Edgar Filing: PARTY CITY CORP

PARTY CITY CORPORATION

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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


For The Quarterly Period Ended		Commission File Number




March 30, 2002		0-27826

PARTY CITY CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		22-3033692




(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)









400 Commons Way		07866




Rockaway, New Jersey		(Zip Code)




(Address of Principal Executive Offices)

973-983-0888
(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 No:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

BOX As of May 3, 2002, there were outstanding 13,333,518 shares of
Common Stock, $.01 par value.

TABLE OF CONTENTS


PART 1. FINANCIAL INFORMATION
	Item 1. Financial Statements
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures about Market Risk
PART II OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 3. Defaults upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Reports on Form 8-K
	EXHIBIT INDEX

PARTY CITY CORPORATION AND SUBSIDIARY

INDEX


			Page No.

Part I. Financial Information




Item 1.		Condensed Consolidated Financial Statements









	Condensed Consolidated Balance Sheets – March 30, 2002 (Unaudited), March 31, 2001 (Unaudited) and June 30, 2001			3









	Condensed Consolidated Statements of Operations (Unaudited) — For the quarters and nine months ended March 30, 2002 and March 31, 2001			4









	Condensed Consolidated Statements of Cash Flows (Unaudited) — For the nine months ended March 30, 2002 and March 31, 2001			5









	Notes to Condensed Consolidated Financial Statements			6









Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		11









Item 3.		Quantitative and Qualitative Disclosures About Market Risk		17









Part II. Other Information				18









Item 1.		Legal Proceedings		18









Item 2.		Changes in Securities and Use of Proceeds		18









Item 3.		Defaults Upon Senior Securities		18









Item 4.		Submission of Matters to a Vote of Security Holders		19









Item 5.		Other Information		19









Item 6.		Exhibits and Reports on Form 8-K		19









Exhibit Index				20

PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

PARTY CITY CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)


				March 30,			March 31,		June 30,
				2002			2001		2001

				(Unaudited)			(Unaudited)

ASSETS









Current assets:




	Cash and cash equivalents			$	7,455		$	12,006	$	9,842




	Merchandise inventory				60,952			54,569		48,034




	Deferred income taxes				5,031			5,305		3,798




	Other current assets				13,349			14,211		12,156

		Total current assets			86,787			86,091		73,830




Property and equipment, net					46,024			42,437		46,351




Goodwill, net					14,206			13,950		13,647




Other assets					5,901			3,824		7,514

			Total assets	$	152,918		$	146,302	$	141,342










LIABILITIES AND STOCKHOLDERS’ EQUITY




Current liabilities:




	Accounts payable			$	40,846		$	40,004	$	27,905




	Accrued expenses and other current liabilities				23,191			18,726		26,274




	Senior Notes, current portion				7,655			14,655		11,366

		Total current liabilities			71,692			73,385		65,545




Deferred rent and other long-term liabilities					9,725			8,531		8,701




Senior Notes					8,759			15,488		16,006




Commitments and contingencies




Stockholders’ equity:




		Common stock, $.01 par value, authorized 25,000,000 shares; issued 13,289,767, 12,722,661 and 12,723,455 shares, respectively			133			127		127




	Additional paid-in capital				38,654			37,972		38,236




Retained earnings					25,784			10,799		12,727




Treasury stock, at cost (284,000 shares)					(1,829	)		—		—

		Total stockholders’ equity			62,742			48,898		51,090

			Total liabilities and stockholders’ equity	$	152,918		$	146,302	$	141,342

See accompanying notes to condensed consolidated financial statements.

PARTY CITY CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)


			Quarter ended						Nine months ended

			March 30,			March 31,			March 30,		March 31,
			2002			2001			2002		2001

Revenues:




	Net sales		$	86,252		$	74,298		$	309,026	$	289,186




	Royalty fees			3,652			2,911			13,031		11,184




	Franchise fees			200			—			543		609

		Total revenues		90,104			77,209			322,600		300,979









Expenses:




	Cost of goods sold and occupancy costs			60,816			53,364			202,411		192,254




	Company-owned stores operating and selling expense			20,031			18,329			69,724		67,442




	Franchise expense			1,612			1,436			4,826		3,849




	General and administrative expense			6,707			8,150			19,409		18,361

		Total expenses		89,166			81,279			296,370		281,906

Income (loss) before interest and income taxes				938			(4,070	)		26,230		19,073




	Interest expense, net			1,099			1,752			4,508		6,038

Income (loss) before income taxes				(161	)		(5,822	)		21,722		13,035




	Provision for income taxes (benefit)			(65	)		(2,295	)		8,665		5,002

Net income (loss)				($96	)		($3,527	)	$	13,057	$	8,033

	Basic earnings (loss) per share			($0.01	)		($0.28	)	$	1.01	$	0.63

		Weighted average shares outstanding — basic		12,982			12,723			12,909		12,722

	Diluted earnings (loss) per share			($0.01	)		($0.28	)	$	0.69	$	0.46

		Weighted average shares outstanding — diluted		12,982			12,723			18,972		17,646

See accompanying notes to condensed consolidated financial statements.

