** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

# **FORM10-K/A***

**(Amendment No. 1)**

 
| **ý**                                                                                                                                                                                                                                | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                      |                                                                                       |
| **For the  fiscal year ended December 25, 2004**                                                                                                                                                                                          |
|                                                                                                                                                                                                                                      |                                                                                       |
| **or**                                                                                                                                                                                                                                    |
|                                                                                                                                                                                                                                      |                                                                                       |
| **o**                                                                                                                                                                                                                                     | **TRANSITION  REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                      |                                                                                       |
| **For the  transition period from                   to                 ** |

 

**Commission file****number 0-25507**

 

----

 

**iPARTY** CORP.

(Exact name of registrantas specified in its charter)

 
| **Delaware**                                                     | ** ** | **76-0547750**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                             |       |                                  |
| **270  Bridge Street, Suite 301, Dedham, Massachusetts**         | ** ** | **02026**                             |
| (Address of  principal executive offices)                        |       | (Zip Code)                            |

** **

**(781)329-3952**

(Registrant’s telephonenumber, including area code)

 

----

 

Securities registeredpursuant to Section 12(b) of the Act:

 

| **Title of  each class**           | ** ** | **Name of  each exchange on which registered** |
|------------------------------------|------------|------------------------------------------------|
| **Common  stock, $.001 par value** | ** ** | **American  Stock Exchange**                   |

 

Securities registeredpursuant to Section 12(g) of the Exchange Act: **None**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.                                                Yes ý No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

 

On June 26, 2004, theaggregate market value of the voting common equity of the registrant (consistingof common stock, $.001 par value (the “common stock”)) held by nonaffiliates ofthe registrant was approximately $14,091,685 based on the closing price forsuch common stock on said date as reported by the American Stock Exchange.  As of March 21, 2005 there were 22,115,239shares of common stock, $.001 par value, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the proxystatement for the annual stockholders’ meeting to be held June 8, 2005 areincorporated by reference into Part III.

 

----

* Amendment to Part II,Item 8 and Part IV, Item 15, as set forth herein.

 

 

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**ExplanatoryNote to Form 10-K/A**

 

We are filing thisAmendment No. 1 to our Annual Report on Form 10-K for the fiscal year endedDecember 25, 2004 to resubmit the Report of Independent Registered PublicAccounting Firm so that it complies with PCAOB Auditing Standard No. 1.  We have been advised by the SEC that it is nolonger appropriate to refer to auditing standards as “generally accepted” inthe United States.  Instead, the auditreport should have described the PCAOB’s standards as “the standards of thePublic Company Accounting Oversight Board (United States)”.  Also, the first paragraph of the opinion ofErnst & Young LLP has been revised to state that the related consolidatedstatements of operations, convertible preferred stock and stockholders’ equity(deficit) and cash flows were audited for the three years in the period endedDecember 25, 2004 as opined by them in the last paragraph.  In accordance with the rules of the SEC, thefull text of the affected Item 8 and Item 15 of the original filing on Form10-K are included in this amendment and the certifications mandated under theSarbanes-Oxley Act of 2002 are hereby submitted as of the date hereof.

 

Amendment No. 1 alsocorrects an inadvertent error in the cover page:  the box for disclosure of delinquent filerspursuant to Item 405 of Regulation S-K should not have been checked.

 

This Form 10-K/A does notamend, modify or update any other information.

 

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**ITEM 8.****   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

The response tothis Item is included in a separate section of this report.  See “Index to Consolidated FinancialStatements” on page F-1.

 

**ITEM 15.****EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K**

 

(a)                      1. Financialstatements:

 

For a listing ofconsolidated financial statements which are included in this document, see pageF–1.

 

                                    2.Financial Statement Schedules:

 

All schedules for whichprovision is made in the applicable accounting regulation of the SEC are notrequired under the related instructions or are inapplicable and, therefore,have been omitted.

 

                                    3.Exhibits:

 

The exhibits listed inthe Exhibit Index immediately preceding the exhibits are filed as part of thisAnnual Report on Form 10-K and are incorporated herein by reference.

 

(b)                     Exhibits:

 

The exhibits listed inthe Exhibit Index immediately preceding the exhibits are filed as part of thisAnnual Report on Form 10-K and are incorporated herein by reference.

 

(c)                      FinancialStatement Schedules:

 

Included in Item 15(a)(2) above.

 

1

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                | iPARTY CORP. |
|---------------------|--------------|
|                |         |   |
|                | By:          | /s/ SAL PERISANO |   |
|                |         | Sal Perisano |   |
| * *            | * *     | *Chairman  of the Board and* |   |
| * *            | * *     | *Chief  Executive Officer* |   |
|                |         |   |
| Dated: May 27, 2005 |         |   |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| **SIGNATURE**              | ** ** | **TITLE**                                   | ** ** | **DATE**     |
|----------------------------|------------|---------------------------------------------|------------|--------------|
|                       |       |                                        |       |         |
| /s/ SAL PERISANO           |       | Chairman of the Board  and                  |       | May 27, 2005 |
| Sal Perisano               |       | Chief Executive Officer                     |       |         |
|                       |       | (Principal Executive  Officer)              |       |         |
|                       |       |                                        |       |         |
| /s/ PATRICK  FARRELL       |       | President and Chief  Financial Officer      |       | May 27, 2005 |
| Patrick Farrell            |       | (Principal Financial  Officer and Principal |       |         |
|                       |       | Accounting Officer)                         |       |         |
|                       |       |                                        |       |         |
| /s/ DANIEL DE  WOLF        |       | Director                                    |       | May 27, 2005 |
| Daniel De Wolf             |       |                                        |       |         |
|                       |       |                                        |       |         |
| /s/ FRANK HAYDU            |       | Director                                    |       | May 27, 2005 |
| Frank Haydu                |       |                                        |       |         |
|                       |       |                                        |       |         |
| /s/ LORENZO  ROCCIA        |       | Director                                    |       | May 27, 2005 |
| Lorenzo Roccia             |       |                                        |       |         |
|                       |       |                                        |       |         |
| /s/ ERIC  SCHINDLER        |       | Director                                    |       | May 27, 2005 |
| Eric Schindler             |       |                                        |       |         |
|                       |       |                                        |       |         |
| /s/ JOSEPH  VASSALLUZZO    |       | Director                                    |       | May 27, 2005 |
| Joseph  Vassalluzzo        |       |                                        |       |         |
|                       |       |                                        |       |         |
| /s/ CHRISTINA  WEAVER-VEST |       | Director                                    |       | May 27, 2005 |
| Christina  Weaver-Vest     |       |                                        |       |         |

 

2

----

 

**i****PARTY****CORP.**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 
| Report  of Independent Registered Public Accounting Firm                                        |   |
|-------------------------------------------------------------------------------------------------|--------|
|                                                                                            |   |
| Consolidated Balance Sheets                                                                     |   |
|                                                                                            |   |
| Consolidated  Statements of Operations                                                          |   |
|                                                                                            |   |
| Consolidated  Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit) |   |
|                                                                                            |   |
| Consolidated  Statements of Cash Flows                                                          |   |
|                                                                                            |   |
| Notes to  Consolidated Financial Statements                                                     |   |

 

The accompanyingnotes are an integral part of these Consolidated Financial Statements.

 

F-1

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**Report ofIndependent Registered Public Accounting Firm**

 

Board of Directors andStockholders

iPartyCorp.

 

We have audited theaccompanying consolidated balance sheets of iParty Corp. and subsidiaries as ofDecember 25, 2004 and December 27, 2003, and the related consolidated statementsof operations, convertible preferred stock and stockholders’ equity (deficit),and cash flows for each of the three years in the period ended December 25,2004.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement.  We werenot engaged to perform an audit of the Company’s internal control overfinancial reporting.  Our audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of iParty Corp. and subsidiariesat December 25, 2004 and December 27, 2003, and the consolidated results oftheir operations and their cash flows for each of the three years in the periodended December 25, 2004, in conformity with U.S. generally accepted accountingprinciples.

 
|                  | /s/ Ernst & Young  LLP |   |
|-----------------------|----------------------------|--------|
|                  |                       |
| Boston, Massachusetts |                       |
| February 24, 2005     |                       |

 

The accompanyingnotes are an integral part of these Consolidated Financial Statements.

 

F-2

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**iPARTY****CORP.**

**CONSOLIDATEDBALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                           | ** ** | **Dec 25, 2004** | ** ** | **Dec 27, 2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                           |       |             |       |             |       |
| Current  assets:                                                                                                                                                                                                                                     |       |             |       |             |       |
| Cash  and cash equivalents                                                                                                                                                                                                                           |       | $                | 1,757,157  |             | $          | 2,442,471 |   |
| Restricted  cash                                                                                                                                                                                                                                     |       | 561,407          |       | 533,284          |       |
| Accounts  receivable                                                                                                                                                                                                                                 |       | 700,961          |       | 487,934          |       |
| Inventory,  net                                                                                                                                                                                                                                      |       | 11,400,971       |       | 9,423,463        |       |
| Prepaid  expenses and other assets                                                                                                                                                                                                                   |       | 476,046          |       | 483,925          |       |
| Total  current assets                                                                                                                                                                                                                                |       | 14,896,542       |       | 13,371,077       |       |
| Property  and equipment, net                                                                                                                                                                                                                         |       | 4,483,705        |       | 1,694,140        |       |
| Other  assets                                                                                                                                                                                                                                        |       | 99,690           |       | 86,763           |       |
| Total  assets                                                                                                                                                                                                                                        |       | $                | 19,479,937 |             | $          | 15,151,980 |   |
|                                                                                                                                                                                                                                                 |       |             |       |             |       |
| **LIABILITIES AND STOCK AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                              |       |             |       |             |       |
| Current  liabilities:                                                                                                                                                                                                                                |       |             |       |             |       |
| Accounts  payable                                                                                                                                                                                                                                    |       | $                | 3,421,195  |             | $          | 3,095,848 |   |
| Accrued  expenses                                                                                                                                                                                                                                    |       | 2,615,835        |       | 2,306,902        |       |
| Current  portion of capital lease obligations                                                                                                                                                                                                        |       | 365,674          |       | 29,220           |       |
| Borrowings  under line of credit                                                                                                                                                                                                                     |       | 5,257,690        |       | 3,760,671        |       |
| Total  current liabilities                                                                                                                                                                                                                           |       | 11,660,394       |       | 9,192,641        |       |
|                                                                                                                                                                                                                                                 |       |             |       |             |       |
| Long-term  liabilities:                                                                                                                                                                                                                              |       |             |       |             |       |
| Capital  lease obligations, net of current portion                                                                                                                                                                                                   |       | 796,693          |       | 260              |       |
| Other  liabilities                                                                                                                                                                                                                                   |       | 471,759          |       | 406,209          |       |
| Total  long-term liabilities                                                                                                                                                                                                                         |       | 1,268,452        |       | 406,469          |       |
|                                                                                                                                                                                                                                                 |       |             |       |             |       |
| Commitments  and contingencies                                                                                                                                                                                                                       |       |             |       |             |       |
|                                                                                                                                                                                                                                                 |       |             |       |             |       |
| Stockholders’  equity:                                                                                                                                                                                                                          |       |             |       |             |       |
| Convertible  preferred stock - $.001 par value; 10,000,000 shares authorized,                                                                                                                                                                        |       |             |       |             |       |
| Series  A convertible preferred stock - 1,000,000 shares authorized, 0 and 1,000,000  issued and outstanding at December 25, 2004 and December 27, 2003,  respectively (aggregate liquidation value of $0 at December 25, 2004)                      |       | —           |       | 1,000,000        |       |
| Series  B convertible preferred stock - 1,150,000 shares authorized; 507,460 and  611,080 shares issued and outstanding at December 25, 2004 and December 27,  2003, respectively (aggregate liquidation value of $10,149,200 at December  25, 2004) |       | 7,551,002        |       | 9,092,870        |       |
| Series  C convertible preferred stock - 100,000 shares authorized, issued and  outstanding (aggregate liquidation value of $2,000,000 at December 25, 2004)                                                                                          |       | 1,492,000        |       | 1,492,000        |       |
| Series  D convertible preferred stock - 250,000 shares authorized, issued and  outstanding (aggregate liquidation value of $5,000,000 at December 25, 2004)                                                                                          |       | 3,652,500        |       | 3,652,500        |       |
| Series  E convertible preferred stock - 533,333 shares authorized; 296,667 and  389,439 shares issued and outstanding at December 25, 2004 and December 27,  2003, respectively (aggregate liquidation value of $1,112,500 at December 25,  2004)    |       | 1,112,500        |       | 1,460,396        |       |
| Series  F convertible preferred stock - 114,286 shares authorized, issued and  outstanding (aggregate liquidation value of $500,000 at December 25, 2004)                                                                                            |       | 500,000          |       | 500,000          |       |
| Total  convertible preferred stock                                                                                                                                                                                                                   |       | 14,308,002       |       | 17,197,766       |       |
|                                                                                                                                                                                                                                                 |       |             |       |             |       |
| Common  stock - $.001 par value; 150,000,000 shares authorized; 22,092,717 and  18,780,204  shares issued and  outstanding at December 25, 2004 and December 27, 2003, respectively                                                             |       | 22,093           |       | 18,780           |       |
|                                                                                                                                                                                                                                                 |       |             |       |             |       |
| Additional  paid-in capital                                                                                                                                                                                                                          |       | 50,448,100       |       | 47,554,621       |       |
| Accumulated  deficit                                                                                                                                                                                                                                 |       | (58,227,104      | )          | (59,218,297      | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                     |       | 6,551,091        |       | 5,552,870        |       |
|                                                                                                                                                                                                                                                 |       |             |       |             |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                     |       | $                | 19,479,937 |             | $          | 15,151,980 |   |

