IParty 10-K 2005
Documents found in this filing:
Washington, D.C. 20549
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
ý ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF
For The Fiscal Year Ended December 25, 2004
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
Commission File Number 0-25507
(Exact Name of Registrant as Specified in Its Charter)
Securities Registered pursuant to Section 12(b) of the Act:
Securities Registered pursuant to Section 12(g) of the Act: None
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 ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o No ý
On June 26, 2004, the aggregate market value of the voting common equity of the registrant (consisting of common stock, $.001 par value (the common stock)) held by nonaffiliates of the registrant was approximately $14,091,685 based on the closing price for such common stock on said date as reported by the American Stock Exchange. On March 21, 2005 there were 22,115,239 shares of common stock, $.001 par value, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual stockholders meeting to be held June 8, 2005 are incorporated by reference into Part III.
ITEM 1. BUSINESS
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 41 of our 45 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. We generated $64.3 million in total revenues and $1.0 million of net income in fiscal 2004.
Our 45 retail stores are located predominantly in New England with 23 stores in Massachusetts, 7 in Connecticut, 5 in New Hampshire, 3 in Rhode Island, 2 in Maine and 1 in Vermont. We also operate 4 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.
Our stores feature over 20,000 products ranging from greeting cards and balloons to more unique merchandise such as piñatas, tiny toys, masquerade and Hawaiian Luau items. Our sales are driven by the following events: Halloween, Christmas, Easter, Valentines Day, New Years, Independence Day, St. Patricks Day, Thanksgiving and Chanukah. 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 two years we have realized approximately 37% of our annual revenues in our fourth quarter, which includes Halloween and Christmas, and approximately 24% of our revenues in the second quarter, which includes school graduations. Also, during these past two years, we have had net income in our second and fourth quarters and generated losses in our first and third quarters.
Our executive offices are located at 270 Bridge Street, Suite 301, Dedham, Massachusetts, 02026. Our phone number is (781) 329-3952. Our licensed website is located at www.iparty.com. The information on our licensed website is not a part of this Annual Report.
Where a reference is made in this Annual Report to a particular year or years, it is a reference to our 52-week fiscal year, unless the context indicates otherwise. For example, 2004 refers to our 52-week fiscal year ended December 25, 2004, 2003 refers to our 52-week fiscal year ended December 27, 2003 and 2002 refers to our 52-week fiscal year ended December 28, 2002.
While we are presently a party goods retail chain operating 45 stores, when we were first incorporated as iParty Corp. (iParty) on March 12, 1998 we were an Internet-based merchant of party goods and services. On July 2, 1998, iParty Corp. merged into WSI Acquisitions, Corp. and began trading on the OTC Bulletin Board under ticker symbol IPTY. On January 2, 2000, iParty Corp. was listed on the American Stock Exchange under ticker symbol IPT.
On August 3, 2000, iParty Retail Stores Corp. (iParty Retail) was incorporated as a wholly-owned subsidiary of iParty Corp. to operate a chain of retail stores selling party goods. On August 15, 2000, iParty Retail acquired inventory, fixed assets and the leases of 33 retail stores from The Big Party Corporation (The Big Party), a privately-held company which was operating under bankruptcy protection, in exchange for cash and the assumption of certain liabilities. This acquisition was approved on August 16, 2000 by the United States Bankruptcy Court for the District of Delaware. We subsequently opened an additional 11 stores through December 25, 2004 and one store since the end of fiscal 2004.
On July 8, 2003, we signed an agreement with Taymark, Inc. (Taymark) to license the iParty.com name to Taymark. In return, Taymark pays us a 15% royalty on all net sales realized through its operation of www.iparty.com. The term of this agreement is for a period of two (2) years, unless sooner terminated. If this
agreement is not terminated, it is automatically renewed for successive one-year periods. Previously, we operated the website with Taymark under a fulfillment agreement.
Our capital structure currently consists of common stock and five series of convertible preferred stock. We have also issued warrants and we have a stock option plan.
Our common stock has a par value of $0.001 per share. We have 150,000,000 shares of common stock authorized, 22,092,717 of which were issued and outstanding as of December 25, 2004. These shares are listed on the American Stock Exchange and trade under the symbol IPT.
We currently have five different series of convertible preferred stock, Series B-F. On January 13, 2004 all 1,000,000 shares of our Series A convertible preferred stock were converted into 1,000,000 shares of common stock. Each share of Series B convertible preferred stock is presently convertible into 12.870 shares of common stock. Each share of Series C convertible preferred stock is presently convertible into 13.106 shares of common stock. Each share of Series D convertible preferred stock is presently convertible into 14.055 shares of common stock. Each share of Series E convertible preferred stock is presently convertible into 10.359 shares of common stock. Each share of Series F convertible preferred stock is presently convertible into 10.367 shares of common stock. We had a total of 1,268,413 shares of convertible preferred stock outstanding as of December 25, 2004, which were convertible into 15,613,426 shares of common stock at that date. Our convertible preferred stock is presented on our balance sheet at its carrying value, which was $14,308,002 at December 25, 2004.