PARTY CITY CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)


				Nine months ended

				March 30,			March 31,
				2002			2001

				(Unaudited)

Cash flow from operating activities:




Net income				$	13,057		$	8,033




Adjustments to reconcile net income to net cash provided by operating activities




	Depreciation and amortization				8,944			7,769




	Impairment of assets				—			2,103




	Deferred taxes				462			3,196




	Non-cash interest				1,128			1,275




	Deferred rent and other long-term liabilities				1,024			651




	Equity-based compensation				257			—




	Provision for doubtful accounts				59			160




	Changes in assets and liabilities:




		Merchandise inventory			(12,620	)		(13,141	)




		Other current assets and other assets			(1,242	)		2,400




		Accounts payable and other current liabilities			9,858			10,057

			Net cash provided by operating activities		20,927			22,503









Cash flow from investment activities:




	Purchases of property and equipment				(8,493	)		(9,989	)




	Proceeds from sale of stores to franchisees				—			1,157




	Stores and non-compete agreement acquired from franchisees				(1,504	)		(516	)

		Net cash used in investment activities			(9,997	)		(9,348	)









Cash flow from financing activities:




	Payments of Senior Notes				(11,655	)		(5,103	)




	Purchases of treasury stock				(1,829	)		—




	Proceeds from exercise of stock options				167			4

		Net cash used in financing activities			(13,317	)		(5,099	)

Net increase (decrease) in cash and cash equivalents					(2,387	)		8,056




Cash and cash equivalents, beginning of period					9,842			3,950

Cash and cash equivalents, end of period				$	7,455		$	12,006










Supplemental disclosure of cash flow information:




	Income taxes paid			$	9,785		$	5,217




	Interest paid				4,098			5,019

See accompanying notes to condensed consolidated financial statements.

PARTY CITY CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The condensed consolidated financial statements, except for the June 30, 2001 consolidated balance sheet, are unaudited. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position of the Company as of March 30, 2002 and March 31, 2001 and the results of operations for the quarters and nine months ended March 30, 2002 and March 31, 2001 and cash flows for the nine months ended March 30, 2002 and March 31, 2001. Because of the seasonality of the party goods industry, operating results of the Company on a quarterly basis may not be indicative of operating results for the full fiscal year.

These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the fiscal year ended June 30, 2001, which are included in the Company’s Annual Report on Form 10-K with respect to such period filed with the Securities and Exchange Commission on September 27, 2001. All significant intercompany accounts and transactions have been eliminated. The June 30, 2001 consolidated balance sheet amounts are derived from the Company’s audited consolidated financial statements.

2. RECENT ACCOUNTING STANDARDS

In October of 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” This statement supersedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of,” but retains the fundamental provisions of SFAS No. 121 for recognition and measurement of the impairment of long-lived assets to be held and used and measurement of long-lived assets to be disposed of by sale. However, SFAS No. 144 applies the fair value method for testing of impairment, which differs from SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30 as it pertains to disposal of a business segment but retains the requirement of that opinion to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001, thereby applying to the Company upon the commencement of its fiscal 2003 fiscal year. The Company is evaluating the impact of the adoption of this standard and has not yet determined the effect of adoption on its financial position and results of operations.

PARTY CITY CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

EARNINGS PER SHARE

The following table sets forth the computations of basic and diluted earnings per share (in thousands, except per share amounts):


	Quarter ended						Nine months ended

	March 30,			March 31,			March 30,		March 31,
	2002			2001			2002		2001

	(Unaudited)						(Unaudited)

Net income (loss)	$	(96	)	$	(3,527	)	$	13,057	$	8,033




Earnings (loss) per share — basic	$	(0.01	)	$	(0.28	)	$	1.01	$	0.63




Earnings (loss) per share — diluted	$	(0.01	)	$	(0.28	)	$	0.69	$	0.46




Average common shares outstanding		12,982			12,723			12,909		12,722




Dilutive effect of warrants		(a	)		(b	)		5,461		4,694




Dilutive effect of stock options(c)		(a	)		(b	)		532		230




Restricted shares		—			—			70		—

Average common and common equivalent shares outstanding		12,982			12,723			18,972		17,646

Average common stock price used for treasury method	$	10.53		$	3.35		$	8.21	$	3.39

(a)		Options to purchase 1,009,888 shares of common stock at prices ranging from $2.00 to $32.50 per share and warrants to purchase 6,280,000 shares of common stock at $1.07 per share were outstanding at March 30, 2002 but were not included in the computation of dilutive loss per share for the quarter ended March 30, 2002 because to do so would have been anti-dilutive.









(b)		Options to purchase 1,075,481 shares of common stock at prices ranging from $2.25 to $32.50 per share and warrants to purchase 6,880,000 shares of common stock at $1.07 per share were outstanding at March 31, 2001 but were not included in the computation of dilutive loss per share for the quarter ended March 31, 2001 because to do so would have been anti-dilutive.





(c)		Options to purchase 578,541 shares of common stock at prices ranging from $7.00 to $32.50 and options to purchase 913,638 shares of common stock at prices ranging from $2.85 to $32.50 were outstanding but were not included in the computation of dilutive earnings per share for the nine months ended March 30, 2002 and March 31, 2001, respectively, because to do so would have been anti-dilutive for the periods presented.

