** **

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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# ** **

# **FORM 10-K**

 

| **x**                                                |       | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|
| ** **                                           | ** ** | ** **                                                                                           |
| **For The Fiscal Year Ended December 26, 2009** |
| ** **                                           | ** ** | ** **                                                                                           |
| **OR**                                               |
| ** **                                           | ** ** | ** **                                                                                           |
| **o**                                                |       | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**   |

 

**Forthe Transition Period from                              to                               **

 

**CommissionFile Number 1-15611**

 

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**iPARTYCORP.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **DELAWARE**                     | ** ** | **76-0547750**       |
|----------------------------------|------------|----------------------|
| (State or Other  Jurisdiction of |       | (IRS Employer        |
| Incorporation or  Organization)  |       | 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 Section 12(b) ofthe Act:

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

 

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

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o  No x

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes o  No x

 

Indicate by check markwhether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (229.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o  No o

 

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

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,a non-accelerated filer or smaller reporting company. See definition of “largeaccelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2of the Exchange Act (Check one).

 

| Large accelerated filer o                |   | Accelerated filer o         |
|-----------------------------------------------|--------|----------------------------------|
|                                          |   |                             |
| Non-accelerated filer o                  |   | Smaller reporting company x |
| (Do not check if a smaller reporting company) |   |                             |

 

Indicate by check mark whether the registrant is a shellcompany as defined in Rule 12b-2 of the Exchange Act. Yes o  No x

 

On June 27, 2009, the aggregate market value of thevoting common equity of the registrant (consisting of common stock, $.001 parvalue (the “common stock”) held by nonaffiliates of the registrant wasapproximately $2,475,565 based on the closing price for such common stock onsaid date as reported by the NYSE Amex . On March 17, 2010  there were 22,798,647 shares of common stock,$.001 par value, issued and outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of the proxy statement for the annual stockholders’meeting scheduled to be held June 2,2010, which we plan to file with theSEC no later than 120 days after the end of our fiscal year ended December 26,2009, are incorporated by reference into Part III.

 

 

 

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**PART I**

 

**ITEM 1.  BUSINESS**

** **

**General**

** **

We are aparty goods retailer operating stores throughout New England, where 46 of our51 retail stores are located, and in Florida. We believe we are a leading brand in the party industry in the marketswe serve and a leading resource in those markets for consumers seeking partygoods, party planning advice and relevant information.  We also license the name iParty.com (atwww.iparty.com) to a third party in exchange for royalties, which to date havenot been significant.  We generated $78.6million in total revenues and net income of $1.1 million in fiscal 2009.

 

As of December 26, 2009, we operated 26 stores inMassachusetts, 7 in Connecticut, 6 in New Hampshire, 3 in Rhode Island, 3 inMaine, 1 in Vermont and 5 stores in Florida. During the 2009 Halloween season, we operated four temporary Halloweenstores.  This was double the number oftemporary stores we operated in 2008.  InDecember 2009, we opened a new store in Boston, Massachusetts.    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 range in size from approximately 8,000square feet to 20,295 square feet and average approximately 10,175 square feetin size.

 

Our stores feature over 20,000 products ranging from paperparty goods, Halloween costumes, greeting cards and balloons to more uniquemerchandise such as piñatas, tiny toys, masquerade and Hawaiian Luauitems.  Our sales are primarily driven bythe following holiday and party 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 andbaby showers.

 

Our business has a seasonal pattern.  In the past three years, we have realized anaverage of approximately 34.3% of our annual revenues in the fourth quarter,which includes Halloween and Christmas, and an average of approximately 24.9%of our revenues in the second quarter, which includes school graduations, and often theEaster holiday. Also, during these past three years, we have had net income in thesecond and fourth quarters and generated losses in the first and thirdquarters.

 

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 contained on our licensed website does not constitute apart of this Annual Report, or any other report we file with or furnish to theSEC.

 

Where a reference is made in this Annual Report to aparticular year or years, it is a reference to our fiscal year, unless thecontext indicates otherwise.  Forexample, “2009” refers to our 52-week fiscal year ended December 26, 2009,“2008” refers to our 52-week fiscal year ended December 27, 2008, and “2007”refers to our 52-week fiscal year ended December 29, 2007.

 

**Organization**

 

While weare currently a party goods retail chain operating 51 stores, when we werefirst incorporated as iParty Corp. (“iParty”) on March 12, 1998, we werean Internet-based merchant of party goods and services.  On January 2, 2000, iParty Corp. waslisted on the American Stock Exchange,which is now known as the NYSE Amex, under the ticker symbol “IPT”.

 

In August 2000, iParty Retail Stores Corp. (“iPartyRetail”) was incorporated as a wholly-owned subsidiary of iParty Corp. tooperate a chain of retail stores selling party goods.  On August 15, 2000, iParty Retailacquired inventory, fixed assets and the leases of 33 retail stores from TheBig Party Corporation (“The Big Party”), a privately-held company, which wasoperating under bankruptcy protection, in exchange for cash and the assumptionof certain liabilities.   We havesubsequently opened an additional eighteen stores, acquired three stores, andclosed three stores.

 

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**Capital Structure**

** **

Our capital structure currently consists of common stockand five outstanding series of convertible preferred stock.  We have also issued warrants convertible intocommon stock and have stock option plans that offer a broad range of equitygrants to attract and retain executive officers and key employees.

 

Our common stock has a par value of $0.001 per share.  We have 150,000,000 shares of common stockauthorized, 22,798,647 of which were issued and outstanding as of December 26,2009.  These shares are listed on the NYSE Amex, formerly known as the AmericanStock Exchange, and trade underthe symbol “IPT”.

 

We currently have five outstanding series of convertiblepreferred stock, Series B through F (“convertible preferred stock”).  On January 13, 2004, all 1,000,000shares of our Series A convertible preferred stock were converted into1,000,000 shares of common stock.  As of December 26,2009, we had a total of 1,220,125 shares of convertible preferred stockoutstanding which were convertible into 15,426,498 shares of common stock onthat date based on the following conversion rates.  As of December 26, 2009, each share of Series Bconvertible preferred stock is presently convertible into 13.396 shares ofcommon stock; each share of Series C convertible preferred stock ispresently convertible into 13.652 shares of common stock; each share of Series Dconvertible preferred stock is presently convertible into 14.609 shares ofcommon stock; each share of Series E convertible preferred stock ispresently convertible into 10.359 shares of common stock; and each share of Series Fconvertible preferred stock is presently convertible into 10.367 shares ofcommon stock.  Our convertible preferredstock is presented on our balance sheet at its carrying value, which was$13,589,491 at December 26, 2009.

 

We also have a stockholder rights plan (the “rights plan”),which expires on November 8, 2011. The rights plan associates rights to our capital stock, 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 exercisableonly in the event that, with certain exceptions, an acquiring party accumulates10 percent or more of our voting stock or if a party announces an offer toacquire 15 percent 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 preferredstock at an initial purchase price of $2.00, subject to adjustment. Inaddition, upon the occurrence of certain events, holders of the rights would beentitled to purchase either iParty Corp. stock or shares in an “acquiringentity” as defined in the rights plan at half of market value.

 

The holders of our convertible preferred stock have aliquidation preference senior to the holders of our common stock. In the eventof liquidation, which is defined in our Restated Certificate of Incorporationto include a merger, acquisition, or a similar transaction involving theacquisition of our company, our convertible preferred stockholders would beentitled to a liquidation value, which was $17,795,957 at December 26,2009.  This amount is in excess of thecarrying value of the convertible preferred stock due to amounts allocated towarrants, which were issued in connection with the original issuances of ourconvertible preferred stock. The difference of approximately $4.2 million willbe accreted when and if a liquidation event occurs. The holders of ourconvertible preferred stock are also entitled to anti-dilution protection inthe event we issue common stock, or certain rights, including option grants in excess of certain amounts,to purchase or convert into common stock, at a price below the applicableconversion prices for the convertible preferred stock.

 

The convertible preferred stockholders are entitled toparticipate in dividends when and if declared by our Board of Directors.

 

We have also issued warrants in connection with the issuanceof certain convertible preferred stock, certain licensing, marketing andfinancing arrangements, and certain investor relations services.  At December 26, 2009, we had a warrantoutstanding with an exercise price of $0.475, which was exercisable for2,083,334 shares of our common stock, and warrants outstanding with a weightedaverage exercise price of $1.50, which were exercisable for 100,000 shares ofour common stock.

 

InMay of 2009, our stockholders approved our 2009 Stock Incentive Plan.   The 2009 Stock Incentive Plan replaces ourAmended and Restated 1998 Incentive and Non-Qualified Plan (the “1998 Plan”)and no new awards 

 

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willbe issued under the 1998 Plan.   Underour 2009 Stock Incentive Plan, we are authorized to grant options, stock appreciation rights, restricted stock, restricted stock units andother equity grants for the purchase of up to 1,322,894 shares of our commonstock plus any shares that expire, terminate or are cancelled without beingexercised under the 1998 Plan (which could increase the pool under the 2009Stock Incentive Plan by 9,241,845).  Atthe time our stockholders approved the 2009 Stock Incentive Plan, we did notseek to increase the number of original shares authorized under our 1998 Plan,which was 11,000,000 shares of our common stock.  At December 26, 2009, we had optionsoutstanding that were exercisable for the purchase of 8,347,879 shares ofcommon stock and optionsoutstanding that were not yet exercisable for the purchase of 1,686,882 sharesof our common stock. As of December 26,2009, we have issued only options under our 2009 Stock Incentive Plan.

 

The following chart summarizes ourcapital structure at December 26, 2009.

 
| ** **                                 | ** ** | **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                              |       | 22,798,647                                              |       |                              |       | 22,798,647                                           |       |                                                                |       | $                      | —     |   |
|                                       |       |                                                    |       |                              |       |                                                 |       |                                                                |       |                   |       |
| Series B  convertible preferred stock |       | 459,173                                                 |       | 13.396                            |       | 6,151,082                                            |       |                                                                |       | 9,183,460              |       |
| Series C  convertible preferred stock |       | 100,000                                                 |       | 13.652                            |       | 1,365,200                                            |       |                                                                |       | 2,000,000              |       |
| Series D  convertible preferred stock |       | 250,000                                                 |       | 14.609                            |       | 3,652,250                                            |       |                                                                |       | 5,000,000              |       |
| Series E  convertible preferred stock |       | 296,666                                                 |       | 10.359                            |       | 3,073,163                                            |       |                                                                |       | 1,112,497              |       |
| Series F  convertible preferred stock |       | 114,286                                                 |       | 10.367                            |       | 1,184,803                                            |       |                                                                |       | 500,000                |       |
| Total  convertible preferred stock         |       | 1,220,125                                               |       |                              |       | 15,426,498                                           |       |                                                                |       | 17,795,957             |       |
|                                       |       |                                                    |       |                              |       |                                                 |       |                                                                |       |                   |       |
| Warrant                                    |       | 2,083,334                                               |       | 1.000                             |       | 2,083,334                                            |       | $                                                                   | 0.48       |                   | —     |   |
| Warrants                                   |       | 100,000                                                 |       | 1.000                             |       | 100,000                                              |       | 1.50                                                                |       | —                 |       |
|                                       |       |                                                    |       |                              |       |                                                 |       |                                                                |       |                   |       |
| Stock  options                             |       | 10,034,761                                              |       | 1.000                             |       | 10,034,761                                           |       | $                                                                   | 0.45       |                   | —     |   |
|                                       |       |                                                    |       |                              |       |                                                 |       |                                                                |       |                   |       |
| Totals                                     |       |                                                    |       |                              |       | 50,443,240                                           |       |                                                                |       | $                      | 17,795,957 |   |

 

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(1) Includes common stock outstanding and common stock issuable upon conversion ofconvertible preferred stock and exercise of outstanding warrants and stockoptions.

 

**Competition**

 

The party supplies retailing business is highly competitiveand fragmented.  We compete with avariety of smaller and larger retailers, including single owner-operated partysupply stores, specialty party supplies retailers, discount department stores,retail drug store chains, general mass merchants and supermarkets, as well ascatalog, Internet merchants and temporary seasonal stores, especially Halloweenstores.

 

Our success depends inpart on our ability to be competitive against many different competitorsin each local market area we serve.  Ifwe fail to anticipate evolving innovations and product offerings from ourcompetitors and fail to offer products that appeal to the changing needs andpreferences of our customers in the various markets we serve, demand for ourproducts could decline and our operating results would be adversely affected.While the competitive importance of product quality, price, service andinnovation varies from product to product, price is a factor, and we experiencepricing pressures from competitors in our markets.

 

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Barriers toentry are minimal.  New competitors canopen new stores and launch new Internet sites at a relatively low cost.However, we believe that the costs to remain competitive over the longer termin the party supplies retailing business can be significant. These costsinclude the hiring of human resources with industry knowledge and the marketingcosts associated with building a widely recognized brand.

 

**Seasonality**

 

Ourbusiness has a seasonal pattern.  In thepast three years, we have realized an average of approximately 34.3% of ourannual revenues in our fourth quarter, which includes Halloween and Christmas,and an average of approximately 24.9% of our revenues in the second quarter,which includes school graduations, and often the Easter holiday.  Also, during these past three years, we havehad net income in our second and fourth quarters and generated losses in ourfirst and third quarters.

 

**Suppliers and Inventory**

** **

The products we sell are sourcedfrom a wide variety of third-party vendors. Many of the products that we offer for sale, such as paper-based partygoods, Halloween masks, and costumes, are manufactured overseas in foreigncountries such as China.  Global sourcingof many of the products we sell is thus an important factor in our financialperformance.

 

The following represents suppliers from whomwe purchased at least 5% of our merchandise in either 2009 or 2008:

 
| **Supplier**                   | ** ** | **Products supplied** | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------|------------|-----------------------|------------|----------|------------|----------|------------|
| Amscan, Inc.              |       | Paper party goods     |       | 23.5     | %          | 22.2     | %          |
| Kendall  Confectionery Company |       | Candy                 |       | 5.5      | %          | 5.1      | %          |
| Hallmark  Marketing Corp.      |       | Paper party goods     |       | 5.0      | %          | 6.7      | %          |
| Unique  Industries, Inc.  |       | Paper party goods     |       | 4.3      | %          | 5.2      | %          |
| Total                          |       |                  |       | 38.3     | %          | 39.2     | %          |

 

In August 2006, we entered into a Supply Agreementwith Amscan, Inc. (“Amscan”) which extends to 2012 and obligates us topurchase increased levels of merchandise from Amscan, our largest supplier, inexchange for, among other things, the right to receive certain additionalrebates and more favorable pricing terms over the life of the agreement thanwere generally available to us under our previous terms with Amscan.

 

The loss of any of these suppliers could materiallyadversely affect our business, results of operations, financial condition andcash flow.  We consider numerous factorsin supplier selection, including, but not limited to, price, credit terms, productofferings and quality.  As is customaryin our industry, we generally do not have long-term contracts with oursuppliers, other than our Supply Agreement, and any supplier may discontinueselling to us at any time.

 

**Intellectual Property**

** **

Wehold trademarks for “iParty” issued by the U.S. Patent and TrademarkOffice.  Trademark registrations for “iParty”were issued on February 19, 2002 and August 26, 2003 under U.S.registration No. 2,541,025 and No. 2,756,735. We own our website www.iparty.com, which we have licensed to a third party.  We have not received significant revenue fromthis license agreement.

 

**Employees**

** **

Asof December 26, 2009, we had 241 full-time employees and 659 part-timeemployees.  None of these employees isrepresented by a labor union, and we consider our relationship with ouremployees to be good.

 

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**Available Information**

** **

Our licensed Internet website address iswww.iparty.com.  Our Annual Reports on Form 10-K,Quarterly Reports on Form 10-Q, Current Reports on Form 8-K andamendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934 are available through the investor relations page of ourlicensed Internet website as soon as reasonably practicable after weelectronically file such material with, or furnish it to, the SEC.  Our licensed Internet website and theinformation contained therein or connected thereto are not incorporated into ora part of this Annual Report on Form 10-K or any other report we file orfurnish to the SEC.

 

The public may read and copy any materials that we filewith the SEC at the SEC’s website, www.sec.gov, which contains reports, proxyand information statements and other information that public companies arerequired to file with or furnish to the SEC. In addition, the public may read and copy any materials we file orfurnish with the SEC at the SEC’s Public Reference Room at 450 FifthStreet, N.W., Washington, D.C., 20549on official business days during the hours of 10:00 am to 3:00 pm. The publicmay obtain information about the SEC’s Public Reference Room by calling1-800-SEC-0330.

 

**ITEM 1A.**     RISK FACTORS

** **

Ourbusiness is subject to certain risks that could materially affect our financialcondition, results of operations, and the value of our common stock.  These risks include, but are not limited to,the ones described below. Additional risks and uncertainties that we areunaware of, or that we may currently deem immaterial, may become importantfactors that may harm our business, financial condition, results of operations,or the value of our common stock.

 

***Our success depends on economic and other externalfactors, particularly in the New England region and during the Halloweenseason, that affect consumer decisions about whether and when to purchase partygoods and supplies.***

 

Ourbusiness success depends in large measure on consumer decisions to buy partygoods and supplies and seek party planning advice, particularly in the NewEngland region, where 46 of our 51 stores are located, and particularly duringthe Halloween season, which is our single most important season. Demand for ourproducts and our business results are sensitive to external factors that,directly or indirectly, affect consumer confidence, consumer spending patterns,levels of disposable consumer income, or otherwise lead consumers to host ornot host parties or purchase party goods and supplies.  Examples of such external factors include:unseasonable weather, especially in New England; the timing, duration andeffects of adverse changes in overall economic conditions, including rates ofjob loss or growth, energy prices, and increases or decreases in interestrates, nationally or more locally in the markets we serve; and the competitivesuccess or failure of local sports teams, such as the New England Patriots orBoston Red Sox, particularly in post-season play.  The precise impact of any of these externalfactors on consumer spending patterns for party goods and supplies is difficultto predict in advance, but one or more of these factors could adversely affectour business or our operating results, particularly with respect to any givenfiscal period, to the extent they adversely impact the consumer spendingpatterns most important to our business success.

 

***TheU.S. economy has recently experienced a severe recession with high levels ofunemployment, declines in housing prices, higher food and gas prices, creditmarket turmoil, and a significant decline in the stock market.  This has contributed to a loss in consumerconfidence and a decline in consumer spending that has had and may continue tohave an impact on our business, which represents relatively discretionaryspending.***

 

Becausepurchases of our merchandise are dependent upon discretionary spending by ourcustomers, our financial performance is sensitive to changes in overalleconomic conditions that affect consumer spending. Consumer spending habits areaffected by, among other things, prevailing economic conditions, levels ofemployment, salaries and wage rates, consumer confidence and consumerperception of economic conditions.  TheUnited States has recently experienced a severe recession, which led to adecline in consumer spending.  Althoughwe are seeing the initial signs of a recovery, the strength and duration of arecovery is unpredictable. A renewed 

 

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economic downturn could furtherreduce consumer spending or cause a shift in consumer discretionary spending toother products, adversely affecting our liquidity and results of operations.

 

***Our failure to generatesufficient cash to meet our liquidity needs may affect our ability to serviceour indebtedness and grow******our business.***

 

Ourbusiness requires access to capital to support growth, improve ourinfrastructure, respond to economic conditions, and meet contractualcommitments.  In the event that our current operating plan or long-termgoals change due to changes in our strategic plans, lower-than-expected revenues,unanticipated expenses, increased competition, unfavorable economic conditions,other risk factors discussed in this report, or other unforeseen circumstances,our liquidity may be negatively impacted.  Our ability to make payments onand to refinance our indebtedness, principally the amounts borrowed under ourbank line of credit and $600,000 note payable due August 2010, and to fundany capital expenditures for systems upgrades, new store openings, if any, andupdating existing stores, we may make in the future will depend in large parton our current and future ability to generate cash.  This, to a certainextent, is subject to general economic, financial, competitive and otherfactors that are beyond our control.  We cannot assure you that ourbusiness will generate sufficient cash flow from operations in the future, thatour currently anticipated growth in revenues and cash flow will be realized onschedule, or that future borrowings will be available to us under our line ofcredit in an amount sufficient to enable us to service indebtedness, undertakestore openings, update existing stores and replace and upgrade our technologysystems to grow our business, or to fund other liquidity needs.  If weneed to refinance all or a portion of our indebtedness from other sources, wecannot assure you that we will be able to do so on terms and conditionsacceptable to us.

 

We used our existing lineof credit to pay off in full the $2.5 million Highbridge Note on September 15,2009, after which we had less availability under the line for working capitaland acquisition needs than we might otherwise have had. Our bank line of creditwith Wells Fargo allows us to borrow up to $12,500,000, subject to a limitationbased on qualified inventory, receivables levels and other reserves set byWells Fargo, with an option to increase that limit up to $15 million.  Asof December 26, 2009, there was $2,526,982 outstanding under our line ofcredit with additional availability of $3,450,662, which we believe to besufficient to fund our operations, working capital requirements, the schedulednote repayment in 2010, and capital expenditures for the next twelve months.

 

***Our business may beadversely affected by the actions of and risks associated with our third-partyvendors.***

 

The products we sell are sourced from a wide variety of third-partyvendors.  We cannot control the supply,design, function or cost of most of the products that we offer for sale and aredependent on the availability and pricing of various products, including, withoutlimitation, paper-based party goods, Halloween masks, and costumes, many ofwhich are manufactured overseas in foreign countries such as China.  Global sourcing of many of the products wesell is thus an important factor in our financial performance.  Our ability to find qualified vendors and accessproducts in a timely and efficient manner is a significant challenge,especially with respect to goods sourced outside the United States.  Disruptions in the availability of rawmaterials used in production of these products may adversely affect our salesand result in customer dissatisfaction. Political instability, the financial instability of suppliers,merchandise quality issues, trade restrictions, tariffs, currency exchangerates, transport capacity and costs, inflation and other factors relating toforeign trade are beyond our control.  Inparticular, volatile oil and gasoline prices impact prices ofpetroleum-based/plastic products, which are a key raw material in much of ourmerchandise, affect our freight costs, and affect consumer confidence andspending patterns.  Additionally, we haveseen shortages in helium supplies affecting the pricing of certain popularproducts, such as balloons. These and other issues directly or indirectlyaffecting our vendors could adversely affect our business and financialperformance.

 

In addition, if our overallperformance deteriorates, or if we experience liquidity challenges, our thirdparty suppliers and vendors may demand accelerated payment of amounts due tothem or require advance payments or letters of credit before goods are shippedto us.  These demands could have asignificant adverse impact on our operating cash flow and on our liquidity.  Our third party suppliers and vendors havealso experienced the current impact of the recession.  If one or more of our third party suppliersfails or is unable to supply us with adequate goods, due to their own financialtroubles or the financial troubles of their suppliers, including factories inChina, we may experience an adverse effect on our business and results ofoperations.

 

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***We face intense competition from many sources.***

 

Theindustry we serve is highly competitive and fragmented. We face intensecompetition from other party supply stores and stores that merchandise andmarket party supplies, including big discount retailers, such as Wal-Mart,retail drug store chains, like CVS and Walgreen, dollar store chains, andtemporary Halloween stores.  Our successthus depends on our ability to be competitive against many differentcompetitors in each local market area we serve. If we fail to anticipate evolving innovations and product offerings fromour competitors and fail to offer products that appeal to the changing needsand preferences of our customers in the various markets we serve, demand forour products could decline and our operating results would be adverselyaffected. While the competitive importance of product quality, price, serviceand innovation varies from product to product, price is a factor, and weexperience pricing pressures from competitors in our markets.

 

In 2008, weopened two temporary Halloween stores in our home New England market; in 2009,we increased the number of temporary Halloween stores to four, also in our homeNew England market. We intend to expand our temporary Halloween stores infuture years, opening more such stores, some of which may be outside of NewEngland. In doing so, we will face intense competition from other operators oftemporary Halloween stores, such as Spirit Halloween, Halloween USA and others.If we fail to secure a sufficient number of appropriate temporary retaillocations, or if sales achieved at those locations fall below planned levels,our operating results would be adversely affected.