We also have a stockholder rights plan (the rights plan). The rights plan associates rights to our capital stock, such that each share of our common stock is entitled to one right and each share of our preferred stock is entitled to such number of rights equal to the number of common shares into which it is convertible. The rights will become exercisable only in the event that, with certain exceptions, an acquiring party accumulates 10 percent or more of our voting stock or if a party announces an offer to acquire 15 percent or more of our voting stock. When exercisable, each right entitles the holder to purchase from us one one-hundredth of a share of a new series of Series G junior preferred stock at an initial purchase price of $2.00, subject to adjustment. In addition, upon the occurrence of certain events, holders of the rights will be entitled to purchase either iParty Corp. stock or shares in an acquiring entity at half of market value.
The holders of our convertible preferred stock have a liquidation preference senior to the holders of our common stock. In the event of liquidation, our convertible preferred stockholders would be entitled to a liquidation value, which was $18,761,700 at December 25, 2004. This amount is in excess of the carrying value of the preferred stock due to amounts allocated to warrants, which were issued in connection with certain issuances of our convertible preferred stock. The difference of approximately $4.5 million is being accreted when and if a liquidation event occurs. The holders of our Series B-F convertible preferred stock are also entitled to anti-dilution protection in the event we issue common stock, or certain rights, including option activity in excess of certain amounts, to purchase or convert into common stock, at a price below their conversion prices.
The Series B-F preferred stockholders are entitled to participate in dividends when and if declared by our Board of Directors.
We have also issued warrants in connection with the issuance of certain convertible preferred stock and certain licensing and marketing arrangements. At December 25, 2004 we had 8,431,651 warrants outstanding, which were exercisable for 13,011,215 shares of our common stock. Substantially all of the warrants contain anti-dilution provisions. Their conversion prices would be adjusted in the event we issue common stock, or certain rights, including option activity in excess of certain amounts, to purchase or convert into common stock, at a price below their exercise prices. There are 7,903,441 warrants scheduled to expire in August 2005, representing 94% of the total warrants outstanding at December 25, 2004.
Under our stock option plan we are authorized to grant options to purchase up to 11,000,000 shares of our common stock. At December 25, 2004, we had options outstanding that were exercisable for the purchase of 10,031,817 shares of common stock.
The following chart summarizes our capital structure at December 25, 2004.
(1) Includes common stock outstanding and common stock issuable upon conversion of convertible preferred stock and exercise of outstanding warrants and stock options.
The party supplies retailing business is highly competitive. We compete with a variety of smaller and larger retailers, including single owner-operated party supplies stores, specialty party supplies retailers, discount department stores, general mass merchants and supermarkets, as well as catalog and Internet merchants.
Barriers to entry are minimal. New competitors can open new stores and/or launch new Internet sites at a relatively low cost. However, we believe that the costs to remain competitive in the party supplies retailing business can be significant. These costs include the hiring of human resources with industry knowledge and the marketing costs associated with building a widely recognized brand.
Certain Risks Associated with the Party Supplies Industry and Our Business
Party supplies businesses are often affected by general economic developments affecting consumer confidence or spending patterns, especially the conditions in existence during the Halloween season, which is usually the most important season for the party supplies industry, the availability of retail store space on reasonable lease terms, the cost and availability of labor, availability of products and the type, number and location of competing retailers. In addition, factors such as increased cost of goods, increased cost of raw materials, such as petroleum based products, which are important components of our vendors costs, increased cost of gasoline, which affects freight costs, unseasonable weather and the potential scarcity of experienced management and hourly employees may also adversely affect the party supplies industry in general and our results of operations and
financial condition in particular. We are subject to all of these risks, particularly as they relate to the New England region, since 41 of our stores are located in this area. For a more complete list of the risk factors affecting our business, please see the Cautionary Statements and Risk Factors text within Item 7., Managements Discussion and Analysis of Financial Condition and Results of Operations, within this Annual Report.
We hold trademarks for iParty and iParty.com issued by the U.S. Patent and Trademark Office. Trademark registrations for iParty were issued on February 19, 2002 and August 26, 2003 under U.S. registration No. 2,541,025 and No. 2,756,735. The trademark registration for iParty.com was issued on November 12, 2002 under U.S. registration No. 2,649,801.
