based compensation expense
determined under fair value based method for all
awards (717,743) (927,744)
------------- -------------
Pro forma $ (3,128,404) $ (5,050,296)
============= =============
Loss per share:
Reported
Basic and diluted: $ (0.11) $ (0.19)
============= =============
Pro forma
Basic and diluted: $ (0.14) $ (0.23)
============= =============
Under the Company's Amended and Restated 1998 Incentive and Nonqualified
Stock Option Plan (the "1998 Plan") options to acquire 11,000,000 shares of
common stock may be granted to officers, directors, key employees and
consultants. The exercise price for qualified incentive options cannot be less
than the fair market value of the stock on the grant date and the exercise price
of nonqualified options can be fixed by the Board. Qualified incentive options
to purchase the Company's common stock under the 1998 Plan have been granted to
employees, directors and consultants of the Company at fair market value at the
date of grant. Generally, the options become exercisable over periods of up to
four years, and expire ten years from the date of grant.
There were no options granted in the third quarter of fiscal 2006. The
weighted-average fair market value, using the Black-Scholes option-pricing
model, of the options granted in the nine month period ended September 30, 2006
was $0.30 per share, and for options granted in the three month and nine month
period ended September 24, 2005 was $0.36 and $0.43 per share, respectively. The
fair market value of the stock options at the date of the grant was estimated
using the Black-Scholes option-pricing model with the following weighted average
assumptions:
For the three months ended For the nine months ended
Sep 30, 2006 Sep 24, 2005 Sep 30, 2006 Sep 24, 2005
------------ ------------ ------------ ------------
Risk-free interest rate N/A 4.01% 5.18% 3.76%
Expected volatility N/A 109.0% 115.6% 111.5%
Weighted average expected life (in years) N/A 5.0 5.0 5.0
Expected dividends N/A 0.00% 0.00% 0.00%
- 8 -
A summary of the Company's stock options is as follows:
Weighted
Number Weighted Average
of Average Remaining Aggregate
Stock Exercise Price Life Intrinsic
Options Price Range (Years) Value
--------------- --------------- ----------------------- --------------- -----------------
Outstanding - December 31,
2005 10,340,841 $0.95 $0.13 - $5.38
Granted 100,000 0.36 0.36 - 0.36
Expired/Forfeited (150,813) 0.60 0.13 - 1.33
Exercised (21,415) 0.16 0.16 - 0.33
---------------
Outstanding - September 30,
2006 10,268,613 $0.95 $0.13 - $5.38 4.9 $522,095
===============
Exercisable - September 30,
2006 10,103,695 $0.96 $0.13 - $5.38 4.9 $519,774
===============
Available for grant -
September 30, 2006 318,428
===============
The following table summarizes information for options outstanding and
exercisable at September 30, 2006:
Outstanding Exercisable
---------------------------------------------------------------------------
Weighted
Number Average Weighted Number Weighted
of Remaining Average of Average
Stock Life Exercise Stock Exercise
Price Range Options (Years) Price Options Price
----------------------------------------------------------------------------------------------------
$0.13 - $0.20 146,250 4.8 $0.18 142,749 $0.18
0.21 - 0.30 3,810,532 4.5 0.25 3,801,926 0.25
0.31 - 0.50 1,173,371 5.9 0.36 1,049,076 0.35
0.51 - 1.00 3,169,830 6.5 0.77 3,141,314 0.77
1.01 - 3.50 978,630 2.8 2.18 978,630 2.18
3.51 - 5.38 990,000 2.6 3.82 990,000 3.82
--------------- ---------------
Total 10,268,613 4.9 $0.95 10,103,695 $0.96
=============== ===============
The total fair value of shares vested during the three months ended
September 30, 2006 was $630. The remaining unrecognized stock based compensation
expense related to unvested awards at September 30, 2006, was $48,345 and the
period of time over which this expense will be recognized is 3.0 years.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation
and are depreciated on the straight-line method over the estimated useful lives
of the assets. Expenditures for maintenance and repairs are charged to
operations as incurred. A listing of the estimated useful 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
- 9 -
Intangible Assets
Intangible assets consist primarily of the value of a five-year
non-compete agreement from Party City Corporation and its affiliates that covers
Massachusetts, Maine, New Hampshire, Vermont, Rhode Island, and Windsor and New
London counties in Connecticut which expires in 2011. This asset has an
estimated life of 60 months. Also included is the value related to the retail
store lease that the Company acquired from Party City in Peabody, Massachusetts.
This asset has an estimated life of 90 months. The other intangible assets
consist of legal and other transaction fees related to the three-year note
payable due on September 15, 2009. These assets are being amortized over the
life of the note payable.
Intangible assets as of September 30, 2006 and December 31, 2005 were:
Sep 30, 2006 Dec 31, 2005
----------------------------------------
Non-compete agreement $ 1,725,369 -
Lease valuation 459,700 -
Other 154,949 -
----------------------------------------
Intangible assets 2,340,018 -
Less: accumulated amortization (72,032) -
----------------------------------------
Intangible assets, net $ 2,267,986 $ -
========================================
Amortization expense for these intangible assets was $72,032 and $0 for
the three months ended September 30, 2006 and September 24, 2005 respectively.
The non-compete agreement amortization expense is included in general and
administrative expense on the Consolidated Statement of Operations. The
occupancy valuation amortization expense is included in cost of goods sold and
occupancy costs. The amortization expense for the other intangible assets is
included in general and administrative expense.
Future amortization expense related to these intangible assets as of
September 30, 2006:
Year Amount
---- --------------------
2006 $114,504
2007 458,017
2008 458,017
2009 440,800
2010 406,367
Thereafter 390,281
--------------------
Total $2,267,986
====================
Accounting for the Impairment of Long-Lived Assets
In accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, the Company reviews each store for impairment
indicators whenever events and changes in circumstances suggest that the
carrying amounts may not be recoverable from estimated future store cash flows.
