<PAGE>   1
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

     For the fiscal year end December 31, 1996

                                       OR

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


      Commission File Number: 0-27826

                             PARTY CITY CORPORATION
            (Exact name of registrant as specified in its charter)


          DELAWARE                                          22-3033692
          --------                                          ----------
    (State or other jurisdiction                          (I.R.S. Employer
    of incorporation or organization)                   Identification No.)

    400 Commons Way, Rockaway, New Jersey                     07866
    (Address of principal executive offices)                (Zip Code)
    

       Registrant's telephone number, including area code: (201) 983-0888

Securities registered pursuant to Section 12(b) of the Act:

         Title of Each Class                             Name of each exchange
                                                          on which registered

                NONE                                            NONE

Securities registered pursuant to Section 12(g) of the Act:

                      Common Stock, par value $.01 per share
                      --------------------------------------
                               (Title of Class)

      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 X  No___

      Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section229.405 of this chapter) is not contained herein,
and will not be contained to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]

<PAGE>   2

      The aggregate market value of the voting stock held by non-affiliates of
the registrant was approximately $54,145,000 based upon the closing price for
the Company's Common Stock, $.01 par value, as reported by the National
Association of Securities Dealers Automated Quotation System on March 5, 1997. 

      Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.

            Class                               Outstanding at March 6, 1997
            -----                               ----------------------------

Common Stock, $.01 par value per share                   6,974,000

                     DOCUMENTS INCORPORATED BY REFERENCE

  PORTIONS OF THE REGISTRANT'S PROXY STATEMENT FOR THE 1997 ANNUAL MEETING OF
SHAREHOLDERS ARE INCORPORATED BY REFERENCE INTO PART III. SUCH PROXY STATEMENT
WILL BE FILED WITHIN 120 DAYS AFTER THE END OF THE FISCAL YEAR COVERED BY THIS
ANNUAL REPORT ON FORM 10-K.


                            [COVER PAGE 2 OF 2 PAGES]




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<PAGE>   3


                        1996 Annual Report on Form 10-K

                               TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                    PART I                                        Page

<S>         <C>                                                                   <C> 
Item 1      Business...........................................................    4

Item 2      Properties.........................................................   15

Item 3      Legal Proceedings..................................................   15

Item 4      Submission of Matters to a Vote of Security Holders................   16

                                    PART II

Item 5      Market for the Registrant's Common Stock and
            Related Security Holder Matters....................................   16

Item 6      Selected Financial Data............................................   18

Item 7      Management's Discussion and Analysis of Financial
            Condition and Results of Operations................................   19

Item 8      Financial Statements and Supplementary Data........................   24

Item 9      Changes in and Disagreements with Accountants on Accounting 
            and Financial Disclosure...........................................   24

                                   PART III

Item 10     Directors and Executive Officers of the Registrant.................   24

Item 11     Executive Compensation.............................................   24

Item 12     Security Ownership of Certain Beneficial Owners
            and Management.....................................................   24

Item 13     Certain Relationships and Related Transactions.....................   24

                                    PART IV

Item 14     Exhibits, Financial Statement Schedules and Reports on Form 8-K....   25
</TABLE>



                                        3

<PAGE>   4
               SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     Certain statements in this Annual Report on Form 10-K constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known
and unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company, or industry results, to be
materially different from any future results, performance, or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the following: changes in general economic and business
conditions; loss of market share through competition; introduction of
competing services by other companies; changes in industry capacity; pressure
on prices from competition or from purchasers of the Company's products;
difficulties in finding new site locations; availability of qualified
personnel; and other factors both referenced and not referenced in this Annual
Report on Form 10-K. When used in this Annual Report on Form 10-K, the words
"estimate," "project," "anticipate," "expect," "intend," "believe," and similar
expressions are intended to identify forward-looking statements.

        
                                 PART I
ITEM 1. BUSINESS

GENERAL

     The Company is a rapidly growing specialty retailer of party supplies
through its network of discount Super Stores. At February 28, 1997, the Company
owned and operated 44 Party City Super Stores in the United States and its
franchisees operated an additional 159 stores in the United States, Puerto Rico,
Canada, and Spain. The Company, based in Rockaway, New Jersey, believes it is
one of the largest party supplies specialty superstore chains. The Company
authorized the first franchise store in 1989 and opened its first Company-owned
store in January 1994. System-wide sales (including net sales at Company-owned
and franchised stores) for the year ended December 31, 1996 totaled $269.7
million, an increase of 47.5% over the year ended December 31, 1995. During the
year ended December 31, 1996, the Company significantly accelerated its
Company-owned Super Store expansion program and opened 20 Company-owned Super
Stores. Primarily as a result of this expansion, the Company's total revenue
increased from approximately $23.1 million in 1995 to approximately $48.5
million in 1996, an increase of 110%. During this same period, income from
operations increased 164% from approximately $2.1 million in 1995 to
approximately $5.6 million in 1996. The Company expects to open approximately 45
to 50 Company-owned Super Stores in 1997 and approximately 70 to 75
Company-owned Super Stores in 1998.
 
     The Company believes that, under its "Party City, The Discount Party Super
Store" trademark, it has transformed the party supplies business by introducing
increased product and marketing focus and greater mass merchandising
sophistication. Pursuant to its merchandising concept, the Company operates and
franchises party supplies Super Stores that typically range in size from 10,000
square feet to 12,000 square feet. These Super Stores offer a broad selection of
merchandise (branded as well as private label) for a wide variety of celebratory
occasions, including birthday parties, weddings, and baby showers as well as
seasonal events such as Halloween, Christmas, New Year's Eve, graduation,
Easter, Valentine's Day, Thanksgiving, St. Patrick's Day, the Super Bowl and the
Fourth of July. Party City seeks to offer customers a "one-stop" party store
that provides a wide selection of merchandise at everyday low prices. A key
element of delivering customer satisfaction is stocking inventory in sufficient
quantities to satisfy customer needs for parties of virtually all sizes and
types.
 
INDUSTRY OVERVIEW
 
     The retail party supplies business has traditionally been a fragmented one,
with consumers purchasing party-related products from single owner-operated
party supplies stores and designated departments in drug stores, general mass
merchandisers, supermarkets, and department stores of local, regional and
national chains. According to Party and Paper Retailer, a retail trade
publication, the market for party and special occasion merchandise, comprised of
party supplies, greeting cards, gift wrap and related items, had estimated
retail sales of $8.85 billion in 1996.
 
     The Company believes that the increasing breadth of party supplies
merchandise produced by manufacturers over the past few years has been a driving
factor in the marketplace's acceptance of the party supplies superstore concept.
Further, the Company believes that the significant revenues experienced by its
Company-owned and franchise Super Stores in the fourth quarter can be
attributed, to a large extent, to the growth in the number of persons
celebrating Halloween and the increased demand for costumes and party supplies
utilized in such celebrations.
 
     The Company has noted the marketplace's acceptance of other types of
superstores and mega-retailers in various categories such as food, home
furnishings and pet supplies, among others. The success of such superstores and
mega-retailers in other industries has prompted the Company to expand its
product lines to include a wider breadth of merchandise in order to make its
Super Stores increasingly attractive destination shopping locations for party
supplies. In addition, the Company believes that the increased breadth of
related and integrated merchandise available to customers in superstores and
mega-retailers influences consumers to increase the number of purchases in a
given trip to a retailer. As such, the Company believes that the broad
 
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<PAGE>   5
 
selection, and relatively low price points, of merchandise offered by its Super
Stores often stimulates customers to purchase additional items on impulse.
 
BUSINESS STRATEGY
 
     The Company's objective is to continue to expand its position as a leading
category-dominant national chain of party supplies superstores. The Company
believes that it has transformed the party supplies business by introducing
increased product and marketing focus and greater mass merchandising
sophistication. Key components of the Company's strategy are:
 
     Pursue Super Store Expansion.  The Company believes that opportunities for
substantial expansion exist by opening additional Super Stores in both new and
existing markets and believes that numerous sites are available for such
expansion. The Company's expansion strategy is to rapidly increase its
Company-owned store base while continuing to add franchise stores. In addition,
the Company recently purchased six franchise stores and anticipates selectively
acquiring additional franchise stores in the future where they will be accretive
to the Company's net income per share. See "Certain Relationships and Related
Transactions." Based on this expansion plan, the Company anticipates opening
approximately 45 to 50 new Company-owned stores and 20 franchise stores in 1997
and approximately 70 to 75 new Company-owned stores and 12 franchise stores in
1998, bringing the total stores in operation to approximately 87 to 92
Company-owned Super Stores and approximately 178 franchise Super Stores by the
end of 1997 and approximately 157 to 167 Company-owned Super Stores and
approximately 190 franchise Super Stores by the end of 1998.
 
     Offer the Broadest Selection of Merchandise in an Exciting Shopping
Environment.  The Company strives to provide party-planners and party-goers with
convenient one-stop shopping for party supplies and offers what it believes is
one of the most extensive selections of party supplies. A typical Party City
Super Store contains approximately 20,000 SKUs. Within its many product
categories, Party City offers a wide variety of patterns, colors and styles. The
Company has been expanding the range of items which it offers in order to create
consumer loyalty and generate repeat business by striving to maintain a new and
exciting product selection. Further, the Company believes that its broad
selection of merchandise and relatively low price points often stimulates
consumers to purchase additional party supplies on impulse.
 
     Establish Convenient Store Locations.  While the Company believes that its
stores typically are destination shopping locations, it seeks to maximize
customer traffic and quickly build the visibility of new stores by situating its
stores in high traffic areas. Site selection criteria include: population
density; demographics; traffic counts; complementary retailers; storefront
visibility and presence (either in a stand-alone building or in a strip or power
shopping center); competition; lease rates; and accessible parking. The Company
believes there is an extensive number of suitable locations available for future
stores.
 
     Maintain Everyday Low Pricing.  The Company, using the buying power of its
more than 200 Company-owned and franchise Super Stores, obtains volume discounts
from its vendors on most products, allowing the Super Stores to offer a broad
line of high quality merchandise at competitive prices. The Company reinforces
customers' expectations of savings by prominently displaying signs announcing
its everyday low prices. The Company also maintains a lowest price guaranty
policy, to which it suggests its franchisees adhere; this policy guarantees that
Party City will meet and discount the advertised prices of a competitor's
products. The Company believes that this policy has helped foster the Company's
image of offering consumers exceptional value for their money.
 
     Provide Excellent Customer Service.  The Company views the quality of its
customers' shopping experience as critical to its continued success. The Company
is committed to making shopping in its Super Stores an enjoyable experience
through the employment of friendly, knowledgeable and energetic sales associates
who provide customers with personalized shopping assistance. At Halloween, an
important selling season for the Company, each store increases significantly the
number of sales associates in the store to ensure prompt service. Sales
associates assist customers in selecting or finding a certain item, which
provides the sales associates with a cross-selling opportunity to suggest
accessories or other complementary products. The
 
                                       5
<PAGE>   6
 
Company believes that the compensation of its store managers and other personnel
is competitive and enables the Company to attract and retain well-qualified,
motivated employees who are committed to providing excellent customer service.
 