As of March 1, 2005 we had 249 full-time employees and 598 part-time employees. None of these employees are represented by a labor union, and we consider our relationship with our employees to be good.
Our licensed Internet website address is www.iparty.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available through our licensed Internet website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our licensed Internet website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.
The public may read and copy any materials that we file with the SEC at the SECs website, www.sec.gov, which contains reports, proxy and information statements and other information that public companies are required to file with the SEC. In addition, the public may read and copy any materials we file with the SEC at the SECs Public Reference Room at 450 Fifth Street, N.W., Washington, D.C., 20549. The public may obtain information about the SECs Public Reference Room by calling 1-800-SEC-0330.
ITEM 2. PROPERTIES
The following table identifies the number of our stores operating as of December 25, 2004, December 27, 2003 and December 28, 2002, by state.
Since the end of 2004 we have opened one additional store, bringing our store count up to 45. Our stores range in size from approximately 8,000 square feet to approximately 20,300 square feet and average approximately 9,800 square feet. We lease all of our retail stores. The leases generally provide for fixed minimum rentals, which typically increase periodically during the life of the lease, and, in some instances, contingent rentals based on a
percentage of sales in excess of specified minimum sales levels, as well as related occupancy costs, such as property taxes and common area maintenance. 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.
In addition to our 45 stores, we lease office space at 270 Bridge Street, Suite 301, Dedham, Massachusetts, 02026. The lease, which expires November 30, 2011, is for 10,600 square feet of space and the monthly rent is $17,500. We also lease office and retail space at 1457 VFW Parkway, West Roxbury, Massachusetts, 02132. This lease, which expires December 31, 2012, is for 20,000 square feet of space. The retail store at our West Roxbury location uses 10,688 square feet and the remainder is used primarily for our corporate training center. The total monthly rent for the retail store and corporate office space is $17,100, subject to certain Consumer Price Index escalation clauses. We believe that these spaces are adequate for our immediate needs. However, we are currently evaluating whether we need to add approximately 3,000 square feet of office space within the next 12 months to support the growth of our business.
We believe that all properties are adequately covered by insurance.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material pending legal proceedings other than ordinary routine matters incidental to our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the fourth quarter of fiscal 2004.
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The American Stock Exchange is the principal market for our common stock, where our shares are traded under the symbol IPT. Our common stock began trading on the American Stock Exchange under the name iParty Corp., symbol IPT, on January 2, 2000. Our common stock was quoted previously on the OTC Electronic Bulletin Board under the name iParty Corp., symbol IPTY, commencing July 1998. Prior to that time, from February 1998 until July 1998, our common stock was quoted on the OTC Bulletin Board under the name of WSI Acquisitions, Inc., symbol WSIA.
The following table sets forth the range of high and low sales prices on the American Stock Exchange for our common stock for each of the fiscal quarters of 2004 and 2003:
MARKET PRICE OF COMMON STOCK
The approximate number of record holders of our common stock as of March 21, 2005 was 117. The number of record owners was determined from our stockholder records, and does not include beneficial owners of our
common stock whose shares are held in the names of various security holders, dealers and clearing agencies. We believe that the number of beneficial owners of our common stock held by others as or in nominee names exceeds 500 in number.
We have never paid a cash dividend on our shares of common stock and have no expectation of doing so for the foreseeable future. Our existing line of credit agreement with Wells Fargo Retail Finance II, LLC generally prohibits the payment of any dividends or other distributions to any of our classes of capital stock.
ITEM 6. SELECTED FINANCIAL DATA
(1) Capital expenditures exclude assets acquired under capital leases.
(2) The holders of our Series A-F convertible preferred stock have the right to a liquidation preference, which was not considered under our control in 2002, 2001 and 2000. Therefore their carrying values have been excluded from stockholders equity for these periods. Their carrying values are included in stockholders equity in 2004 and 2003 as redemption is deemed to be solely within our control.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our Consolidated Financial Statements and the related Notes included below.
At the end of 2004 we operated 44 retail stores, including 40 in New England and 4 in Florida, and for the year we had net income of approximately $1.0 million, our second consecutive year of being profitable. We opened six new stores in 2004, twice as many as we had opened in 2003. In 2004 we also achieved a 4.6% increase in comparable stores sales, defined as sales from those stores open for at least one full year. This marks our third consecutive year of solid comparable store sales growth.