The Company's review considers store operating results, future sales growth and
cash flows.
Subsequent Events
On October 24, 2006, the Company, pursuant to its Supply Agreement with
Amscan Inc. dated August 7, 2006, elected to convert $1,143,896 of extended
payables originally due to Amscan as of August 8, 2006 as well as an additional
$675,477 of payables due to Amscan as of September 28, 2006 into a single
subordinated promissory note in the total principal amount of $1,819,373. The
note will bear interest at the rate of 11.0% per annum and will be payable in
thirty-six (36) equal monthly installments of principal and interest of
$59,562.48 commencing on November 1, 2006, and on the first day of each month
thereafter until October 1, 2009, when the entire remaining principal balance
and all accrued interest shall be due and payable.
- 10 -
On October 30, 2006, the Company further amended its agreement with Wells
Fargo to extend the maturity date of its outstanding term loan in the amount of
$500,000 from October 31, 2006 to January 2, 2007.
On October 9, 2006, the Company decided to close its store in East
Providence, Rhode Island effective November 4, 2006 due to underperforming
sales. As a result of this closing, the Company will incur a charge in the
fourth quarter of approximately $120,000 related to remaining lease payments and
other closing costs. The initial term of the lease is due to expire on August
31, 2007.
On November 13, 2006, the Company signed a commitment letter with Wells
Fargo to extend its line of credit for three years to January 2, 2010. In
addition to the three year extension, the terms of the commitment letter include
an option to increase the line of credit to $15,000,000. The Company expects to
sign a new agreement with Wells Fargo which incorporates the terms of the
commitment letter prior to the maturity date on the existing line of credit.
However, the obligation of Wells Fargo to establish the credit facility
contemplated by the commitment letter is not unconditional and is subject to the
satisfaction of certain terms and conditions specified in the commitment letter,
including the execution and delivery of definitive loan documents.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the unaudited
Consolidated Financial Statements and related Notes included in Item 1 of this
Quarterly Report on Form 10-Q and the audited Consolidated Financial Statements
and related Notes and Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations", contained in our Annual Report on Form
10-K for the fiscal year ended December 31, 2005.
Certain statements in this Quarterly Report on Form 10-Q, particularly
statements contained in this Item 2, "Management's Discussion and Analysis of
Financial Condition and Results of Operations" constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The
words "anticipate", "believe", "estimate", "expect", "plan", "intend" and other
similar expressions are intended to identify these forward-looking statements,
but are not the exclusive means of identifying them. Forward-looking statements
included in this Quarterly Report on Form 10-Q or hereafter included in other
publicly available documents filed with the Securities and Exchange Commission
("SEC"), reports to our stockholders and other publicly available statements
issued or released by us involve known and unknown risks, uncertainties, and
other factors which could cause our actual results, performance (financial or
operating) or achievements to differ from the future results, performance
(financial or operating) or achievements expressed or implied by such forward
looking statements. Such future results are based upon our best estimates based
upon current conditions and the most recent results of operations. Various
risks, uncertainties and contingencies could cause our actual results,
performance or achievements to differ materially from those expressed in, or
implied by, the forward-looking statements contained in this Quarterly Report on
Form 10-Q. These include, but are not limited to, those described below under
the heading "Factors That May Affect Future Results" and in Part II, Item 1A,
"Risk Factors" as well as under Item 1A, "Risk Factors" of our most recently
filed Annual Report on Form 10-K for the year ended December 31, 2005.
Overview
We believe we are a leading brand in the party industry in the markets we
serve and a leading resource in those markets for consumers seeking party goods,
party planning advice and relevant information. We are a party goods retailer
operating stores throughout New England, where 46 of our 51 retail stores are
located. We also license the name "iparty.com" (at www.iparty.com) to a third
party in exchange for royalties, which to date have not been significant.
Our 51 retail stores are located predominantly in New England with 26
stores in Massachusetts, 7 in Connecticut, 6 in New Hampshire, 3 in Rhode
Island, 3 in Maine and 1 in Vermont. We also operate 5 stores in Florida. Our
stores range in size from approximately 8,000 square feet to 20,300 square feet
and average approximately 9,800 square feet in size. We lease our properties,
typically for 10 years and usually with options from our landlords to renew our
leases for an additional 5 or 10 years.
- 11 -
The following table shows the number of stores in operation:
For the three months ended For the nine months ended
------------------------------ ------------------------------
Sep 30, 2006 Sep 24, 2005 Sep 30, 2006 Sep 24, 2005
------------------------------ ------------------------------
Beginning of period 50 45 50 44
Openings / Acquisitions 1 5 1 6
Closings - - - -
------------------------------ ------------------------------
End of period 51 50 51 50
============================== ==============================
On August 7, 2006, we acquired one store in Peabody, Massachusetts.
Our stores feature over 20,000 products ranging from paper party goods,
Halloween costumes, greeting cards and balloons to more unique merchandise such
as pinatas, tiny toys, masquerade and Hawaiian Luau items. Our sales are driven
by the following holiday and party events: Halloween, Christmas, Easter,
Valentine's Day, New Year's, Independence Day, St. Patrick's Day, Thanksgiving
and Hanukkah. We also focus our business closely on lifetime events such as
anniversaries, graduations, birthdays, and bridal or baby showers.
Our business has a seasonal pattern. In the past three years, we have
realized approximately 37.4% of our annual revenues in our fourth quarter, which
includes Halloween and Christmas, and approximately 23.6% of our revenues in the
second quarter, which includes school graduations. Also, during the past three
years, we have had net income in our second and fourth quarters and generated
losses in our first and third quarters.