 

***We face new competitive threats as a result ofconsolidation in our industry following Amscan Holdings, Inc.’sacquisitions of Party City Corporation, Party America and Factory Card andParty Outlet.***

 

AmscanHoldings, Inc. (“AHI”), the parent company of Amscan, Inc. (“Amscan”)our largest supplier and the largest supplier in our industry, or AHI’s parent,AAH Holdings Corporation (“AAH”), owns Party City Corporation, Party Americaand Factory Card & Party Outlet Corp. (“Factory Card”).  Through the acquisitions of these party goodscompanies, AHI and AAH own a total of approximately 851 corporate and franchiseparty supply stores nationwide. None of these companies currently has asignificant presence in the New England region.

 

We have a Supply Agreement with Amscanwhich extends to 2012 and obligates us to purchase increased levels ofmerchandise from Amscan, in exchange for, among other things, the right toreceive certain additional rebates and more favorable pricing terms over thelife of the agreement than were generally available to us under our previousterms with Amscan.  In addition to the Supply Agreement withAmscan, we have a five-year non-competition agreement from Party Cityand its affiliates that covers Massachusetts, Maine, New Hampshire, Vermont,Rhode Island, and Windsor and New London counties in Connecticut.

 

Any furthergeographic expansion by us outside of the New England market could result ingreater direct competition with one or all of Party City, Party America andFactory Card.  If so, AAH and AHI’sacquisitions of Party City, Party America and Factory Card, and its status asour largest supplier and the largest supplier in our industry could adverselyaffect our ability to compete favorably or operate successfully in a changedmarketplace.  Price pressures from suchnew sources of competition, particularly in the event of a strain or rupture inour relationship with Amscan, could erode our margins and cause our financialresults of operations to suffer.  Oursuccess depends on our ability to evaluate and respond to the threats arisingfrom growing consolidation and changing marketplaces and identify ways in whichwe can competitively operate and strategically grow our store base.

 

***A major failure of our information systems would harmour business.***

 

The failureof any of our systems, including, without limitation, our point-of-sale systemand our existing merchandise management system, the latter of which wasdeveloped by a vendor who is no longer in business and is thus currentlyunsupported by a third-party, would have a material adverse effect on ourbusiness and financial results of operations. We depend on these information systems to operate our retail stores, processtransactions, respond to customer inquiries, manage inventory, purchase andsell goods on a timely basis, and maintain cost-efficient operations.  We may experience operational problems withour information systems as a result of system failures or any inability on ourpart to find and retain qualified personnel to monitor, maintain, and upgradethese systems, particularly with respect to our merchandise management system,or other causes.

 

7

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We cannotassure you that our systems will be adequate to support future growth, eitheras currently configured or as we plan to possibly update them.  Any material disruption or slowdown of oursystems would severely interfere with the normal operation of our retail storeoperations and could have a materially negative impact on our businessoperations and financial results.  Inparticular, our total borrowing base under our line of credit depends, amongother things, on our inventory levels, credit card receivables, customerdeposits, and merchandise credits. Accordingly, any material disruption or problem affecting ourpoint-of-sale or merchandise management systems could materially and adverselyaffect our borrowing level, our compliance with various covenants under ourbank agreement, and our liquidity and cash resources.

 

***Our quarterly operating results are subject tosignificant fluctuation.***

 

Our operating results have fluctuated from quarter toquarter in the past, and we expect that they will continue to do so in thefuture.  Factors that could cause thesequarterly fluctuations, both sequentially and on a year-over-year basis,include the following: extreme weather-related disruptions, particularly in NewEngland; the timing of movable holidays, such as Easter, which typically fallsin the second quarter but on occasion falls in the first quarter; thecompetitive success or failure of local sports teams, such as the New EnglandPatriots or Boston Red Sox, particularly in post-season play, which may resultin fluctuations from one year to the next in our sales in the first and fourthquarters; the extent to which sales in new stores result in the loss of salesin existing stores; the mix of products sold; pricing and marketing actions ofcompetitors; the level of advertising and promotional expenses; andseasonality, primarily because the sales and profitability of our stores aretypically lower in the first and third quarters, when we have often operated ata loss, and are typically higher in the second quarter, which includes schoolgraduations, and the fourth quarter, which includes Halloween, our single mostimportant selling season, as well as the Christmas holiday season.  Most of our operating expenses, such as rentexpense, advertising expense and employee salaries, do not vary directly withthe amount of sales and are difficult to adjust in the short term.  As a result, if sales in a particular quarterare below expectations for that quarter, we may not be able to proportionatelyreduce operating expenses for that quarter, and therefore such a salesshortfall would have a disproportionate effect on our net income (or loss) forthe quarter.

 

***Our failure to attract, retain, and motivate qualifiedpersonnel would adversely affect our business.***

 

Our successdepends in large part on the efforts and abilities of our senior managementteam.  Their skills, experience andindustry contacts significantly benefit our operations and administration.  The failure to attract, retain, and properlymotivate the members of our senior management team and other key employees, orto find suitable replacements for them in the event of death, ill health, ortheir desire to pursue other professional opportunities, could have a negativeeffect on our operating results.

 

Ourperformance is also largely dependent on attracting and retaining qualityassociates that are able to make the consumer shopping experience at our storesa fun and informative experience.  Weface intense competition for qualified associates, and many of our associatesare in entry-level or part-time positions with historically high rates ofturnover.  Our ability to generally meetour labor needs while controlling our labor costs is subject to numerousexternal factors, including the availability of a sufficient number ofqualified persons in the work force, unemployment levels, prevailing wagerates, changing demographics, health and other insurance costs and changes inemployment legislation, particularly in the New England region.  If we are unable to attract and retainqualified associates or our labor costs increase significantly, our businessand financial performance may be adversely affected.

 

***Risks associated with recent and possible future newstore openings could adversely affect our business.***

 

Animportant part of our long-range business plan is to increase our number ofstores, including temporary stores, and, over time, enter new geographicmarkets.  We have opened 16 new stores,acquired three stores, closed three stores and operated six temporary Halloweenstores over the past six years, bringing our total number of stores from 35 atthe beginning of 2004 to 51 at the end of 2009. Going forward into 2010, inaddition to continuing our careful management of expenses, we intend to growthe company through opening new retail locations, continuing the expansion ofour temporary Halloween store strategy and through sales growth in our existingretail stores.  For a growthstrategy to be successful, we must identify and lease or acquire favorablestore sites, hire and train

 

8

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associates and store managers, andadapt management and operational systems to meet the needs of our expanded operations.  These tasks may be difficult to accomplishsuccessfully.  If we are unable to openor acquire new or temporary stores in locations and on terms acceptable to usas quickly as planned, our future sales and profits may be adverselyaffected.  Even if we succeed in openingor acquiring new stores or opening temporary stores, these stores may notachieve the same sales or profit levels as our existing stores.  Also, our expansion strategy includes openingnew or temporary stores in markets where we already have a presence so we cantake advantage of economies of scale in marketing, distribution and supervisioncosts.  However, these new or temporarystores may result in the loss of sales in existing stores in nearby areas,which could adversely affect our business and financial performance. Inaddition, future store openings could cause us, among other things, to incuradditional debt and increased interest expense, as well as experience dilutionin earnings, if any, per share. Impairment losses could also occur as a result of new store openings inthe event that new store openings prove unsuccessful.

 

***Our ownership structure includes large investors whoown preferred stock and whose interests and rights in our company may differ inimportant respects from those of our common stock investors.***

 

As of December 26,2009, there were 22,798,647 shares of common stock outstanding, and 27,644,593potential additional common share equivalents outstanding that may be issuedupon the conversion of outstanding convertible preferred stock, warrants andoptions to purchase our common stock. The average weekly trading volumes in our common stock as reported onthe NYSE Amex for the fifty twoweek periods ended December 26, 2009 and December 27, 2008 were164,371 shares and 51,683 shares, respectively. Additionally, a number of investors in our company own largeconcentrations of our common and convertible preferred stock making our sharesmore illiquid than if our ownership structure were more widely distributed. Theownership rights of these holders of our convertible preferred stock impact thetrading liquidity of our common shares, our corporate governance, and therelative economic stake that our common stock and convertible preferred stockinvestors have in the enterprise value of our business.  Although a more active trading market may developin the future, the limited market liquidity for our stock may affect yourability to sell at a price that is satisfactory to you.

 

Ourcorporate governance is affected by our ownership structure to the extent thatcertain of our convertible preferred stock investors currently enjoy, amongother things, contractual rights to nominate and elect two of the members ofour board of directors, although neither of these board seats is currentlyfilled.  These rights and theconcentration of share ownership enjoyed by certain of our convertible preferredstock investors mean that our largest investors can influence our strategicdirection and that of our senior management in ways that are different frommost of our common stock investors.  Ourconvertible preferred stock investors also enjoy certain economic rights thatdifferentiate their ownership rights and interests from those of our commonstock investors.  For instance, upon theoccurrence of merger, acquisition or a similar transaction involving the acquisitionof our company, the holders of our convertible preferred stock would generallybe entitled to a “liquidation preference” that would entitle them,collectively, to the first $17.8 million of net proceeds, unless they decide toconvert their shares of convertible preferred stock into common stock.  This feature of our convertible preferredstock investors’ rights could make the attractiveness of our company as anacquisition target differ materially from what it would be without it.  In addition, our convertible preferred stockinvestors enjoy certain “anti-dilution” protections not afforded to our commonstock investors, which generally means that investors in shares of our commonstock could be adversely affected by subsequent dilutive financings, if any, inways that are different from some or all of our convertible preferred stockinvestors.

 

****Shares that may be resold pursuant to ourprospectus on Form S-3  or eligiblefor sale in the future could negatively affect our stock price.****

 

Certain securities may be sold in the future pursuant toregistration statements filed with the SEC or without registration under theSecurities Act, to the extent permitted by Rule 144 or other exemptionsunder the Securities Act.  We may issueadditional shares in the future in connection with acquisitions, compensationor otherwise, although we cannot ensure that we will be able to identify orcomplete any acquisition in the future. The market price of our common stockcould decline as a result of sales of a large number of shares of our commonstock or the perception that these sales could occur.  This may also make it more difficult for usto raise funds through the issuance of debt or the sale of equity securities.

 

9

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As of December 26,2009, there were 27,644,593 potential additional common share equivalentsoutstanding.  These included 15,426,498shares issuable upon the conversion of immediately convertible preferred stock,2,083,334 shares issuable upon the exercise of a warrant with an exercise priceof $0.475, 100,000 shares issuable upon the exercise of warrants with aweighted average price of $1.50, and 10,034,761 shares issuable upon theexercise of stock options with a weighted average exercise price of $0.45.

 

***Our common stock is thinly traded, may fluctuate basedon relatively small levels of trading activity, and may be adversely affectedby our capital structure, which makes it more difficult for investors to valueour business.***

 

Investingin shares of our common stock entails a high degree of risk.  Public trading of our common stock on the NYSE Amex (formerly known as the AmericanStock Exchange) typically occurs at relatively low sales volumes and very few,if any, security analysts regularly follow our stock.  Moreover, our common stock price has tradedbelow $1.00 for significant periods of time. In addition, our capital structure, which includes various series ofconvertible preferred stock with various contractual rights, generally makes itmore difficult for investors, or prospective acquirers of our company, to valueour business on an aggregate basis or to value our shares of common stock on atrading basis.  As a result of thesefactors, speculative investors may have a greater effect on our common stockprice than would be the case for a company with a simpler ownership structure,a larger market capitalization, or common shares that are more diffusely heldor heavily traded.  Accordingly, ourcommon stock price could be subject to considerable speculative volatility andmay not necessarily follow market expectations regarding our business prospectsor financial performance.  In particular,our common stock price may be sensitive to non-financial developments involvingour company as well as market rumors disseminated on the Internet or otherforms of media regarding our company or our industry. If our quarterlyfinancial performance does not meet the expectations of investors that trade inshares of our common stock, our stock price would likely decline.  If so, the decrease in the stock price may bedisproportionate to the shortfall, real or perceived, in our financialperformance.

 

***Compliance with changing regulation of corporategovernance, public disclosure, and accounting standards may result inadditional expenses and risks.***

 

Changinglaws, regulations and standards relating to corporate governance, publicdisclosure and changes to accounting standards and practices, including theSarbanes-Oxley Act of 2002, new SEC regulations, corporate law developments inDelaware, and evolving rules applicable to publicly-traded companies onthe NYSE Amex are creatinguncertainty, and hence risks, for companies such as ours.  These new or changed laws, regulations andstandards are subject to varying interpretations due to the fact that they arenew and there has not yet emerged a well-developed body of interpretation.  As a result, their application in practicemay evolve over time as new guidance is provided by regulatory and governingbodies.  This development could result incontinuing uncertainty regarding compliance matters and higher costsnecessitated by ongoing revisions to disclosure, governance and accountingpractices.

 

Our effortsto comply with evolving laws, regulations and standards have resulted in, andare likely to continue to result in, increased general and administrativeexpenses and a diversion of management time and attention fromrevenue-generating activities to compliance activities.  In particular, we have applied significantmanagement and financial resources to document, test, monitor and enhance ourinternal controls over financial reporting in order to meet the various currentrequirements of the Sarbanes-Oxley Act of 2002. Additional costs may berequired to be incurred in 2010 since current regulations will require ourinternal controls to be audited by our external auditors. Currently, onlymanagement is required to certify as to the effectiveness of our internalcontrols. Any failure in the effectiveness of our internal controls overfinancial reporting could have a material effect on our financial reporting orcause us to fail to meet reporting obligations, which upon disclosure, couldnegatively impact the market price of our common stock.  Our efforts to comply with these types of newregulatory requirements regarding our required assessment of our internalcontrols over financial reporting and our external auditors’ audit of ourfinancial statements have required the commitment of increasing levels offinancial and managerial resources. If our efforts to comply with new orchanged laws, regulations and standards differ from the activities intended byregulatory or governing bodies, we could face various material and adverseconsequences, including a decline in our common stock price or a possibledelisting of our common stock.

 

10

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***Our stock is listed on the NYSE Amex and subject to anumber of continued listing requirements, the failure to comply with which mayresult in the delisting of our common stock.***

 

Our common stock is currently listed on the NYSE Amex.  Subject to NYSE Amex rules, we are requiredto maintain compliance with a number of continued listing standards, includingbut not limited to, the requirement that our stock trade above certain pricinglevels for a continued period. Our common stock price has traded below $1.00for significant periods of time.  If theexchange considers our common stock to be a low-priced stock, our common stockcould be subject to delisting.  Adelisting of our common stock could negatively impact us by reducing furtherthe liquidity and market price of our common stock, or by reducing the numberof investors willing to hold or acquire our common stock, which couldnegatively impact our ability to raise equity capital.

 

***Product liability may adversely impact our operationsand merchandise offerings.***

 

We and our vendors are subject to regulations by a variety of state andfederal regulatory authorities, including the Consumer Product SafetyCommission. If one or more of our vendors fails to adhere to product safetyrequirements, our reputation and brands could be damaged and we could besubject to product liability suits and government fines and penalties, whichcould adversely affect our business and results of operations.  Furthermore, to the extent we are unable toreplace any non-compliant products, we may have to reduce our merchandiseofferings, resulting in a decrease in sales.

 

***A privacy breach could adversely affect our business.***

 

The protection of customer, employee, andcompany data is critical to us. The regulatory environment surroundinginformation security and privacy is increasingly demanding, with the frequentimposition of new and constantly changing requirements. In addition, customershave a high expectation that we will adequately protect their personal information. A significant breach of customer,employee, or company data could damage our reputation and result in lost sales,fines, or lawsuits.

 

**Forward Looking Statements**

 

Certainstatements in this Annual Report, particularly statements contained in Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”constitute “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities 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 otherpublicly available documents filed with the SEC, reports to our stockholdersand other publicly available statements issued or released by us involve knownand unknown risks, uncertainties, and other factors which could cause ouractual results, performance (financial or operating) or achievements to differfrom the future results, performance (financial or operating) or achievementsexpressed or implied by such forward looking statements. Such future resultsare based upon our best estimates based upon current conditions and the mostrecent results of operations.  Ourforward-looking statements speak only as of the date of this document, and wedo not intend to update these statements to reflect events or circumstancesthat occur after that date.

 

Various risks, uncertainties and contingencies could causeour actual results, performance or achievements to differ materially from thoseexpressed in, or implied by, the forward-looking statements contained in thisAnnual Report.  These include, but arenot limited to, those listed above in this Item 1A, “Risk Factors.”

 

**ITEM 1B. UNRESOLVED STAFF COMMENTS**

** **

Not applicable.

 

11

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**ITEM 2.  PROPERTIES**

** **

Thefollowing table identifies the number of our stores operating as of December 26,2009, December 27, 2008, and December 29, 2007, by state:

 
| ** **     | ** ** | **Number of Stores, for the fiscal year ended** | ** ** |
|----------------|------------|-------------------------------------------------|------------|
| ** **     | ** ** | **Dec 26, 2009**                                | ** ** | **Dec 27, 2008** | ** ** | **Dec 29, 2007** | ** ** |
| **States**     | ** ** | **End   of   Period**                           | ** ** | **Closings** | ** ** | **Acquired/   Openings** | ** ** | **End   of   Period** | ** ** | **Closings** | ** ** | **Acquired/  Openings** | ** ** | **End   of   Period** | ** ** | **Closings** | ** ** | **Acquired/   Openings** | ** ** |
| Connecticut    |       | 7                                               |       | — |   | — |   | 7 |   | — |   | — |   | 7 |   | — |   | — |   |
| Florida        |       | 5                                               |       | — |   | — |   | 5 |   | — |   | — |   | 5 |   | — |   | — |   |
| Maine          |       | 3                                               |       | — |   | — |   | 3 |   | — |   | — |   | 3 |   | — |   | — |   |
| Massachusetts  |       | 26                                              |       | — |   | 1 |   | 25 |   | 1 |   | — |   | 26 |   | — |   | — |   |
| New  Hampshire |       | 6                                               |       | — |   | — |   | 6 |   | — |   | — |   | 6 |   | — |   | — |   |
| Rhode  Island  |       | 3                                               |       | — |   | — |   | 3 |   | 1 |   | 2 |   | 2 |   | — |   | — |   |
| Vermont        |       | 1                                               |       | — |   | — |   | 1 |   | — |   | — |   | 1 |   | — |   | — |   |
| Total          |       | 51                                              |       | — |   | 1 |   | 50 |   | 2 |   | 2 |   | 50 |   | — |   | — |   |

 

Our stores range in size from approximately 8,000 squarefeet to approximately 20,500 square feet and average approximately 10,300square feet.  We lease all of our retailstores.  The leases generally provide forfixed minimum rentals, which typically increase periodically during the life ofthe lease, and, in some instances, contingent rentals based on a percentage ofsales in excess of specified minimum sales levels, as well as related occupancycosts, such as property taxes and common area maintenance.  We lease our properties typically for 10years and usually with options from our landlords to renew our leases for anadditional 5 or 10 years.

 

In addition to our 51 stores, we lease office space at 270Bridge Street, Suite 301, Dedham, Massachusetts, 02026.  The lease, which expires November 30,2011, is for 10,600 square feet of space and the monthly rent is $18,750.  We also lease office and retail space at 1457VFW Parkway, West Roxbury, Massachusetts, 02132.  This lease, which expires December 31,2012, is for 20,500 square feet of space. The retail store at our West Roxbury location uses 10,688 square feetand the remainder is used primarily for our corporate training center.  The total monthly rent for the retail storeand corporate training center space is $19,937, subject to certain ConsumerPrice Index escalation clauses. We believe that these spaces are adequate forour immediate needs.

 

We believe that all properties are adequately covered byinsurance.

 

**ITEM 3.  LEGALPROCEEDINGS**

** **

We are not a party to any material pending legal proceedingsother than ordinary routine matters incidental to our business, which we do notexpect, individually or in the aggregate, to have a material adverse effect onour company.

 

**ITEM 4.  (Removed andReserved)**

 

12

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**PART II**

 

**ITEM 5.  MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES**

** **

**Market Information**

** **

The NYSE Amexis the principal market for our common stock, where our shares are traded underthe symbol “IPT”.

 

The following table sets forth the range of high and lowsales prices on the NYSE Amex forour common stock for each of the fiscal quarters of 2009 and 2008:

** **

**MARKETPRICE OF COMMON STOCK**

 
| **Period**             | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------|------------|----------|------------|---------|------------|
| **2009**               |       |     |       |    |       |
| Fourth  fiscal quarter |       | $        | 0.32       |    | $          | 0.22 |   |
| Third  fiscal quarter  |       | 0.34     |       | 0.12    |       |
| Second  fiscal quarter |       | 0.17     |       | 0.06    |       |
| First  fiscal quarter  |       | 0.10     |       | 0.03    |       |
|                   |       |     |       |    |       |
| **2008**               |       |     |       |    |       |
| Fourth  fiscal quarter |       | $        | 0.20       |    | $          | 0.06 |   |
| Third  fiscal quarter  |       | 0.25     |       | 0.16    |       |
| Second  fiscal quarter |       | 0.30     |       | 0.20    |       |
| First  fiscal quarter  |       | 0.34     |       | 0.17    |       |

 

**Holders**

** **

The approximate number of record holders of our commonstock as of December 26, 2009 was 117. The number of record owners was determined from our stockholder records,and does not include beneficial owners of our common stock whose shares are heldin the names of various security holders, dealers and clearing agencies.  We believe that the number of beneficialowners of our common stock held by others as or in nominee names exceeds 500 innumber.

 

**Dividends**

** **

We have never paid a cash dividend on our shares of commonstock and have no expectation of doing so for the foreseeable future.  Our existing line of credit agreement withWells Fargo Retail Finance, LLC generally prohibits the payment of any dividendsor other distributions to any of our classes of capital stock.

 

**Recent Sales of Unregistered Securities**

** **

There were no sales of unregistered securities made duringthe fourth quarter of 2009.

 

**Purchases of Equity Securities by the Issuer and AffiliatedPurchasers**

** **

There were no stock repurchases made during the fourthquarter of 2009.

