**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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# ** **

# **FORM 10-K**

#  

**FORANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

**ý****ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For The Fiscal Year Ended December 25, 2004**

 

**OR**

 

**TRANSITION REPORT UNDER SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the Transition Period from               to               **

 

**Commission File Number 0-25507**

 

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** **

**iPARTY CORP.**

(Exact Name of Registrant as Specified in ItsCharter)

 
| **DELAWARE**                                                    | ** ** | **76-0547750**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |       | (IRS Employer  Identification No.) |
|                                                            |       |                               |
| **270 BRIDGE STREET, SUITE 301  DEDHAM, MASSACHUSETTS**         |       | **02026**                          |
| (Address of Principal Executive Offices)                        |       | (Zip Code)                         |
|                                                            |       |                               |
| **(781) 329-3952**                                              |
| (Registrant’s Telephone Number, Including  Area Code)      |

 

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Securities Registered pursuant to Section12(b) of the Act:

 
| **Title of  Each Class**          | ** ** | **Name of  Each Exchange on Which Registered** |
|-----------------------------------|------------|------------------------------------------------|
| **COMMON STOCK, $.001 PAR VALUE** | ** ** | **AMERICAN STOCK EXCHANGE**                    |

 

Securities Registered pursuant to Section12(g) of the Act:  **None**

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o 

 

Indicate by check markif disclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained 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. ý 

 

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

 

On June 26, 2004, the aggregate market value of the voting commonequity of the registrant (consisting of common stock, $.001 par value (the “commonstock”)) held by nonaffiliates of the registrant was approximately $14,091,685based on the closing price for such common stock on said date as reported bythe American Stock Exchange.  On March21, 2005 there were 22,115,239 shares of common stock, $.001 par value, issuedand outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of the proxy statement for the annual stockholders’ meeting tobe held June 8, 2005 are incorporated by reference into Part III.

 

 

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**PART I**

 

**ITEM1.  BUSINESS**

** **

**General**

** **

Webelieve we are a leading brand in the party industry in the markets we serveand a leading resource in those markets for consumers seeking party goods,party planning advice and relevant information. We are a party goods retailer operating stores throughout New England,where 41 of our 45 retail stores are located. We also license the name iParty.com (at www.iparty.com) to a third partyin exchange for royalties, which to date have not been significant.  We generated $64.3 million in total revenuesand $1.0 million of net income in fiscal 2004.

 

Our 45 retail stores are located predominantly in New England with 23stores in Massachusetts, 7 in Connecticut, 5 in New Hampshire, 3 in RhodeIsland, 2 in Maine and 1 in Vermont.  Wealso operate 4 stores in Florida.  Ourstores range in size from approximately 8,000 square feet to 20,300 square feetand average approximately 9,800 square feet in size.  We lease our properties, typically for 10years and usually with options from our landlords to renew our leases for anadditional 5 or 10 years.

 

Our stores feature over 20,000 products ranging from greeting cards andballoons to more unique merchandise such as piñatas, tiny toys, masquerade andHawaiian Luau items.  Our sales aredriven by the following events: Halloween, Christmas, Easter, Valentine’s Day, New Year’s, IndependenceDay, St. Patrick’s Day, Thanksgiving and Chanukah.  We also focus our business closely onlifetime events such as anniversaries, graduations, birthdays, and bridal orbaby showers.

 

Our business has a seasonal pattern. In the past two years we have realized approximately 37% of our annualrevenues in our fourth quarter, which includes Halloween and Christmas, andapproximately 24% of our revenues in the second quarter, which includes schoolgraduations.  Also, during these past twoyears, we have had net income in our second and fourth quarters and generatedlosses in our first and third quarters.

 

Our executive offices are located at 270 Bridge Street, Suite 301,Dedham, Massachusetts, 02026.  Our phonenumber is (781) 329-3952.  Our licensedwebsite is located at www.iparty.com. The information on our licensed website is not a part of this AnnualReport.

 

Where a reference is made in this Annual Report to a particular year oryears, it is a reference to our 52-week fiscal year, unless the contextindicates otherwise.  For example, “2004”refers to our 52-week fiscal year ended December 25, 2004, “2003” refers to our52-week fiscal year ended December 27, 2003 and “2002” refers to our 52-weekfiscal year ended December 28, 2002.

 

**Organization**

 

Whilewe are presently a party goods retail chain operating 45 stores, when we werefirst incorporated as iParty Corp. (“iParty”) on March 12, 1998 we were anInternet-based merchant of party goods and services.  On July 2, 1998, iParty Corp. merged into WSIAcquisitions, Corp. and began trading on the OTC Bulletin Board under tickersymbol “IPTY”.  On January 2, 2000,iParty Corp. was listed on the American Stock Exchange under ticker symbol “IPT”.

 

On August 3, 2000, iParty Retail Stores Corp. (“iParty Retail”) wasincorporated as a wholly-owned subsidiary of iParty Corp. to operate a chain ofretail stores selling party goods.  OnAugust 15, 2000, iParty Retail acquired inventory, fixed assets and the leasesof 33 retail stores from The Big Party Corporation (“The Big Party”), aprivately-held company which was operating under bankruptcy protection, inexchange for cash and the assumption of certain liabilities.  This acquisition was approved on August 16,2000 by the United States Bankruptcy Court for the District of Delaware.  We subsequently opened an additional 11stores through December 25, 2004 and one store since the end of fiscal 2004.

 

OnJuly 8, 2003, we signed an agreement with Taymark, Inc. (“Taymark”) to license the iParty.com name toTaymark.  In return, Taymark pays us a15% royalty on all net sales realized through its operation ofwww.iparty.com.  The term of this agreementis for a period of two (2) years, unless sooner terminated.  If this

 

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agreement is not terminated,it is automatically renewed for successive one-year periods.  Previously, we operated the website with Taymarkunder a fulfillment agreement.

 

**CapitalStructure**

** **

Our capital structure currently consists of common stock and fiveseries of convertible preferred stock. We have also issued warrants and we have a stock option plan.

 

Our common stock has a par value of $0.001 per share.  We have 150,000,000 shares of common stockauthorized, 22,092,717 of which were issued and outstanding as of December 25,2004.  These shares are listed on theAmerican Stock Exchange and trade under the symbol “IPT”.

 

We currently have five different series of convertible preferred stock,Series B-F.  On January 13, 2004 all1,000,000 shares of our Series A convertible preferred stock were convertedinto 1,000,000 shares of common stock. Each share of Series B convertible preferred stock is presentlyconvertible into 12.870 shares of common stock. Each share of Series C convertible preferred stock is presentlyconvertible into 13.106 shares of common stock. Each share of Series D convertible preferred stock is presentlyconvertible into 14.055 shares of common stock. Each share of Series E convertible preferred stock is presentlyconvertible into 10.359 shares of common stock. Each share of Series F convertible preferred stock is presentlyconvertible into 10.367 shares of common stock. We had a total of 1,268,413 shares of convertible preferred stockoutstanding as of December 25, 2004, which were convertible into 15,613,426shares of common stock at that date.  Ourconvertible preferred stock is presented on our balance sheet at its carryingvalue, which was $14,308,002 at December 25, 2004.

 

We also have a stockholder rights plan (the “rights plan”).  The rights plan associates rights to ourcapital stock, such that each share of our common stock is entitled to oneright and each share of our preferred stock is entitled to such number ofrights equal to the number of common shares into which it is convertible.  The rights will become exercisable only inthe event that, with certain exceptions, an acquiring party accumulates 10 percentor more of our voting stock or if a party announces an offer to acquire 15percent or more of our voting stock. When exercisable, each right entitles the holder to purchase from us oneone-hundredth of a share of a new series of Series G junior preferred stock atan initial purchase price of $2.00, subject to adjustment.  In addition, upon the occurrence of certainevents, holders of the rights will be entitled to purchase either iParty Corp.stock or shares in an “acquiring entity” at half of market value.

 

The holders of our convertible preferred stock have a liquidationpreference senior to the holders of our common stock.  In the event of liquidation, our convertiblepreferred stockholders would be entitled to a liquidation value, which was $18,761,700at December 25, 2004.  This amount is inexcess of the carrying value of the preferred stock due to amounts allocated towarrants, which were issued in connection with certain issuances of ourconvertible preferred stock.  Thedifference of approximately $4.5 million is being accreted when and if aliquidation event occurs.  The holders ofour Series B-F convertible preferred stock are also entitled to anti-dilutionprotection in the event we issue common stock, or certain rights, includingoption activity in excess of certain amounts, to purchase or convert intocommon stock, at a price below their conversion prices.

 

The Series B-F preferred stockholders are entitled to participate individends when and if declared by our Board of Directors.

 

We have also issued warrants in connection with the issuance of certainconvertible preferred stock and certain licensing and marketingarrangements.  At December 25, 2004 wehad 8,431,651 warrants outstanding, which were exercisable for 13,011,215shares of our common stock. Substantially all of the warrants contain anti-dilution provisions.  Their conversion prices would be adjusted inthe event we issue common stock, or certain rights, including option activityin excess of certain amounts, to purchase or convert into common stock, at aprice below their exercise prices.  Thereare 7,903,441 warrants scheduled to expire in August 2005, representing 94% ofthe total warrants outstanding at December 25, 2004.

 

Under our stock option plan we are authorized to grant options topurchase up to 11,000,000 shares of our common stock.  At December 25, 2004, we had optionsoutstanding that were exercisable for the purchase of 10,031,817 shares ofcommon stock.

 

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The following chart summarizes our capital structure at December 25,2004.

 
| ** **                           | ** ** | **Number of  Shares/  Warrants/  Options  Outstanding** | ** ** | **Conversion/  Exercise  Ratios** | ** ** | **Total  Common  Shares  Issued and  Issuable (****1)** | ** ** | **Weighted  Average  Exercise  Price per  Common  Share  Issuable** | ** ** | **Liquidation  Value** | ** ** |
|--------------------------------------|------------|---------------------------------------------------------|------------|-----------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------------------|------------|------------------------|------------|
| Common stock                         |       | 22,092,717                                              |       |                              |       | 22,092,717                                              |       |                                                                |       | $                      | —     |   |
|                                 |       |                                                    |       |                              |       |                                                    |       |                                                                |       |                   |       |
| Series B convertible preferred stock |       | 507,460                                                 |       | 12.870                            |       | 6,531,105                                               |       |                                                                |       | 10,149,200             |       |
| Series C convertible preferred stock |       | 100,000                                                 |       | 13.106                            |       | 1,310,600                                               |       |                                                                |       | 2,000,000              |       |
| Series D convertible preferred stock |       | 250,000                                                 |       | 14.055                            |       | 3,513,750                                               |       |                                                                |       | 5,000,000              |       |
| Series E convertible preferred stock |       | 296,667                                                 |       | 10.359                            |       | 3,073,168                                               |       |                                                                |       | 1,112,500              |       |
| Series F convertible preferred stock |       | 114,286                                                 |       | 10.367                            |       | 1,184,803                                               |       |                                                                |       | 500,000                |       |
| Total convertible preferred stock    |       | 1,268,413                                               |       |                              |       | 15,613,426                                              |       |                                                                |       | 18,761,700             |       |
|                                 |       |                                                    |       |                              |       |                                                    |       |                                                                |       |                   |       |
| Warrants                             |       | 528,210                                                 |       | 1.000                             |       | 528,210                                                 |       | $                                                                   | 3.79       |                   | —     |   |
| Warrants                             |       | 5,223,512                                               |       | 1.600                             |       | 8,357,619                                               |       | 1.25                                                                |       | —                 |       |
| Warrants                             |       | 500,000                                                 |       | 1.600                             |       | 800,000                                                 |       | 1.25                                                                |       | —                 |       |
| Warrants                             |       | 929,929                                                 |       | 1.600                             |       | 1,487,886                                               |       | 1.25                                                                |       | —                 |       |
| Warrants                             |       | 1,250,000                                               |       | 1.470                             |       | 1,837,500                                               |       | 1.36                                                                |       | —                 |       |
| Total warrants                       |       | 8,431,651                                               |       |                              |       | 13,011,215                                              |       |                                                                |       | —                 |       |
|                                 |       |                                                    |       |                              |       |                                                    |       |                                                                |       |                   |       |
| Stock options                        |       | 10,031,817                                              |       | 1.000                             |       | 10,031,817                                              |       | $                                                                   | 0.96       |                   | —     |   |
|                                 |       |                                                    |       |                              |       |                                                    |       |                                                                |       |                   |       |
| Total                                |       |                                                    |       |                              |       | 60,749,175                                              |       |                                                                |       | $                      | 18,761,700 |   |

 

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(1)  Includes common stockoutstanding and common stock issuable upon conversion of convertible preferredstock and exercise of outstanding warrants and stock options.

