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IN RE PARTY CITY SECURITIES LITIGATION

May 29, 2001

IN RE: PARTY CITY SECURITIES LITIGATION


The opinion of the court was delivered by: Lechner, District Judge.

        OPINION

This is an action for securities fraud brought on behalf of purchasers of Party City Corporation ("Party City") common stock ("Party City Stock"), seeking damages for violations of Sections 10(b) ("Section 10(b)") and 20(a) ("Section 20(a)") of the Securities Exchange Act of 1934 (the "Exchange Act"), as amended, 15 U.S.C. § 78j(b) and 78t(a), and Rule 10b-5 ("Rule 10b-5") promulgated thereunder, 17 C.F.R. § 240.10b-5, from Party City, Steven Mandell ("Mandell") and David Lauber ("Lauber") (collectively, the "Defendants"). The asserted class period is from 26 February 1998 through 18 March 1999 (the "Class Period"). Jurisdiction is alleged pursuant to 28 U.S.C. § 1331.

Currently pending is a motion to dismiss (the "Motion to Dismiss") the second amended complaint (the "Second Amended Complaint") pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure ("Rule 12(b)(6)").*fn1 For the reasons set forth below, the Motion to Dismiss is granted.

Facts*fn2

A. The Parties

Party City is a Delaware Corporation with its principal place of business in Rockaway, New Jersey. Second Amended Complaint at ¶ 10. Party City is a retailer of party supplies which it markets through a nationwide network of discount stores. Id.

Mandell was the founder and former President, Chief Executive Officer and Director of Party City. Id. at ¶ 11. Mandell signed quarterly reports on Form 10-Q filed with the Securities and Exchange Commission (the "SEC"). Id. Mandell also issued statements on behalf of Party City. Id.

Lauber is the former Chief Financial Officer and Principal Accounting Officer and Director of Party City. Id. at ¶ 12. Lauber signed quarterly reports on Form 10-Q filed with the SEC. Id. Lauber also issued statements on behalf of Party City. Id.

B. Procedural History

This action is a consolidation of several cases filed against Party City, Mandell and Lauber*fn3 seeking to recover for alleged violations of the Exchange Act.

By order, dated 13 September 1999, (the "13 September 1999 Order") plaintiffs (the "Plaintiffs") were directed to file a consolidated amended complaint (the "Consolidated Amended Complaint"). 13 September 1999 Order at 4. The 13 September 1999 Order further provided that within seven business days of service of the Consolidated Amended Complaint, the Defendants were to notify the Plaintiffs if they intended to move against the complaint and, if so, the basis for such a motion. Id. Within five business days of such notification, the Plaintiffs were required to advise the Defendants of their intention to either stand on the Consolidated Amended Complaint or to amend. Id.

On 18 October 1999, the Plaintiffs filed the Consolidated Amended Complaint. By letter, dated 27 October 1999, (the "27 October 1999 Letter") the Defendants notified the Plaintiffs of their intent to move to dismiss the Consolidated Amended Complaint, as well as the basis of such a motion. 27 October 1999 Letter, attached as Ex. B to the Greiner Aff. By letter, dated 3 November 1999, (the "3 November 1999 Letter") counsel for the Plaintiffs responded that they would "stand firm" on the Consolidated Amended Complaint. 3 November 1999 Letter, attached as Ex. E to the Greiner Aff.

On 3 December 1999, the Defendants served their motion to dismiss. Notwithstanding their previously stated decision to "stand firm" on the Consolidated Amended Complaint, the Plaintiffs included a footnote in their opposition to the motion asking for leave to again amend their complaint in the event the motion to dismiss was granted. Plaintiffs' Memorandum of Law in Opposition to Defendants' Motion to Dismiss at 38 n. 12, attached as Ex. W to the Greiner Aff.

C. Background

As stated, Party City is a retailer of party supplies. Party City operates a network of company owned retail outlets in the United States and its franchisees operated outlets in the United States, Puerto Rico, Canada, Spain and Portugal.

The allegations in the Second Amended Complaint are based upon an "investigation made by and through [counsel]." Second Amended Complaint at Preamble. The Second Amended Complaint alleges Defendants disseminated materially false and misleading information concerning the financial condition of Party City in order to artificially inflate the price of Party City Stock. Id. at ¶ 1. The Second Amended Complaint further alleges the financial and accounting systems employed by Party City were in disarray, causing the financial results reported by Party City during the Class Period to be materially inaccurate and overstated. Id. at ¶ 30. The Second Amended Complaint asserts that as a result of the alleged misrepresentations and omissions of the Defendants, the true operating status and financial condition of Party City was not known. Id. It is alleged this misinformation caused Party City Stock to trade at artificially high prices during the Class Period. Id.