STOCK REPURCHASE

On September 19, 2001, the Board of Directors authorized the Company to repurchase up to $15 million of the Company’s outstanding common stock. The stock repurchases are made at the discretion of management. As of March 30, 2002, the Company had repurchased 284,000 shares for an aggregate amount of $1.8 million, or 12.2% of the total amount authorized to be repurchased. No stock repurchases were made during the quarter ended, or subsequent to, March 30, 2002.

DEBT MATURITIES

The amounts of Senior Notes (as defined below) outstanding are as follows (in thousands):


		March 30,			March 31,			June 30,
Note	Description	2002			2001			2001

Series A	12.5%(i) Secured Notes due 2003	$	2,552		$	5,104		$	5,104




Series B	13.0%(i) Secured Notes due 2003		5,103			5,103			5,103




Series C	13.0%(i) Secured Notes due 2002		––			5,103			5,103




Series D	14.0%(i) Secured Notes due 2004		10,207			10,207			10,207




Series E	14.0% Senior Secured Notes due 2002		––			7,000			4,000

			17,862			32,517			29,517




	Unamortized debt discount		(1,448	)		(2,374	)		(2,145	)




	Less: Current portion, net of debt discount		(7,655	)		(14,655	)		(11,366	)

		$	8,759		$	15,488		$	16,006

(i)		Interest rate was increased by 450 basis points for all amounts outstanding on and after January 13, 1999.

6.		LITIGATION

The Company was named as a defendant in twelve class action complaints. The Company’s former Chief Executive Officer and the former Chief Financial Officer and Executive Vice President of Operations were also named as defendants. All of the complaints were filed in the United States District Court for the District of New Jersey. The complaints were filed as class actions on behalf of persons who purchased or acquired Party City common stock during various time periods between February 26, 1998 and March 18, 1999 (the “Class Period”). In October 1999, plaintiffs filed an amended class action complaint and, in February 2000, plaintiffs filed a second amended complaint.

The second amended complaint alleged, among other things, violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, and sought unspecified damages. The plaintiffs alleged that defendants issued a series of false and misleading statements and failed to disclose material facts concerning, among other things, the Company’s financial condition, adequacy of internal controls and compliance with certain loan covenants during the Class Period. The plaintiffs further alleged that because of the issuance of a series of false and misleading statements and/or the failure to disclose material facts, the price of Party City’s common stock was artificially inflated.

In early 2000, defendants moved to dismiss the second amended complaint on the ground that it failed to state a cause of action. On May 29, 2001, the District Court issued an Opinion and Order dismissing the Complaint against all defendants with prejudice. On June 27, 2001, plaintiffs filed a Notice of Appeal to the United States Court of Appeals for the Third Circuit. Prior to the argument of the appeal, the parties reached an agreement in principle to settle the action. The parties have requested that the Court of Appeals remand the case to the District Court to supervise the implementation of the settlement. The proposed amount to be paid by the Company under the settlement is not material and is subject to various conditions. These include the completion of the negotiation of a definitive settlement agreement and the approval of the terms of the settlement agreement by the District Court after notice to the members of the class who have the right to object. There can be no assurance that all these conditions will be satisfied.

A lawsuit was filed on September 25, 2001 against the Company in Los Angeles Superior Court by an assistant manager in one of the Company’s California stores for himself and on behalf of other members of an alleged class of Party City store managers (the “Class”) who claim the Company misclassified the Class as exempt from California overtime wage and hour laws. The lawsuit seeks relief in the form of disgorgement of overtime wages allegedly owed by the Company to the Class but not paid. The plaintiffs also seek punitive damages and statutory penalties. The Company denies the allegations and is vigorously defending against the claim.

In addition to the foregoing, the Company is from time to time involved in routine litigation incidental to the conduct of its business. The Company is aware of no other material existing or threatened litigation to which it is or may be a party.

SEGMENT INFORMATION

The following table contains key financial information of the Company’s business segments (in thousands):


	Quarter ended						Nine months ended

	March 30,			March 31,			March 30,			March 31,
	2002			2001			2002			2001

	(Unaudited)						(Unaudited)

RETAIL




Net revenue	$	86,252		$	74,298		$	309,026		$	289,186




Operating earnings		5,405			2,605			36,891			29,490




Identifiable assets		131,779			130,543			131,779			130,543




Depreciation/amortization		1,829			2,262			5,439			6,098




Capital expenditures		1,663			2,090			4,024			4,413




FRANCHISING




Net revenue	$	3,852		$	2,911		$	13,574		$	11,793




Operating earnings		2,240			1,475			8,748			7,944




Identifiable assets		2,923			2,215			2,923			2,215




Depreciation/amortization		—			—			—			—




Capital expenditures		—			—			—			—




CORPORATE/OTHER




Net revenue	$	—		$	—		$	—		$	—




Operating loss		(6,707	)		(8,150	)		(19,409	)		(18,361	)