 

**Competition**

** **

The party supplies retailingbusiness is highly competitive.  Wecompete with a variety of smaller and larger retailers, including singleowner-operated party supplies stores, specialty party supplies retailers,discount department stores, general mass merchants and supermarkets, as well ascatalog and Internet merchants.

 

Barriersto entry are minimal.  New competitorscan open new stores and/or launch new Internet sites at a relatively lowcost.  However, we believe that the coststo remain competitive in the party supplies retailing business can besignificant.  These costs include thehiring of human resources with industry knowledge and the marketing costsassociated with building a widely recognized brand.

 

**Certain Risks Associated with the Party Supplies Industry and OurBusiness**

 

Party supplies businesses are often affected by general economicdevelopments affecting consumer confidence or spending patterns, especially theconditions in existence during the Halloween season, which is usually the mostimportant season for the party supplies industry, the availability of retailstore space on reasonable lease terms, the cost and availability of labor,availability of products and the type, number and location of competingretailers.  In addition, factors such asincreased cost of goods, increased cost of raw materials, such as petroleumbased products, which are important components of our vendors’ costs, increasedcost of gasoline, which affects freight costs, unseasonable weather and thepotential scarcity of experienced management and hourly employees may alsoadversely affect the party supplies industry in general and our results ofoperations and

 

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financial condition in particular. We are subject to all of these risks, particularly as they relate to theNew England region, since 41 of our stores are located in this area.  For a more complete list of the risk factorsaffecting our business, please see the Cautionary Statements and Risk Factorstext within Item 7., Management’s Discussion and Analysis of FinancialCondition and Results of Operations, within this Annual Report.

 

**IntellectualProperty**

** **

We hold trademarks for “iParty”and “iParty.com” issued by the U.S. Patent and Trademark Office.  Trademark registrations for “iParty” wereissued on February 19, 2002 and August 26, 2003 under U.S. registration No.2,541,025 and No. 2,756,735.  Thetrademark registration for “iParty.com” was issued on November 12, 2002 underU.S. registration No. 2,649,801.

 

**Employees**

** **

As of March 1, 2005 wehad 249 full-time employees and 598 part-time employees.  None of these employees are represented by alabor union, and we consider our relationship with our employees to be good.

 

**AvailableInformation**

** **

Our licensed Internet website address is www.iparty.com.  Our Annual Reports on Form 10-K, QuarterlyReports on Form 10-Q, Current Reports on Form 8-K and amendments to thosereports filed or furnished pursuant to Section 13(a) or 15(d) of the SecuritiesExchange Act of 1934 are available through our licensed Internet website assoon as reasonably practicable after we electronically file such material with,or furnish it to, the SEC.  Our licensedInternet website and the information contained therein or connected thereto arenot intended to be incorporated into this Annual Report on Form 10-K.

 

The public may read and copy any materials that we file with the SEC atthe SEC’s website, www.sec.gov, which contains reports, proxy and informationstatements and other information that public companies are required to filewith the SEC.  In addition, the publicmay read and copy any materials we file with the SEC at the SEC’s PublicReference Room at 450 Fifth Street, N.W., Washington, D.C., 20549.  The public may obtain information about theSEC’s Public Reference Room by calling 1-800-SEC-0330.

 

**ITEM2.  PROPERTIES**

** **

The following table identifies the number of ourstores operating as of December 25, 2004, December 27, 2003 and December 28,2002, by state.

 
| ** **    | ** ** | **Number of Stores, for the fiscal year ended** | ** ** |
|---------------|------------|-------------------------------------------------|------------|
| ** **    | ** ** | **Dec 25, 2004**                                | ** ** | **Dec 27, 2003** | ** ** | **Dec 28, 2002** | ** ** |
| **States**    | ** ** | **End of  Period**                              | ** ** | **Closings** | ** ** | **Openings** | ** ** | **End of  Period** | ** ** | **Closings** | ** ** | **Openings** | ** ** | **End of  Period** | ** ** | **Closings** | ** ** | **Openings** | ** ** |
| Connecticut   |       | 6                                               |       | — |   | — |   | 6 |   | — |   | 1 |   | 5 |   | — |   | — |   |
| Florida       |       | 4                                               |       | — |   | 1 |   | 3 |   | — |   | — |   | 3 |   | — |   | — |   |
| Maine         |       | 2                                               |       | — |   | 1 |   | 1 |   | — |   | — |   | 1 |   | — |   | — |   |
| Massachusetts |       | 23                                              |       | — |   | 2 |   | 21 |   | — |   | 2 |   | 19 |   | — |   | 1 |   |
| New Hampshire |       | 5                                               |       | — |   | 1 |   | 4 |   | — |   | — |   | 4 |   | — |   | 1 |   |
| Rhode Island  |       | 3                                               |       | — |   | — |   | 3 |   | — |   | — |   | 3 |   | — |   | — |   |
| Vermont       |       | 1                                               |       | — |   | 1 |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Total         |       | 44                                              |       | — |   | 6 |   | 38 |   | — |   | 3 |   | 35 |   | — |   | 2 |   |

 

Since the end of 2004 we have opened one additional store, bringing ourstore count up to 45.  Our stores rangein size from approximately 8,000 square feet to approximately 20,300 squarefeet and average approximately 9,800 square feet.  We lease all of our retail stores.  The leases generally provide for fixedminimum rentals, which typically increase periodically during the life of thelease, and, in some instances, contingent rentals based on a

 

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percentage of sales in excess of specified minimum sales levels, aswell as related occupancy costs, such as property taxes and common areamaintenance.  We lease our properties,typically for 10 years and usually with options from our landlords to renew ourleases for an additional 5 or 10 years.

 

In addition to our 45 stores, we lease office space at 270 BridgeStreet, Suite 301, Dedham, Massachusetts, 02026.  The lease, which expires November 30, 2011,is for 10,600 square feet of space and the monthly rent is $17,500.  We also lease office and retail space at 1457VFW Parkway, West Roxbury, Massachusetts, 02132.  This lease, which expires December 31, 2012,is for 20,000 square feet of space.  Theretail store at our West Roxbury location uses 10,688 square feet and theremainder is used primarily for our corporate training center.  The total monthly rent for the retail storeand corporate office space is $17,100, subject to certain Consumer Price Indexescalation clauses.  We believe thatthese spaces are adequate for our immediate needs.  However, we are currently evaluating whetherwe need to add approximately 3,000 square feet of office space within the next12 months to support the growth of our business.

 

We believe that all properties are adequately covered by insurance.

 

**ITEM3.  LEGAL PROCEEDINGS**

** **

We are not a party to anymaterial pending legal proceedings other than ordinary routine mattersincidental to our business.

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

** **

No matters were submitted to a vote of our security holders during thefourth quarter of fiscal 2004.

 

**PART II**

** **

**ITEM5.  MARKET FOR REGISTRANT’S COMMONEQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

** **

The American Stock Exchange is the principal market for our commonstock, where our shares are traded under the symbol “IPT”.  Our common stock began trading on theAmerican Stock Exchange under the name iParty Corp., symbol “IPT”, on January2, 2000.  Our common stock was quotedpreviously on the OTC Electronic Bulletin Board under the name iParty Corp.,symbol “IPTY”, commencing July 1998. Prior to that time, from February 1998 until July 1998, our common stockwas quoted on the OTC Bulletin Board under the name of WSI Acquisitions, Inc.,symbol “WSIA”.

 

The followingtable sets forth the range of high and low sales prices on the American StockExchange for our common stock for each of the fiscal quarters of 2004 and 2003:

 

**MARKET PRICE OF COMMON STOCK**

 

| **Period**     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2004**       |       |     |       |    |       |
| Fourth quarter |       | $        | 0.89       |    | $          | 0.65 |   |
| Third quarter  |       | 0.97     |       | 0.58    |       |
| Second quarter |       | 1.32     |       | 0.81    |       |
| First quarter  |       | 1.63     |       | 0.78    |       |
| **2003**       |       |     |       |    |       |
| Fourth quarter |       | $        | 1.34       |    | $          | 0.53 |   |
| Third quarter  |       | 0.74     |       | 0.23    |       |
| Second quarter |       | 0.32     |       | 0.20    |       |
| First quarter  |       | 0.26     |       | 0.13    |       |

 

The approximate number of record holders of our common stock as ofMarch 21, 2005 was 117.  The number ofrecord owners was determined from our stockholder records, and does not includebeneficial owners of our

 

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common stock whose shares are held in the names of various securityholders, dealers and clearing agencies. We believe that the number of beneficial owners of our common stock heldby others as or in nominee names exceeds 500 in number.

 

We have never paid acash dividend on our shares of common stock and have no expectation of doing sofor the foreseeable future.  Our existingline of credit agreement with Wells Fargo Retail Finance II, LLC generallyprohibits the payment of any dividends or other distributions to any of ourclasses of capital stock.

