UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


FORM
10-Q





þ QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For
the Quarterly Period Ended September 26, 2009





OR





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





For
the Transition Period from _______________ to _______________





Commission
File Number 1-15611








iPARTY
CORP.


(Exact
Name of Registrant as Specified in Its Charter)


Delaware
              76-0547750(State
      or Other Jurisdiction of
              (I.R.S.
      EmployerIncorporation
      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)








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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o No o





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


Large
      accelerated filer o
              Accelerated
      filer oNon-accelerated
      filer o (Do
      not check if smaller reporting company)
              Smaller
      reporting company  þ


Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.) Yes o No þ





As of
November 4, 2009, there were 22,731,667 shares of common stock, $.001 par value,
outstanding.











iPARTY
CORP.


QUARTERLY
REPORT ON FORM 10-Q


TABLE
OF CONTENTS











PART I - FINANCIAL INFORMATIONPageItem 1.
            Financial Statements (Unaudited)Consolidated Balance Sheets
            2Consolidated Statements of Operations
            3Consolidated Statements of Cash
Flows
            4Notes to Consolidated Financial
    Statements
            5Item 2.
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            14Item 3.
            Quantitative and Qualitative Disclosures about Market
      Risk
            27Item 4.
            Controls and Procedures
            27PART II - OTHER INFORMATIONItem 1.
            Legal Proceedings
            28Item 1A.
            Risk Factors
            28Item 2.
            Unregistered Sales of Equity Securities and Use of
      Proceeds
            29Item 3.
            Defaults upon Senior Securities
            29Item 4.
            Submission of Matters to a Vote of Security
      Holders
            29Item 5.
            Other Information
            29Item 6.
            Exhibits
            29SIGNATURES
            30EXHIBIT INDEX
            31




- 1
-







PART I - FINANCIAL
INFORMATION


Item 1.  Financial
  Statements






iPARTY CORP.CONSOLIDATED
      BALANCE SHEETS (unaudited)Sep 26, 2009
              
              
              Dec 27, 2008ASSETSCurrent
      assets:Cash
      and cash equivalents
              
              $
              64,350
              
              
              $
              60,250Restricted
      cash
              
              
              512,641
              
              
              
              775,357Accounts
      receivable
              
              
              1,012,979
              
              
              
              730,392Inventories,
      net
              
              
              18,377,554
              
              
              
              13,022,142Prepaid
      expenses and other assets
              
              
              445,156
              
              
              
              279,185Total
      current assets
              
              
              20,412,680
              
              
              
              14,867,326Property
      and equipment, net
              
              
              3,008,388
              
              
              
              3,646,481Intangible
      assets, net
              
              
              1,780,862
              
              
              
              2,303,692Other
      assets
              
              
              371,082
              
              
              
              177,774Total
      assets
              
              $
              25,573,012
              
              
              $
              20,995,273LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable and book overdrafts
              
              $
              10,838,220
              
              
              $
              4,048,833Accrued
      expenses
              
              
              2,403,546
              
              
              
              2,495,955Current
      portion of capital lease obligations
              
              
              9,228
              
              
              
              6,444Current
      notes payable
              
              
              600,000
              
              
              
              2,876,182Borrowings
      under line of credit
              
              
              4,741,878
              
              
              
              1,950,019Total
      current liabilities
              
              
              18,592,872
              
              
              
              11,377,433Long-term
      liabilities:Capital
      lease obligations, net of current portion
              
              
              16,148
              
              
              
              -Notes
      payable
              
              
              -
              
              
              
              600,000Other
      liabilities
              
              
              1,469,377
              
              
              
              1,200,174Total
      long-term liabilities
              
              
              1,485,525
              
              
              
              1,800,174Commitments
      and contingenciesStockholders'
      equity:Convertible
      preferred stock - $.001 par value; 10,000,000 shares
      authorized,Series
      B convertible preferred stock - 1,150,000 shares authorized; 464,173
      shares issuedand
      outstanding (aggregate liquidation value of $9,283,460 at September 26,
      2009)
              
              
              6,906,894
              
              
              
              6,890,723Series
      C convertible preferred stock - 100,000 shares authorized, issued and
      outstanding(aggregate
      liquidation value of $2,000,000 at September 26, 2009)
              
              
              1,492,000
              
              
              
              1,492,000Series
      D convertible preferred stock - 250,000 shares authorized, issued and
      outstanding(aggregate
      liquidation value of $5,000,000 at September 26, 2009)
              
              
              3,652,500
              
              
              
              3,652,500Series
      E convertible preferred stock - 533,333 shares authorized; 296,666 shares
      issuedand
      outstanding (aggregate liquidation value of $1,112,497 at September 26,
      2009)
              
              
              1,112,497
              
              
              
              1,112,497Series
      F convertible preferred stock - 114,286 shares authorized, issued and
      outstanding(aggregate
      liquidation value of $500,000 at September 26, 2009)
              
              
              500,000
              
              
              
              500,000Total
      convertible preferred stock
              
              
              13,663,891
              
              
              
              13,647,720Common
      stock - $.001 par value; 150,000,000 shares
      authorized; 22,731,667shares
      issued and outstanding at September 26, 2009 and December 27,
      2008
              
              
              22,732
              
              
              
              22,732Additional
      paid-in capital
              
              
              52,199,874
              
              
              
              52,095,711Accumulated
      deficit
              
              
              (60,391,882
              )
              
              
              (57,948,497
              )Total
      stockholders' equity
              
              
              5,494,615
              
              
              
              7,817,666Total
      liabilities and stockholders' equity
              
              $
              25,573,012
              
              
              $
              20,995,273












- 2
-




iPARTY CORP.CONSOLIDATED
      STATEMENTS OF OPERATIONS (unaudited)For the three months ended
              
              
              For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008
              
              
              Sep 26, 2009
              
              
              Sep 27, 2008Revenues
              
              $
              16,404,046
              
              
              $
              17,742,315
              
              
              $
              50,541,462
              
              
              $
              53,990,071Operating
      costs:Cost
      of products sold and occupancy costs
              
              
              10,282,326
              
              
              
              10,629,144
              
              
              
              31,356,342
              
              
              
              32,225,078Marketing
      and sales
              
              
              5,810,227
              
              
              
              6,677,703
              
              
              
              16,231,004
              
              
              
              18,703,915General
      and administrative
              
              
              1,582,751
              
              
              
              1,580,277
              
              
              
              5,006,742
              
              
              
              5,490,076Operating
      loss
              
              
              (1,271,258
              )
              
              
              (1,144,809
              )
              
              
              (2,052,626
              )
              
              
              (2,428,998
              )Interest
      income
              
              
              45
              
              
              
              240
              
              
              
              90
              
              
              
              2,160Interest
      expense
              
              
              (125,769
              )
              
              
              (178,061
              )
              
              
              (390,849
              )
              
              
              (576,714
              )Net
      loss
              
              $
              (1,396,982
              )
              
              $
              (1,322,630
              )
              
              $
              (2,443,385
              )
              
              $
              (3,003,552
              )Loss
      per share:Basic
      and diluted
              
              $
              (0.06
              )
              
              $
              (0.06
              )
              
              $
              (0.11
              )
              
              $
              (0.13
              )Weighted-average
      shares outstanding:Basic
      and diluted
              
              
              22,731,667
              
              
              
              22,730,295
              
              
              
              22,731,667
              
              
              
              22,719,425













- 3
-




iPARTY CORP.CONSOLIDATED
      STATEMENTS OF CASH FLOWS(unaudited)For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008Operating
      activities:Net
      loss
              
              $
              (2,443,385
              )
              
              $
              (3,003,552
              )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
              
              
              1,571,640
              
              
              
              1,522,738Deferred
      rent
              
              
              20,887
              
              
              
              57,090Non-cash
      stock-based compensation expense
              
              
              118,765
              
              
              
              119,153Loss
      on disposal of property and equipment
              
              
              1,430
              
              
              
              -Non
      cash warrant expense
              
              
              137,936
              
              
              
              160,644Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              (34,271
              )
              
              
              (2,920
              )Inventories
              
              
              (5,355,412
              )
              
              
              (3,751,939
              )Prepaid
      expenses and other assets
              
              
              (393,712
              )
              
              
              (33,050
              )Accounts
      payable
              
              
              6,789,387
              
              
              
              5,223,443Accrued
      expenses and other liabilities
              
              
              (92,409
              )
              
              
              164,662Net
      cash provided by operating activities
              
              
              320,856
              
              
              
              456,269Investing
      activities:Acquisition
      of retail stores and non-compete agreement
              
              
              -
              
              
              