 

Theaccompanying notes are an integral part of these Consolidated FinancialStatements.

 

F-3

----

 

**iPARTY****CORP.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 
| ** **                                                 | ** ** | **For the twelve months ended** | ** ** |
|------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                 | ** ** | **Dec 25, 2004**                | ** ** | **Dec 27, 2003** | ** ** | **Dec 28, 2002** | ** ** |
| Revenues                                                   |       | $                               | 64,276,225 |   | $ | 56,697,246 |   | $ | 52,177,923 |   |
| Operating  costs:                                          |       |                            |       |   |   |   |   |
| Cost  of products sold                                     |       | 35,826,820                      |       | 31,758,625 |   | 30,420,475 |   |
| Marketing  and sales                                       |       | 21,176,925                      |       | 18,363,193 |   | 16,527,832 |   |
| General  and administrative                                |       | 6,335,067                       |       | 5,516,273 |   | 5,245,867 |   |
| Special  charge                                            |       | —                          |       | — |   | 396,465 |   |
|                                                       |       |                            |       |   |   |   |   |
| Operating  income (loss)                                   |       | 937,413                         |       | 1,059,155 |   | (412,716 | ) |
|                                                       |       |                            |       |   |   |   |   |
| Other  income                                              |       | 382,500                         |       | — |   | — |   |
|                                                       |       |                            |       |   |   |   |   |
| Income  (loss) before income taxes                         |       | 1,319,913                       |       | 1,059,155 |   | (412,716 | ) |
|                                                       |       |                            |       |   |   |   |   |
| Interest  income                                           |       | 1,354                           |       | 1,262 |   | 9,045 |   |
| Interest  expense                                          |       | (225,074                        | )          | (212,227 | ) | (280,898 | ) |
|                                                       |       |                            |       |   |   |   |   |
| Income  (loss) before income taxes                         |       | 1,096,193                       |       | 848,190 |   | (684,569 | ) |
|                                                       |       |                            |       |   |   |   |   |
| Income  taxes                                              |       | 105,000                         |       | 97,233 |   | — |   |
|                                                       |       |                            |       |   |   |   |   |
| Net  income (loss)                                         |       | $                               | 991,193    |   | $ | 750,957 |   | $ | (684,569 | ) |
|                                                       |       |                            |       |   |   |   |   |
| Net  income (loss) available to common stockholders        |       | $                               | 991,193    |   | $ | 750,957 |   | $ | (774,719 | ) |
|                                                       |       |                            |       |   |   |   |   |
| Income  (loss) per share:                                  |       |                            |       |   |   |   |   |
| Basic                                                      |       | $                               | 0.03       |   | $ | 0.02 |   | $ | (0.04 | ) |
| Diluted                                                    |       | $                               | 0.02       |   | $ | 0.02 |   | $ | (0.04 | ) |
|                                                       |       |                            |       |   |   |   |   |
| Income  (loss) per share available to common stockholders: |       |                            |       |   |   |   |   |
| Basic                                                      |       | $                               | 0.03       |   | $ | 0.02 |   | $ | (0.05 | ) |
| Diluted                                                    |       | $                               | 0.02       |   | $ | 0.02 |   | $ | (0.05 | ) |
|                                                       |       |                            |       |   |   |   |   |
| Weighted-average  shares outstanding:                      |       |                            |       |   |   |   |   |
| Basic                                                      |       | 37,649,400                      |       | 36,683,142 |   | 16,219,436 |   |
| Diluted                                                    |       | 41,517,036                      |       | 38,868,484 |   | 16,219,436 |   |

 

The accompanyingnotes are an integral part of these Consolidated Financial Statements.

 

F-4

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**IPARTY CORP.**

**CONSOLIDATEDSTATEMENTS OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY DEFICIT)**

 
|                                                                              |   | ** **           |   | ** **           |       | **Stockholders’  Equity (Deficit)** |      |
|-----------------------------------------------------------------------------------|--------|----------------------|--------|----------------------|------------|------------------------------------------|-----------|
|                                                                              |   | **Convertible**      |   | **Convertible**      |       | ** **                               |      | ** ** |   | **Additional** |   | ** ** |   | **Total** |   |
|                                                                              |   | **Preferred  Stock** |   | **Preferred  Stock** |       | **Common  Stock**                        |      | **Paid-In** |   | **Accumulated** |   | **Stockholders’** |   |
|                                                                              |   | **Shares**           |   | **Amount**           |       | **Shares**                               |      | **Amount** |   | **Shares** |   | **Amount** |   | **Capital** |   | **Deficit** |   | **Equity  (Deficit)** |   |
| Balance  December 29, 2001                                                        |   | 3,274,372            |   | $                    | 20,092,667 |                                     | —    |   | $ | — |   | 15,122,675 |   | $ | 15,123 |   | $ | 44,395,314 |   | $ | (59,194,535 | ) | $ | (14,784,098 | ) |
|                                                                              |   |                 |   |                 |       |                                     |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance  of common stock upon conversion of Series B convertible preferred stock |   | (119,786             | )      | (1,257,886           | )          | —                                   |      | — |   | 1,197,860 |   | 1,198 |   | 1,256,688 |   | — |   | 1,257,886 |   |
| Issuance  of common stock upon conversion of Series E convertible preferred stock |   | (66,666              | )      | (250,000             | )          | —                                   |      | — |   | 666,660 |   | 667 |   | 249,333 |   | — |   | 250,000 |   |
| Series  B convertible preferred stock adjustment                                  |   | (313,974             | )      | (314                 | )          | —                                   |      | — |   | — |   | — |   | 314 |   | — |   | 314 |   |
| Series  C convertible preferred stock adjustment                                  |   | (45,198              | )      | (45                  | )          | —                                   |      | — |   | — |   | — |   | 45 |   | — |   | 45 |   |
| Series  D convertible preferred stock adjustment                                  |   | (112,996             | )      | (113                 | )          | —                                   |      | — |   | — |   | — |   | 113 |   | — |   | 113 |   |
| Equity  portion of special charge                                                 |   | —               |   | —               |       | —                                   |      | — |   | — |   | — |   | 171,465 |   | — |   | 171,465 |   |
| Exercise  of stock options                                                        |   | —               |   | —               |       | —                                   |      | — |   | 9,375 |   | 9 |   | 4,679 |   | — |   | 4,688 |   |
| Convertible  preferred stock beneficial conversion dividend                       |   | —               |   | —               |       | —                                   |      | — |   | — |   | — |   | 90,150 |   | (90,150 | ) | — |   |
| Net  loss                                                                         |   | —               |   | —               |       | —                                   |      | — |   | — |   | — |   | — |   | (684,569 | ) | (684,569 | ) |
| Balance  December 28, 2002                                                        |   | 2,615,752            |   | 18,584,309           |       | —                                   |      | — |   | 16,996,570 |   | 16,997 |   | 46,168,101 |   | (59,969,254 | ) | (13,784,156 | ) |
|                                                                              |   |                 |   |                 |       |                                     |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance  of common stock upon conversion of Series B convertible preferred stock |   | (73,719              | )      | (1,096,939           | )          |                                     |      |   |   | 948,690 |   | 948 |   | 1,095,991 |   | — |   | 1,096,939 |   |
| Issuance  of common stock upon conversion of Series E convertible preferred stock |   | (77,228              | )      | (289,604             | )          |                                     |      |   |   | 823,944 |   | 824 |   | 288,780 |   | — |   | 289,604 |   |
| Reclassification  of Series A convertible preferred stock (Note 1)                |   | (1,000,000           | )      | (1,000,000           | )          | 1,000,000                                |      | 1,000,000 |   |   |   |   |   |   |   |   |   | 1,000,000 |   |
| Reclassification  of Series B convertible preferred stock (Note 1)                |   | (611,080             | )      | (9,092,870           | )          | 611,080                                  |      | 9,092,870 |   |   |   |   |   |   |   |   |   | 9,092,870 |   |
| Reclassification  of Series C convertible preferred stock (Note 1)                |   | (100,000             | )      | (1,492,000           | )          | 100,000                                  |      | 1,492,000 |   |   |   |   |   |   |   |   |   | 1,492,000 |   |
| Reclassification  of Series D convertible preferred stock (Note 1)                |   | (250,000             | )      | (3,652,500           | )          | 250,000                                  |      | 3,652,500 |   |   |   |   |   |   |   |   |   | 3,652,500 |   |
| Reclassification  of Series E convertible preferred stock (Note 1)                |   | (389,439             | )      | (1,460,396           | )          | 389,439                                  |      | 1,460,396 |   |   |   |   |   |   |   |   |   | 1,460,396 |   |
| Reclassification  of Series F convertible preferred stock (Note 1)                |   | (114,286             | )      | (500,000             | )          | 114,286                                  |      | 500,000 |   |   |   |   |   |   |   |   |   | 500,000 |   |
| Exercise  of stock options                                                        |   | —               |   | —               |       | —                                   |      | — |   | 11,000 |   | 11 |   | 1,749 |   | — |   | 1,760 |   |
| Net  income                                                                       |   | —               |   | —               |       | —                                   |      | — |   | — |   | — |   | — |   | 750,957 |   | 750,957 |   |
| Balance  December 27, 2003                                                        |   | —               |   | —               |       | 2,464,805                                |      | 17,197,766 |   | 18,780,204 |   | 18,780 |   | 47,554,621 |   | (59,218,297 | ) | 5,552,870 |   |
|                                                                              |   |                 |   |                 |       |                                     |      |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance  of common stock upon conversion of Series A convertible preferred stock |   | —               |   | —               |       | (1,000,000                               | )         | (1,000,000 | ) | 1,000,000 |   | 1,000 |   | 999,000 |   |   |   | — |   |
| Issuance  of common stock upon conversion of Series B convertible preferred stock |   | —               |   | —               |       | (103,620                                 | )         | (1,541,869 | ) | 1,333,693 |   | 1,333 |   | 1,540,536 |   |   |   | — |   |
| Issuance  of common stock upon conversion of Series E convertible preferred stock |   | —               |   | —               |       | (92,772                                  | )         | (347,895 | ) | 961,025 |   | 961 |   | 346,934 |   |   |   | — |   |
| Exercise  of stock options                                                        |   | —               |   | —               |       | —                                   |      | — |   | 17,795 |   | 19 |   | 7,009 |   |   |   | 7,028 |   |
| Net  income                                                                       |   | —               |   | —               |       | —                                   |      | — |   | — |   | — |   | — |   | 991,193 |   | 991,193 |   |
| Balance  December 25, 2004                                                        |   | —               |   | $                    | —     |                                     | 1,268,413 |   | $ | 14,308,002 |   | 22,092,717 |   | $ | 22,093 |   | $ | 50,448,100 |   | $ | (58,227,104 | ) | $ | 6,551,091 |   |

 

The accompanyingnotes are an integral part of these Consolidated Financial Statements.