 

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**ITEM 6.  SELECTED FINANCIAL DATA**

 
| ** **                                                    | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** | **2000**    | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|-------------|------------|
| **Statement of Operations Data:**                             |       |       |       |       |       |       |       |       |       |        |       |
| Revenues                                                      |       | $          | 64,276,225 |       | $          | 56,697,246 |       | $          | 52,177,923 |        | $          | 47,983,404 |   | $ | 18,619,877 |   |
| Operating costs:                                              |       |       |       |       |       |       |       |       |       |        |       |
| Cost of products sold                                         |       | 35,826,820 |       | 31,758,625 |       | 30,420,475 |       | 28,966,573 |       | 11,734,011  |       |
| Marketing and sales                                           |       | 21,176,925 |       | 18,363,193 |       | 16,527,832 |       | 15,345,744 |       | 18,456,073  |       |
| General and administrative                                    |       | 6,335,067  |       | 5,516,273  |       | 5,245,867  |       | 5,522,688  |       | 3,502,169   |       |
| Amortization of fulfillment partner warrant                   |       | —     |       | —     |       | —     |       | —     |       | 4,532,930   |       |
| Restructuring expenses                                        |       | —     |       | —     |       | —     |       | —     |       | 1,093,328   |       |
| Loss resulting from abandonment of assets                     |       | —     |       | —     |       | —     |       | —     |       | 5,784       |       |
| Special charge                                                |       | —     |       | —     |       | 396,465    |       | —     |       | —      |       |
| Stock option compensation expense                             |       | —     |       | —     |       | —     |       | 320,373    |       | 812,510     |       |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Operating income (loss)                                       |       | 937,413    |       | 1,059,155  |       | (412,716   | )          | (2,171,974 | )          | (21,516,928 | )          |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Other income                                                  |       | 382,500    |       | —     |       | —     |       | —     |       | —      |       |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Income (loss) before interest and taxes                       |       | 1,319,913  |       | 1,059,155  |       | (412,716   | )          | (2,171,974 | )          | (21,516,928 | )          |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Interest income                                               |       | 1,354      |       | 1,262      |       | 9,045      |       | 117,431    |       | 733,163     |       |
| Interest expense                                              |       | (225,074   | )          | (212,227   | )          | (280,898   | )          | (381,763   | )          | (149,346    | )          |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Income (loss) before taxes                                    |       | 1,096,193  |       | 848,190    |       | (684,569   | )          | (2,436,306 | )          | (20,933,111 | )          |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Income taxes                                                  |       | 105,000    |       | 97,233     |       | —     |       | —     |       | —      |       |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Net income (loss)                                             |       | $          | 991,193    |       | $          | 750,957    |       | $          | (684,569   | )           | $          | (2,436,306 | ) | $ | (20,933,111 | ) |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Net income (loss) available to common  stockholders           |       | $          | 991,193    |       | $          | 750,957    |       | $          | (774,719   | )           | $          | (2,436,306 | ) | $ | (23,182,465 | ) |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Income (loss) per share:                                      |       |       |       |       |       |       |       |       |       |        |       |
| Basic                                                         |       | $          | 0.03       |       | $          | 0.02       |       | $          | (0.04      | )           | $          | (0.18 | ) | $ | (1.85 | ) |
| Diluted                                                       |       | $          | 0.02       |       | $          | 0.02       |       | $          | (0.04      | )           | $          | (0.18 | ) | $ | (1.85 | ) |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Net income (loss) per share available to  common stockholders |       |       |       |       |       |       |       |       |       |        |       |
| Basic                                                         |       | $          | 0.03       |       | $          | 0.02       |       | $          | (0.05      | )           | $          | (0.18 | ) | $ | (2.05 | ) |
| Diluted                                                       |       | $          | 0.02       |       | $          | 0.02       |       | $          | (0.05      | )           | $          | (0.18 | ) | $ | (2.05 | ) |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| Weighted-average shares outstanding:                          |       |       |       |       |       |       |       |       |       |        |       |
| Basic                                                         |       | 37,649,400 |       | 36,683,142 |       | 16,219,436 |       | 13,411,866 |       | 11,321,578  |       |
| Diluted                                                       |       | 41,517,036 |       | 38,868,484 |       | 16,219,436 |       | 13,411,866 |       | 11,321,578  |       |
|                                                          |       |       |       |       |       |       |       |       |       |        |       |
| **Other Data:**                                               |       |       |       |       |       |       |       |       |       |        |       |
| Net cash provided by (used in) operating  activities          |       | $          | 129,690    |       | $          | 1,368,798  |       | $          | 581,930    |        | $          | (2,616,844 | ) | $ | (14,159,135 | ) |
| Net cash used in investing activities                         |       | (2,121,134 | )          | (1,166,258 | )          | (775,147   | )          | (210,738   | )          | (4,086,471  | )          |
| Net cash provided by (used in) financing  activities          |       | 1,306,130  |       | (86,412    | )          | 120,476    |       | 224,412    |       | 4,574,556   |       |
| Capital expenditures (1)                                      |       | 2,121,134  |       | 1,166,258  |       | 775,147    |       | 210,738    |       | 202,059     |       |

 
| ** **                                                       | ** ** | **Dec 25, 2004** | ** ** | **Dec 27, 2003** | ** ** | **Dec 28, 2002** | ** ** | **Dec 29, 2001** | ** ** | **Dec 30, 2000** | ** ** |
|------------------------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| **Balance Sheet Data:**                                          |       |             |       |             |       |             |       |             |       |             |       |
| Working capital                                                  |       | $                | 3,236,148  |             | $          | 4,178,436        |       | $                | 4,021,692  |             | $          | 4,841,696 |   | $ | 6,455,832 |   |
| Total assets                                                     |       | 19,479,937       |       | 15,151,980       |       | 13,815,883       |       | 14,533,218       |       | 16,343,053       |       |
| Total long-term liabilities and convertible  preferred stock (2) |       | 1,268,452        |       | 406,469          |       | 19,266,414       |       | 20,929,419       |       | 23,458,131       |       |
|                                                                  |            |                  |            |                  |            |                  |            |                  |            |                  |            |  |  |  |  |  |

 

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(1)  Capital expenditures exclude assets acquiredunder capital leases.

 

(2)  The holders of ourSeries A-F convertible preferred stock have the right to a liquidationpreference, which was not considered under our control in 2002, 2001 and2000.  Therefore their carrying valueshave been excluded from stockholders’ equity for these periods.  Their carrying values are included instockholders’ equity in 2004 and 2003 as redemption is deemed to be solelywithin our control.

 

7

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**ITEM7.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

*The following discussion should be read inconjunction with our Consolidated Financial Statements and the related Notesincluded below.*

 

**Overview**

** **

At the end of 2004 we operated 44 retail stores, including 40 in NewEngland and 4 in Florida, and for the year we had net income of approximately$1.0 million, our second consecutive year of being profitable.  We opened six new stores in 2004, twice asmany as we had opened in 2003.  In 2004we also achieved a 4.6% increase in comparable stores sales, defined as salesfrom those stores open for at least one full year.  This marks our third consecutive year ofsolid comparable store sales growth.

 

The year began positively, with a 10.6% increase in comparable storesales in our first quarter.  The NewEngland Patriots run to the Super Bowl in January 2004 elevated interest in thegame within the New England region beyond normal levels and we took advantageof this opportunity by supplementing our regular inventory of party supplieswith special New England Patriots and Super Bowl merchandise, all of which soldwell.  The year also ended on a positivenote, with a 5.1% increase in comparable store sales in the fourth quarter,when most of our Halloween season business occurs.  We were pleased by these results because thisyear’s Halloween season followed a positive Halloween season in 2003, which ledto a 12.6% increase in comparable store sales in the fourth quarter of thatyear.  Halloween is our most important seasonand our organization met or exceeded our management’s expectations in order toachieve these positive results.

 

In November 2003, we relocated our headquarters from West Roxbury,Massachusetts to larger office space in Dedham, Massachusetts and in January2004 we completed the renovation of our previous headquarters into a newcorporate training facility.  During 2003and early 2004 we enhanced our corporate governance by expanding our Board ofDirectors with the addition of four new independent directors.  Also in January 2004, we concludednegotiations extending the maturity date of our bank line-of-credit agreementuntil January 2007 and added the option to increase the line in increments of$2,500,000 beyond the present limit of $7,500,000, to a limit of $12,500,000,upon 15 days written notice, as long as we are in compliance of debt covenantsand the provisions of the loan agreement. Our inventory and accounts receivable secure our line of credit.

 

In early 2004 we began the development of a new point-of-salesystem.  The new system was rolled out toour stores in the June-July timeframe and the system was in operation for ourHalloween season.  The new system isdesigned to allow us to achieve greater operating efficiencies and improvecustomer service.  We believe that itallowed us to handle the peak sales volumes we experienced during the Halloweenseason better than the system it replaced.

 

We believe that all of these accomplishments have positioned us forcontinued success.  Our goals in 2005include opening as many as seven new stores during the year, including the onenew store that we opened since the end of fiscal 2004.

 

**Cautionary Statements and Risk Factors**

 

Certain statements in this Annual Report, and particularly thismanagement discussion and analysis, constitute “forward-looking statements”within the meaning of Section 27A of the Securities Act of 1933, as amended,and Section 21E of the Securities Exchange Act of 1934, as amended.  The words “anticipate”, “believe”, “estimate”,“expect”, “plan”, “intend” and other similar expressions are intended toidentify these forward-looking statements, but are not the exclusive means ofidentifying them.  Forward-lookingstatements included in this Annual Report or hereafter included in other publiclyavailable documents filed with the Securities and Exchange Commission (“SEC”),reports to our stockholders and other publicly available statements issued orreleased by us involve known and unknown risks, uncertainties, and otherfactors which could cause our actual results, performance (financial oroperating) or achievements to differ from the future results, performance(financial or operating) or achievements expressed or implied by such forwardlooking statements.  Such future resultsare based upon our best estimates based upon current conditions and the mostrecent results of operations.

 

8

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Various risks, uncertainties and contingencies could cause our actualresults, performance or achievements to differ materially from those expressedin, or implied by, the forward-looking statements contained in this AnnualReport.  These include, but are notlimited to, the following:

 

•                  the success orfailure of our efforts to implement our business strategy

•                  our inability toobtain additional financing, if required

•                  third-partysuppliers’ failure to fulfill their obligations to us

•                  unseasonableweather

•                  intensecompetition

•                  the availabilityof retail store space on reasonable lease terms

•                  the failure ofany of our systems, including, without limitation, our newly-installedpoint-of-sale system and our merchandise management system, the latter of whichwas developed by a vendor who is no longer in business

•                  any problemsaffecting our third-party suppliers and

•                  general economicand other developments affecting consumer confidence or spending patterns,particularly in the New England region and particularly during the Halloweenseason, which is our single most important season.

 

**Fiscal2004 Compared to Fiscal 2003**

** **

*Revenues*

 

Our consolidated revenues for 2004 were $64,276,225, an increase of$7,578,979, or 13.4% from the prior year. Revenues include the selling price of party goods sold, net of returnsand discounts, and are recognized at the point of sale.  This increase was due to an increase of 4.6%in comparable stores sales, sales from six new stores that opened in 2004 andsales from three new stores that opened in 2003 which were not included incomparable stores sales in 2004 until they had been open for one fullyear.  The increase in comparable storessales was largely attributable to a stronger Halloween season compared to theprior year.

 

*Cost of products sold*

 

In 2004 our consolidated cost of products sold was 55.7% of revenues, adecrease of 0.3 percentage points from the prior year.  Cost of products sold consists of the cost ofmerchandise sold to customers and the occupancy costs for our stores.  This decrease was primarily attributable tothe elimination of costs of products sold for our Internet business, which waslicensed to a third party in 2003 in exchange for royalties under a licenseagreement.

 

*Marketing and sales expense*

 

Our consolidated marketing and sales expense for 2004 was $21,176,925or 32.9% of revenues, an increase of $2,813,732, or 0.5 percentage points, as apercentage of revenues, from the prior year. Marketing and sales expense consists primarily of all store payroll andrelated expenses for personnel engaged in marketing and selling activities, aswell as advertising, public relations and promotional expenditures.

 

This increase, as a percentage of revenues, was due to store payrolland other expenses related to marketing and sales in our new stores, which runat a higher than normal rate until they reach maturity.  Our experience has been that it usually takesabout eighteen months after opening for a store to reach maturity.

 

*General and administrative expense*

 

Our consolidated general and administrative (“G&A”) expense for2004 was $6,335,067 or 9.9% of revenue, an increase of $818,794, or 0.1percentage points, as a percentage of revenues, from the prior year.  G&A expense consists of payroll andrelated expenses for executive, merchandising, finance and administrative personnel,as well as information technology, professional fees and other generalcorporate expenses.