     Utilize Sophisticated Merchandising Systems.  The Company believes that the
daily use of its customized MIS system enables the Company to quickly analyze
the performance of Company-owned and franchise stores in order to allow it to
more rapidly react to changing consumer preferences. The MIS system is a
critical element in management's efforts to evaluate the sales performance of
individual stores and to assist in analyzing and deciding upon the proper mix of
merchandise. In addition, the MIS system is essential in assisting the
individual store managers in constantly replenishing their shelves, which is
consistent with the Company's goal of having shelves fully stocked in order to
make the stores more exciting to consumers and to take advantage of sales
opportunities. The Company continually evaluates and updates its systems.
 
     Capitalize on Direct Marketing and Advertising.  The Company believes that
its advertising and marketing strategy allows it to open stores in any area of
the country without the need to cluster stores. Direct mailings to potential
customers are the principal form of advertising. The Company accomplishes this
by soliciting zip code information from customers at the time of their
purchases. This information is input into the MIS system and is used to
determine the geographical area where the most likely potential customers live.
With this information, in conjunction with major seasonal events, each store
effects approximately 10 to 12 direct mailings per year to residents in those
targeted areas.
 
     Investment in Infrastructure to Support Growth.  As the Company has
increased its base of Company-owned Super Stores, it has made additions to its
management team. During 1996, the Company added a chief operating officer as
well as key people in the Company's MIS, real estate, merchandising,
administrative support and construction departments. The Company believes it
will not require significant additions to its management team to realize its
expansion plans for Company-owned stores.
 
EXPANSION PLANS
 
     The Company's expansion strategy is to increase its market share in
existing markets and to penetrate new markets with a goal of maintaining a
leading position as a category-dominant retailer of party supplies merchandise.
Over the next few years, the Company intends to continue to devote greater
resources to the opening of Company-owned stores and therefore believes that for
the next several years its revenue growth increasingly will be derived from the
opening of Company-owned, rather than franchise Super Stores. The Company is
experienced in overseeing a large number of stores which are geographically
disbursed. The Company believes that there is an extensive number of suitable
locations available for future sites. As of February 28, 1997, the Company had
opened two Company-owned stores and acquired six franchise stores in 1997. In
1996, the Company opened 20 Company-owned stores and its franchisees opened an
additional 32 stores. During 1995, the Company owned nine Company-owned stores
and its franchisees opened an additional 35 stores. Based on its current
planning and market information, the Company plans to open approximately 43 to
48 additional Company-owned stores in 1997, and believes that new and existing
franchisees will open approximately 20 stores. The Company has signed leases for
23 of its planned Company-owned locations to be opened in 1997, and one of its
planned Company-owned locations to be opened in 1998, which are detailed below.
 
                      COMPANY-OWNED STORES OPENED IN 1997
                  -------------------------------------------
 
<TABLE>
<CAPTION>
                                   LOCATIONS                             SQUARE FOOTAGE
        ---------------------------------------------------------------  --------------
        <S>                                                              <C>
        Encinitas, CA..................................................       8,658
        Lighthouse Point, FL...........................................       8,000
</TABLE>
 
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<PAGE>   7
 
                   COMPANY-OWNED STORES TO BE OPENED IN 1997
 
<TABLE>
<CAPTION>
                               SIGNED LOCATIONS                          SQUARE FOOTAGE
        ---------------------------------------------------------------  --------------
        <S>                                                              <C>
        Atlantic City, NJ..............................................      12,000
        Bronx, NY......................................................      10,000
        Bronx (Co-Op City), NY.........................................       7,500
        Brooklyn (Nostrand), NY........................................      10,000
        Centereach, NY.................................................      15,000
        Cincinnati (Waterstone), OH....................................      10,000
        Las Vegas (Rainbow), NV........................................      10,500
        Lauderhill, FL.................................................      12,700
        Livonia, MI....................................................      14,400
        Madison, WI....................................................      12,316
        National City, CA..............................................       7,500
        New Hyde Park, NY..............................................      10,000
        Olivette, MO...................................................      14,204
        Pasadena, CA...................................................      11,200
        Rochester Hills, MI............................................      10,200
        Roseville, CA..................................................      11,314
        St. Louis (Mirr Mead), MO......................................      10,400
        St. Louis (Sun Hills), MO......................................      12,000
        South Miami, FL................................................       9,704
        Stamford, CT...................................................      10,000
        Tustin, CA.....................................................       9,729
        West Paterson, NJ..............................................      11,800
        Woodbury, NY...................................................      10,000
</TABLE>
 
                   COMPANY-OWNED STORES TO BE OPENED IN 1998
 
<TABLE>
<CAPTION>
                               SIGNED LOCATIONS                          SQUARE FOOTAGE
        ---------------------------------------------------------------  --------------
        <S>                                                              <C>
        Baldwin Park, CA...............................................      10,147
</TABLE>
 
     In addition to opening new Company-owned stores, the Company may purchase
selected existing franchised locations from its franchisees. (See "Certain
Relationships and Related Transactions.") As of February 28, 1997,
the Company had purchased the following six stores from its franchisees in 1997:
 
                FRANCHISE STORES ACQUIRED BY THE COMPANY IN 1997
 
<TABLE>
<CAPTION>
                                   LOCATIONS                             SQUARE FOOTAGE
        ---------------------------------------------------------------  --------------
        <S>                                                              <C>
        Livingston, NJ.................................................       8,426
        Randolph, NJ...................................................       7,479
        East Brunswick, NJ.............................................       7,700
        Wayne, NJ......................................................       9,500
        North Iselin, NJ...............................................       8,700
        Parsippany, NJ.................................................      11,400
</TABLE>
 
     The Company anticipates that approximately 20 new franchise Super Stores
will be opened in 1997. As of February 28, 1997, one new franchise store was
opened in Texas and nine leases for new stores had been signed by franchisees in
California, Florida, Texas, Oregon, North Carolina and Canada.
 
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<PAGE>   8
 
STORE ECONOMICS
 
     The Company believes that the Party City Super Store concept offers
attractive unit economics and is conducive to the Company's planned expansion of
its store base. The Company's 16 Company-owned stores that were in operation for
all of 1996 generated average sales revenue of $1,662,000 and an average store
contribution of $200,000, or 12% of net sales. The stores included in such
average are comprised of seven and nine stores opened in 1994 and 1995,
respectively.

 
     The Company expects that the average cost for new Company-owned stores will
continue to be approximately $375,000 for a typical 10,000 to 12,000 square feet
leased store. The Company's cost of leasehold improvements in its present stores
has ranged from $0 to $250,000, with an average cost of $52,000. The average
cost of the investment in equipment and fixtures in Company-owned stores has
been $163,000. Pre-opening costs, which are expensed as incurred, have averaged
$35,000 per Company-owned store. These pre-opening expenses primarily consist of
labor, supplies, and occupancy charges. Each new store spends approximately
$125,000 for inventory, net of accounts payable.
 
STORE LOCATIONS
 
     As of February 28, 1997, there were 203 Party City Discount Super Stores
open in the United States, Canada, Puerto Rico, and Spain. Of these, 44 were
Company-owned and 159 were operated by the Company's independent franchisees.
 
     Since the opening of its first franchise store, the Company has grown
rapidly. The following table shows the growth in the Company's network of stores
during the last six years.
 
<TABLE>
<CAPTION>
                                                                  YEAR ENDED DECEMBER 31,
                                                          ---------------------------------------
                                                          1991   1992   1993   1994   1995   1996
                                                          ----   ----   ----   ----   ----   ----
    <S>                                                   <C>    <C>    <C>    <C>    <C>    <C>
    Company-owned:
      Number of stores opened during period.............   --     --     --      7      9     20
      Number of stores closed during period.............   --     --     --      0      0      0
      Number of stores open at end of period............   --     --     --      7     16     36
    Franchise:
      Number of stores opened during period.............    5     16     26     42     35     32
      Number of stores closed during period.............    0      0      0      1      2      0
      Number of stores open at end of period............   16     32     58     99    132    164
                                                           --     --     --    ---    ---    ---
    Total stores open at end of period..................   16     32     58    106    148    200
</TABLE>
 
     The Company typically seeks sites for new Super Stores that are stand-alone
buildings or which are located in a strip or power shopping center near high
traffic routes. The Company seeks to lease sites rather than own the real
estate. Often the site may be a shopping center under construction or renovation
and may be available for occupancy typically in a period ranging from three
months to one year. The Company visits numerous sites throughout the year in the
United States and in several foreign countries. The Company's site selection
criteria include, but are not limited to: population density and/or
demographics; traffic count; complementary retailers; store-front visibility and
presence; competition; lease rates; and accessible parking. In addition, the
Company carefully considers the presence of existing, and the potential for
future, competition in the market when selecting a site. The Company believes
there is an extensive number of suitable locations available for future sites.
 
MERCHANDISING
 
     SUPER STORE LAYOUT.  Party City Super Stores are designed to give the
shopper a feeling of excitement and create a festive atmosphere. The Company's
goal is for the customer to be pleasantly surprised by his or her shopping
experience. The Company's strategy to achieve this goal is to maintain an
in-stock position of the
 
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<PAGE>   9
 
widest selection of party supplies; this helps ensure that the Company will
reduce the possibility of missed sale opportunities.
 
     Party City Super Stores range in size from 6,750 to 13,320 square feet with
a typical store size between 10,000 and 12,000 square feet. A typical store
stocks over 20,000 SKUs on its shelves. The stores are divided into various
sections of different categories of party supplies, displayed to emphasize the
everyday low prices and breadth of merchandise available. The floor plan is
designed to impress the customer with the breadth of selection in each product
category.
 
     PRODUCT CATEGORIES.  The typical Party City Super Store offers a broad
selection of merchandise consisting of over 20,000 SKUs divided into the
following categories:
 
     Halloween.  An important merchandising concept for Party City Super Stores
is to provide an extensive selection of costumes for Halloween through its
"Halloween Costume Warehouse" department. The stores also carry a broad array of
decorations and accessories for the Halloween season. The Halloween merchandise
is prominently displayed to provide an exciting and fun shopping experience for
customers. The Company, because of the buying power of the Party City system, is
often able to obtain supplies of some of the most sought after Halloween-related
merchandise. The stores display Halloween-related merchandise throughout the
year to position the Company as the customer's Halloween shopping resource. The
Company believes that the importance of Halloween, among both young children and
adults, is growing significantly.
 
     Seasonal.  Customer purchases made for seasonal holiday events compose a
significant part of Party City's business. The seasonal category includes
products which are carried for the Super Bowl, Valentine's Day, St. Patrick's
Day, Passover, Easter, First Communion, graduation, the Fourth of July,
Christmas, Hanukkah and New Year's Eve. Some of the major items within this
category are tableware, decorations, cutouts, lights and balloons tailored to
the particular event.
 
     Birthdays.  The birthday product category includes a wide assortment of
merchandise to fulfill customer needs for celebrating birthdays, including
special ones such as "first," "sweet sixteen" and other milestone birthdays such
as 40th and 50th birthdays. Some of the products in this category include
invitations, thank you cards, tableware, hats, horns, banners, cascades,
balloons, novelty gifts, pinatas and candles.
 
     Party Favors.  The Company maintains a party favors department which
includes a broad selection of packaged and bulk favors appealing to different
age groups. The assortment includes different product lines varying in price
points designed to offer customers a variety of purchasing options.
 