 

F-5

----

 

**iPARTY****CORP.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                                         | ** ** | **For the twelve months ended** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                         | ** ** | **Dec 25, 2004**                | ** ** | **Dec 27, 2003** | ** ** | **Dec 28, 2002** | ** ** |
| **Operating activities:**                                                                          |       |                            |       |   |   |   |   |
|                                                                                               |       |                            |       |   |   |   |   |
| Net  income (loss)                                                                                 |       | $                               | 991,193    |   | $ | 750,957 |   | $ | (684,569 | ) |
| Adjustments  to reconcile net income (loss) to net cash provided by used in operating  activities: |       |                            |       |   |   |   |   |
| Depreciation  and amortization                                                                     |       | 634,250                         |       | 601,015 |   | 633,173 |   |
| Non-cash  portion of special charge                                                                |       | —                          |       | — |   | 171,465 |   |
| Deferred  rent                                                                                     |       | 65,550                          |       | (22,723 | ) | 102,518 |   |
| Changes  in operating assets and liabilities:                                                      |       |                            |       |   |   |   |   |
| Accounts  receivable                                                                               |       | (213,027                        | )          | (41,946 | ) | 95,715 |   |
| Inventory                                                                                          |       | (1,977,508                      | )          | (506,799 | ) | 366,188 |   |
| Prepaid  expenses and other assets                                                                 |       | 191,345                         |       | 55,351 |   | 36,541 |   |
| Accounts  payable                                                                                  |       | 325,347                         |       | 343,537 |   | 116,151 |   |
| Accrued  expenses and other liabilities                                                            |       | 112,540                         |       | 189,406 |   | (255,252 | ) |
| Net  cash provided by operating activities                                                         |       | 129,690                         |       | 1,368,798 |   | 581,930 |   |
|                                                                                               |       |                            |       |   |   |   |   |
| **Investing activities:**                                                                          |       |                            |       |   |   |   |   |
|                                                                                               |       |                            |       |   |   |   |   |
| Purchase  of property and equipment                                                                |       | (2,121,134                      | )          | (1,166,258 | ) | (775,147 | ) |
| Net  cash used in investing activities                                                             |       | (2,121,134                      | )          | (1,166,258 | ) | (775,147 | ) |
|                                                                                               |       |                            |       |   |   |   |   |
| **Financing activities:**                                                                          |       |                            |       |   |   |   |   |
|                                                                                               |       |                            |       |   |   |   |   |
| Net  borrowings under line of credit                                                               |       | 1,497,019                       |       | 283,933 |   | 121,761 |   |
| Decrease  (increase) in restricted cash                                                            |       | (28,123                         | )          | (161,332 | ) | 296,005 |   |
| Principal  payments on capital lease obligations                                                   |       | (169,794                        | )          | (210,773 | ) | (301,978 | ) |
| Proceeds  from exercise of stock options                                                           |       | 7,028                           |       | 1,760 |   | 4,688 |   |
| Net  cash provided by (used in) financing activities                                               |       | 1,306,130                       |       | (86,412 | ) | 120,476 |   |
|                                                                                               |       |                            |       |   |   |   |   |
| **Net increase (decrease) in cash and cash  equivalents**                                          |       | (685,314                        | )          | 116,128 |   | (72,741 | ) |
|                                                                                               |       |                            |       |   |   |   |   |
| **Cash and cash equivalents, beginning of year**                                                   |       | 2,442,471                       |       | 2,326,343 |   | 2,399,084 |   |
|                                                                                               |       |                            |       |   |   |   |   |
| **Cash and cash equivalents, end of year**                                                         |       | $                               | 1,757,157  |   | $ | 2,442,471 |   | $ | 2,326,343 |   |
|                                                                                               |       |                            |       |   |   |   |   |
| Supplemental  disclosure of non-cash financing activities:                                         |       |                            |       |   |   |   |   |
|                                                                                               |       |                            |       |   |   |   |   |
| Conversion  of Series A convertible preferred stock to common stock                                |       | $                               | 1,000,000  |   | $ | — |   | $ | — |   |
| Conversion  of Series B convertible preferred stock to common stock                                |       | 1,541,869                       |       | 1,096,939 |   | 1,257,886 |   |
| Conversion  of Series E convertible preferred stock to common stock                                |       | 347,895                         |       | 289,604 |   | 250,000 |   |
| Total  conversion of convertible preferred stock to common stock                                   |       | $                               | 2,889,764  |   | $ | 1,386,543 |   | $ | 1,507,886 |   |
|                                                                                               |       |                            |       |   |   |   |   |
| Acquisition  of assets under capital lease                                                         |       | $                               | 1,302,681  |   | $ | — |   | $ | 7,881 |   |

 

The accompanyingnotes are an integral part of these Consolidated Financial Statements.

 

F-6

----

 

**iPARTY****CORP.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**December25, 2004**

 

**1.  THE COMPANY**

 

*Background*

 

The Company’s efforts aredevoted to the sale of party goods and services through its retail stores.  At the end of fiscal 2004 the Company had 40 retailstores located throughout New England, with four additional stores located inFlorida.  In 2003, the Company licensedits Internet business to a third party in exchange for royalties under alicense agreement, which to date have not been significant.  Previously, the Company operated the Internetbusiness with the same party under a fulfillment agreement.

 

The stores feature over 20,000products ranging from greeting cards and balloons to more unique merchandisesuch as piñatas, gag gifts, masquerade and Hawaiian Luau items.  The Company’s sales are driven by thefollowing events:  Halloween, Christmas,Easter, Valentine’s Day, New Year’s, Independence Day, St. Patrick’s Day,Thanksgiving, and Chanukah.  The Companyalso focuses its business closely on lifetime events such as anniversaries,graduations, birthdays, and bridal or baby showers.  The Company’s business has a seasonal patternwith higher revenues in the second and fourth quarters, reflecting schoolgraduations and Halloween, respectively.

 

*Management’sPlans*

 

The Company believes,based on its current operating plan, that anticipated revenues from operationsand borrowings available under the existing line of credit will be sufficientto fund its operations and working capital requirements through the next twelvemonths.  The Company’s current operatingplan includes opening up to seven additional new stores in 2005, including the onenew store that the Company opened since the end of fiscal 2004.  In the event that the Company’s operating planchanges or proves inaccurate due to decreased revenues, unanticipated expenses,increased competition, unfavorable economic conditions or other unforeseencircumstances, the Company’s liquidity may be negatively impacted.  Accordingly, the Company would be required toadjust its expenditures in 2005 to conserve working capital or raise additionalcapital to fund operations.  There can beno assurance, however, that, should the Company require additional financing,such financing will be available on terms and conditions acceptable to theCompany.

 

**2.  SIGNIFICANT ACCOUNTING POLICIES:**

 

*Principlesof Consolidation*

 

The consolidatedfinancial statements include the accounts of the Company and its wholly-ownedsubsidiaries after elimination of all significant intercompany transactions andbalances.

 

*RevenueRecognition*

 

Revenues include theselling price of party goods sold, net of returns and discounts, and arerecognized at the point of sale.  TheCompany estimates returns based upon historical return rates and such amountshave not been significant.

 

*Concentrations*

 

The Company purchases itsinventory from a diverse group of vendors and is not overly dependent upon anysingle source for its merchandise, often using more than one vendor for similarkinds of products.

 

Accounts receivableprimarily represent amounts due from credit card companies and vendors forinventory rebates.  Management does notprovide for doubtful accounts as such amounts have not been significant todate; the Company does not require collateral.

 

F-7

----

 

*Useof Estimates*

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period.  Actual results coulddiffer from these estimates.

 

*Cashand Cash Equivalents, Outstanding Checks and Restricted Cash*

 

The Company considers allhighly liquid investments with an original maturity date of three months orless to be cash equivalents.  Cashequivalents consist primarily of money market accounts and are carried at costplus accrued interest, which approximates fair value.

 

The Company usescontrolled disbursement banking arrangements as part of its cash managementprogram.  Outstanding checks, which wereincluded in accounts payable, totaled $950,156 at December 25, 2004 and $989,816at December 27, 2003.  The Company hadsufficient funds available to fund the outstanding checks when they werepresented for payment.

 

Restrictedcash represents money deposited in blocked accounts established for the benefitof and under the control of Wells Fargo Retail Finance II, LLC, the Company’slender under its line of credit, and constitutes collateral for amounts outstandingunder the Company’s line of credit.

 

*FairValue of Financial Instruments*

 

The carrying values ofcash and cash equivalents, accounts receivable and accounts payable approximatefair value because of the short-term nature of these instruments.  The fair value of borrowings under its line ofcredit approximates carrying value because the debt bears interest at avariable market rate.

 

*Inventories*

 

Inventories consist ofparty supplies and are valued at the lower of moving weighted-average cost or market. Inventory has been reduced by anallowance for obsolete and excess inventory, which is based on management’sreview of inventories on hand compared to estimated future sales.  The Company records vendor rebates, discountsand certain other adjustments to inventory, including freight costs, and theseamounts are recognized in the income statement as the related goods are sold.

 

The Company also makes adjustments to reduce thevalue of its inventory for an allowance for obsolete and excess inventory,which is based on its review of inventories on hand compared to estimatedfuture sales.

 

In 2003, the Company refined its methodology foraccounting for vendor rebates, discounts and freight.  The net impact of these adjustments increasedpre-tax income by $141,757, net income by $125,455 and had no impact on netincome per basic and diluted share.

 

*Advertising*

 

Advertising costs areexpensed upon first showing.  Advertisingcosts amounted to $3,174,446, $2,706,596, and $2,705,330 for the years ended December25, 2004, December 27, 2003 and December 28, 2002, respectively.

 

*DeferredRent*

 

Certain operating leaseagreements contain scheduled rent increases, which are being amortized over theterms of the agreements using the straight-line method, and are included inother liabilities in the accompanying consolidated balance sheet.  Deferred rent was $471,759 at December 25,2004 and $406,209 at December 27, 2003.