              (1,350,000
              )Purchase
      of property and equipment
              
              
              (347,724
              )
              
              
              (643,878
              )Net
      cash used in investing activities
              
              
              (347,724
              )
              
              
              (1,993,878
              )Financing
      activities:Net
      borrowings under line of credit
              
              
              2,791,859
              
              
              
              1,707,203Principal
      payments on notes payable
              
              
              (3,012,549
              )
              
              
              (459,206
              )Decrease
      in restricted cash
              
              
              262,716
              
              
              
              305,575Principal
      payments on capital lease obligations
              
              
              (11,058
              )
              
              
              (24,932
              )Net
      cash provided in financing activities
              
              
              30,968
              
              
              
              1,528,640Net
      increase (decrease) in cash and cash equivalents
              
              
              4,100
              
              
              
              (8,969
              )Cash
      and cash equivalents, beginning of period
              
              
              60,250
              
              
              
              71,532Cash
      and cash equivalents, end of period
              
              $
              64,350
              
              
              $
              62,563Supplemental
      disclosure of non-cash financing activities:Conversion
      of Series B convertible preferred stock to common stock
              
              $
              -
              
              
              $
              34,447Acquisition
      of equipment under capital lease
              
              $
              29,990
              
              
              $
              -Disposal
      of property and equipment
              
              $
              28,168
              
              
              $
              -












- 4
-







iPARTY CORP.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


September
26, 2009


(Unaudited)





1.  BASIS OF PRESENTATION
AND SIGNIFICANT ACCOUNTING POLICIES:





Interim
Financial Information





The
interim consolidated financial statements as of September 26, 2009 have been
prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission (the “SEC”) for interim financial
reporting.  These consolidated statements are unaudited and, in the
opinion of management, include all adjustments (consisting of normal recurring
adjustments and accruals) necessary to present fairly the consolidated balance
sheets, consolidated operating results, and consolidated cash flows for the
periods presented in accordance with U.S. generally accepted accounting
principles.  The consolidated balance sheet at December 27, 2008 has
been derived from the audited consolidated financial statements at that
date.  Operating results for the Company on a quarterly basis may not
be indicative of the results for the entire year due, in part, to the
seasonality of the party goods industry.  Historically, higher
revenues and operating income have been experienced in the second and fourth
fiscal quarters, while the Company has generated losses in the first and third
quarters.  Certain information and footnote disclosures normally
included in financial statements prepared in accordance with U.S. generally
accepted accounting principles have been omitted in accordance with the rules
and regulations of the SEC.  These consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements, and accompanying notes, included in the Company’s Annual Report on
Form 10-K, for the year ended December 27, 2008.





Principles
of Consolidation





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





Revenue
Recognition





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





Concentrations





The
Company purchases its inventory from a diverse group of vendors. Six suppliers
account for approximately 48% of the Company’s purchases of merchandise for the
nine months ended September 26, 2009, but the Company does not believe that it
is overly dependent upon any single source for its merchandise, often using more
than one vendor for similar kinds of products.  The Company entered
into a Supply Agreement with its largest supplier on August 7, 2006. Beginning
with calendar year 2008, the Supply Agreement requires the Company to purchase
on an annual basis merchandise equal to the total number of stores open during
such calendar year, multiplied by $180,000.  The Supply Agreement
provides for penalties in the event the Company fails to attain the annual
purchase commitment that would require the Company to pay 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 the
Company but not filled within a specified time period by the
supplier.  During 2008, the supplier experienced difficulty in filling
completely certain orders sourced out of China.  Accordingly, the
supplier agreed to reduce the Company’s purchase commitment for 2008 to 90% of
the contractual minimum for that year. The Company met the contractual minimum
purchase requirement, as amended, for 2008.  The Company believes that
its purchases for 2009 will fall short of the annual commitment by approximately
$500,000. The supplier has agreed to allow the Company to roll over of any
shortfall for the year 2009 into future years’ requirements. The Company is not
aware of any reason that would prevent it from meeting the minimum purchase
requirements, including any 2009 shortfall, during the remainder of the term of
the Supply Agreement.





- 5
-





Accounts
receivable primarily represent amounts due from credit card companies and
vendors for inventory rebates.  Management does not provide for
doubtful accounts as such amounts have not been significant to date; the Company
does not require collateral to secure the payment obligations for these
accounts.





Use
of Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.  Actual results could differ from these
estimates.





Cash
and Cash Equivalents and Restricted Cash





The
Company considers all highly liquid investments with an original maturity date
of three months or less to be cash equivalents.  Cash equivalents
consist primarily of store cash funds and daily store receipts in transit to our
concentration bank and are carried at cost, which approximates market
value.





The
Company uses controlled disbursement banking arrangements as part of its cash
management program.  Outstanding checks, which were included in
accounts payable and book overdrafts, totaled $1,119,612 at September 26, 2009
and $194,381 at December 27, 2008.  The increase in outstanding checks
as of September 26, 2009 is due to the timing of payments made in September
2009, principally related to occupancy costs, compared to the timing of payments
made in December 2008.





Restricted
cash represents funds on deposit established for the benefit of and under the
control of Wells Fargo Retail Finance, LLC (“Wells Fargo”), the Company’s lender
under its line of credit, and constitutes collateral for amounts outstanding
under the Company’s line of credit.





Fair
Value of Financial Instruments





The
carrying values of cash and cash equivalents, accounts receivable and accounts
payable approximate fair value because of the short-term nature of these
instruments.  The fair value of borrowings under the Company’s line of
credit approximates carrying value because the debt bears interest at a variable
market rate.  The fair value of the notes payable approximates the
carrying value based on their short term maturity.  The fair value of
the warrants issued in 2006 was determined by using the Black-Scholes model
(volatility of 108%, interest of 4.73% and expected life of five
years).  The fair value of the warrants issued in 2008 was also
determined by using the Black-Scholes model (volatility of 101%, risk free rate
of 2.36% and expected life of five years).





As
permitted by ASC 820-10-65-1, Effective Date of ASC 820, “Fair Value
Measurements and Disclosures”, the Company elected to defer the adoption of ASC
820 for all non-financial assets and non-financial liabilities, except those
that are recognized or disclosed at fair value in the financial statements on a
recurring basis, until December 28, 2008. The adoption of ASC 820-10-65-1in
fiscal 2009 has not had a material impact on the Company's financial position,
results of operations or cash flows.





Inventories





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





- 6
-





The
activity in the allowance for obsolete and excess inventory is as
follows:




Nine
      months ended
              
              
              Twelve
      months endedSep 26, 2009
              
              
              Dec 27, 2008Beginning
      balance
              
              $
              942,587
              
              
              $
              969,859Increases
      to reserve
              
              
              250,000
              
              
              
              405,000Write-offs
      against reserve
              
              
              (278,136
              )
              
              
              (432,272
              )Ending
      balance
              
              $
              914,451
              
              
              $
              942,587





Net
Loss per Share





Net loss
per basic share is computed by dividing net loss available to common
shareholders by the weighted-average number of common shares
outstanding.  The common share equivalents of Series B-F preferred
stock are required to be included in the calculation of net income per basic
share, since the preferred stockholders are entitled to participate in dividends
when and if declared by the Board of Directors on the same basis as if the
shares of Series B-F preferred stock were converted to common stock. For periods
with net losses, the Company does not allocate losses to Series B-F preferred
stock.





Net loss
per diluted share is computed by dividing net loss by the weighted average
number of common shares outstanding, plus the common share equivalents of Series
B-F preferred stock on an as if-converted basis, plus the common share
equivalents of the “in the money” stock options and warrants as computed by the
treasury method.  For the periods with net losses, the Company
excludes these common share equivalents since their impact would be
anti-dilutive.





As of
September 26, 2009, there were 27,802,157 potential additional common share
equivalents outstanding, which were not included in the calculation of diluted
net loss per share for the three months and nine months then ended because their
effect would be anti-dilutive.  These included 15,493,478 shares upon
the conversion of the Company’s Series B-F preferred stock, 2,083,334 shares
upon the exercise of a warrant with an exercise price of $0.475 per share,
100,000 shares upon the exercise of warrants with a weighted average exercise
price of $1.50 per share and 10,125,345 shares upon the exercise of stock
options with a weighted average exercise price of $0.46 per share.





Stock
option compensation expense





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





- 7
-





The stock
based compensation expense recognized by the Company was:




For the three months ended
              
              
              For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008
              
              
              Sep 26, 2009
              
              
              Sep 27, 2008Stock
      Based Compensation Expense
              
              $
              41,248
              
              
              $
              38,204
              
              
              $
              118,765
              
              
              $
              119,153








Stock
based compensation expense is included in general and administrative expense and
had no impact on cash flow from operations and cash flow from financing
activities for the nine months ended September 26, 2009.