     Candy.  The candy product category includes novelty and packaged candy sold
to enhance children's parties or to be used as pinata fillers. Candy is sold
both in individual units and in bulk packaging for customers' convenience.
 
     Balloons.  The Company maintains a balloon department which carries a vast
selection of basic and decorative latex balloons in many sizes, qualities,
colors and package sizes. The mylar balloon department consists of numerous
sizes, shapes and designs relating to birthday, seasonal, anniversary and other
themes.
 
     Baby Shower.  The Company maintains a baby shower department, which
includes tableware, decorations, balloons, favors, centerpieces and garlands.
 
     Bridal/Wedding/Anniversary.  This product category includes personalized
invitations, tableware, balloons, favors, place setting cards, confetti,
honeycomb bells and personalized ribbons. Personalized invitation books, which
contain numerous samples of customizable event invitations, are carried from the
leading invitation stationers at discounted prices.
 
     Catering Supplies.  Party City stores offer a broad selection of catering
supplies that consists of trays, platters, foil, bowls, warming racks and fuel.
 
     Gift Wrap.  This product category includes wide assortments of gift bags,
bows, tissue paper, ribbons (both solid and printed), glossy printed bags, solid
gift wrap, printed gift wrap and foil gift wrap.
 
                                       9
<PAGE>   10
 
     Greeting Cards.  This product category includes greeting cards from a
quality national card vendor at everyday low prices.
 
     General.  The Company carries a wide range of other products, including
decorative tableware, solid tableware, plastic and paper table covers, cutlery,
crepe paper, cups and tumblers. Party City stores carry private label items, as
well as its typical branded merchandise.
 
     PRODUCT SELECTION, PURCHASING AND SUPPLIERS.  The Company's management
continuously reviews new and existing product selections to provide the widest
and most current assortment of party supplies. In pursuit of this goal,
management attends various industry trade shows including the National Annual
Halloween Trade Show in Rosemont, Illinois and the Toy Fair in New York. In an
effort to keep abreast of new and popular merchandise, management views
presentations given specifically for the Company by its major vendors. The
Company utilizes its inventory tracking system to give the purchasing staff
constant feedback on customers' preferences.
 
     Each Super Store typically purchases inventory from approximately 300
suppliers. The Company does not have long-term purchase commitments or exclusive
contracts with any particular manufacturer or supplier. The Company considers
numerous factors in supplier selection, including price, credit terms, product
offerings and quality. The Company negotiates pricing with suppliers on behalf
of all stores in the system (both Company-owned and franchise) and believes that
such buying power enables it to not only receive the most favorable pricing
terms, but as importantly, to more readily obtain high demand merchandise,
especially popular Halloween costumes. As the Company continues to add new
stores, the Company believes it will increase the volume of its inventory
purchases and thereby may benefit further from increased discounts and more
favorable trade credit terms from its suppliers.
 
     In order to maintain consistency throughout its store system, the Company
has established an approved list of items that are permitted to be sold in Super
Stores. Pursuant to the terms of the Company's franchise agreements, franchise
stores must adhere to these guidelines. The Company establishes a standard store
merchandise layout and presentation format to be followed by Company-owned and
franchise Super Stores. Any layout or format changes developed by the Company
are communicated to the managers of Super Stores on a periodic basis.
 
     All of the merchandise purchased by Super Stores is shipped directly from
suppliers to the stores. The purchasing decisions and inventory control are
facilitated by the use of sophisticated point-of-sale inventory control
technology. Almost all merchandise is bar coded either by the supplier prior to
delivery or at the time of receipt at the store. Consistent with the Party City
Super Store concept, almost all inventory is displayed on the shelves with
little or no space used for stocking. Excess merchandise is stored above the
gondola fixtures on the store sales floor.
 
STORE OPERATIONS
 
     Each Super Store is typically managed by a general manager and two
assistant managers who are responsible for all aspects of the store's day-to-day
operations, including employee hiring and training, work scheduling, inventory
control, expense control, maintenance activities and communications with central
office staff. The sales and stocking staff ranges from three to eight people,
except during certain holiday selling seasons when additional store employees
are used. The Company seeks to pay its store managers at the top end of the
competitive pay scale in order to hire and retain experienced and dedicated
managers. In addition, the Company has instituted its Amended and Restated 1994
Stock Option Plan pursuant to which managers of Company-owned stores are
eligible for stock option awards.
 
     MANAGEMENT INFORMATION SYSTEMS.  The MIS system is a vital tool for
increasing the efficiency of store operations. The Company believes that its
management information system is an important factor in allowing the Company to
support its rapid growth and enhance its competitive position in the industry.
Through the MIS system, store managers are able to quickly evaluate the sales
performance of their stores and of individual items in their stores, while also
replenishing stock shelves in a timely fashion. Typically, merchandise is
 
                                       10
<PAGE>   11
 
received already bar coded, enabling managers to control inventory and pricing
by SKU, to manage assortment within a category, and to analyze gross margins and
inventory turnover.
 
     Each Super Store uploads transaction information into the Company's
corporate headquarters' MIS system on a daily basis. The headquarters' system
has all of the functionality of the individual store's system and can
consolidate information into multiple store groupings. All file information
(i.e., vendor, item price, etc.) is maintained and downloaded nightly to each
store location. The Company's MIS system allows it to monitor daily sales and
gross profit across its entire store base.
 
     TRAINING.  In Company-owned stores, corporate store managers are trained
for a minimum of two weeks prior to the opening of a store. During the store
set-up, a manager receives additional training from the Company's store set-up
team. During the first few days after the initial opening of a store, corporate
headquarters' personnel spend concentrated time in the store overseeing the
operations.
 
     In franchise locations, all franchisees go through an intense training
program consisting of one week in the classroom and one week in the store to
learn the fundamentals of the store's operation. During the set up of their
store, the franchisee receives additional training from the team leader of the
set-up crew that is dispatched by the Company to assist the franchisee with the
store opening. Shortly after a store opens, a representative from the Company
visits the franchise and spends several days assisting with the day-to-day
operations of running the store. To ensure efficient operations and that the
systems, policies and processes are being followed, subsequent visits are
scheduled on a regular basis to review what was covered during the initial
training.
 
CUSTOMER SERVICE
 
     Customer service and shopping convenience are integral components of Party
City's one-stop shopping concept. The Company views the quality of its
customers' shopping experience as critical to its continued success. To this
end, the Company employs friendly, knowledgeable and energetic sales associates
who provide customers with personalized shopping assistance. For example, at
Halloween, an important selling season for the Company, each store increases
significantly the number of sales associates in the store. These employees will
assist customers in selecting a costume, which provides the sales associates
with a cross-selling opportunity to suggest various accessories and other
complementary products. Also, at Halloween the associates utilize two-way
radios, which the Company believes help stock personnel to quickly fill
requested items, thus expediting sales and reducing lost business caused by slow
service.
 
     The Company believes that the compensation of its store managers and other
personnel is highly competitive and enables the Company to attract and retain
well-qualified, highly motivated employees who are committed to providing
excellent customer service.
 
MARKETING AND ADVERTISING
 
     For each Company-owned store, the Company budgets approximately five
percent of annual sales for advertising. Under the Company's current franchise
agreement, each franchisee is required to allocate a minimum of $5,500 to
promote the store's grand opening and the lesser of 3.0% of net sales or $60,000
per year for local advertising and promotions. To promote the Party City Super
Store concept on a larger scale and to produce professional quality advertising
for system use, franchisees must also pay an additional one percent of gross
sales per year to a Party City group advertising fund.
 
     Direct mailings to potential customers are the principal form of
advertising. The Company believes that direct mail advertising has enabled the
Company and its franchisees to successfully open stores in any location without
the need to cluster stores. The overall success the Company and its franchisees
have experienced with direct mailings can be attributed to targeting potential
customers in the areas surrounding stores. The Company accomplishes this by
soliciting zip code information from customers at the time of their purchases.
This information is entered into the MIS system and used to determine the
geographical area where the most likely potential customers live. With this
information, in conjunction with major seasonal events, each store effects
approximately ten to twelve direct mailings per year to residents in those
targeted areas.
 
                                       11
<PAGE>   12
 
COMPANY-OWNED STORES
 
     The Company believes that an increasing amount of the growth in its
operations in the future will continue to come from Company-owned Super Stores.
At February 28, 1997 there were 44 Company-owned Party City Super Stores,
including two Super Stores opened in 1997 and six franchised Super Stores
purchased by the Company in February 1997. The Company plans to open
approximately 43 to 48 additional stores in 1997 and approximately 70 to 75
stores in 1998. The table below lists certain information with respect to
Company-owned Super Stores open as of February 28, 1997.
 
<TABLE>
<CAPTION>
                                                                       DATE OPENED    SQUARE
                                LOCATIONS                              OR ACQUIRED    FOOTAGE
    -----------------------------------------------------------------  ------------   -------
    <S>                                                                <C>            <C>
    Orlando (East), FL...............................................    01/29/94       9,760
    Norristown, PA...................................................    08/03/94       9,975
    Chicago (Ford City), IL..........................................    09/22/94      12,000
    Middletown, NY...................................................    09/27/94       9,000
    Orlando (West), FL...............................................    09/28/94      10,000
    Hamden, CT.......................................................    09/30/94      12,100
    Chula Vista, CA..................................................    10/03/94       8,260
    Parma Heights, OH................................................    04/21/95       7,782
    Roseville, MI....................................................    07/29/95      12,000
    Miami (Kendall), FL..............................................    09/06/95      10,125
    Greenbelt, MD....................................................    09/14/95       8,500
    Long Island City, NY.............................................    09/16/95       6,750
    Pico Sepulveda, CA...............................................    09/28/95      13,169
    Dearborn, MI.....................................................    09/29/95       7,560
    Royal Oak, MI....................................................    10/06/95      11,926
    Lathrup Village, MI..............................................    10/06/95       6,960
    Miami Gardens, FL................................................    05/19/96       9,000
    Lansing, IL......................................................    06/29/96      13,200
    Lawrence, NY.....................................................    06/29/96      10,000
    Anaheim, CA......................................................    06/29/96       9,400
    Towson, MD.......................................................    08/02/96      12,136
    Boca Raton, FL...................................................    08/10/96      10,680
    Alhambra, CA.....................................................    09/04/96      13,125
    Fresno, CA.......................................................    09/20/96      12,000
    Carle Place, NY..................................................    09/21/96      11,049
    Chicago Ridge, IL................................................    09/24/96      13,320
    LaHabra, CA......................................................    09/24/96       9,000
    El Cajon, CA.....................................................    09/25/96      10,000
    Hicksville, NY...................................................    09/28/96      10,147
    Del Ray Beach, FL................................................    09/29/96      11,550
    Las Vegas (Mission), NV..........................................    10/01/96      12,000
    Turnersville, NJ.................................................    10/03/96      10,080
    Sterling Heights, MI.............................................    10/04/96      11,508
    Milpitas, CA.....................................................    10/04/96       9,870
    Brooklyn, NY.....................................................    10/04/96       8,140
    Buffalo, NY......................................................    10/18/96      11,115
    Lighthouse Point, FL.............................................    01/31/97       8,000
    Encinitas, CA....................................................    02/03/97       8,658
    Livingston, NJ...................................................    02/28/97       8,426
    Randolph, NJ.....................................................    02/28/97       7,479
    East Brunswick, NJ...............................................    02/28/97       7,700
    Wayne, NJ........................................................    02/28/97       9,500
    North Iselin, NJ.................................................    02/28/97       8,700
    Parsippany, NJ...................................................    02/28/97      11,400
</TABLE>
 
                                       12
<PAGE>   13
 
     None of the leases for the 44 stores listed above expires before 2003. As
of February 28, 1997, the Company had signed leases for an additional 23
Company-owned locations to be opened during 1997 and one store to be opened
during 1998.
 