 

F-8

----

 

*Net Income(Loss) per Share*

 

Net income per basic shareis computed by dividing net income by the weighted-average number of commonshares outstanding plus the common share equivalents of Series B-F preferredstock.  The common share equivalents ofSeries B-F are included in the calculation of net income per basic share inaccordance with EITF Topic D-95, *Effect of ParticipatingConvertible Securities on the Computation of Basic Earnings Per Share*,since the preferred stockholders are entitled to participate in dividends whenand if declared by the Board of Directors. For the periods with net losses, the Company excludes those common shareequivalents since their impact would be anti-dilutive.

 

Net income per dilutedshare is computed by dividing net income by the weighted average number ofcommon shares outstanding, plus the common share equivalents of Series A-Fpreferred stock, plus the common share equivalents of the “in the money” stockoptions and warrants as computed by the treasury method.  For the periods with net losses, the Companyexcludes those common share equivalents since their impact would beanti-dilutive.

 

The following table setsforth the computation of net income (loss) per basic and diluted share availableto common stockholders:

 
| ** **                                                          | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|---------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Net  income (loss)                                                  |       | $          | 991,193    |       | $          | 750,957    |       | $ | (684,569 | ) |
| Preferred  stock beneficial conversion feature                      |       | —     |       | —     |       | (90,150    | )          |
|                                                                |       |       |       |       |       |       |       |
| Net  income (loss) available to common stockholders                 |       | $          | 991,193    |       | $          | 750,957    |       | $ | (774,719 | ) |
|                                                                |       |       |       |       |       |       |       |
| Net  income (loss) per share available to common stockholders       |       |       |       |       |       |       |       |
| Basic                                                               |       | $          | 0.03       |       | $          | 0.02       |       | $ | (0.05 | ) |
| Diluted                                                             |       | $          | 0.02       |       | $          | 0.02       |       | $ | (0.05 | ) |
|                                                                |       |       |       |       |       |       |       |
| Weighted-average  shares outstanding:                               |       |       |       |       |       |       |       |
| Common  shares                                                      |       | 21,364,673 |       | 17,652,805 |       | 16,219,436 |       |
| Common  share equivalents of Series B-F convertible preferred stock |       | 16,284,727 |       | 19,030,337 |       | —     |       |
| Basic  weighted-average shares outstanding                          |       | 37,649,400 |       | 36,683,142 |       | 16,219,436 |       |
|                                                                |       |       |       |       |       |       |       |
| Common  share equivalents of Series A convertible preferred stock   |       | 48,077     |       | 1,000,000  |       | —     |       |
| Common  share equivalents of “in the money” stock options |       | 3,819,559  |       | 1,185,342  |       | —     |       |
| Common  share equivalents of “in the money” warrants      |       | —     |       | —     |       | —     |       |
| Diluted  weighted-average shares outstanding                        |       | 41,517,036 |       | 38,868,484 |       | 16,219,436 |       |

 

The common shareequivalents of “out of the money” stock options and warrants which wereexcluded from the computation of net income per diluted share available tocommon stockholders were 3,309,630 and 13,011,215 in 2004, respectively, and 2,157,980and 13,563,212 in 2003, respectively.

 

*StockOption Compensation Expense*

 

The Company accounts forits stock option compensation agreements with employees under the provisions ofAccounting Principles Board (“APB”) Opinion No. 25, *Accountingfor Stock Issued to Employees*.  The Company has adopted the disclosure-onlyprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation*, as amended by SFASNo. 148, *Accounting for Stock-Based Compensation –Transition and Disclosure, an amendment of Financial Accounting Standards Board(“FASB”) Statement No. 123*.

 

The Company has computedthe value of options using the Black-Scholes option pricing model prescribed bySFAS No. 123.  The weighted-average fairvalue of the options granted was $0.73 per share in 2004, $0.38 per share 

 

F-9

----

 

during 2003 and $0.29 pershare during 2002, using the Black-Scholes option-pricing model with thefollowing assumptions:  no dividendyield, volatility of 116% to 119% in 2004, 119% to 125% in 2003, and 125% in 2002,a risk-free interest rate of 2.71% to 4.00% in 2004, 2.13% to 3.51% in 2003 and4.86% to 5.95% in 2002, and an expected life of five years from date of thegrant.  Had compensation cost for theCompany’s stock option plan been determined based upon the fair value at thegrant date for awards under the plan consistent with the methodology prescribedunder SFAS 123, the Company’s net income (loss) and net income (loss) per shareand net income (loss) available to common stockholders and net income (loss)per share available to common stockholders would have been the following proforma amounts:

 
| ** **                                                             | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net  income (loss):                                                    |       |     |       |     |       |     |       |
| Reported                                                               |       | $        | 991,193    |     | $          | 750,957  |       | $ | (684,569 | ) |
| Stock  option compensation expense                                     |       | (668,223 | )          | (480,268 | )          | (671,029 | )          |
| Pro  forma                                                             |       | $        | 322,970    |     | $          | 270,689  |       | $ | (1,355,598 | ) |
|                                                                   |       |     |       |     |       |     |       |
| Net  income (loss) per basic share:                                    |       |     |       |     |       |     |       |
| Reported                                                               |       | $        | 0.03       |     | $          | 0.02     |       | $ | (0.04 | ) |
| Pro  forma                                                             |       | $        | 0.01       |     | $          | 0.01     |       | $ | (0.08 | ) |
|                                                                   |       |     |       |     |       |     |       |
| Net  income (loss) per diluted share:                                  |       |     |       |     |       |     |       |
| Reported                                                               |       | $        | 0.02       |     | $          | 0.02     |       | $ | (0.04 | ) |
| Pro  forma                                                             |       | $        | 0.01       |     | $          | 0.01     |       | $ | (0.08 | ) |
|                                                                   |       |     |       |     |       |     |       |
| Net  income (loss) available to common stockholders:                   |       |     |       |     |       |     |       |
| Reported                                                               |       | $        | 991,193    |     | $          | 750,957  |       | $ | (774,719 | ) |
| Stock  option compensation expense                                     |       | (668,223 | )          | (480,268 | )          | (671,029 | )          |
| Pro  forma                                                             |       | $        | 322,970    |     | $          | 270,689  |       | $ | (1,445,748 | ) |
|                                                                   |       |     |       |     |       |     |       |
| Net  income (loss) per basic share available to common stockholders:   |       |     |       |     |       |     |       |
| Reported                                                               |       | $        | 0.03       |     | $          | 0.02     |       | $ | (0.05 | ) |
| Pro  forma                                                             |       | $        | 0.01       |     | $          | 0.01     |       | $ | (0.09 | ) |
|                                                                   |       |     |       |     |       |     |       |
| Net  income (loss) per diluted share available to common stockholders: |       |     |       |     |       |     |       |
| Reported                                                               |       | $        | 0.02       |     | $          | 0.02     |       | $ | (0.05 | ) |
| Pro  forma                                                             |       | $        | 0.01       |     | $          | 0.01     |       | $ | (0.09 | ) |

 

*Propertyand Equipment*

 

Property and equipmentare stated at cost less accumulated depreciation and are depreciated on thestraight-line method over the estimated useful lives of the assets.  At the beginning of fiscal 2004 the Companyadopted a new policy for estimating the useful life of fixed assets whichextended the useful life of equipment and furniture and fixtures.  Changing the estimated life of the assets inthese categories as of the beginning of the year reduced depreciation expenseby approximately $130,885.  Net income in2004 would have been $0.02 per basic and diluted share if this change inestimating the useful life of fixed assets had not been adopted.  Expenditures for maintenance and repairs arecharged to operations as incurred.  Alisting of the estimated useful life of the various categories of property andequipment is as follows:

 

| **Asset  Classification**       | ** ** | **Estimated Useful Life**            | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| Leasehold  improvements         |       | Lesser of term of lease  or 10 years |       |
| Furniture  and fixtures         |       | 7 years                              |       |
| Equipment                       |       | 5 years                              |       |
| Computer  hardware and software |       | 3 years                              |       |

 

F-10

----

 

*Accountingfor the Impairment of Long-Lived Assets*

 

The Company adopted SFASNo. 144, *Accounting for the Impairment orDisposal of Long-Lived Assets*,**in fiscal 2002, which requiresthat long-lived assets be measured at the lower of carrying amount or fairvalue less cost to sell.  The adoption ofSFAS No. 144 did not have a material impact on the Company’s consolidatedresults of operations.

 

*NewAccounting Pronouncements*

 

In January 2003, the FASBissued Interpretation No. 46, *Consolidationof Variable Interest Entities*,*anInterpretation of Accounting Research Bulletin (“ARB”) No. 51* (“FIN 46”)*.*  FIN 46 requires certain variable interestentities to be consolidated by the primary beneficiary of the entity if theequity investors in the entity do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties.  FIN 46 is effective forall new variable interest entities created or acquired after January 31,2003.  For variable interest entitiescreated or acquired prior to February 1, 2003, the provisions of FIN 46 must beapplied for the first interim or annual period beginning after June 15,2003.  However, in October 2003, the FASBdeferred the effective date of FIN 46 to the end of the first interim or annualperiod ending after December 15, 2003 for those arrangements involving specialpurpose entities entered into prior to February 1, 2003.  All other arrangements within the scope ofFIN 46 are subject to its provisions beginning in 2004.  The Company adopted FIN 46, as required, withno material impact to its consolidated financial position or results of operations.

 

On December 16, 2004, theFASB issued SFAS No. 123 (revised 2004), *Share-Based Payment*,which is a revision of SFAS No. 123, *Accounting for Stock-BasedCompensation*. Statement 123(R) supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and amends SFASNo. 95, *Statement of Cash Flows*.  Generally, the approach in SFAS 123(R) issimilar 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 incomestatement based on their fair values. Pro forma disclosure is no longer an alternative.

 

SFAS 123(R) must beadopted by the Company no later than July 1, 2005. Early adoption will bepermitted in periods in which financial statements have not yet beenissued.  The Company expects to adopt SFAS123(R) on July 1, 2005.

 

SFAS 123(R) permitspublic companies to adopt its requirements using one of two methods:

 

•      A“modified prospective” method in which compensation cost is recognizedbeginning 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 onthe requirements of SFAS 123 for all awards granted to employees prior to theeffective date of SFAS 123(R) that remain unvested on the effective date.

 

•      A“modified retrospective” method which includes the requirements of the modifiedprospective method described above, but also permits entities to restate basedon the amounts previously recognized under SFAS 123 for purposes of pro formadisclosures either (a) all prior periods presented or (b) prior interim periodsof the year of adoption.

 

The Company has not yetdetermined which method it will use.

 

As permitted by SFAS 123,the Company currently accounts for share-based payments to employees usingOpinion 25’s intrinsic value method and, as such, generally recognizes nocompensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R)’s fair value method will have asignificant impact on the Company’s results of operations, although it willhave no impact on its overall financial position.  The impact of adoption of SFAS 123(R) cannotbe predicted at this time because it will depend on levels of share-basedpayments granted in the future.  However,had the Company adopted SFAS 123(R) in prior periods, the impact of thatstandard would have approximated the impact of SFAS 123 as described in thedisclosure of pro forma net loss and net loss per share discussed above.