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





Under the
Company’s Plans, options to acquire shares of common stock may be granted to
officers, directors, key employees and consultants.   Under the
2009 Plan, the exercise price for qualified incentive options and non-qualified
options cannot be less than the fair market value of the stock on the grant
date, as determined by the Company’s Board of Directors. In addition, under the
2009 Plan, 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 total
of 11,000,000 shares of common stock or other stock based awards may be
granted.  To date, the Company has only issued options under its
Plans, which have been granted to employees, directors and consultants of the
Company at fair market value at the date of grant.  Generally,
employee options become exercisable over periods of up to four years, and expire
ten years from the date of grant.




The
Company granted options for the purchase of an aggregate of 1,085,000 shares of
common stock to key employees, including its executive officers, and each of the
four independent members of the Board of Directors on May 27, 2009 at an
exercise price of $0.11 per share.  In addition, the Company granted
options for the purchase of an aggregate of 200,000 shares of common stock to
its Chief Financial Officer on March 4, 2009 at an exercise price of $0.07 per
share.  On June 4, 2008, the Company granted options for the purchase
of an aggregate of 200,000 shares of common stock to its Chief Financial Officer
and each of the four independent members of the Board of Directors at an
exercise price of $0.29 per share. The weighted-average fair market value using
the Black-Scholes option pricing model of the options granted on May 27, 2009
was $0.09 per share, was $0.06 per share for the options granted on March 4,
2009 and was $0.22 per share for the options granted on June 4, 2008. The fair
market value of the options at the date of the grant was estimated using the
Black-Scholes option-pricing model with the following weighted average
assumptions:




For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008Risk-free
      interest rate
              
              
              2.23
              %
              
              
              3.21
              %Expected
      volatility
              
              
              109.52
              %
              
              
              101.20
              %Weighted
      average expected life (in years)
              
              
              6.25
              
              
              
              5.00Expected
      dividends
              
              
              -
              
              
              
              -





- 8
-





A summary
of the Company's stock options is as follows:





WeightedNumber
              
              
              Weighted
              
              
              
              
              
              
              
              
              
              
              
              Averageof
              
              
              Average
              
              
              
              
              
              
              
              
              
              
              
              Remaining
              
              
              AggregateStock
              
              
              Exercise
              
              
              Price
              
              
              Life
              
              
              IntrinsicOptions
              
              
              Price
              
              
              Range
              
              
              (Years)
              
              
              ValueOutstanding
      - December 27, 2008
              
              
              9,082,198
              
              
              $
              0.55
              
              
              $
              0.13
              
              
              
              -
              
              
              $
              4.25Granted
              
              
              1,285,000
              
              
              
              0.10
              
              
              
              0.07
              
              
              
              -
              
              
              
              0.11Expired/Forfeited
              
              
              (241,853
              )
              
              
              2.19
              
              
              
              0.18
              
              
              
              -
              
              
              
              3.13Exercised
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Outstanding
      - September 26, 2009
              
              
              10,125,345
              
              
              $
              0.46
              
              
              $
              0.07
              
              
              
              -
              
              
              $
              4.25
              
              
              
              4.2
              
              
              $
              179,107Exercisable
      - September 26, 2009
              
              
              8,304,399
              
              
              $
              0.52
              
              
              $
              0.11
              
              
              
              -
              
              
              $
              4.25
              
              
              
              3.1
              
              
              $
              -Available
      for grant - September 26, 2009
              
              
              439,394








The
following table summarizes information for options outstanding and exercisable
at September 26, 2009:




Outstanding
              
              
              ExercisableWeightedNumber
              
              
              Average
              
              
              Weighted
              
              
              Number
              
              
              Weightedof
              
              
              Remaining
              
              
              Average
              
              
              of
              
              
              AverageStock
              
              
              Life
              
              
              Exercise
              
              
              Stock
              
              
              ExercisePrice Range
              
              
              Options
              
              
              (Years)
              
              
              Price
              
              
              Options
              
              
              Price$
              0.07
              
              
              
              -
              
              
              $
              0.20
              
              
              
              1,415,350
              
              
              
              8.9
              
              
              $
              0.11
              
              
              
              155,350
              
              
              $
              0.170.21
              
              
              
              -
              
              
              
              0.30
              
              
              
              3,412,797
              
              
              
              1.9
              
              
              
              0.25
              
              
              
              3,344,047
              
              
              
              0.250.31
              
              
              
              -
              
              
              
              0.50
              
              
              
              2,434,120
              
              
              
              5.6
              
              
              
              0.39
              
              
              
              1,941,924
              
              
              
              0.380.51
              
              
              
              -
              
              
              
              1.00
              
              
              
              2,674,778
              
              
              
              3.6
              
              
              
              0.77
              
              
              
              2,674,778
              
              
              
              0.771.01
              
              
              
              -
              
              
              
              3.50
              
              
              
              88,300
              
              
              
              2.1
              
              
              
              2.40
              
              
              
              88,300
              
              
              
              2.403.51
              
              
              
              -
              
              
              
              4.25
              
              
              
              100,000
              
              
              
              0.2
              
              
              
              4.14
              
              
              
              100,000
              
              
              
              4.14Total
              
              
              
              
              
              
              
              
              
              
              
              10,125,345
              
              
              
              4.2
              
              
              $
              0.46
              
              
              
              8,304,399
              
              
              $
              0.52






The
remaining unrecognized stock based compensation expense related to unvested
awards at September 26, 2009 was $242,248 and the period of time over which this
expense will be recognized is 3.67 years.





Property
and Equipment





Property
and equipment are stated at cost less accumulated depreciation and are
depreciated on the straight-line method over the estimated useful lives of the
assets.  Expenditures for maintenance and repairs are charged to
operations as incurred.  A listing of the estimated useful life of the
various categories of property and equipment is as follows:




Asset Classification
              
              Estimated Useful LifeLeasehold
      improvements
              
              Lesser
      of term of lease or 10 yearsFurniture
      and fixtures
              
              7
      yearsComputer
      hardware and software
              
              3
      yearsEquipment
              
              5
      years




- 9
-





Intangible
Assets





On August
15, 2007, the Company entered into an Asset Purchase Agreement to purchase two
franchised Party City Corporation retail stores in Lincoln, Rhode Island and
Warwick, Rhode Island, in exchange for aggregate consideration of $1,350,000
plus up to $400,000 for associated inventory.  On January 2, 2008, the
Company 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 the Company’s existing line of credit
with Wells Fargo. The stores were converted into iParty stores immediately
following the closing of the transaction.





Intangible
assets consist primarily of (i) the values of two non-compete agreements
acquired 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 respective acquisition
dates using significant other observable inputs, or Level 2 criteria, defined in
the Fair Value Measurements section below.





The first
non-compete agreement, from Party City Corporation and its affiliates, covers
Massachusetts, Maine, New Hampshire, Vermont, Rhode Island, and Windsor and New
London counties in Connecticut, and expires in 2011.  The second
non-compete agreement was acquired in connection with the Company’s purchase in
January 2008 of the two party supply stores in Lincoln and Warwick, Rhode Island
described above. It covers Rhode Island for five years from the date of closing
and within a certain distance 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 subject to certain terms and conditions in their respective
acquisition agreements.





The
occupancy valuations relate to acquired retail store leases for stores in
Peabody, Massachusetts (estimated life of 90 months), Lincoln, Rhode Island
(estimated life of 79 months) and Warwick, Rhode Island (estimated life of 96
months). Intangible assets also include legal and other transaction costs
incurred related to the purchase of the Peabody, Lincoln and Warwick
stores.





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




Sep 26, 2009
              
              
              Dec 27, 2008Non-compete
      agreements
              
              $
              2,358,540
              
              
              $
              2,358,540Occupancy
      valuations
              
              
              944,716
              
              
              
              944,716Other
              
              
              157,855
              
              
              
              157,855Intangible
      assets
              
              
              3,461,111
              
              
              
              3,461,111Less:
      accumulated amortization
              
              
              (1,680,249
              )
              
              
              (1,157,419
              )Intangible
      assets, net
              
              $
              1,780,862
              
              
              $
              2,303,692




Amortization
expense for these intangible assets was:




For the three months ended
              
              
              For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008
              
              
              Sep 26, 2009
              
              
              Sep 27, 2008Amortization
      expense
              
              $
              174,277
              
              
              $
              130,427
              
              
              $
              522,830
              
              
              $
              445,581




The
amortization expense for the non-compete agreements and other intangible assets
is included in general and administrative expense in the Consolidated Statements
of Operations.  The amortization expense for occupancy valuation is
included in cost of products sold and occupancy costs in the Consolidated
Statements of Operations.