 

9

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The increase in G&A costs was attributable to rate increases inpayroll-related costs, such as unemployment insurance, health insurance andworkers’ compensation insurance, and start-up costs associated withimplementing our new point-of-sale system.

 

*Other income*

 

In 2004 we reached a settlement with a thirdparty in connection with the special charge previously recorded in fiscal year2002.  We recorded the net settlement of$382,500 as other income.

 

*Interest expense*

 

Our interest expense was $225,074 in 2004, an increase of $12,847 fromthe prior year.  This increase was due tohigher average borrowings that were largely offset by lower interest rates.

 

*Income taxes*

 

In 2004 our provision for income taxes was $105,000, which included$20,000 for federal alternative minimum taxes and $85,000 for state incometaxes.  We were able to utilizeapproximately $923,000 of net operating loss carryforwards for federal incometax purposes in 2004, which were fully reserved for in the prior year due tothe uncertainty of future taxable income.

 

At the end of 2004 we had estimated net operating loss carryforwards ofapproximately $23.0 million, which begin to expire in 2018.  In accordance with Section 382 of theInternal Revenue Code, the use of these carryforwards may be subject to annuallimitations based upon certain ownership changes of our stock that may haveoccurred or that may occur.

 

**Fiscal2003 Compared to Fiscal 2002**

** **

*Revenues*

 

Our consolidated revenues for 2003 were $56,697,246, an increase of$4,519,323, or 8.7% from the prior year. Revenues include the selling price of party goods sold, net of returnsand discounts, and are recognized at the point of sale.  This increase was due to an increase of 4.8%in comparable stores sales, sales from three new stores that opened in 2003 andsales from two new stores that opened in 2002 which were not included incomparable stores sales in 2003 until they had been open for one fullyear.  The increase in comparable storessales was largely attributable to a stronger Halloween season compared to theprior year.

 

*Cost of products sold*

 

In 2003 our consolidated cost of products sold was 56.0% of revenues, adecrease of 2.3 percentage points from the prior year.  Cost of products sold consists of the cost ofmerchandise sold to customers and the occupancy costs for our stores.  This decrease was primarily attributable toimproved vendor pricing and terms.

 

In 2003, we refined our methodology for accounting for vendor rebates,discounts and freight.  We also continuedto refine our methodology for estimating an appropriate allowance for obsoleteand excess inventory.  The net impact ofthese adjustments increased 2003 pre-tax income by $141,757, net income by$125,455 and had no impact on basic and diluted earnings per share.

 

*Marketing and sales expense*

 

Our consolidated marketing and sales expense for 2003 was $18,363,193or 32.4% of revenues, an increase of $1,835,361, or 0.7 percentage points, as apercentage of revenues, from the prior year. Marketing and sales expense consists primarily of advertising, publicrelations and promotional expenditures, as well as all store payroll andrelated expenses for personnel engaged in marketing and selling activities.

 

As a percentage of revenues, the increase in marketing and salesexpense was attributable to the addition of retail store management staff toprovide closer supervision of our retail stores, an upgrade to our stores’

 

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telecommunications network to improve reliability and establish thecapability to support future systems enhancements, and higher store pre-openingcosts as a result of opening three stores in 2003 compared to two stores in2002.

 

*General and administrative expense*

 

Our consolidated general and administrative (“G&A”) expense for2003 was $5,516,273 or 9.7% of revenue, an increase of $270,406 and decrease of0.3 percentage points, as a percentage of revenues, from the prior year.  G&A expense consists of payroll andrelated expenses for executive, merchandising, finance and administrativepersonnel, as well as information technology, professional fees and other generalcorporate expenses.

 

The increase in G&A costs was attributable to an increase inprofessional fees associated with information technology, including consultingfees associated with enhancing systems, and increased labor costs for positionsadded to support growth.

 

*Interest expense*

 

Our interest expense was $212,227 in 2003, a decrease of $68,671 fromthe prior year.  This decrease was due tothe expiration of capital leases in 2002.

 

*Income taxes*

 

In 2003 our provision for income taxes was $97,233, which included$30,000 for federal alternative minimum taxes and $67,233 for state incometaxes.  When we filed our 2003 AnnualReport on Form 10-K we reported that we were able to utilize approximately$997,000 of net operating loss carryforwards for federal income tax purposes in2003, which were fully reserved for in the prior year due to the uncertainty offuture taxable income. This amount was based on preliminary projections of taxliability and it was revised to $792,000 upon subsequent completion of ourfinal tax returns for 2003.

 

When we filed our 2003 Annual Report on Form 10-K we reported that atthe end of 2003 we had estimated net operating loss carryforwards ofapproximately $23.7 million, which begin to expire in 2018.  This amount was based on preliminaryprojections of tax liability and it was revised to $23.9 million uponsubsequent completion of our final tax returns for 2003.  In accordance with Section 382 of theInternal Revenue Code, the use of these carryforwards may be subject to annuallimitations based upon certain ownership changes of our stock that may haveoccurred or that may occur.

 

**CriticalAccounting Policies**

** **

Our financial statements are based on the application of significantaccounting policies, many of which require management to make significantestimates and assumptions (see Note 2 to the consolidated financialstatements).  We believe the followingaccounting policies to be those most important to the portrayal of ourfinancial condition and those that require the most subjective judgment.  If actual results differ significantly frommanagement’s estimates and projections, there could be a material effect on ourfinancial statements.

 

*Inventory and Related Allowance for Obsolete andExcess Inventory*

 

Our inventory consists of party supplies and isvalued at the lower of moving weighted-average cost or market.  We record vendor rebates, discounts andcertain other adjustments to inventory, including freight costs, and werecognize these amounts in the income statement as the related goods are sold.

 

During each interim reporting period we estimatethe impact on cost of products sold associated with inventory shortage.  The actual inventory shortage is determinedupon reconciliation of the annual physical inventory, which occurs shortlyafter our year ends, and an adjustment to cost of products sold is recorded atthe end of the fourth quarter to recognize the difference between the estimatedand actual inventory shortage for the full year.  The adjustment in the fourth quarter of 2004included an estimated reduction of $149,316 to the cost of products sold duringthe previous three quarters.  Theadjustment in the fourth quarter of 2003 included an estimated reduction of$145,983 to the cost of products sold during the previous three quarters.

 

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We also make adjustments to reduce the value ofour inventory for an allowance for obsolete and excess inventory, which isbased on our review of inventories on hand compared to estimated futuresales.  We conduct reviews periodicallythroughout the year on each stock keeping unit (“SKU”).  As we identify obsolete and excess inventory,we take immediate measures to reduce our inventory risk on these items and weadjust our allowance accordingly.  Thus,actual results could differ from our estimates.

 

In 2003, we refined our methodology foraccounting for vendor rebates, discounts and freight and for estimating anappropriate allowance for obsolete and excess inventory.  The net impact of these adjustments increasedpre-tax income by $141,757, net income by $125,455 and had no impact on basicand diluted earnings per share.

 

*Revenue Recognition*

 

Revenues include the selling price of party goods sold, net of returnsand discounts, and are recognized at the point of sale.  We estimate returns based upon historicalreturn rates and such amounts have not been significant.

 

*Propertyand Equipment*

 

Property and equipment are stated at cost less accumulated depreciationand are depreciated on the straight-line method over the estimated useful livesof the assets.  At the beginning offiscal 2004 we adopted a new policy for estimating the useful life of fixedassets which extended 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.

 

*Impairment of Long-Lived Assets*

 

We adopted Statement of Financial Accounting Standards (“SFAS”) No.144, *Accounting for the Impairment or Disposal ofLong-Lived Assets* in 2002, which requires that long-lived assets bemeasured at the lower of carrying amount or fair value less cost to sell.  The adoption of SFAS No. 144 did not have amaterial impact on our consolidated results of operations in 2002.

 

We review each store for impairment indicators annually, consideringoperating results and cash flows.  We arenot aware of any impairment indicators for any of our stores at December 25,2004.

 

*Income Taxes*

 

Historically, we have not recognized an incometax benefit for our losses.  Accordinglywe record a valuation allowance against our deferred tax assets because of theuncertainty of future taxable income and the realizability of the deferred taxassets.  Should we determine that we willbe able to realize our deferred tax assets in the future, an adjustment to ourdeferred tax assets would increase income in the period we made such adetermination.  The value of our deferredtax assets was $9,675,000 at December 25, 2004, which has been fully reserved.

 

*Previous Restatement of Financial Information andBalance Sheet Presentation of Series A-F Convertible Preferred Stock*

 

Theholders of our various series of convertible preferred stock have the right toa liquidation preference, which previously could have been exercised undercertain events not within our control. In accordance with EITF Topic D-98, we have included the respectiveequity securities outside of permanent stockholders’ deficit in ouraccompanying table of selected financial data as of December 28, 2002, December29, 2001 and December 30, 2000 at their respective carrying values.

 

Duringthe fourth quarter of 2003, the composition of our Board of Directors changedsuch that holders of our convertible preferred stock or the designates of ourpreferred stockholders no longer constituted a majority of our Boardmembers.  This change in the compositionof our Board of Directors has permitted us to present our

 

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convertiblepreferred stock in equity in the accompanying balance sheets as of December 25,2004 and December 27, 2003, at their respective carrying values as theredemption is deemed to be solely within our control.

 

Wewill continue to review and consider the criteria in EITF Topic D-98 at thereporting of each balance sheet.

 

*StockOption Compensation Expense*

 

We account for our stock option compensation agreements with employeesunder the provisions of Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*.  We have adopted the disclosure-onlyprovisions of SFAS No. 123, *Accounting for Stock-BasedCompensation*, as amended by SFAS No. 148, *Accountingfor Stock-Based Compensation — Transition and Disclosure, an amendment ofFinancial Accounting Standards Board (“FASB”) Statement No. 123*.

 

*Use of Estimates*

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires us to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period.  Our actualresults could differ from our estimates.

 

**New Accounting Pronouncements**

 

In January 2003, the FASB issued InterpretationNo. 46, *Consolidation of Variable InterestEntities, an Interpretation 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.  We adopted FIN 46, as required, with nomaterial impact to our consolidated financial position or results ofoperations.

 

On December 16, 2004, the FASB issued SFAS No. 123(revised 2004), *Share-Based Payment*,which is a revision of SFAS No. 123, *Accountingfor Stock-Based Compensation*. SFAS 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.

 

We must adopt SFAS 123(R) no later than July 1,2005.  Early adoption will be permittedin periods in which financial statements have not yet been issued.  We expect to adopt SFAS 123(R) on July 1,2005.

 

SFAS 123(R) permits public companies to adopt itsrequirements using one of two methods:

 

•                  A “modified prospective” method in whichcompensation cost is recognized beginning with the effective date (a) based onthe requirements of SFAS 123(R) for all share-based payments granted after theeffective date and (b) based on the requirements of SFAS 123 for all awardsgranted to employees prior to the effective date of SFAS 123(R) that remainunvested on the effective date.

 

•                  A “modified retrospective” method which includesthe requirements of the modified prospective method described above, but alsopermits entities to restate based on the amounts previously recognized underSFAS 123 for purposes of pro forma disclosures either (a) all prior periodspresented or (b) prior interim periods of the year of adoption.

 

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We have not yet determined which method we willuse.