 

F-11

----

 

*Reclassifications*

 

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

 

**3.  PROPERTY AND EQUIPMENT:**

 

Property and equipmentconsist of the following:

 

| ** **                      | ** ** | **Dec 25, 2004** | ** ** | **Dec 27, 2003** | ** ** |
|---------------------------------|------------|------------------|------------|------------------|------------|
| Leasehold  improvements         |       | $                | 2,017,339  |             | $          | 996,460 |   |
| Furniture  and fixtures         |       | 1,798,389        |       | 860,982          |       |
| Equipment  under capital leases |       | 1,321,160        |       | 289,737          |       |
| Computer  hardware and software |       | 728,946          |       | 401,598          |       |
| Equipment                       |       | 446,680          |       | 339,922          |       |
|                            |       |             |       |             |       |
| Property  and equipment         |       | 6,312,514        |       | 2,888,699        |       |
| Less  accumulated depreciation  |       | (1,828,809       | )          | (1,194,559       | )          |
|                            |       |             |       |             |       |
| Property  and equipment, net    |       | $                | 4,483,705  |             | $          | 1,694,140 |   |

 

**4.  LEASES:**

 

The Company conducts its operations in leasedfacilities with certain leased equipment accounted for as operating and capitalleases.  Real estate leases generallyprovide for fixed minimum rentals, which typically increase periodically duringthe life of the lease, and, in some instances, contingent rentals based on apercentage of sales in excess of specified minimum sales levels, as well asoccupancy costs, such as property taxes and common area maintenance.  The leases are typically for 10 years,usually with options from the Company’s landlords to renew the Company’s leasesfor an additional 5 or 10 years.

 

The original cost of assets under capital leasesat December 25, 2004 and December 27, 2003 was $1,321,161 and $289,737,respectively. The accumulated depreciation of assets under capital leases at December25, 2004 and December 27, 2003 was $132,631 and $286,847, respectively.  The amortization related to those assetsunder capital lease is included in depreciation expense.

 

At December 25, 2004 the minimum rentalcommitments under all non-cancelable capital and operating leases with initialor remaining terms of more than one year were as follows:

 

| **Year**                                                 | ** ** | **Capital** | ** ** | **Operating** | ** ** |
|----------------------------------------------------------|------------|-------------|------------|---------------|------------|
| 2005                                                     |       | $           | 490,561    |          | $          | 7,223,873 |   |
| 2006                                                     |       | 501,942     |       | 6,949,341     |       |
| 2007                                                     |       | 323,784     |       | 5,642,420     |       |
| 2008                                                     |       | —      |       | 4,293,303     |       |
| 2009                                                     |       | —      |       | 4,104,859     |       |
| Thereafter                                               |       | —      |       | 14,601,593    |       |
| Total  future minimum lease payments                     |       | 1,316,287   |       | $             | 42,815,389 |   |
|                                                     |       |        |       |          |       |
| Less  amount representing interest                       |       | 153,920     |       |          |       |
|                                                     |       |        |       |          |       |
| Present  value of minimum lease payments                 |       | 1,162,367   |       |          |       |
| Less  current portion of obligation under capital leases |       | 365,674     |       |          |       |
|                                                     |       |        |       |          |       |
| Long-term  obligation under capital leases               |       | $           | 796,693    |          |       |   |

 

F-12

----

 

The Company’s rentalexpense under operating leases amounted to $6,431,752 in 2004, $5,323,409 in2003 and $4,746,886 in 2002.  Included inthese amounts are contingent rentals totaling $45,039 in 2004, $37,948 in 2003and $24,941 in 2002.

 

**5.  ACCRUED EXPENSES:**

 

There was no accrued expense which exceeded 5%of current liabilities on the balance sheet at December 25, 2004.  The only accrued expense which exceeded 5% ofcurrent liabilities on the balance sheet at December 27, 2003 was accruedpayroll and benefits of $461,204.

 

**6.  INCOME TAXES:**

 

A reconciliation of theeffective rate with the federal statutory rate is as follows:

 

| ** **                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal  statutory rate                     |       | 34.0     | %          | 34.0     | %          | -34.0    | %          |
| State  income taxes, net of federal benefit |       | 5.1      | %          | 5.2      | %          | -6.0     | %          |
| Permanent  differences                      |       | 1.7      | %          | 1.1      | %          | 10.0     | %          |
| Change  in valuation allowance              |       | -31.2    | %          | -28.8    | %          | 30.0     | %          |
| Effective  tax rate                         |       | 9.6      | %          | 11.5     | %          | 0.0      | %          |

 

Deferred tax assetsconsist of the following:

 

| ** **                                          | ** ** | **2004**   | ** ** | **2003**    | ** ** |
|-----------------------------------------------------|------------|------------|------------|-------------|------------|
| Net  operating loss carryforwards                   |       | $          | 8,732,000  |        | $          | 9,436,000 |   |
| Inventory  reserves                                 |       | 503,000    |       | 557,000     |       |
| Deferred  rent                                      |       | 186,000    |       | 162,000     |       |
| Accrued  vacation                                   |       | 103,000    |       | 90,000      |       |
| Other                                               |       | 91,000     |       | 40,000      |       |
| Excess  book over tax depreciation and amortization |       | 60,000     |       | 156,000     |       |
|                                                |       | 9,675,000  |       | 10,441,000  |       |
| Less  valuation allowance                           |       | (9,675,000 | )          | (10,441,000 | )          |
| Net  deferred tax asset                             |       | $          | —     |        | $          | — |   |

 

The Company has recordeda valuation allowance against its deferred tax assets because of theuncertainty regarding the realizability of these assets against future taxableincome.

 

The Company usedapproximately $923,000 and $792,000 of net operating loss carryforwards in 2004and 2003, respectively.

 

As of December 25, 2004,the Company has estimated net operating loss carryforwards of approximately $23.0million, which begin to expire in 2018. In accordance with Section 382 of the Internal Revenue Code, the use ofsome of these carryforwards will be subject to annual limitations based uponownership changes of the Company’s stock which may have occurred or that mayoccur.

 

The Company made cashpayments for state income taxes of $157,752 in 2004, $77,279 in 2003 and$16,500 in 2002.  The Company made cashpayments for federal income taxes of $35,000 in 2004, $0 in 2003 and $0 in2002.

 

F-13

----

 

**7.  CONTRACTUALARRANGEMENTS:**

 

*LicenseArrangement*

 

On July 8, 1999, theCompany entered into a product fulfillment agreement with Taymark, a directmarketer of party supplies, to utilize the direct marketer’s inventory andfulfillment services to deliver merchandise ordered on the Company’s website,or directly through a toll-free telephone number, to consumers.

 

On July 8, 2003 theCompany signed a new agreement with Taymark to license the iParty.com name toTaymark, which now operates the website at www.iparty.com.  In return, Taymark pays the Company a 15%royalty on all net sales realized through its operation of www.iparty.com.  The term of this agreement is for a period oftwo (2) years, unless sooner terminated. If this agreement is not terminated, it shall be automatically renewedfor successive one-year periods.

 

*Earn-outagreement*

 

The Company purchasedfrom The Big Party, Debtor and Debtor-in-Possession (the “sellers”) in 2000inventory, fixed assets and the leases of 33 retail stores in consideration ofcash and assumption of certain liabilities. In addition, the Company agreed to pay the sellers, no later than March31, 2004, an amount equivalent to the greater of $250,000, or a percentage ofthe aggregate operating results of the 33 acquired locations.  In connection with the Company’s purchaseaccounting in 2000, the Company accrued the guaranteed amount of $250,000,which based on actual results is the minimum and final amount due as of December27, 2003, and paid this amount during the first quarter of 2004.

 

**8.  RELATED PARTY TRANSACTIONS:**

 

On August 26, 1999 theCompany granted Mr. Sal Perisano, its Chief Executive Officer, options topurchase an aggregate of 434,730 shares of the Company’s common stock pursuantto the Company’s stock option plan with an exercise price of $2.00, which wasbelow the then-current market price of $3.38. As of December 29, 2001 all such options had vested.  These options were fully expensed as of December29, 2001.  The Company charged $273,971related to this stock option grant to stock option compensation expense in 2001,the final year of vesting.

 

On September 7, 1999, theCompany and Mr. Stuart Moldaw, who served as a Director of the Company from1999 to 2003, entered into a consulting agreement that had a term of threeyears.  Upon the expiration of thisagreement, the Company and Mr. Moldaw entered into an oral agreement that Mr.Moldaw would continue to provide consulting services to the Company.  On November 6, 2003 the CompensationCommittee of the Company’s Board of Directors approved a stock option grant toMr. Moldaw, vesting immediately, with the strike price set at the closing priceof the Company’s common stock on that day, to purchase 50,000 shares of commonstock, for consulting services performed by Mr. Moldaw in 2003.  The fair value of the options granted to Mr.Moldaw on November 6, 2003 was $25,000.  OnJanuary 31, 2005 the Compensation Committee of the Company’s Board of Directorsapproved a stock option grant to Mr. Moldaw, vesting immediately, with thestrike price set at the closing price of the Company’s common stock on thatday, to purchase 50,000 shares of common stock, for consulting servicesperformed by Mr. Moldaw in 2004.  Thefair value of the options granted on January 31, 2005 was $28,500.  The committee approved this grant, but notedthat Mr. Moldaw would not receive any additional stock option grants forconsulting services in the future.

 

**9.  LINE OF CREDIT:**

 

On January 2, 2004 theCompany amended its existing line of credit (“the line”) with Wells FargoRetail Finance II, LLC.  The amendmentextended the maturity date of the line to January 2, 2007, eliminated theminimum interest rate of 6.5%, established a new interest rate at the bank’sbase rate plus 50 basis points and added the option to increase the line inincrements 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 the Company is incompliance of all debt covenants and the provisions of the loan agreement.  Inventory and accounts receivable secure theCompany’s line.

 

F-14

----

 

The amended agreementincludes a financial covenant requiring the Company to maintain a minimumavailability under the line of 5% of the credit limit, which at the currentlimit of $7,500,000, is $375,000.  If theCompany adjusts the credit limit in the future, the minimum availability wouldbe 5% of the adjusted credit limit.  Theamended agreement also has a covenant that requires the Company to limit itscapital expenditures to within 110% of those amounts included in its businessplan, which may be updated from time to time. At December 25, 2004, the Companywas in compliance with these financial covenants.  The line generally prohibits the payment ofany dividends or other distributions to any of the Company’s classes of capitalstock.

 

At December 27, 2003 theline had a maturity date of July 31, 2004 and a minimum interest rate of6.5%.  The line allowed for borrowingsequal to the lesser of $7,500,000 or the borrowing base, as defined.  Inventory and other assets secured theline.  The Company was required tomaintain a minimum availability under the line in the amount of $300,000.

 

The amounts outstandingunder the line as of December 25, 2004 and December 27, 2003 were $5,257,690 and$3,760,671, respectively.  The interestrate on these borrowings was 5.75% at December 25, 2004 and 6.5% at December27, 2003.  The outstanding balances underthe line are classified as current liabilities in the accompanying consolidatedbalance sheets since the Company is required to apply daily lock box receiptsto reduce the amount outstanding.  At December25, 2004, the Company had approximately $305,000 of additional availabilityunder the line.  In the third quarter offiscal 2004, the Company established a letter of credit for $356,000 with WellsFargo Bank, N.A. associated with the leasing of its new point-of-salesystem.  This $356,000 letter of creditwas outstanding at December 25, 2004.

 

The Company made cashpayments for interest of $218,765 in 2004, $217,268 in 2003, and $285,515 in2002.