- 10
-





Future
amortization expense related to these intangible assets as of September 26, 2009
is:




Year
              
              Amount2009
              
              $
              174,2772010
              
              
              672,1082011
              
              
              467,4122012
              
              
              242,4382013
              
              
              127,029Thereafter
              
              
              97,598Total
              
              $
              1,780,862


Accounting
for the Impairment of Long-Lived Assets





The
Company reviews each store for impairment indicators whenever events and changes
in circumstances suggest that the carrying amounts may not be recoverable from
estimated future store cash flows.  The Company’s review considers store
operating results, future sales growth and cash flows.   During
the third quarter of 2007, the Company decided to close its stores in North
Providence, Rhode Island and Auburn, Massachusettsat the end of their
lease terms, which expired on January 31, 2008.  No material
impairment costs were incurred as a result of that decision.  As of
September 26, 2009, the Company does not believe that any of its assets are
impaired.





Notes
Payable





Notes
payable consist of three notes entered into in fiscal 2006.





The
“Highbridge Note” was a subordinated note in the stated principal amount of
$2,500,000 that bore interest at the prime rate plus one percent.  The
Highbridge Note was part of a financing transaction that raised $2.5 million
through a combination of the issuance of the Highbridge Note and a warrant
exercisable for 2,083,334 shares of common stock at an exercise price of $0.475
per share. The original discount associated with the warrant issued in
conjunction with the Highbridge Note (original discount amount $613,651) was
amortized using the effective interest method over the life of the note.
Interest only was payable quarterly in arrears during the term of the note and
the 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 plus all accrued interest.





The
“Amscan Note” was a subordinated 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 in thirty-six (36) equal monthly installments of principal and
interest of $59,562 beginning on November 1, 2006. The remaining principal
balance and all accrued interest were paid in full on September 24,
2009.





The “Party
City Note” is a subordinated promissory note in the principal amount of
$600,000.   The note bears interest at the rate of 12.25% per
annum and 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.





On August
7, 2006, the Company entered into a Supply Agreement with Amscan Inc.
(“Amscan”), the largest supplier in the party goods industry.  The
Supply Agreement with Amscan gives the Company the right to receive certain
additional rebates and more favorable pricing terms over the term of the
agreement than generally were available to the Company 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 and other factors provided for in the Supply Agreement.  In
exchange, the Supply Agreement obligates the Company to purchase increased
levels of merchandise from Amscan until 2012.  The Supply Agreement
provided for an initial ramp-up period during 2006 and 2007 and, beginning with
calendar year 2008, requires the Company to purchase on an annual basis
merchandise equal to the total number of its stores open during such calendar
year, multiplied by $180,000 until 2012.  The Supply Agreement
provides for penalties in the event the Company fails to attain the annual
purchase commitment.  Under the terms of the Supply Agreement, the
annual purchase commitment for any individual year can be reduced for orders
placed by the Company but not filled by the supplier within a specified time
period.  During 2008, the supplier experienced difficulty in filling
completely certain orders sourced out of China.  Accordingly, the
supplier agreed to reduce the Company’s purchase commitment for 2008 to 90% of
the contractual minimum for that year.  The Company believes that its
purchases for 2009 will fall short of the annual commitment by approximately
$500,000. The supplier has agreed to allow the Company to roll over
any shortfall for the year 2009 into future years’ requirements. The Company is
not aware of any reason that would prevent it from meeting the minimum purchase
requirements, including any 2009 shortfall, for the remainder of the term
of the Supply Agreement.




- 11
-





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





On August
7, 2006, the Company also entered into and simultaneously closed an Asset
Purchase Agreement with Party City, an affiliate of Amscan, pursuant to which
the Company 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 in the
principal amount of $600,000, which is the Party City Note defined above, and
$1,850,000 in cash.





Line
of Credit





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





The Agreement amended 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 for three years to July 2,
2012.  In addition, the Agreement includes an option whereby the
Borrowers may increase the revolving line of credit up to a maximum level of
$15,000,000, at any time until July 2, 2011.  The amount of credit
that is available from time to time under the Agreement is determined as a
percentage of the value of eligible inventory plus a percentage of the value of
eligible credit card receivables, as reduced by certain reserve amounts that may
be required by Wells Fargo.





Borrowings under the Agreement will
generally accrue interest at a margin ranging from 3.00% to 3.50% (determined
according to the average daily excess availability during the fiscal quarter
immediately preceding the adjustment date) over, at the Borrowers’ election,
either the London Interbank Offered Rate (“LIBOR”) or a base rate determined by
Wells Fargo from time to time.  The credit facility also provides for
letters of credit and includes an unused line fee on the unused portion of the
revolving credit line.




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





The Agreement has financial covenants
that are limited to minimum availability and capital expenditures and contains a
number of restrictive covenants, such as incurrence, payment or entry into
certain indebtedness, liens, investments, acquisitions, mergers, dispositions
and dividends. The Agreement contains events of default customary for credit
facilities of this type.  Upon an event of default that is not cured
or waived within any applicable cure periods, in addition to other remedies that
may be available to Wells Fargo, the obligations under the Agreement may be
accelerated, outstanding letters of credit may be required to be cash
collateralized and the lenders may exercise remedies to collect the balance due,
including to foreclose on the collateral.  Should the Agreement be
prepaid or the maturity accelerated for any reason, the Borrowers 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 year of the
term of the facility, (ii) 1.00% of the revolving credit facility ceiling then
in effect within the second year of the term of the facility and (ii) 0.50%
thereafter.





- 12
-





Stockholders’
Equity





During the
nine months ended September 26, 2009, there were no exercises of stock options
or warrants, and no conversions of convertible preferred stock.





On May 27,
2009, the Company’s stockholders approved an amendment to the Company's Restated
Certificate of Incorporation to authorize the Board of Directors to implement a
reverse stock split, pursuant to which the existing shares of the Company's
common stock would be combined into new shares of the Company's common stock at
an exchange ratio ranging between one-for-five and one-for-thirty, with the
exchange ratio to be determined by the Board of Directors (the "Reverse Stock
Split").  With the approval of the Reverse Stock Split, the Board of
Directors will have the authority, but not the obligation, to effect the Reverse
Stock Split at any time prior to the date of the 2010 Annual Meeting of
Stockholders, without further approval or authorization of
stockholders.   The Reverse Stock Split will be effected, if at
all, only upon a determination by the Board of Directors that implementing a
Reverse Stock Split is in the best interest of the Company and its stockholders
and after the filing of an amendment to the Company’s Restated Certificate of
Incorporation with the Secretary of State of the State of Delaware.





Fair
Value Measurements





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





Level 1 –
quoted prices in active markets for identical assets or liabilities





Level 2 –
observable inputs other than quoted prices in active markets for identical
assets or liabilities





Level 3 –
unobservable inputs in which there is little or no market data available, which
require the reporting entity to develop its own assumptions





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








2.
            SUBSEQUENT
      EVENTS





The
Company has evaluated subsequent events through the time of the filing of this
Quarterly Report on Form 10-Q with the SEC on November 9, 2009 and has
determined that there were no subsequent events to recognize or disclose in
these financial statements.




- 13
-





Item 2.  Management’s Discussion and Analysis of
Financial Condition and Results of Operations





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 and our other periodic
reports filed with the SEC. We assume no obligation to update these forward
looking statements contained in this report, whether as a result of new
information, future events or otherwise.





Overview





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.





Our 50
retail stores are located predominantly in New England with 25 stores in
Massachusetts, 7 in Connecticut, 6 in New Hampshire, 3 in Rhode Island, 3 in
Maine and 1 in Vermont.  We also operate 5 stores in
Florida.  Our stores range in size from approximately 8,000 square
feet to 20,500 square feet and average approximately 10,300 square feet in
size.  We lease our properties, typically for 10 years and usually
with options from our landlords to renew our leases for an additional 5 or 10
years.





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




For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008Beginning
      of period
              
              
              50
              
              
              
              50Openings
      / Acquisitions
              
              
              -
              
              
              
              2Closings
              
              
              -
              
              
              
              (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 piñatas, 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.




- 14
-





In
addition to the stores discussed in the paragraphs above, we opened two
temporary Halloween stores in the greater Boston area in September
2008.  Those stores were closed in early November 2008.  In
September 2009, we opened four temporary Halloween stores.  Three of
the stores were in the greater Boston area and one of the stores was in New
Hampshire.  These stores feature a strategically selected assortment
of Halloween related merchandise and were closed in early November
2009.