The year began positively, with a 10.6% increase in comparable store sales in our first quarter. The New England Patriots run to the Super Bowl in January 2004 elevated interest in the game within the New England region beyond normal levels and we took advantage of this opportunity by supplementing our regular inventory of party supplies with special New England Patriots and Super Bowl merchandise, all of which sold well. The year also ended on a positive note, with a 5.1% increase in comparable store sales in the fourth quarter, when most of our Halloween season business occurs. We were pleased by these results because this years Halloween season followed a positive Halloween season in 2003, which led to a 12.6% increase in comparable store sales in the fourth quarter of that year. Halloween is our most important season and our organization met or exceeded our managements expectations in order to achieve these positive results.
In November 2003, we relocated our headquarters from West Roxbury, Massachusetts to larger office space in Dedham, Massachusetts and in January 2004 we completed the renovation of our previous headquarters into a new corporate training facility. During 2003 and early 2004 we enhanced our corporate governance by expanding our Board of Directors with the addition of four new independent directors. Also in January 2004, we concluded negotiations extending the maturity date of our bank line-of-credit agreement until January 2007 and added the option to increase the line in increments of $2,500,000 beyond the present limit of $7,500,000, to a limit of $12,500,000, upon 15 days written notice, as long as we are in compliance of debt covenants and the provisions of the loan agreement. Our inventory and accounts receivable secure our line of credit.
In early 2004 we began the development of a new point-of-sale system. The new system was rolled out to our stores in the June-July timeframe and the system was in operation for our Halloween season. The new system is designed to allow us to achieve greater operating efficiencies and improve customer service. We believe that it allowed us to handle the peak sales volumes we experienced during the Halloween season better than the system it replaced.
We believe that all of these accomplishments have positioned us for continued success. Our goals in 2005 include opening as many as seven new stores during the year, including the one new store that we opened since the end of fiscal 2004.
Cautionary Statements and Risk Factors
Certain statements in this Annual Report, and particularly this management discussion and analysis, 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 Annual Report 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 Annual Report. These include, but are not limited to, the following:
the success or failure of our efforts to implement our business strategy
our inability to obtain additional financing, if required
third-party suppliers failure to fulfill their obligations to us
the availability of retail store space on reasonable lease terms
the failure of any of our systems, including, without limitation, our newly-installed point-of-sale system and our merchandise management system, the latter of which was developed by a vendor who is no longer in business
any problems affecting our third-party suppliers and
general economic and other developments affecting consumer confidence or spending patterns, particularly in the New England region and particularly during the Halloween season, which is our single most important season.
Fiscal 2004 Compared to Fiscal 2003
Our consolidated revenues for 2004 were $64,276,225, an increase of $7,578,979, or 13.4% from the prior year. Revenues include the selling price of party goods sold, net of returns and discounts, and are recognized at the point of sale. This increase was due to an increase of 4.6% in comparable stores sales, sales from six new stores that opened in 2004 and sales from three new stores that opened in 2003 which were not included in comparable stores sales in 2004 until they had been open for one full year. The increase in comparable stores sales was largely attributable to a stronger Halloween season compared to the prior year.
Cost of products sold
In 2004 our consolidated cost of products sold was 55.7% of revenues, a decrease of 0.3 percentage points from the prior year. Cost of products sold consists of the cost of merchandise sold to customers and the occupancy costs for our stores. This decrease was primarily attributable to the elimination of costs of products sold for our Internet business, which was licensed to a third party in 2003 in exchange for royalties under a license agreement.
Marketing and sales expense
Our consolidated marketing and sales expense for 2004 was $21,176,925 or 32.9% of revenues, an increase of $2,813,732, or 0.5 percentage points, as a percentage of revenues, from the prior year. Marketing and sales expense consists primarily of all store payroll and related expenses for personnel engaged in marketing and selling activities, as well as advertising, public relations and promotional expenditures.
This increase, as a percentage of revenues, was due to store payroll and other expenses related to marketing and sales in our new stores, which run at a higher than normal rate until they reach maturity. Our experience has been that it usually takes about eighteen months after opening for a store to reach maturity.
General and administrative expense
Our consolidated general and administrative (G&A) expense for 2004 was $6,335,067 or 9.9% of revenue, an increase of $818,794, or 0.1 percentage points, as a percentage of revenues, from the prior year. 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.
The increase in G&A costs was attributable to rate increases in payroll-related costs, such as unemployment insurance, health insurance and workers compensation insurance, and start-up costs associated with implementing our new point-of-sale system.
In 2004 we reached a settlement with a third party in connection with the special charge previously recorded in fiscal year 2002. We recorded the net settlement of $382,500 as other income.
Our interest expense was $225,074 in 2004, an increase of $12,847 from the prior year. This increase was due to higher average borrowings that were largely offset by lower interest rates.
