The following discussion should be read in conjunction with the unaudited Consolidated Financial Statements and related Notes included in Item 1 of this Quarterly Report on Form 10-Q and the audited Consolidated Financial Statements and related Notes and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", contained in our Annual Report on Form 10-K for the fiscal year ended December 27, 2008.

Certain statements in this Quarterly Report on Form 10-Q, particularly statements contained in this Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words "anticipate", "believe", "estimate", "expect", "plan", "intend" and other similar expressions are intended to identify these forward-looking statements, but are not the exclusive means of identifying them. Forward-looking statements included in this Quarterly Report on Form 10-Q or hereafter included in other publicly available documents filed with the Securities and Exchange Commission ("SEC"), reports to our stockholders and other publicly available 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 future results, performance (financial or operating) or achievements expressed or implied by such forward looking statements. Such future results are based upon our best estimates based upon current conditions and the most recent results of operations. Various risks, uncertainties and contingencies could cause our actual results, performance or achievements to differ materially from those expressed in, or implied by, the forward-looking statements contained in this Quarterly Report on Form 10-Q. These include, but are not limited to, those described below under the heading "Factors That May Affect Future Results" and in Part II, Item 1A, "Risk Factors" as well as under Item 1A, "Risk Factors" of our most recently filed Annual Report on Form 10-K for the year ended December 27, 2008.

Overview

We believe we are a leading brand in the party industry in the markets we serve and a leading resource in those markets for consumers seeking party goods, party planning advice and relevant information. We are a party goods retailer operating stores throughout New England, where 45 of our 50 retail stores are located. We also license the name "iparty.com" (at www.iparty.com) to a third party in exchange for royalties, which to date have not been significant.

The following table shows the number of stores in operation (not including temporary stores):

                                          For the three months ended
                                     Mar 28, 2009            Mar 29, 2008
           Beginning of period                  50                      50
           Openings / Acquisitions               -                       2
           Closings                              -                      (2 )
           End of period                        50                      50

Our stores feature over 20,000 products ranging from paper party goods, Halloween costumes, greeting cards and balloons to more unique merchandise such as piņatas, tiny toys, masquerade and Hawaiian Luau items. Our sales are driven by the following holiday and party events: Halloween, Christmas, Easter, Valentine's Day, New Year's, Independence Day, St. Patrick's Day, Thanksgiving, Hanukkah and professional sports playoff events. We also focus our business closely on lifetime events such as anniversaries, graduations, birthdays, and bridal or baby showers.

In addition to the stores discussed in the paragraphs above, we opened two temporary Halloween stores in the greater Boston area in September of 2008. These stores featured a strategically selected assortment of Halloween related merchandise and were closed in early November 2008.

Trends and Quarterly Summary

Our business has a seasonal pattern. In the past three years, we have realized approximately 34.7% of our annual revenues in our fourth quarter, which includes Halloween and Christmas, and approximately 24.5% of our revenues in the second quarter, which includes school graduations and usually includes Easter. Also, during the past three years, we have had net income in our second and fourth quarters and generated losses in our first and third quarters.

For the first quarter of 2009, our consolidated revenues were $14.6 million, compared to $16.1 million for the first quarter in 2008. The decrease 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. The decrease in consolidated revenue was primarily due to decreased customer traffic, which, we believe, is mostly attributable to a falloff in general consumer confidence due to the deepening recession in the U.S. and world economies. Consolidated gross profit margin was 35.6% for the first quarter of 2009 compared to a margin of 38.2% for the same period in 2008. The decline in gross margins was substantially due to increases in occupancy costs as well as the decreased leveraging of those costs related to lower sales. The consolidated net loss for the first quarter of 2009 was $1,715,271, or $0.08 per share, compared to a consolidated net loss of $1,864,528, or $0.08 per share, for the first quarter in 2008, an improvement of $149,257. Despite the difficult economic conditions in the first quarter and the decline in revenues as compared to the first quarter of 2008, we were able to report an improvement in our net loss as compared to the first quarter of 2008, due primarily to the cost cutting initiatives we undertook at the end of 2008. As a result of those initiatives, we estimate that we eliminated $3 million in annualized expenses throughout the company for 2009.