FRANCHISE OPERATIONS
 
     Until opening its first Company-owned store in January 1994, the Company
operated exclusively as a franchisor. As of February 28, 1997, the Company was
the franchisor for 159 Super Stores throughout the United States, Puerto Rico,
Canada and Spain. A Party City Super Store run by a franchisee utilizes the
Company's format, design specifications, methods, standards, operating
procedures, systems and trademarks.
 
     The Company's 159 franchise stores are located in the following states and
foreign countries:
<TABLE>
<CAPTION>
                                      NUMBER
                                        OF
               STATE                  STORES
------------------------------------  ------
<S>                                   <C>
Alabama.............................     3
Arizona.............................     4
Arkansas............................     1
California..........................     9
Colorado............................     1
Connecticut.........................     4
Delaware............................     1
Florida.............................    11
Georgia.............................     9
Hawaii..............................     1
Illinois............................     6
Kansas..............................     2
Louisiana...........................     4
Maryland............................     4
Mississippi.........................     1
 
<CAPTION>
                                      NUMBER
                                        OF
               STATE                  STORES
------------------------------------  ------
<S>                                   <C>
Missouri............................     1
New Jersey..........................    16
New Mexico..........................     2
New York............................    12
North Carolina......................     8
Ohio................................     3
Oregon..............................     2
Pennsylvania........................     9
South Carolina......................     2
Tennessee...........................     7
Texas...............................    19
Virginia............................     8
Canada..............................     3
Puerto Rico.........................     4
Spain...............................     2
</TABLE>
 
     The following table summarizes the Company's franchise operations history
through December 31, 1996:
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                               -----------------------------------------------------
                                               1991     1992     1993      1994      1995      1996
                                               -----    -----    -----    ------    ------    ------
<S>                                            <C>      <C>      <C>      <C>       <C>       <C>
Number of stores open at end of period.......   16       32       58        99       132       164
Total sales of franchise stores ($
  millions)..................................  $14.8    $28.1    $56.9    $109.0    $166.7    $230.6
</TABLE>
 
     The Company receives revenue from its franchisees, including an initial
one-time fee (currently at $35,000) and an ongoing royalty fee (currently 4.0%
of net sales for new franchisees, payable monthly). In addition, each franchisee
has a mandated advertising budget, which consists of a minimum of $5,500 to
promote the initial store opening and thereafter the lesser of 3.0% of net sales
or $60,000 per year for local advertising and promotions. Further, the
franchisee must pay an additional 1.0% of net sales to a Party City group
advertising fund to cover common advertising materials related to the Party City
Super Store concept. The Company does not offer financing for a franchisee's
initial investment. Franchise start-up expenses include the franchise fee, rent,
leasehold improvements, equipment and furniture, initial inventory, opening
promotion, signs, other deposits, insurance, training expenses and professional
fees.
 
     Current franchise agreements provide for an assigned area or territory that
typically equals a three-mile radius from the franchisee's store location and
the right to use the Party City logo type and trademark "The Discount Party
Super Store." In most stores, the franchisee or the majority shareholder of a
corporate franchisee devotes full time to the management, operation and
on-premises supervision of the franchise.
 
     Pursuant to the franchise agreement entered into with franchisees, all site
locations must be approved by the Company, which approval is based primarily on
demographic studies and proximity to heavily traveled highways or interchanges.
As franchisor, Party City also supplies valuable and proprietary information
pertaining to the operation of the Party City Super Store business, as well as
advice regarding location,
 
                                       13
<PAGE>   14
 
improvements and promotion. The Company also supplies consultation in the areas
of purchasing, inventory control, pricing, marketing, merchandising, hiring,
training, improvements and new developments in the franchisee's business and
general business operations, as well as the provision of assistance in opening
and initially promoting the store.
 
     As of February 28, 1997 the Company had eight territory agreements with
certain franchisees. These agreements permit the holder of the territory rights
to open a minimum of two and in some cases three or more stores within a stated
time period. If stores are not opened pursuant to the schedule, the territory
agreement may be terminated. The following areas are governed by territory
agreements: North Carolina; Louisiana/Alabama; Phoenix, AZ and Santa
Fe/Albuquerque, NM; Atlanta, GA; Dallas, TX; Canada; Spain and Puerto Rico.
 
COMPETITION
 
     The party supplies retailing business is highly competitive. Party City
Super Stores compete with a variety of smaller and larger retailers, including
single owner-operated party supplies stores, specialty party supplies retailers
(including superstores), designated departments in drug stores, general mass
merchandisers, supermarkets and department stores of local, regional and
national chains. Many of these competitors have substantially greater financial
resources than the Company.
 
     Management believes that Party City Super Stores maintain a leading
position in the party supplies business by offering a wider breadth of
merchandise, greater selection within merchandise class and discount prices
offered on most items in the stores. The Company believes that the significant
buying power resulting from the size of the Party City Super Store System is an
integral advantage.
 
TRADEMARKS
 
     The Company has registered a number of trademarks and service marks with
the United States Patent and Trademark Office, including the names Party
City,(R) The Discount Party Super Store(R) and Halloween Costume Warehouse.(R)
 
GOVERNMENT REGULATION
 
     As a franchisor, the Company must comply with regulations adopted by the
Federal Trade Commission (the "FTC") and with several state laws that regulate
the offer and sale of franchises. The Company also must comply with a number of
state laws that regulate certain substantive aspects of the
franchisor-franchisee relationship. The FTC's Trade Regulation Rule on
Franchising (the "FTC Rule") requires that the Company furnish prospective
franchisees with a franchise offering circular containing information prescribed
by the FTC Rule. State laws that regulate the offer and sale of franchises
require the Company to register before the offer and sale of a franchise can be
made in that state.
 
     State laws that regulate the franchisor-franchisee relationship presently
exist in a substantial number of states. Those laws regulate the franchise
relationship, for example, by requiring the franchisor to deal with its
franchisees in good faith, by prohibiting interference with the right of free
association among franchisees and by regulating discrimination among franchisees
with regard to charges, royalties or fees. Those laws also restrict a
franchisor's rights with regard to the termination of a franchise agreement (for
example, by requiring "good cause" to exist as a basis for the termination) by
requiring the franchisor to give advance notice to the franchisee of the
termination and give the franchisee an opportunity to cure any default, and by
requiring the franchisor to repurchase the franchisee's inventory or provide
other compensation. To date, those laws have
 
                                       14
<PAGE>   15
not precluded the Company from seeking franchisees in any given area and have
not had a material adverse effect on the Company's operations.
 
     Each Party City Super Store must comply with regulations adopted by federal
agencies and with licensing and other regulations enforced by state and local
health, sanitation, safety, fire and other departments. Difficulties or failures
in obtaining the required licenses or approvals can delay and sometimes prevent,
the opening of a new store.
 
     Party City stores must comply with federal and state environmental
regulations, but the cost of complying with those regulations has not been
material. More stringent and varied requirements of local governmental bodies
with respect to zoning, land use, and environmental factors can delay, and
sometimes prevent, development of new stores in particular locations.
 
     The Company and its franchisees must comply with the Fair Labor Standards
Act and various state laws governing various matters such as minimum wages,
overtime and other working conditions. The Company and its franchisees also must
comply with the provisions of the Americans with Disabilities Act, which require
that employers provide reasonable accommodation for employees with disabilities
and that stores be accessible to customers with disabilities.
 
EMPLOYEES
 
     As of February 28, 1997, the Company employed 312 full-time and 503
part-time employees. The Company considers its relationships with its employees
to be good. None of the Company's employees is covered by a collective
bargaining agreement.
 
ITEM 2.  PROPERTIES
 
     As of February 28, 1997, the Company leased 44 stores and had signed leases
for 24 additional stores in the locations mentioned under Item 1. The Company
maintains its headquarters at 400 Commons Way, Rockaway, New Jersey 07866. The
Company occupies approximately 10,610 square feet of office space for its
headquarters under a lease expiring in 2005.
 
ITEM 3.  LEGAL PROCEEDINGS

     The Company is from time to time involved in routine litigation incidental
to the conduct of its business. As of the date of this Annual Report on Form
10-K, the Company is aware of no material existing or threatened litigation to
which it is or may be a party.
 
                                       15
<PAGE>   16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
        
        Not Applicable.
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The Company's Common Stock has traded on the Nasdaq National Market under
the symbol "PCTY" since the Company's initial public offering. The following
table sets forth the high and low closing sale prices of the Company's Common
Stock as reported on the Nasdaq National Market for the periods indicated.
 
<TABLE>
<CAPTION>
    1996 YEAR                                                                HIGH     LOW
                                                                             ----     ---
    <S>                                                                      <C>      <C>
    First Quarter (beginning March 27, 1996)...............................  14 3/4   11 1/2
    Second Quarter.........................................................  19 1/4   13 1/2
    Third Quarter..........................................................  22 1/4   16 1/4
    Fourth Quarter.........................................................  19 3/4    14
    1997 YEAR
    First Quarter (through March 5, 1997)..................................  16 3/4   15 1/2
</TABLE>
 
     On March 5, 1997, the last sale price of the Common Stock reported on the
Nasdaq National Market was $16.25 per share. At February 28, 1997, the
approximate number of holders of record of the Common Stock was 55.
 
DIVIDENDS

     Except for the S Corporation distribution of a portion of previously
undistributed earnings to the Company's stockholders in 1994 upon the Company's
election to be taxed as a C Corporation, the Company has never paid cash
dividends on its capital stock and does not intend to pay cash dividends for the
foreseeable future. The Company expects that earnings will be retained for the
continued growth and development of the Company's business. Future dividends, if
any, will depend upon the Company's earnings, financial condition, working
capital requirements, compliance with covenants in agreements to which the
Company is or may be subject, future prospects and other factors deemed relevant
by the Company's Board of Directors. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
 
                                       16
<PAGE>   17

UNREGISTERED SECURITIES

   Within the past three years, the Company has sold the following securities
which were not registered under the Securities Act:

   On April 27, 1994, the Company sold 1,200,000 shares of Common Stock in a
private placement to four individuals for an aggregate principal price of
$2,500,000 based upon an exemption from registration under Section 4(2) of the
Securities Act.

   On August 12, 1994, the Company sold 24,000 shares of Common Stock in a
private placement to two individuals for an aggregate purchase price of $50,000
based upon an exemption from registration under Section 4(2) of the Securities
Act.

   During 1996 the Company sold 36,667 shares of Common Stock pursuant to the
exercise of stock options for an aggregate purchase price of $175,003 based
upon an exemption from registration under Section 4(2) of the Securities Act.