Among our primary goals are to increase our comparable store sales,
increase our gross profit margin percentage and leverage our occupancy costs,
marketing and sales expense and general and administrative expense as the 12
stores we opened over the past two years reach maturity. We do not currently
plan to open any new stores. We acquired one store in August 2006.
Results of Operations
Fiscal year 2006 has 52 weeks and ends on December 30, 2006. Fiscal year
2005 had 53 weeks and ended on December 31, 2005.
The third quarter of fiscal year 2006 had 13 weeks and ended on September
30, 2006. The third quarter of fiscal year 2005 had 13 weeks and ended on
September 24, 2005.
Three Months Ended September 30, 2006 Compared to Three Months Ended September
24, 2005
Revenues
Revenues include the selling price of party goods sold, net of returns
and discounts, and are recognized at the point of sale. Our consolidated
revenues for the third quarter of fiscal 2006 were $17,240,535, an increase of
$2,041,484, or 16.2% from the third quarter of the prior fiscal year.
For the three months ended
----------------------------------------
Sep 30, 2006 Sep 24, 2005
----------------------------------------
Revenues $17,240,535 $14,839,051
Increase in revenues 16.2% 12.8%
- 12 -
Sales for the third quarter of fiscal 2006 included sales from 45
comparable stores (defined as stores open for at least one full year), sales
from five new stores that opened in the third quarter of 2005 and which were not
included in comparable store sales for the third quarter of 2006 until they had
been open for one full year, and sales from one store that was acquired during
the third quarter of 2006. Comparable store sales for the quarter increased by
7.0%.
Cost of goods sold and occupancy costs
Cost of goods sold and occupancy costs consist of the cost of merchandise
sold to customers and the occupancy costs for our stores. Our cost of goods sold
and occupancy costs for the third quarter of fiscal 2006 was $10,266,805, or
59.6% of revenues, an increase of $1,224,640 and a decrease of 1.3 percentage
points, as a percentage of revenues, from the third quarter of the prior fiscal
year.
For the three months ended
------------------------------
Sep 30, 2006 Sep 24, 2005
------------------------------
Cost of goods sold and occupancy costs $10,266,805 $9,042,165
Percentage of revenues 59.6% 60.9%
As a percentage of revenues, the decrease in cost of goods sold and
occupancy costs was primarily attributable to improved pricing from vendors and
improved product mix.
Marketing and sales expense
Marketing and sales expense consists primarily of advertising and
promotional expenditures, all store payroll and related expenses for personnel
engaged in marketing and selling activities and other non-payroll expenses
associated with operating our stores. Our consolidated marketing and sales
expense for the third quarter of fiscal 2006 was $6,583,780, or 38.2% of
revenues, an increase of $379,240 and a decrease of 3.6 percentage points, as a
percentage of revenues, from the third quarter of the prior fiscal year.
For the three months ended
------------------------------
Sep 30, 2006 Sep 24, 2005
------------------------------
Marketing and sales $6,583,780 $6,204,540
Percentage of revenues 38.2% 41.8%
As a percentage of revenues, the decrease in marketing and sales expense
was primarily attributable to store payroll and lower pre-opening related
expenses.
General and administrative expense
General and administrative ("G&A") expense consists of payroll and
related expenses for executive, merchandising, finance and administrative
personnel, as well as information technology, professional fees and other
general corporate expenses. Our consolidated G&A expense for the third quarter
of fiscal 2006 was $1,639,993, or 9.5% of revenues, a decrease of $212,054 and
3.0 percentage points, as a percentage of revenues, from the third quarter of
the prior fiscal year.
For the three months ended
------------------------------
Sep 30, 2006 Sep 24, 2005
------------------------------
General and administrative $1,639,993 $1,852,047
Percentage of revenues 9.5% 12.5%
The decrease in G&A expense is largely attributable to reductions in
professional fees related to the support of our point-of-sale system and
information technology consulting fees offset by the amortization expense of the
non-compete agreement, compared to the third quarter of fiscal 2005.
- 13 -
Operating loss
Our operating loss for the third quarter of fiscal 2006 was $1,250,043,
or 7.3% of revenues, compared to an operating loss of $2,259,701, or 15.2% of
revenues for the third quarter of the prior fiscal year.
Interest expense, net
Our interest expense in the third quarter of fiscal 2006 was $222,285, an
increase of $70,849 from the third quarter of the prior fiscal year. The
increase in the third quarter of fiscal 2006 was due to an increase in interest
rates, interest related to notes payable, and warrant expense related to notes
payable. Our average loan balance was approximately $7,112,625 during the third
quarter of fiscal 2006 compared to $7,242,844 in the third quarter of fiscal
2005, which decreased interest expense by approximately $3,011. However, the
effective interest rate on our borrowings under our line of credit was 9.2%
during the third quarter of fiscal 2006 compared to 6.9% in the third quarter of
fiscal 2005, which increased interest expense by approximately $41,919. The
interest expense in the third quarter of 2006 related to the notes payable and
warrants was $10,137 and $17,046, respectively. The interest rate on our line of
credit for the third quarter of 2006 is based on the bank's base rate plus 75
basis points. There was no interest income offsetting the interest expense in
the third quarter of fiscal 2006, a decrease of $477 from the third quarter of
fiscal 2005.
Income taxes
We have not provided for income taxes for the third quarter of fiscal
2006 or fiscal 2005 due to the uncertainty of future taxable income.
At the end of fiscal 2005, we had estimated net operating loss
carryforwards of approximately $23.7 million, which begin to expire in 2018. In
accordance with Section 382 of the Internal Revenue Code, the use of these
carryforwards will be subject to annual limitations based upon certain ownership
changes of our stock that have occurred or that may occur.