Acquisition and Growth Strategy

We operate in a largely un-branded market that has many small businesses. As a result, we have considered, and may continue to consider, growing our business through acquisitions of other entities. Any determination to make an acquisition will be based upon a variety of factors, including, without limitation, the purchase price and other financial terms of the transaction, the business prospects, geographical location and the extent to which any acquisition would enhance our prospects. Given the current state of the economy and our focus on maintaining liquidity, we do not expect to acquire any new stores in 2009 unless we see an early recovery in the economy.

On January 2, 2008, we completed the purchase of the two stores. The aggregate consideration paid was $1,350,000 plus approximately $195,000 for associated inventory. Funding for the purchase was obtained from our existing line of credit with Wells Fargo Retail Finance, LLC. The stores were converted into iParty stores immediately following the closing of the transaction. The consideration paid for the assets acquired in the transaction was allocated based upon an independent appraisal to the following, based on their fair values on the date of purchase:

                                               Fair Value at
                                                Jan 2, 2008
                      Non-compete agreement   $       781,000
                      Occupancy valuation             495,000
                      Equipment and other              74,000
                                              $     1,350,000

Results of Operations

Fiscal year 2009 has 52 weeks and ends on December 26, 2009. Fiscal year 2008 had 52 weeks and ended on December 27, 2008.

The first quarter of fiscal year 2009 had 13 weeks and ended on March 28, 2009. The first quarter of fiscal year 2008 had 13 weeks and ended on March 29, 2008.

Expense Management Actions for Fiscal 2009

In 2008, the US economy entered into a recessionary period combined with a systematic lack of financial liquidity. During that year, the housing crisis deepened, the stock market declined dramatically, and unemployment rose steeply. All of these factors contributed to a difficult retail environment. Many economists anticipate a difficult 2009. Although we fared better than many of our competitors in 2008, we have taken significant steps in response to the economic crisis. We reviewed and revamped our headquarters and store expenses, which included reducing our headcount and decreasing our advertising and other administrative costs. We expect to save up to $3 million through reduced operating expenses in 2009 from these actions. In addition, we do not expect to open any additional stores in 2009, unless we see an early recovery in the economy. We continue to monitor sales performance, customer buying patterns and consumer confidence, and we are prepared to make further adjustments to our cost structure as needed to manage our way through this recession.

Three Months Ended March 28, 2009 Compared to Three Months Ended March 29, 2008

Revenues

Revenues include the selling price of party goods sold, net of returns and discounts, and are recognized at the point of sale. Our consolidated revenues for the first quarter of fiscal 2009 were $14,568,407, a decrease of $1,575,681, or 9.8% from the first quarter of the prior fiscal year. The decline was primarily due, we believe, to the U.S. recession, but was also substantially affected by two retail events, namely the shift in Easter from fiscal March 2008 to fiscal April 2009 and the reduction in revenue in January related to the football playoffs and Super Bowl, due to the absence of the New England Patriots from those events in 2009.

                                               For the three months ended
                                             Mar 28, 2009      Mar 29, 2008
          Revenues                          $   14,568,407     $  16,144,088

          Increase (decrease) in revenues             -9.8 %             3.5 %

Sales for the first quarter of fiscal 2009 included sales from 50 comparable stores (defined as stores open for at least one full year) as well as six additional days revenue in 2009 from the Lincoln and Warwick, RI stores, which were opened on January 5, 2008. Comparable store sales for the quarter decreased by 9.9%.

Cost of products sold and occupancy costs

Cost of products sold and occupancy costs consist of the cost of merchandise sold to customers and the occupancy costs for our stores. Our cost of products sold and occupancy costs for the first quarter of fiscal 2009 were $9,382,066, or 64.4% of revenues, a decrease of $601,281 and an increase of 2.6 percentage points, as a percentage of revenues, from the first quarter of the prior fiscal year.