Identifiable assets		18,216			13,544			18,216			13,544




Depreciation/amortization		1,244			335			3,505			1,671




Capital expenditures		1,897			3,510			4,584			5,863




CONSOLIDATED TOTALS




Net revenue	$	90,104		$	77,209		$	322,600		$	300,979




Operating income (loss)		938			(4,070	)		26,230			19,073




Interest expense, net		1,099			1,752			4,508			6,038

Income (loss) before income taxes (benefit)		(161	)		(5,822	)		21,722			13,035




Provision for income taxes (benefit)		(65	)		(2,295	)		8,665			5,002

Net income (loss)		($96	)		($3,527	)	$	13,057		$	8,033

Identifiable assets	$	152,918		$	146,302		$	152,918		$	146,302




Depreciation/amortization		3,073			2,597			8,944			7,769




Capital expenditures		3,560			5,600			8,608			10,276

PARTY CITY CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

GOODWILL AND OTHER INTANGIBLE ASSETS

On July 1, 2001, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” As a result, the Company no longer amortizes goodwill. Instead the Company periodically evaluates goodwill for recoverability. The Company also evaluates goodwill whenever events and changes in circumstance suggest that the carrying amount may not be recoverable from its estimated future cash flows. Upon adoption, the Company established reporting units based on its current reporting structure. The Company then assigned all goodwill to the reporting units, as well as other assets and liabilities, to the extent that they relate to the reporting unit. The Company completed the first step of the transitional goodwill impairment test and has determined that no potential impairment exists. As a result, no transitional impairment loss was recorded in fiscal 2002 in connection with the adoption of SFAS No. 142.

The following pro forma financial information is presented as if the statement were adopted at the beginning of the quarter ended September 30, 2000 (in thousands, except per share amounts):


	Quarter ended						Nine months ended

	March 30,			March 31,			March 30,		March 31,
	2002			2001			2002		2001

	(Unaudited)						(Unaudited)

Reported net income (loss)	$	(96	)	$	(3,527	)	$	13,057	$	8,033




Add back:




Goodwill amortization, net of taxes		—			181			—		547

Pro forma net income (loss)	$	(96	)	$	(3,346	)	$	13,057	$	8,580

Earnings (loss) per share reported — basic	$	(0.01	)	$	(0.28	)	$	1.01	$	0.63




Goodwill amortization		—			0.01			—		0.04

Pro forma earnings (loss) per share — basic	$	(0.01	)	$	(0.27	)	$	1.01	$	0.67

Earnings (loss) per share reported — diluted	$	(0.01	)	$	(0.28	)	$	0.69	$	0.46




Goodwill amortization		—			0.01			—		0.03

Pro forma net earnings (loss) per share — diluted	$	(0.01	)	$	(0.27	)	$	0.69	$	0.49

The changes in the carrying amount of goodwill and other intangibles for the nine months ended March 30, 2002, by operating segment, are as follows (in thousands):


Retail:




Balance as of June 30, 2001		$	13,647




	Goodwill acquired during the period		559




	Other intangibles		550

Balance as of March 30, 2002		$	14,756

Other intangibles, included in “Other assets,” consisted of amounts paid to a franchisee in connection with a seven-year agreement not to compete. This intangible asset is being amortized over a seven-year period.

Estimated amortization expense for other intangibles is approximately $21,000 and $27,000 for the quarter and nine months ended March 30, 2002, respectively.

SUBSEQUENT EVENTS

On April 25, 2002, the Company announced that it had completed the acquisition of thirteen stores in the Seattle, Washington market from Paper Warehouse, Inc. The Company plans to convert these locations to the Party City format. Management currently plans to open these stores in its first fiscal quarter ending September 28, 2002.

On May 7, 2002, the Company assumed the lease of a franchisee for a store in Sacramento, California under the default terms of the franchisee's lease agreement. The Company plans to reopen the store in June 2002.

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

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires the appropriate application of certain accounting policies, many of which require estimates and assumptions about future events and their impact on amounts reported in the financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from estimates. Such differences could be material to the consolidated financial statements.

Management believes application of accounting policies, and the estimates inherently required by the policies, are reasonable. These accounting policies and estimates are constantly reevaluated, and adjustments are made when facts and circumstances dictate a change. Historically, management has found the application of accounting policies to be appropriate, and actual results generally do not differ materially from those determined using necessary estimates.

The Company’s accounting policies are more fully described in Note 1 to the consolidated financial statements set forth in the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on September 27, 2001. Management has identified certain material accounting policies that are more fully described below.

Merchandise inventory - Merchandise inventory is carried at the lower of cost or market on a first-in, first-out basis. Inventory is written down for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

Long-lived assets. In the evaluation of the fair value and future benefits of long-lived assets, management performs an analysis of the anticipated undiscounted future net cash flows of the related long-lived assets. If the carrying value of the related asset exceeds the undiscounted cash flows, the carrying value is reduced to its fair value, which is generally calculated using discounted cash flows. Various factors including future sales growth and profit margins are included in this analysis. To the extent these future projections or strategies change, the conclusion regarding impairment may differ from the current estimates.