Net Loss
Our net loss in the third quarter of fiscal 2006 was $1,472,328, or $0.07
per basic and diluted share, compared to a net loss of $2,410,661, or $0.11 per
basic and diluted share, in the third quarter of the prior fiscal year.
Nine months ended September 30, 2006 Compared to Nine months ended September 24,
2005
Revenues
Revenues include the selling price of party goods sold, net of returns
and discounts, and are recognized at the point of sale. Our consolidated
revenues for the first nine months of fiscal 2006 were $49,373,503, an increase
of $4,857,167, or 10.9% from the first nine months of the prior fiscal year.
For the nine months ended
------------------------------
Sep 30, 2006 Sep 24, 2005
------------------------------
Revenues $49,373,503 $44,516,336
Increase in revenues 10.9% 9.8%
Sales for the first nine months of fiscal 2006 included sales from 45
comparable stores (defined as stores open for at least one full year), sales
from five new stores that opened in the third quarter of 2005 and which were not
included in comparable store sales for the first nine months of 2006 until they
had been open for one full year, and sales from one store that was acquired
during the third quarter of 2006. Our comparable store sales for the nine month
year-to-date period increased by 2.6%.
- 14 -
Cost of goods sold and occupancy costs
Cost of goods sold and occupancy costs consist of the cost of merchandise
sold to customers and the occupancy costs for our stores. Our cost of goods sold
and occupancy costs for the first nine months of fiscal 2006 was $29,662,875, or
60.1% of revenues, an increase of $2,910,533 and remained the same as a
percentage of revenues, from the first nine months of the prior fiscal year.
For the nine months ended
------------------------------
Sep 30, 2006 Sep 24, 2005
------------------------------
Cost of goods sold and occupancy costs $29,662,875 $26,752,342
Percentage of revenues 60.1% 60.1%
Marketing and sales expense
Marketing and sales expense consists primarily of advertising and
promotional expenditures, all store payroll and related expenses for personnel
engaged in marketing and selling activities and other non-payroll expenses
associated with operating our stores. Our consolidated marketing and sales
expense for the first nine months of fiscal 2006 was $17,931,894, or 36.3% of
revenues, an increase of $1,615,077 and a decrease of 0.4 percentage points, as
a percentage of revenues, from the first nine months of the prior fiscal year.
For the nine months ended
------------------------------
Sep 30, 2006 Sep 24, 2005
------------------------------
Marketing and sales $17,931,894 $16,316,817
Percentage of revenues 36.3% 36.7%
As a percentage of revenues, the decrease in marketing and sales expense
was primarily attributable to lower pre-opening related expenses.
General and administrative expense
General and administrative ("G&A") expense consists of payroll and
related expenses for executive, merchandising, finance and administrative
personnel, as well as information technology, professional fees and other
general corporate expenses. Our consolidated G&A expense for the first nine
months of fiscal 2006 was $4,737,681, or 9.6% of revenues, a decrease of
$449,508 and 2.1 percentage points, as a percentage of revenues, from the first
nine months of the prior fiscal year.
For the nine months ended
------------------------------
Sep 30, 2006 Sep 24, 2005
------------------------------
General and administrative $4,737,681 $5,187,189
Percentage of revenues 9.6% 11.7%
The decrease in general and administrative expense in the first nine
months of fiscal 2006 compared to the first nine months of fiscal 2005 is
largely attributable to reductions in professional fees related to our
compliance work for Section 404 of Sarbanes-Oxley Act, support of our
point-of-sale system and information technology consulting fees offset by the
amortization expense of the non-compete agreement.
Operating loss
Our operating loss for the first nine months of fiscal 2006 was
$2,958,947, or 6.0% of revenues, compared to an operating loss of $3,740,012, or
8.4% of revenues for the first nine months of the prior fiscal year.
- 15 -
Interest expense, net
Our interest expense in the first nine months of fiscal 2006 was
$550,398, an increase of $167,100 from the first nine months of the prior fiscal
year. The increase in the first nine months of fiscal 2006 was due primarily to
an increase in interest rates, a higher average loan balance, interest related
to notes payable, and warrant expense related to notes payable. Our average loan
balance was approximately $6,759,048 during the first nine months of fiscal 2006
compared to $6,360,499 in the first nine months of fiscal 2005, which increased
interest expense by approximately $26,336. The effective interest rate on our
borrowings under our line of credit was 9.0% during the first nine months of
fiscal 2006 compared to 6.3% in the first nine months of fiscal 2005, which
increased interest expense by approximately $126,263. The interest expense for
the first nine months of 2006 related to notes payable and warrants was $10,137
and $17,046, respectively. The interest rate on our line of credit in the first
nine months is based on the bank's base rate plus 75 basis points. Interest
income offsetting the interest expense in the first nine months of fiscal 2006
was $592, a decrease of $166 from the first nine months of the prior fiscal
year.
Income taxes
We have not provided for income taxes for the first nine months of fiscal
2006 or fiscal 2005 due to the uncertainty of future taxable income.
At the end of fiscal 2005, we had estimated net operating loss
carryforwards of approximately $23.7 million, which begin to expire in 2018. In
accordance with Section 382 of the Internal Revenue Code, the use of these
carryforwards will be subject to annual limitations based upon certain ownership
changes of our stock that have occurred or that may occur.
Net Loss
Our net loss in the first nine months of fiscal 2006 was $3,508,753, or
$0.16 per basic and diluted share, compared to a net loss of $4,122,552, or
$0.19 per basic and diluted share, in the first nine months of the prior fiscal
year.