1. Alleged Materially False and Misleading Statements

The following press releases, reports and statements are alleged to have been materially false and misleading.

a. The 26 February 1998 Press Release

On 26 February 1998, Party City issued a press release (the "26 February Press Release") announcing its 1997 fourth quarter and year-end results. Id. at ¶ 26. The 26 February 1998 Press Release stated net income for the fourth quarter of 1997 increased 137% to $7,305,000, or $.57 per "diluted share," compared with net income of $3,077,000, or $.29 per diluted share, for 1996. Id. The 26 February 1998 Press Release further stated net income for fiscal year 1997 increased 104% to $7,670,000, or $.64 per diluted share, compared to net income of $3,756,000, or $.38 per diluted share, for fiscal year 1996. Id. Commenting on the 1997 fiscal year results, Mandell stated:

We are delighted with the strong sales and earnings results Party City achieved in 1997. Despite our aggressive store opening schedule, we were able to manage our growth effectively, as evidenced by our improved operating margin. We are also very pleased with the 16% comparable store sales growth in 1997, compared with the 18% comparable store sales growth achieved in 1996. These solid results are testimony to the management team and the support systems we have put into place to manage our expansion.
As we head into 1998, we have already made significant head way in our aggressive store opening schedule. We have opened six company-owned stores this year, as compared to two store openings at this point last year. We have signed 38 leases for additional company-owned store locations to open in 1998. With such a healthy head start this early in the year, we are confident in our ability to accomplish our 1998 expansion plans.

Id. (quoting the 26 February 1998 Press Release) (emphasis in the Second Amended Complaint).

b. The 1997 Form 10-K

On 31 March 1998, Party City filed its 1997 Form 10-K (the "1997 Form 10-K") with the SEC. Second Amended Complaint at ¶ 28. In addressing its internal inventory controls, Party City stated:

The Company's management continuously reviews new and existing product selections to provide the widest and most current assortment of party supplies. In pursuit of this goal, management attends various industry trade shows including the National Annual Halloween Trade Show in Rosemont, Illinois and the Toy Fair in New York. In an effort to keep abreast of new and popular merchandise, management views presentations given specifically for the Company by its major vendors. The Company utilizes its inventory tracking system to give the purchasing staff constant feedback on customers' preferences.
All of the merchandise purchased by the Super Stores is shipped directly from suppliers to the stores. The purchasing decisions and inventory control are facilitated by the use of sophisticated point-of-sale inventory control technology. Almost all merchandise is bar coded either by the supplier prior to delivery or at the time of receipt at the store. Consistent with the Party City Super Store concept, almost all inventory is displayed on the shelves with little or no space used for stocking.
The MIS system is a vital tool for increasing the efficiency of store operations. The Company believes that its management information system is an important factor in allowing the Company to support its rapid growth and enhance its competitive position in the industry. Through the MIS system, store managers are able to quickly evaluate the sales performance of their stores and of individual items in their stores, while also replenishing stock shelves in a timely fashion. Typically, merchandise is received already bar coded, enabling managers to control inventory and pricing by SKU, to manage assortment within a category, and to analyze gross margins and inventory turnover.

Id. at ¶¶ 28-29 (quoting the 1997 Form 10-k) (emphasis in the Second Amended Complaint).

c. The 9 April 1998 Press Release

On 9 April 1998, Party City announced its sales results for the first quarter of 1998 (the "9 April 1998 Press Release"). Second Amended Complaint at ¶ 31. The 9 April 1998 Press Release reported revenues for the first quarter of 1998 increased 179% to $40.7 million, up from $14.6 million for the same period in 1997. The 9 April 1998 Press Release further reported sales from company-owned stores for the quarter ended 31 March 1998 increased 206% to $38.7 million, up from $12.6 million in the first quarter of 1997. Id.

Party City also announced:

Party City opened a total of 14 new stores during the first quarter, 12 of which are company-owned and two of which are franchised. In addition, one franchise store was acquired during the quarter, located in the Miami, Florida market. As of March 31, 1998, a total of 288 Party City stores were in operation, compared to 209 stores last year, an increase of 38%. As of April 1, 1998, additional leases for 38 company-owned stores and four franchise stores have been signed for openings this year.

Id. (quoting the 9 April 1998 Press Release).

The 9 April 1998 Press Release quoted Mandell as stating:

We are pleased with our continued strong sales results in the first quarter. We expect the calendar shift of Easter into the month of April to help fuel continued sales growth in the second quarter, as initial sales results look solid.