Results of Operations

SELECTED FINANCIAL DATA
(in thousands, except per share and store data)


		Quarter ended						Nine months ended

		March 30,			March 31,			March 30,		March 31,
		2002			2001			2002		2001

		(Unaudited)						(Unaudited)

Statement of Operations Data




Total revenue		$	90,104		$	77,209		$	322,600	$	300,979

Company-owned stores:




	Net sales	$	86,252		$	74,298		$	309,026	$	289,186




	Cost of goods sold and occupancy costs		60,816			53,364			202,411		192,254

	Gross profit		25,436			20,934			106,615		96,932




	Store operating and selling expense		20,031			18,329			69,724		67,442

	Company-owned stores profit contribution		5,405			2,605			36,891		29,490




Franchise stores:




	Royalty fees		3,652			2,911			13,031		11,184




	Franchise fees		200			—			543		609

	Total franchise revenues		3,852			2,911			13,574		11,793




	Total franchise expense		1,612			1,436			4,826		3,849

	Franchise profit contribution		2,240			1,475			8,748		7,944




General and administrative expense:




	Impairment provision		—			2,113			—		2,113




	Other general and administrative expenses		6,707			6,037			19,409		16,248

			6,707			8,150			19,409		18,361

Income (loss) before interest and income			938			(4,070	)		26,230		19,073




Interest expense, net			1,099			1,752			4,508		6,038

Income (loss) before income taxes (benefit)			(161	)		(5,822	)		21,722		13,035




Provision for income taxes (benefit)			(65	)		(2,295	)		8,665		5,002

Net income (loss)			($96	)		($3,527	)	$	13,057	$	8,033

Basic earnings (loss) per share			($0.01	)		($0.28	)	$	1.01	$	0.63




Diluted earnings (loss) per share			($0.01	)		($0.28	)	$	0.69	$	0.46




Weighted average shares outstanding —basic			12,982			12,723			12,909		12,722




Weighted average shares outstanding — diluted			12,982			12,723			18,972		17,646




EBITDA (a)			4,011			640			35,174		28,955




Depreciation and amortization			3,073			2,597			8,944		7,769


				Quarter ended						Nine months ended

				March 30,			March 31,			March 30,			March 31,
				2002			2001			2002			2001

				(Unaudited)						(Unaudited)

Store Data:




	Company-owned:




		Stores open at beginning of period			198			195			193			197




			Stores opened		2			—			6			—




			Stores closed		––			(2	)		––			(2	)




			Stores acquired from franchisees		––			—			1			1




			Stores sold to franchisees		––			—			––			(3	)

		Stores open at end of period			200			193			200			193




	Average Company-owned stores open in period				199			193			195			194









	Franchise:




		Stores open at beginning of period			272			259			261			211




			Stores opened		5			2			19			48




			Stores closed		(33	)(c)		—			(35	)(c)		—




			Stores sold to Company		––			—			(1	)		(1	)




			Stores acquired from Company		––			—			––			3

		Stores open at end of period			244			261			244			261

Average franchise stores open in period					267			260			270			236




Total stores chainwide					444			454			444			454










Chainwide sales				$	185,644		$	164,830		$	684,153		$	623,402




Same store sales increase:




		Company-owned stores			13.5	%		12.9	%		5.8	%		10.5	%




		Franchise stores			9.7	%		10.0	%		4.3	%		4.3	%




		Average sales per Company-owned store		$	433.4		$	384.9		$	1,584.7		$	1,486.9









Balance Sheet Data:




	Working capital			$	15,095		$	12,706		$	15,095		$	12,706




	Total assets				152,918			146,302			152,918			146,302




	Bank borrowings and other debt (b)				16,414			30,154			16,414			30,154




	Capital lease obligation				122			540			122			540




	Stockholders’ equity				62,742			48,898			62,742			48,898

(a)		The Company’s definition of EBITDA is earnings before interest, taxes, depreciation, amortization and impairment provision.









(b)		The bank borrowings and other debt at March 30, 2002 and March 31, 2001 is net of an unamortized debt discount of $1.4 million and $2.4 million, respectively.









(c)		Includes 28 stores closed as a result of Canadian franchise bankruptcy.

Quarter Ended March 30, 2002 Compared to Quarter Ended March 31, 2001

Retail. Net sales from Company-owned stores increased 16.1% to $86.3 million for the third quarter of fiscal 2002 from $74.3 million for the third quarter of the last fiscal year. Benefitting from the earlier Easter holiday, total chain-wide sales (which include aggregate sales for the collective group of Company-owned and franchise stores) increased 12.6% to $185.6 million from $164.8 million in the comparable period last year. Same store sales increased 13.5% in the third quarter of fiscal 2002. Gross profit reflects the cost of goods sold and store occupancy costs including rent, common area maintenance, real estate taxes, repair and maintenance, depreciation and utilities. Gross profit for the third quarter of fiscal 2002 increased 21.5% to $25.4 million from $20.9 million for the third quarter of the last fiscal year. The increase was primarily due to increased sales volume and improved leverage on occupancy costs. Gross margin was 29.5% for the third quarter of fiscal 2002 compared with 28.2% for the third quarter of the last fiscal year.

Store operating and selling expenses increased 9.3% to $20.0 million for the third quarter of fiscal 2002 from $18.3 million in the third quarter of the last fiscal year. The increase in store operating expenses is primarily attributable to the increase in sales. Store operating and selling expenses were 23.2% and 24.7% of sales for the third quarter of fiscal 2002 and fiscal 2001, respectively. The decrease as a percentage of sales is primarily due to increased store labor productivity. Company-owned stores recorded a contribution of $5.4 million for the third quarter of fiscal 2002, compared to $2.6 million for the third quarter of the last fiscal year. The improvement over the prior year is primarily the result of improved gross margin as well as improved operating efficiencies. The Company opened two new stores during the fiscal quarter ended March 30, 2002. No new stores were opened during the quarter ended March 31, 2001. Pre-opening expenses for these stores and other stores planned to be opened later in the fiscal year were $241,000. All costs of pre-opening are expensed when incurred.