Trends
and Quarterly Summary





Third
Quarter 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
third quarter of 2009, our consolidated revenues were $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 was primarily due to a decrease in
customer traffic and an increase in promotional markdowns, both of which are
related to the effects of the recession in the U.S. and world
economies.  Consolidated gross profit margin was 37.3% for the third
quarter of 2009 compared to a margin of 40.1% for the same period in
2008. The decline in gross profit margin 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 third quarter of 2009
was $1,396,982 or $0.06 per share, compared to a consolidated net loss of
$1,322,630, or $0.06 per share, for the third quarter in 2008, an increase of
$74,352. We have mitigated the decline in revenues year over year primarily
through the cost cutting initiatives we undertook at the end of 2008, resulting
in a flat net loss in the third quarter of 2009 compared to the third quarter of
2008.





October
Summary




On
November 4, 2009, we reported sales results for the calendar month and year, and
for the fiscal month and year, ended October, 2009, to provide information
regarding our Halloween season which is our most important selling season. For
the thirty-one day calendar month of October 2009, sales at comparable stores
increased 0.1% compared to the same period in 2008. Consolidated
revenues for the calendar month were approximately $18.42 million, a 5.4%
increase compared to $17.48 million for the same period in 2008. For the five
week fiscal month of October, which ended on October 31st, sales at comparable
stores decreased 1.8% compared to fiscal October 2008. Consolidated revenues
increased by 3.3% for the October fiscal month compared to the same fiscal month
period in 2008.  The increase in consolidated revenues for the
calendar and fiscal months of October 2009 included the impact of four temporary
Halloween stores opened in mid-September 2009, compared to two such stores
opened in mid-September 2008.




For the
calendar year 2009 through October, sales at comparable stores decreased 5.4%
compared to the same period in 2008. Consolidated revenues were approximately
$68.31 million, a 4.1% decrease compared to $71.20 million for the same period
in 2008. For the forty-four week period through fiscal October 2009, which ended
on October 31st, sales at comparable stores decreased 5.3% compared to the same
period in 2008. Consolidated revenues decreased by 3.9% for the fiscal
year-to-date period through October compared to the same period in
2008.  The decrease in consolidated revenues for the calendar and
fiscal year-to-date periods through October included the impact of four
temporary Halloween stores opened in mid-September 2009, compared to two such
stores opened in mid-September 2008.





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 or through opening new iParty
stores.  Any determination to make an acquisition or open a new store
will be based upon a variety of factors, including, without limitation, the
purchase price and other financial terms of the acquisition , the business
prospects and geographical location of the potential acquisition or store
opening, and the extent to which any acquisition or store opening would enhance
our prospects.  Given the
current state of the economy and our focus on maintaining liquidity, we do not
expect to acquire or open any new stores in the remainder of 2009, except for
the temporary Halloween stores, and we are currently reviewing our strategy with
respect to 2010. However, in view of the operating results from the four
temporary Halloween stores opened in 2009, we currently expect to open
additional temporary Halloween stores in 2010.





- 15
-





On January
2, 2008, we completed the purchase of two stores in Rhode Island. The aggregate
consideration paid was $1,350,000 plus approximately $195,000 for associated
inventory. Funding for the purchase was obtained from our line of credit with
Wells Fargo Retail Finance, LLC (“Wells Fargo”).  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, 2008Non-compete
      agreement
              
              $
              781,000Occupancy
      valuation
              
              
              495,000Equipment
      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 third
quarter of fiscal year 2009 had 13 weeks and ended on September 26,
2009.  The third quarter of fiscal year 2008 had 13 weeks and ended on
September 27, 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 anticipated 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.  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 September 26, 2009 Compared to Three Months Ended September 27,
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 third quarter of fiscal 2009 were $16,404,046, a decrease of $1,338,269, or
7.5% from the third quarter of the prior fiscal year. The decline was primarily
due to the decreased level of consumer demand and increased level of promotional
markdowns, both of which are related to the U.S. recession.




For the three months endedSep 26, 2009
              
              
              Sep 27, 2008Revenues
              
              $
              16,404,046
              
              
              $
              17,742,315Decrease
      in revenues
              
              
              -7.5
              %
              
              
              -2.6
              %


Comparable
store sales for the quarter decreased by 7.7%.





- 16
-





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 third quarter of fiscal 2009 were
$10,282,326, or 62.7% of revenues, a decrease of $346,818 and an increase
of  2.8 percentage points, as a percentage of revenues, from the third
quarter of the prior fiscal year.




For the three months endedSep 26, 2009
              
              
              Sep 27, 2008Cost
      of products sold and occupancy costs
              
              $
              10,282,326
              
              
              $
              10,629,144Percentage
      of revenues
              
              
              62.7
              %
              
              
              59.9
              %





As a
percentage of revenues, the increase in cost of products sold and occupancy
costs was primarily attributable to increased occupancy costs and the decreased
leveraging of these occupancy costs related to lower sales in the third quarter
of 2009 compared to the third quarter of 2008.




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 third quarter of fiscal 2009 was $5,810,227, or 35.4% of revenues, a
decrease of $867,476 or 2.2 percentage points, as a percentage of revenues, from
the third quarter of the prior fiscal year.




For the three months endedSep 26, 2009
              
              
              Sep 27, 2008Marketing
      and sales
              
              $
              5,810,227
              
              
              $
              6,677,703Percentage
      of revenues
              
              
              35.4
              %
              
              
              37.6
              %




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 third quarter of
fiscal 2009 was $1,582,751, or 9.6% of revenues, an increase of $2,474 or 0.7
percentage points, as a percentage of revenues, from the third quarter of the
prior fiscal year.




For the three months endedSep 26, 2009
              
              
              Sep 27, 2008General
      and administrative
              
              $
              1,582,751
              
              
              $
              1,580,277Percentage
      of revenues
              
              
              9.6
              %
              
              
              8.9
              %




The flat
level of general and administrative expense in the third quarter of 2009
compared to the third quarter of the prior fiscal year was the result of
offsetting factors. Expense savings in 2009 related to reduced payroll and other
costs were offset by the absence in the third quarter of 2009 of an expense
reversal included in the third quarter of 2008 related to the
cancellation of 2008 management bonuses.




- 17
-




The
increase in general and administrative expense as a percentage of revenues from
the third quarter of the prior fiscal year was due to the decreased leveraging
of these costs related to lower sales in the third quarter of 2009 compared to
the third quarter of 2008.





Operating
income





Our
operating loss for the third quarter of fiscal 2009 was $1,271,258, or 7.7% of
revenues, compared to an operating loss of $1,144,809, or 6.5% of revenues for
the third quarter of the prior fiscal year.





Interest
expense





Our
interest expense in the third quarter of fiscal 2009 was $125,769, a decrease of
$52,292 from the third quarter of the prior fiscal year.  The decrease
in the third quarter of fiscal 2009 was primarily due to a lower effective rate
on our Highbridge Note which was paid in full on September 15, 2009 and lower
interest expense on our Amscan Note due to principal amortization of that
indebtedness, which was paid in full on September 24, 2009.





Income
taxes





We have
not provided for income taxes for the third quarter of fiscal 2009 or fiscal
2008 due to losses in  the nine month period ended September 26, 2009
and for fiscal 2008 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 third quarter of fiscal 2009 was $1,396,982, or $0.06 per basic and
diluted share, compared to a net loss of $1,322,630, or $0.06 per basic and
diluted share, in the third quarter of the prior fiscal year.





Nine
Months Ended September 26, 2009 Compared to Nine Months Ended September 27,
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 nine months of fiscal 2009 were $50,541,462, a decrease of $3,448,609
or 6.4% from the first nine months of the prior fiscal year.




For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008Revenues
              
              $
              50,541,462
              
              
              $
              53,990,071Decrease
      in revenues
              
              
              -6.4
              %
              
              
              -0.4
              %




Comparable
store sales for the first nine months decreased by 6.5%.





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 nine months of fiscal 2009 were
$31,356,342, or 62.0% of revenues, a decrease of $868,736 and an increase of 2.3
percentage points, as a percentage of revenues, from the first nine months of
the prior fiscal year.





- 18
-




For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008Cost
      of products sold and occupancy costs
              
              $
              31,356,342
              
              
              $
              32,225,078Percentage
      of revenues
              
              
              62.0
              %
              
              
              59.7
              %




As a
percentage of revenues, the increase in cost of products sold and occupancy
costs was primarily attributable to increased occupancy costs and the decreased
leveraging of these occupancy costs related to lower sales in the first nine
months of 2009 compared to the first nine months 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 nine months of fiscal 2009 was $16,231,004, or 32.1% of revenues,
a decrease of $2,472,911 or 2.5 percentage points, as a percentage of revenues,
from the first nine months of the prior fiscal year.