 

As permitted by SFAS 123, we currently account forshare-based payments to employees using Opinion 25’s intrinsic value methodand, as such, generally recognize no compensation cost for employee stockoptions.  Accordingly, the adoption ofSFAS 123(R)’s fair value method will have a significant impact on our resultsof operations, although it will have no impact on our overall financialposition.  The impact of adoption of SFAS123(R) cannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. However, had we 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 in Note 2 to theconsolidated financial statements.

 

In February 2005, theChief Accountant of the SEC issued a letter clarifying his staff’sinterpretation of certain accounting issues and their application undergenerally accepted accounting principles (“GAAP”) relating to operatingleases.  In summary, their interpretationis that (1) leasehold improvements should be amortized by the lessee over theshorter of their economic lives or the lease term, which could include lease renewalterms when the renewals are “reasonably assured,” (2) free or reduced rentsshould be recognized by the lessee on a straight-line basis over the lease term(including any free or reduced rent period) and (3) the statement of cash flowsshould reflect cash received from the lessor that is accounted for as a leaseincentive within operating activities and the acquisition of leaseholdimprovements for cash within investing activities.  These positions are based upon existingaccounting literature.  We believe that ourpresent accounting policies are consistent with the positions described by theChief Accountant and his staff in this letter. Our policy is to amortize leasehold improvements for 10 years or thelife of the lease, whichever period is shorter. Our policy is to amortize free or reduced rent on a straight-line basisover the lease term (including any free or reduced rent periods).  We generally do not enter into agreementsthat involve receiving cash from lessors/landlords.

 

**Liquidityand Capital Resources**

** **

Ouroperating activities provided $129,690 in net cash in 2004 compared to$1,368,798 in 2003, a decrease of $1,239,108, which was due to our growth ininventory, partially offset by an increase in net income.  The increase in net cash used in inventorywas primarily for the six new stores we opened in 2004.

 

In2004, we financed $309,000 of premiums related to property and casualtyinsurance at a fixed interest rate of 4.25% with a maturity date of May2005.  During the period we also financed$129,200 of premiums related to directors and officers insurance at a fixedinterest rate of 5.62% with a maturity date of January 2005.  The remaining insurance premium payments andannual insurance expenses are recorded in accrued expenses and prepaidexpenses.

 

Weinvested cash in property and equipment, including new store capitalexpenditures, totaling $2,121,134 in 2004 and $1,166,258 in 2003.  The cash invested in 2004 includedapproximately $1,587,000 for fixed assets associated with new stores, $347,000for improvements to other stores and $187,000 for all other capitalexpenditures.  The increase in capitalexpenditures was largely due to the addition of six new stores in 2004 comparedto three new stores in 2003.

 

During2004 we also acquired assets under capital leases totaling $1,302,681 for a newpoint-of-sale system.  The capital leaseobligations outstanding at December 25, 2004 were $1,162,367.

 

Wegenerated $1,306,130 in net cash from financing activities in 2004 compared tousing $86,412 in net cash in financing activities in 2003.  We increased our borrowings under our line ofcredit by $1,497,019 in 2004 compared to an increase of $283,933 in 2003,largely to finance capital expenditures for new stores.

 

At December 25, 2004 we had a line of credit (“the line”) with Wells FargoRetail Finance II, LLC.  The line wasamended on January 2, 2004.  Theamendment extended the maturity date of our line to January 2, 2007, eliminatedthe minimum interest rate of 6.5%, established a new interest rate at the bank’sbase rate plus 50 basis points and added an 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 we are in compliance ofdebt covenants and the provisions of the loan agreement.  Our inventory and accounts receivable secureour line.

 

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The amended agreement includes a financial covenant requiring us tomaintain a minimum availability under the line in the amount of 5% of thecredit limit, which at the current limit of $7,500,000, is $375,000.  If we adjust the credit limit in the future,the minimum availability would be 5% of the adjusted credit limit.  The amended agreement also has a covenantthat requires us to limit our capital expenditures to within 110% of thoseamounts included in our business plan, which may be updated from time totime.  At December 25, 2004, we were incompliance with these financial covenants. The line generally prohibits the payment of any dividends or otherdistributions to any of our classes of capital stock.

 

The amount outstanding under our line was $5,257,690 as of December 25,2004 and $3,760,671 on December 27, 2003. The interest rate on these borrowings was 5.75% at December 25, 2004 and6.5% at December 27, 2003.  Theoutstanding balances under the line are classified as current liabilities inthe accompanying consolidated balance sheets since we are required to applydaily lock box receipts to reduce the amount outstanding.  At December 25, 2004, we had approximately $305,000of additional availability under the line. In the third quarter of fiscal 2004, we established a letter of creditfor $356,000 with Wells Fargo Bank, N.A. associated with the leasing of our newpoint-of-sale system.  This $356,000letter of credit was outstanding at December 25, 2004.

 

Our prospective cash flows are subject to certain trends, events anduncertainties, including demands for capital to support growth, economicconditions, and contractual matters.  Weexpect our capital expenditures for 2005 to be primarily related to new stores,store improvements and other technology advancements in support of growth andoperational enhancements.

 

Contractual obligations at December 25, 2004 were as follows:

 
| ** **                                        | ** ** | **Payments Due By Period** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|
| ** **                                        | ** ** | **Within  1 Year**         | ** ** | **Within  2 - 3  Years** | ** ** | **Within  4 - 5  Years** | ** ** | **After  5 Years** | ** ** | **Total** | ** ** |
| Line of credit                                    |       | $                          | 5,257,690  |   | $ | — |   | $ | — |   | $ | — |   | $ | 5,257,690 |   |
| Capital lease obligations                         |       | 365,674                    |       | 796,693 |   | — |   | — |   | 1,162,367 |   |
| Operating leases (including retail space  leases) |       | 7,223,873                  |       | 12,591,761 |   | 8,398,162 |   | 14,601,593 |   | 42,815,389 |   |
| Total contractual obligations                     |       | $                          | 12,847,237 |   | $ | 13,388,454 |   | $ | 8,398,162 |   | $ | 14,601,593 |   | $ | 49,235,446 |   |

 

In addition, at December 25, 2004, we had outstanding purchase orderstotaling approximately $216,000 for the acquisition of inventory that wasscheduled for delivery after December 25, 2004.

 

We believe, based on our current operating plan,that anticipated cash from operations and borrowings available under theexisting line of credit will be sufficient to fund our operations and workingcapital requirements for the next 12 months. Our current operating plan includes the opening of up to sevenadditional new stores in 2005, including the one new store that we opened sincethe end of fiscal 2004.

 

In the event that our operating plan changes orproves inaccurate due to decreased revenues, unanticipated expenses, increasedcompetition, unfavorable economic conditions, or other unforeseencircumstances, our liquidity may be negatively impacted.  Accordingly, we would be required to adjustour expenditures to conserve working capital or raise additional capital tofund operations.  There can be noassurance, however, that, should we require additional financing, suchfinancing will be available on terms and conditions acceptable to us.

 

**Acquisitions**

 

We operate in a largely un-branded business arena that has many smallplayers.  As a result, we may considergrowing our business through acquisitions of other entities.  Any determination to make an acquisition willbe based upon a variety of factors, including, without limitation, the purchaseprice and other financial terms of the transaction, the business prospects,geographical location and the extent to which any acquisition would enhance ourprospects.  We presently have no plans,agreements, understandings, or arrangements with respect to any acquisitions.

 

15

----

 

**StockholderRights Plan**

** **

On November 9, 2001, we announced that our Board of Directors adopted astockholder rights plan (the “rights plan”). Under the rights plan each share of our capital stock outstanding at theclose of business on November 9, 2001 and each share of our capital stockissued subsequent to that date has a right associated with it, such that eachshare of our common stock is entitled to one right and each share of ourpreferred stock is entitled to such number of rights equal to the number ofcommon shares into which it is convertible. The rights will become exercisable only in the event that, with certainexceptions, an acquiring party accumulates 10 percent or more of our votingstock or if a party announces an offer to acquire 15 percent or more of ourvoting stock.  The rights expire on November9, 2011.  When exercisable, each rightentitles the holder to purchase from us one one-hundredth of a share of a newseries of Series G junior preferred stock at an initial purchase price of$2.00, subject to adjustment.  Inaddition, upon the occurrence of certain events, holders of the rights will beentitled to purchase either iParty Corp. stock or shares in an “acquiringentity” at half of market value.  Wegenerally will be entitled to redeem the rights at $0.001 per right at any timeuntil the date on which a 10 percent position in our voting stock is acquiredby any person or group.  Until a right isexercised, the holder of a right will have no rights as a stockholder of iPartysolely by virtue of being a rights holder, including, without limitation, theright to vote or receive dividends.

 

**Effectsof Inflation**

** **

Wedo not view the effects of inflation to have a material effect upon ourbusiness.

 

**Off-Balance SheetArrangements**

 

Wedo not have any off-balance sheet arrangements that have or are reasonablylikely to have a current or future effect on our financial condition, changesin financial condition, revenues or expenses, results of operations, liquidity,capital expenditures or capital resources that is material to investors.

 

**ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Wedo not believe that we have any material market risk exposure owing to foreigncurrency risk, exchange rate risk, commodity price risk and other relevantmarket rate or price risks that require the quantitative and qualitativedisclosures set forth in Item 305 of Regulation S-K.  We have interest rate risk on our line ofcredit debt obligation to the extent that if interest rates were to rise ourrate of interest under our line of credit would also increase.  We do not believe that this interest raterisk is material and we have not entered into any hedging or similarcontractual arrangements with respect to such risk.  We do not enter into contracts for tradingpurposes.

 

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

 

Theresponse to this item is included in a separate section of this report. See “Indexto Consolidated Financial Statements” on page F–1.

 

**ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A.  CONTROLS AND PROCEDURES**

 

(a)  *Evaluationof Disclosure Controls and Procedures.*  Our management, with the participation of ourChief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluatedthe effectiveness of our disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of December25, 2004.  In designing and evaluatingour disclosure controls and procedures, our management recognized that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving their objectives, and our managementnecessarily applied its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.  Basedon this evaluation, our CEO and CFO concluded that, as of December 25, 2004,our disclosure controls and procedures were (1) designed to ensure thatmaterial information relating to us, including our consolidated subsidiaries,is made known to our CEO and

 

16

----

 

CFOby others within those entities, particularly during the period in which thisreport was being prepared and (2) effective, in that they provide reasonableassurance that information required to be disclosed by us in the reports thatwe file or submit under the Securities Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms.

 

(b)  *Attestation Report of theRegistered Public Accounting Firm.* We are not an accelerated filer, as such term is defined in Rule 12b-2under the Securities Exchange Act. Accordingly, the attestation report of our independent registered publicaccounting firm on our management's assessment of our internal control overfinancial reporting is not required to be included in this Annual Report onForm 10-K.

 

(c)  *Changes in Internal Controls.*  No change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the SecuritiesExchange Act) occurred during the fiscal quarter ended December 25, 2004 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

 

 

**ITEM 9B.  OTHER INFORMATION**

 

None.

 

**PART III**

** **

**ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT**

 

Informationrelating to our directors is incorporated herein by reference to the sectionsentitled “Proposal 1—Election of Directors” and “Section 16(a) BeneficialOwnership Reporting Compliance” of our Company’s definitive proxy statementwhich will be filed no later than 120 days after December 25, 2004.

 

We have adopted awritten code of business conduct and ethics that applies to all our directors,officers and employees.  We intend todisclose any amendments to, or waivers from, our code of business conduct andethics on the Investor Relations page of our website which is located at www.iparty.com*.*

 

**ITEM 11.  EXECUTIVE COMPENSATION**

 

Informationrequired by Item 11 is incorporated herein by reference to the Sectionsentitled “Proposal 1—Election of Directors—Director Compensation” and “ExecutiveCompensation” of our definitive proxy statement which will be filed no laterthan 120 days after December 25, 2004.