Franchising. Franchise revenue is composed of the initial franchise fees that are recorded as revenue when the store opens, and ongoing royalty fees, generally 4.0% of the store’s net sales. Five franchise stores were opened and franchise fees of $200,000 were recognized in the third quarter of fiscal 2002. No franchise stores were opened and no franchise fees were recognized in the third quarter of the prior fiscal year. Royalty fees increased 25.5% to $3.7 million in the third quarter of fiscal 2002 from $2.9 million in the third quarter of the last fiscal year which is primarily due to an increase in the average number of stores and a same store sales increase of 9.7% for the franchise stores in the third quarter of fiscal 2002.

Expenses directly related to franchise revenue increased 12.3% to $1.6 million for the third quarter of fiscal 2002 from $1.4 million for the third quarter of the last fiscal year. As a percentage of franchise revenue, franchise expenses were 41.9% and 49.3% for the third quarter of fiscal 2002 and fiscal 2001, respectively, due to increased revenue on relatively fixed operating costs.

General and Administrative Expenses. General and administrative expenses decreased 17.7% to $6.7 million in the third quarter of fiscal 2002 from $8.2 million in the third quarter of the last fiscal year. This decrease is primarily due to an impairment provision of $2.1 million which was recorded in the third quarter of the prior fiscal year related to replacement of store registers. This was offset in part by an increase of $519,000 in depreciation related to new systems placed in service. The balance of the increase is primarily due to increases in legal and tax consulting fees and equity based compensation. General and administrative expenses were 7.8% and 11.0% of sales for the third quarter of fiscal 2002 and fiscal 2001. Exclusive of the impairment provision, general and administrative expenses were 8.1% in the prior fiscal year.

Interest Expense. Interest expense decreased 37.3% to $1.1 million for the third quarter of fiscal 2002 from $1.8 million in the third quarter of the last fiscal year. The decreased expense is primarily attributable to lower outstanding principal balances outstanding due to payments made over the last twelve months on the Company’s 12.5% Secured Notes due 2003, 13.0% Secured Notes due 2003, 13.0% Secured Notes due 2002, 14.0% Secured Notes due 2004 and 14.0% Senior Secured Notes due 2002 (collectively, the “Senior Notes”).

Income Taxes. The Company’s effective income tax rate was 40.0% in the third quarter of fiscal 2002 compared to 39.4% in the third quarter of the last fiscal year. The tax rate increased as a result of the increase in the federal statutory rate.

Net Income. As a result of the above factors, net loss for the third quarter of fiscal 2002 was $96,000, or $0.01 loss per basic and diluted share, as compared to net loss of $3.5 million, or $0.28 loss per basic share and diluted share in the third quarter of the last fiscal year.

Nine Months Ended March 30, 2002 Compared to Nine Months Ended March 31, 2001

Retail. Net sales from Company-owned stores increased 6.9% to $309.0 million for the nine months ended March 30, 2002 from $289.2 million for the nine months ended March 31, 2001. Same store sales increased 5.8% in the nine months ended March 30, 2002. Gross profit reflects the cost of goods sold and store occupancy costs including rent, common area maintenance, real estate taxes, repair and maintenance, depreciation and utilities. Gross profit for the nine months ended March 30, 2002 increased 10.0% to $106.6 million from $96.9 million for the nine months ended March 31, 2001. The increase was primarily due to increased sales volume and leverage on fixed occupancy costs. Gross margin was 34.5% for the nine months ended March 30, 2002 compared with 33.5% for the nine months ended March 31, 2001.

Store operating and selling expenses increased 3.4% to $69.7 million for the nine months ended March 30, 2002 from $67.4 million in the nine months ended March 31, 2001. The increase in store operating expenses is attributable to the increase in sales. Store operating and selling expenses were 22.6% and 23.3% of sales for the nine-month period ended March 30, 2002 and March 31, 2001, respectively. The decrease as a percentage of sales is primarily due to improvements in efficiency in the management of store labor hours and savings in advertising and supply expenses. Company-owned stores recorded a contribution of $36.9 million for the nine months ended March 30, 2002 compared to $29.5 million for the nine months ended March 31, 2001. The improvement over the prior year is primarily the result of improved gross margin as well as improved operating efficiencies. The Company opened six new stores during the nine months ended March 30, 2002. No new stores were opened in the nine months ended March 31, 2001. Pre-opening expenses for these stores and stores planned to be opened later in the fiscal year were $456,000. All costs of pre-opening are expensed when incurred.

Franchising. Franchise revenue is composed of the initial franchise fees that are recorded as revenue when the store opens, and ongoing royalty fees, generally 4.0% of the store’s net sales. Franchise fees, recognized on 19 store openings, were $543,000 for the nine months ended March 30, 2002, compared to $609,000 for the nine months ended March 31, 2001 relating to 48 store openings. Royalty fees increased 16.5% to $13.0 million in the nine months ended March 30, 2002 from $11.2 million in the nine months ended March 31, 2001 which is primarily due to an increase in the average number of stores and a same store sales increase of 4.3% for the franchise stores in the nine month period ended March 30, 2002.