For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008Marketing
      and sales
              
              $
              16,231,004
              
              
              $
              18,703,915Percentage
      of revenues
              
              
              32.1
              %
              
              
              34.6
              %


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 nine months
of fiscal 2009 was $5,006,742, or 9.9% of revenues, a decrease of $483,334, or
0.3 percentage points, as a percentage of revenues, from the first nine months
of the prior fiscal year.




For the nine months endedSep 26, 2009
              
              
              Sep 27, 2008General
      and administrative
              
              $
              5,006,742
              
              
              $
              5,490,076Percentage
      of revenues
              
              
              9.9
              %
              
              
              10.2
              %




General
and administrative expense decreased as a percentage of revenues from the third
quarter of the prior fiscal year as a result of the cost reduction initiatives
implemented in 2009.





Operating
loss





Our
operating loss for the first nine months of fiscal 2009 was $2,052,626, or 4.1%
of revenues, compared to an operating loss of $2,428,998, or 4.5% of revenues
for the first nine months of the prior fiscal year.





Interest
expense





Our
interest expense in the first nine months of fiscal 2009 was $390,849, a
decrease of $185,865 from the first nine months of the prior fiscal
year.  The decrease in the first nine months of fiscal 2009 was
primarily due to lower average borrowing on our line of credit,  a
lower effective rate on our Highbridge Note which was paid in full on September
15, 2009 and lower interest expense on our Amscan Note, due to amortization of
that indebtedness.





- 19
-





Income
taxes





We have
not provided for income taxes for the first nine months of fiscal 2009 or fiscal
2008 due to availability of net operating loss (NOL) carryforwards to eliminate
federal taxable income during those periods. No benefit has been recognized with
respect to 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, 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 nine months of fiscal 2009 was $2,443,385, or $0.11 per basic
and diluted share, compared to a net loss of $3,003,552, or $0.13 per basic and
diluted share, in the first nine months of the prior fiscal year. The decrease
in net loss was mainly attributable to lower store payroll expenses, lower
advertising costs and decreased general and administrative
expenses.





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 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 meet contractual commitments. Based on our
current operating plan, we believe that anticipated revenues from operations and
borrowings available under our line of credit, which was amended and restated on
July 1, 2009, 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 changes due to
changes in our strategic plans, lower-than-expected revenues, unanticipated
expenses, increased competition, unfavorable economic conditions, further
weakening of consumer confidence and spending, or other unforeseen
circumstances, our liquidity may be negatively impacted.  If so, we
could be required to furtheradjust our
expenditures for the remainder of 2009 and into 2010 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 than recently refinanced
debt.





NotesPayable





At the
beginning of our fiscal year 2009 we had three notes payable outstanding. We
refer to these notes as the Highbridge Note, the Amscan Note and the Party City
Note.  For a more detailed description of these notes, we refer you to
the section titled “Notes Payable” in the Notes to Consolidated Financial
Statements for the quarter ended September 26, 2009 included in Item 1 of this
Quarterly Report on Form 10-Q. In the third quarter of 2009, we paid in full the
Highbridge Note and the Amscan Note. The Highbridge Note was paid off through
additional borrowings under our line of credit with Wells Fargo. At September
26, 2009 only the 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.





- 20
-





In connection with the issuance of 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 day immediately prior to the
closing of the transaction.  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.





Line of
Credit




On July 1, 2009, we entered into a Second Amended and
Restated Credit Agreement (the “new line”) with Wells Fargo , which amended and
restated the previous revolving credit facility with Wells Fargo.  The
new line continues the revolving line of credit in the amount of up to
$12,500,000 and extends the maturity date for three 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 of credit 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 the Agreement is determined as a percentage of
the value of eligible inventory plus a percentage of the value of eligible
credit card receivables, as reduced by certain reserve amounts that may be
required by Wells Fargo.





Borrowings under the new line will generally accrue
interest at a margin ranging from 3.00% to 3.50% (determined according to the
average daily excess availability during the fiscal quarter immediately
preceding the adjustment date) over, at our election, either the London
Interbank Offered Rate (“LIBOR”) or a base rate determined by Wells Fargo from
time to time.   The new line margins are an increase over the
previous line, and may result in an increase in overall borrowing cost under the
new line.  The new line also provides for letters of credit for up to
a sublimit of $2 million to be used in connection with inventory purchases and
includes an unused line fee on the unused portion of the revolving 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 secured by a lien on substantially all of our personal
property.





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 $18,316,461 at September 26,
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 $300,413 at September 26, 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 September 26, 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 $4,741,878 at September 26, 2009 and $1,950,019
as of December 27, 2008, an increase of $2,791,859. Our additional availability
was $6,557,797 at September 26, 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 because we are required to apply daily
lock-box receipts to reduce the amount outstanding.





As with
the previous line, the new line has financial covenants that are limited to
minimum availability and capital expenditures 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 minimum availability of 7.5% of the
credit limit, which is an increase from the previous requirement of 5% and,
consistent with the previous line, 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 September 26, 2009 we were in compliance with these
financial covenants.




- 21
-





The new
line contains events of default customary for credit facilities of this
type.  Upon an event of default that is not cured or waived within any
applicable cure periods, in addition to other remedies that may be available to
Wells Fargo, the obligations under the new line may be accelerated, outstanding
letters of credit may be required to be cash collateralized and the lenders may
exercise remedies to collect the balance due, including to foreclose on the
collateral.  Should the new line be prepaid or the maturity
accelerated for any reason, 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 year of the term of the facility, (ii) 1.00% of the
revolving credit facility ceiling then in effect within the second year of the
term of the facility and (iii) 0.50% thereafter.





Supply Agreement with Amscan





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.   Beginning with calendar year 2008, the Supply Agreement
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 believe that our purchases for 2009
will fall short of the annual commitment by approximately $500,000. The supplier
has agreed to allow the Company to roll over any shortfall for
the year 2009 into future years’ requirements. The Company is not aware of any
reason that would prevent it from meeting the minimum purchase requirements,
including any 2009 shortfall, for the remainder of the term of the Supply
Agreement. 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.





Operating, Investing and Financing
Activities





Our operating activities provided $320,856 during the
nine months of 2009 compared to $456,269 during the first nine months of 2008, a
decrease of $135,413.The decrease in cash provided by operating activities
was primarily due to the timing of rent payments at the end of September 2009
compared to the timing of those payments at the end of September
2008.





We used $347,724 in investing activities during the nine
months of 2009 compared to $1,993,878 during the first nine months of 2008, a
decrease of $1,646,154.  The cash invested in the first nine months of
2009 was primarily due to the modification of our internal systems to improve
our compliance with payment card industry data security standards and the
relocation of our Walpole store to a new, larger location.The cash invested in the first nine months
of 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 $30,968 during the nine months of 2009 compared to
providing $1,528,640 during the first nine months of 2008, a decrease of
$1,497,672.  The decrease was primarily related to the additional
borrowings in 2008 related to the acquisition of the two retail stores in Rhode
Island.As
mentioned above, on January 2, 2008, we completed the purchase of two franchised
Party City Corporation retail stores in Lincoln, Rhode Island and Warwick, Rhode
Island.   The aggregate consideration for the assets purchased
and related non-competition covenants was $1,350,000, plus approximately
$195,000 for associated inventory, paid in cash at closing, on terms and
conditions specified in the particular asset purchase
agreement.  Funding for the purchase was obtained from our line of
credit with Wells Fargo.





- 22
-





Contractual Obligations





Contractual
obligations at September 26, 2009 were as follows:




Payments Due By PeriodWithin
              
              
              WithinWithin
              
              
              2
      - 3
              
              
              4
      - 5
              
              
              After1 Year
              
              
              Years
              
              
              Years
              
              
              5 Years
              
              
              TotalLine
      of credit
              
              $
              4,750,255
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              4,750,255Capital
      lease obligations
              
              
              11,400
              
              
              
              19,950
              
              
              
              -
              
              
              
              -
              
              
              
              31,350Notes
      payable
              
              
              662,626
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              662,626Supply
      agreement
              
              
              8,461,420
              
              
              
              17,038,580
              
              
              
              -
              
              
              
              -
              
              
              
              25,500,000Operating
      leases (including retail space leases)
              
              
              9,309,800
              
              
              
              15,902,869
              
              
              
              10,617,934
              
              
              
              10,377,925
              
              
              
              46,208,528Total
      contractual obligations
              
              $
              23,195,501
              
              
              $
              32,961,399
              
              
              $
              10,617,934
              
              
              $
              10,377,925
              
              
              $
              77,152,759







In
addition, at September 26, 2009, we had outstanding purchase orders totaling
approximately $4,214,386 for the acquisition of inventory and non-inventory
items that were scheduled for delivery after September 26, 2009.