 

**ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Informationrelated to security ownership required by Item 12 is incorporated herein byreference to the Section entitled “Stock Ownership” of our definitive proxystatement which will be filed no later than 120 days after December 25, 2004.

 

Securitiesauthorized under equity compensation plans as of December 25, 2004, were asfollows:

 

**EQUITYCOMPENSATION PLAN INFORMATION**

 
| ** **                                                  | ** ** | **Column a**                                                                  | ** ** | **Column b**                                                 | ** ** | **Column c**                                                                                                                                         | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan Category**                                           | ** ** | **Number of Securities  to be Issued  upon Exercise of  Outstanding Options** | ** ** | **Weighted Average  Exercise Price of  Outstanding Options** | ** ** | **Number of Securities  Remaining Available  for Future Issuances  under Equity  Compensation Plans  (Excluding Securities  Reflected in Column a)** | ** ** |
| Equity compensation plans approved by  security holders     |       | 10,031,817                                                                    |       | $                                                            | 0.96       |                                                                                                                                                 | 595,013    |   |
| Equity compensation plans not approved by  security holders |       | —                                                                        |       | —                                                       |       | —                                                                                                                                               |       |
| Total                                                       |       | 10,031,817                                                                    |       | $                                                            | 0.96       |                                                                                                                                                 | 595,013    |   |

 

17

----

 

Under the iParty.Corp. Amended and Restated 1998 Incentive and Nonqualified Stock Option Plan weare authorized to grant options for the purchase of up to 11,000,000 shares ofour common stock.  As of December 25, 2004,373,170 shares had been issued pursuant to the exercise of previously issuedstock options.  As of December 25, 2004,there were options outstanding to purchase 10,031,817 shares of our commonstock.  Consequently, as of December 25,2004, options for the purchase of up to 595,013 common shares remain availablefor future grants.

 

**ITEM 13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

Informationrequired by Item 13 is incorporated herein by reference to the section entitled“Executive Compensation–Certain Relationships and Related Transactions” of ourdefinitive proxy statement which will be filed no later than 120 days afterDecember 25, 2004.

 

**ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

Informationrequired by Item 14 is incorporated herein by reference to the section entitled“Independent Public Accountants” of our definitive proxy statement which willbe filed no later than 120 days after December 25, 2004.

 

**PART IV**

 

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

 

(a)                      1. Financial statements:

 

For a listing of consolidated financialstatements which are included in this document, see page F–1.

 

2. Financial Statement Schedules:

 

All schedules for which provision is made in the applicable accountingregulation of the SEC are not required under the related instructions or areinapplicable and, therefore, have been omitted.

 

3. Exhibits:

 

The exhibits listed in the Exhibit Index immediately preceding theexhibits are filed as part of this Annual Report on Form 10-K and areincorporated herein by reference.

 

(b)                     Exhibits:

 

The exhibits listed in the Exhibit Index immediately preceding theexhibits are filed as part of this Annual Report on Form 10-K and areincorporated herein by reference.

 

(c)                      Financial Statement Schedules:

 

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

 

18

----

 

**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|                  | iPARTY CORP. |
|-----------------------|--------------|
|                  |         |   |
|                  | By:          |   | /s/ SAL PERISANO |   |
|                  |         |   | Sal Perisano |   |
|                  |         |   | *Chairman of the Board and* |   |
|                  |         |   | *Chief Executive Officer* |   |
|                  |         |
| Dated: March 25, 2005 |         |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
| **SIGNATURE**             | ** ** | **TITLE**                                  | ** ** | **DATE**       |
|---------------------------|------------|--------------------------------------------|------------|----------------|
|                      |       |                                       |       |           |
| /s/ SAL PERISANO          |       | Chairman of the Board and                  |       | March 25, 2005 |
| Sal Perisano              |       | Chief Executive Officer                    |       |           |
|                      |       | (Principal Executive Officer)              |       |           |
|                      |       |                                       |       |           |
| /s/ PATRICK FARRELL       |       | President and Chief Financial Officer      |       | March 25, 2005 |
| Patrick Farrell           |       | (Principal Financial Officer and Principal |       |           |
|                      |       | Accounting Officer)                        |       |           |
|                      |       |                                       |       |           |
| /s/ DANIEL DE WOLF        |       | Director                                   |       | March 25, 2005 |
| Daniel De Wolf            |       |                                       |       |           |
|                      |       |                                       |       |           |
|                      |       |                                       |       |           |
| /s/ FRANK HAYDU           |       | Director                                   |       | March 25, 2005 |
| Frank Haydu               |       |                                       |       |           |
|                      |       |                                       |       |           |
|                      |       |                                       |       |           |
| /s/ LORENZO ROCCIA        |       | Director                                   |       | March 25, 2005 |
| Lorenzo Roccia            |       |                                       |       |           |
|                      |       |                                       |       |           |
|                      |       |                                       |       |           |
| /s/ ERIC SCHINDLER        |       | Director                                   |       | March 25, 2005 |
| Eric Schindler            |       |                                       |       |           |
|                      |       |                                       |       |           |
|                      |       |                                       |       |           |
| /s/ JOSEPH VASSALLUZZO    |       | Director                                   |       | March 25, 2005 |
| Joseph Vassalluzzo        |       |                                       |       |           |
|                      |       |                                       |       |           |
|                      |       |                                       |       |           |
| /s/ CHRISTINA WEAVER-VEST |       | Director                                   |       | March 25, 2005 |
| Christina Weaver-Vest     |       |                                       |       |           |

 

19

----

 

**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 accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

F-1

----

 

**Report of Independent Registered PublicAccounting Firm**

 

Board of Directors and Stockholders

iParty Corp.

 

We have audited the accompanying consolidated balance sheets of iPartyCorp. and subsidiaries as of December 25, 2004 and December 27, 2003, and therelated consolidated statements of operations, convertible preferred stock andstockholders’ equity (deficit), and cash flows for the years then ended.  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 auditing standards generally accepted in the UnitedStates.  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  We were not engaged to perform an audit ofthe Company’s internal control over financial reporting.  Our audit included consideration of internalcontrol over financial reporting as a basis of designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting.  Accordingly, we express nosuch opinion.  An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation.  We believe thatour audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the consolidated financial position of iPartyCorp. and subsidiaries at December 25, 2004 and December 27, 2003, and theconsolidated results of their operations and their cash flows for each of thethree years in the period ended December 25, 2004, in conformity with U.S.generally accepted accounting principles.

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

 

The accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

F-2

----

 

**iPARTYCORP.**

**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 |   |

 

The accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

F-3

----

 

**iPARTYCORP.**

**CONSOLIDATED STATEMENTS 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 accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

F-4

----

 

**IPARTYCORP.**

**CONSOLIDATED****STATEMENTS OF CONVERTIBLE PREFERRED STOCK ANDSTOCKHOLDERS’ EQUITY (DEFICIT)**

 
| ** **                                                                        | ** ** | ** **                       | ** ** | ** **                       | ** ** | **Stockholders’  Equity (Deficit)** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|------------------------------------------|------------|
| ** **                                                                        | ** ** | **Convertible  Preferred Stock** | ** ** | **Convertible  Preferred Stock** | ** ** | **Common  Stock**                        | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | **Total  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 accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

F-5

----

 

**iPARTYCORP.**

**CONSOLIDATED STATEMENTS 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 accompanying notes are an integral part of these ConsolidatedFinancial Statements.

 

F-6

----

 

**iPARTY CORP.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**December 25, 2004**

 

**1.  THECOMPANY**

 

*Background*

 

The Company’s efforts are devoted to the sale of party goods andservices through its retail stores.  Atthe end of fiscal 2004 the Company had 40 retail stores located throughout NewEngland, with four additional stores located in Florida.  In 2003, the Company licensed its Internetbusiness to a third party in exchange for royalties under a license agreement,which to date have not been significant. Previously, the Company operated the Internet business with the sameparty under a fulfillment agreement.

 

The stores feature over 20,000 products ranging from greeting cards andballoons to more unique merchandise such as piñatas, gag gifts, masquerade andHawaiian Luau items.  The Company’s salesare driven by the following events: Halloween, Christmas, Easter, Valentine’s Day, New Year’s, IndependenceDay, St. Patrick’s Day, Thanksgiving, and Chanukah.  The Company also focuses its business closelyon lifetime events such as anniversaries, graduations, birthdays, and bridal orbaby showers.  The Company’s business hasa seasonal pattern with higher revenues in the second and fourth quarters,reflecting school graduations and Halloween, respectively.

 

*Management’s Plans*

 

The Company believes, based on its current operating plan, thatanticipated revenues from operations and borrowings available under theexisting line of credit will be sufficient to fund its operations and workingcapital requirements through the next twelve months.  The Company’s current operating plan includesopening up to seven additional new stores in 2005, including the one new storethat the Company opened since the end of fiscal 2004.  In the event that the Company’s operatingplan changes or proves inaccurate due to decreased revenues, unanticipatedexpenses, increased competition, unfavorable economic conditions or otherunforeseen circumstances, the Company’s liquidity may be negativelyimpacted.  Accordingly, the Company wouldbe required to adjust its expenditures in 2005 to conserve working capital orraise additional capital to fund operations. There can be no assurance, however, that, should the Company requireadditional financing, such financing will be available on terms and conditionsacceptable to the Company.

 

**2.  SIGNIFICANT ACCOUNTING POLICIES:**

** **

*Principles of Consolidation*

 

The consolidated financial statements include the accounts of theCompany and its wholly-owned subsidiaries after elimination of all significantintercompany transactions and balances.

 

*RevenueRecognition*

 

Revenues include the selling price of party goods sold, net of returnsand discounts, and are recognized at the point of sale.  The Company estimates returns based uponhistorical return rates and such amounts have not been significant.

 

*Concentrations*

 

TheCompany purchases its inventory from a diverse group of vendors and is notoverly dependent upon any single source for its merchandise, often using morethan one vendor for similar kinds of products.

 

Accountsreceivable primarily represent amounts due from credit card companies andvendors for inventory rebates. Management does not provide for doubtful accounts as such amounts havenot been significant to date; the Company does not require collateral.

 

F-7

----

 

*Use of Estimates*

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenue and expensesduring the reporting period.  Actualresults could differ from these estimates.

 

*Cash and Cash Equivalents, Outstanding Checksand Restricted Cash*

 

The Company considers all highly liquid investments with an originalmaturity date of three months or less to be cash equivalents.  Cash equivalents consist primarily of moneymarket accounts and are carried at cost plus accrued interest, whichapproximates 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.

 

Restricted cash represents money deposited inblocked accounts established for the benefit of and under the control of WellsFargo Retail Finance II, LLC, the Company’s lender under its line of credit,and constitutes collateral for amounts outstanding under the Company’s line ofcredit.

 

*FairValue of Financial Instruments*

 

Thecarrying values of cash and cash equivalents, accounts receivable and accountspayable approximate fair value because of the short-term nature of theseinstruments.  The fair value ofborrowings under its line of credit approximates carrying value because thedebt bears interest at a variable market rate.