 

13

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**ITEM 6. SELECTED FINANCIAL DATA**

 

The following selected consolidatedfinancial data is derived from our audited consolidated financial statementsand should be read in conjunction with our audited consolidated financialstatements and related notes, which are included in Item 8 “FinancialStatements and Supplementary Data” below, and “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” included in Item 7below.

 
| ** **                                           | ** ** | **2009**     | ** ** | **2008**     | ** ** | **2007**     | ** ** | **2006**     | ** ** | **2005 (1)** | ** ** |
|------------------------------------------------------|------------|--------------|------------|--------------|------------|--------------|------------|--------------|------------|--------------|------------|
| ** **                                           | ** ** | **52 weeks** | ** ** | **52 weeks** | ** ** | **52 weeks** | ** ** | **52 weeks** | ** ** | **53 weeks** | ** ** |
| **Statement of Operations Data:**                    |       |         |       |         |       |         |       |         |       |         |       |
| Revenues                                             |       | $            | 78,595,088 |         | $          | 81,210,999   |       | $            | 81,798,634 |         | $          | 78,458,329 |   | $ | 72,537,998 |   |
| Operating  costs:                                    |       |         |       |         |       |         |       |         |       |         |       |
| Cost  of products sold and occupancy costs           |       | 46,557,039   |       | 46,885,215   |       | 46,465,441   |       | 44,942,542   |       | 41,395,193   |       |
| Marketing  and sales                                 |       | 23,703,308   |       | 26,793,885   |       | 26,181,504   |       | 25,625,547   |       | 24,116,050   |       |
| General  and administrative                          |       | 6,934,478    |       | 7,205,067    |       | 7,553,869    |       | 6,736,197    |       | 6,762,583    |       |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| Operating  income                                    |       | 1,400,263    |       | 326,832      |       | 1,597,820    |       | 1,154,043    |       | 264,172      |       |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| Income  before interest and taxes                    |       | 1,400,263    |       | 326,832      |       | 1,597,820    |       | 1,154,043    |       | 264,172      |       |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| Interest  income                                     |       | 340          |       | 4,609        |       | 17,806       |       | 10,217       |       | 801          |       |
| Interest  expense                                    |       | (444,801     | )          | (720,891     | )          | (857,612     | )          | (772,334     | )          | (532,649     | )          |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| Income  (loss) before taxes                          |       | 955,802      |       | (389,450     | )          | 758,014      |       | 391,926      |       | (267,676     | )          |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| Income  taxes (benefit)                              |       | (147,930     | )          | 50,605       |       | 146,323      |       | 17,279       |       | —       |       |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| Net  income (loss)                                   |       | $            | 1,103,732  |         | $          | (440,055     | )          | $            | 611,691    |         | $          | 374,647 |   | $ | (267,676 | ) |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| Income  (loss) per share:                            |       |         |       |         |       |         |       |         |       |         |       |
| Basic                                                |       | $            | 0.03       |         | $          | (0.02        | )          | $            | 0.02       |         | $          | 0.01 |   | $ | (0.01 | ) |
| Diluted                                              |       | $            | 0.03       |         | $          | (0.02        | )          | $            | 0.02       |         | $          | 0.01 |   | $ | (0.01 | ) |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| Weighted-average  shares outstanding:                |       |         |       |         |       |         |       |         |       |         |       |
| Basic                                                |       | 38,220,804   |       | 22,722,485   |       | 38,204,374   |       | 37,862,928   |       | 22,186,581   |       |
| Diluted                                              |       | 38,440,489   |       | 22,722,485   |       | 39,913,274   |       | 39,535,874   |       | 22,186,581   |       |
|                                                 |       |         |       |         |       |         |       |         |       |         |       |
| **Other Data:**                                      |       |         |       |         |       |         |       |         |       |         |       |
| Net  cash provided by (used in) operating activities |       | $            | 3,256,482  |         | $          | 3,229,642    |       | $            | (239,008   | )            | $          | 4,412,036 |   | $ | (259,907 | ) |
| Net  cash used in investing activities               |       | (525,563     | )          | (2,027,709   | )          | (802,174     | )          | (2,579,007   | )          | (1,663,647   | )          |
| Net  cash provided by (used in) financing activities |       | (2,730,119   | )          | (1,213,215   | )          | 352,338      |       | (1,771,847   | )          | 865,591      |       |
| Capital  expenditures (2)                            |       | 525,563      |       | 2,027,709    |       | 802,174      |       | 709,892      |       | 1,663,647    |       |

 
| ** **                   | ** ** | **Dec 26, 2009** | ** ** | **Dec 27, 2008** | ** ** | **Dec 29, 2007** | ** ** | **Dec 30, 2006** | ** ** | **Dec 31, 2005** | ** ** |
|------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| **Balance Sheet Data:**      |       |                       |       |                       |       |                       |       |                       |       |                       |       |
| Working  capital             |       | $                          | 5,429,194  |                       | $          | 3,489,893                  |       | $                          | 6,184,373  |                       | $          | 4,954,989 |   | $ | 2,091,213 |   |
| Total  assets                |       | 20,292,422                 |       | 20,995,273                 |       | 22,977,086                 |       | 22,697,373                 |       | 21,717,076                 |       |
| Total  long-term liabilities |       | 1,543,098                  |       | 1,800,174                  |       | 4,394,367                  |       | 4,707,964                  |       | 1,095,998                  |       |
|                              |            |                            |            |                            |            |                            |            |                            |            |                            |            |  |  |  |  |  |

 

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(1)  Fiscal year 2005 refers to a53-week fiscal year, while fiscal years 2009, 2008, 2007, 2006 refer to 52-weekfiscal years.

 

(2)  Capital expenditures exclude assetsacquired under capital leases.

 

14

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**ITEM 7.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

** **

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

 

*Certain statements in this Annual Report, particularly statementscontained in this Item 7, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” constitute “forward-looking statements”within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended.  The words “anticipate”, “believe”,“estimate”, “expect”, “plan”, “intend” and other similar expressions areintended to identify these forward-looking statements, but are not theexclusive means of identifying them. Forward-looking statements included in this Annual Report or hereafterincluded in other publicly available documents filed with the Securities andExchange Commission (“SEC”), reports to our stockholders and other publiclyavailable statements issued or released by us involve known and unknown risks,uncertainties, and other factors which could cause our actual results,performance (financial or operating) or achievements to differ from the futureresults, performance (financial or operating) or achievements expressed orimplied by such forward looking statements. Such future results are based upon our best estimates based upon currentconditions and the most recent results of operations.  Various risks, uncertainties and contingenciescould cause our actual results, performance or achievements to differmaterially from those expressed in, or implied by, the forward-lookingstatements contained in this Annual Report. These include, but are not limited to, those described above under Item1A, “Risk Factors.”  Our forward-lookingstatements speak only as of the date of this document, and we do not intend toupdate these statements to reflect events or circumstances that occur afterthat date.*

 

**Overview**

** **

At the end of 2009, we operated 51 retail stores, including46 in New England and five in Florida. We also operated four temporaryHalloween stores in 2009, twice as many as in 2008, and opened our first urbanstore at the end of the year.  After aslow start in the first half of the year due to the recession, our salesimproved.  We ended fiscal 2009 withapproximately $78.6 million in sales, adecline of 3.2% from the prior year.  Wereported net income of approximately $1.1 million as compared to a net loss of $0.4 million in2008. Comparable store sales in 2009 decreased 4.5% compared to sales in2008, which was within the rangeexperienced by many other specialty stores in 2009. Comparable storesales are defined as sales from those stores open for at least one full year. We offset our same store sales performancewith the successful operation of temporary Halloween stores and through ourstrategic cost reductions, initiated at the beginning of 2009. Our costreductions achieved savings in almost every area of company operations, includingstore payroll, advertising and marketing, non-payroll operating expenses, andgeneral and administrative expenses.

 

For the first quarter of 2009, our consolidated revenueswere $14.6 million, compared to $16.1 million for the first quarter of 2008. Thedecrease in first quarter revenues from the year-ago period included a 9.9%decrease in comparable store sales from stores open more than one year. Thedecrease in consolidated revenue was primarily due to decreased customertraffic, which, we believe, was mostly attributable to a falloff in generalconsumer confidence due to the deepening recession in the U.S. and worldeconomies.  Theconsolidated net loss for the first quarter of 2009 was $1,715,271, or $0.08per share, compared to a consolidated net loss of $1,864,528, or $0.08 pershare, for the first quarter of 2008, an improvement of $149,257.

 

For the second quarter of 2009, our consolidated revenueswere $19.6 million, compared to $20.1 million for the second quarter of 2008.The decrease in second quarter revenues from the year-ago period included a2.6% decrease in comparable store sales. The decrease in consolidated revenuewas primarily due to a decrease in customer traffic and an increase inpromotional markdowns, both of which were related to the continuing recessionin the U.S. and world economies.  Theconsolidated net income for the second quarter of 2009 was $668,868 or $0.02per share, compared to a consolidated net income of $183,606, or $0.00 pershare, for the second quarter of 2008, an improvement of $485,262. Despite thedecline in revenues as compared to the second quarter of 2008, we were able toreport a significant improvement in our net income as compared to the secondquarter of 2008, due primarily to the cost cutting initiatives we undertook atthe beginning of 2009.

 

15

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For the third quarter of 2009, our consolidated revenueswere $16.4 million, compared to $17.7 million for the third quarter of 2008.The decrease in third quarter revenues from the year-ago period included a 7.7%decrease in comparable store sales. The decrease in consolidated revenue wasprimarily due to a decrease in customer traffic and an increase in promotionalmarkdowns, both of which were related to the effects of the continuingrecession.  The consolidated net loss forthe third quarter of 2009 was $1,396,982 or $0.06 per share, compared to aconsolidated net loss of $1,322,630, or $0.06 per share, for the third quarterof 2008, an increase of $74,352.

 

The year ended with a 0.7% decrease in comparable storesales in the fourth quarter, which included a 1.8% decrease in comparable storesales in the five week fiscal month of October, and a 0.1% increase incomparable store sales in the 31 day calendar month of October. Total companysales increased 3.1 % in the fourth quarter as compared to the fourth quarterof 2008. This increase included a 3.3% increase in total company sales for thefive week fiscal month of October, and a 5.4% increase in total company salesfor the 31 day calendar month of October. Total sales for fiscal and calendar October alsoincluded the impact of four temporary Halloween stores opened in mid-September 2009,compared to two such stores opened in mid-September 2008.   For the quarter, our net income was $3.5million, compared to $2.6 million in the fourth quarter of 2008.

 

**Overview Summary for 2009**

 

In 2009, the US economy endured arecessionary period combined with a systematic lack of liquidity.  During the year, the continuing housingcrisis, volatility in the stock market, and continuing high unemployment allcontributed to a difficult retail environment.  In response to these conditions, we took significant strategic steps,which resulted in significant reductions in our headquarters and storeexpenses, including our advertising and other administrative costs. As a resultof these actions, we were able to achieve improved operating profit and netincome in 2009, and maintain comfortable liquidity levels during the period.

 

**Fiscal 2009 Compared to Fiscal 2008**

** **

*Revenues*

 

Our consolidated revenues for 2009 were $78,595,088, adecrease of $2,615,911, or 3.2% from 2008. Revenues include the selling price of party goods sold, net of returnsand discounts, and are recognized at the point of sale.

 
| ** **                            | ** ** | **For the year ended** | ** ** |
|---------------------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **Dec 26, 2009**       | ** ** | **Dec 27, 2008** | ** ** |
| Revenues                              |       | $                      | 78,595,088 |   | $ | 81,210,999 |   |
|                                  |       |                   |       |   |   |
| Decrease  in revenues from prior year |       | -3.2                   | %          | -0.7 | % |
|                                       |            |                        |            |  |  |  |  |

 

Sales for 2009 included a decrease of 4.5% in comparablestore sales, and sales for several days in early January 2009 from the twoRhode Island stores that we acquired in the first quarter of 2008, prior tothose stores’ one year anniversary.

 

*Cost of goods sold and occupancy costs*

 

Our cost of products sold and occupancy costs for 2009 was$46,557,039, or 59.2% of revenues, a decrease of $328,176 and an increase of1.5 percentage points, as a percentage of revenues, from 2008.  Cost of products sold and occupancy costsconsist of the cost of merchandise sold to customers and the occupancy costsfor our stores.

 

16

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| ** **                              | ** ** | **For the year ended** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **Dec 26, 2009**       | ** ** | **Dec 27, 2008** | ** ** |
| Cost  of goods sold and occupancy costs |       | $                      | 46,557,039 |   | $ | 46,885,215 |   |
|                                    |       |                   |       |   |   |
| Percentage  of revenues                 |       | 59.2                   | %          | 57.7 | % |
|                                         |            |                        |            |  |  |  |  |

 

As a percentage of revenues, the increase in cost ofproducts sold was primarily attributable to increased occupancy costs due toscheduled rent escalations and other occupancy related costs.

 

*Marketing and sales expense*

 

Our consolidated marketing and sales expense for 2009 was$23,703,308 or 30.2% of revenues, a decrease of $3,090,577 and a decrease of2.8 percentage points, as a percentage of revenues, from 2008.  Marketing and sales expenses consistprimarily of advertising and promotional expenditures, all store payroll andrelated expenses for personnel engaged in marketing and selling activities andother non-payroll expenses associated with operating our stores.

 
| ** **              | ** ** | **For the year ended** | ** ** |
|-------------------------|------------|------------------------|------------|
| ** **              | ** ** | **Dec 26, 2009**       | ** ** | **Dec 27, 2008** | ** ** |
| Marketing  and sales    |       | $                      | 23,703,308 |   | $ | 26,793,885 |   |
|                    |       |                   |       |   |   |
| Percentage  of revenues |       | 30.2                   | %          | 33.0 | % |
|                         |            |                        |            |  |  |  |  |

 

As a percentage of revenues, the decrease in marketing andsales expense was primarily the result of our cost reduction actions related tostore payroll and advertising expenses, as described above.

 

*General and administrative expense*

 

Our consolidated general and administrative (“G&A”)expenses for 2009 were $6,934,478, or 8.8% of revenues, a decrease of $270,589,or 0.1 percentage points as a percentage of revenues, from 2008. G&Aexpenses consist of payroll and related expenses for executive, merchandising,finance and administrative personnel, as well as information technology,professional fees and other general corporate expenses.

 
| ** **                  | ** ** | **For the year ended** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **Dec 26, 2009**       | ** ** | **Dec 27, 2008** | ** ** |
| General  and administrative |       | $                      | 6,934,478  |   | $ | 7,205,067 |   |
|                        |       |                   |       |   |   |
| Percentage  of revenues     |       | 8.8                    | %          | 8.9 | % |
|                             |            |                        |            |  |  |  |  |

 

As a percentage of revenues, the decrease in general andadministrative expense was primarily attributable to the cost reductioninitiatives implemented in 2009.

 

*Operating income*

 

Our operating income for 2009 was $1,400,263, or 1.8% of revenues,compared to an operating income of $326,832, or 0.4% of revenues in 2008.

 

*Interest expense*

 

Our interest expense in 2009 was $444,801, a decrease of $276,090 from2008.  The decrease during 2009 was dueprimarily to interest expense related to the decrease in notes payable interestduring the year.  The effective interestrate on our borrowings under our line of credit increased to 5.0% during 2009compared to 4.7% in 2008, which increased interest expense by approximately$6,941. The interest rate was based on the bank’s base rate. Our averagerevolving loan balance was approximately $2,595,427 during 2009 compared to$3,656,861 in 2008, which 

 

17

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decreased interest expense byapproximately $53,815. Interest expense related to notes payable in 2009 was$179,602, compared to interest expense in 2008 of $338,630. These decreases were due to lower interest rates onthe Highbridge note, three months’ less interest on the Highbridge note becauseit was paid off on September 15, 2009, and the decreasing principal on theAmscan note, which were partially offset by the higher principal under ourcredit facility due to the pay off of the Highbridge note. Our average notespayable balance was approximately $2,505,201 during 2009, compared to$3,689,225 in 2008, which decreased interest expense by approximately $174,329.The effective interest rate on our notes payable decreased to 12.6% in 2009,compared to 14.7% in 2008, which decreased interest expense by $52,883.Additionally, interest expense from capital leases and other sources in 2009decreased by $2,004 from 2008.

 

*Income taxes*

 

In 2009, our income tax benefit was $147,930, whichincluded $39,212 for current federal taxes, $227,545 for current state incometaxes, and a deferred tax benefit of $414,687. Our provision for current statetaxes exceeds the average statutory rate net of federal tax benefit because ofpermanent and temporary differences between taxable and book income, includingamounts associated with stock based compensation expense, depreciation, andamortization of intangibles and common stock warrants. The deferred tax benefitof $414,687 resulted from the release of a portion of our deferred taxvaluation reserves, which was based on our estimates of fiscal 2010 book andtax income. We were able to utilize approximately $2,566,584 of net operatingloss carryforwards for federal income tax purposes in 2009, which were fullyreserved for in the prior year due to the uncertainty of future taxable income.

 

In 2008, our provision for income taxes was $50,605, whichincluded $16,485 for federal alternative minimum taxes and $34,120 for stateincome taxes. Our provision for state taxes exceeded the average statutory ratenet of federal tax benefit because of permanent and temporary differences, forwhich we provided a valuation allowance, between taxable and book income,including amounts associated with stock based compensation expense, depreciation,and amortization of intangibles and common stock warrants. We were able toutilize approximately $886,387 of net operating loss carryforwards for federalincome tax purposes in 2008, which were fully reserved for in the prior yeardue to the uncertainty of future taxable income.

 

At the end of 2009, we had estimated net operating losscarryforwards of approximately $17.9 million, which begin to expire in2019.  In accordance with Section 382of the Internal Revenue Code, the use of these carryforwards may be subject toannual limitations based upon certain ownership changes of our stock that mayhave occurred or that may occur.

 

*Net income (loss)*

 

Our netincome in 2009 was $1,103,732 or $0.03 net income per basic and diluted share,compared to a net loss of $440,055 or $0.02 net loss per basic and dilutedshare in 2008.

 

**Fiscal 2008 Compared to Fiscal 2007**

** **

*Revenues*

 

Our consolidated revenues for 2008 were $81,210,999, adecrease of $587,635, or 0.7% from 2007. Revenues include the selling price of party goods sold, net of returnsand discounts, and are recognized at the point of sale.

 
| ** **                                       | ** ** | **For the year ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **Dec 27, 2008**       | ** ** | **Dec 29, 2007** | ** ** |
| Revenues                                         |       | $                      | 81,210,999 |   | $ | 81,798,634 |   |
|                                             |       |                   |       |   |   |
| Increase  (decrease) in revenues from prior year |       | -0.7                   | %          | 4.3 | % |
|                                                  |            |                        |            |  |  |  |  |

 

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Sales for 2008 included a decrease of 2.4% in comparablestore sales, and sales from two stores that we acquired in the first quarter of2008, but were not included in the comparable stores sales calculation untilthe first quarter of 2009, the stores’ one year anniversary.

 

*Cost of goods sold and occupancy costs*

 

Our cost of products sold and occupancy costs for 2008 was$46,885,215, or 57.7% of revenues, an increase of $419,774 and an increase of0.9 percentage points, as a percentage of revenues, from 2007.  Cost of products sold and occupancy costsconsist of the cost of merchandise sold to customers and the occupancy costsfor our stores.

 
| ** **                              | ** ** | **For the year ended** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **Dec 27, 2008**       | ** ** | **Dec 29, 2007** | ** ** |
| Cost  of goods sold and occupancy costs |       | $                      | 46,885,215 |   | $ | 46,465,441 |   |
|                                    |       |                   |       |   |   |
| Percentage  of revenues                 |       | 57.7                   | %          | 56.8 | % |
|                                         |            |                        |            |  |  |  |  |

 

As a percentage of revenues, the increase in cost ofproducts sold was primarily attributable to increased occupancy costs due toscheduled rent escalations and other occupancy related costs.

 

*Marketing and sales expense*

 

Our consolidated marketing and sales expense for 2008 was$26,793,885 or 33.0% of revenues, an increase of $612,381 and an increase of1.0 percentage point, as a percentage of revenues, from 2007.  Marketing and sales expenses consistprimarily of advertising and promotional expenditures, all store payroll andrelated expenses for personnel engaged in marketing and selling activities andother non-payroll expenses associated with operating our stores.

 
| ** **              | ** ** | **For the year ended** | ** ** |
|-------------------------|------------|------------------------|------------|
| ** **              | ** ** | **Dec 27, 2008**       | ** ** | **Dec 29, 2007** | ** ** |
| Marketing  and sales    |       | $                      | 26,793,885 |   | $ | 26,181,504 |   |
|                    |       |                   |       |   |   |
| Percentage  of revenues |       | 33.0                   | %          | 32.0 | % |
|                         |            |                        |            |  |  |  |  |

 

As a percentage of revenues, the increase in marketing andsales expense was primarily attributable to store opening costs associated withthe two Rhode Island stores acquired on January 2, 2008 and two temporaryHalloween stores opened in September 2008, plus increased payroll costs.

 

*General and administrative expense*

 

Our consolidated general and administrative (“G&A”)expenses for 2008 were $7,205,067, or 8.9% of revenues, a decrease of $348,802,or 0.3 percentage points as a percentage of revenues, from 2007. G&Aexpenses consist of payroll and related expenses for executive, merchandising,finance and administrative personnel, as well as information technology,professional fees and other general corporate expenses.

 
| ** **                  | ** ** | **For the year ended** | ** ** |
|-----------------------------|------------|------------------------|------------|
| ** **                  | ** ** | **Dec 27, 2008**       | ** ** | **Dec 29, 2007** | ** ** |
| General  and administrative |       | $                      | 7,205,067  |   | $ | 7,553,869 |   |
|                        |       |                   |       |   |   |
| Percentage  of revenues     |       | 8.9                    | %          | 9.2 | % |
|                             |            |                        |            |  |  |  |  |

 

As a percentage of revenues, the decrease in general andadministrative expense was primarily attributable to the reduction in generaland administrative payroll expense and incentive based compensation.

 

19

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*Operating income*

 

Our operating income for 2008 was $326,832, or 0.4% ofrevenues, compared to an operating income of $1,597,820, or 2.0% of revenues in2007.

 

### *Interest expense*

### * *

Ourinterest expense in 2008 was $720,891, a decrease of $136,721 from 2007.  The decrease during 2008 was due primarily tointerest expense related to the decrease in prime rate during the year.  The effective interest rate on our borrowingsunder our line of credit decreased to 4.7% during 2008 compared to 8.2% in2007, which decreased interest expense by approximately $126,664. The interestrate was based on the bank’s base rate. Our average revolving loan balance wasapproximately $3,656,861 during 2008 compared to $2,071,953 in 2007, whichincreased interest expense by approximately $129,983. Interest expense relatedto notes payable in 2008 was $338,630, compared to interest expense in 2007 of $463,862. These decreases were dueto lower interest rates on the Highbridge note and the decreasing principal onthe Amscan note. Our average notes payable balance was approximately $3,689,225during 2008, compared to $4,079,132 in 2007, which decreased interest expenseby approximately $63,891. The effective interest rate on our notes payabledecreased to 14.7% in 2008, compared to 16.3% in 2007, which decreased interestexpense by $61,341. Additionally, interest expense from capital leases andother sources in 2008 decreased by $14,809 from 2007. Interest expense in 2008was also slightly offset by interest income of $4,609.

 

*Income taxes*

 

In 2008, our provision for income taxes was $50,605, whichincluded $16,485 for federal alternative minimum taxes and $34,120 for stateincome taxes. Our provision for state taxes exceeds the average statutory ratenet of federal tax benefit because of permanent and temporary differences, forwhich we provide a valuation allowance, between taxable and book income,including amounts associated with stock based compensation expense,depreciation, and amortization of intangibles and common stock warrants. Wewere able to utilize approximately $886,387 of net operating loss carryforwardsfor federal income tax purposes in 2008, which were fully reserved for in theprior year due to the uncertainty of future taxable income.

 

In 2007, our provision for income taxes was $146,323, whichincluded $19,215 for federal alternative minimum taxes and $127,108 for stateincome taxes. Our provision for state taxes exceeds the average statutory ratenet of federal tax benefit because of permanent and temporary differences, forwhich we provided a valuation allowance, between taxable and book income,including amounts associated with stock based compensation expense,depreciation, and note payable amortization. We were able to utilize approximately$1,436,844 of net operating loss carryforwards for federal income tax purposesin 2007, which were fully reserved for in the prior year due to the uncertaintyof future taxable income.

 

At the end of 2008, we had estimated net operating losscarryforwards of approximately $20.3 million, which begin to expire in2019.  In accordance with Section 382of the Internal Revenue Code, the use of these carryforwards may be subject toannual limitations based upon certain ownership changes of our stock that may haveoccurred or that may occur.

 

*Net income (loss)*

 

Our netloss in 2008 was $440,055 or $0.02 net loss per basic and diluted share,compared to net income of $611,691, or $0.02 net income per basic and dilutedshare, in 2007.

 

**Critical Accounting Policies**

** **

Our financial statements are based on the application ofsignificant accounting policies, many of which require our management to makesignificant estimates and assumptions (see Note 2 to our consolidated financialstatements).  We believe the following accountingpolicies to be those most important to the portrayal of our financial conditionand operating results and those that require the most subjective judgment.  If actual results differ 

 

20

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significantly from management’s estimates and projections,there could be a material effect on our financial statements.

 

*Inventory and Related Allowance for Obsolete and Excess Inventory*

 

Ourinventory consists of party supplies and is valued at the lower of movingweighted-average cost or market which approximates FIFO (first-in,first-out).  We record vendor rebates,discounts and certain other adjustments to inventory, including freight costs,and we recognize these amounts in the income statement as the related goods aresold.

 

During eachinterim reporting period, we estimate the impact on cost of products soldassociated with inventory shortage.  Theactual inventory shortage is determined upon reconciliation of the annualphysical inventory, which occurs shortly before and after our year end, and anadjustment to cost of products sold is recorded at the end of the fourthquarter to recognize the difference between the estimated and actual inventoryshortage for the full year.  Theadjustment in the fourth quarter of 2009 included an estimated reduction of$142,010 to the cost of goods sold during the previous three quarters.  The adjustment in the fourth quarter of 2008included an estimated reduction of $261,915 to the cost of products sold duringthe previous three quarters.  Theadjustment in the fourth quarter of 2007 included an estimated reduction of$123,249 to the cost of products sold during the previous three quarters.