Seasonality





Due to the
seasonality of our business, sales and operating income are typically higher in
our second and fourth quarters.  Our business is highly dependent upon
sales of Easter, graduation and summer merchandise in the second quarter and
sales of Halloween and Christmas merchandise in the fourth
quarter.  We have typically operated at a loss during the first and
third quarters.





Geographic
Concentration





As of
September 26, 2009, we operated a total of 50 stores, 45 of which are located in
New England,and 5 of which are located in
Florida, plus three temporary Halloween stores in Massachusetts and one
temporary Halloween store in New Hampshire. As a result, a severe or prolonged
regional recession or regional changes in demographics, employment levels,
population, weather patterns, real estate market conditions, consumer confidence
and spending patterns or other factors specific to the New England
region or in Florida may adversely
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 a direct material effect upon our
business, we believe that volatility in oil and gasoline prices impacts the cost
of producing petroleum-based/plastic products, which are a key raw material in
much of our merchandise, and also impacts prices of shipping products made
overseas in foreign countries, such as China, which includes much of our
merchandise.  Volatile oil and gasoline prices also impact freight
costs, consumer confidence and spending patterns.  These and other
issues directly or indirectly affecting our vendors and us could adversely
affect our business and financial performance.





Off-Balance
Sheet Arrangements


We do not
have any off-balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that are material to investors.





Factors
That May Affect Future Results





Our
business is subject to certain risks that could materially affect our financial
condition, results of operations, and the value of our common stock. These risks
include, but are not limited to, the ones described under Item 1A, “Risk
Factors” of our Annual Report on Form 10-K for the fiscal year ended December
27, 2008, and Part II, Item 1A, “Risk Factors” contained in our Quarterly
Reports on Form 10-Q, including this one, and in our periodic reports filed with
the Commission.  Additional risks and uncertainties that we are
unaware of, or that we may currently deem immaterial, may become important
factors that harm our business, financial condition, results of operations, or
the value of our common stock.





- 23
-





Critical
Accounting Policies





Our
financial statements are based on the application of significant accounting
policies, many of which require our management to make significant estimates and
assumptions (see Note 2 to our consolidated financial statements for the fiscal
year ended December 27, 2008 included in Item 8 of our Annual Report on Form
10-K for that fiscal year, as filed with the SEC on March 23,
2009).  We believe the following accounting policies to be those most
important to the portrayal of our financial condition and operating results and
those that require the most subjective judgment.  If actual results
differ significantly from management’s estimates and projections, there could be
a material effect on our financial statements.





Inventories
and Related Allowance for Obsolete and Excess Inventory





Inventories
consist of party supplies and are valued at the lower of moving weighted-average
cost or market.  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 are sold.





During
each interim reporting period, we estimate the impact on cost of products sold
associated with inventory shortage.  The actual inventory shortage is
determined upon reconciliation of the annual physical inventory, which occurs
shortly before and after our year end, and an adjustment to cost of products
sold is recorded at the end of the fourth quarter to recognize the difference
between the estimated and actual inventory shortage for the full
year.  The adjustment in the fourth quarter of 2008 included an
estimated reduction of $261,915 to the cost of products sold during the previous
three quarters.  The adjustment in the fourth quarter of 2007 included
an estimated reduction of $123,249 to the cost of products sold during the
previous three quarters.  The adjustment in the fourth quarter of 2006
included an estimated reduction of $251,806 to the cost of products sold during
the previous three quarters.





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





Revenue
Recognition





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





Property
and Equipment





Property
and equipment are stated at cost less accumulated depreciation and are
depreciated on the straight-line method over the estimated useful lives of the
assets. Expenditures for maintenance and repairs are charged to operations as
incurred.





Intangible
Assets





Intangible
assets consist primarily of the values of two non-compete agreements acquired in
conjunction with the purchase of retail stores in 2006 and 2008, and the values
of retail store leases acquired in those transactions.





The first
non-compete agreement, from Party City Corporation and its affiliates, covers
Massachusetts, Maine, New Hampshire, Vermont, Rhode Island, and Windsor and New
London counties in Connecticut, and expires in 2011.  The second
non-compete agreement was acquired in connection with our purchase in January
2008 of two franchised party supply stores in Lincoln and Warwick, Rhode
Island.  The acquired Rhode Island stores had been operated as Party
City franchise stores, and were converted to iParty stores immediately following
the closing. The second non-compete agreement covers Rhode Island for five years
from the date of closing and within a certain distance from our stores in the
rest of New England for three years. Both non-compete agreements have an
estimated life of 60 months and are subject to certain terms and conditions in
their respective acquisition agreements.





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





Non-compete
agreements are amortized based on the pattern of their expected cash flow
benefits. Occupancy valuations are amortized over the terms 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 and changes in
circumstances suggest that the carrying amounts may not be recoverable from
estimated future store cash flows.  Our review considers store
operating results, future sales growth and cash flows.  The conclusion
regarding impairment may differ from current estimates if underlying assumptions
or business strategies change.  We closed two stores in early January
2008, at the end of their lease terms.  No impairment charges were
required for these stores, as the assets related to them have been fully
amortized, except for immaterial amounts, and no liability existed for future
lease costs. We are not aware of any impairment indicators for any of our
remaining stores at September 26, 2009.





Income
Taxes





Historically,
we have not recognized an income tax benefit for our losses. Accordingly, we
record a valuation allowance against our deferred tax assets because of the
uncertainty of future taxable income and the realizability of the deferred tax
assets.  In determining if a valuation allowance against our deferred
tax asset is appropriate, we consider both positive and negative
evidence.  The positive evidence that we considered included (1) we
were able to use a portion of our net operating loss carryforwards in 2008, 2007
and 2006, (2) we have achieved positive comparable store sales growth for six
out of the last seven years and (3) we had improved merchandise margins in
2007.  The negative evidence that we considered included (1) we
realized a net loss in 2005 and 2008, (2) our merchandise margins decreased in
2008, 2006 and 2005, (3) our future profitability is vulnerable to certain
risks, including (a) the risk that we may not be able to generate significant
taxable income to fully utilize our net operating loss carryforwards of
approximately $20.3 million at December 27, 2008, (b) the risk of unseasonable
weather and other factors in a single geographic region, New England, where our
stores are concentrated, (c) the risk of being so dependent upon a single
season, Halloween, for a significant amount of annual sales and profitability
and (d) the risk of fluctuating prices for petroleum products, which are a key
raw material for much of our merchandise and which affect our freight costs and
those of our suppliers and affect our customers’ spending levels and patterns,
(4) the risk that opening or acquiring new stores will put pressure on our
profit margins until these stores reach maturity, (5) the expected costs of
increased regulatory compliance, including, without limitation, professional
fees associated with Section 404 of the Sarbanes-Oxley Act, which will likely
have a negative impact on our profitability, (6) the current economic recession
in the U.S. and the uncertainty as to the timing and strength of an economic
recovery, further reduce discretionary spending or cause a shift in consumer
discretionary spending to other
products.





The
negative evidence is strong enough for us to conclude that the level of our
future profitability is uncertain at this time. We believe that it is prudent
for us to maintain a valuation allowance against our deferred tax assets until
we have a longer track record of profitability and we can reduce our exposure to
the risks described above.  Should we determine that we will be able
to realize our deferred tax assets in the future, an adjustment to our deferred
tax assets would increase income in the period in which we made such a
determination.





Stock
Option Compensation Expense





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





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Use
of Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period.  Our actual results could differ from our
estimates.





New
Accounting Pronouncements





In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standard (“SFAS”) No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162.  This statement modifies the
Generally Accepted Accounting Principles (“GAAP”) hierarchy by establishing only
two levels of GAAP, authoritative and nonauthoritative accounting literature.
Effective July 2009, the FASB Accounting Standards Codification (“ASC”), also
known collectively as the “Codification,” is considered the single source of
authoritative U.S. accounting and reporting standards, except for additional
authoritative rules and interpretive releases issued by the
SEC.  Nonauthoritative guidance and literature would include, among
other things, FASB Concepts Statements, American Institute of Certified Public
Accountants Issue Papers and Technical Practice Aids and accounting textbooks.
The Codification was developed to organize GAAP pronouncements by topic so that
users can more easily access authoritative accounting guidance.  It is
organized by topic, subtopic, section, and paragraph, each of which is
identified by a numerical designation.  This statement applies
beginning in third quarter 2009.  All accounting references have been
updated, and therefore SFAS references have been replaced with ASC
references.