 

*Inventories*

 

Inventories consist of party supplies and are valued at the lower ofmoving weighted-average cost or market. Inventory has been reduced by an allowance for obsolete and excessinventory, which is based on management’s review of inventories on handcompared to estimated future sales.  TheCompany records vendor rebates, discounts and certain other adjustments toinventory, including freight costs, and these amounts are recognized in theincome 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 are expensed upon first showing.  Advertising costs amounted to $3,174,446,$2,706,596, and $2,705,330 for the years ended December 25, 2004, December 27,2003 and December 28, 2002, respectively.

 

*DeferredRent*

 

Certain operating lease agreements contain scheduled rent increases,which are being amortized over the terms of the agreements using thestraight-line method, and are included in other liabilities in the accompanyingconsolidated balance sheet.  Deferred rentwas $471,759 at December 25, 2004 and $406,209 at December 27, 2003.

 

F-8

----

 

*NetIncome (Loss) per Share*

 

Net income per basic share is computed by dividing net income by theweighted-average number of common shares outstanding plus the common shareequivalents of Series B-F preferred stock. The common share equivalents of Series B-F are included in thecalculation of net income per basic share in accordance with EITF Topic D-95, *Effect of Participating Convertible Securities on the Computation of BasicEarnings Per Share*, since the preferred stockholders are entitled toparticipate in dividends when and if declared by the Board of Directors.  For the periods with net losses, the Companyexcludes those common share equivalents since their impact would beanti-dilutive.

 

Net income per diluted share is computed by dividing net income by theweighted average number of common shares outstanding, plus the common shareequivalents of Series A-F preferred stock, plus the common share equivalents ofthe “in the money” stock options and warrants as computed by the treasurymethod.  For the periods with net losses,the Company excludes those common share equivalents since their impact would beanti-dilutive.

 

The following table sets forth the computation of net income (loss) perbasic and diluted share available to 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 share equivalents of “out of the money” stock options andwarrants which were excluded from the computation of net income per dilutedshare available to common stockholders were 3,309,630 and 13,011,215 in 2004,respectively, and 2,157,980 and 13,563,212 in 2003, respectively.

 

*StockOption Compensation Expense*

 

The Company accounts for its stock option compensation agreements withemployees under the provisions of Accounting Principles Board (“APB”) OpinionNo. 25, *Accounting for 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 computed the value of options using the Black-Scholesoption pricing model prescribed by SFAS No. 123.  The weighted-average fair value of theoptions granted was $0.73 per share in 2004, $0.38 per share

 

F-9

----

 

during 2003 and $0.29 per share during 2002, using the Black-Scholesoption-pricing model with the following assumptions:  no dividend yield, volatility of 116% to 119%in 2004, 119% to 125% in 2003, and 125% in 2002, a risk-free interest rate of2.71% to 4.00% in 2004, 2.13% to 3.51% in 2003 and 4.86% to 5.95% in 2002, andan expected life of five years from date of the grant.  Had compensation cost for the Company’s stockoption plan been determined based upon the fair value at the grant date forawards under the plan consistent with the methodology prescribed under SFAS123, the Company’s net income (loss) and net income (loss) per share and netincome (loss) available to common stockholders and net income (loss) per shareavailable to common stockholders would have been the following pro forma 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 equipment are stated at cost less accumulated depreciationand are depreciated on the straight-line method over the estimated useful livesof the assets.  At the beginning offiscal 2004 the Company adopted a new policy for estimating the useful life offixed assets which extended the useful life of equipment and furniture andfixtures.  Changing the estimated life ofthe assets in these categories as of the beginning of the year reduceddepreciation expense by approximately $130,885. Net income in 2004 would have been $0.02 per basic and diluted share ifthis change in estimating the useful life of fixed assets had not beenadopted.  Expenditures for maintenanceand repairs are charged to operations as incurred.  A listing of the estimated useful life of thevarious categories of property and equipment is as follows:

 

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

 

F-10

----

 

*Accounting for the Impairment of Long-LivedAssets*

 

The Company adopted SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*,**infiscal 2002, which requires that long-lived assets be measured at the lower ofcarrying amount or fair value less cost to sell.  The adoption of SFAS No. 144 did not have amaterial impact on the Company’s consolidated results of operations.

 

*NewAccounting Pronouncements*

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities*,*an Interpretation of Accounting Research Bulletin (“ARB”)No. 51* (“FIN 46”)*.* FIN 46 requires certain variable interest entities to be consolidated bythe primary beneficiary of the entity if the equity investors in the entity donot have the characteristics of a controlling financial interest or do not havesufficient equity at risk for the entity to finance its activities withoutadditional subordinated financial support from other parties.  FIN 46 is effective for all new variableinterest entities created or acquired after January 31, 2003.  For variable interest entities created oracquired prior to February 1, 2003, the provisions of FIN 46 must be appliedfor the first interim or annual period beginning after June 15, 2003.  However, in October 2003, the FASB deferredthe effective date of FIN 46 to the end of the first interim or annual periodending after December 15, 2003 for those arrangements involving special purposeentities 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 ofoperations.

 

On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment*, which is a revision of SFAS No. 123, *Accounting for Stock-Based Compensation*. Statement 123(R)supersedes APB Opinion No. 25, *Accounting for StockIssued to Employees*, and amends SFAS No. 95, *Statement ofCash Flows*.  Generally, theapproach in SFAS 123(R) is similar to the approach described in SFAS 123.  However, SFAS 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the income statement based on their fair values.  Pro forma disclosure is no longer analternative.

 

SFAS 123(R) must be adopted by the Company no later than July 1, 2005.Early adoption will be permitted in periods in which financial statements havenot yet been issued.  The Company expectsto adopt SFAS 123(R) on July 1, 2005.

 

SFAS 123(R) permits public companies to adopt its requirements usingone of two methods:

 

•                  A “modifiedprospective” method in which compensation cost is recognized beginning with theeffective date (a) based on the requirements of SFAS 123(R) for all share-basedpayments granted after the effective date and (b) based on the requirements ofSFAS 123 for all awards granted to employees prior to the effective date ofSFAS 123(R) that remain unvested on the effective date.

 

•                  A “modifiedretrospective” 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 yet determined which method it will use.

 

As permitted by SFAS 123, the Company currently accounts forshare-based payments to employees using Opinion 25’s intrinsic value methodand, as such, generally recognizes no compensation cost for employee stockoptions.  Accordingly, the adoption ofSFAS 123(R)’s fair value method will have a significant impact on the Company’sresults of operations, although it will have no impact on its overall financialposition.  The impact of adoption of SFAS123(R) cannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. However, had the Company adopted SFAS 123(R) in prior periods, the impactof that standard would have approximated the impact of SFAS 123 as described inthe disclosure 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 equipment consist 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 atDecember 25, 2004 and December 27, 2003 was $132,631 and $286,847,respectively.  The amortization relatedto those assets under 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 rental expense under operating leases amounted to$6,431,752 in 2004, $5,323,409 in 2003 and $4,746,886 in 2002.  Included in these amounts are contingentrentals totaling $45,039 in 2004, $37,948 in 2003 and $24,941 in 2002.

 

**5.  ACCRUED EXPENSES:**

** **

There was no accruedexpense which exceeded 5% of current liabilities on the balance sheet atDecember 25, 2004.  The only accruedexpense which exceeded 5% of current liabilities on the balance sheet at December27, 2003 was accrued payroll 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 recorded a valuation allowance against its deferred taxassets because of the uncertainty regarding the realizability of these assetsagainst future taxable income.

 

The Company used approximately $923,000 and $792,000 of net operatingloss carryforwards in 2004 and 2003, respectively.

 

As of December 25, 2004, the Company has estimated net operating losscarryforwards of approximately $23.0 million, which begin to expire in2018.  In accordance with Section 382 ofthe Internal Revenue Code, the use of some of these carryforwards will besubject to annual limitations based upon ownership changes of the Company’s stockwhich may have occurred or that may occur.

 

The Company made cash payments for state income taxes of $157,752 in2004, $77,279 in 2003 and $16,500 in 2002. The Company made cash payments for federal income taxes of $35,000 in2004, $0 in 2003 and $0 in 2002.

 

F-13

----

 

**7.  CONTRACTUALARRANGEMENTS:**

 

*License Arrangement*

 

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 purchased from The Big Party, Debtor andDebtor-in-Possession (the “sellers”) in 2000 inventory, fixed assets and theleases of 33 retail stores in consideration of cash and assumption of certainliabilities.  In addition, the Companyagreed to pay the sellers, no later than March 31, 2004, an amount equivalentto the greater of $250,000, or a percentage of the aggregate operating resultsof the 33 acquired locations.  Inconnection with the Company’s purchase accounting in 2000, the Company accruedthe guaranteed amount of $250,000, which based on actual results is the minimumand final amount due as of December 27, 2003, and paid this amount during thefirst quarter of 2004.

 

**8.  RELATED PARTY TRANSACTIONS:**

** **

On August 26, 1999 the Company granted Mr. Sal Perisano, its ChiefExecutive Officer, options to purchase an aggregate of 434,730 shares of theCompany’s common stock pursuant to the Company’s stock option plan with anexercise price of $2.00, which was below the then-current market price of$3.38.  As of December 29, 2001 all suchoptions had vested.  These options werefully expensed as of December 29, 2001. The Company charged $273,971 related to this stock option grant to stockoption compensation expense in 2001, the final year of vesting.

 

On September 7, 1999, the Company and Mr. Stuart Moldaw, who served asa Director of the Company from 1999 to 2003, entered into a consultingagreement that had a term of three years. Upon the expiration of this agreement, the Company and Mr. Moldawentered into an oral agreement that Mr. Moldaw would continue to provideconsulting services to the Company.  OnNovember 6, 2003 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 2003.  Thefair value of the options granted to Mr. Moldaw on November 6, 2003 was$25,000.  On January 31, 2005 theCompensation Committee of the Company’s Board of Directors approved a stockoption grant to Mr. Moldaw, vesting immediately, with the strike price set atthe closing price of the Company’s common stock on that day, to purchase 50,000shares of common stock, for consulting services performed by Mr. Moldaw in 2004.  The fair value of the options granted onJanuary 31, 2005 was $28,500.  Thecommittee approved this grant, but noted that Mr. Moldaw would not receive anyadditional stock option grants for consulting services in the future.

 

**9.  LINE OF CREDIT:**

** **

On January 2, 2004 the Company amended its existing line of credit (“theline”) with Wells Fargo Retail Finance II, LLC. The amendment extended the maturity date of the line to January 2, 2007,eliminated the minimum interest rate of 6.5%, established a new interest rateat the bank’s base rate plus 50 basis points and added the option to increasethe line in increments of $2,500,000 beyond the previous limit of $7,500,000,to a limit of $12,500,000, upon 15 days written notice, as long as the Companyis in compliance of all debt covenants and the provisions of the loanagreement.  Inventory and accountsreceivable secure the Company’s line.

 

F-14

----

 

The amended agreement includes a financial covenant requiring the Companyto maintain a minimum availability under the line of 5% of the credit limit,which at the current limit of $7,500,000, is $375,000.  If the Company adjusts the credit limit inthe future, the minimum availability would be 5% of the adjusted credit limit.  The amended agreement also has a covenantthat requires the Company to limit its capital expenditures to within 110% ofthose amounts included in its business plan, which may be updated from time totime. At December 25, 2004, the Company was in compliance with these financialcovenants.  The line generally prohibitsthe payment of any dividends or other distributions to any of the Company’sclasses of capital stock.