Second Amended Complaint at ¶ 31 (quoting the 9 April 1998 Press Release).

d. The 23 April 1998 Press Release

On 23 April 1998, Party City announced its financial results for the first quarter of 1998 (the "23 April 1998 Press Release"). Second Amended Complaint at ¶ 32. The 23 April 1998 Press Release noted that while Party City had experienced a net loss of $.10 per share for the period, total revenues for the period increased 179% to $40.7 million, up from $14.6 million for the same period in 1997. Id. Addressing the results for the first quarter of 1998, Mandell stated:

We are pleased with the results we achieved in the first quarter. Due to the calendar shift of Easter this year, we expanded our promotional program during the month of March and were successful in generating store traffic and sales. We were able to do this and still improve margins for the quarter versus a year ago. Early sales indications in the month of April thus far are solid, which positions us well for the remainder of the quarter.
During the first quarter we exceeded our internal store opening plan by opening 12 company-owned stores. The store we opened in Toledo, Ohio is in a new market for Party City, and stores opened in San Antonio, California, Florida and the New York metropolitan area help to further penetrate these existing markets. We are benefitting from our expanded infrastructure that has been put in place to support our growth. For example, our broadened real estate team enables us to better canvas the country as we continue to look for home run store locations. To date, we have an additional 37 leases signed for 1998 openings, including new markets such as Seattle, Boston, Kansas City and Columbus, Ohio.

Id. (quoting the 23 April 1998 Press Release) (emphasis in the Second Amended Complaint).

e. The 9 July 1998 Press Release

On 9 July 1998, Party City announced its sales results for the second quarter and first six months of 1998 (the "9 July 1998 Press Release"). Second Amended Complaint at ¶ 35. The 9 July 1998 Press Release stated the total revenues for the second quarter of 1998 increased 151.9% to $56.6 million. Id. The 9 July 1998 Press Release further stated revenues in the first six months of 1998 increased 162.4% to $97.3 million. Id. The 9 July 1998 Press Release accentuated the rapid growth Party City was experiencing:

Party City opened a total of 20 new stores during the second quarter, 15 of which are company-owned and five of which are franchised. As of the end of the second quarter a total of 308 Party City stores were in operation, compared to 224 stores last year, an increase of 37.5%. Additionally, two new company-owned stores opened in early July, with the associated pre-opening costs booked as incurred in the second quarter. As of July 8, 1998, additional leases for 33 company-owned stores and six franchise stores have been signed for openings this year.

Id. (quoting the 9 July 1998 Press Release).

Mandell commented:

The solid sales results we achieved in the second quarter are on target with our internal plan. Our 1998 store opening schedule is also tracking to our expectations. With 29 new company-owned stores already opened and another 33 signed leases, we are well positioned to reach our store opening goal for the year.

Second Amended Complaint at ¶ 36 (quoting the 9 July 1998 Press Release).

f. The 23 July 1998 Press Release

On 23 July 1998, Party City issued a press release over the Business Wire announcing financial results for the second quarter and six months ended 30 June 1998 (the "23 July 1998 Press Release"). Second Amended Complaint at ¶ 39. The 23 July 1998 Press Release reported net income for the second quarter increased 16.1% to $1,042,000, or $.08 per share on both a basic and diluted basis, compared to net income of $897,000 or $.07 per share for the same period in 1997. Id. Party City reported a net loss for the first six months of 1998 of $229,000 or $.02 per share on both a basic and diluted basis, as compared to net income of $609,000 or $.05 per share for the same period in 1997. Id. Party City attributed the net loss for the first six months to a higher interest expense, resulting from the efforts of Party City to fund its aggressive growth, and to higher pre-opening expenses due to the greater number of stores opened in 1998 versus 1997. Id.

Mandell commented:

We are pleased to report our strong sales and earnings results for the second quarter. Earnings in the period were driven by our ability to improve store contribution margins while leveraging our G & A expenses over a wider sales base. We were able to achieve these improved results despite the significant pre-opening expenses incurred in the quarter due to our aggressive store expansion plans. We are confident that we will continue to efficiently execute our operating strategy and expect to meet our stated goals for the year.