                                                    For the three months ended
                                                 Mar 28, 2009        Mar 29, 2008
    Cost of products sold and occupancy costs   $    9,382,066      $    9,983,347

    Percentage of revenues                                64.4 %              61.8 %

As a percentage of revenues, the increase in cost of products sold and occupancy costs was primarily attributable to decreased leveraging of occupancy costs related to lower sales in the first quarter of 2009 compared to the first quarter of the prior fiscal year.

Marketing and sales expense

Marketing and sales expense consists primarily of advertising and promotional expenditures, all store payroll and related expenses for personnel engaged in marketing and selling activities and other non-payroll expenses associated with operating our stores. Our consolidated marketing and sales expense for the first quarter of fiscal 2009 was $4,979,318, or 34.2% of revenues, a decrease of $870,434 or a decrease of 2.0 percentage points, as a percentage of revenues, from the first quarter of the prior fiscal year.

                                          For the three months ended
                                       Mar 28, 2009        Mar 29, 2008
             Marketing and sales      $    4,979,318      $    5,849,752

             Percentage of revenues             34.2 %              36.2 %

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

General and administrative expense

General and administrative ("G&A") expense consists of payroll and related expenses for executive, merchandising, finance and administrative personnel, as well as information technology, professional fees and other general corporate expenses. Our consolidated G&A expense for the first quarter of fiscal 2009 was $1,785,770, or 12.3% of revenues, a decrease of $177,395 or an increase of 0.1 percentage points, as a percentage of revenues, from the first quarter of the prior fiscal year.

                                            For the three months ended
                                         Mar 28, 2009        Mar 29, 2008
           General and administrative   $    1,785,770      $    1,963,165

           Percentage of revenues                 12.3 %              12.2 %

As a result of the cost reduction initiatives implemented in the first quarter of 2009, our general and administrative costs remained approximately flat to the first quarter of 2008, as a percentage of revenues, despite the significant decrease in sales.

Operating loss

Our operating loss for the first quarter of fiscal 2009 was $1,578,747, or 10.8% of revenues, compared to an operating loss of $1,652,176, or 10.2% of revenues for the first quarter of the prior fiscal year.

Interest expense

Our interest expense in the first quarter of fiscal 2009 was $136,552, a decrease of $77,476 from the first quarter of the prior fiscal year. The decrease in the first quarter of fiscal 2009 was primarily due to a lower effective rate on our Highbridge Note and lower interest expense on our Amscan Note due to principal amortization of that indebtedness.

Income taxes

We have not provided for income taxes for the first quarter of fiscal 2009 or fiscal 2008 due to losses in those periods and the availability of net operating loss (NOL) carryforwards to eliminate federal taxable income on an annual basis. No benefit has been recognized with respect to current losses or NOL carryforwards due to the uncertainty of future taxable income.

At the end of fiscal 2008, we had estimated federal net operating loss carryforwards of approximately $20.3 million, which begin to expire in 2019. In accordance with Section 382 of the Internal Revenue Code of 1986, as amended, the use of these carryforwards will be subject to annual limitations based upon certain ownership changes of our stock that have occurred or that may occur.

Net loss

Our net loss in the first quarter of fiscal 2009 was $1,715,271, or $0.08 per basic and diluted share, compared to a net loss of $1,864,528, or $0.08 per basic and diluted share, in the first quarter of the prior fiscal year. The decrease in net loss was mainly attributable to the reduced cost of goods sold, lower advertising expenditures, and decreased general and administrative costs, all of which combined to more than offset the effect of the significant decrease in sales.

Liquidity and Capital Resources

Our primary uses of cash are:

· purchases of inventory, including purchases under our Supply Agreement with Amscan, as described more fully below;

· occupancy expenses of our stores;

· employee salaries; and

· new store openings, including acquisitions.