                                        17
 
<PAGE>   18
 
ITEM 6. SELECTED FINANCIAL DATA
 
     The following selected financial data for each of the years ended December
31, 1992 and 1993 are derived from financial statements of the Company not
included herein. The selected financial data for the three years in the period
ended December 31, 1996 are derived from the financial statements of the
Company, included elsewhere in this Annual Report on Form 10-K, which have been
audited by Deloitte & Touche LLP, independent auditors, as stated in their
report appearing elsewhere herein. The financial data set forth below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Financial Statements, including the
notes thereto, appearing elsewhere in this Annual Report on Form 10-K.
 
<TABLE>
<CAPTION>
                                                                                   YEAR ENDED DECEMBER 31,
                                                             --------------------------------------------------------------------
                                                                1992          1993          1994          1995           1996
                                                             ----------    ----------    ----------    -----------    -----------
<S>                                                          <C>           <C>           <C>           <C>            <C>
INCOME STATEMENT DATA:
Total revenue.............................................   $1,060,890    $2,408,828    $8,852,796    $23,120,342    $48,528,385
                                                             ==========    ==========    ==========    ===========    ===========
Company-owned stores:
  Net sales...............................................                               $3,991,589    $16,118,163    $39,143,625
  Cost of goods sold and occupancy costs..................                                2,686,881     10,758,209     25,937,444
                                                                                         ----------    -----------    -----------
  Gross profit............................................                                1,304,708      5,359,954     13,206,181
  Store operating and selling expense.....................                                1,239,769      4,254,475     10,116,160
                                                                                         ----------    -----------    -----------
  Company-owned stores profit contribution................                                   64,939      1,105,479      3,090,021
                                                                                         ----------    -----------    -----------
Franchise stores:
  Royalty fees............................................   $  733,390    $1,793,828    $3,836,207    $ 6,074,679    $ 8,449,760
  Franchise fees..........................................      327,500       615,000     1,025,000        927,500        935,000
                                                             ----------    ----------    ----------    -----------    -----------
  Total franchise revenue.................................    1,060,890     2,408,828     4,861,207      7,002,179      9,384,760
  Total franchise expense.................................      758,000     1,580,644     2,049,894      2,943,814      3,729,050
                                                             ----------    ----------    ----------    -----------    -----------
  Franchise profit contribution...........................      302,890       828,184     2,811,313      4,058,365      5,655,710
                                                             ----------    ----------    ----------    -----------    -----------
General and administrative expense........................      287,888       570,075     1,929,850      3,023,540      3,096,811
                                                             ----------    ----------    ----------    -----------    -----------
Income before interest and income taxes...................       15,002       258,109       946,402      2,140,304      5,648,920
Interest income (expense), net............................       (5,349)        4,128        62,121         22,861        475,805
                                                             ----------    ----------    ----------    -----------    -----------
Income before income taxes................................        9,653       262,237     1,008,523      2,163,165      6,124,725
Provision for income taxes................................        1,915        27,500       466,000        863,200      2,369,200
                                                             ----------    ----------    ----------    -----------    -----------
Net income................................................   $    7,738    $  234,737    $  542,523    $ 1,299,965    $ 3,755,525
                                                             ==========    ==========    ==========    ===========    ===========
Net income per share......................................                                             $      0.24    $      0.56
                                                                                                       ===========    ===========
Pro forma(1):
  Income before income taxes..............................   $    9,653    $  262,237    $1,008,523
  Income taxes............................................        3,952       130,019       410,089
                                                             ----------    ----------    ----------
  Net income..............................................   $    5,701    $  132,218    $  598,434
                                                             ==========    ==========    ==========
  Net income per share....................................   $       --    $     0.03    $     0.12
                                                             ==========    ==========    ==========
Weighted average shares outstanding(2)....................    3,323,904     4,098,333     5,008,333      5,322,333      6,664,202
STORE DATA:
  Number of Company-owned stores (end of period)..........                                        7             16             36
  Increase in Company-owned same store sales(3)...........                                                    26.6%          17.9%
  Number of franchise stores (end of period)..............           32            58            99            132            164
  Increase in franchise same store sales(3)...............         17.1%          8.1%         19.1%          10.3%          13.5%
  Average sales per Company-owned store(4)................                                             $ 1,510,000    $ 1,662,000
BALANCE SHEET DATA (AT END OF PERIODS):
  Working capital.........................................   $  (35,412)   $  381,759    $2,087,769    $ 1,998,988    $17,418,467
  Total assets............................................      558,290     1,459,643     6,009,133     10,307,572     34,603,107
  Long-term obligations...................................       65,306       276,506       489,176        996,093      1,665,624
  Stockholders' equity....................................       48,141       326,659     3,232,394      4,581,707     23,561,141
</TABLE>
 
---------------
(1) Until April 27, 1994, the Company elected to be taxed as an S Corporation
    under the Internal Revenue Code. As a result, the pro forma income statement
    data for each of the five years in the period ended December 31, 1994
    reflect adjustments to the historical income statement data assuming the
    Company had not elected S Corporation status.
 
(2) In April 1994, the stockholders of the Company approved a 26,667-for-1
    Common Stock split. All share information has been restated to give
    retroactive effect to the stock split.
 
(3) Increases in Company-owned and franchise same store sales have been
    calculated for stores that were open for at least 13 months as of the end of
    such applicable period.
 
(4) For stores open at least one full calendar year. Includes seven stores and
    16 stores in 1995 and 1996, respectively.
 
                                       18
<PAGE>   19
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
        AND RESULTS OF OPERATIONS
 
      Through April 27, 1994, the Company operated as an S Corporation for
Federal income tax purposes. As a result, through this period the Company did
not record or pay any Federal income taxes. For the purpose of discussion and
analysis, the Company has presented a pro forma tax provision and pro forma net
income. These pro forma amounts represent what the income tax provision and the
net income would have been if the Company had been a C Corporation and thus was
subject to Federal income taxation for the entire period. Net income per share
is computed using the weighted average common stock equivalent shares
outstanding during each period. The 26,667-for-1 stock split which occurred in
April 1994 has been given retroactive effect for all periods discussed.
 
     Same store sales increases or decreases are calculated for stores open at
least thirteen full months. Company-owned same store sales increased 26.6% in
1995 and 17.9% in 1996. The Company's 16 stores that were in operation for all
of 1996 generated average net sales of approximately $1,662,000 and average
store-level profit contribution of approximately $200,000, or 12.0% of average
net sales.
 
RESULTS OF OPERATIONS
 
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
 
  Company-owned Stores
 
     Net sales from Company-owned stores increased to $39,143,625 in the year
ended December 31, 1996 from $16,118,163 in the year ended December 31, 1995.
The 1996 results include 16 stores which were open at the beginning of that year
plus 20 stores opened during the year, four of which were opened in the second
quarter, 10 in the third quarter and six in the month of October. The 1995
amount represents sales from seven stores which were open at the beginning of
the year plus nine stores opened during the year, five of which were opened in
September and two in October. Of the total sales increase, 54% is attributable
to new store openings in 1996. Same store sales increased 17.9% in 1996. Gross
profit reflects the cost of goods sold and store occupancy costs including rent,
common area maintenance, real estate taxes, repair and maintenance,
 
                                       19
<PAGE>   20
 
depreciation and utilities. Gross profit for the year ended December 31, 1996
was $13,206,181 compared to $5,359,954 for 1995. The increase in 1996 was due to
increased sales volume. Gross margin was 33.7% and 33.3% of sales for the years
ended December 31, 1996 and 1995, respectively.
 
     Store operating and selling expenses were $10,116,160 for the year ended
December 31, 1996 compared to $4,254,475 in 1995. The increase in store
operating expenses is attributable to the increased number of stores operated by
the Company during 1996. Store operating expenses were 25.8% and 26.4% of sales
for December 31, 1996 and 1995, respectively. Company-owned store profit
contribution was $3,090,021 for the year ended December 31, 1996, compared to a
profit contribution of $1,105,479 for 1995.
 
  Franchise Operations
 
     Franchise revenue is composed of the initial franchise fees which are
recorded as revenue when the store opens, and ongoing royalty fees, generally
4.0% of the store's net sales. Franchise fees, recognized on 32 store openings
during the year ended December 31, 1996 were $935,000 compared to $927,500
during 1995, which represents 35 store openings. Royalty fees increased 39.1% to
$8,449,760 in the year ended December 31, 1996 from $6,074,679 in 1995.
Franchise same store sales increases for the years ended December 31, 1996 and
1995 were 13.5% and 10.3%, respectively.
 
     Expenses directly related to franchise revenue increased to $3,729,050 for
the year ended December 31, 1996 from $2,943,814 for the year ended December 31,
1995. This increase is primarily attributable to additional franchise personnel
required to operate this portion of the Company's business and the necessary
infrastructure to support such employees. As a percentage of franchise revenue,
franchise expenses were 39.7% and 42.0% for the years ended December 31, 1996
and 1995, respectively.
 
     Franchise profit contribution was $5,655,710 for the year ended December
31, 1996 compared to $4,058,365 for the year ended December 31, 1995. The 39.4%
increase in franchise profit contribution is due to the increase in royalty fees
and franchise fees offset in part by an increase in franchise expenses, as
discussed above.
 
  General and Administrative
 
     General and administrative expenses increased 2.4% to $3,096,811 in the
year ended December 31, 1996 compared to $3,023,540 in the year ended December
31, 1995. The increase is primarily attributable to an increase in payroll and
related benefits, recruitment and moving of new employees and increased travel
as a result of establishing the necessary organizational infrastructure to allow
the Company to build the Company-owned store base. General and administrative
expenses for 1995 included a one time severance expense of $275,000 and a
litigation settlement expense of $200,000. As a percentage of revenue, general
and administrative expenses were 6.4% and 13.1% for the years ended December 31,
1996 and 1995, respectively. This decrease as a percentage of revenue resulted
from increased leverage of general and administrative expenses over a larger
sales base.
 
  Net Income
 
     Net income increased 189% to $3,755,525, or $0.56 per share, in the year
ended December 31, 1996 as compared to net income of $1,299,965, or $0.24 per
share in the year ended December 31, 1995.
 
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
 
  Company-owned Stores
 
     Net sales from Company-owned stores were $16,118,163 for the year ended
December 31, 1995 compared to $3,991,589 for the year ended December 31, 1994.
The 1995 results include seven stores which were open at the beginning of that
year plus nine stores opened during the year, five of which were opened in
September and two in October. The 1994 amount represents sales from one store
opened in January, one in August, four in September and one in October of that
year. Of the total sales increase, 46% is attributable to new store openings in
1995. Same store sales increased 26.6% in 1995. Gross profit for the year ended
 
                                       20
<PAGE>   21
 
December 31, 1995 was $5,359,954 compared to $1,304,708 for the year ended
December 31, 1994. The increase in 1995 was due to increased sales volume. Gross
margin was 33.3% and 32.7% of sales for the years ended December 31, 1995 and
1994, respectively.
 
     Store operating and selling expenses were $4,254,475 for the year ended
December 31, 1995 compared to $1,239,769 in the comparable 1994 period. The
increase in store operating expenses is attributable to the increased number of
stores operated by the Company during the year ended December 31, 1995. Company-
owned store profit contribution was $1,105,479 for the year ended December 31,
1995 compared to $64,939 for the comparable 1994 period.
 