 

At December 27, 2003 the line had a maturity date of July 31, 2004 anda minimum interest rate of 6.5%.  Theline allowed for borrowings equal to the lesser of $7,500,000 or the borrowingbase, as defined.  Inventory and otherassets secured the line.  The Company wasrequired to maintain a minimum availability under the line in the amount of$300,000.

 

The amounts outstanding under the line as of December 25, 2004 andDecember 27, 2003 were $5,257,690 and $3,760,671, respectively.  The interest rate on these borrowings was5.75% at December 25, 2004 and 6.5% at December 27, 2003.  The outstanding balances under the line areclassified as current liabilities in the accompanying consolidated balancesheets since the Company is required to apply daily lock box receipts to reducethe amount outstanding.  At December 25,2004, the Company had approximately $305,000 of additional availability underthe line.  In the third quarter of fiscal2004, the Company established a letter of credit for $356,000 with Wells FargoBank, N.A. associated with the leasing of its new point-of-sale system.  This $356,000 letter of credit wasoutstanding at December 25, 2004.

 

The Company made cash payments for interest of $218,765 in 2004,$217,268 in 2003, and $285,515 in 2002.

 

**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

----

 

*Series A Convertible Preferred Stock*

 

On January 13, 2004, all shares of Series A convertible preferred stockwere converted into 1,000,000 shares of common stock on a 1.00 to 1.00ratio.  Holders of Series A convertiblepreferred stock had a liquidation preference senior to the Company’s commonstockholders, 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.

 

*Series B Convertible Preferred Stock*

 

The shares of Series B convertible preferred stock are immediatelyconvertible into 6,531,105 shares of common stock on a 1.000 to 12.870 ratio atDecember 25, 2004, and carry an aggregate liquidation value of $10,149,200($1.55 per common share 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’sCertificate of Incorporation as amended at a price below the conversionprice.  The Series B convertiblepreferred stock will automatically convert into common stock at the conversionprice then in effect in the event the Company consummates a secondary publicoffering resulting in gross proceeds to the Company of at least $10,000,000.

 

In the event of liquidation, the holders of Series B convertiblepreferred stock have preference to holders of the Company’s common stock, andare *pari passu* with the Company’s Series C,D, E and F convertible preferred stock.

 

Holders of Series B convertible preferred stock are entitled to 12votes per share (i.e., one vote for each whole number of shares of common stockinto which each such share is presently convertible) on all matters submittedto a vote of the Company’s stockholders and are entitled to participate individends when and if declared by the Board of Directors.

 

*Series C Convertible Preferred Stock*

 

The shares of Series C convertible preferredstock are immediately convertible into 1,310,600 shares of common stock on a1.000 to 13.106 ratio at December 25, 2004, and carry an aggregate liquidationvalue of $2,000,000 ($1.53 per common share issuable upon conversion) atDecember 25, 2004.  With certainexceptions, the conversion price will be adjusted on a weighted-average basisin 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 Cconvertible preferred stock will automatically convert into common stock at theconversion price then in effect in the event the Company consummates asecondary public offering resulting in gross proceeds to the Company of atleast $10,000,000.

 

In the event of liquidation, the holders of Series C convertiblepreferred stock have preference to holders of the Company’s common stock, andare *pari passu* with the Company’s Series B,D, E and F convertible preferred stock.

 

Holders of Series C convertible preferred stock are entitled to 13votes per share (i.e., one vote for each whole number of shares of common stockinto which each such share is presently convertible) on all matters submittedto a vote of the Company’s stockholders and are entitled to participate individends when and if declared by the Board of Directors.

 

*Series D Convertible Preferred Stock*

 

The shares of Series D convertible preferred stock are immediatelyconvertible into 3,513,750 shares of common stock on a 1.000 to 14.055 ratio atDecember 25, 2004, and carry an aggregate liquidation value of

 

F-16

----

 

$5,000,000 ($1.42 per common share issuable upon conversion) atDecember 25, 2004.  With certainexceptions, the conversion price will be adjusted on a weighted-average basisin 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 Dconvertible preferred stock will automatically convert into common stock at theconversion price then in effect in the event the Company consummates asecondary public offering resulting in gross proceeds to the Company of atleast $10,000,000.

 

In the event of liquidation, the holders of Series D convertiblepreferred stock have preference to holders of the Company’s common stock, andare *pari passu* with the Company’s Series B,C, E and F convertible preferred stock.

 

Holders of Series D convertible preferred stock are entitled to 14votes per share (i.e., one vote for each whole number of shares of common stockinto which each such share is presently convertible) on all matters submittedto a vote of the Company’s stockholders and are entitled to participate individends when and if declared by the Board of Directors.

 

*Series E Convertible Preferred Stock*

 

The shares of Series E convertible preferred stock are immediatelyconvertible into 3,073,168 shares of common stock on a 1.000 to 10.359 ratio atDecember 25, 2004, and carry an aggregate liquidation value of $1,112,500($0.36 per common share 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 issues commonstock 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 E convertible preferred stock willautomatically convert into common stock at the conversion price then in effectin the event the average closing bid price of the common stock equals orexceeds $10.00 per share for 20 days within any 30-day period.

 

In the event of liquidation, the holders of Series E convertible preferredstock have preference 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 E convertible preferred stock are entitled to 10votes per share (i.e., one vote for each whole number of shares of common stockinto which each such share is presently convertible) on all matters submittedto a vote of the Company’s stockholders and are entitled to participate individends when and if declared by the Board of Directors.

 

*Series F Convertible Preferred Stock*

 

Theshares of Series F convertible preferred stock are immediately convertible into1,184,803 shares of common stock on a 1.000 to 10.367 ratio at December 25,2004, and carry an aggregate liquidation value of $500,000 ($0.42 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 F convertible preferred stock willautomatically convert into common stock at the conversion price then in effectin the event the average closing bid price of the common stock equals orexceeds $10.00 per share for 20 days within any 30-day period.

 

In the event of liquidation, the holders of Series F convertiblepreferred stock have preference to holders of the Company’s common stock, andare pari passu with the Company’s Series B, C, D and E convertible preferredstock.

 

F-17

----

 

Holders of Series F preferred stock are entitled to 10 votes per share(i.e., one vote for each whole number of shares of common stock into which eachsuch share is presently convertible) on all matters submitted to a vote of theCompany’s stockholders and are entitled to participate in dividends when and ifdeclared by the Board of Directors.

 

*Accretion of Dividends in the Event ofLiquidation*

 

The carrying values of Series B-F convertible preferred stock have beendetermined based on their fair market values at the original dates ofissuance.  In certain cases, warrantswere issued, which the Company allocated value to and included in additionalpaid in capital.  Should such aliquidation event occur, the difference between the carrying value of theconvertible preferred stock and their 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 forshares of the Company’s common stock. These warrants were issued in connection with certain preferred stockfinancings and certain licensing and marketing arrangements.  Substantially all of the warrant agreementscontain certain anti-dilution provisions, which protect the warrant holdersagainst dilution upon the occurrence of certain events, including the sale of commonstock or certain rights, including option activity in excess of certainamounts, to purchase or convert into common stock, as defined in the warrantagreement for less than fair market value or less than the exercise price ofthe previously issued warrants.  If suchan event occurs, this can result in additional shares being available to thewarrant holder and a reduction in the exercise price for each share.

 

Thefollowing table summarizes the Company’s outstanding warrants, including theimpact of anti-dilution events which occurred in previous years, at December25, 2004:

 
| **Number of Warrants** | ** ** | **Total Common**

**Shares Issuable** | ** ** | **Exercise Price per Common**

**Share Issuable** | ** ** | **Expiration 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 the Company’s stock options isas follows:

 
| ** **                              | ** ** | **Number of Stock Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **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                     |       |                                   |       |            |       |   |   |

 

Thefollowing table summarizes information for options outstanding and exercisableat December 25, 2004:

 
| **Price Range** | ** ** | **Number of  Stock  Options** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Stock  Options** | ** ** | **Weighted  Average  Exercise  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 38,656,458 shares of common stock for issuancein connection with the conversion of convertible preferred stock and theexercise of warrants and stock options.

 

**13.  STOCKHOLDER RIGHTS PLAN:**

** **

The Company has a Stockholder Rights Plan (the “Plan”) effectiveNovember 9, 2001.  Under the Plan eachshare of the Company’s capital stock outstanding at the close of business onNovember 9, 2001 and each share of the Company’s capital stock issuedsubsequent to that date has a right associated with it, such that each share ofits

 

F-19

----

 

common stock is entitled to one right and each share of its preferredstock is entitled to such number of rights equal to the number of common sharesinto which it is convertible.

 

The rights are exercisable only in the event, with certain exceptions,an acquiring party accumulates 10 percent or more of the Company’s votingstock, or if a party announces an offer to acquire 15 percent or more of theCompany’s voting stock.  The rightsexpire on November 9, 2011.

 

When exercisable, each right entitles the holder to purchase from theCompany, one one-hundredth of a share of a new series of Series G juniorpreferred stock at an initial purchase price of $2.00.  In addition, upon the occurrence of certainevents, holders of the rights will be entitled to purchase either iParty Corp.stock or shares in an “acquiring entity” at half of market value.  The Company generally will be entitled toredeem the rights at $0.001 per right at any time until the date on which a 10percent position in its voting stock is acquired by any person or group.  Until a right is exercised, the holderthereof, as such, will have no rights as a stockholder of the Company,including, without limitation, the right to vote or receive dividends.

 

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

** **

TheiParty 401(k) Plan is a qualified profit sharing plan covering substantiallyall of its employees.  Contributions tothis plan are 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:**

** **

SFASNo. 131, *Disclosures about Segments of an Enterprise andRelated Information*, establishes standards for the way businessenterprises report information about operating segments in annual financialstatements and requires that those enterprises report selected informationabout operating segments in interim financial reports issued to stockholders.

 

Inthe past the Company had determined that its reportable segments consisted of aretail stores operation and an Internet operation.  As of 2003, with the transition of theInternet operation to a license arrangement and the insignificance of therevenues prior to the transition (less than 2%) and results of operations (lessthan 5%) to the overall business, the Company no longer reports Internetoperating 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 reviewed the anti-dilution provisions of certain ofits warrants to purchase common stock that were issued in conjunction with theAffected Preferred Stock (the “Affected Warrants”), and has determined that itmistakenly issued additional warrant certificates, instead of adjusting theAffected Warrants’ conversion ratios. The warrant calculations****alsomistakenly omitted the dilutive effect of a warrant issued by the Company inDecember 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

----

 

•                  Beginning inSeptember 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.

 

•                  Beginning inSeptember 2000, the Company believed and treated holders of Affected Warrantsas if they were entitled to 116,291 fewer common shares upon exercise of theirAffected 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

----

 

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

 

**QUARTERLYFINANCIAL 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       |       |

 

----

(1)  Cost of products soldconsists of the cost of merchandise sold to customers and the occupancy costsfor stores.

 

(2)  The fourth quarter of2004 included an estimated reduction of $149,316 to the cost of products soldduring the previous three quarters due to the completion of physicalinventories, for which shortage had been estimated during the year.

 

(3)  The fourth quarter of2003 included an estimated reduction of $145,983 to the cost of products soldduring the previous three quarters due to the completion of physicalinventories, for which shortage had been estimated during the year.

 

F-22

----

 

**EXHIBIT INDEX**

 
| **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                |   | **     |   |            |   | Subsidiaries of Registrant. |
| 23.1                |   | **     |   |            |   | 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. |

 

----

| **  |   | 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.    |

 

----

 
| (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.                                                    |

 

----