Liquidity and Capital Resources
Our operating activities provided $279,980 in the first nine months of
fiscal 2006 compared to a use of $3,345,488 in the first nine months of the
prior fiscal year, a decrease of $3,625,468. The decrease in cash used in
operating activities was primarily due to lower purchases of inventory offset by
an increase in prepaid expenses for occupancy costs and advertising. In the
first nine months of fiscal 2005, inventory purchases were higher due to the
initial inventory purchases related to the six new stores that were opened
during that period. We did not open any new stores in the first nine months of
fiscal 2006.
We used $2,301,160 in investing activities in the first nine months of
fiscal 2006 compared to $1,480,824 in the first nine months of the prior fiscal
year. The cash invested in the first nine months of fiscal 2006 was primarily
due to the acquisition in August 2006 of a retail store located in Peabody,
Massachusetts and a five-year non-compete agreement from Party City for
aggregate consideration of $1,870,617. This consideration included closing costs
of $19,117 for prepaid rent and utilities. The cash invested in the first nine
months of fiscal 2005 was primarily for fixed assets associated with new store
openings in that period and point-of-sale system enhancements.
We provided $2,367,200 by financing activities in the first nine months
of fiscal 2006 compared to $4,070,376 in the first nine months of the prior
fiscal year, a decrease of $1,103,176. We decreased our borrowings under our
line of credit by $1,329,516 in the first nine months of fiscal 2006 (to $5.3
million) compared to an increase of $4,261,780 in the first nine months of
fiscal 2005 (to $9.5 million). The borrowings under our line of credit in the
first nine months of fiscal 2006 were lower than the first nine months of fiscal
2005 primarily due to paying the line of credit down with funds received from a
$2.5 million note payable that we entered into during the third quarter of 2006.
Other factors contributing to higher borrowings in the first nine months of 2005
were capital expenditures related to the six 2005 new store openings,
enhancements to our point-of-sale system, and to support our net loss.
- 16 -
At September 30, 2006, we had a line of credit (the "line of credit")
with Wells Fargo Retail Finance II, LLC ("Wells Fargo"), which, as amended, has
a maturity date of January 2, 2007, has a current credit limit of $12,500,000,
and bears interest at the bank's base rate plus 50 basis points. Our inventory
and accounts receivable secure our line of credit. We borrow against these
assets at agreed upon advance rates, which may vary at different times of the
year.
During the third quarter, on August 7, 2006, we further amended our
agreement with Wells Fargo to permit us to enter into a Supply Agreement with
Amscan Inc. ("Amscan") and an Asset Purchase Agreement with Party City
Corporation ("Party City"). The amendment also allows for us to incur the
indebtedness represented by the Amscan Note and the Party City Note (each as
defined below), and to incur other unsecured subordinated indebtedness consented
to by Wells Fargo.
Subsequent to the end of our third quarter, on November 13, 2006, we
signed a commitment letter with Wells Fargo to extend our line of credit for
three years to January 2, 2010. In addition to the three year extension, the
terms of the commitment letter include an option to increase the line of credit
to $15,000,000. We expect to sign a new agreement with Wells Fargo which
incorporates the terms of the commitment letter prior to the maturity date on
the existing line of credit. However, the obligation of Wells Fargo to establish
the credit facility contemplated by the commitment letter is not unconditional
and is subject to the satisfaction of certain terms and conditions specified in
the commitment letter, including the execution and delivery of definitive loan
documents.
Our inventory consists of party supplies which are valued at the lower of
moving weighted-average cost or market and are reduced by an allowance for
obsolete and excess inventory and other adjustments, including vendor rebates,
discounts and freight costs. Our line of credit availability calculation allows
us to borrow against "acceptable inventory at cost," which takes our inventory
at cost and reflects adjustments that our lender has approved which may be
different than adjustments we use for valuing our inventory in our financial
statements, such as the adjustment to reserve for inventory shortage. The amount
of "acceptable inventory at cost" was $18,035,708 at September 30, 2006.
Our accounts receivable consist primarily of vendor rebate receivables
and credit card receivables. Our line of credit availability calculation allows
us to borrow against "eligible credit card receivables," which are the credit
card receivables for the previous two to three days of business. The amount of
"eligible credit card receivables" was $320,167 at September 30, 2006.
Our total borrowing base is 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 credit limit, which was $12,500,000 at September 30, 2006. Under the
terms of our line of credit, our $12,500,000 credit limit was further reduced by
(1) a minimum availability block, (2) customer deposits, (3) gift certificates,
(4) merchandise credits and (5) outstanding letters of credit. Therefore, our
additional availability was $7,232,742 at September 30, 2006 and $386,681 at
December 31, 2005.
The amount outstanding under our line was $5,306,358 as of September 30,
2006, and $6,635,874 as of December 31, 2005. The outstanding balances under our
line are classified as current liabilities in the accompanying consolidated
balance sheets since we are required to apply daily lock-box receipts to reduce
the amount outstanding. As of November 10, 2006, we were in compliance with the
covenants under the line of credit.
On January 17, 2006, we amended our agreement with Wells Fargo to allow
for a $500,000 term loan which increased our borrowing base, but did not
increase our $12.5 million credit limit. We borrowed the full $500,000 on that
date. The interest rate on the term loan is the bank's base rate plus 125 basis
points. During the time the term loan remains outstanding, the interest rate on
our line of credit is the bank's base rate plus 75 basis points. The amendment
also waived a default as a consequence of the fact that the principal balance of
the line of credit exceeded our availability on January 12, 2006.
Subsequent to the end of our third quarter, on October 30, 2006, we
further amended our agreement with Wells Fargo to extend the maturity date of
our outstanding term loan in the amount of $500,000 from October 31, 2006 to
January 2, 2007.