  Franchise Operations
 
     Franchise fees, recognized on the 35 store openings during the year ended
December 31, 1995 were $927,500 compared to $1,025,000, representing 42 store
openings, during the year ended December 31, 1994. The reduction in franchise
fees caused by fewer store openings was partially offset by the increase in such
fees to $30,000 from $25,000 per store with respect to franchise agreements
signed after January 1, 1995. Royalty fees of $6,074,679 in the year ended
December 31, 1995 represented an increase of 58.4% over the $3,836,207 royalty
fees generated in the year ended December 31, 1994. Approximately 42.3% of the
increase was attributable to sales at the 35 stores opened in 1995. The balance
of the increase was caused by increases in sales at stores open as of December
31, 1994. Franchise same store sales increases for the years ended December 31,
1995 and 1994 were 10.3% and 19.1%, respectively.
 
     Expenses directly related to franchise revenue increased $893,920 to
$2,943,814 for the year ended December 31, 1995 from $2,049,894 for the year
ended December 31, 1994. This increase is primarily attributable to additional
franchise personnel required to operate this portion of the Company's business
and the necessary infrastructure to support such employees. As a percentage of
revenue, franchise expenses were 42.0% and 42.2% for the years ended December
31, 1995 and 1994, respectively.
 
     Franchise profit contribution increased 44.4% to $4,058,365 for the year
ended December 31, 1995 from $2,811,313 for the year ended December 31, 1994.
The increase in franchise profit contribution is due to the increase in royalty
fees attributable to the opening of 35 new franchises and increases in existing
franchise store sales offset in part by a decrease in franchise fees and an
increase in franchise expenses, as discussed above.
 
  General and Administrative
 
     General and administrative expenses increased 56.7% to $3,023,540 in the
year ended December 31, 1995 compared to $1,929,850 in the year ended December
31, 1994. The increase is primarily attributable to an increase in payroll and
related benefits of approximately $458,000 as a result of establishing the
necessary organizational infrastructure to allow the Company to build the
Company-owned store base, professional fee increases of approximately $196,000
due primarily to increases in legal and consulting fees and the accrual of
$275,000 related to a severance agreement for a senior executive paid through
August 31, 1996. As a percentage of revenue, general and administrative expenses
were 13.1% and 21.8% for the years ended December 31, 1995 and 1994,
respectively. This decrease as a percentage of revenue resulted from increased
leverage of general and administrative expenses over a larger sales base.
 
  Income Tax
 
     In April 1994, the Company changed its tax status from an S Corporation to
a federally taxable C Corporation. As a result of the change, certain tax losses
sustained by the Company through the period it was an S Corporation were not
available to offset income earned subsequently as a C Corporation. Therefore,
because of these non-deductible losses, the Company's effective tax rate was
46.2% in 1994 compared to 39.9% in 1995. Pro forma income taxes, assuming that
the Company was a C Corporation for the entire year ended December 31, 1994,
were $410,089 compared to $863,200 for the year ended December 31, 1995.
 
                                       21
<PAGE>   22
 
  Net Income
 
     Net income increased 139.6% to $1,299,965, or $0.24 per share, in the year
ended December 31, 1995 compared to $542,523 in the year ended December 31,
1994. On a pro forma basis, which assumes the Company was always organized as a
C Corporation, net income for the year ended December 31, 1994 would have been
$598,434 and net income per share for the year ended December 31, 1994 would
have been $0.12.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     The Company's cash provided by operating activities was $3,557,529,
$1,600,975 and $40,965 in the years ended December 31, 1996, 1995 and 1994,
respectively. The increase in cash provided by operating activities in 1996
compared to 1995 was primarily attributable to an increase in net income. The
increase in cash provided by operating activities in 1995 compared to 1994 was
primarily attributable to increases in net income and accounts payable.
 
     Cash used in investing activities was $4,872,000, $2,082,158 and $1,396,214
in the years ended December 31, 1996, 1995 and 1994, respectively. The increases
in cash used in investing activities in 1996 compared to 1995 and in 1995
compared to 1994 were attributable to increased purchases of property and
equipment necessary to support the accelerating growth in Company-owned stores.
Such purchases were substantially funded by the Company's available cash.
 
     Cash provided by financing activities was $15,151,619, $100,138 and
$2,299,031 for the years ended December 31, 1996, 1995 and 1994, respectively.
Cash provided by financing activities in 1996 was primarily attributable to the
proceeds of the Company's initial public offering. Cash provided by financing
activities in 1994 was primarily attributable to a private placement of the
Company's Common Stock.
 
     Prior to 1994, the Company financed its business activities primarily with
funds generated from operating activities. The Company has a revolving
credit/term loan facility in the amount of $5,000,000 expiring June 30, 1998.
Advances under the revolving credit/term loan facility bear interest at the
bank's prime rate (8.25% at February 28, 1997) plus 1/4 of 1% and are
collateralized by all assets of the Company. The Company must pay a quarterly
commitment fee of 1/2 of 1% of the unused amount of the available facility. The
credit facility contains various covenants including, among others, restrictions
on capital expenditures, the maintenance of a defined minimum tangible net
worth, interest coverage ratio, total liabilities to tangible net worth ratio
and current ratio. At December 31, 1996, the Company was in compliance with such
loan agreement covenants. There was no outstanding balance under the facility at
December 31, 1996.
 
     On March 3, 1997, the Company signed a commitment letter (the "Commitment
Letter") to refinance and replace its existing loan facility with a $20,000,000
committed revolving line of credit facility maturing on June 30, 2000. Advances
under the line will bear interest, at the Company's option, at 1/2 of 1% below
the bank's prime rate (8.25% as of February 28, 1997) or LIBOR plus 1.25% (which
margin for the LIBOR rate option is subject to reduction to .75% or increase to
1.75% based on the Company's ratio of total liabilities to tangible net worth).
The Commitment Letter requires a facility fee of $50,000 and a quarterly
commitment fee equal to .125% of the average unused portion of the line and is
secured by substantially all of the assets of the Company. The Commitment Letter
also provides various covenants including, among others, restrictions on capital
expenditures, the maintenance of a defined minimum tangible net worth, interest
coverage ratio, total liabilities to tangible net worth ratio and current ratio.
The terms of the Commitment Letter are subject to the negotiation and execution
of definitive loan documents.
 
     Over the next several years, the Company intends to devote greater
resources to the opening of Company-owned stores and therefore believes that its
revenue growth increasingly will be derived from the opening of Company-owned,
rather than franchise, Super Stores. Based on its current planning and marketing
information, the Company plans to open approximately 45 to 50 Company-owned
stores in 1997. Therefore, it is anticipated that approximately $16,875,000 to
$18,750,000 of its existing cash and the proceeds of the Offering will be used
to open these stores in 1997. In addition, the Company anticipates that new and
existing franchisees will open approximately 20 additional stores in 1997. The
Company anticipates opening approximately 70 to 75 Company-owned stores during
1998, using a combination of its existing cash and operating cash flow, funds
available under the Company's revolving credit facility, and/or any remaining
 
                                       22
<PAGE>   23
 
proceeds from the Offering for these openings. In addition, the Company may seek
to acquire existing stores from franchises. At present, the Company has no
agreement to acquire any franchise store. The Company expects that the average
new store cost for Company-owned stores will continue to be approximately
$375,000. These expenditures include $163,000 for equipment and fixtures,
including point of sale equipment, $52,000 for leasehold improvements and
approximately $125,000 for store inventory, net of accounts payable. Pre-opening
expenses are estimated to be $35,000 per store. The Company typically leases
space ranging from 10,000 to 12,000 square feet and seeks to lease sites rather
than own the real estate.
 
     Out of its planned 45 to 50 Company-owned stores to be opened during 1997,
as of February 28, 1997, the Company had opened two stores and had signed leases
for 23 locations. In addition, as of February 28, 1997, the Company had signed a
lease for a Company-owned store to be opened in 1998. Most of such leases are
for ten-year terms, each with two five-year renewal options. One lease has a
term of 20 years. The minimum lease obligation for these 26 leases is
approximately $51,678,000 over the life of the leases.
 
     The Company believes the proceeds from the Offering, its cash flows from
operations and its borrowing capacity under the proposed credit facility will be
adequate to fund its cash requirements for at least the next 24 months.
 
  Impact of Inflation
 
     The Company believes that inflation did not have a material impact on its
operations for the periods reported. Significant increases in labor, employee
benefits and other operating expenses could have a material adverse effect on
the Company's performance.
 
 
                                       23
<PAGE>   24




ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

      The response to this item is submitted as a separate section of this
Report commencing on page F-1.

ITEM 9.   DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

      Not applicable.


                                   PART III

      In accordance with general instruction G(3) of Form 10-K, the information
called for by items 10, 11, 12 and 13 of Part III is incorporated by reference
to the Company's definitive Proxy Statement for its 1997 Annual Meeting of
Shareholders.

                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

      (a)   List of Documents filed as part of this Annual Report on Form 10-K.

      1. The following financial statements of the Company are filed as a
separate section of this Report commencing on page F-1.

      Report of Deloitte & Touche LLP, Independent Auditors

      Balance Sheets -- December 31, 1996 and 1995

      Statements of Income for the years ended December 31, 1996, 1995 and 1994

      Statements of Shareholders' Equity for the years ended December 31, 1996, 
      1995 and 1994

      Statements of Cash Flows for the years ended December 31, 1996, 1995 and 
      1994

      Notes to Financial Statements for the years ended December 31, 1996, 1995
      and 1994

      2.    Financial Statement Schedules - Not Applicable.

      3.    List of Exhibits.

      The following exhibits are included as a part of this Annual Report on
Form 10-K or incorporated herein by reference.

              3.1/1  - Certificate of Incorporation of the Company.
              3.2/1  - Bylaws of the Company.
              4.1/1  - Specimen stock certificate evidencing the Common Stock.
             10.1/1  - Form of Unit Franchise Agreement entered into by the 
                       Company and franchisees.
             10.2/1  - Employment Agreement, dated January 1, 1994 and amended
                       as of January 16, 1996, by and between the Company and 
                       Steve Mandell.
             10.3/3  - Amendment to Employment Agreement dated March 5, 1997, by
                       and between the Company and Steven Mandell.   
             10.4/1  - Employment Agreement, dated January 1, 1994 and amended 
                       as of January 16, 1996, by and between the Company and 
                       Perry Kaplan.
             10.5/1  - Employment Agreement of David Lauber, dated June 12,
                       1995, by and between Company and David Lauber.
             10.6/1  - Employment Agreement of Lawrence Fine, dated October 13, 
                       1995, by and between the Company and Lawrence Fine.
             10.7/2  - Amended Stock Option Plan of the Registrant.
             10.8/2  - Amended and Restated 1994 Stock Option Plan of the
                       Company               
             10.9/1  - Loan and Security Agreement, dated February 15, 1995 and
                       amended as of October 6, 1995, by and between Company
                       and Midlantic Bank, N.A.
             10.10/3 - Commitment letter between PNC Bank and the Company  
             23.1    - Consent of Deloitte & Touche LLP.