 

We alsomake adjustments to reduce the value of our inventory for an allowance for obsoleteand excess inventory, which is based on our review of inventories on handcompared to estimated future sales. We conduct reviews periodically throughoutthe year on each stock keeping unit (“SKU”). As we identify obsolete and excessinventory, we take immediate measures to reduce our inventory risk on theseitems and we adjust our allowance accordingly. Thus, actual results coulddiffer from our estimates.

 

*Revenue Recognition*

 

Revenues include the selling price of party goods sold, netof returns and discounts, and are recognized at the point of sale. We estimatereturns based upon historical return rates and such amounts have not beensignificant.

 

*Property and Equipment*

 

Property and equipment are stated at cost less accumulateddepreciation and are depreciated on the straight-line method over the estimateduseful lives of the assets. Expenditures for maintenance and repairs arecharged to operations as incurred.

 

*Intangible Assets*

 

Intangible assets consist primarily of the values of twonon-compete agreements acquired in conjunction with the purchase of retailstores in 2006 and 2008, and the values of retail store leases acquired inthose transactions.

 

The firstnon-compete agreement, from Party City Corporation and its affiliates, coversMassachusetts, Maine, New Hampshire, Vermont, Rhode Island, and Windsor and NewLondon counties in Connecticut, and expires in 2011.  The second non-compete agreement was acquiredin connection with our purchase in January 2008 of two franchised partysupply stores in Lincoln and Warwick, Rhode Island.  The acquired Rhode Island stores had beenoperated as Party City franchise stores, and were converted to iParty storesimmediately following the closing. The second non-compete agreement coversRhode Island for five years from the date of closing and within a certaindistance from our stores in the rest of New England for three years. Bothnon-compete agreements have an estimated life of 60 months and are subject tocertain terms and conditions in their respective acquisition agreements.

 

Theoccupancy valuations related to acquired retail store leases are for stores inPeabody, Massachusetts (estimated life of 90 months), Lincoln, Rhode Island(estimated life of 79 months) and Warwick, Rhode Island (estimated life of 96months). Intangible assets also include legal and other transaction costsincurred related to the purchase of the Peabody, Lincoln and Warwick stores.

 

21

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Non-competeagreements are amortized based on the pattern of their expected cash flowbenefits. Occupancy valuations are amortized on a straight line basis over theterms of the related leases.

 

*Impairment of Long-Lived Assets*

 

In connection with our ongoing long-lived asset assessment,we perform a review of each store for impairment indicators whenever events andchanges in circumstances suggest that the carrying amounts may not berecoverable from estimated future store cash flows.  Our review considers store operating results,future sales growth and cash flows.  Theconclusion regarding impairment may differ from current estimates if underlyingassumptions or business strategies change. We closed two stores in early January 2008, at the end of theirlease terms.  No impairment charges wererequired for these stores, as the assets related to them have been fullyamortized, except for immaterial amounts, and no liability existed for futurelease costs.

 

We are not aware of any impairment indicators for any ofour remaining stores at December 26, 2009.

 

*Income Taxes*

 

Historically,we have not recognized an income tax benefit for our losses. Accordingly, werecord a valuation allowance against our deferred tax assets because of theuncertainty of future taxable income and the realizability of the deferred taxassets.  In determining if a valuationallowance against our deferred tax asset is appropriate, we consider bothpositive and negative evidence.  Thepositive evidence that we considered included (1) we were profitable in2009, 2007 and 2006, (2) we have achieved positive comparable store salesgrowth for six out of the last eight years, (3) we were able tosignificantly reduce store and headquarters operating expenses in 2009, and (4) wewere able to use federal net operating loss deductions in each tax year from2002 through 2008, and expect to do so for tax year 2009.  The negative evidence that we consideredincluded (1) we realized a net loss in 2005 and 2008, (2) ourmerchandise margins decreased in 2009, 2008, 2006 and 2005, (3) our futureprofitability is vulnerable to certain risks, including (a) the risk thatwe may not be able to generate significant taxable income to fully utilize ournet operating loss carryforwards of approximately $17.9 million at December 26,2009, (b) the risk of unseasonable weather and other factors in a singlegeographic region, New England, where our stores are concentrated, (c) therisk of being so dependent upon a single season, Halloween, for a significantamount of annual sales and profitability and (d) the risk of fluctuatingprices for petroleum products, which are a key raw material for much of ourmerchandise and which affect our freight costs and those of our suppliers andaffect our customers’ spending levels and patterns, (4) the costs thatopening or acquiring new stores will put pressure on our profit margins untilthese stores reach maturity, (5) the expected costs of increasedregulatory compliance, including, without limitation, those associated with Section 404of the Sarbanes-Oxley Act, will likely have a negative impact on ourprofitability, (6) the risk that a continued, general or perceivedslowdown in the U.S economy, or uncertainty as to the economic outlook, whichthe U.S. and world economies have recently experienced, could continue toreduce discretionary spending or cause a shift in consumer discretionaryspending to other products.

 

Thepositive evidence is strong enough for us to conclude that we will realizesufficient levels of taxable income in 2010 to support the release of a portionof the related reserves in fiscal 2009. However, we believe that it is prudentfor us to maintain a valuation allowance against our remaining deferred taxassets until we have a longer track record of profitability and we can reduceour exposure to the risks described above. Should we determine that we will be able to realize our deferred taxassets in the future, an adjustment to our deferred tax assets would increaseincome in the period we made such a determination.

 

*Stock Option Compensation Expense*

 

We use the Black-Scholes option pricing model to determinethe fair value of stock based compensation. The Black-Scholes model requires us to make several subjectiveassumptions, including the estimated length of time employees will retain theirvested stock options before exercising them (“expected term”), and theestimated volatility of our common stock price over the expected term, which isbased on historical volatility of our common stock over a time period equal tothe expected term.  The Black-Scholes modelalso requires a risk-free interest rate, which is based on the U.S. Treasuryyield curve in effect at the time of the grant, and the dividend yield on ourcommon stock, which is assumed to be zero since we do not pay dividends andhave no current plans to do so in the 

 

22

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future.  Changes inthese assumptions can materially affect the estimate of fair value of stockbased compensation and consequently, the related expense recognized in theConsolidated Statements of Operations. We recognize stock based compensation expense on a straight-line basisover the vesting period of each grant.

 

*Use of Estimates*

 

The preparation of financial statements in conformity withaccounting principles generally accepted in the United States requires us tomake estimates 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 AccountingPronouncements**

 

In December 2009,the Financial Accounting Standards Board (“FASB”) issued Update No. 2009-16*Transfers and Servicing (Topic 860); Accounting forTransfers of Financial Assets**— an amendment of FASBStatement No. 166.*Update No. 2009-16 will be effectivefor financial statements issued for fiscal years and interim periods beginningafter November 15, 2009, with early adoption encouraged, or for us thefiscal year ending December 25, 2010. We do not expect the adoption ofUpdate No. 2009-16 (Topic 860) to have a material effect on our financialstatements.

 

In December 2009,FASB issued Update No. 2009-17 *Consolidations (Topic810); Improvements to Financial Reporting by Enterprises Involved with VariableInterest Entities— an amendment of FASB Statement No. 167. * Update No. 2009-17 will be effective forfinancial statements issued for fiscal years and interim periods beginningafter November 15, 2009, with early adoption encouraged, or for us thefiscal year ending December 25, 2010. We do not expect the adoption ofUpdate No. 2009-17 (Topic 810) to have a material effect on our financialstatements.

 

In January 2010,FASB issued Update No. 2010-01 *Equity (Topic 505)Accounting for Distributions to Shareholders with Components of Stock and Cash(A Consensus of the FASB Emerging Issues Task Force). *Update No. 2010-01 iseffective for financial statements issued for fiscal years and interim periodsending on or after December 15, 2009, or for us the fiscal year ending December 26,2009, and is applied on a retrospective basis. The adoption of Update No. 2010-01(Topic 505) did not have a material effect on our financial statements.

 

In January 2010,FASB issued Update No. 2010-02, *Consolidation (Topic 810);Accounting and Reporting for Decreases in Ownership of a Subsidiary — a ScopeClarification. *Update No. 2010-02is effective for financial statements issued for fiscal years and interimperiods ending on or after December 15, 2009, or for us the fiscal yearended December 26, 2009, and is applied on a retrospective basis. Theadoption of Update No. 2010-02 (Topic 810) did not have a material effecton our financial statements.

 

In January 2010,FASB issued Update No. 2010-06, *Fair Value Measurementsand Disclosures (Topic 820) Improving Disclosures about Fair ValueMeasurements.*Update No. 2010-06 is effective for financialstatements issued for fiscal years and interim periods beginning after December 15,2009, or for us the fiscal year ending December 25, 2010, except for thedisclosure referencing purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscalyears beginning after December 15, 2010, and for interim periods withinthose years with early adoption encouraged. We do not anticipate that the adoption of Update No. 2010-06 (Topic820) will have a material effect on our financial statements.

 

23

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**Liquidity and Capital Resources**

** **

Our primary uses of cash are:

 

·      purchasesof inventory, including purchases under our Supply Agreement with Amscan, asdescribed more fully below;

·      occupancyexpenses of our stores;

·      employeesalaries; and

·      newand temporary store openings, including acquisitions.

 

Our primary sources of cash are:

 

·      cashfrom operating activities; and

·      debt,including our line of credit and note payable.

 

Our prospective cash flows are subject to certain trends,events and uncertainties, including demands for capital to support growth,improve our infrastructure, respond to economic conditions, and meetcontractual commitments. Based on our current operating plan, we believe thatanticipated revenues from operations and borrowings available under our line ofcredit will be sufficient to fund our operations, working capital requirements,scheduled note payment as discussed below, and capital expenditures through the next twelve months.  In the event that our operating plan changesdue to changes in our strategic plans, lower-than-expected revenues, unanticipatedexpenses, increased competition, unfavorable economic conditions, declines inconsumer confidence and spending, or other unforeseen circumstances, ourliquidity may be negatively impacted.  Ifso, we could be required to adjust our expenditures for 2010 to conserveworking capital or raise additional capital, possibly including debt or equityfinancing and to fund operations and our business strategy.  Given the current state of the debt andequity markets, this could be difficult and expensive, and we might not be ableto do so on terms acceptable to us.

 

*Notes Payable*

 

At the beginning of our fiscalyear 2009, we had three notes payable outstanding. We refer to these notes asthe Highbridge Note, the Amscan Note and the Party City Note.  For a more detailed description of thesenotes, we refer you to the section titled “Notes Payable” in the Notes toConsolidated Financial Statements for the year ended December 26, 2009included in Item 8 of this Annual Report on Form 10-K. In the thirdquarter of 2009, we paid in full the Highbridge Note and the Amscan Note. TheHighbridge note was paid off through additional borrowings under our line ofcredit with Wells Fargo. The Amscan Note was payable in monthly installments,the last of which was paid in September, 2009. At December 26, 2009 onlythe Party City Note, with a principal balance of $600,000 remained outstanding.The full principal amount is due at the note’s maturity on August 7, 2010.

 

In connection with the issuanceof the Highbridge Note, we also issued a warrant, the Highbridge Warrant,exercisable for 2,083,334 shares of our common stock at an exercise price of$0.475 per share, or 125% of the closing price of our common stock on the dayimmediately prior to the closing of the transaction.  The agreements entered into in connection withthe financing granted Highbridge resale registration rights with respect to theshares of common stock underlying the Highbridge Warrant and provide forcertain anti-dilution rights and other covenants with respect to the listing ofour common stock. The issuance of the Highbridge Warranttriggered certain anti-dilution provisions of our Series B, C, and Dconvertible preferred stock.

 

*Line of Credit*

 

On July 1, 2009, we enteredinto a Second Amended and Restated Credit Agreement (the “new line”) with WellsFargo Retail Finance, LLC (“Wells Fargo”), which amended and restated theprevious revolving credit facility with Wells Fargo.  The new line continues the revolving line ofcredit in the amount of up to $12,500,000 and extends the maturity date forthree years to July 2, 2012. As with the previous line with Wells Fargo,the new line includes an option whereby we may increase the revolving line ofcredit up to a maximum level of $15,000,000 at any time prior to July 2,2011. The amount of credit that is available from time to time under theAgreement is 

 

24

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determined as a percentage of thevalue of eligible inventory plus a percentage of the value of eligible creditcard receivables, as reduced by certain reserve amounts that may be required byWells Fargo.

 

Borrowings under the new linewill generally accrue interest at a margin ranging from 3.00% to 3.50%(determined according to the average daily excess availability during thefiscal quarter immediately preceding the adjustment date) over, at ourelection, either the London Interbank Offered Rate (“LIBOR”) or a base ratedetermined by Wells Fargo from time to time.  The new line margins are an increase over the previous line, and mayresult in an increase in overall borrowing cost under the new line.  The new line also provides for letters ofcredit for up to a sublimit of $2 million to be used in connection with inventorypurchases and includes an unused line fee on the unused portion of therevolving credit line. The new line also provided for a closing fee of$125,000, which was paid to Wells Fargo at closing.  Our obligations under the new line continue to be securedby a lien on substantially all of our personal property.

 

Our inventory consists of party supplies which are valuedat the lower of weighted-average cost or market, which approximates FIFO(first-in, first-out) and are reduced by an allowance for obsolete and excessinventory and are further reduced or increased by other adjustments, includingvendor rebates and discounts and freight costs. Our line of credit availability calculation allows us to borrow against “acceptableinventory at cost”, which is based on our inventory at cost and applies adjustmentsthat our lender has approved, which may be different than adjustments we usefor valuing our inventory in our financial statements, such as the adjustmentto reserve for inventory shortage.  Theamount of “acceptable inventory at cost” was approximately $12,759,103 at December 26,2009.

 

Our accounts receivable consist primarily of credit cardreceivables and vendor rebates receivable. Our line of credit availability calculation allows us to borrow against “eligiblecredit card receivables”, which are the credit card receivables for theprevious two to three days of business. The amount of “eligible credit card receivables” was approximately$286,640 at December 26, 2009.

 

Our total borrowing base is determined by adding the “acceptableinventory at cost” times an agreed upon advance rate plus the “eligible creditcard receivables” times an agreed upon advance rate but not to exceed ourestablished credit limit, which was $12,500,000 at December 26, 2009.  Under the terms of our line of credit, our$12,500,000 credit limit was further reduced by (1) a minimum availabilityblock, (2) customer deposits, (3) gift certificates, (4) merchandisecredits and (5) outstanding letters of credit. The amounts outstandingunder our line were $2,526,982 at December 26, 2009 and $1,950,019 as of December 27,2008, an increase of $576,963. Our additional availability was $3,450,662 at December 26,2009 and $4,694,603 at December 27, 2008.

 

The outstanding balances under our line are classified ascurrent liabilities in the accompanying consolidated balance sheets because weare required to apply daily lock-box receipts to reduce the amount outstanding.

 

As with the previous line, the new line hasfinancial covenants that are limited to minimum availability and capitalexpenditures and contains various restrictive covenants, such as incurrence,payment or entry into certain indebtedness, liens, investments, acquisitions,mergers, dispositions and dividends. Under the new line, we are required to maintain a minimumavailability of 7.5% of the credit limit, which is an increase from theprevious requirement of 5% and, consistent with the previous line, to limit ourcapital expenditures to within 110% of those amounts included in our businessplan, which may be updated from time to time. At December 26, 2009, we were in compliance with these financialcovenants.

 

The new line containsevents of default customary for credit facilities of this type.  Upon an event of default that is not cured orwaived within any applicable cure periods, in addition to other remedies thatmay be available to Wells Fargo, the obligations under the new line may beaccelerated, outstanding letters of credit may be required to be cashcollateralized and the lenders may exercise remedies to collect the balancedue, including to foreclose on the collateral. Should the new line be prepaid or the maturity accelerated for anyreason, we would be responsible for an early termination fee in the amount of (i) 1.50%of the revolving credit facility ceiling then in effect within the first yearof the term of the facility, (ii) 1.00% of the revolving credit facilityceiling then in effect within the second year of the term of the facility and (iii) 0.50%thereafter.

 

25

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*SupplyAgreement with Amscan*

 

Our Supply Agreement with Amscan gives us the right toreceive certain additional rebates and more favorable pricing terms over theterm of the agreement than generally were available to us under our previousterms with Amscan.  The right to receiveadditional rebates, and the amount of such rebates, are subject to ourachievement of increased levels of purchases and other factors provided for inthe Supply Agreement.  In exchange, theSupply Agreement obligates us to purchase increased levels of merchandise fromAmscan until 2012.   Beginning withcalendar year 2008, the Supply Agreement requires us to purchase on an annualbasis merchandise equal to the total number of our stores open during suchcalendar year, multiplied by $180,000. The Supply Agreement provides for penalties in the event we fail toattain the annual purchase commitment that would require us to pay Amscan thedifference between the purchases for that year and the annual purchasecommitment for that year. Under the terms of the Supply Agreement, the annualpurchase commitment for any individual year can be reduced for orders placed byus but not filled by the supplier. During 2008, the supplier experienced difficulty in fulfilling certainof our orders sourced out of China. Accordingly, the supplier agreed to reduce our purchase commitment for2008 to 90% of the contractual minimum for that year. Our purchases for 2008exceeded the minimum purchase amount commitments, as adjusted, under the SupplyAgreement. Our purchases for 2009 fell short of the annual commitment byapproximately $368,000. The supplier has agreed to allow us to roll overany shortfall for the year 2009 into future years’ requirements. We are notaware of any reason that would prevent us from meeting the minimum purchaserequirements, including the 2009 shortfall, for the remainder of the term of the Supply Agreement. Although we do not expectto incur any penalties under this Supply Agreement, if they were to occur,there could be a material adverse effect on our uses and sources of cash.

 

*Operating,Investing and Financing Activities*

 

Our operating activities provided $3,256,482 in 2009 compared to$3,229,642 in 2008, an increase of $26,840. The increase in cash provided by operating activities was primarily dueto the increase in net income in 2009, offset by an increase in prepaidexpenses at the end of 2009 compared to 2008. The increase in prepaid expenseat the end of 2009 was the result of the timing of January rent paymentscompared to the prior year.

 

We used $525,563 in investingactivities in 2009 compared to $2,027,709 in 2008, a decrease of$1,502,146.  The cash invested in 2009was primarily due to the modification of our internal systems to improve ourcompliance with payment card industry data security standards, storeimprovements and the relocation of our Walpole store to a new, largerlocation.  The cash invested in 2008 wasprimarily due to the acquisition in January 2008 of two retail storeslocated in Rhode Island and the related non-compete agreement (see discussionbelow).

 

We used $2,730,119 in financingactivities in 2009 compared to $1,213,215 during 2008, an increase of$1,516,904.  The increase was primarilyrelated to the repayment of the Highbridge note payable in September 2009.

 

*ContractualObligations*

 

Contractual obligations at December 26, 2009 were asfollows:

 
| ** **                                        | ** ** | **Payments Due By Period** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|
| ** **                                        | ** ** | **Within  1 Year**         | ** ** | **Within   2 - 3   Years** | ** ** | **Within   4 - 5   Years** | ** ** | **After**

**5 Years** | ** ** | **Total** | ** ** |
| Line  of credit                                   |       | $                          | 2,529,886  |   | $ | — |   | $ | — |   | $ | — |   | $ | 2,529,886 |   |
| Capital  lease obligations                        |       | 11,400                     |       | 17,100 |   | — |   | — |   | 28,500 |   |
| Notes  payable                                    |       | 662,626                    |       | — |   | — |   | — |   | 662,626 |   |
| Supply  agreement                                 |       | 9,548,748                  |       | 14,535,000 |   | — |   | — |   | 24,083,748 |   |
| Operating  leases (including retail space leases) |       | 9,406,207                  |       | 16,613,936 |   | 11,055,925 |   | 10,019,664 |   | 47,095,732 |   |
| Total  contractual obligations                    |       | $                          | 22,158,867 |   | $ | 31,166,036 |   | $ | 11,055,925 |   | $ | 10,019,664 |   | $ | 74,400,492 |   |

 

26

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In addition, at December 26, 2009, we had outstandingpurchase orders totaling approximately $2,088,061 for the acquisition ofinventory and non-inventory items that were scheduled for delivery after December 26,2009.

 

**Acquisitions**

 

We operate in a largely un-branded market that has manysmall businesses.  As a result, we haveconsidered, and may continue to consider, growing our business throughacquisitions of other entities.  Anydetermination to make an acquisition will be based upon a variety of factors,including, without limitation, the purchase price and other financial terms ofthe transaction, the business prospects, geographical location and the extentto which any acquisition would enhance our prospects

 

On January 2, 2008, we completed the purchase of tworetail stores located in Rhode Island and a related non-compete agreement. Theaggregate consideration paid was $1,350,000 plus approximately $195,000 forassociated inventory. The stores were converted into iParty stores immediatelyfollowing the closing of the transaction. We did not complete any other acquisitions in 2008 or 2009, although weopened two temporary Halloween stores during the fourth quarter of 2008, andfour temporary Halloween stores and one new store during the fourth quarter of2009.

 

**Stockholder Rights Plan**

** **

On November 9, 2001, we announced that our board ofdirectors adopted a stockholder rights plan (the “rights plan”).  Under the rights plan each share of ourcapital stock outstanding at the close of business on November 9, 2001 andeach share of our capital stock issued subsequent to that date has a rightassociated with it, 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 10percent or more of our voting stock or if a party announces an offer to acquire15 percent or more of our voting stock. The rights expire on November 9, 2011.  When exercisable, each right entitles theholder to purchase from us one one-hundredth of a share of a new series of Series Gjunior preferred stock at an initial purchase price of $2.00, subject toadjustment.  In addition, upon theoccurrence of certain events, holders of the rights will be entitled topurchase either iParty Corp. stock or shares in an “acquiring entity” at halfof market value.  We generally will beentitled to redeem the rights at $0.001 per right at any time until the date onwhich a 10 percent position in our voting stock is acquired by any person orgroup.  Until a right is exercised, theholder of a right will have no rights as a stockholder of iParty solely by virtueof being a rights holder, including, without limitation, the right to vote orreceive dividends.

 

On September 15, 2006, we amended the rights plan toclarify that the issuance of the Highbridge Warrant did not constitute atriggering event under the rights plan.

 

**Seasonality**

** **

**Due to the seasonality of our business,sales and operating income are typically higher in the second and fourthquarters.  Our business is highlydependent upon sales of Easter, graduation and summer merchandise in the secondquarter and sales of Halloween and Christmas merchandise in the fourthquarter.  We have typically operated at aloss during the first and third quarters.**

** **

**Geographic Concentration**

** **

**As of December 26, 2009, weoperated a total of 51 stores, 46 of which are located in New England**and 5 of which are located in Florida. As aresult, a severe or prolonged regional recession or regional changes indemographics, employment levels, population, weather patterns, real estatemarket conditions, consumer confidence and spending patterns or other factorsspecific to the New England region or in Florida mayadversely affect us more than a company that is more geographically diverse.

** **

**Effects of Inflation**

** **

While we do not view the effects of inflation as having adirect material effect upon our business, we believe that volatility in oil andgasoline prices impacts the cost of producing petroleum-based/plastic products,which are a 

 

27

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key raw material in much of our merchandise, and alsoimpacts prices of shipping products made overseas in foreign countries, such asChina, which includes much of our merchandise. Volatile oil and gasoline prices also impact our freight costs, consumerconfidence and spending patterns.  Theseand other issues directly or indirectly affecting our vendors and us couldadversely affect our business and financial performance.

 

**Off-Balance SheetArrangements**

 

We do nothave any off-balance sheet arrangement that has or is reasonably likely to havea current or future effect on our financial condition, changes in financialcondition, revenues or expenses, results of operations, liquidity, capitalexpenditures or capital resources that is material to investors.