Our primary sources of cash are:

· cash from operating activities; and

· debt, including our line of credit and notes 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 meet contractual commitments. Based on our current operating plan, we believe that anticipated revenues from operations and borrowings available under our existing line of credit, which expires on January 2, 2010, will be sufficient to fund our operations, working capital requirements and capital expenditures through the next twelve months. In the event that our operating plan changes due to changes in our strategic plans, lower-than-expected revenues, unanticipated expenses, increased competition, unfavorable economic conditions or other unforeseen circumstances, including the continued uncertainty in the credit markets, and further weakening of consumer confidence and spending, our liquidity may be negatively impacted. If so, we could be required to further adjust our expenditures for 2009 to conserve working capital or raise additional capital, possibly including debt or equity financing, to fund operations and our business strategy and to refinance our outstanding debt. Given the current state of the debt and equity markets, this could be more difficult and expensive. We are in the process of negotiating financing to extend or replace our existing line of credit, which expires on January 2, 2010. While we expect to extend the bank line of credit with Wells Fargo or another lender, given the state of the economy, we expect that the borrowing margins will increase and the terms of the loan will be more stringent. If the terms are less favorable than the existing line, our results of operations and liquidity may be adversely affected.

We currently have three notes payable outstanding with principal balances totaling $3,416,792 at March 28, 2009. We refer to these notes as the Highbridge Note, the Amscan Note and the Party City Note. For a full description of these notes, we refer you to the section titled "Notes Payable" in the Notes to Consolidated Financial Statements for the quarter ended March 28, 2009 included in Item 1 of this Quarterly Report on Form 10-Q. The Amscan Note bears interest at the rate of 11.0% per annum and is payable in thirty-six
(36) equal monthly installments of principal and interest of $59,562 commencing on November 1, 2006, and on the first day of each month thereafter until October 1, 2009. The Party City Note, which has a principal amount of $600,000, is payable by quarterly interest-only payments over four years, with the full principal amount due at the note's maturity on August 7, 2010.

In September 2006, we closed a financing transaction with an institutional accredited investor whereby we issued a three-year $2.5 million subordinated note, the Highbridge Note, that bears interest at an interest rate of prime plus one percent and 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 day immediately prior to the closing of the transaction. The Highbridge Note matures on September 15, 2009. The agreements entered into in connection with the financing provide for certain restrictions and covenants consistent with Highbridge's status as a subordinated lender, and also grant Highbridge resale registration rights with respect to the shares of common stock underlying the Highbridge Warrant. The issuance of the Highbridge Warrant triggered certain anti-dilution provisions of our Series B, C, and D convertible preferred stock. We expect to pay off the Highbridge Note from the availability under our bank line of credit and available cash flow. If we are unable to use our bank line of credit or available cash flow to pay off the Highbridge note when due, or if there is a material increase in the cost to do so, we would need to secure alternative financing, which may not be available on commercially reasonable terms or at all, and could result in a materially adverse effect on our results of operations and financial position.

We have a line of credit (the "line") with Wells Fargo, which expires on January 2, 2010. The maximum loan amount available under the line of credit with Wells Fargo is $12,500,000, which may be increased up to a maximum level of $15 million, upon 15 days written notice, as long as we are in compliance with all debt covenants and the other provisions of the loan agreement. The agreement permits us, at our option, to use the London Interbank Offered Rate ("LIBOR") for certain of our borrowings rather than the bank's base rate. Borrowings under our line of credit are secured by our inventory and accounts receivable. We borrow against these assets at agreed upon advance rates, which vary at different times of the year.

Our inventory consists of party supplies which are valued at the lower of weighted-average cost or market and are reduced by an allowance for obsolete and excess inventory and are further reduced or increased by other adjustments, including vendor rebates and discounts and freight costs. Our line of credit availability calculation allows us to borrow against "acceptable inventory at cost", which is based on our inventory at cost and applies adjustments that our lender has approved, which may be different than adjustments we use for valuing our inventory in our financial statements, such as the adjustment to reserve for inventory shortage. The amount of "acceptable inventory at cost" was approximately $14,068,236 at March 28, 2009.