- 17 -
Our Supply Agreement with Amscan gives us the right to receive certain
additional rebates and more favorable pricing terms over the term of the
agreement than generally were available to us under our previous terms with
Amscan. The right to receive additional rebates, and the amount of such rebates,
are subject to our achievement of increased levels of purchases and other
factors provided for in the Supply Agreement. In exchange, the Supply Agreement
obligates us to purchase increased levels of merchandise from Amscan until 2012.
The Supply Agreement provides for a ramp-up period during 2006 and 2007 and,
beginning with calendar year 2008, requires us to purchase on an annual basis
merchandise equal to the total number of our stores open during such calendar
year, multiplied by $180,000. The Supply Agreement provides for penalties in the
event we fail to attain the annual purchase commitment.
The Supply Agreement also provided for Amscan to extend, until October
31, 2006, approximately $1,150,000 of certain currently due Amscan payables owed
by us to Amscan which would otherwise have been payable by us on August 8, 2006
(the "extended payables") and gave us the right, at our option, to convert the
extended payables into a subordinated promissory note (the "Amscan Note").
Subsequent to the end of our third quarter, on October 24, 2006, we
elected to convert $1,143,896 of extended payables originally due to Amscan as
of August 8, 2006 as well as an additional $675,477 of payables due to Amscan as
of September 28, 2006 into a single subordinated promissory note in the total
principal amount of $1,819,373. In accordance with the Supply Agreement, the
note will bear interest at the rate of 11.0% per annum and will be payable in
thirty-six (36) equal monthly installments of principal and interest of
$59,562.48 commencing on November 1, 2006, and on the first day of each month
thereafter until October 1, 2009, when the entire remaining principal balance
and all accrued interest shall be due and payable.
On August 7, 2006, we also entered into and simultaneously closed an
Asset Purchase Agreement with Party City, an affiliate of Amscan, pursuant to
which we acquired a Party City retail party goods store in Peabody,
Massachusetts and received a five-year non-competition covenant from Party City,
for aggregate consideration of $2,450,000, payable by a subordinated note in the
principal amount of $600,000, which will bear interest at the rate of 12.25% per
annum (the "Party City Note") and $1,850,000 in cash. The Party City Note will
be payable by quarterly interest-only payments over four years, with the full
principal amount due at the note's maturity on August 7, 2010.
On September 15, 2006, we entered into a Securities Purchase Agreement
pursuant to which we raised $2.5 million through a combination of subordinated
debt and warrants issued on September 15, 2006 to Highbridge International LLC
("Highbridge"), an institutional accredited investor.
Under the terms of the financing, we issued Highbridge a three-year
subordinated note (the "Highbridge Note") that bears interest at an interest
rate of prime plus one percent. The note matures on September 15, 2009. In
addition, we issued Highbridge a warrant (the "Highbridge Warrant") exercisable
for 2,083,334 shares of our common stock at an exercise price of $0.475 per
share, or 125% of the closing price of our common stock on the day immediately
prior to the closing of the transaction. We allocated approximately $613,651 of
value to the warrants using the Black-Scholes model (volatility of 108%,
interest of 4.73% and expected life of five years). The warrants are being
amortized using the effective interest method over the life of the note payable.
The agreements entered into in connection with the financing provide for certain
restrictions and covenants consistent with Highbridge's status as a subordinated
lender, and also grant Highbridge resale registration rights with respect to the
shares of common stock underlying the Highbridge Warrant.
The issuance of the Highbridge Warrant triggered certain anti-dilution
provisions of our Series B, C, and D convertible preferred stock. As a result,
the outstanding shares of these three series of preferred stock are now
convertible into approximately 442,354 additional shares of common stock. The
issuance of the Highbridge Warrant, however, did not trigger the anti-dilution
provisions of our Series E or F convertible preferred stock or any of our other
outstanding warrant.
Our prospective cash flows are subject to certain trends, events and
uncertainties, including our operating results for the Halloween season, which
is our single most important season, as well as demands for working capital to
improve our infrastructure, respond to economic conditions, take advantage of
strategic opportunities, support growth, and meet our contractual commitments.
We expect our capital expenditures for the balance of 2006 to be primarily
related to general store improvements and continued enhancements of our point of
- 18 -
sale system. We have also deferred a final decision regarding when to replace
our merchandising system, which we had planned to begin in late 2006 with an
installation in fiscal 2007. Our current operating plan includes opening no
additional new stores in the next twelve months.
Based on our current operating plan, we believe that anticipated revenues
from operations and borrowings available under our line of credit, which we
expect to be able to extend to January 2, 2010 in accordance with the commitment
letter we signed with Wells Fargo on November 3, 2006, will be sufficient to
fund our operations and working capital requirements through at least the next
twelve months.
Contractual obligations at September 30, 2006 were as follows:
Payments Due By Period
---------------------------------------------------------------------------
Within Within
Within 2 - 3 4 - 5 After
1 Year Years Years 5 Years Total
---------------------------------------------------------------------------
Line of credit $ 5,306,358 $ - $ - $ - $ 5,306,358
Capital lease obligations 449,311 65,867 - - 515,178
Notes payable 541,514 3,777,859 600,000 - 4,919,373
Operating leases (including retail space
leases) 8,442,644 14,523,152 11,750,164 11,875,836 46,591,796
---------------------------------------------------------------------------
Total contractual obligations $ 14,739,827 $ 18,366,878 $ 12,350,164 $ 11,875,836 $ 57,332,705
===========================================================================
In addition, at September 30, 2006, we had outstanding purchase orders
totaling approximately $2,875,767 for the acquisition of inventory and
non-inventory items that was scheduled for delivery after September 30, 2006.
Seasonality
Due to the seasonality of our business, sales and operating income are
typically higher in our second and fourth quarters. Our business is highly
dependent upon sales of Easter, graduation and summer merchandise in the second
quarter and sales of Halloween and Christmas merchandise in the fourth quarter.