                                       24

<PAGE>   25




            24.1 - Power of Attorney (contained on the signature page of this 
                   Registration Statement).
            27.1 - Financial Data Schedule.

Notes

1.    Incorporated by reference to the Company's Registration Statement as
      amended on Form S-1 Number 333- 350 as filed with the Commission on
      January 18, 1996.

2.    Incorporated by reference to the Company's Registration Statement on Form
      S-8 as filed with the Commission on January 9, 1997.

3.    Incorporated by reference to the Company's Registration Statement on Form
      S-1 as filed with the Commission on March 6, 1997.

-------------------


      (b)   Reports on Form 8-K.

      No reports on Form 8-K were filed during the last quarter of the fiscal
year covered by this Annual Report on Form 10-K.


                                      25

<PAGE>   26
                              POWER OF ATTORNEYS


      KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints Steven Mandell and David Lauber, and each
of them, each with full power to act without the other, his true and lawful
attorney-in-fact and agent, each with full power of substitution and
resubstitution for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments (including post-effective amendments)
to this report on Form 10-K, and to file the same with all exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto each of said attorneys-in-fact and agents full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in connection therewith, as fully to all intents and
purposes as he might or could do in person hereby, ratifying and confirming that
each of said attorneys-in-fact and agents or his substitutes may lawfully do or
cause to be done by virtue hereof.

      Pursuant to the requirements of Section 13 or 15(d) 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.




Dated:March __, 1997               PARTY CITY CORPORATION



                                    By:
                                       ----------------------------------------
                                          Steven Mandell, Chairman of the Board
                                              and President




                                       26
<PAGE>   27


      Pursuant to the requirements of the Securities Exchange Act of 1934, this
report on Form 10-K has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
      Signatures                    Title                                           Date
      ----------                    -----                                           ----

<S>                        <C>                                               <C>

-----------------          Chairman of the Board and President,              March __, 1997
Steven Mandell             Director (principal executive officer)



-----------------           Vice President and Chief Financial               March __, 1997
David Lauber                Director (principal financial and
                            accounting officer)


-----------------           Director                                         March __, 1997
John J. Oberdorf



-----------------           Director                                         March __, 1997
Raymond Hemmig



-----------------           Director                                         March __, 1997
Duayne Weinger

</TABLE>


                                       27
<PAGE>   28
 
                         INDEX TO FINANCIAL STATEMENTS
 
                             PARTY CITY CORPORATION
 
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
<S>                                                                                     <C>
Independent Auditors' Report..........................................................  F-2
Balance Sheets........................................................................  F-3
Statements of Income..................................................................  F-4
Statements of Stockholders' Equity....................................................  F-5
Statements of Cash Flows..............................................................  F-6
Notes to Financial Statements.........................................................  F-7
</TABLE>
 
                                       F-1
<PAGE>   29
 
                          INDEPENDENT AUDITORS' REPORT
 
The Stockholders of
Party City Corporation
Rockaway, New Jersey
 
     We have audited the accompanying balance sheets of Party City Corporation
as of December 31, 1995 and 1996 and the related statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, such financial statements present fairly, in all material
respects, the financial position of Party City Corporation as of December 31,
1995 and 1996, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
 
February 17, 1997
Parsippany, New Jersey
 
                                       F-2
<PAGE>   30
 
                             PARTY CITY CORPORATION
 
                                 BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,     DECEMBER 31,
                                                                        1995             1996
                                                                    ------------     ------------
<S>                                                                 <C>              <C>
ASSETS
CURRENT ASSETS:
  Cash and cash equivalents.......................................  $  1,112,566     $ 14,949,714
  Restricted assets for advertising fund..........................       541,919          101,573
  Receivables from franchisees:
     Royalty fees (net of allowance for doubtful accounts of
      $40,000 at December 31, 1995 and $32,847 at December 31,
      1996).......................................................       652,961        1,015,161
     Other........................................................       108,343          178,571
  Merchandise inventory...........................................     3,840,926        9,305,027
  Due from affiliates.............................................         5,794           35,815
  Deferred income taxes -- current................................       150,631          193,188
  Prepaid expenses and other current assets.......................       315,620        1,015,760
                                                                    ------------     ------------
          TOTAL CURRENT ASSETS....................................     6,728,760       26,794,809
Property and equipment -- net.....................................     3,195,738        7,310,740
Deferred income taxes.............................................       109,176          218,224
Other assets......................................................       273,898          279,334
                                                                    ------------     ------------
          TOTAL ASSETS............................................  $ 10,307,572     $ 34,603,107
                                                                    ============     ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
  Accounts payable -- trade.......................................  $  1,960,873     $  4,977,430
  Accrued expenses................................................     1,225,635        1,980,696
  Advertising fund................................................       541,919          101,573
  Income taxes payable............................................       514,458        1,904,562
  Current portion -- long term debt...............................        22,725               --
  Due to affiliates...............................................         1,779               --
  Deferred revenue................................................       462,383          412,081
                                                                    ------------     ------------
          TOTAL CURRENT LIABILITIES...............................     4,729,772        9,376,342
                                                                    ------------     ------------
LONG TERM LIABILITIES:
  Long-term debt -- net of current portion........................        49,565               --
  Deferred rent...................................................       464,653        1,170,624
  Deferred revenue................................................       481,875          495,000
                                                                    ------------     ------------
          TOTAL LONG TERM LIABILITIES.............................       996,093        1,665,624
                                                                    ------------     ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
  Common stock, $.01 par value: authorized shares -- 10,000,000 at
     December 31, 1995 and 25,000,000 at December 31, 1996; shares
     issued and outstanding -- 5,224,000 at December 31, 1995 and
     6,960,667 at December 31, 1996...............................        52,240           69,607
  Additional paid-in capital......................................     2,541,492       17,748,034
  Retained earnings...............................................     1,987,975        5,743,500
                                                                    ------------     ------------
          TOTAL STOCKHOLDERS' EQUITY..............................     4,581,707       23,561,141
                                                                    ------------     ------------
          TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY..............  $ 10,307,572     $ 34,603,107
                                                                    ============     ============
</TABLE>
 
                See accompanying notes to financial statements.
 
                                       F-3
<PAGE>   31
 
                             PARTY CITY CORPORATION
 
                              STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                          ---------------------------------------
                                                             1994          1995          1996
                                                          -----------   -----------   -----------
<S>                                                       <C>           <C>           <C>
REVENUES:
  Net sales.............................................  $ 3,991,589   $16,118,163   $39,143,625
  Royalty fees..........................................    3,836,207     6,074,679     8,449,760
  Franchise fees........................................    1,025,000       927,500       935,000
                                                          -----------   -----------    ----------
          TOTAL REVENUES................................    8,852,796    23,120,342    48,528,385
EXPENSES:
  Cost of goods sold and occupancy costs................    2,686,881    10,758,209    25,937,444
  Company-owned stores operating and selling expense....    1,239,769     4,254,475    10,116,160
  Franchise expense.....................................    2,049,894     2,943,814     3,729,050
  General and administrative expense....................    1,929,850     3,023,540     3,096,811
                                                          -----------   -----------    ----------
          TOTAL EXPENSES................................    7,906,394    20,980,038    42,879,465
                                                          -----------   -----------    ----------
          INCOME BEFORE INTEREST AND INCOME TAXES.......      946,402     2,140,304     5,648,920
Interest income, net....................................       62,121        22,861       475,805
                                                          -----------   -----------    ----------
INCOME BEFORE INCOME TAXES..............................    1,008,523     2,163,165     6,124,725
Provision for income taxes..............................      466,000       863,200     2,369,200
                                                          -----------   -----------    ----------
NET INCOME..............................................  $   542,523   $ 1,299,965   $ 3,755,525
                                                          ===========   ===========    ==========
NET INCOME PER SHARE....................................                $      0.24   $      0.56
                                                                        ===========    ==========
Weighted average shares outstanding.....................                  5,322,333     6,664,202
Pro Forma:
  Income before income taxes............................  $ 1,008,523
  Provision for income taxes............................      410,089
                                                          -----------
  Net income............................................  $   598,434
                                                          ===========
  Net income per share..................................  $      0.12
                                                          ===========
Weighted average shares outstanding.....................    5,008,333
</TABLE>
 
                 See accompanying notes to financial statements
 
                                       F-4
<PAGE>   32
 
                             PARTY CITY CORPORATION
 
                       STATEMENTS OF STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                      COMMON STOCK
                                  ---------------------     ADDITIONAL       RETAINED     NOTE RECEIVABLE-
                                   SHARES       AMOUNT    PAID-IN-CAPITAL    EARNINGS      SALE OF STOCK
                                  ---------     -------   ---------------   ----------   ------------------
<S>                               <C>           <C>       <C>               <C>          <C>
Balance -- January 1, 1994......  4,000,000     $40,000     $   137,000     $  245,487       $  (95,828)
Distribution to stockholders....                                              (100,000)
Sale of common shares...........  1,200,000      12,000       2,488,000
Expenses incurred on sale of
  common shares.................                               (133,268)
Sale of common shares...........     24,000         240          49,760
Proceeds from note receivable...                                                                 46,480
Net income......................                                               542,523
                                  ---------     -------     -----------     ----------       ----------
Balance -- December 31, 1994....  5,224,000      52,240       2,541,492        688,010          (49,348)
Proceeds from note receivable...                                                                 49,348
Net income......................                                             1,299,965
                                  ---------     -------     -----------     ----------       ----------
Balance -- December 31, 1995....  5,224,000      52,240       2,541,492      1,987,975
Sale of common shares...........  1,700,000      17,000      16,983,000
Expenses incurred on sale of
  common shares.................                             (1,989,661)
Exercise of stock options.......     36,667         367         174,628
Tax effect of non-qualified
  options.......................                                 38,575
Net income......................                                             3,755,525
                                  ---------     -------     -----------     ----------       ----------
Balance -- December 31, 1996....  6,960,667     $69,607     $17,748,034     $5,743,500       $       --
                                  =========     =======     ===========     ==========       ==========
</TABLE>
 
                See accompanying notes to financial statements.
 