In 2004 our provision for income taxes was $105,000, which included $20,000 for federal alternative minimum taxes and $85,000 for state income taxes. We were able to utilize approximately $923,000 of net operating loss carryforwards for federal income tax purposes in 2004, which were fully reserved for in the prior year due to the uncertainty of future taxable income.
At the end of 2004 we had estimated net operating loss carryforwards of approximately $23.0 million, which begin to expire in 2018. In accordance with Section 382 of the Internal Revenue Code, the use of these carryforwards may be subject to annual limitations based upon certain ownership changes of our stock that may have occurred or that may occur.
Fiscal 2003 Compared to Fiscal 2002
Our consolidated revenues for 2003 were $56,697,246, an increase of $4,519,323, or 8.7% from the prior year. Revenues include the selling price of party goods sold, net of returns and discounts, and are recognized at the point of sale. This increase was due to an increase of 4.8% in comparable stores sales, sales from three new stores that opened in 2003 and sales from two new stores that opened in 2002 which were not included in comparable stores sales in 2003 until they had been open for one full year. The increase in comparable stores sales was largely attributable to a stronger Halloween season compared to the prior year.
Cost of products sold
In 2003 our consolidated cost of products sold was 56.0% of revenues, a decrease of 2.3 percentage points from the prior year. Cost of products sold consists of the cost of merchandise sold to customers and the occupancy costs for our stores. This decrease was primarily attributable to improved vendor pricing and terms.
In 2003, we refined our methodology for accounting for vendor rebates, discounts and freight. We also continued to refine our methodology for estimating an appropriate allowance for obsolete and excess inventory. The net impact of these adjustments increased 2003 pre-tax income by $141,757, net income by $125,455 and had no impact on basic and diluted earnings per share.
Marketing and sales expense
Our consolidated marketing and sales expense for 2003 was $18,363,193 or 32.4% of revenues, an increase of $1,835,361, or 0.7 percentage points, as a percentage of revenues, from the prior year. Marketing and sales expense consists primarily of advertising, public relations and promotional expenditures, as well as all store payroll and related expenses for personnel engaged in marketing and selling activities.
As a percentage of revenues, the increase in marketing and sales expense was attributable to the addition of retail store management staff to provide closer supervision of our retail stores, an upgrade to our stores
telecommunications network to improve reliability and establish the capability to support future systems enhancements, and higher store pre-opening costs as a result of opening three stores in 2003 compared to two stores in 2002.
General and administrative expense
Our consolidated general and administrative (G&A) expense for 2003 was $5,516,273 or 9.7% of revenue, an increase of $270,406 and decrease of 0.3 percentage points, as a percentage of revenues, from the prior year. 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.
The increase in G&A costs was attributable to an increase in professional fees associated with information technology, including consulting fees associated with enhancing systems, and increased labor costs for positions added to support growth.
Our interest expense was $212,227 in 2003, a decrease of $68,671 from the prior year. This decrease was due to the expiration of capital leases in 2002.
In 2003 our provision for income taxes was $97,233, which included $30,000 for federal alternative minimum taxes and $67,233 for state income taxes. When we filed our 2003 Annual Report on Form 10-K we reported that we were able to utilize approximately $997,000 of net operating loss carryforwards for federal income tax purposes in 2003, which were fully reserved for in the prior year due to the uncertainty of future taxable income. This amount was based on preliminary projections of tax liability and it was revised to $792,000 upon subsequent completion of our final tax returns for 2003.
When we filed our 2003 Annual Report on Form 10-K we reported that at the end of 2003 we had estimated net operating loss carryforwards of approximately $23.7 million, which begin to expire in 2018. This amount was based on preliminary projections of tax liability and it was revised to $23.9 million upon subsequent completion of our final tax returns for 2003. In accordance with Section 382 of the Internal Revenue Code, the use of these carryforwards may be subject to annual limitations based upon certain ownership changes of our stock that may have occurred or that may occur.
Critical Accounting Policies
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 2 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 managements 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 after our year ends, 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. The adjustment in the fourth quarter of 2004 included an estimated reduction of $149,316 to the cost of products sold during the previous three quarters. The adjustment in the fourth quarter of 2003 included an estimated reduction of $145,983 to the cost of products sold during the previous three quarters.
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.
In 2003, we refined our methodology for accounting for vendor rebates, discounts and freight and for estimating an appropriate allowance for obsolete and excess inventory. The net impact of these adjustments increased pre-tax income by $141,757, net income by $125,455 and had no impact on basic and diluted earnings per share.
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. At the beginning of fiscal 2004 we adopted a new policy for estimating the useful life of fixed assets which extended the useful life of equipment and furniture and fixtures. Changing the estimated life of the assets in these categories as of the beginning of the year reduced depreciation expense by approximately $130,885. Net income in 2004 would have been $0.02 per basic and diluted share if this change in estimating the useful life of fixed assets had not been adopted. Expenditures for maintenance and repairs are charged to operations as incurred.