 

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

 

We are exposedto market risk from changes in interest rates and, indirectly, foreign exchangerates and commodity price risk with respect to fluctuating oil prices as morefully described in Item 1A, “Risk Factors”. In general, however, we do not believe we have the various market orprice risks that require the quantitative and qualitative disclosures set forthin Item 305 of Regulation S-K.  We haveinterest rate risk on our line of credit debt obligation to the extent that ifinterest rates were to rise our rate of interest under our line of credit wouldalso increase.  We do not believe thatthis interest rate risk is material and we have not entered into any hedging orsimilar contractual arrangements with respect to such risk or with respect tothe indirect market risks we face from changes in foreign exchange rates andoil prices.  We do not enter intocontracts for trading purposes.

 

**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)       *Evaluation of Disclosure Controls and Procedures.*  The Chief Executive Officer and the ChiefFinancial Officer of iParty (its principal executive officer and principalfinancial officer, respectively) have concluded, based on their evaluation asof December 26, 2009, the end of the fiscal year to which this reportrelates, that iParty’s disclosure controls and procedures: are effective toensure that information required to be disclosed by iParty in the reports filedor submitted by it under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms; and include controls and procedures designedto ensure that information required to be disclosed by iParty in such reportsis accumulated and communicated to iParty’s management, including the ChiefExecutive Officer and the Chief Financial Officer, to allow timely decisionsregarding required disclosure.  iParty’sdisclosure controls and procedures were designed to provide a reasonable levelof assurance of reaching iParty’s disclosure requirements and are effective in reachingthat level of assurance.

 

(b)       *Management’s Report on Internal Control OverFinancial Reporting.*Our management is responsible for establishingand maintaining adequate internal control over financial reporting, as definedin Rules 13a-15(f) and 15d-15(f) under the Securities ExchangeAct of 1934, as amended.

 

Because of its inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements. Also, projectionsof any evaluation of effectiveness to future periods are subject to risk thatcontrols may become inadequate because of changes in conditions, or the degreeof compliance with the policies and procedures may deteriorate.

 

28

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Ourmanagement has assessed the effectiveness of its internal control overfinancial reporting as of December 26, 2009. This evaluation was based onthe framework in *Internal Control-IntegratedFramework* issued by the Committee of Sponsoring Organizations (“COSO”).Based on its assessment, our management concluded that our internal controlover financial reporting was effective as of December 26, 2009 to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles.

 

*This report shall not be deemed to befiled for purposes of Section 18 of the Securities Exchange Act of 1934 orotherwise subject to the liability of that Section nor incorporated byreference into a filing under the Securities Act of 1933 or Securities ExchangeAct of 1934.*

 

(c)       *AttestationReport of the Registered Public Accounting Firm*.  We are not an accelerated filer, as such termis defined in Rule 12b-2 under the Securities Exchange Act of 1934, asamended.  Accordingly, this annual reportdoes not include an attestation report of our independent registered publicaccounting firm regarding internal control over financial reporting asmanagement’s report was not subject to attestation by our registered publicaccounting firm pursuant to temporary rules of the SEC that permit us toprovide only management’s report in this annual report.

 

(d)      *Changesin Internal Controls.*  Nochange in our internal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934, as amended) occurredduring the fiscal year ended December 26, 2009 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**ITEM 9A(T).CONTROLS AND PROCEDURES**

 

Theinformation required by this Item is included in Item 9A of this report.

 

**ITEM 9B. OTHER INFORMATION**

 

None.

 

**PART III**

** **

**ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

 

Theinformation required by this Item is contained in our proxy statement for theannual meeting of stockholders scheduled to be held on June 2, 2010, whichwe plan to file with the SEC no later than 120 days after the end of our fiscalyear ended December 26, 2009.  Suchinformation is hereby incorporated by reference.

 

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

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

Theinformation required by this Item is contained in our proxy statement for theannual meeting of stockholders scheduled to be held on June 2, 2010, whichwe plan to file with the SEC no later than 120 days after the end of our fiscalyear ended December 26, 2009.  Suchinformation is hereby incorporated by reference.

 

**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS**

 

Theinformation required by this Item is contained in our proxy statement for theannual meeting of stockholders scheduled to be held on June 2, 2010, whichwe plan to file with the SEC no later than 120 days after the end of our fiscalyear ended December 26, 2009.  Suchinformation is hereby incorporated by reference.

 

29

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**ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

Theinformation required by this Item is contained in our proxy statement for theannual meeting of stockholders scheduled to be held on June 2, 2010, whichwe plan to file with the SEC no later than 120 days after the end of our fiscalyear ended December 26, 2009.  Suchinformation is hereby incorporated by reference.

 

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

 

Theinformation required by this Item is contained in our proxy statement for theannual meeting of stockholders scheduled to be held on June 2, 2010, whichwe plan to file with the SEC no later than 120 days after the end of our fiscalyear ended December 26, 2009.  Suchinformation is hereby incorporated by reference.

 

**PART IV**

 

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENTSCHEDULES**

 

(a)          1.Financial statements:

 

For a listing of consolidated financial statements whichare included in this document, see page F-1.

 

2. Financial Statement Schedules:

 

All schedules for which provision is made under Item 15(a)(2) areinapplicable and, therefore, have been omitted.

 

3. Exhibits:

 

The exhibits listed in the Exhibit Index immediatelypreceding the exhibits are filed as part of this Annual Report on Form 10-Kand are incorporated herein by reference.

 

(b)         Exhibits:

 

The exhibits listed in the Exhibit Index immediatelypreceding the exhibits are filed as part of this Annual Report on Form 10-Kand are incorporated herein by reference.

 

(c)          FinancialStatement Schedules:

 

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

 

30

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on 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 23,2010

 

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

 

| **SIGNATURE**          | ** ** | **TITLE**                                                                         | ** ** | **DATE**       |
|------------------------|------------|-----------------------------------------------------------------------------------|------------|----------------|
|                   |       |                                                                              |       |           |
| /s/ SAL PERISANO       |       | Chairman of the Board and Chief Executive Officer   (Principal Executive Officer) |       | March 23, 2010 |
|                   |       |                                                                              |       |
| Sal Perisano           |       |                                                                              |       |
|                   |       |                                                                              |       |           |
| /s/ DAVID ROBERTSON    |       | Chief Financial Officer                                                           |       | March 23, 2010 |
| David Robertson        |       | (Principal Financial Officer and PrincipalAccounting Officer)                     |       |           |
|                   |       |                                                                              |       |           |
| /s/ DANIEL DE WOLF     |       | Director                                                                          |       | March 23, 2010 |
|                   |       |                                                                              |       |           |
| Daniel De Wolf         |       |                                                                              |       |           |
|                   |       |                                                                              |       |           |
| /s/ FRANK HAYDU        |       | Director                                                                          |       | March 23, 2010 |
|                   |       |                                                                              |       |           |
| Frank Haydu            |       |                                                                              |       |           |
|                   |       |                                                                              |       |           |
| /s/ ERIC SCHINDLER     |       | Director                                                                          |       | March 23, 2010 |
|                   |       |                                                                              |       |           |
| Eric Schindler         |       |                                                                              |       |           |
|                   |       |                                                                              |       |           |
| /s/ JOSEPH VASSALLUZZO |       | Director                                                                          |       | March 23, 2010 |
|                   |       |                                                                              |       |           |
| Joseph Vassalluzzo     |       |                                                                              |       |           |

 

31

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**iPARTY CORP.**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

 
| ** **                                                                                      | **Page** |
|-------------------------------------------------------------------------------------------------|----------|
|                                                                                            |     |
| Report of Independent Registered Public Accounting  Firm                                        | F-2      |
|                                                                                            |     |
| Consolidated Balance Sheets                                                                     | F-3      |
|                                                                                            |     |
| Consolidated Statements of Operations                                                           | F-4      |
|                                                                                            |     |
| Consolidated Statements of Convertible Preferred Stock  and Stockholders’ Equity (Deficit) | F-5      |
|                                                                                            |     |
| Consolidated Statements of Cash Flows                                                           | F-6      |
|                                                                                            |     |
| Notes to Consolidated Financial Statements                                                      | F-7      |

 

The accompanying notes are anintegral part of these Consolidated Financial Statements.

 

F-1

----

 

**Report of Independent Registered Public Accounting Firm**

 

Board of Directors and Stockholders

iParty Corp.

 

We have audited the accompanyingconsolidated balance sheets of iParty Corp. and subsidiary as of December 26,2009 and December 27, 2008, and the related consolidated statements ofoperations, convertible preferred stock and stockholders’ equity (deficit), andcash flows for each of the three years in the period ended December 26, 2009.  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 audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement.  We were notengaged to perform an audit of the Company’s internal control over financialreporting.  Our audits includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the financialstatements referred to above present fairly, in all material respects, theconsolidated financial position of iParty Corp. and subsidiary at December 26,2009 and December 27, 2008, and the consolidated results of theiroperations and their cash flows for each of the three years in the period endedDecember 26, 2009, in conformity with U.S. generally accepted accountingprinciples.

 
|   | /s/ Ernst & Young LLP |
|--------|--------------------------------|

 

Boston, Massachusetts

March 23, 2010

 

Theaccompanying notes are an integral part of these Consolidated FinancialStatements.

 

F-2

----

 

**iPARTYCORP.**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                                              | ** ** | **Dec 26, 2009** | ** ** | **Dec 27, 2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Current  assets:                                                                                                                                                                                                                                                        |       |             |       |             |       |
| Cash  and cash equivalents                                                                                                                                                                                                                                              |       | $                | 61,050     |             | $          | 60,250 |   |
| Restricted  cash                                                                                                                                                                                                                                                        |       | 1,056,525        |       | 775,357          |       |
| Accounts  receivable                                                                                                                                                                                                                                                    |       | 688,506          |       | 730,392          |       |
| Inventories,  net                                                                                                                                                                                                                                                       |       | 13,048,104       |       | 13,022,142       |       |
| Prepaid  expenses and other assets                                                                                                                                                                                                                                      |       | 174,752          |       | 279,185          |       |
| Deferred  income tax asset - current                                                                                                                                                                                                                                    |       | 70,997           |       | —           |       |
| Total  current assets                                                                                                                                                                                                                                                   |       | 15,099,934       |       | 14,867,326       |       |
| Property  and equipment, net                                                                                                                                                                                                                                            |       | 2,892,835        |       | 3,646,481        |       |
| Intangible  assets, net                                                                                                                                                                                                                                                 |       | 1,606,585        |       | 2,303,692        |       |
| Other  assets                                                                                                                                                                                                                                                           |       | 349,378          |       | 177,774          |       |
| Deferred  income tax asset                                                                                                                                                                                                                                              |       | 343,690          |       | —           |       |
| Total  assets                                                                                                                                                                                                                                                           |       | $                | 20,292,422 |             | $          | 20,995,273 |   |
|                                                                                                                                                                                                                                                                    |       |             |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                           |       |             |       |             |       |
| Current  liabilities:                                                                                                                                                                                                                                                   |       |             |       |             |       |
| Accounts  payable and book overdrafts                                                                                                                                                                                                                                   |       | $                | 3,885,062  |             | $          | 4,048,833 |   |
| Accrued  expenses                                                                                                                                                                                                                                                       |       | 2,649,468        |       | 2,495,955        |       |
| Current  portion of capital lease obligations                                                                                                                                                                                                                           |       | 9,228            |       | 6,444            |       |
| Current  notes payable, net of discount of $136,367 at December 27, 2008                                                                                                                                                                                           |       | 600,000          |       | 2,876,182        |       |
| Borrowings  under line of credit                                                                                                                                                                                                                                        |       | 2,526,982        |       | 1,950,019        |       |
| Total  current liabilities                                                                                                                                                                                                                                              |       | 9,670,740        |       | 11,377,433       |       |
|                                                                                                                                                                                                                                                                    |       |             |       |             |       |
| Long-term  liabilities:                                                                                                                                                                                                                                                 |       |             |       |             |       |
| Capital  lease obligations, net of current portion                                                                                                                                                                                                                      |       | 13,841           |       | —           |       |
| Notes  payable                                                                                                                                                                                                                                                          |       | —           |       | 600,000          |       |
| Other  liabilities                                                                                                                                                                                                                                                      |       | 1,529,257        |       | 1,200,174        |       |
| Total  long-term liabilities                                                                                                                                                                                                                                            |       | 1,543,098        |       | 1,800,174        |       |
|                                                                                                                                                                                                                                                                    |       |             |       |             |       |
| Commitments  and contingencies                                                                                                                                                                                                                                          |       |             |       |             |       |
|                                                                                                                                                                                                                                                                    |       |             |       |             |       |
| Stockholders’  equity:                                                                                                                                                                                                                                             |       |             |       |             |       |
| Convertible  preferred stock - $.001 par value; 10,000,000 shares authorized,                                                                                                                                                                                           |       |             |       |             |       |
| Series B  convertible preferred stock - 1,150,000 shares authorized; 459,173 and  463,086 shares issued and outstanding at December 26, 2009 and  December 27, 2008, respectively (aggregate liquidation value of  $9,183,460 at December 26, 2009) |       | 6,832,494        |       | 6,890,723        |       |
| Series C  convertible preferred stock - 100,000 shares authorized, issued and  outstanding (aggregate liquidation value of $2,000,000 at December 26,  2009)                                                                                                  |       | 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 26,  2009)                                                                                                  |       | 3,652,500        |       | 3,652,500        |       |
| Series E  convertible preferred stock - 533,333 shares authorized; 296,666 shares  issued and outstanding (aggregate liquidation value of $1,112,497 at  December 26, 2009)                                                                                   |       | 1,112,497        |       | 1,112,497        |       |
| Series F  convertible preferred stock - 114,286 shares authorized, issued and  outstanding (aggregate liquidation value of $500,000 at December 26,  2009)                                                                                                    |       | 500,000          |       | 500,000          |       |
| Total  convertible preferred stock                                                                                                                                                                                                                                      |       | 13,589,491       |       | 13,647,720       |       |
|                                                                                                                                                                                                                                                                    |       |             |       |             |       |
| Common  stock - $.001 par value; 150,000,000 shares authorized; 22,798,647 and  22,731,667 shares issued and outstanding at December 26, 2009 and  December 27, 2008, respectively                                                                            |       | 22,799           |       | 22,732           |       |
|                                                                                                                                                                                                                                                                    |       |             |       |             |       |
| Additional  paid-in capital                                                                                                                                                                                                                                             |       | 52,311,059       |       | 52,095,711       |       |
| Accumulated  deficit                                                                                                                                                                                                                                                    |       | (56,844,765      | )          | (57,948,497      | )          |
| Total  stockholders’ equity                                                                                                                                                                                                                                        |       | 9,078,584        |       | 7,817,666        |       |
|                                                                                                                                                                                                                                                                    |       |             |       |             |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                                        |       | $                | 20,292,422 |             | $          | 20,995,273 |   |

 

The accompanying notes arean integral part of these Consolidated Financial Statements.

 

F-3

----

 

**iPARTYCORP.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                 | ** ** | **For the periods ended** | ** ** |
|--------------------------------------------|------------|---------------------------|------------|
| ** **                                 | ** ** | **Dec 26, 2009**          | ** ** | **Dec 27, 2008** | ** ** | **Dec 29, 2007** | ** ** |
| ** **                                 | ** ** | **(52 weeks)**            | ** ** | **(52 weeks)** | ** ** | **(52 weeks)** | ** ** |
| Revenues                                   |       | $                         | 78,595,088 |   | $ | 81,210,999 |   | $ | 81,798,634 |   |
| Operating  costs:                          |       |                      |       |   |   |   |   |
| Cost  of products sold and occupancy costs |       | 46,557,039                |       | 46,885,215 |   | 46,465,441 |   |
| Marketing  and sales                       |       | 23,703,308                |       | 26,793,885 |   | 26,181,504 |   |
| General  and administrative                |       | 6,934,478                 |       | 7,205,067 |   | 7,553,869 |   |
|                                       |       |                      |       |   |   |   |   |
| Operating  income                          |       | 1,400,263                 |       | 326,832 |   | 1,597,820 |   |
|                                       |       |                      |       |   |   |   |   |
| Income  before income taxes                |       | 1,400,263                 |       | 326,832 |   | 1,597,820 |   |
|                                       |       |                      |       |   |   |   |   |
| Interest  income                           |       | 340                       |       | 4,609 |   | 17,806 |   |
| Interest  expense                          |       | (444,801                  | )          | (720,891 | ) | (857,612 | ) |
|                                       |       |                      |       |   |   |   |   |
| Income  (loss) before income taxes         |       | 955,802                   |       | (389,450 | ) | 758,014 |   |
|                                       |       |                      |       |   |   |   |   |
| Income  taxes (benefit)                    |       | (147,930                  | )          | 50,605 |   | 146,323 |   |
|                                       |       |                      |       |   |   |   |   |
| Net  income (loss)                         |       | $                         | 1,103,732  |   | $ | (440,055 | ) | $ | 611,691 |   |
|                                       |       |                      |       |   |   |   |   |
| Income  (loss) per share:                  |       |                      |       |   |   |   |   |
| Basic                                      |       | $                         | 0.03       |   | $ | (0.02 | ) | $ | 0.02 |   |
| Diluted                                    |       | $                         | 0.03       |   | $ | (0.02 | ) | $ | 0.02 |   |

 

The accompanying notes arean integral part of these Consolidated Financial Statements.

 

F-4

----

** **

**IPARTYCORP.**

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

 
| ** **                                                                             | ** ** | **Stockholders’ Equity (Deficit)** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                             | ** ** | **Convertible**                                   | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | **Total** | ** ** |
| ** **                                                                             | ** ** | **Preferred Stock**                          | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Accumulated** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                             | ** ** | **Shares**                                        | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Deficit** | ** ** | **Equity (Deficit)** | ** ** |
| Balance  December 30, 2006                                                        |       | 1,232,353                                         |       | $ | 13,771,447 |   | 22,603,877 |   | $ | 22,604 |   | $ | 51,671,087 |   | $ | (58,120,133 | ) | $ | 7,345,005 |   |
|                                                                                   |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance  of common stock upon conversion of Series B convertible preferred stock |       | (6,000                                            | )          | (89,280 | ) | 80,376 |   | 81 |   | 89,199 |   | — |   | — |   |
| Stock  based compensation                                                              |       | —                                            |       | — |   | — |   | — |   | 129,628 |   | — |   | 129,628 |   |
| Exercise  of stock options                                                             |       | —                                            |       | — |   | 16,402 |   | 16 |   | 4,567 |   | — |   | 4,583 |   |
| Warrants                                                                               |       | —                                            |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Net  income                                                                            |       | —                                            |       | — |   | — |   | — |   | — |   | 611,691 |   | 611,691 |   |
| Balance  December 29, 2007                                                        |       | 1,226,353                                         |       | 13,682,167 |   | 22,700,655 |   | 22,701 |   | 51,894,481 |   | (57,508,442 | ) | 8,090,907 |   |
|                                                                                   |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance  of common stock upon conversion of Series B convertible preferred stock |       | (2,315                                            | )          | (34,447 | ) | 31,012 |   | 31 |   | 34,416 |   | — |   | — |   |
| Stock  based compensation                                                              |       | —                                            |       | — |   | — |   | — |   | 156,484 |   | — |   | 156,484 |   |
| Exercise  of stock options                                                             |       | —                                            |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Warrants                                                                               |       | —                                            |       | — |   | — |   | — |   | 10,330 |   | — |   | 10,330 |   |
| Net  loss                                                                              |       | —                                            |       | — |   | — |   | — |   | — |   | (440,055 | ) | (440,055 | ) |
| Balance  December 27, 2008                                                        |       | 1,224,038                                         |       | 13,647,720 |   | 22,731,667 |   | 22,732 |   | 52,095,711 |   | (57,948,497 | ) | 7,817,666 |   |
|                                                                                   |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Issuance  of common stock upon conversion of Series B convertible preferred stock |       | (5,000                                            | )          | (74,400 | ) | 66,980 |   | 67 |   | 74,333 |   | — |   | — |   |
| Other  Series B Adjustments                                                       |       | 1,087                                             |       | 16,171 |   |   |   |   |   | (16,171 | ) |   |   | — |   |
| Stock  based compensation                                                              |       | —                                            |       | — |   | — |   | — |   | 157,757 |   | — |   | 157,757 |   |
| Exercise  of stock options                                                             |       | —                                            |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Warrants                                                                               |       | —                                            |       | — |   | — |   | — |   | (571 | ) | — |   | (571 | ) |
| Net  income                                                                            |       | —                                            |       | — |   | — |   | — |   | — |   | 1,103,732 |   | 1,103,732 |   |
| Balance  December 26, 2009                                                        |       | 1,220,125                                         |       | $ | 13,589,491 |   | 22,798,647 |   | $ | 22,799 |   | $ | 52,311,059 |   | $ | (56,844,765 | ) | $ | 9,078,584 |   |

 

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

 

F-5

----

 

**iPARTY CORP.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                                           | ** ** | **For the periods ended** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                                           | ** ** | **Dec 26, 2009**          | ** ** | **Dec 27, 2008** | ** ** | **Dec 29, 2007** | ** ** |
| ** **                                                                                           | ** ** | **(52 weeks)**            | ** ** | **(52 weeks)** | ** ** | **(52 weeks)** | ** ** |
| **Operating activities:**                                                                            |       |                      |       |   |   |   |   |
|                                                                                                 |       |                      |       |   |   |   |   |
| Net  income (loss)                                                                                   |       | $                         | 1,103,732  |   | $ | (440,055 | ) | $ | 611,691 |   |
| Adjustments  to reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                      |       |   |   |   |   |
| Depreciation  and amortization                                                                       |       | 2,039,310                 |       | 2,037,108 |   | 1,705,948 |   |
| Deferred  rent                                                                                       |       | 79,108                    |       | 86,652 |   | 184,323 |   |
| Non  cash stock based compensation expense                                                           |       | 157,757                   |       | 156,484 |   | 129,628 |   |
| Loss  on disposal of assets                                                                          |       | 1,430                     |       | — |   | — |   |
| Non  cash warrant expense                                                                            |       | 135,796                   |       | 197,834 |   | 204,550 |   |
| Changes  in operating assets and liabilities:                                                        |       |                      |       |   |   |   |   |
| Accounts  receivable                                                                                 |       | 291,861                   |       | 375,415 |   | 10,235 |   |
| Inventories,  net                                                                                    |       | (25,962                   | )          | 617,389 |   | (1,374,794 | ) |
| Prepaid  expenses and other assets                                                                   |       | (516,292                  | )          | 881,149 |   | (351,302 | ) |
| Accounts  payable and book overdrafts                                                                |       | (163,771                  | )          | (674,537 | ) | (793,036 | ) |
| Accrued  expenses and other liabilities                                                              |       | 153,513                   |       | (7,797 | ) | (566,251 | ) |
| Net  cash provided by (used in) operating activities                                                 |       | 3,256,482                 |       | 3,229,642 |   | (239,008 | ) |
|                                                                                                 |       |                      |       |   |   |   |   |
| Investing  activities:                                                                               |       |                      |       |   |   |   |   |
| Acquisition  of retail stores and non-compete agreements                                             |       | —                    |       | (1,350,000 | ) | — |   |
| Purchase  of property and equipment                                                                  |       | (525,563                  | )          | (677,709 | ) | (802,174 | ) |
| Net  cash used in investing activities                                                               |       | (525,563                  | )          | (2,027,709 | ) | (802,174 | ) |
|                                                                                                 |       |                      |       |   |   |   |   |
| Financing  activities:                                                                               |       |                      |       |   |   |   |   |
| Net  borrowings (repayments) under line of credit                                                    |       | 576,963                   |       | (663,492 | ) | 1,450,792 |   |
| Principal  payments on notes payable                                                                 |       | (3,012,549                | )          | (603,660 | ) | (600,036 | ) |
| Decrease  (increase) in restricted cash                                                              |       | (281,168                  | )          | 87,179 |   | (156,470 | ) |
| Principal  payments on capital lease obligations                                                     |       | (13,365                   | )          | (33,242 | ) | (346,531 | ) |
| Proceeds  from exercise of stock options                                                             |       | —                    |       | — |   | 4,583 |   |
| Net  cash provided by (used in) financing activities                                                 |       | (2,730,119                | )          | (1,213,215 | ) | 352,338 |   |
|                                                                                                 |       |                      |       |   |   |   |   |
| Net  increase (decrease) in cash and cash equivalents                                                |       | 800                       |       | (11,282 | ) | (688,844 | ) |
|                                                                                                 |       |                      |       |   |   |   |   |
| Cash  and cash equivalents, beginning of year                                                        |       | 60,250                    |       | 71,532 |   | 760,376 |   |
|                                                                                                 |       |                      |       |   |   |   |   |
| Cash  and cash equivalents, end of year                                                              |       | $                         | 61,050     |   | $ | 60,250 |   | $ | 71,532 |   |
|                                                                                                 |       |                      |       |   |   |   |   |
| Supplemental  disclosure of non-cash financing activities:                                           |       |                      |       |   |   |   |   |
|                                                                                                 |       |                      |       |   |   |   |   |
| Conversion  of Series B convertible preferred stock to common stock                             |       | $                         | 74,400     |   | $ | 34,447 |   | $ | 89,280 |   |
|                                                                                                 |       |                      |       |   |   |   |   |
| Acquisition  of assets under capital lease                                                           |       | $                         | 29,990     |   | $ | — |   | $ | — |   |

 

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

 

F-6

----

 

**iPARTY CORP.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**December 26, 2009**

 

**1. THE COMPANY:**

 

*Background*

 

The Company’s efforts are devoted to the sale of partygoods and services through its retail stores. At the end of fiscal 2009, the Company had 46 retail stores locatedthroughout New England, with five additional stores located in Florida. TheCompany licenses its Internet business to a third party in exchange forroyalties under a license agreement, which to date have not been significant.