We have typically operated at a loss during the first and third quarters.
Geographic Concentration
As of September 30, 2006, we operated a total of 51 stores, 46 of which
are located in New England. As a result, a severe or prolonged regional
recession or regional changes in demographics, employment levels, population,
weather patterns, real estate market conditions, consumer confidence and
spending patterns or other factors specific to the New England region may
adversely affect us more than a company that is more geographically diverse.
Effects of Inflation
While we do not view the effects of inflation as having a direct material
effect upon our business, we believe that volatility in oil and gas prices
impact the cost of producing petroleum-based/plastic products, which are a key
raw material in much of our merchandise, and also impact prices of shipping
products made overseas in foreign countries, such as China, which includes much
of our merchandise. Volatile oil and gas prices also impact our freight costs,
consumer confidence and spending patterns. These and other issues directly or
indirectly affecting our vendors and us could adversely affect our business and
financial performance.
Factors That May Affect Future Results
Our business is subject to certain risks that could materially affect our
financial condition, results of operations, and the value of our common stock.
These risks include, but are not limited to, the ones described under Item 1A,
"Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended
December 31, 2005 and Part II, Item 1A, "Risk Factors" of subsequent Quarterly
Reports on Form 10-Q, including this one. Additional risks and uncertainties
that we are unaware of, or that we may currently deem immaterial, may become
important factors that harm our business, financial condition, results of
operations, or the value of our common stock.
- 19 -
Critical Accounting Policies and Estimates
Our financial statements are based on the application of significant
accounting policies, many of which require management to make significant
estimates and assumptions (see Note 1 to the Consolidated Financial Statements).
We believe the following accounting policies to be those most important to the
portrayal of our financial condition and those that require the most subjective
judgment. If actual results differ significantly from management's estimates and
projections, there could be a material effect on our financial statements.
Inventory and Related Allowance for Obsolete and Excess Inventory
Our inventory consists of party supplies and is valued at the lower of
moving weighted-average cost or market. 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 are sold.
During each interim reporting period, we estimate the impact on cost of
products sold associated with inventory shortage. The actual inventory shortage
is determined upon reconciliation of the annual physical inventory, which occurs
shortly before and after our year end, and an adjustment to cost of products
sold is recorded at the end of the fourth quarter to recognize the difference
between the estimated and actual inventory shortage for the full year.
We also make adjustments to reduce the value of our inventory for an
allowance for obsolete and excess inventory, which is based on our review of
inventories on hand compared to estimated future sales. We conduct reviews
periodically throughout the year on each stock keeping unit ("SKU"). As we
identify obsolete and excess inventory, we take immediate measures to reduce our
inventory risk on these items and we adjust our allowance accordingly. Thus,
actual results could differ from our estimates.
Revenue Recognition
Revenues include 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 amounts have not been significant.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation
and are depreciated on the straight-line method over the estimated useful lives
of the assets. Expenditures for maintenance and repairs are charged to
operations as incurred.
Impairment of Long-Lived Assets
In accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, we perform a review of each store for impairment
indicators whenever events and changes in circumstances suggest that the
carrying amounts may not be recoverable from estimated future store cash flows.
Our review considers store operating results, future sales growth and cash
flows. The conclusion regarding impairment may differ from current estimates if
underlying assumptions or business strategies change. We were not aware of any
impairment indicators for any of our stores at September 30, 2006. However,
subsequent to the end of the third quarter we decided to close its store in East
Providence, Rhode Island effective November 4, 2006 due to underperforming
sales. As a result of this closing, we will incur a charge in the fourth quarter
of approximately $120,000 related to remaining lease payments and other closing
costs. The initial term of the lease is due to expire on August 31, 2007.
Income Taxes
Historically, we have not recognized an income tax benefit for our
losses. Accordingly, we record a valuation allowance against our deferred tax
assets because of the uncertainty of future taxable income and the realizability
of the deferred tax assets. In determining if a valuation allowance against our
deferred tax asset is appropriate, we consider both positive and negative
evidence. The positive evidence that we considered included (1) we were
profitable in 2004 and 2003 due to the success of our Halloween seasons, (2) we
have achieved positive comparable store sales growth for the last three years
and (3) improved merchandise margins in 2004 and 2003. The negative evidence
- 20 -
that we considered included (1) after two years of profitability we realized a
net loss in 2005, (2) our merchandise margins decreased in 2005, (3) our future
profitability is vulnerable to certain risks, including (a) the risk that we may
not be able to generate significant taxable income to fully utilize our net
operating loss carryforwards of approximately $23.7 million, (b) the risk of
unseasonable weather and other factors in a single geographic region, New
England, where our stores are concentrated, (c) the risk of being so dependent
upon a single season, Halloween, for a significant amount of annual sales and
profitability and (d) the risk of rising prices for petroleum products, which
are a key raw material for much of our merchandise and which affect our freight
costs and those of our suppliers and affect our customers' spending levels and
patterns, (4) the costs that opening new stores will put pressure on our profit
margins until these stores reach maturity, (5) the investment in infrastructure
required in fiscal 2006 will increase our costs and (6) the expected costs of
increased regulatory compliance, including, without limitation, those associated
with Section 404 of the Sarbanes-Oxley Act, will likely have a negative impact
on our profitability.
The negative evidence is strong enough for us to conclude that the level
of our future profitability is uncertain at this time. We believe that it is
prudent for us to maintain a valuation allowance until we have a longer track
record of profitability and we can reduce our exposure to the risks described
above. Should we determine that we will be able to realize our deferred tax
assets in the future, an adjustment to our deferred tax assets would increase
income in the period we made such a determination.