Impairment of Long-Lived Assets
We adopted Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets in 2002, which requires that long-lived assets be measured at the lower of carrying amount or fair value less cost to sell. The adoption of SFAS No. 144 did not have a material impact on our consolidated results of operations in 2002.
We review each store for impairment indicators annually, considering operating results and cash flows. We are not aware of any impairment indicators for any of our stores at December 25, 2004.
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. 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. The value of our deferred tax assets was $9,675,000 at December 25, 2004, which has been fully reserved.
Previous Restatement of Financial Information and Balance Sheet Presentation of Series A-F Convertible Preferred Stock
The holders of our various series of convertible preferred stock have the right to a liquidation preference, which previously could have been exercised under certain events not within our control. In accordance with EITF Topic D-98, we have included the respective equity securities outside of permanent stockholders deficit in our accompanying table of selected financial data as of December 28, 2002, December 29, 2001 and December 30, 2000 at their respective carrying values.
During the fourth quarter of 2003, the composition of our Board of Directors changed such that holders of our convertible preferred stock or the designates of our preferred stockholders no longer constituted a majority of our Board members. This change in the composition of our Board of Directors has permitted us to present our
convertible preferred stock in equity in the accompanying balance sheets as of December 25, 2004 and December 27, 2003, at their respective carrying values as the redemption is deemed to be solely within our control.
We will continue to review and consider the criteria in EITF Topic D-98 at the reporting of each balance sheet.
Stock Option Compensation Expense
We account 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. We have adopted the disclosure-only provisions of SFAS 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 revenue and expenses during the reporting period. Our actual results could differ from our estimates.
New Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51 (FIN 46). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. However, in October 2003, the FASB deferred the effective date of FIN 46 to the end of the first interim or annual period ending after December 15, 2003 for those arrangements involving special purpose entities entered into prior to February 1, 2003. All other arrangements within the scope of FIN 46 are subject to its provisions beginning in 2004. We adopted FIN 46, as required, with no material impact to our consolidated financial position or results of operations.
On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. SFAS 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.
We must adopt SFAS 123(R) no later than July 1, 2005. Early adoption will be permitted in periods in which financial statements have not yet been issued. We expect to adopt SFAS 123(R) on July 1, 2005.
SFAS 123(R) permits public companies to adopt its requirements using one of two methods:
A modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date.
A modified retrospective method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.
We have not yet determined which method we will use.
As permitted by SFAS 123, we currently account for share-based payments to employees using Opinion 25s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R)s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net loss and net loss per share in Note 2 to the consolidated financial statements.
In February 2005, the Chief Accountant of the SEC issued a letter clarifying his staffs interpretation of certain accounting issues and their application under generally accepted accounting principles (GAAP) relating to operating leases. In summary, their interpretation is that (1) leasehold improvements should be amortized by the lessee over the shorter of their economic lives or the lease term, which could include lease renewal terms when the renewals are reasonably assured, (2) free or reduced rents should be recognized by the lessee on a straight-line basis over the lease term (including any free or reduced rent period) and (3) the statement of cash flows should reflect cash received from the lessor that is accounted for as a lease incentive within operating activities and the acquisition of leasehold improvements for cash within investing activities. These positions are based upon existing accounting literature. We believe that our present accounting policies are consistent with the positions described by the Chief Accountant and his staff in this letter. Our policy is to amortize leasehold improvements for 10 years or the life of the lease, whichever period is shorter. Our policy is to amortize free or reduced rent on a straight-line basis over the lease term (including any free or reduced rent periods). We generally do not enter into agreements that involve receiving cash from lessors/landlords.
Liquidity and Capital Resources
Our operating activities provided $129,690 in net cash in 2004 compared to $1,368,798 in 2003, a decrease of $1,239,108, which was due to our growth in inventory, partially offset by an increase in net income. The increase in net cash used in inventory was primarily for the six new stores we opened in 2004.
In 2004, we financed $309,000 of premiums related to property and casualty insurance at a fixed interest rate of 4.25% with a maturity date of May 2005. During the period we also financed $129,200 of premiums related to directors and officers insurance at a fixed interest rate of 5.62% with a maturity date of January 2005. The remaining insurance premium payments and annual insurance expenses are recorded in accrued expenses and prepaid expenses.
We invested cash in property and equipment, including new store capital expenditures, totaling $2,121,134 in 2004 and $1,166,258 in 2003. The cash invested in 2004 included approximately $1,587,000 for fixed assets associated with new stores, $347,000 for improvements to other stores and $187,000 for all other capital expenditures. The increase in capital expenditures was largely due to the addition of six new stores in 2004 compared to three new stores in 2003.