In
April 2008, the FASB issued  ASC 350-30-35-2, “Determination of
the Useful Life of Intangible Assets”. ASC 350-30-35-2 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under ASC 350,
“Intangibles - Goodwill and Other” . The intent of this amendment is to improve
the consistency between the useful life of a recognized intangible asset under
ASC 350 and the period of expected cash flows used to measure the fair value of
the asset under ASC 805 “Business Combinations”, and other U.S. generally
accepted accounting principles.  The Company adopted the provisions of
ASC 350-30-35-2 on December 28, 2008, and the adoption did not have a material
impact on its financial position, results of operations or cash
flows.





As
permitted by ASC 820-10-65-1, Effective Date of ASC 820, “Fair Value
Measurements and Disclosures”, the Company elected to defer the adoption of ASC
820 for all non-financial assets and non-financial liabilities, except those
that are recognized or disclosed at fair value in the financial statements on a
recurring basis, until December 28, 2008. The adoption of ASC 820-10-65-1in
fiscal 2009 has not had a material impact on the Company's financial position,
results of operations or cash flows.





In May
2009, the FASB issued ASC 855, “Subsequent Events”, which provides guidance to
establish general standards of accounting for and disclosures of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. ASC 855 also requires entities to disclose the date
through which subsequent events were evaluated as well as the rationale for why
that date was selected. ASC 855 is effective for interim and annual periods
ending after June 15, 2009. ASC 855 is effective for us during our fiscal year
ending December 26, 2009. We do not believe that the adoption of ASC 855 has had
a material impact on our financial condition, results of operations, and
disclosures.





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Item 3.  Quantitative and Qualitative Disclosures about
Market Risk





There has
been no material change in our market risk exposure since the filing of our
Annual Report on Form 10-K for the period ended December 27, 2008, which was
filed with the SEC on March 23, 2009.





Item 4. Controls and Procedures





(a)     Evaluation of Disclosure Controls
and Procedures.  The Chief Executive Officer and the Chief
Financial Officer of iParty (its principal executive officer and principal
financial officer, respectively) have concluded, based on their evaluation as of
September 26, 2009, the end of the fiscal quarter to which this report relates,
that iParty's disclosure controls and procedures: are effective to ensure that
information required to be disclosed by iParty in the reports filed or submitted
by it under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms; and include controls and procedures designed to ensure
that information required to be disclosed by iParty in such reports is
accumulated and communicated to iParty's management, including the Chief
Executive Officer and the Chief Financial Officer, to allow timely decisions
regarding required disclosure.  iParty’s disclosure controls and
procedures were designed to provide a reasonable level of assurance of reaching
iParty’s disclosure requirements and are effective in reaching that level of
assurance.





(b)     Changesin Internal
Controls.  No change in our internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities
Exchange Act of 1934, as amended) occurred during the fiscal quarter ended
September 26, 2009 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.




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PART II – OTHER
INFORMATION





Item 1. Legal Proceedings





We are not
a party to any material pending legal proceedings, other than ordinary routine
matters incidental to our business, which we do not expect, individually or in
the aggregate, to have a material effect on our financial position or results of
operations.





Item 1A. Risk Factors





There have
been no material changes to the risk factors disclosed in the “Risk Factors”
section of our Annual Report on Form 10-K for the fiscal year ended
December 27, 2008, as filed with the SEC on March 23, 2009, and in our
subsequent periodic reports filed with the SEC except as set forth
below:





Our
failure to generate sufficient cash to meet our liquidity needs may affect our
ability to service our indebtedness and grow our business.





Our
business requires access to capital to support growth, improve our
infrastructure, respond to economic conditions, and meet contractual
commitments.  In the event that our current operating plan or long-term
goals 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 on and to refinance our indebtedness, principally the amounts
borrowed under our bank line of credit and $600,000 note payable, and to fund
any capital expenditures for systems upgrades and new store openings, if any, we
may make in the future will depend in large part on our current and future
ability to generate cash.  This, to a certain extent, is subject to general
economic, financial, competitive and other factors that are beyond our
control.  We cannot assure you that our business will generate sufficient
cash flow from operations in the future, that our currently anticipated growth
in revenues and cash flow will be realized on schedule, or that future
borrowings will be available to us under our line of credit in an amount
sufficient to enable us to service indebtedness, undertake store openings and
replace and upgrade our technology systems to grow our business, or to fund
other liquidity needs.  If we need to refinance all or a portion of our
indebtedness from other sources, we cannot assure you that we will be able to do
so on terms and conditions acceptable to us.





We used
our existing line of credit to pay off in full the $2.5 million Highbridge Note
on September 15, 2009, providing us with less availability under the line for
working capital and acquisition needs than we might otherwise have. Our new bank
line of credit with Wells Fargo allows us to borrow up to $12,500,000, subject
to a limitation based on qualified inventory, receivables levels and other
reserves set by Wells Fargo, with an option to increase that limit up to $15
million.  As of September 26, 2009, there was $4,741,878 outstanding
under our line of credit with additional availability of $6,557,797, which we
believe to be sufficient to fund our operations, working capital requirements,
the scheduled note payment in 2010, and capital expenditures for the next twelve
months.





Compliance
with changing regulation of corporate governance, public disclosure, and
accounting standards may result in additional expense and risks.





Changing
laws, regulations and standards relating to corporate governance, public
disclosure and changes to accounting standards and practices, including the
Sarbanes-Oxley Act of 2002, new SEC regulations, corporate law developments in
Delaware, and evolving rules applicable to publicly-traded companies on the NYSE
Amex, are creating uncertainty, and hence risks, for companies such as ours.
These new or changed laws, regulations and standards are subject to varying
interpretations due to the fact that they are new and there has not yet emerged
a well-developed body of interpretation. As a result, their application in
practice may evolve over time as new guidance is provided by regulatory and
governing bodies. This development could result in uncertainty regarding
compliance matters and higher costs necessitated by ongoing revisions to
disclosure, governance and accounting practices.





Our
efforts to comply with evolving laws, regulations and standards have resulted
in, and are likely to continue to result in, increased general and
administrative expenses and a diversion of management time and attention from
revenue-generating activities to compliance activities.  In
particular, we have applied significant management and financial resources to
document, test, monitor and enhance our internal control over financial
reporting in order to meet the various current requirements of the
Sarbanes-Oxley Act of 2002. Additional costs may be required to be incurred in
2009 and 2010 since current regulations will require our internal controls to be
audited by our external auditors for fiscal year 2010. Currently, only
management is required to certify as to the effectiveness of our internal
controls. Any failure in the effectiveness of our internal control over
financial reporting could have a material effect on our financial reporting or
cause us to fail to meet reporting obligations, which upon disclosure, could
negatively impact the market price of our common stock.  Our efforts
to comply with these types of new regulatory requirements regarding our required
assessment of our internal controls over financial reporting and our external
auditors’ audit of our financial statements have required the commitment of
increasing levels of financial and managerial resources. If our efforts to
comply with new or changed laws, regulations and standards differ from the
activities intended by regulatory or governing bodies, we could face various
material and adverse consequences, including, a decline in our common stock
price or a possible delisting of our common stock.




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Item 2.   Unregistered Sales of Equity and
Securities and Use of Proceeds




Not
applicable




Item 3.   Defaults upon Senior
Securities





Not
applicable




Item
4.Submission
of Matters to a Vote of Security Holders





Not
applicable





Item 5.   Other Information





Not
applicable





Item 6.    Exhibits





The
exhibits listed in the Exhibit Index immediately preceding the exhibits are
filed as part of this Quarterly Report on Form 10-Q and are incorporated herein
by reference.




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SIGNATURES








Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.




iPARTY
      CORP.By:
                /s/ SAL
      PERISANOSal
      PerisanoChairman
      of the Board and Chief Executive Officer(Principal
      Executive Officer)By:
                /s/ DAVID
    ROBERTSONDavid
      RobertsonChief
      Financial Officer(Principal
      Financial and Accounting Officer)Dated:
      November 9, 2009




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EXHIBIT INDEX





EXHIBITNUMBER
              DESCRIPTIONEx.
      10.1
              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, Collateral Agent, Swing Line
      Lender and Lender dated as of July 1, 2009. (Incorporated by reference
      from the Company’s Current Report on Form 8-K filed with the Commission on
      July 6, 2009)Ex.
      31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      ActEx.
      31.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      ActEx.
      32.1
              Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section
    1350Ex.
      32.2
              Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section
    1350










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