Our accounts receivable consist primarily of credit card receivables and vendor rebate receivables. Our line of credit availability calculation allows us to borrow against "eligible credit card receivables", which are the credit card receivables for the previous two to three days of business. The amount of "eligible credit card receivables" was approximately $196,669 at March 28, 2009.

Our total borrowing base is determined by adding the "acceptable inventory at cost" times an agreed upon advance rate plus the "eligible credit card receivables" times an agreed upon advance rate but not to exceed our established credit limit, which was $12,500,000 at March 28, 2009. Under the terms of our line of credit, our $12,500,000 credit limit was further reduced by (1) a minimum availability block, (2) customer deposits, (3) gift certificates, (4) merchandise credits and (5) outstanding letters of credit. The amounts outstanding under our line were $2,681,782 at March 28, 2009 and $1,950,019 as of December 27, 2008, an increase of $731,763. Our additional availability was $4,389,401 at March 28, 2009 and $4,694,603 at December 27, 2008.

The outstanding balances under our line are classified as current liabilities in the accompanying consolidated balance sheets since we are required to apply daily lock-box receipts to reduce the amount outstanding.

Our line of credit includes a number of covenants, including a financial covenant requiring us to maintain a minimum availability under the line of 5% of the credit limit. The agreement also has a covenant that requires us to limit our capital expenditures to within 110% of those amounts included in our business plan, which may be updated from time to time. At March 28, 2009, we were in compliance with these financial covenants.

Our Supply Agreement with Amscan gives us the right to receive certain additional rebates and more favorable pricing terms over the term of the agreement than generally were available to us under our previous terms with Amscan. The right to receive additional rebates, and the amount of such rebates, are subject to our achievement of increased levels of purchases and other factors provided for in the Supply Agreement. In exchange, the Supply Agreement obligates us to purchase increased levels of merchandise from Amscan until 2012. The Supply Agreement provided for a ramp-up period during 2006 and 2007 and, for five years beginning with calendar year 2008, requires us to purchase on an annual basis merchandise equal to the total number of our stores open during such calendar year, multiplied by $180,000. The Supply Agreement provides for penalties in the event we fail to attain the annual purchase commitment that would require us to pay to Amscan the difference between the purchases for that year and the annual purchase commitment for that year. Under the terms of the Supply Agreement, the annual purchase commitment for any individual year can be reduced for orders placed by us but not filled by the supplier. During 2008, the supplier experienced difficulty in fulfilling certain of our orders sourced out of China. Accordingly, the supplier agreed to reduce our purchase commitment for 2008 to 90% of the contractual minimum for that year. Our purchases for 2008 exceeded the minimum purchase amount commitments, as adjusted, under the Supply Agreement. We are not aware of any reason or circumstance that would prevent us from meeting the full minimum purchase commitments for 2009. Although we do not expect to 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.

Our operating activities used $724,586 during the first quarter of 2009 compared to a use of $19,554 during the first quarter of 2008, an increase of $705,032. The increase in cash used by operating activities was primarily due to lower accounts payable and book overdrafts for the first quarter of 2009 compared to the first quarter of 2008.

We used $200,881 in investing activities during the first quarter of 2009 compared to $1,657,523 during the first quarter of 2008 a decrease of $1,456,642. The cash invested in the first quarter of 2009 was primarily due to the relocation of our Walpole store to a new, larger location and the modification of our internal systems to improve our compliance with payment card industry data security standards. The cash invested in 2008 was primarily due to the acquisition in January 2008 of two retail stores located in Rhode Island and the related non-compete agreement (see discussion below).

Our financing activities provided $924,967 during the first quarter of 2009 . . .