During 2004 we also acquired assets under capital leases totaling $1,302,681 for a new point-of-sale system. The capital lease obligations outstanding at December 25, 2004 were $1,162,367.
We generated $1,306,130 in net cash from financing activities in 2004 compared to using $86,412 in net cash in financing activities in 2003. We increased our borrowings under our line of credit by $1,497,019 in 2004 compared to an increase of $283,933 in 2003, largely to finance capital expenditures for new stores.
At December 25, 2004 we had a line of credit (the line) with Wells Fargo Retail Finance II, LLC. The line was amended on January 2, 2004. The amendment extended the maturity date of our line to January 2, 2007, eliminated the minimum interest rate of 6.5%, established a new interest rate at the banks base rate plus 50 basis points and added an 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 of debt covenants and the provisions of the loan agreement. Our inventory and accounts receivable secure our line.
The amended agreement includes a financial covenant requiring us to maintain a minimum availability under the line in the amount of 5% of the credit limit, which at the current limit of $7,500,000, is $375,000. If we adjust the credit limit in the future, the minimum availability would be 5% of the adjusted credit limit. The amended agreement also has a covenant that requires us to limit our capital expenditures to within 110% of those amounts included in our business plan, which may be updated from time to time. At December 25, 2004, we were in compliance with these financial covenants. The line generally prohibits the payment of any dividends or other distributions to any of our classes of capital stock.
The amount outstanding under our line was $5,257,690 as of December 25, 2004 and $3,760,671 on December 27, 2003. The interest rate on these borrowings was 5.75% at December 25, 2004 and 6.5% at December 27, 2003. The outstanding balances under the 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. At December 25, 2004, we had approximately $305,000 of additional availability under the line. In the third quarter of fiscal 2004, we established a letter of credit for $356,000 with Wells Fargo Bank, N.A. associated with the leasing of our new point-of-sale system. This $356,000 letter of credit was outstanding at December 25, 2004.
Our prospective cash flows are subject to certain trends, events and uncertainties, including demands for capital to support growth, economic conditions, and contractual matters. We expect our capital expenditures for 2005 to be primarily related to new stores, store improvements and other technology advancements in support of growth and operational enhancements.
Contractual obligations at December 25, 2004 were as follows:
In addition, at December 25, 2004, we had outstanding purchase orders totaling approximately $216,000 for the acquisition of inventory that was scheduled for delivery after December 25, 2004.
We believe, based on our current operating plan, that anticipated cash from operations and borrowings available under the existing line of credit will be sufficient to fund our operations and working capital requirements for the next 12 months. Our current operating plan includes the opening of up to seven additional new stores in 2005, including the one new store that we opened since the end of fiscal 2004.
In the event that our operating plan changes or proves inaccurate due to decreased revenues, unanticipated expenses, increased competition, unfavorable economic conditions, or other unforeseen circumstances, our liquidity may be negatively impacted. Accordingly, we would be required to adjust our expenditures to conserve working capital or raise additional capital to fund operations. There can be no assurance, however, that, should we require additional financing, such financing will be available on terms and conditions acceptable to us.
We operate in a largely un-branded business arena that has many small players. As a result, we may consider growing our business through acquisitions of other entities. Any determination to make an acquisition will be based upon a variety of factors, including, without limitation, the purchase price and other financial terms of the transaction, the business prospects, geographical location and the extent to which any acquisition would enhance our prospects. We presently have no plans, agreements, understandings, or arrangements with respect to any acquisitions.
Stockholder Rights Plan
On November 9, 2001, we announced that our Board of Directors adopted a stockholder rights plan (the rights plan). Under the rights plan each share of our capital stock outstanding at the close of business on November 9, 2001 and each share of our capital stock issued subsequent to that date has a right associated with it, such that each share of our common stock is entitled to one right and each share of our preferred stock is entitled to such number of rights equal to the number of common shares into which it is convertible. The rights will become exercisable only in the event that, with certain exceptions, an acquiring party accumulates 10 percent or more of our voting stock or if a party announces an offer to acquire 15 percent or more of our voting stock. The rights expire on November 9, 2011. When exercisable, each right entitles the holder to purchase from us one one-hundredth of a share of a new series of Series G junior preferred stock at an initial purchase price of $2.00, subject to adjustment. In addition, upon the occurrence of certain events, holders of the rights will be entitled to purchase either iParty Corp. stock or shares in an acquiring entity at half of market value. We generally will be entitled to redeem the rights at $0.001 per right at any time until the date on which a 10 percent position in our voting stock is acquired by any person or group. Until a right is exercised, the holder of a right will have no rights as a stockholder of iParty solely by virtue of being a rights holder, including, without limitation, the right to vote or receive dividends.