Expenses directly related to franchise revenue increased 25.4% to $4.8 million for the nine months ended March 30, 2002 from $3.8 million for the nine months ended March 31, 2001. As a percentage of franchise revenue, franchise expenses were 35.6% and 32.6% for the nine months ended March 30, 2002 and March 31, 2001, respectively. This increase is primarily due to the recording of a provision for bad debt related to the Company’s Canadian franchisee.

General and Administrative Expenses. General and administrative expenses increased 5.7% to $19.4 million in the nine months ended March 30, 2002 from $18.4 million in the nine months ended March 31, 2001. This increase is attributable, in part, to an increase of $1.4 million in depreciation related to new systems placed in service. The balance of the increase is primarily due to increases in legal and tax consulting fees and equity based compensation. General and administrative expenses were 6.3% of sales for the nine months ended March 30, 2002 and March 31, 2001, respectively, reflecting investments in management and systems. Excluding an impairment provision of $2.1 million which was recorded in the third quarter of the prior fiscal year related to replacement of store registers, general and administrative expenses were 5.6% of sales for the nine months ended March 31, 2001.

Interest Expense. Interest expense decreased 25.3% to $4.5 million for the nine months ended March 30, 2002 from $6.0 million in the nine months ended March 31, 2001. The decreased expense is primarily attributable to lower

average borrowings outstanding under the Loan Agreement, dated January 14, 2000, as amended (“the Loan Agreement”) with Congress Financial Corporation and reduced outstanding principal balances on Senior Notes due to payments made over the last twelve months.

Income Taxes. The effective income tax rate was 40.0% in the nine months ended March 30, 2002 compared to 38.4% in the nine months ended March 31, 2001. The tax rate increased as a result of the increase in the federal statutory rate.

Net Income. As a result of the above factors, net income for the nine months ended March 30, 2002 was $13.1 million, or $1.01 per basic share and $0.69 per diluted share, as compared to net income of 8.0 million, or $0.63 per basic share and $0.46 per diluted share for the nine months ended March 31, 2001.

Liquidity and Capital Resources

The Company’s cash requirements are primarily for working capital, the opening of new stores, the improvement and expansion of existing facilities and the improvement of information systems. Historically, these cash requirements have been met through cash flow from operations and borrowings under the Loan Agreement. At March 30, 2002, working capital was $15.1 million.

For the nine-month period ended March 30, 2002, cash provided by operating activities was $20.9 million, compared to $22.5 million for the same period of the last fiscal year. The decrease in cash provided by operating activities was primarily attributable to a decrease in non-cash impairment charges compared to the preceding period.

Cash used in investment activities for the nine-month period ended March 30, 2002 was $10.0 million compared to $9.3 million in the same period in the last fiscal year. The increase in cash used in investing activities was primarily attributable to the continued investment in new systems, new stores and payments made for an acquisition. Six Company-owned stores were opened in the period.

Cash used in financing activities was $13.3 million for the nine-month period ended March 30, 2002. This relates to payments of $11.7 million on Senior Notes and purchases of treasury stock of $1.8 million.

At March 30, 2002, the Company had a nominal balance outstanding under the Loan Agreement due to accrued fees. Under the terms of the Loan Agreement, the Company may from time to time borrow amounts, based on a percentage of its eligible inventory, up to a maximum of $40 million at any time outstanding. Advances bear interest, at the Company’s option, (i) at the adjusted Eurodollar rate plus the applicable margin, which was 2.25% per annum at March 30, 2002 or (ii) at the rate of 3/4% per annum above the prime rate, totaling 5.5% at March 30, 2002. The term of the Loan Agreement is three years, and is secured by a lien on substantially all of the assets of the Company. At May 3, 2002, the Company had no balance outstanding and $33.2 million was available to be borrowed under the Loan Agreement.

Company management currently believes that the cash generated by operations, together with the borrowing availability under the Loan Agreement, will be sufficient to meet the Company’s working capital needs for the next twelve months, including planned new store openings.

Accounting and Reporting Changes

In October of 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” This statement supersedes SFAS No. 121 but retains the fundamental provisions of SFAS No. 121 for recognition and measurement of the impairment of long-lived assets to be held and used and measurement of long-lived assets to be disposed of by sale. However, SFAS No. 144 applies the fair value method for testing of impairment, which differs from SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30 as it pertains to disposal of a business segment but retains the requirement of that opinion to report discontinued operations separately from continuing operations and extends that reporting to a component of an entity that either has been disposed of or is classified as held for sale. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001, thereby applying to the Company upon the commencement of its fiscal 2003 fiscal year. The Company is evaluating the impact of the adoption of this standard and has not yet determined the effect of adoption on its financial position and results of operations.

Forward-Looking Statements

This Form 10-Q (including the information incorporated herein by reference) contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. The statements are made a number of times throughout the document and may be identified by forward-looking terminology as “estimate”, “project”, “expect”, “believe”, “may”, “will”, “intend” or similar statements or variations of such terms. Such forward-looking statements involve certain risks and uncertainties, and include among others, the following: levels of sales, store traffic, acceptance of product offerings, competitive pressures from other party supplies retailers, availability of qualified personnel, availability of suitable future store locations, schedules of store expansion plans and other factors. As a result of the foregoing risks and uncertainties, actual results and performance may differ materially from that projected or suggested herein. Additional information concerning certain risks and uncertainties that could cause actual results to differ materially from that projected or suggested may be identified from time to time in the Company’s Securities and Exchange Commission filings and the Company’s public announcements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company, in the normal course of doing business, is exposed to interest rate change market risk. As borrowing patterns are cyclical, the Company is not dependent on borrowing throughout the year. Therefore, a sudden increase in interest rates (which under the Loan Agreement is dependent on the prime rate) may, during peak borrowing, have a negative impact on short-term results.