Stock Option Compensation Expense
On January 1, 2006, we adopted Statement No. 123(R) using the modified
prospective method in which compensation cost is recognized beginning with the
effective date (a) based on the requirements of Statement No. 123(R) for all
share-based payments granted after the effective date and (b) based on the
requirements of Statement No. 123 for all awards granted to employees prior to
the effective date of Statement No. 123(R) that remain unvested on the effective
date. Prior to January 1, 2006, we accounted for our stock option compensation
agreements with employees under the provisions of Accounting Principles Board
("APB") Opinion No. 25, Accounting for Stock Issued to Employees and the
disclosure-only provisions of Statement No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of Financial Accounting
Standards Board ("FASB") Statement No. 123.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Our actual results could differ from our estimates.
New Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board ("FASB") issued
Interpretation of FASB Statement No. 109, Accounting for Uncertainty in Income
Taxes, which is a clarification of FASB Statement No. 109, Accounting for Income
Taxes. Interpretation of FASB 48 ("FIN 48") is effective for fiscal years
beginning after December 15, 2006.
FIN 48 prescribes a minimum recognition threshold that a tax position
must meet before it can be recognized in the financial statements. This
Interpretation also provides guidance of derecognition, measurement,
classification, interest and penalties, accounting in interim periods,
disclosure and transition.
FIN 48 evaluates tax positions by utilizing a two step approach
(recognition and measurement).
o Recognition occurs when an enterprise determines whether it is more
likely than not that a tax position will be sustained upon
examination. Once the enterprise has determined that the tax position
will be recognized, the measurement step (step two) needs to be
evaluated.
- 21 -
o A tax position that meets the criteria in step one is measured to
determine the amount of benefit to recognize in the financial
statements. The tax position is measured at the largest amount of
benefit that has a greater than 50% likelihood of being realized upon
ultimate settlement.
We have not yet completed our evaluation of the impact of adoption on our
financial position or results of operations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
There has been no material change in our market risk exposure since the
filing of our Annual Report on Form 10-K.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. Our management,
with the participation of our Chief Executive Officer, or CEO, and Chief
Financial Officer, or CFO, evaluated the effectiveness of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended) as of September 30, 2006. In
designing and evaluating our disclosure controls and procedures, our management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving their objectives,
and our management necessarily applied its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. Based on this
evaluation, our CEO and CFO concluded that, as of September 30, 2006, our
disclosure controls and procedures were (1) designed to ensure that material
information relating to us, including our consolidated subsidiaries, is made
known to our CEO and CFO by others within those entities, particularly during
the period in which this report was being prepared and (2) effective, in that
they provide reasonable assurance that information required to be disclosed by
us in the reports that we file or submit under the Securities Exchange Act is
recorded, processed, summarized, communicated to management, including our CEO
and CFO, and reported within the time periods specified in the SEC's rules and
forms.
(b) Changes in Internal Controls. No change in our internal controls over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934, as amended) occurred during the fiscal quarter
ended September 30, 2006 that has materially affected, or is reasonably likely
to materially affect, our internal controls over financial reporting.
- 22 -
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 1A. Risk Factors
Except as noted below, there have been no material changes to the risk
factors previously disclosed in Item 1A, "Risk Factors" in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2005, as filed with the SEC on
March 30, 2006.
We supplement the risk factor, "We face new competitive threats as a
result of consolidation in our industry following Amscan's acquisition of Party
City Corporation," which appears on page 5 of our Annual Report. On August 7,
2006 we announced that we had entered into a Supply Agreement with Amscan which
extends to 2012 and obligates us to purchase increased levels of merchandise
from Amscan, our largest supplier, in exchange for, among other things, the
right to receive certain additional rebates and more favorable pricing terms
over the life of the agreement than were generally available to us under our
previous terms with Amscan. On that same date, we announced that we had entered
into a $2.45 million dollar agreement with Party City pursuant to which we
acquired Party City's retail store in Peabody, Massachusetts and received a
five-year non-competition agreement from Party City and its affiliates that
covers Massachusetts, Maine, New Hampshire, Vermont, Rhode Island, and Windsor
and New London counties in Connecticut. Notwithstanding these agreements with
Amscan and Party City, Amscan's acquisition of Party City and its status as our
largest supplier and the largest supplier in our industry, could continue to
adversely affect our ability to compete favorably or operate successfully in a
changed marketplace. Price pressures, particularly in the event of a strain or
rupture in our relationship with Amscan, could erode our margins and cause our
financial results of operations to suffer.
We also supplement the risk factor, "Our failure to generate sufficient
cash to meet our liquidity needs may affect our ability to service our
indebtedness and grow our business," which appears on pages 6 and 7 of our
Annual Report. Our existing line of credit with Wells Fargo matures on January
2, 2007. Subsequent to the end of the third quarter, on November 3, 2006, we
signed a commitment letter with Wells Fargo to extend our line of credit for
three years to January 2, 2010. In addition to the three year extension, the
terms of the commitment letter include an option to increase the line of credit
to $15,000,000. We expect to sign a new agreement with Wells Fargo which
incorporates the terms of the commitment letter prior to the maturity date on
the existing line of credit, but can provide no assurance that we will in fact
be able to do so, in which case our business prospects could be materially and
adversely affected.
Item 2. Unregistered Sales of Equity and Securities and Use of Proceeds
We filed a Current Report on Form 8-K on September 18, 2006 with respect
to the unregistered sale of certain securities to Highbridge International LLC,
an institutional accredited investor, that would otherwise be required to be
reported under this Item 2.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits
The exhibits listed in the Exhibit Index immediately preceding the
exhibits are filed as part of this Quarterly Report on Form 10-Q and are
incorporated herein by reference.
- 23 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
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 14, 2006
- 24 -
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
- 25 -