 

The stores feature over 20,000 products ranging fromgreeting cards and balloons to more unique merchandise such as piñatas, gaggifts, masquerade and Hawaiian Luau items. The Company’s sales are driven by the following events:  Halloween, Christmas, Easter, Valentine’sDay, New Year’s, Independence Day, St. Patrick’s Day, Thanksgiving, andChanukah.  The Company also focuses itsbusiness closely on lifetime events such as anniversaries, graduations,birthdays, and bridal or baby showers. The Company’s business has a seasonal pattern with higher revenues inthe second and fourth quarters, reflecting school graduations and Halloween,respectively.

 

The Company’s fiscal years ended December 26, 2009, December 27,2008 and December 29, 2007, eachconsisted of 52 weeks.

 

*Management’s Plans*

 

The Company operates in a largely un-branded market thathas many small businesses.  As a result,it may consider growing its business through acquisitions of otherentities.  Any determination to make anacquisition will be based upon a variety of factors, including, withoutlimitation, the purchase price and other financial terms of the transaction,the business prospects, geographical location and the extent to which anyacquisition by iParty would enhance the target entity’s prospects.

 

On August 15, 2007, the Company entered into an AssetPurchase Agreement to purchase two franchised Party City Corporation retailstores in Lincoln, Rhode Island and Warwick, Rhode Island. The purchase wascompleted on January 2, 2008. The aggregate consideration paid was$1,350,000 plus approximately $195,000 for associated inventory. Funding forthe purchase was obtained from the Company’s existing line of credit with WellsFargo Retail Finance. The stores were converted into iParty stores immediatelyfollowing the closing of the transaction.

 

The Company used its existingline of credit to pay off in full the $2.5 million Highbridge Note on September 15,2009, after which the Company had less availability under the line for workingcapital and acquisition needs than it would otherwise have had. The new bankline of credit with Wells Fargo, which the Company signed on July 2, 2009,allows it to borrow up to $12,500,000, subject to a limitation based onqualified inventory, receivables levels and other reserves set by Wells Fargo,with an option to increase that limit up to $15 million.  As of December 26,2009, there was $2,526,982 outstanding under the line of credit with additionalavailability of $3,450,662, which the Company believes to be sufficient to fundits operations, working capital requirements, the scheduled note payment in2010, and capital expenditures for the next twelve months.

 

**2.  SIGNIFICANTACCOUNTING POLICIES:**

** **

*Principles of Consolidation*

 

The consolidated financial statements include the accountsof the Company and its wholly-owned subsidiary after elimination of allsignificant intercompany transactions and balances.

 

F-7

----

 

*Revenue Recognition*

 

Revenues include the selling price of party goods sold, netof returns and discounts, and are recognized at the point of sale. The Companyestimates returns based upon historical return rates and such amounts have notbeen significant to date.

 

*Concentrations*

 

The Company purchases itsinventory from a diverse group of vendors. Four suppliers account for approximately38.3% of the Company’s purchases of merchandise for 2009, but the Company doesnot believe that it is overly dependent upon any single source for itsmerchandise, often using more than one vendor for similar kinds ofproducts.  The Company entered into aSupply Agreement with its largest supplier on August 7, 2006. Beginning with calendar year 2008, the Supply Agreement requires theCompany to purchase on an annual basis merchandise equal to the total number ofstores open during such calendar year, multiplied by $180,000.  The Supply Agreement provides for penaltiesin the event the Company fails to attain the annual purchase commitment thatwould require the Company to pay the difference between the purchases for thatyear and the annual purchase commitment for that year.  Under the terms of the Supply Agreement, theannual purchase commitment for any individual year can be reduced for ordersplaced by the Company but not filled within a specified time period by thesupplier.  During 2008, the supplierexperienced difficulty in filling completely certain orders sourced out ofChina.  Accordingly, the supplier agreedto reduce the Company’s purchase commitment for 2008 to 90% of the contractualminimum for that year. The Company met the contractual minimum purchaserequirement, as amended, for 2008.  Thepurchases for 2009 fell short of the annual commitment by approximately$368,000. The supplier has agreed to allow the Company to roll over anyshortfall for the year 2009 into future years’ requirements. The Company is notaware of any reason that would prevent it from meeting the minimum purchaserequirements, including any 2009 shortfall, during the remainder of the term ofthe Supply Agreement.

 

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

 

### *Use of Estimates*

### * *

The preparation of consolidated financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the consolidated financial statements and the reported amountsof revenues and expenses during the reporting period. Actual results coulddiffer from these estimates.

 

*Cash and Cash Equivalents and Restricted Cash*

 

The Company considers all highly liquid investments with anoriginal maturity date of three months or less to be cash equivalents.  Cash equivalents consist primarily of storecash funds and daily store receipts in transit to our concentration bank andare carried at cost.

 

The Companyuses controlled disbursement banking arrangements as part of its cashmanagement program.  Outstanding checks,which were included in accounts payable and book overdrafts, totaled $197,948at December 26, 2009 and $194,381 at December 27, 2008.

 

Restrictedcash represents funds on deposit established for the benefit of and under thecontrol of Wells Fargo Retail Finance LLC, the Company’s lender under its lineof credit, and constitutes collateral for amounts outstanding under this line.

 

F-8

----

 

*Fair Value 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 the Company’s line of credit approximates the carrying valuebecause the debt bears interest at a variable market rate.  The fair value of the capital leaseobligations approximates the carrying value. The fair value of the notes payable approximates the carrying valuebased on the short term maturity.  Thefair value of the warrants issued in 2006 was determined by using theBlack-Scholes model (volatility of 108%, risk free rate of 4.73% and expectedlife of five years).  The fair value ofthe warrants issued in 2008 was also determined by using the Black-Scholesmodel (volatility of 108%, risk free rate of 2.57% and expected life of fiveyears).

 

As permitted by Accounting Standards Codification (“ASC”)820-10-65-1, Effective Date of ASC 820, “*Fair Value Measurementsand Disclosures*”, the Company elected to defer the adoption of ASC820 for all non-financial assets and non-financial liabilities, except thosethat are recognized or disclosed at fair value in the financial statements on arecurring basis, until December 28, 2008. The adoption of ASC820-10-65-1in fiscal 2009 has not had a material impact on the Company’sfinancial position, results of operations or cash flows.

 

*Inventories*

 

Inventoriesconsist of party supplies and are valued at the lower of movingweighted-average cost or market which approximates FIFO (first-in, first-out).  Inventories have been reduced by an allowancefor obsolete and excess inventory, which is based on management’s review ofinventories on hand compared to estimated future sales.  The Company records vendor rebates, discountsand certain other adjustments to inventories, including freight costs, andthese amounts are recognized in the income statement as the related goods aresold.

 

Theactivity in the allowance for obsolete and excess inventories is as follows:

 
| ** **                  | ** ** | **2009** | ** ** | **2008** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
| Beginning  balance          |       | $        | 942,587    |     | $          | 969,859 |   |
| Increases  to reserve       |       | 280,000  |       | 405,000  |       |
| Write-offs  against reserve |       | (321,670 | )          | (432,272 | )          |
| Ending  balance             |       | $        | 900,917    |     | $          | 942,587 |   |

 

### *Advertising*

### * *

Advertising costs are expensed upon first showing.  Advertising costs amounted to $2,395,358,$3,638,752, and $3,721,516 for the years ended December 26, 2009, December 27,2008 and December 29, 2007, respectively.

 

*Deferred Rent*

 

Certain operating lease agreements contain scheduled rentincreases, which are being amortized over the terms of the agreements using thestraight-line method, and are included in other liabilities in the accompanyingconsolidated balance sheets.  Deferredrent was $1,529,257 at December 26, 2009 and $1,200,174 at December 27,2008.

 

*Net Income (Loss) per Share*

 

Net income (loss) per basic share is computed by dividingnet income (loss) available to common shareholders by the weighted-averagenumber of common shares outstanding.  Thecommon share equivalents of Series B-F preferred stock are required to beincluded in the calculation of net income (loss) per basic share in accordancewith *ASC 260-10-45, Earnings Per Share – OtherPresentation Matters.*Since the preferred stockholders are entitled to participate in dividends whenand if declared by the Board of Directors on the same basis as if the shares ofSeries B-F preferred stock were converted to common 

 

F-9

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stock, the application of ASC 260-10-45 has no effect onthe amount of net income (loss) per basic share of common stock.  For periods with net losses, the Company doesnot allocate losses to Series B-F preferred stock.

 

Net income (loss) per diluted share under ASC 260-10-45 iscomputed by dividing net income (loss) by the weighted average number of commonshares outstanding, plus the common share equivalents of Series B-Fpreferred stock on an as if-converted basis, plus the common share equivalentsof the “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 netincome (loss) per basic and diluted share available to common stockholders:

 
| ** **                                                               | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|--------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Common  shares                                                           |       | $          | 656,663    |       | $          | (440,055   | )          | $ | 362,525 |   |
| Convertible  preferred Series B-F                                   |       | 447,069    |       | —     |       | 249,166    |       |
| Net  income (loss)                                                       |       | $          | 1,103,732  |       | $          | (440,055   | )          | $ | 611,691 |   |
|                                                                     |       |       |       |       |       |       |       |
| Net  income (loss) per share                                             |       |       |       |       |       |       |       |
| Basic                                                                    |       | $          | 0.03       |       | $          | (0.02      | )          | $ | 0.02 |   |
| Diluted                                                                  |       | $          | 0.03       |       | $          | (0.02      | )          | $ | 0.02 |   |
|                                                                     |       |       |       |       |       |       |       |
| Weighted-average  shares outstanding:                                    |       |       |       |       |       |       |       |
| Common  shares - basic                                                   |       | 22,739,395 |       | 22,722,485 |       | 22,642,564 |       |
| Common  share equivalents of Series B-F convertible preferred stock |       | 15,481,409 |       | —     |       | 15,561,810 |       |
| If -  converted weighted-average shares outstanding                      |       | 38,220,804 |       | 22,722,485 |       | 38,204,374 |       |
|                                                                     |       |       |       |       |       |       |       |
| Common  share equivalents of “in the money” stock options      |       | 219,685    |       | —     |       | 1,708,900  |       |
| Common  share equivalents of “in the money” warrants           |       | —     |       | —     |       | —     |       |
| Diluted  weighted-average shares outstanding                             |       | 38,440,489 |       | 22,722,485 |       | 39,913,274 |       |

 

The common share equivalents of “out of the money” stockoptions and warrants which were excluded from the computation of net income(loss) per diluted share available to common stockholders were 8,059,946 and2,183,334 in 2009, 9,082,198 and 2,711,544 in 2008, respectively, and 4,654,753and 2,611,544 in 2007, respectively.

 

*Stock Option Compensation Expense*

 

The Company uses the Black-Scholes option pricing model todetermine the fair value of stock based compensation.  The Black-Scholes model requires the Companyto make several subjective assumptions, including the estimated length of timeemployees will retain their vested stock options before exercising them (“expectedterm”), and the estimated volatility of the Company’s common stock price overthe expected term, which is based on historical volatility of the Company’scommon stock over a time period equal to the expected term.  The Black-Scholes model also requires arisk-free interest rate, which is based on the U.S. Treasury yield curve ineffect at the time of the grant, and the dividend yield on the Company’s commonstock, which is assumed to be zero since the Company does not pay dividends andhas no current plans to do so in the future. Changes in these assumptions can materially affect the estimate of fairvalue of stock based compensation and consequently, the related expenserecognized in the consolidated statements of operations.  The Company recognizes stock basedcompensation expense on a straight-line basis over the vesting period of eachgrant.

 

F-10

----

 

The stock based compensation expense recognized by theCompany was:

 
| ** **                        | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Stock  Based Compensation Expense |       | $        | 157,757    |     | $          | 156,484  |       | $ | 129,628 |   |
|                                   |            |          |            |          |            |          |            |  |  |  |

 

Stock based compensation expense is included in general andadministrative expense and had no impact on cash flow from operations and cashflow from financing activities for the years ended December 26, 2009, December 27,2008 and December 29, 2007.

 

On September 26, 2007, the Board of Directors, acting onthe recommendation of the Compensation Committee, extended the expiration dateon options to purchase 970,087 shares of the Company’s common stock held by aformer officer for an additional six months following his termination date,making the expiration date August 15, 2008.  As a result, additional stock basedcompensation of $14,569, representing the change in the fair value of theseoptions immediately before and after this modification, was recorded as of September 26,2007. The options covered by this extension were not exercised, and expired on August 15,2008.

 

On May 27, 2009, the Company’sstockholders approved a new equity incentive plan entitled the 2009 StockIncentive Plan (the “2009 Plan”).  TheCompany will no longer grant equity awards under its former equity incentiveplan,  the Amended and Restated 1998Incentive and Nonqualified Stock Option Plan (the “1998 Plan” and with the 2009Plan, the “Plans”).

 

Under the Company’s Plans, options to acquire shares ofcommon stock may be granted to officers, directors, key employees andconsultants.   Under the 2009 Plan, theexercise price for qualified incentive options and non-qualified options cannotbe less than the fair market value of the stock on the grant date, asdetermined by the Company’s Board of Directors. In addition, under the 2009Plan, other stock-based and performance awards may be granted to officers,directors, key employees and consultants, including stock appreciation rights,restricted stock, and restricted stock units. Under the Plans, a combined totalof 11,000,000 shares of common stock or other stock based awards may begranted.  To date, the Company has onlyissued options for shares under its Plans, which have been granted toemployees, directors and consultants of the Companyat fair market value at the date of grant.  Of the options that have been issued, optionsfor 435,261 shares have been exercised and options for 10,034,761 shares remainoutstanding at December 26, 2009. Generally, employee options becomeexercisable over periods of up to four years, and expire ten years from thedate of grant.

 

The Company granted options for the purchase of an aggregateof 1,085,000 shares of common stock to key employees, including its executiveofficers, and each of the four independent members of the Board of Directors onMay 27, 2009 at an exercise price of $0.11 per share.  In addition, the Company granted options forthe purchase of an aggregate of 200,000 shares of common stock to its ChiefFinancial Officer on March 4, 2009 at an exercise price of $0.07 pershare.  On June 4, 2008, the Companygranted options for the purchase of an aggregate of 200,000 shares of commonstock to its Chief Financial Officer and each of the four independent membersof the Board of Directors at an exercise price of $0.29 per share. Similarly,the Company granted options for the purchase of an aggregate of 1,350,000shares of common stock to key employees and each of the four independentmembers of the Board of Directors on June 6, 2007 at an exercise price of$0.42 per share. The weighted-average fair market value using the Black-Scholesoption pricing model of the options granted in 2009, 2008 and 2007 was $0.09,$0.22 and $0.33, respectively.

 

F-11

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The fair market value of the options at the date of the grantwas estimated using the Black-Scholes option-pricing model with the followingweighted average assumptions:

 
| ** **                                 | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Risk-free  interest rate                   |       | 2.23     | %          | 3.21     | %          | 4.94     | %          |
| Expected  volatility                       |       | 109.5    | %          | 101.2    | %          | 102.6    | %          |
| Weighted  average expected life (in years) |       | 6.3      |       | 5.0      |       | 5.0      |       |
| Expected  dividends                        |       | 0.00     | %          | 0.00     | %          | 0.00     | %          |

 

The total fair value of shares vested during 2009 was$144,022.  The remaining unrecognizedstock based compensation expense related to unvested awards at December 26,2009, was $188,454 and the period of time over which this expense will berecognized is 3.5 years.

 

*Property and Equipment*

 

Property and equipment are stated at cost less accumulateddepreciation and are depreciated on the straight-line method over the estimateduseful lives of the assets.  Expendituresfor maintenance and 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                              |

 

*Intangible Assets*

 

On August 15, 2007, the Company entered into an AssetPurchase Agreement to purchase two franchised Party City Corporation retailstores in Lincoln, Rhode Island and Warwick, Rhode Island, in exchange foraggregate consideration of $1,350,000 plus up to $400,000 for associatedinventory.  On January 2, 2008, theCompany completed the purchase of the two stores. The aggregate considerationpaid was $1,350,000 plus approximately $195,000 for associated inventory.Funding for the purchase was obtained from the Company’s existing line ofcredit with Wells Fargo. The stores were converted into iParty storesimmediately following the closing of the transaction.

 

Intangibleassets consist primarily of (i) the values of two non-compete agreementsacquired in conjunction with the purchase of retail stores in 2006 and 2008,and (ii) the values of retail store leases acquired in those transactions.These assets have been accounted for at fair value as of their respectiveacquisition dates using significant other observable inputs, or Level 2criteria, defined in the Fair Value Measurements section below.

 

The firstnon-compete agreement, from Party City Corporation and its affiliates, coversMassachusetts, Maine, New Hampshire, Vermont, Rhode Island, and Windsor and NewLondon counties in Connecticut, and expires in 2011.  The second non-compete agreement was acquiredin connection with the Company’s purchase in January 2008 of the two partysupply stores in Lincoln and Warwick, Rhode Island described above. It coversRhode Island for five years from the date of closing and within a certaindistance from the Company’s stores in the rest of New England for three years.Both non-compete agreements have an estimated life of 60 months and are subjectto certain terms and conditions in their respective acquisition agreements.

 

Theoccupancy valuations relate to acquired retail store leases for stores inPeabody, Massachusetts (estimated life of 90 months), Lincoln, Rhode Island(estimated life of 79 months) and Warwick, Rhode Island

 

F-12

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(estimated life of 96 months). Intangible assets alsoinclude legal and other transaction costs incurred related to the purchase ofthe Peabody, Lincoln and Warwick stores.

 

Intangible assets as of December 26, 2009 and December 27,2008 were:

 
| ** **                      | ** ** | **Dec 26, 2009** | ** ** | **Dec 27, 2008** | ** ** |
|---------------------------------|------------|------------------|------------|------------------|------------|
| Non-compete  agreement          |       | $                | 2,358,540  |             | $          | 2,358,540 |   |
| Lease  valuation                |       | 944,716          |       | 944,716          |       |
| Other                           |       | 157,855          |       | 157,855          |       |
|                            |       |             |       |             |       |
| Intangible  assets              |       | 3,461,111        |       | 3,461,111        |       |
|                            |       |             |       |             |       |
| Less:  accumulated amortization |       | (1,854,526       | )          | (1,157,419       | )          |
|                            |       |             |       |             |       |
| Intangible  assets, net         |       | $                | 1,606,585  |             | $          | 2,303,692 |   |

 

Non-compete agreements are amortized based on the patternof their expected cash flow benefits. Occupancy valuations are amortized on astraight line basis over the terms of the related leases. Amortization expensefor these intangible assets was $697,107 in 2009, $594,109 in 2008 and $393,991in 2007, respectively.  The non-competeagreement amortization expense is included in general and administrativeexpense on the Consolidated Statement of Operations.  The lease valuation amortization expense isincluded in cost of goods sold and occupancy costs.

 

Future amortization expense related to these intangibleassets as of December 26, 2009:

 
| **Year**   | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|
| 2010       |       | $          | 672,108    |   |
| 2011       |       | 467,412    |       |
| 2012       |       | 242,438    |       |
| 2013       |       | 127,029    |       |
| Thereafter |       | 97,598     |       |
| Total      |       | $          | 1,606,585  |   |

 

*Accounting for the Impairment ofLong-Lived Assets*

 

The Company reviews each store for impairment indicatorswhenever events and changes in circumstances suggest that the carrying amountsmay not be recoverable from estimated future store cash flows.  TheCompany’s review considers store operating results, future sales growth andcash flows.   During the third quarter of2007, the Company decided to close its stores in North Providence, Rhode Islandand Auburn, Massachusetts at the end of their lease terms, which expired on January 31,2008.  No material impairment costs wereincurred as a result of that decision. As of December 26, 2009, theCompany has not identified any indicators of impairment based on its review ofeach of its stores’ operations and, accordingly, does not believe that any ofits remaining long-lived assets are impaired.

 

*Fair Value Measurements*

 

Effective December 30,2007, the Company adopted Accounting Standards Codification (ASC) 820, *Fair Value Measurements and Disclosures.*ASC 820 definedfair value as the price that would be received for an asset or paid to transfera liability (an exit price) in the principal or most advantageous market forthe asset or liability in an orderly transaction between market participants onthe measurement date. ASC 820 also described three levels of inputs that may beused to measure the fair value:

 

Level 1 — quoted pricesin active markets for identical assets or liabilities

 

F-13

----

 

Level 2 — observableinputs other than quoted prices in active markets for identical assets orliabilities

 

Level 3 — unobservable inputs in which there is littleor no market data available, which require the reporting entity to develop itsown assumptions

 

The only assets andliabilities subject to fair value measurement standards at December 26,2009 and December 27, 2008 are cash equivalents and restricted cash whichare based on Level 1 inputs.

 

*New Accounting Pronouncements*

 

In December 2009,the Financial Accounting Standards Board (“FASB”) issued Update No. 2009-16,*Transfers and Servicing (Topic 860); Accounting forTransfers of Financial Assets**— an amendment of FASBStatement No. 166.*Update No. 2009-16 will be effectivefor financial statements issued for fiscal years and interim periods beginningafter November 15, 2009, with early adoption encouraged, or for us thefiscal year ending December 25, 2010. The Company does not expect theadoption of Update No. 2009-16 (Topic 860) to have a material effect onits financial statements.

 

In December 2009,FASB issued Update No. 2009-17, *Consolidations (Topic810); Improvements to Financial Reporting by Enterprises Involved with VariableInterest Entities— an amendment of FASB Statement No. 167. * Update No. 2009-17 will be effective forfinancial statements issued for fiscal years and interim periods beginningafter November 15, 2009, with early adoption encouraged, or for theCompany the fiscal year ending December 25, 2010. The Company does notexpect the adoption of Update No. 2009-17 (Topic 810) to have a materialeffect on its financial statements.

 

In January 2010,FASB issued Update No. 2010-01, *Equity (Topic 505)Accounting for Distributions to Shareholders with Components of Stock and Cash(A Consensus of the FASB Emerging Issues Task Force). *Update No. 2010-01 iseffective for financial statements issued for fiscal years and interim periodsending on or after December 15, 2009, or for the Company the fiscal yearending December 26, 2009, and is applied on a retrospective basis. Theadoption of Update No. 2010-01 (Topic 505) did not have a material effecton the financial statements.

 

In January 2010,FASB issued Update No. 2010-02, *Consolidation (Topic 810);Accounting and Reporting for Decreases in Ownership of a Subsidiary — a ScopeClarification.*Update No. 2010-02 is effective for financialstatements issued for fiscal years and interim periods ending on or after December 15,2009, or for the Company the fiscal year ended December 26, 2009, and isapplied on a retrospective basis. The adoption of Update No. 2010-02(Topic 810) did not have a material effect on the financial statements.