 

**10.  PREFERRED STOCK:**

 

The following table summarizes the changes in thenumber of shares of convertible preferred stock during the past two years.

 
| ** **                            | ** ** | **Shares  Issued  and  Outstanding  as of 12/25/04** | ** ** | **Conversions  to  Common  Stock** | ** ** | **Shares  Issued  and  Outstanding  as of 12/27/03** | ** ** | **Conversions  to  Common  Stock** | ** ** | **Shares  Historically  Reported as  Issued and  Outstanding  as of 12/28/02** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|------------------------------------|------------|------------------------------------------------------|------------|------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| Series  A convertible preferred stock |       | —                                               |       | (1,000,000                         | )          | 1,000,000                                            |       | —                             |       | 1,000,000                                                                      |       |
| Series  B convertible preferred stock |       | 507,460                                              |       | (103,620                           | )          | 611,080                                              |       | (73,719                            | )          | 684,799                                                                        |       |
| Series  C convertible preferred stock |       | 100,000                                              |       | —                             |       | 100,000                                              |       | —                             |       | 100,000                                                                        |       |
| Series  D convertible preferred stock |       | 250,000                                              |       | —                             |       | 250,000                                              |       | —                             |       | 250,000                                                                        |       |
| Series  E convertible preferred stock |       | 296,667                                              |       | (92,772                            | )          | 389,439                                              |       | (77,228                            | )          | 466,667                                                                        |       |
| Series  F convertible preferred stock |       | 114,286                                              |       | —                             |       | 114,286                                              |       | —                             |       | 114,286                                                                        |       |
| Total                                 |       | 1,268,413                                            |       | (1,196,392                         | )          | 2,464,805                                            |       | (150,947                           | )          | 2,615,752                                                                      |       |

 

OnOctober 31, 2002, the Company concluded it had incorrectly applied theanti-dilution provisions of its Series B, C and D convertible preferred stock(the “Affected Preferred Stock”) in conjunction with dilutive financings inAugust and September 2000.  The Companydetermined that it inadvertently issued additional shares of Affected PreferredStock, instead of adjusting the Affected Preferred Stock’s conversionratios.  The Company also miscalculatedthe number of common shares issuable upon conversion of the Affected PreferredStock.  As a result of the abovetransactions, the anti-dilution provisions of the Company’s Series E and SeriesF convertible preferred stock were also triggered, increasing the number ofshares issuable upon conversion of the Company’s Series E and Series Fconvertible preferred stock.

 

SeeNote 16 for additional information on this subject.

 

F-15

----

 

*SeriesA Convertible Preferred Stock*

 

On January 13, 2004, all sharesof Series A convertible preferred stock were converted into 1,000,000 shares ofcommon stock on a 1.00 to 1.00 ratio.  Holdersof Series A convertible preferred stock had a liquidation preference senior tothe Company’s common stockholders, and were *pari passu* withthe Company’s Series B, C, D, E and F convertible preferred stock.  Until their shares of Series A convertiblepreferred stock were converted into shares of common stock, holders of Series Aconvertible preferred stock were not entitled to any dividends or to vote onmatters submitted to a vote of the Company’s stockholders, except to the extentotherwise expressly provided by the General Corporation Law of Delaware.

 

*SeriesB Convertible Preferred Stock*

 

The shares of Series Bconvertible preferred stock are immediately convertible into 6,531,105 sharesof common stock on a 1.000 to 12.870 ratio at December 25, 2004, and carry anaggregate liquidation value of $10,149,200 ($1.55 per common share issuableupon conversion) at December 25, 2004. With certain exceptions, the conversion price will be adjusted on aweighted-average basis in the event the Company issues common stock or certainrights, including option activity in excess of certain amounts, to purchase orconvert into common stock as defined in the Company’s Certificate ofIncorporation as amended at a price below the conversion price.  The Series B convertible preferred stock willautomatically convert into common stock at the conversion price then in effectin the event the Company consummates a secondary public offering resulting ingross proceeds to the Company of at least $10,000,000.

 

In the event ofliquidation, the holders of Series B convertible preferred stock havepreference to holders of the Company’s common stock, and are *pari passu* with the Company’s Series C, D, E and Fconvertible preferred stock.

 

Holders of Series Bconvertible preferred stock are entitled to 12 votes per share (i.e., one votefor each whole number of shares of common stock into which each such share ispresently convertible) on all matters submitted to a vote of the Company’sstockholders and are entitled to participate in dividends when and if declaredby the Board of Directors.

 

*SeriesC Convertible Preferred Stock*

 

The shares ofSeries C convertible preferred stock are immediately convertible into 1,310,600shares of common stock on a 1.000 to 13.106 ratio at December 25, 2004, andcarry an aggregate liquidation value of $2,000,000 ($1.53 per common shareissuable upon conversion) at December 25, 2004. With certain exceptions, the conversion price will be adjusted on aweighted-average basis in the event the Company issues common stock or certainrights, including option activity in excess of certain amounts, to purchase orconvert into common stock as defined in the Company’s Preferred Stock Charterat a price below the conversion price. The Series C convertible preferred stock will automatically convert intocommon stock at the conversion price then in effect in the event the Companyconsummates a secondary public offering resulting in gross proceeds to theCompany of at least $10,000,000.

 

In the event ofliquidation, the holders of Series C convertible preferred stock havepreference to holders of the Company’s common stock, and are *pari passu* with the Company’s Series B, D, E and Fconvertible preferred stock.

 

Holders of Series Cconvertible preferred stock are entitled to 13 votes per share (i.e., one votefor each whole number of shares of common stock into which each such share ispresently convertible) on all matters submitted to a vote of the Company’sstockholders and are entitled to participate in dividends when and if declaredby the Board of Directors.

 

*SeriesD Convertible Preferred Stock*

 

The shares of Series Dconvertible preferred stock are immediately convertible into 3,513,750 sharesof common stock on a 1.000 to 14.055 ratio at December 25, 2004, and carry anaggregate liquidation value of 

 

F-16

----

 

$5,000,000 ($1.42 per commonshare issuable upon conversion) at December 25, 2004.  With certain exceptions, the conversion pricewill be adjusted on a weighted-average basis in the event the Company issuescommon stock or certain rights, including option activity in excess of certainamounts, to purchase or convert into common stock as defined in the Company’sPreferred Stock Charter at a price below the conversion price.  The Series D convertible preferred stock willautomatically convert into common stock at the conversion price then in effectin the event the Company consummates a secondary public offering resulting ingross proceeds to the Company of at least $10,000,000.

 

In the event ofliquidation, the holders of Series D convertible preferred stock havepreference to holders of the Company’s common stock, and are *pari passu* with the Company’s Series B, C, E and Fconvertible preferred stock.

 

Holders of Series Dconvertible preferred stock are entitled to 14 votes per share (i.e., one votefor each whole number of shares of common stock into which each such share ispresently convertible) on all matters submitted to a vote of the Company’s stockholdersand are entitled to participate in dividends when and if declared by the Boardof Directors.

 

*SeriesE Convertible Preferred Stock*

 

The shares of Series Econvertible preferred stock are immediately convertible into 3,073,168 sharesof common stock on a 1.000 to 10.359 ratio at December 25, 2004, and carry anaggregate liquidation value of $1,112,500 ($0.36 per common share issuable uponconversion) at December 25, 2004.  Withcertain exceptions, the conversion price will be adjusted on a weighted-averagebasis in the event the Company issues common stock or certain rights, includingoption activity in excess of certain amounts, to purchase or convert intocommon stock as defined in the Company’s Preferred Stock Charter at a pricebelow the conversion price.  The Series Econvertible preferred stock will automatically convert into common stock at theconversion price then in effect in the event the average closing bid price ofthe common stock equals or exceeds $10.00 per share for 20 days within any 30-dayperiod.

 

In the event ofliquidation, the holders of Series E convertible preferred stock havepreference to holders of the Company’s common stock, and are *pari passu* with the Company’s Series B, C, D and Fconvertible preferred stock.

 

Holders of Series Econvertible preferred stock are entitled to 10 votes per share (i.e., one votefor each whole number of shares of common stock into which each such share is presentlyconvertible) on all matters submitted to a vote of the Company’s stockholdersand are entitled to participate in dividends when and if declared by the Boardof Directors.

 

*SeriesF Convertible Preferred Stock*

 

The shares of Series Fconvertible preferred stock are immediately convertible into 1,184,803 sharesof common stock on a 1.000 to 10.367 ratio at December 25, 2004, and carry anaggregate liquidation value of $500,000 ($0.42 per common share issuable uponconversion) at December 25, 2004.  Withcertain exceptions, the conversion price will be adjusted on a weighted-averagebasis in the event the Company issues common stock or certain rights, includingoption activity in excess of certain amounts, to purchase or convert intocommon stock as defined in the Company’s Preferred Stock Charter at a pricebelow the conversion price.  The Series Fconvertible preferred stock will automatically convert into common stock at theconversion price then in effect in the event the average closing bid price ofthe common stock equals or exceeds $10.00 per share for 20 days within any30-day period.

 

In the event ofliquidation, the holders of Series F convertible preferred stock havepreference to holders of the Company’s common stock, and are pari passu withthe Company’s Series B, C, D and E convertible preferred stock.

 

F-17

----

 

Holders of Series Fpreferred stock are entitled to 10 votes per share (i.e., one vote for eachwhole number of shares of common stock into which each such share is presently convertible)on all matters submitted to a vote of the Company’s stockholders and areentitled to participate in dividends when and if declared by the Board ofDirectors.

 

*Accretionof Dividends in the Event of Liquidation*

 

The carrying values ofSeries B-F convertible preferred stock have been determined based on their fairmarket values at the original dates of issuance.  In certain cases, warrants were issued, whichthe Company allocated value to and included in additional paid in capital.  Should such a liquidation event occur, thedifference between the carrying value of the convertible preferred stock andtheir liquidation value will be accreted. This amount was $4,453,698 on December 25, 2004.

 

**11.  WARRANTS:**

 

At December 25, 2004,there were various warrants outstanding for shares of the Company’s commonstock.  These warrants were issued inconnection with certain preferred stock financings and certain licensing andmarketing arrangements.  Substantiallyall of the warrant agreements contain certain anti-dilution provisions, whichprotect the warrant holders against dilution upon the occurrence of certainevents, including the sale of common stock or certain rights, including optionactivity in excess of certain amounts, to purchase or convert into commonstock, as defined in the warrant agreement for less than fair market value orless than the exercise price of the previously issued warrants.  If such an event occurs, this can result inadditional shares being available to the warrant holder and a reduction in theexercise price for each share.

 

The following tablesummarizes the Company’s outstanding warrants, including the impact ofanti-dilution events which occurred in previous years, at December 25, 2004:

 

| ** **   | ** ** | ** **   | ** ** | **Exercise**                              | ** ** | ** **     | ** **                                |
|--------------|------------|--------------|------------|-------------------------------------------|------------|----------------|-------------------------------------------|
| ** **   | ** ** | **Total**    | ** ** | **Price per**                             | ** ** | ** **     | ** **                                |
| **Number**   | ** ** | **Common**   | ** ** | **Common**                                | ** ** | ** **     | ** **                                |
| **of**       | ** ** | **Shares**   | ** ** | **Share**                                 | ** ** | **Expiration** | ** **                                |
| **Warrants** | ** ** | **Issuable** | ** ** | **Issuable**                              | ** ** | **Date**       | ** **                                |
| 528,210      |       | 528,210      |       | $ 2.63  -  $5.13 |       |           | 04/16/09  -  08/15/09 |   |   |
| 5,223,512    |       | 8,357,619    |       | 1.25                                      |       |           | 08/26/05                                  |   |   |
| 500,000      |       | 800,000      |       | 1.25                                      |       |           | 08/26/05                                  |   |   |
| 929,929      |       | 1,487,886    |       | 1.25                                      |       |           | 08/26/05                                  |   |   |
| 1,250,000    |       | 1,837,500    |       | 1.36                                      |       |           | 08/26/05                                  |   |   |
| 8,431,651    |       | 13,011,215   |       | 1.37                                      |       |           |                                      |   |

 

Commencing one year fromthe issue date, the Company may, at its option, on a 30-day notice, redeemcertain common stock warrants at a price of $0.05 per warrant if the averageclosing bid price of the common stock equals or exceeds $8.00 per share for 20days within any 30-day period.