PART II OTHER INFORMATION

Item 1. Legal Proceedings

Item 2. Changes in Securities and Use of Proceeds

None

Item 3. Defaults upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

(a) The exhibits required to be filed as part of this report on Form 10-Q are listed in the attached Exhibit Index.

(b) Reports on Form 8-K

None

EXHIBIT INDEX


Exhibit No.

3.1(1)	—	Certificate of Incorporation of the Company.









3.2(4)	—	Bylaws of the Company, as amended.









4.1(1)	—	Specimen stock certificate evidencing the Common Stock.









4.2(5)	—	Form of Amended and Restated Warrant.









4.3(2)	—	Form of A Note.









4.4(2)	—	Form of B Note.









4.5(2)	—	Form of C Note.









4.6(2)	—	Form of D Note.









4.7(5)	—	Form of E Note.









4.8(2)	—	Form of Securities Purchase Agreement, dated as of August 16, 1999, by and between the Company and each of the Investors.









4.9(5)	—	First Amendment to Securities Purchase Agreement, dated as of January 14, 2000, by and between the Company and each of the Investors.









4.10(7)	—	Second Amendment to Securities Purchase Agreement, dated as of April 1, 2001, by and among the Company and each of the Investors.









10.1(1)	—	Form of Unit Franchise Agreement entered into by the Company and franchisees.









10.2(6)	—	Amended and Restated 1999 Stock Incentive Plan of the Company.









10.3(3)	—	Option Agreement, dated as of June 8, 1999, between Steven Mandell and Jack Futterman.









10.4(3)	—	Stock Pledge Agreement, dated as of June 8, 1999, between Steven Mandell and Jack Futterman.









10.5(3)	—	Employment Agreement, dated as of June 8, 1999, between the Company and Jack Futterman.









10.6(2)	—	Investor Rights Agreement, dated as of August 16, 1999, by and among the Company, the Investors and Jack Futterman.









10.7(2)	—	Standstill and Forbearance Agreement, dated as of August 16, 1999, by and among the Company, PNC Bank, National Association, as Agent, and the Banks.









10.8(2)	—	Vendor Forbearance and Standstill Agreement, dated as of August 16, 1999, by and among the Company and the Trade Vendors.


Exhibit No.





10.9(7)	—	First Amendment to Investor Rights Agreement, dated as of October 11, 2000, by and among the Company, the Investors and Jack Futterman.









10.10(7)	—	Second Amendment to Investor Rights Agreement, dated as of November 20, 2000, by and among the Company, the Investors and Jack Futterman.









10.11(5)	—	Loan and Security Agreement, dated January 14, 2000, by and between the Company and Congress Financial Corporation.









10.12(6)	—	Description of oral consulting agreement between the Company and Ralph Dillon.









10.13(6)	—	Employment Agreement of James Shea, dated as of December 10, 1999, by and between the Company and James Shea.









10.14(6)	—	Employment Agreement of Andrew Bailen, dated as of August 7, 2000, by and between the Company and Andrew Bailen.









10.15(6)	—	Employment Agreement of Thomas Larson, dated as of June 18, 1999, by and between the Company and Thomas Larson.









10.16(8)	—	Management Stock Purchase Plan of the Company









21.1	—	Subsidiaries. The wholly owned subsidiary of the Company is Party City Michigan, Inc. incorporated on October 23, 1997, in the State of Delaware. This subsidiary does business under the name Party City Michigan, Inc.

Notes

(1)		Incorporated by reference to the Company’s Registration Statement as amended on Form S-1 Number 333-00350 as filed with the Commission on January 18, 1996.

(2)		Incorporated by reference to the Company’s Current Report on Form 8-K as filed with the Commission on August 25, 1999.

(3)		Incorporated by reference to Amendment No. 1 to Schedule 13D as filed by Jack Futterman with the Commission on June 17, 1999.

(4)		Incorporated by reference to the Company’s Current Report on Form 8-K as filed with the Commission on June 8, 2000.

(5)		Incorporated by reference to the Company’s Current Report on Form 8-K as filed with the Commission on January 19, 2000.

(6)		Incorporated by reference to the Company’s Quarterly Report on Form 10-Q as filed with the Commission on February 13, 2001.

(7)		Incorporated by reference to the Company’s Quarterly Report on Form 10-Q as filed with the Commission on May 15, 2001.

(8)		Incorporated by reference to the Company’s Registration Statement on Form S-8 as filed with the Commission on July 23, 2001.

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.


	PARTY CITY CORPORATION









	By	/s/	JAMES SHEA

		(James Shea)




		Chief Executive Officer









	By	/s/	THOMAS E. LARSON

		(Thomas E. Larson)




		Chief Financial Officer









	By	/s/	LINDA M. SILUK

		(Linda M. Siluk)




		Chief Accounting Officer









Date: May 14, 2002

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