 

In January 2010,FASB issued Update No. 2010-06, *Fair Value Measurementsand Disclosures (Topic 820) Improving Disclosures about Fair ValueMeasurements.*Update No. 2010-06 is effective for financialstatements issued for fiscal years and interim periods beginning after December 15,2009, or for the Company the fiscal year ending December 25, 2010, exceptfor the disclosure referencing purchases, sales, issuances, and settlements inthe roll forward of activity in Level 3 fair value measurements.  Those disclosures are effective for fiscalyears beginning after December 15, 2010, and for interim periods withinthose years with early adoption encouraged. The Company does not anticipate that the adoption of Update No. 2010-06(Topic 820) will have a material effect on its financial statements.

 

F-14

----

 

**3.  PROPERTY ANDEQUIPMENT:**

** **

Property and equipment consist of the following:

 
| ** **                      | ** ** | **Dec 26, 2009** | ** ** | **Dec 27, 2008** | ** ** |
|---------------------------------|------------|------------------|------------|------------------|------------|
| Leasehold  improvements         |       | $                | 3,665,211  |             | $          | 3,557,500 |   |
| Furniture  and fixtures         |       | 2,948,324        |       | 2,822,854        |       |
| Equipment  under capital leases |       | 1,313,356        |       | 1,416,334        |       |
| Computer  hardware and software |       | 2,056,926        |       | 1,888,592        |       |
| Equipment                       |       | 776,363          |       | 680,484          |       |
|                            |       |             |       |             |       |
| Property  and equipment         |       | 10,760,180       |       | 10,365,764       |       |
| Less  accumulated depreciation  |       | (7,867,345       | )          | (6,719,283       | )          |
|                            |       |             |       |             |       |
| Property  and equipment, net    |       | $                | 2,892,835  |             | $          | 3,646,481 |   |

 

**4.  LEASES:**

** **

The Companyconducts its operations in leased facilities with certain leased equipmentaccounted for as operating and capital leases. Real estate leases generally provide for fixed minimum rentals, whichtypically increase periodically during the life of the lease, and, in someinstances, contingent rentals based on a percentage of sales in excess ofspecified minimum sales levels, as well as occupancy costs, such as propertytaxes and common area maintenance.  Theleases are typically for 10 years, usually with options from the Company’slandlords to renew the Company’s leases for an additional 5 or 10 years.

 

Theoriginal cost of assets under capital leases was $1,313,356 at December 26,2009 and $1,416,334 at December 27, 2008. The accumulated amortization ofassets under capital leases at December 26, 2009 and December 27,2008 was $1,304,048 and $1,271,391, respectively.  The amortization related to those assetsunder capital lease is included in depreciation expense.

 

At December 26,2009, the minimum rental commitments under all non-cancelable operating leaseswith initial or remaining terms of more than one year were as follows:

 
| **Year**                             | ** ** | **Operating** | ** ** |
|--------------------------------------|------------|---------------|------------|
| 2010                                 |       | $             | 9,406,207  |   |
| 2011                                 |       | 9,140,802     |       |
| 2012                                 |       | 7,473,134     |       |
| 2013                                 |       | 6,209,099     |       |
| 2014                                 |       | 4,846,826     |       |
| Thereafter                           |       | 10,019,664    |       |
| Total  future minimum lease payments |       | $             | 47,095,732 |   |

 

The Company’s rental expense under operating leasesamounted to $9,471,472 in 2009, $9,114,774 in 2008 and $8,857,650 in 2007.  Included in these amounts are contingentrentals totaling $91,526 in 2009, $65,425 in 2008 and $50,643 in 2007.

 

F-15

----

 

**5.  INCOME TAXES:**

** **

A reconciliation of the effective ratewith the federal statutory rate is as follows:

 
| ** **                                  | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal  statutory rate                     |       | 34.0     | %          | 34.0     | %          | 34.0     | %          |
| State  income taxes, net of federal benefit |       | 8.3      | %          | -13.1    | %          | 9.5      | %          |
| Permanent  differences                      |       | 10.8     | %          | -33.1    | %          | 7.2      | %          |
| Release  of valuation allowance             |       | -36.0    | %          | 0.0      | %          | 0.0      | %          |
| Net  operating loss deduction and other     |       | -32.6    | %          | -0.8     | %          | -31.3    | %          |
| Effective  tax rate                         |       | -15.5    | %          | -13.0    | %          | 19.4     | %          |

 

The Company’s provision for state taxes exceeds the averagestatutory rate net of federal tax benefit because of permanent and temporarydifferences, for which valuation allowances have been provided, between taxableand book income, including amounts associated with stock based compensationexpense, depreciation, and note payable amortization.

 

Deferred tax assets consist of the following:

 
| ** **                        | ** ** | **2009**   | ** ** | **2008**   | ** ** |
|-----------------------------------|------------|------------|------------|------------|------------|
| Net  operating loss carryforwards |       | $          | 6,079,339  |       | $          | 6,908,962 |   |
| Inventory  allowances             |       | 260,286    |       | 231,669    |       |
| Deferred  rent                    |       | 602,194    |       | 477,844    |       |
| Accrued  compensation             |       | 60,403     |       | 63,217     |       |
| Intangible  assets                |       | 469,033    |       | 283,309    |       |
| Deferred  compensation            |       | 36,816     |       | 29,884     |       |
| Property  and equipment           |       | 515,949    |       | 285,112    |       |
|                              |       | 8,024,020  |       | 8,279,997  |       |
| Less  valuation allowance         |       | (7,609,333 | )          | (8,279,997 | )          |
| Net  deferred tax asset           |       | $          | 414,687    |       | $          | — |   |

 

The Companyhas historically recorded a valuation allowance against its deferred tax assetsbecause of the uncertainty regarding the realizability of these assets againstfuture taxable income. In fiscal 2009, the Company reduced the valuationallowance based on its judgment of the likelihood of sufficient pretaxaccounting income and taxable income in fiscal 2010. However, the Company believesthat it is prudent to maintain a valuation allowance against its remainingdeferred tax assets until establishment of a longer track record ofprofitability.

 

The Company used approximately $2,566,584 and $886,387 ofnet operating loss carryforwards in 2009 and 2008, respectively.

 

As of December 26, 2009, the Company has estimatedfederal net operating loss carryforwards of approximately $17.9 million, whichbegin to expire in 2019.  In accordancewith Section 382 of the Internal Revenue Code, the use of some of thesecarryforwards may be subject to annual limitations based upon ownership changesof the Company’s stock which may have occurred or that may occur.

 

The Company made cash payments for state income taxes of$90,900 in 2009, $159,386 in 2008 and $56,478 in 2007.  The Company made cash payments for federalincome taxes of $8,400 in 2009, $5,000 in 2008 and $0 in 2007.

 

At December 26, 2009, the Company had no materialunrecognized tax benefits and no adjustments to liabilities or operations wererequired.

 

F-16

----

 

The Company recognizes interest and penalties related touncertain tax positions in income tax expense which were $2,910 and $2,248 forthe year ended December 26, 2009 and the year ended December 27,2008, respectively.

 

Tax years 2006 through 2008 are subject to examination bythe federal and state taxing authorities. There is a 2007 federal income taxexamination currently in process.

 

**6.  CONTRACTUAL ARRANGEMENTS:**

 

*License Arrangement*

 

TheCompany has an agreement withTaymark, a direct marketer of party supplies, to license the iParty.com name toTaymark, which now operates the website at www.iparty.com.  Underthe agreement, Taymark pays the Company a 15% royalty on all net salesrealized through its operation of www.iparty.com.  Royalties have not been material in 2007,2008 or 2009. The original termof this agreement was for a period of two (2) years.  If this agreement is not terminated, itautomatically renews for successive one-year periods.  On July 8, 2009, the Company enteredinto its fifth consecutive one-yearrenewal period.

 

**7.  RELATED PARTY TRANSACTIONS:**

** **

On June 6, 2007, the Company’s Board of Directorsapproved the payment of up to $60,000 to Joseph Vassalluzzo, a Director of theCompany, for services as a part-time consultant for a one-year period.  As of December 26, 2009, this amount hadbeen earned and paid.

 

On June 4, 2008, the Company’s Board of Directorsapproved the payment of up to $60,000 to Joseph Vassalluzzo, a Director of theCompany, for services as a part-time consultant for a one-year period.  As of December 26, 2009, this amount hadbeen earned and paid.

 

On May 27, 2009, the Company’s Board of Directorsapproved the payment of up to $60,000 to Joseph Vassalluzzo, a Director of theCompany, for services as a part-time consultant for a one-year period.  As of December 26, 2009, $15,000 hadbeen earned and paid.

 

**8.**  **LINE OF CREDIT:**

 

On July 1, 2009, theCompany and its wholly-owned subsidiary, iParty Retail Stores Corp., asborrowers (together, the “Borrowers”), and Wells Fargo , as administrativeagent, collateral agent, swing line lender and lender, entered into a SecondAmended and Restated Credit Agreement (the “Agreement”).

 

The Agreementamended and restated the previous revolving credit facility with Wells Fargo,continued the revolving line of credit with Wells Fargo in the amount of up to$12,500,000 and extended the maturity date of the revolving line of credit forthree years to July 2, 2012.  Inaddition, the Agreement includes an option whereby the Borrowers may increasethe revolving line of credit up to a maximum level of $15,000,000, at any timeuntil July 2, 2011.  The amount ofcredit that is available from time to time under the Agreement is determined asa percentage of the value of eligible inventory plus a percentage of the valueof eligible credit card receivables, as reduced by certain reserve amounts thatmay be required by Wells Fargo.

 

Borrowings underthe Agreement will generally accrue interest at a margin ranging from 3.00% to3.50% (determined according to the average daily excess availability during thefiscal quarter immediately preceding the adjustment date) over, at theBorrowers’ election, either the London Interbank Offered Rate (“LIBOR”) or abase rate determined by Wells Fargo from time to time.  The credit facility also provides for lettersof credit and includes an unused line fee on the unused portion of therevolving credit line.

 

The obligations of theBorrowers under the Agreement and the other loan documents are secured by alien on substantially all of the personal property of the Borrowers.

 

F-17

----

 

The Agreement hasfinancial covenants that are limited to minimum availability and capitalexpenditures and contains a number of restrictive covenants, such asincurrence, payment or entry into certain indebtedness, liens, investments,acquisitions, mergers, dispositions and dividends. The Agreement containsevents of default customary for credit facilities of this type.  Upon an event of default that is not cured orwaived within any applicable cure periods, in addition to other remedies thatmay be available to Wells Fargo, the obligations under the Agreement may beaccelerated, outstanding letters of credit may be required to be cashcollateralized and the lenders may exercise remedies to collect the balancedue, including to foreclose on the collateral. Should the Agreement be prepaid or the maturity accelerated for anyreason, the Borrowers would be responsible for an early termination fee in theamount of (i) 1.50% of the revolving credit facility ceiling then ineffect within the first year of the term of the facility, (ii) 1.00% ofthe revolving credit facility ceiling then in effect within the second year ofthe term of the facility and (ii) 0.50% thereafter.

 

The line includes a financial covenant requiring theCompany to maintain a minimum availability under the line of 7.5% of the creditlimit.  At the current credit limit of$12,500,000, the minimum availability is $937,500.  At December 26, 2009, the Company was incompliance with this financial covenant.  The amended Agreement also has a covenant that requires the Company tolimit its capital expenditures to within 110% of those amounts included in itsbusiness plan, which may be updated from time to time.  Actual capital expenditures for fiscal year2007 totaled $802,174, or 116% of the Company’s business plan amount. On December 28,2007, Wells Fargo waived compliance with the capital expenditure covenant for2007.   For fiscal years ended December 26,2009 and December 27, 2008, the Company was in compliance with all debtcovenants.  The Agreement also includes a0.5% unused line fee.  The line generallyprohibits the payment of any dividends or other distributions to any of theCompany’s classes of capital stock.

 

The amounts outstanding under the line as of December 26,2009 and December 27, 2008 were $2,526,982 and $1,950,019,respectively.  The interest rate on theseborrowings was 5.0% at December 26, 2009 and 4.7% at December 27,2008.  The Agreement also includes a0.25% unused line fee.  The outstandingbalances under the line are classified as current liabilities in theaccompanying consolidated balance sheets since the Company is required to applydaily lock box receipts to reduce the amount outstanding.  At December 26, 2009, the Company hadapproximately $3,450,662 of additional availability under the line.

 

**9.  NOTES PAYABLE:**

** **

Notes payable consist ofthree notes entered into in fiscal 2006.

 

The “Highbridge Note” wasa subordinated note in the stated principal amount of $2,500,000 that boreinterest at the prime rate plus one percent. The Highbridge Note was part of a financing transaction that raised $2.5million through a combination of the issuance of the Highbridge Note and awarrant exercisable for 2,083,334 shares of common stock at an exercise priceof $0.475 per share. The original discount associated with the warrant issuedin conjunction with the Highbridge Note (original discount amount $613,651) wasamortized using the effective interest method over the life of the note.Interest only was payable quarterly in arrears during the term of the note andthe entire principal balance was due at the maturity date. The note matured on September 15,2009, at which time the Company paid the full principal amount of $2,500,000 plusall accrued interest.

 

The “Amscan Note” was asubordinated promissory note in the original principal amount of $1,819,373.The note bore interest at the rate of 11.0% per annum and was payable inthirty-six (36) equal monthly installments of principal and interest of $59,562beginning on November 1, 2006. The remaining principal balance and allaccrued interest were paid in full on September 24, 2009.

 

The “Party City Note” isa subordinated promissory note in the principal amount of $600,000.   The note bears interest at the rate of12.25% per annum and is payable by quarterly interest-only payments over fouryears, with the full principal amount due at the note’s maturity on August 7,2010.

 

On August 7, 2006,the Company entered into a Supply Agreement with Amscan Inc. (“Amscan”), thelargest supplier in the party goods industry. The Supply Agreement with Amscan gives the Company the right to receivecertain additional rebates and more favorable pricing terms over the term ofthe agreement than generally were 

 

F-18

----

 

available to theCompany under its previous terms with Amscan. The right to receive additional rebates, and the amount of such rebates,are subject to the Company’s achievement of increased levels of purchases andother factors provided for in the Supply Agreement.  In exchange, the Supply Agreement obligatesthe Company to purchase increased levels of merchandise from Amscan until 2012.  The Supply Agreement provided for an initialramp-up period during 2006 and 2007 and, beginning with calendar year 2008,requires the Company to purchase on an annual basis merchandise equal to thetotal number of its stores open during such calendar year, multiplied by$180,000 until 2012.  The Supply Agreementprovides for penalties in the event the Company fails to attain the annualpurchase commitment.  Under the terms ofthe Supply Agreement, the annual purchase commitment for any individual yearcan be reduced for orders placed by the Company but not filled by the supplierwithin a specified time period.  During2008, the supplier experienced difficulty in filling completely certain orderssourced out of China.  Accordingly, thesupplier agreed to reduce the Company’s purchase commitment for 2008 to 90% ofthe contractual minimum for that year. The Company’s purchases for 2009 fell short of the annual commitment byapproximately $368,000. The supplier has agreed to allow the Company to rollover any shortfall for the year 2009 into future years’ requirements. TheCompany is not aware of any reason that would prevent it from meeting theminimum purchase requirements, including any 2009 shortfall, for the remainderof the term of the Supply Agreement.

 

The Supply Agreement alsoprovided for Amscan to extend, until October 31, 2006, approximately$1,150,000 of certain currently due amounts owed by the Company to Amscan whichwould otherwise have been payable on August 8, 2006 (the “extendedpayables”) and gave the Company the right, at its option, to convert theextended payables into a subordinated promissory note. On October 24,2006, the Company converted $1,143,896 of extended payables originally due toAmscan as of August 8, 2006 as well as an additional $675,477 of payablesdue to Amscan as of September 28, 2006 into a single subordinatedpromissory note in the total principal amount of $1,819,373, which was theAmscan Note defined above. As noted above, the Company has paid in full theAmscan Note.

 

On August 7, 2006,the Company also entered into and simultaneously closed an Asset PurchaseAgreement with Party City, an affiliate of Amscan, pursuant to which theCompany acquired a Party City retail party goods store in Peabody,Massachusetts and received a five-year non-competition covenant from Party City,for aggregate consideration of $2,450,000, payable by a subordinated note inthe principal amount of $600,000, which is the Party City Note defined above,and $1,850,000 in cash.

 

Total cash payments for interest under the Company’s lineof credit, notes payable and capital leases totaled $316,692 in 2009, $500,090in 2008 and $645,392 in 2007.

 

**10.  PREFERRED STOCK:**

** **

The following table summarizes the changes in the number ofshares of convertible preferred stock during the past two years:

 
| ** **                                 | ** ** | **Shares**         | ** ** | ** **      | ** ** | **Shares**         | ** ** | ** **      | ** ** | **Shares**         | ** ** |
|--------------------------------------------|------------|--------------------|------------|-----------------|------------|--------------------|------------|-----------------|------------|--------------------|------------|
| ** **                                 | ** ** | **Issued**         | ** ** | **Conversions** | ** ** | **Issued**         | ** ** | **Conversions** | ** ** | **Issued**         | ** ** |
| ** **                                 | ** ** | **and**            | ** ** | **to**          | ** ** | **and**            | ** ** | **to**          | ** ** | **and**            | ** ** |
| ** **                                 | ** ** | **Outstanding**    | ** ** | **Common**      | ** ** | **Outstanding**    | ** ** | **Common**      | ** ** | **Outstanding**    | ** ** |
| ** **                                 | ** ** | **as of 12/26/09** | ** ** | **Stock**       | ** ** | **as of 12/27/08** | ** ** | **Stock**       | ** ** | **as of 12/29/07** | ** ** |
| Series B  convertible preferred stock |       | 459,173            |       | (3,913          | )          | 463,086            |       | (2,315          | )          | 465,401            |       |
| 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 |       | 296,666            |       | —          |       | 296,666            |       | —          |       | 296,666            |       |
| Series F  convertible preferred stock |       | 114,286            |       | —          |       | 114,286            |       | —          |       | 114,286            |       |
| Total                                      |       | 1,220,125          |       | (3,913          | )          | 1,224,038          |       | (2,315          | )          | 1,226,353          |       |

 

F-19

----

 

*Series B Convertible Preferred Stock*

* *

The shares of Series B convertible preferred stock areimmediately convertible into 6,151,082 shares of common stock on a 1.000 to13.396 ratio at December 26, 2009, and carry an aggregate liquidationvalue of $9,183,460 ($1.49 per common share issuable upon conversion) at December 26,2009.  With certain exceptions, theconversion price will be adjusted on a weighted-average basis in the event theCompany issues common stock or certain rights, including option activity inexcess of certain amounts, to purchase or convert into common stock as definedin the Company’s Certificate of Incorporation, as amended, at a price below theconversion price.  The Series Bconvertible 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 Bconvertible preferred stock have preference to holders of the Company’s common stock,and are *pari passu* with theCompany’s Series C, D, E and F convertible preferred stock.

 

Holders of Series B convertible preferred stock areentitled to 13 votes per share (i.e., one vote for each whole number of sharesof common stock into which each such share is presently convertible) on allmatters submitted to a vote of the Company’s stockholders and are entitled toparticipate in dividends when and if declared by the Board of Directors.

 

*Series C Convertible Preferred Stock*

 

The shares of Series C convertible preferred stock areimmediately convertible into 1,365,200 shares of common stock on a 1.000 to13.652 ratio at December 26, 2009, and carry an aggregate liquidationvalue of $2,000,000 ($1.47 per common share issuable upon conversion) at December 26,2009.  With certain exceptions, theconversion price will be adjusted on a weighted-average basis in the event theCompany issues common stock or certain rights, including option activity inexcess of certain amounts, to purchase or convert into common stock as definedin the Company’s Certificate of Incorporation, as amended, at a price below theconversion 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 Cconvertible preferred stock have preference to holders of the Company’s commonstock, and are *pari passu* withthe Company’s Series B, D, E and F convertible preferred stock.

 

Holders of Series C convertible preferred stock areentitled to 13 votes per share (i.e., one vote for each whole number of sharesof common stock into which each such share is presently convertible) on allmatters submitted to a vote of the Company’s stockholders and are entitled toparticipate in dividends when and if declared by the Board of Directors.

 

*Series D Convertible Preferred Stock*

 

The shares of Series D convertible preferred stock areimmediately convertible into 3,652,250 shares of common stock on a 1.000 to14.609 ratio at December 26, 2009, and carry an aggregate liquidationvalue of $5,000,000 ($1.37 per common share issuable upon conversion) at December 26,2009.  With certain exceptions, theconversion price will be adjusted on a weighted-average basis in the event theCompany issues common stock or certain rights, including option activity inexcess of certain amounts, to purchase or convert into common stock as definedin the Company’s Certificate of Incorporation, as amended, at a price below theconversion 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.

 

F-20

----

 

In the event of liquidation, the holders of Series Dconvertible preferred stock have preference to holders of the Company’s commonstock, and are *pari passu* withthe Company’s Series B, C, E and F convertible preferred stock.

 

Holders of Series D convertible preferred stock areentitled to 14 votes per share (i.e., one vote for each whole number of sharesof common stock into which each such share is presently convertible) on allmatters submitted to a vote of the Company’s stockholders and are entitled toparticipate in dividends when and if declared by the Board of Directors.

 

*Series EConvertible Preferred Stock*

 

The shares of Series E convertible preferred stock areimmediately convertible into 3,073,163 shares of common stock on a 1.000 to10.359 ratio at December 26, 2009, and carry an aggregate liquidationvalue of $1,112,497 ($0.362 per common share issuable upon conversion) at December 26,2009.  With certain exceptions, theconversion price will be adjusted on a weighted-average basis in the event theCompany issues common stock or certain rights, including option activity inexcess of certain amounts, to purchase or convert into common stock as definedin the Company’s Certificate of Incorporation, as amended, at a price below theconversion price.  The Series Econvertible preferred stock will automatically convert into common stock at theconversion price then in effect in the event the average closing bid price ofthe common stock equals or exceeds $10.00 per share for 20 days within any30-day period.

 

In the event of liquidation, the holders of Series Econvertible preferred stock have preference to holders of the Company’s commonstock, and are *pari passu* withthe Company’s Series B, C, D and F convertible preferred stock.

 

Holders of Series E convertible preferred stock areentitled to 10 votes per share (i.e., one vote for each whole number of sharesof common stock into which each such share is presently convertible) on allmatters submitted to a vote of the Company’s stockholders and are entitled toparticipate in dividends when and if declared by the Board of Directors.

 

*Series F Convertible Preferred Stock*

 

The shares of Series F convertible preferred stock areimmediately convertible into 1,184,803 shares of common stock on a 1.000 to10.367 ratio at December 26, 2009, and carry an aggregate liquidation valueof $500,000 ($0.422 per common share issuable upon conversion) at December 26,2009.  With certain exceptions, theconversion price will be adjusted on a weighted-average basis in the event theCompany issues common stock or certain rights, including option activity inexcess of certain amounts, to purchase or convert into common stock as definedin the Company’s Certificate of Incorporation, as amended, at a price below theconversion price.  The Series Fconvertible preferred stock will automatically convert into common stock at theconversion price then in effect in the event the average closing bid price ofthe common stock equals or exceeds $10.00 per share for 20 days within any30-day period.

 

In the event of liquidation, the holders of Series Fconvertible preferred stock have preference to holders of the Company’s commonstock, and are *pari passu*withthe Company’s Series B, C, D and E convertible preferred stock.

 

Holders of Series F 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.

 

*Highbridge Warrant Anti-Dilution Shares*

 

On September 15, 2006, the Company entered into aSecurities Purchase Agreement pursuant to which it raised $2.5 million througha combination of subordinated debt and warrant issued on September 15,2006 to Highbridge, an institutional accredited investor.  The warrant issued to Highbridge isexercisable for 2,083,334 

 

F-21

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shares of the Company’s common stock at an exercise priceof $0.475 per share.  The issuance of theHighbridge Warrant triggered certain anti-dilution provisions of the Company’s Series B,C, and D convertible preferred stock.  Asa result, the number of shares of common stock into which the Series B, Cand D preferred stock convert increased by 249,254, 54,600, and 138,500additional shares, respectively.