 

**12.  STOCK OPTION PLAN:**

 

Under the Company’s Amended and Restated 1998Incentive and Nonqualified Stock Option Plan (the “1998 Plan”) options toacquire 11,000,000 shares of common stock may be granted to officers,directors, key employees and consultants. The exercise price for qualified incentive options cannot be less thanthe fair market value of the stock on the grant date and the exercise price ofnonqualified options can be fixed by the Board. Qualified incentive options to purchase the Company’s common stock underthe 1998 Plan have been granted to employees, directors and consultants of theCompany at fair market value at the date of grant.  Generally, the options become exercisableover periods of up to four years, and expire ten years from the date of grant.

 

F-18

----

 

A summary of theCompany’s stock options is as follows:

 

| ** **                               | ** ** | **Number**  | ** ** | **Weighted** | ** ** | ** **                                            | ** **                                                  |
|------------------------------------------|------------|-------------|------------|--------------|------------|-------------------------------------------------------|-------------------------------------------------------------|
| ** **                               | ** ** | **of**      | ** ** | **Average**  | ** ** | ** **                                            | ** **                                                  |
| ** **                               | ** ** | **Stock**   | ** ** | **Exercise** | ** ** | **Price**                                             | ** **                                                  |
| ** **                               | ** ** | **Options** | ** ** | **Price**    | ** ** | **Range**                                             | ** **                                                  |
| Outstanding  - December 29, 2001         |       | 7,522,964   |       | $            | 1.07       |                                                  | $ 0.10  -    $ 5.38 |   |
| Granted                                  |       | 863,457     |       | 0.33         |       | 0.21  -       0.67 |                                                        |
| Expired/Forfeited                        |       | (133,862    | )          | 0.31         |       | 0.10  -       0.50 |                                                        |
| Exercised                                |       | (9,375      | )          | 0.50         |       | 0.50  -       0.50 |                                                        |
|                                     |       |        |       |         |       |                                                  |                                                        |
| Outstanding  - December 28, 2002         |       | 8,243,184   |       | 1.01         |       | 0.11  -       5.38 |                                                        |
| Granted                                  |       | 455,555     |       | 0.45         |       | 0.15  -       1.06 |                                                        |
| Expired/Forfeited                        |       | (170,021    | )          | 0.29         |       | 0.15  -       0.44 |                                                        |
| Exercised                                |       | (11,000     | )          | 0.16         |       | 0.16  -       0.16 |                                                        |
|                                     |       |        |       |         |       |                                                  |                                                        |
| Outstanding  - December 27, 2003         |       | 8,517,718   |       | 0.99         |       | 0.11  -       5.38 |                                                        |
| Granted                                  |       | 1,801,300   |       | 0.89         |       | 0.69  -       1.33 |                                                        |
| Expired/Forfeited                        |       | (269,406    | )          | 1.50         |       | 0.11  -       4.00 |                                                        |
| Exercised                                |       | (17,795     | )          | 0.39         |       | 0.20  -       0.50 |                                                        |
|                                     |       |        |       |         |       |                                                  |                                                        |
| Outstanding  - December 25, 2004         |       | 10,031,817  |       | $            | 0.96       |                                                  | $ 0.13  -   $ 5.38            |   |
|                                     |       |        |       |         |       |                                                  |                                                        |
| Exercisable  - December 25, 2004         |       | 8,210,070   |       | $            | 1.01       |                                                  | $ 0.13  -   $ 5.38            |   |
|                                     |       |        |       |         |       |                                                  |                                                        |
| Available  for grant - December 25, 2004 |       | 595,013     |       |         |       |                                                  |                                                        |

 

The following tablesummarizes information for options outstanding and exercisable at December 25,2004:

 

| ** **                                                         | ** ** | ** **  | ** ** | **Weighted**  | ** ** | ** **   | ** ** | ** **  | ** ** | ** **   | ** ** |
|--------------------------------------------------------------------|------------|-------------|------------|---------------|------------|--------------|------------|-------------|------------|--------------|------------|
| ** **                                                         | ** ** | **Number**  | ** ** | **Average**   | ** ** | **Weighted** | ** ** | **Number**  | ** ** | **Weighted** | ** ** |
| ** **                                                         | ** ** | **of**      | ** ** | **Remaining** | ** ** | **Average**  | ** ** | **of**      | ** ** | **Average**  | ** ** |
| ** **                                                         | ** ** | **Stock**   | ** ** | **Life**      | ** ** | **Exercise** | ** ** | **Stock**   | ** ** | **Exercise** | ** ** |
| **Price  Range**                                                   | ** ** | **Options** | ** ** | **(Years)**   | ** ** | **Price**    | ** ** | **Options** | ** ** | **Price**    | ** ** |
| $ 0.11  -   $ 0.20                        |       | 244,860     |       | 6.9           |       | $            | 0.18       |        | 187,396    |         | $          | 0.18 |   |
|    0.21   -      0.30 |       | 3,832,882   |       | 6.2           |       | 0.25         |       | 3,592,078   |       | 0.25         |       |
|    0.31   -      0.50 |       | 1,092,768   |       | 7.2           |       | 0.35         |       | 980,726     |       | 0.35         |       |
|    0.51   -      1.00 |       | 2,882,177   |       | 8.1           |       | 0.80         |       | 1,497,515   |       | 0.74         |       |
|    1.01   -      3.50 |       | 989,130     |       | 4.7           |       | 2.17         |       | 962,355     |       | 2.19         |       |
|    3.51   -      5.38 |       | 990,000     |       | 4.4           |       | 3.82         |       | 990,000     |       | 3.82         |       |
| Total                                                              |       | 10,031,817  |       | 6.5           |       | $            | 0.96       |        | 8,210,070  |         | $          | 1.01 |   |

 

The Company has reserved 38,656,458shares of common stock for issuance in connection with the conversion ofconvertible preferred stock and the exercise of warrants and stock options.

 

**13.  STOCKHOLDER RIGHTS PLAN:**

 

The Company has aStockholder Rights Plan (the “Plan”) effective November 9, 2001.  Under the Plan each share of the Company’scapital stock outstanding at the close of business on November 9, 2001 and eachshare of the Company’s capital stock issued subsequent to that date has a rightassociated with it, such that each share of its 

 

F-19

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common stock is entitledto one right and each share of its preferred stock is entitled to such numberof rights equal to the number of common shares into which it is convertible.

 

The rights areexercisable only in the event, with certain exceptions, an acquiring partyaccumulates 10 percent or more of the Company’s voting stock, or if a partyannounces an offer to acquire 15 percent or more of the Company’s voting stock.  The rights expire on November 9, 2011.

 

When exercisable, eachright entitles the holder to purchase from the Company, one one-hundredth of ashare of a new series of Series G junior preferred stock at an initial purchaseprice of $2.00.  In addition, upon theoccurrence of certain events, holders of the rights will be entitled topurchase either iParty Corp. stock or shares in an “acquiring entity” at halfof market value.  The Company generallywill be entitled to redeem the rights at $0.001 per right at any time until thedate on which a 10 percent position in its voting stock is acquired by anyperson or group.  Until a right isexercised, the holder thereof, as such, will have no rights as a stockholder ofthe Company, including, without limitation, the right to vote or receivedividends.

 

**14.  PROFIT SHARING 401(k) PLAN:**

 

The iParty 401(k) Plan isa qualified profit sharing plan covering substantially all of itsemployees.  Contributions to this planare at the discretion of the Board of Directors.  The Company’s expense, including matchingcontributions and any discretionary amounts was $111,799 in 2004, $95,405 in2003 and $88,532 in 2002.

 

**15.  SEGMENT REPORTING:**

 

SFAS No. 131, *Disclosures about Segments of an Enterprise and Related Information*,establishes standards for the way business enterprises report information aboutoperating segments in annual financial statements and requires that thoseenterprises report selected information about operating segments in interimfinancial reports issued to stockholders.

 

In the past the Companyhad determined that its reportable segments consisted of a retail storesoperation and an Internet operation.  Asof 2003, with the transition of the Internet operation to a license arrangementand the insignificance of the revenues prior to the transition (less than 2%)and results of operations (less than 5%) to the overall business, the Company nolonger reports Internet operating segment information.

 

**16.  SPECIAL CHARGE:**

 

OnOctober 31, 2002, the Company concluded it had incorrectly applied theanti-dilution provisions of its Series B, C and D convertible preferred stock(the “Affected Preferred Stock”) in conjunction with dilutive financings inAugust and September 2000.

 

TheCompany determined that it inadvertently issued additional shares of AffectedPreferred Stock, instead of adjusting the Affected Preferred Stock’s conversionratios.  The Company also miscalculatedthe number of common shares issuable upon conversion of the Affected PreferredStock.

 

The Company also reviewedthe anti-dilution provisions of certain of its warrants to purchase commonstock that were issued in conjunction with the Affected Preferred Stock (the “AffectedWarrants”), and has determined that it mistakenly issued additional warrant certificates,instead of adjusting the Affected Warrants’ conversion ratios.  The warrant calculations****also mistakenly omitted the dilutiveeffect of a warrant issued by the Company in December 1999.

 

TheCompany performed the calculations to compute the correct number of shares ofAffected Preferred Stock and Affected Warrants that should be issued andoutstanding as of December 28, 2002, along with the appropriate conversionratios in effect at December 28, 2002. The Company notified each holder of Affected Preferred Stock as ofDecember 2, 2002.  The Company alsoinstructed its transfer agent to apply any Affected Stock conversions using thecorrected ratios and prices.  The Companyhas presented its earnings per share and all footnotes information for 2002, inaccordance with the corrected information. The accounting implications of this situation are as follows:

 

F-20

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•                  Beginningin September 2000, the Company believed and treated holders of Affected PreferredStock as if they were entitled to approximately 2.3 million more common sharesupon conversion of their Affected Preferred Stock than they were in factentitled to.  Of this overstated amount,590,327 common shares were issued upon conversions of shares of AffectedPreferred Stock and sold in the public market (the “Overissued Shares”)beginning in October 2000.  On October31, 2002, the Company’s Board of Directors ratified the issuance of theOverissued Shares.

 

•                  Beginningin September 2000, the Company believed and treated holders of AffectedWarrants as if they were entitled to 116,291 fewer common shares upon exerciseof their Affected Warrants than they were in fact entitled to.  None of the Affected Warrants have beenexercised as of March 21, 2005.

 

Theimpact of these matters did not require the Company to make any changes to itspreviously reported earnings per share. The impact of the common stock equivalents did not affect quarterly orannual loss per diluted share, since such the inclusion of such shares wouldhave been anti-dilutive.  The impact ofcommon stock equivalents did not impact quarterly net income per diluted sharein such periods of profit, given the minimal amount of net income in comparisonto the weighted-average shares outstanding.

 

TheCompany recorded a special charge for the year ended December 28, 2002 in theamount of $396,465, which included a non-cash charge of $171,465 for therecognition of the Overissued Shares, and $225,000 of professional feesincurred through December 28, 2002.

 

The Company also recorded a beneficial conversiondividend in the amount of $90,150 in the fourth quarter of 2002, which reflectsthe impact of anti-dilution adjustments to the conversion ratios of the SeriesE and F convertible preferred stock.

 

In 2004 the Company reached a settlement with athird party in connection with the special charge previously recorded in fiscalyear 2002.  The Company recorded the netsettlement of $382,500 as other income.