Effects of Inflation
We do not view the effects of inflation to have a material effect upon our business.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not believe that we have any material market risk exposure owing to foreign currency risk, exchange rate risk, commodity price risk and other relevant market rate or price risks that require the quantitative and qualitative disclosures set forth in Item 305 of Regulation S-K. We have interest rate risk on our line of credit debt obligation to the extent that if interest rates were to rise our rate of interest under our line of credit would also increase. We do not believe that this interest rate risk is material and we have not entered into any hedging or similar contractual arrangements with respect to such risk. We do not enter into contracts for trading purposes.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is included in a separate section of this report. See Index to Consolidated Financial Statements on page F1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. 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) as of December 25, 2004. 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 December 25, 2004, 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 and reported within the time periods specified in the SECs rules and forms.
(b) Attestation Report of the Registered Public Accounting Firm. We are not an accelerated filer, as such term is defined in Rule 12b-2 under the Securities Exchange Act. Accordingly, the attestation report of our independent registered public accounting firm on our management's assessment of our internal control over financial reporting is not required to be included in this Annual Report on Form 10-K.
(c) Changes in Internal Controls. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended December 25, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to our directors is incorporated herein by reference to the sections entitled Proposal 1Election of Directors and Section 16(a) Beneficial Ownership Reporting Compliance of our Companys definitive proxy statement which will be filed no later than 120 days after December 25, 2004.
We have adopted a written code of business conduct and ethics that applies to all our directors, officers and employees. We intend to disclose any amendments to, or waivers from, our code of business conduct and ethics on the Investor Relations page of our website which is located at www.iparty.com.
ITEM 11. EXECUTIVE COMPENSATION
Information required by Item 11 is incorporated herein by reference to the Sections entitled Proposal 1Election of DirectorsDirector Compensation and Executive Compensation of our definitive proxy statement which will be filed no later than 120 days after December 25, 2004.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information related to security ownership required by Item 12 is incorporated herein by reference to the Section entitled Stock Ownership of our definitive proxy statement which will be filed no later than 120 days after December 25, 2004.
Securities authorized under equity compensation plans as of December 25, 2004, were as follows:
EQUITY COMPENSATION PLAN INFORMATION
Under the iParty. Corp. Amended and Restated 1998 Incentive and Nonqualified Stock Option Plan we are authorized to grant options for the purchase of up to 11,000,000 shares of our common stock. As of December 25, 2004, 373,170 shares had been issued pursuant to the exercise of previously issued stock options. As of December 25, 2004, there were options outstanding to purchase 10,031,817 shares of our common stock. Consequently, as of December 25, 2004, options for the purchase of up to 595,013 common shares remain available for future grants.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by Item 13 is incorporated herein by reference to the section entitled Executive CompensationCertain Relationships and Related Transactions of our definitive proxy statement which will be filed no later than 120 days after December 25, 2004.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required by Item 14 is incorporated herein by reference to the section entitled Independent Public Accountants of our definitive proxy statement which will be filed no later than 120 days after December 25, 2004.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial statements:
For a listing of consolidated financial statements which are included in this document, see page F1.
2. Financial Statement Schedules:
All schedules for which provision is made in the applicable accounting regulation of the SEC are not required under the related instructions or are inapplicable and, therefore, have been omitted.
The exhibits listed in the Exhibit Index immediately preceding the exhibits are filed as part of this Annual Report on Form 10-K and are incorporated herein by reference.
The exhibits listed in the Exhibit Index immediately preceding the exhibits are filed as part of this Annual Report on Form 10-K and are incorporated herein by reference.
(c) Financial Statement Schedules:
Included in Item 15(a)(2) above.
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying notes are an integral part of these Consolidated Financial Statements.
Board of Directors and Stockholders
We have audited the accompanying consolidated balance sheets of iParty Corp. and subsidiaries as of December 25, 2004 and December 27, 2003, and the related consolidated statements of operations, convertible preferred stock and stockholders equity (deficit), and cash flows for the years then ended. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Companys internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis of designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of iParty Corp. and subsidiaries at December 25, 2004 and December 27, 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 25, 2004, in conformity with U.S. generally accepted accounting principles.
The accompanying notes are an integral part of these Consolidated Financial Statements.
The accompanying notes are an integral part of these Consolidated Financial Statements.
The accompanying notes are an integral part of these Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS EQUITY (DEFICIT)
The accompanying notes are an integral part of these Consolidated Financial Statements.