 

*Accretion of Dividends in the Event ofLiquidation*

 

The carrying values of Series B through F convertiblepreferred stock have been determined based on their fair market values at theoriginal dates of issuance.  In certaincases, warrants were issued to which the Company allocated value and includedin additional paid in capital.  Shouldsuch a liquidation event occur, the difference between the carrying value ofthe convertible preferred stock and their liquidation value will beaccreted.  This amount was $4,206,466 on December 26,2009.

 

**11.  WARRANTS:**

** **

At December 26, 2009, there were warrants outstandingwhich were exercisable for 2,183,334 shares of the Company’s common stock.  These warrants were issued in connection withsubordinated debt financings and professional service contracts.

 

During the period April 1999 through August 1999,the Company issued warrants in connection with convertible debt exercisable fora total of 528,210 shares of its common stock, at exercise prices ranging from$2.81 to $5.13 per share. These warrants expired between April and August 2009.

 

On September 15, 2006, the Company entered into aSecurities Purchase Agreement pursuant to which it raised $2.5 million througha combination of subordinated debt and warrant issued on September 15,2006 to Highbridge, an institutional accredited investor. Under the terms ofthe financing, the Company issued Highbridge a warrant (the “Highbridge Warrant”)exercisable for 2,083,334 shares of its common stock at an exercise price of$0.475 per share, or 125% of the closing price of the Company’s common stock onthe day immediately prior to the closing of the transaction.  The Company allocated approximately $613,651of value to the Highbridge Warrant using the Black-Scholes model withvolatility of 108%, interest of 4.73% and expected life of five years.  The Highbridge Warrant was amortized usingthe effective interest method over the life of the Highbridge Note.  The Highbridge Warrant was fully amortized asof December 26, 2009.  Theagreements entered into in connection with the financing provided for certainrestrictions and covenants consistent with Highbridge’s status as asubordinated lender, and also grant Highbridge resale registration rights withrespect to the shares of common stock underlying the Highbridge Warrant.

 

On February 28, 2008, the Company entered into anagreement with Booke and Company, Inc. for investor relations services. Inconnection with that agreement, the Company issued warrants to purchase 100,000shares of its common stock at an exercise price of $1.50 per share. Thewarrants expire on February 28, 2013. The Company determined the fairvalue of the 2008 warrants to be $9,759 at December 26, 2009 by using theBlack-Scholes model (volatility of 108%, risk free rate of 2.57% and expectedlife of 5.0 years). The fair value of the 2008 warrants was amortized overtheir vesting period of one year.

 

The following table summarizes the Company’s outstandingwarrants at December 26, 2009:

 
| **Shares  Issuable** | ** ** | **Exercise Price** | ** ** | **Expiration Date** | ** ** |
|----------------------|------------|--------------------|------------|---------------------|------------|
| 2,083,334            |       | 0.48               |       | 09/15/11            |       |
| 100,000              |       | 1.50               |       | 02/28/13            |       |

 

F-22

----

 

**12.  STOCK OPTIONPLAN:**

** **

On May 27, 2009, the Company’sstockholders approved a new equity incentive plan entitled the 2009 StockIncentive Plan (the “2009 Plan”).  TheCompany will no longer grant equity awards under its former equity incentiveplan,  the Amended and Restated 1998Incentive and Nonqualified Stock Option Plan (the “1998 Plan” and with the 2009Plan, the “Plans”).

 

Under the Company’s Plans, options to acquire shares ofcommon stock may be granted to officers, directors, key employees andconsultants.   Under the 2009 Plan, theexercise price for qualified incentive options and non-qualified options cannotbe less than the fair market value of the stock on the grant date, asdetermined by the Company’s Board of Directors. In addition, under the 2009Plan, other stock based and performance awards may be granted to officers,directors, key employees and consultants, including stock appreciation rights,restricted stock, and restricted stock units. Under the Plans, a combined totalof 11,000,000 shares of common stock or other stock based awards may be granted.  To date, the Company has only issued optionsunder its Plans, which have been granted to employees, directors andconsultants of the Companyatfair market value at the date of grant. Generally, employee options become exercisable over periods of up tofour years, and expire ten years from the date of grant.

 

A summary of the Company’s stockoptions is as follows:

 
| ** **                                   | ** ** | **Number of**     | ** ** | ** **   | ** ** | ** **      | ** **                |
|----------------------------------------------|------------|-------------------|------------|--------------|------------|-----------------|---------------------------|
| ** **                                   | ** ** | **Shares of**     | ** ** | **Weighted** | ** ** | ** **      | ** **                |
| ** **                                   | ** ** | **Common Stock**  | ** ** | **Average**  | ** ** | ** **      | ** **                |
| ** **                                   | ** ** | **Underlying**    | ** ** | **Exercise** | ** ** | **Price**       | ** **                |
| ** **                                   | ** ** | **Stock Options** | ** ** | **Price**    | ** ** | **Range**       | ** **                |
| Outstanding  - December 27, 2008        |       | 9,082,198         |       | 0.55         |       | 0.13 - 4.25     |                      |
| Granted                                      |       | 1,285,000         |       | 0.10         |       | 0.07 - 0.11     |                      |
| Expired/Forfeited                            |       | (332,437          | )          | 1.94         |       | 0.11 - 3.81     |                      |
| Exercised                                    |       | —            |       | —       |       | — - — |                      |
|                                         |       |              |       |         |       |            |                      |
| Outstanding  - December 26, 2009        |       | 10,034,761        |       | 0.45         |       | 0.07 - 4.25     |                      |
|                                         |       |              |       |         |       |            |                      |
| Exercisable  - December 26, 2009        |       | 8,347,879         |       | $            | 0.50       |            | $ 0.11 - $ 4.25 |   |
|                                         |       |              |       |         |       |            |                      |
| Available for grant - December 26, 2009 |       | 529,978           |       |         |       |            |                      |
|                                              |            |                   |            |              |            |                 |                           |  |

 

Thefollowing table summarizes information for options outstanding and exercisableat December 26, 2009:

 

 
| ** **               | ** ** | **Outstanding**   | ** ** | **Exercisable** | ** ** |
|--------------------------|------------|-------------------|------------|-----------------|------------|
| ** **               | ** ** | **Number of**     | ** ** | **Weighted**    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Shares of**     | ** ** | **Average**     | ** ** | **Weighted** | ** ** | **Number** | ** ** | **Weighted** | ** ** |
| ** **               | ** ** | **Common Stock**  | ** ** | **Remaining**   | ** ** | **Average** | ** ** | **of** | ** ** | **Average** | ** ** |
| ** **               | ** ** | **Underlying**    | ** ** | **Life**        | ** ** | **Exercise** | ** ** | **Stock** | ** ** | **Exercise** | ** ** |
| **Price Range**          | ** ** | **Stock Options** | ** ** | **(Years)**     | ** ** | **Price** | ** ** | **Options** | ** ** | **Price** | ** ** |
| $ 0.07- $ 0.20 |       | 1,393,350         |       | 8.66            |       | $ | 0.11 |   | 178,350 |   | $ | 0.16 |   |
| 0.21- 0.30               |       | 3,411,297         |       | 1.67            |       | 0.25 |   | 3,348,798 |   | 0.25 |   |
| 0.31- 0.50               |       | 2,392,036         |       | 5.10            |       | 0.39 |   | 1,982,653 |   | 0.38 |   |
| 0.51- 1.00               |       | 2,674,778         |       | 3.22            |       | 0.77 |   | 2,674,778 |   | 0.77 |   |
| 1.01- 3.50               |       | 88,300            |       | 1.81            |       | 2.40 |   | 88,300 |   | 2.40 |   |
| 3.51- 4.25               |       | 75,000            |       | 0.02            |       | 4.25 |   | 75,000 |   | 4.25 |   |
| Total                    |       | 10,034,761        |       | 3.86            |       | $ | 0.45 |   | 8,347,879 |   | $ | 0.50 |   |

 

F-23

----

 

**The Companyhas reserved 27,644,593 shares of common stock for issuance in connection withthe conversion of convertible preferred stock (15,426,498 shares), the exerciseof warrants (2,183,334 shares) and the exercise of stock options (10,034,761shares).**

** **

**13.**       STOCKHOLDER RIGHTS PLAN:

** **

The Company has a StockholderRights Plan (the “Plan”) effective November 9, 2001.  Under the Plan, each share of the Company’scapital stock outstanding at the close of business on November 9, 2001 andeach share of the Company’s capital stock issued subsequent to that date has aright associated with it, such that each share of its common stock is entitledto one right and each share of its preferred stock is entitled to such numberof rights equal to the number of common shares into which it is convertible.

 

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

 

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

 

On September 15, 2006, the Company amended the Plan to clarify that the issuance ofthe Highbridge Warrant did not constitute a triggering event under the Plan.

 

**14.  PROFIT SHARING401(k) PLAN:**

** **

The iParty401(k) Plan is a qualified profit sharing plan covering substantially allof its employees.  Contributions to thisplan are at the discretion of the Board of Directors.  The Company’s expense, including matchingcontributions and any discretionary amounts, was $154,427 in 2009, $164,954 in2008 and $120,084 in 2007.

 

**15.  SEGMENTREPORTING:**

** **

AccountingStandards Codificiation Subtopic 280-10, *Disclosuresabout Segments of an Enterprise and Related Information*, establishesstandards for the way business enterprises report information about operating segmentsin annual financial statements and requires that those enterprises reportselected information about operating segments in interim financial reportsissued to stockholders.  The Companyreports one operating segment as revenues from the other segment are notmaterial.

 

**16.  SUBSEQUENTEVENTS:**

** **

**The Company has evaluated subsequent eventsas required by ASC 855, *Subsequent Events*,and has determined that there were no subsequent events to recognize ordisclose in these financial statements.**

 

F-24

----

 

**17.  QUARTERLYFINANCIAL DATA (UNAUDITED):**

** **

**QUARTERLY FINANCIAL DATA**

 
| ** **                                         | ** ** | **Mar 28, 2009** | ** ** | **Jun 27, 2009** | ** ** | **Sep 26, 2009** | ** ** | **Dec 26, 2009** | ** ** |
|----------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| Revenues                                           |       | $                | 14,568,407 |             | $          | 19,569,009       |       | $                | 16,404,046 |   | $ | 28,053,626 |   |
| Cost  of products sold and occupancy costs(1), (2) |       | 9,382,066        |       | 11,691,950       |       | 10,282,326       |       | 15,200,697       |       |
| Operating  income (loss)                           |       | (1,578,747       | )          | 797,379          |       | (1,271,258       | )          | 3,452,889        |       |
| Net  income (loss)                                 |       | (1,715,271       | )          | 668,868          |       | (1,396,982       | )          | 3,547,117        |       |
|                                               |       |             |       |             |       |             |       |             |       |
| Net  income (loss) per share                       |       |             |       |             |       |             |       |             |       |
| Basic                                              |       | $                | (0.08      | )                | $          | 0.02             |       | $                | (0.06      | ) | $ | 0.09 |   |
| Diluted                                            |       | $                | (0.08      | )                | $          | 0.02             |       | $                | (0.06      | ) | $ | 0.09 |   |
|                                               |       |             |       |             |       |             |       |             |       |
| Weighted-average  shares outstanding:              |       |             |       |             |       |             |       |             |       |
| Basic                                              |       | 22,731,667       |       | 38,222,344       |       | 22,731,667       |       | 38,225,145       |       |
| Diluted                                            |       | 22,731,667       |       | 38,222,344       |       | 22,731,667       |       | 38,816,993       |       |

 
| ** **                                          | ** ** | **Mar 29, 2008** | ** ** | **Jun 28, 2008** | ** ** | **Sep 27, 2008** | ** ** | **Dec 27, 2008** | ** ** |
|-----------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| Revenues                                            |       | $                | 16,144,088 |             | $          | 20,103,668       |       | $                | 17,742,315 |   | $ | 27,220,928 |   |
| Cost  of products sold and occupancy costs (1), (3) |       | 9,905,029        |       | 11,515,061       |       | 10,543,073       |       | 14,922,052       |       |
| Operating  income (loss)                            |       | (1,573,858       | )          | 465,513          |       | (1,058,738       | )          | 2,493,915        |       |
| Net  income (loss)                                  |       | (1,786,210       | )          | 281,132          |       | (1,236,559       | )          | 2,301,582        |       |
|                                                |       |             |       |             |       |             |       |             |       |
| Net  income (loss) per share                        |       |             |       |             |       |             |       |             |       |
| Basic                                               |       | $                | (0.08      | )                | $          | 0.01             |       | $                | (0.05      | ) | $ | 0.06 |   |
| Diluted                                             |       | $                | (0.08      | )                | $          | 0.01             |       | $                | (0.05      | ) | $ | 0.06 |   |
|                                                |       |             |       |             |       |             |       |             |       |
| Weighted-average  shares outstanding:               |       |             |       |             |       |             |       |             |       |
| Basic                                               |       | 22,708,383       |       | 38,210,583       |       | 22,730,295       |       | 38,210,583       |       |
| Diluted                                             |       | 22,708,383       |       | 38,319,767       |       | 22,730,295       |       | 38,212,561       |       |

 

----

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

 

(2) The fourth quarter of 2009 included an estimated reduction of $142,010 to thecost of products sold during the previous three quarters due to the completionof physical inventories, for which shortage had been estimated during the year.

 

(3)  The fourth quarter of 2008 included anestimated reduction of $261,915 to the cost of products sold during theprevious three quarters due to the completion of physical inventories, forwhich shortage had been estimated during the year.

 

F-25

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**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                 | (5)    |            | Certificate  of Designation of Series E Preferred Stock of iParty Corp. |
| 3.7                 | (9)    |            | Certificate  of Correction to Certificate of Designation of Series E Preferred Stock  of iParty Corp. |
| 3.8                 | (6)    |            | Certificate  of Designation of Series F Preferred Stock of iParty Corp. |
| 3.9                 | (8)    |            | Certificate  of Designation of Series G Junior Preferred Stock of iParty Corp. |
| 3.10                | (20)   |            | Amended  and Restated By-Laws of iParty Corp. |
| 10.1                | (1)    |            | Agreement  and Plan of Merger between iParty Corp. and WSI Acquisitions Corp. |
| 10.2                | (9)    | ##              | Amended  and Restated 1998 Incentive and Non-Qualified Stock Option Plan. |
| 10.3                | (12)   | ##              | Form of  Non-qualified Stock Option Agreement. |
| 10.4                | (12)   | ##              | Form of  Incentive Stock Option Agreement. |
| 10.5                | (11)   | ##              | Form of  Stock Option Agreement granted to Messrs. DeWolf, Haydu, Schindler, and  Vassalluzzo. |
| 10.6                | (16)   | ##              | Option  Cancellation Agreement between Sal Perisano and iParty Corp., dated  December 8, 2006. |
| 10.7                | (16)   | ##              | Option  Cancellation Agreement between Patrick Farrell and iParty Corp., dated December 8,  2006. |
| 10.8                | (16)   | ##              | Option  Cancellation Agreement between Dorice Dionne and iParty Corp, dated  December 8, 2006. |
| 10.9                | (22)   | ##              | Employment  Agreement between iParty Corp. and Sal Perisano, dated March 22, 2007. |
| 10.9a               | (25)   | ##              | First  Amendment dated December 30, 2008 to Employment Agreement by and between  iParty Corp. and Sal Perisano. |
| 10.10               | (22)   | ##              | Employment  Agreement between iParty Corp. and Dorice Dionne, dated March 22, 2007. |
| 10.10a              | (25)   | ##              | First  Amendment dated December 30, 2008 to Employment Agreement by and between  iParty Corp. and Dorice Dionne. |
| 10.11               | (18)   | ##              | Amended  and Restated Employment Agreement between iParty Corp. and Patrick Farrell,  dated January 8, 2007. |
| 10.12               | (23)   | ##              | Compensation  Arrangements dated June 6, 2007 with Messrs. DeWolf, Haydu,  Schindler, and Vassalluzzo. |
| 10.12a              | (24)   | ##              | Compensation  Arrangements dated June 4, 2008 with Messrs. DeWolf, Haydu,  Schindler, and Vassalluzzo. |
| 10.12b              | (28)   | ##              | Compensation  Arrangements dated May 27, 2009 with Messrs. DeWolf, Haydu, Schindler and  Vassalluzzo. |
| 10.13               | (23)   | ##              | Written  Summary of Renewed One-Year Part-time Consulting Arrangement with Joseph  Vassalluzzo dated June 7, 2007. |
| 10.13a              | (24)   | ##              | Written  Summary of Renewed One-Year Part-time Consulting Arrangement with Joseph  Vassalluzzo dated June 4, 2008. |
| 10.13b              | (28)   | ##              | Written  Summary of Renewed One-Year Part-time Consulting Arrangement with Joseph  Vassalluzzo dated May 27, 2009. |
| 10.14               | (10)   |            | Web  Site License Agreement between iParty Corp. and Taymark, Inc. |
| 10.15               | (7)    |            | Rights  Agreement between iParty Corp. and Continental Stock Transfer &  Trust, as Rights Agent. |
| 10.16               | (14)   |            | Amendment  to Rights Agreement between iParty Corp. and Continental Stock  Transfer & Trust, as Rights Agent, dated September 15, 2006. |

 

F-26

----

 
| 10.17  | (17) |   | Amended  and Restated Loan and Security Agreement by and among iParty Corp., iParty  Retail Stores Corp. and Wells Fargo Retail Finance II, LLC dated  December 21, 2006.                                                                                     |
|--------|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.18  | (13) |   | Supply  Agreement with Amscan Inc., dated August 7, 2006.                                                                                                                                                                                                     |
| 10.19  | (13) |   | Asset  Purchase Agreement with Party City Corporation, dated August 7, 2006.                                                                                                                                                                                  |
| 10.20  | (14) |   | Securities  Purchase Agreement with Highbridge International LLC, dated  September 15, 2006.                                                                                                                                                                  |
| 10.21  | (19) |   | Amendment  Agreement between iParty Corp. and Highbridge International LLC, dated  January 9, 2007.                                                                                                                                                           |
| 10.22  | (14) |   | Senior  Subordinated Note with Highbridge International LLC, dated September 15,  2006.                                                                                                                                                                       |
| 10.23  | (19) |   | Warrant  to Purchase Common Stock with Highbridge International LLC, issued September 15,  2006, as amended January 9, 2007.                                                                                                                             |
| 10.24  | (14) |   | Registration  Rights Agreement with Highbridge International LLC, dated September 15,  2006.                                                                                                                                                                  |
| 10.25  | (15) |   | Subordinated  Promissory Note of iParty Corp., dated October 24, 2006.                                                                                                                                                                                        |
| 10.26  | (9)  |   | Trademark  Security Agreement between iParty Corp. and Wells Fargo Retail Finance, LLC.                                                                                                                                                                            |
| 10.27  | (5)  |   | Stock  Purchase Agreement by and among iParty Corp., Ajmal Khan and Robert Lessin.                                                                                                                                                                                 |
| 10.28  | (6)  |   | Stock  Purchase Agreement between iParty Corp. and Patriot Capital Ltd.                                                                                                                                                                                            |
| 10.29  | (3)  |   | Funding  Agreement among iParty Corp., Robert Lessin and Ajmal Khan.                                                                                                                                                                                               |
| 10.30  | (21) |   | Asset  Purchase Agreement by and among Party City of Warwick, Inc. and Party  City of Lincoln, LLC, as Sellers, and iParty Corp. and iParty Retail Stores  Corp., as Buyers, dated as of August 15, 2007.                                                |
| 10.31  | (22) | ##     | Letter  Agreement between iParty Corp. and David E. Robertson, dated March 22,  2007                                                                                                                                                                          |
| 10.31a | (25) | ##     | First  Amendment dated December 30, 2008 to Letter Agreement dated  March 22, 2007 by and between iParty Corp. and David E. Robertson.                                                                                                                   |
| 10.32  | (26) | ##     | 2009  Stock Incentive Plan.                                                                                                                                                                                                                                        |
| 10.32a | (28) | ##     | Form of  Director Stock Option Agreement of 2009 Stock Incentive Plan.                                                                                                                                                                                        |
| 10.32b | (28) | ##     | Form of  Incentive Stock Option Agreement for 2009 Stock Incentive Plan.                                                                                                                                                                                      |
| 10.34  | (27) |   | Second  Amended and Restated Credit Agreement among iParty Corp. and its wholly owned  subsidiary iParty Retail Stores Corp., as borrowers, and Wells Fargo Retail  Finance, LLC, as Administrative Agent, Swing Line Lender and Lender, dated  July 1, 2009. |
| 21.1   | **   |   | Subsidiary  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.

##       Managementcontract or compensatory plan or arrangement.

(1)       Filed as an exhibit to iParty’s RegistrationStatement on Form 10-SB, Registration No. 0-25507, as filed with theSEC on March 8, 1999 and incorporated herein by reference.

(2)       Filed as an exhibit to Amendment No. 2 toiParty’s Registration Statement on Form 10-SB, Registration No. 0-25507,as filed with the SEC on October 19, 1999 and incorporated herein byreference.

(3)       Filed as an exhibit to Amendment No. 1 toiParty’s Registration Statement on Form 10-SB, Registration No. 0-25507,as filed with the SEC on July 12, 1999 and incorporated herein byreference.

(4)       Filed as an exhibit to iParty’s Annual Report on Form 10-KSBfor 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 Current Report on Form 8-K,filed with the SEC on August 30, 2000 and incorporated herein byreference.

 

F-27

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(6)       Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on September 15, 2000 and incorporated herein byreference.

(7)       Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on November 16, 2001 and incorporated herein byreference.

(8)       Included as an exhibit (Exhibit C) to Exhibit 99.2to iParty’s Current Report on Form 8-K, filed with the SEC on November 16,2001 and incorporated herein by reference.

(9)       Filed as an exhibit to iParty’s Annual Report on Form 10-KSBfor the year ended December 28, 2002, filed with the SEC on March 28,2003 and incorporated herein by reference.

(10)     Filed as an exhibit to iParty’s Quarterly Report on Form 10-Q,filed with the SEC on August 12, 2003 and incorporated herein byreference.

(11)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on March 30, 2006 and incorporated herein by reference.

(12)     Filed as an exhibit to iParty’s Annual Report on Form 10-K,filed with the SEC on March 30, 2006 and incorporated herein by reference.

(13)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on August 7, 2006 and incorporated herein by reference.

(14)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on September 18, 2006 and incorporated herein byreference.

(15)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on October 25, 2006 and incorporated herein byreference.

(16)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on December 12, 2006 and incorporated herein byreference.

(17)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on December 26, 2006 and incorporated herein byreference.

(18)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on January 8, 2007 and incorporated herein byreference.

(19)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on January 10, 2007 and incorporated herein byreference.

(20)     Filed as an exhibit to iParty’s Current Report on Form 8-Kfiled with the SEC on December 10, 2007 and incorporated herein byreference.

(21)     Filed as an exhibit to iParty’s Current Report on Form 8-Kfiled with the SEC on August 16, 2007 and incorporated herein byreference.

(22)     Filed as an exhibit to iParty’s Current Report on Form 8-Kfiled with the SEC on March 26, 2007 and incorporated herein by reference.

(23)     Filed as an exhibit to iParty’s Current Report on Form 8-Kfiled with the SEC on June 12, 2007 and incorporated herein by reference.

(24)     Filed as an exhibit to iParty’s Quarterly Report on Form 10-Q,filed with the SEC on August 11, 2008 and incorporated herein byreference.

(25)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on January 5, 2009 and incorporated herein byreference.

(26)     Filed as an exhibit to iParty’s Definitive ProxyStatement filed witht the SEC on April 24, 2009 and incorporated here byreference.

(27)     Filed as an exhibit to iParty’s Current Report on Form 8-K,filed with the SEC on July 6, 2009 and incorporated here by reference.

(28)     Filed as an exhibit to iParty’s Quarterly Report on Form 10-Qon August 6, 2009 and incorporated here by reference.

 

F-28

----