 

F-21

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**17.  QUARTERLY FINANCIAL DATA (UNAUDITED):**

 

**QUARTERLY FINANCIAL DATA**

 
| ** **                            | ** ** | **Mar 27, 2004** | ** ** | **Jun 26, 2004** | ** ** | **Sep 25, 2004** | ** ** | **Dec 25, 2004** | ** ** |
|---------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| Revenues                              |       | $                | 12,036,066 |             | $          | 15,360,388       |       | $                | 13,157,546 |   | $ | 23,722,225 |   |
| Cost  of products sold (1), (2)       |       | 6,973,329        |       | 8,482,813        |       | 7,849,135        |       | 12,521,543       |       |
| Operating  income (loss)              |       | (810,759         | )          | 494,417          |       | (1,477,668       | )          | 2,731,423        |       |
| Net  income (loss)                    |       | (838,005         | )          | 805,852          |       | (1,526,977       | )          | 2,550,323        |       |
|                                  |       |             |       |             |       |             |       |             |       |
| Net  income (loss) per share          |       |             |       |             |       |             |       |             |       |
| Basic                                 |       | $                | (0.04      | )                | $          | 0.02             |       | $                | (0.07      | ) | $ | 0.07 |   |
| Diluted                               |       | $                | (0.04      | )                | $          | 0.02             |       | $                | (0.07      | ) | $ | 0.06 |   |
|                                  |       |             |       |             |       |             |       |             |       |
| Weighted-average  shares outstanding: |       |             |       |             |       |             |       |             |       |
| Basic                                 |       | 20,227,671       |       | 37,698,128       |       | 22,019,408       |       | 37,649,400       |       |
| Diluted                               |       | 20,227,671       |       | 41,834,415       |       | 22,019,408       |       | 41,468,959       |       |

 
| ** **                            | ** ** | **Mar 27, 2003** | ** ** | **Jun 28, 2003** | ** ** | **Sep 27, 2003** | ** ** | **Dec 27, 2003** | ** ** |
|---------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| Revenues                              |       | $                | 10,287,577 |             | $          | 13,805,555       |       | $                | 11,878,460 |   | $ | 20,725,654 |   |
| Cost  of products sold (1),  (3) |       | 6,241,696        |       | 7,849,863        |       | 7,060,170        |       | 10,606,896       |       |
| Operating  income (loss)              |       | (1,112,040       | )          | 408,242          |       | (969,252         | )          | 2,732,205        |       |
| Net  income (loss)                    |       | (1,164,266       | )          | 351,777          |       | (1,034,727       | )          | 2,598,173        |       |
|                                  |       |             |       |             |       |             |       |             |       |
| Net  income (loss) per share          |       |             |       |             |       |             |       |             |       |
| Basic                                 |       | $                | (0.07      | )                | $          | 0.01             |       | $                | (0.06      | ) | $ | 0.07 |   |
| Diluted                               |       | $                | (0.07      | )                | $          | 0.01             |       | $                | (0.06      | ) | $ | 0.06 |   |
|                                  |       |             |       |             |       |             |       |             |       |
| Weighted-average  shares outstanding: |       |             |       |             |       |             |       |             |       |
| Basic                                 |       | 16,999,935       |       | 36,678,915       |       | 17,687,448       |       | 36,688,228       |       |
| Diluted                               |       | 16,999,935       |       | 37,747,608       |       | 17,687,448       |       | 41,091,732       |       |

 

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(1)    Cost of products sold consists of the costof merchandise sold to customers and the occupancy costs for stores.

 

(2)    The fourth quarter of 2004 included anestimated reduction of $149,316 to the cost of products sold during theprevious three quarters due to the completion of physical inventories, forwhich shortage had been estimated during the year.

 

(3)    The fourth quarter of 2003 included anestimated reduction of $145,983 to the cost of products sold during theprevious three quarters due to the completion of physical inventories, forwhich shortage had been estimated during the year.

 

F-22

----

 

**EXHIBITINDEX**

 
| **EXHIBIT** | ** ** | ** **      |
|-------------|------------|-----------------|
| **NUMBER**  | ** ** | **DESCRIPTION** |
| 3.1         | (1)        |            | Restated Certificate of  Incorporation of WSI Acquisition Corp. and Certificate of Merger by iParty  Corp. into WSI Acquisition Corp. |
| 3.2         | (1)        |            | Certificate of  Designation of Series A Preferred Stock of WSI Acquisitions, Corp. |
| 3.3         | (2)        |            | Certificate of  Designation of Series B Preferred Stock of iParty Corp. |
| 3.4         | (2)        |            | Certificate of  Designation of Series C Preferred Stock of iParty Corp. |
| 3.5         | (4)        |            | Certificate of  Designation of Series D Preferred Stock of iParty Corp. |
| 3.6         | (6)        |            | Certificate of  Designation of Series E Preferred Stock of iParty Corp. |
| 3.7         | (12)       |            | Certificate of  Correction to Certificate of Designation of Series E Preferred Stock of  iParty Corp. |
| 3.8         | (7)        |            | Certificate of  Designation of Series F Preferred Stock of iParty Corp. |
| 3.9         | (9)        |            | Certificate of  Designation of Series G Junior Preferred Stock of iParty Corp. |
| 3.10        | (1)        |            | By-Laws of WSI  Acquisition Corp., as amended. |
| 4.1         | (2)        |            | Warrant Agreement  between iParty Corp., Continental Stock Transfer & Trust Company and  Commonwealth Associates, LP. |
| 4.2         | (2)        |            | Warrant Agreement  between iParty Corp., Continental Stock Transfer & Trust Company and  Commonwealth Associates, LP. |
| 4.3         | (5)        |            | Taymark Warrant  Certificate. |
| 10.1        | (1)        |            | Agreement and Plan of  Merger between iParty Corp. and WSI Acquisitions Corp. |
| 10.2        | (1)        |            | 1998 Incentive and  Non-Qualified Stock Option Plan. |
| 10.3        | (11)       |            | Amended and Restated  1998 Incentive and Non-Qualified Stock Option Plan. |
| 10.4        | (14)       | ##              | Employment Agreement  between iParty Corp. and Sal Perisano, dated May 14, 2004. |
| 10.5        | (14)       | ##              | Employment Agreement  between iParty Corp. and Patrick Farrell, dated May 14, 2004. |
| 10.6        | (14)       | ##              | Employment Agreement  between iParty Corp. and Dorice Dionne, dated May 14, 2004. |
| 10.7        | (3)        |            | Fulfillment Agreement  between iParty Corp. and Taymark. |
| 10.8        | (11)       |            | Extension to  Fulfillment Agreement between iParty Corp. and Taymark. |
| 10.9        | (12)       |            | Web Site License  Agreement between iParty Corp. and Taymark, Inc. |
| 10.10       | (8)        |            | Rights Agreement  between iParty Corp. and Continental Stock Transfer & Trust, as Rights  Agent. |
| 10.11       | (11)       |            | Loan and Security  Agreement between iParty Retail Stores Corp. and Paragon Capital LLC. |
| 10.12       | (10)       |            | First Amendment to Loan  and Security Agreement by and among iParty Corp., iParty Retail Stores Corp.  and Wells Fargo Retail Finance, LLC. |
| 10.13       | (13)       |            | Second Amendment to  Loan and Security Agreement by and among iParty Corp., iParty Retail Stores  Corp. and Wells Fargo Retail Finance II, LLC. |
| 10.14       | (11)       |            | Trademark Security  Agreement between iParty Retail Stores Corp. and Paragon Capital LLC. |
| 10.15       | (11)       |            | Trademark Security  Agreement between iParty Corp. and Wells Fargo Retail Finance, LLC. |
| 10.16       | (6)        |            | Stock Purchase  Agreement by and among iParty Corp., Ajmal Khan and Robert Lessin. |
| 10.17       | (7)        |            | Stock Purchase  Agreement between iParty Corp. and Patriot Capital Ltd. |
| 10.18       | (3)        |            | Funding Agreement among  iParty Corp., Robert Lessin and Ajmal Khan. |
| 21.1        | (15)       |            | Subsidiaries of  Registrant. |
| 23.1        | (15)       |            | Consent of Ernst &  Young LLP, Independent Registered Public Accounting Firm. |
| 31.1        | **         |            | Certification of Chief  Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act. |
| 31.2        | **         |            | Certification  of Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act. |
| 32.1        | **         |            | Certification  of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act. |
| 32.2        | **         |            | Certification  of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act. |

 

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| **  |   | Filed  herewith.                                                                                                                                                                                           |
|-----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ##  |   | Management  contract or compensatory plan or arrangement.                                                                                                                                                  |
| (1) |   | Filed  as an exhibit to iParty’s Registration Statement on Form 10-SB, Registration  No. 0-25507, as filed with the SEC on March 8, 1999 and incorporated herein  by reference.                       |
| (2) |   | Filed  as an exhibit to Amendment No. 2 to iParty’s Registration Statement on Form  10-SB, Registration No. 0-25507, as filed with the SEC on October 19, 1999  and incorporated herein by reference. |
| (3) |   | Filed  as an exhibit to Amendment No. 1 to iParty’s Registration Statement on Form  10-SB, Registration No. 0-25507, as filed with the SEC on July 12, 1999 and  incorporated herein by reference.    |

 

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| (4)  |   | Filed  as an exhibit to iParty’s Annual Report on Form 10-KSB for the year ended  December 31, 1999, as filed with the SEC on April 14, 2000 and incorporated  herein by reference.             |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (5)  |   | Filed  as an exhibit to iParty’s Registration Statement on Form SB-2, Registration  No. 333-40568, as filed with the SEC on June 30, 2000 and incorporated herein  by reference.                |
| (6)  |   | Filed  as an exhibit to iParty’s Current Report on Form 8-K, filed with the SEC on  August 30, 2000 and incorporated herein by reference.                                                       |
| (7)  |   | Filed  as an exhibit to iParty’s Current Report on Form 8-K, filed with the SEC on  September 15, 2000 and incorporated herein by reference.                                                    |
| (8)  |   | Filed  as an exhibit to iParty’s Current Report on Form 8-K, filed with the SEC on  November 16, 2001 and incorporated herein by reference.                                                     |
| (9)  |   | Included  as an exhibit (Exhibit C) to Exhibit 99.2 to iParty’s Current Report on Form  8-K, filed with the SEC on November 16, 2001 and incorporated herein by  reference.                     |
| (10) |   | Filed  as an exhibit to iParty’s Quarterly Report on Form 10-QSB for the quarterly  period ended June 29, 2002, as filed with the SEC on August 13, 2002 and  incorporated herein by reference. |
| (11) |   | Filed  as an exhibit to iParty’s Annual Report on Form 10-KSB for the year ended  December 28, 2002, filed with the SEC on March 28, 2003 and incorporated  herein by reference.                |
| (12) |   | Filed  as an exhibit to iParty’s Quarterly Report on Form 10-Q, filed with the SEC  on August 12, 2003 and incorporated herein by reference.                                                    |
| (13) |   | Filed  as an exhibit to iParty’s Current Report on Form 8-K, filed with the SEC on  January 29, 2004 and incorporated herein by reference.                                                      |
| (14) |   | Filed  as an exhibit to iParty’s Quarterly Report on Form 10-Q, filed with the SEC  on August 10, 2004 and incorporated herein by reference.                                                    |
| (15) |   | Filed  as an exhibit to iParty’s Annual Report on Form 10-K, filed with the SEC on  March 25, 2005 and incorporated herein by reference.                                                        |

 

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