Id. (quoting the July 1998 Press Release).

g. The 14 August 1998 Form 10-Q

On 14 August 1998, Party City filed its Form 10-Q, for the quarter ended 30 June 1998 with the SEC (the "14 August 1998 Form 10-Q"). Second Amended Complaint at ¶ 42. The 14 August 1998 Form 10-Q was signed by Mandell and by Lauber. Id. The 14 August 1998 Form 10-Q repeated the financial results set forth in the 23 July 1998 Press Release. Id.

h. The 2 September 1998 Press Release

On 2 September 1998, Party City issued a press release (the "2 September 1998 Press Release") announcing it expected to report a net loss of between $.15 to $.18 per fully diluted share for the third quarter ending 30 September 1998. Id. at ¶ 46. Party City stated this expectation was based upon lower than anticipated sales results for the months of July and August. Id. Party City asserted the lower sales were due to less aggressive promotional pricing than in the comparable period the prior year, a more aggressive new store expansion effort, and delays in the acquisitions of five franchise stores. Id.

Party City stated it believed its new store openings and franchise acquisitions had positioned Party City well for the important Halloween selling season. Id. Party City further stated "management expects a portion of the revenues and income shortfall in the third quarter will be recouped in the fourth quarter of 1998 and remains comfortable that full year results will be in line with expectations." Id. (quoting the 2 September 1998 Press Release).

i. The 3 September 1998 Star-Ledger Interview

On 3 September 1998, Lauber gave an interview to the Newark Star Ledger (the "3 September 1998 Star-Ledger Interview"). Second Amended Complaint at ¶ 50. Lauber addressed the 34% drop in the price of Party City Stock that had resulted from the release of expected third quarter numbers in the 2 September 1998 Press Release. Id. Lauber stated the expected third quarter loss was tied to the costs of opening 52 new stores, compared with 34 new stores the prior year. Lauber stated "it was imperative to get these stores open in time for Halloween" so Party City could capture more business during its busiest season. Id. (quoting the 3 September 1998 Star-Ledger Interview). Addressing the quarterly shortfall, Lauber said Party City made the mistake of offering shoppers fewer store-circular bargains that year. Id. Lauber explained: "We thought there was an opportunity to pick up some dollars in our margins, so we did not promote on price as strongly in July and August. . . . It was an error on our part. But we're back on track." Id.

j. The 3 September 1998 Dow Jones Interview

On 3 September 1998, Lauber gave an interview to the Dow Jones News Service (the "3 September 1998 Dow Jones Interview"). Second Amended Complaint at ¶ 52. Lauber told Dow Jones he did not understand why investors had "been so skittish" about the stock: "The real issue is that the fundamentals of this business remain intact." Id. (quoting the 3 September 1998 Dow Jones Interview). Lauber asserted Party City would recover some of the third quarter losses in the fourth quarter. Second Amended Complaint at ¶ 52.

Lauber stated he was comfortable with the estimates of several analysts that earnings would be $.93 per share for 1998. Id. Lauber noted that, given recent activity in the stock market, some investors may have been looking for reasons to sell Party City Stock. Id. Lauber, however, maintained Party City was different from its competitors in that Party City offered a deeper selection, had a better inventory system, and received better prices because of its purchasing power. Id. Lauber also said that concerns about inventory levels were overblown: "We're very comfortable with our inventory levels." Id. (quoting the 3 September 1998 Dow Jones Interview).

k. The 8 October 1998 Press Release

On 8 October 1998, Party City issued a press release (the "8 October 1998 Press Release") announcing its sales results for the third quarter and nine months ended 30 September 1998. Second Amended Complaint at ¶ 58. The 8 October 1998 Press Release reported revenues for the third quarter of 1998 increased 108.6% to $58.4 million, and sales from company-owned stores were reported to have increased 117.9% to $56.0 million. Id. Total revenues for the nine months ended 30 September 1998 were reported to have increased 139.2% to $155.7 million, up from $65.1 million for the same period in 1997. Id. Mandell commented that

during the third quarter, we opened 52 stores and entered a number of new, key markets including Boston, Kansas City and Salt Lake City. Our aggressive push during the quarter to open more stores, combined with the strong rebound in our September sales, places us in an excellent position to capitalize on the important Halloween season.

Id. (quoting the 8 October 1998 Press Release).

1. The 22 October 1998 Press Release

On 22 October 1998, Party City issued a press release (the "22 October 1998 Press Release") announcing its financial results for the third quarter of 1998. Second Amended Complaint at ¶ 60. The 22 October 1998 Press Release reported a net loss of $0.17 per share for the third quarter compared with a net loss of $0.02 per share for the same period in the prior year. Id. Mandell commented:

Now that the third quarter is behind we are in a stronger position than ever to capitalize on the Halloween selling season. . . . [Our new store opening] schedule is an aggressive yet prudent level of new store activity for the company. We believe that 50 to 60 new company-owned stores will enhance our leading competitive position within the party goods industry.

Id. at ΒΆ 60 (quoting the 22 October 1998 ...


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