                                       F-5
<PAGE>   33
 
                             PARTY CITY CORPORATION
 
                            STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                           YEARS ENDED DECEMBER 31,
                                                                    ---------------------------------------
                                                                       1994          1995          1996
                                                                    -----------   -----------   -----------
<S>                                                                 <C>           <C>           <C>
Cash Flow from Operating Activities:
Net income........................................................  $   542,523   $ 1,299,965   $ 3,755,525
Adjustments to reconcile net income to net cash provided by
  operating activities:
    Depreciation and amortization.................................       99,158       321,936       745,889
    Loss on abandonment/sale of property and equipment............       64,918            --        11,109
    Deferred tax benefit..........................................      (96,000)     (160,499)     (151,605)
  Changes in assets and liabilities:
    Sale of marketable securities.................................      223,552        20,558            --
    Royalty fees receivable.......................................     (201,904)     (256,118)     (362,200)
    Other receivable..............................................      (24,593)      (83,750)      (70,228)
    Merchandise inventory.........................................   (1,486,399)   (2,354,527)   (5,464,101)
    Due to/from affiliates........................................       28,689         8,607       (31,800)
    Prepaid expenses and other current assets.....................     (138,032)     (103,333)     (700,140)
    Other assets..................................................     (125,257)     (131,521)       (5,436)
    Accounts payable..............................................      271,319     1,689,554     3,016,557
    Accrued expenses..............................................      702,318       347,814       755,061
    Income taxes payable..........................................       89,333       397,218     1,390,104
    Deferred revenue..............................................      (47,767)      279,525       (37,177)
    Deferred rent.................................................      139,107       325,546       705,971
                                                                    -----------   -----------   -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES.........................       40,965     1,600,975     3,557,529
                                                                    -----------   -----------   -----------
Cash Flow from Investment Activities:
  Purchases of property and equipment.............................   (1,396,214)   (2,082,158)   (4,875,877)
  Proceeds from sale of property and equipment....................           --            --         3,877
                                                                    -----------   -----------   -----------
NET CASH USED IN INVESTING ACTIVITIES.............................   (1,396,214)   (2,082,158)   (4,872,000)
                                                                    -----------   -----------   -----------
Cash Flow from Financing Activities:
  Net proceeds from sale of stock.................................    2,463,212        49,348    15,010,339
  Proceeds from exercise of stock options.........................           --            --       174,995
  Tax effect of non-qualified stock options.......................           --            --        38,575
  Proceeds from long term debt....................................           --       288,127            --
  Repayments of long term debt....................................      (27,834)     (237,337)      (72,290)
  Repayment of note payable-officer...............................      (36,347)           --            --
  Distribution to stockholders....................................     (100,000)           --            --
                                                                    -----------   -----------   -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES.........................    2,299,031       100,138    15,151,619
                                                                    -----------   -----------   -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS..............      943,782      (381,045)   13,837,148
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD....................      549,829     1,493,611     1,112,566
                                                                    -----------   -----------   -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD..........................  $ 1,493,611   $ 1,112,566   $14,949,714
                                                                    ===========   ===========   ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income Taxes Paid.................................................  $   555,893   $   375,850   $ 1,147,812
Interest Paid.....................................................  $     3,284   $     8,956   $    41,009
</TABLE>
 
                See accompanying notes to financial statements.
 
                                       F-6
<PAGE>   34
 
                             PARTY CITY CORPORATION
 
                         NOTES TO FINANCIAL STATEMENTS
 
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
     Party City Corporation (the "Company"), which is incorporated in the State
of Delaware, operates retail party goods stores within the continental United
States and sells franchises on an individual store and area franchise basis
throughout the United States, Puerto Rico, Spain and Canada. In April, 1994, the
Shareholders approved an increase in the authorized Common Stock from 2,500 to
10,000,000 shares and a 26,667-for-1 common stock split. All share information
has been restated to give retroactive effect to the stock split. On January 16,
1996, the Company increased its authorized Common Stock from 10,000,000 to
25,000,000 shares. On March 27, 1996, the Company completed an initial public
offering of 1,700,000 shares of common stock, $.01 par value, issued by the
Company, at an initial offering price of $10 per share. Proceeds to the Company,
net of offering expenses of $1,989,661 were $15,010,339.
 
     Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles 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 those estimates.
 
     Franchising Revenue Recognition -- The Company is obligated in accordance
with the terms of each franchisee's respective agreement to provide the
following initial services: advice on site location, store design and layout,
training and pre-opening assistance. Revenue from individual franchise sales,
recorded as franchise fees, is recognized by the Company upon completion of the
aforementioned initial services, which normally coincide with the opening of the
franchisee's store. On an ongoing basis, the Company provides assistance
regarding sources of supply, pricing, advertising and promotion programs and
other defined assistance. Royalty fees are recorded on a monthly basis as a
percentage of the franchisee's net sales.
 
     Area franchise sales represent agreements with franchisees to open a
specified number of franchises within defined geographic areas and development
periods. The Company's policy is to receive in advance, a deposit for each of
the potential stores, based on its standard initial franchise fee at the time
the contract is signed. Upon receipt, the deposit is recorded as deferred
revenue. When the Company satisfies its initial obligations to the franchisee
and the store is opened, the Company recognizes the deposit as revenue.
Information regarding franchise activity follows:
 
<TABLE>
<CAPTION>
                                                                                YEAR ENDED
                                                                               DECEMBER 31,
                                                                          ----------------------
                                                                          1994     1995     1996
                                                                          ----     ----     ----
<S>                                                                       <C>      <C>      <C>
Number of franchises in operation at beginning of the period............   58       99      132
Number of franchises opened in the period...............................   42       35       32
Number of franchises closed during the period...........................   (1)      (2)      --
                                                                          ---      ---      ---
Number of franchises in operation at end of the period..................   99      132      164
                                                                          ===      ===      ===
</TABLE>
 
     Cash and Cash Equivalents -- The Company considers all highly liquid
investments with initial maturities of three months or less at the time of
purchase to be cash equivalents. Cash equivalents consist of an investment in a
certificate of deposit and money market funds.
 
     Marketable Securities -- The Company classifies its investments as trading
securities, carries the securities at fair market value and recognizes
unrealized gains and losses in earnings. Realized gains and losses are
determined on the first-in, first-out method. There were no marketable
securities held at December 31, 1995 and 1996.
 
     Fair Value of Financial Instruments -- Financial instruments consist
primarily of investments in cash, trade account receivables, accounts payable
and debt obligations. The Company estimates the fair value of financial
instruments based on interest rates available to the Company and by comparison
to quoted market
 
                                       F-7
<PAGE>   35
 
                             PARTY CITY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
prices. At December 31, 1995 and 1996, the fair value of the Company's financial
instruments approximated the carrying value.
 
     Inventory -- The Company values its inventory at the lower of average cost
or market.
 
     Advertising Fund -- Pursuant to its franchise agreements, the Company
collects 1% of the net sales of its franchise stores, which is restricted to use
for advertising on their behalf. Receipts and disbursements are not recorded as
income or expense since the Company does not have complete discretion over the
use of the funds. The Company also contributes 1% of net sales of its owned
stores into the Advertising Fund. To cover the expenses of administering the
Advertising Fund, the Company charges the fund a management fee equal to 5% of
the funds contributed by franchisees. During 1995 and 1996, $90,715 and
$133,542, respectively, of Advertising Fund management fees were collected by
the Company and credited to general and administrative expense.
 
     Property and Equipment -- Property and equipment are carried at cost less
accumulated depreciation. The Company uses the straight-line method of
depreciation for property and equipment placed in service on or after January 1,
1993. Property and equipment placed in service prior to January 1, 1993 are
depreciated using an accelerated method. The difference between the two methods
is not material. Property and equipment are depreciated over their estimated
useful lives as follows: automobiles, five years; furniture and equipment, 5-7
years. Leasehold improvements are amortized over the remaining period of the
lease or the estimated useful life of the asset, whichever is less.
 
     Intangibles -- Trademarks, which are included in other assets, consist
primarily of capitalized legal costs and are being amortized using the
straight-line method over the estimated useful lives of the assets.
 
     Income Taxes -- Prior to April 27, 1994 the Company had elected to be taxed
under the S corporation regulations of the Internal Revenue Code, thereby
exempting it from federal income taxes. Effective April 27, 1994, the Company's
election was terminated and the Company commenced paying tax as a C Corporation.
 
     The Company provides for the tax effects of transactions reported in the
financial statements which and consist of taxes currently due plus deferred
taxes as a result of temporary differences. Temporary differences in the basis
of assets and liabilities for financial statements and income tax reporting
arise from using different methods and lives to calculate depreciation, certain
costs related to the start up of store operations, inventory capitalization,
deferred rent, accrued expenses and the recognition of vacation pay.
 
     Net Income Per Share -- Net income per share is computed using the weighted
average common and common equivalent shares outstanding during each period.
 
     Pro forma Data -- Pro forma net income reflects the income tax expense the
Company would have incurred assuming it was taxed as a C corporation for all
periods presented.
 
     Pre-opening Store Costs -- The costs associated with opening a store are
expensed as incurred.
 
     Advertising Costs -- The costs associated with store advertising are
expensed in the period in which the related promotion and sales occur.
Advertising expense was approximately $327,700, $1,034,800 and $2,342,000 for
the years ended December 31, 1994, 1995 and 1996, respectively.
 
     Accounting and Reporting Changes -- Effective January 1, 1996, the Company
adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." SFAS No. 121 establishes accounting standards for the recognition of an
impairment of long-lived assets, certain identifiable intangibles, and goodwill
related to those assets to be held and used, and for long-lived assets and
certain identifiable intangibles to be disposed. The
 
                                       F-8
<PAGE>   36
 
                             PARTY CITY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)

adoption of SFAS No. 121 did not have a material effect on the Company's
financial position or results of operations.
 
     Reclassifications -- Certain reclassifications have been made to the prior
period financial statements, the most significant of which is the
reclassification of store occupancy costs from Company-owned store operating and
selling expenses to cost of sales and occupancy costs, to be consistent with the
prevailing practice in the retail industry and to conform the current period
presentation.
 
NOTE 2 -- RESTRICTED ASSETS FOR ADVERTISING FUND
 
     Amounts restricted for advertising include:
 
<TABLE>
<CAPTION>
                                                                          DECEMBER 31,
                                                                       -------------------
                                                                         1995       1996
                                                                       --------   --------
    <S>                                                                <C>        <C>
    Cash and cash equivalents........................................  $ 99,042   $101,573
    Marketable securities............................................   442,877         --
                                                                       --------   --------
                                                                       $541,919   $101,573
                                                                       ========   ========
</TABLE>
 
NOTE 3 -- PROPERTY AND EQUIPMENT
 
     Property and equipment consisted of the following:
 
<TABLE>
<CAPTION>
                                                                        DECEMBER 31,
                                                                  -------------------------
                                                                     1995           1996
                                                                  ----------     ----------
    <S>                                                           <C>            <C>
    Equipment.................................................    $1,298,646     $2,974,980
    Furniture.................................................     1,102,979      2,773,322
    Leasehold improvements....................................     1,175,817      2,687,462
    Automobiles...............................................        94,793         94,793
                                                                  ----------     ----------
                                                                   3,672,235      8,530,557
    Less: Accumulated depreciation and amortization...........       476,497      1,219,817
                                                                  ----------     ----------
                                                                  $3,195,738     $7,310,740
                                                                  ==========     ==========
</TABLE>
 
NOTE 4 -- DEBT
 
     Long-term debt consisted of four installment notes with an outstanding
balance of $72,290 at December 31, 1995. The notes were collateralized by
equipment and have interest rates ranging from 1.00% to 1.25% above the bank's
base rate (8.50% at December 31, 1995) and were repaid in full during March
1996. At December 31, 1996 there was no long-term debt outstanding.
 
     During February 1995, the Company obtained a revolving credit/term loan
facility in the amount of $2,500,000, which was amended in September 1995 and
again in December 1996. Under the second amendment, the Company has available
borrowings of $5,000,000 as of December 31, 1996 until June 30, 1998. The
amended facility expires June 30, 1998. The Company has the option to convert
its outstanding borrowings at June 30, 1996, 1997 and 1998 to a four-year term
loan with a corresponding reduction in the amount available under the credit
facility. Both the revolving credit facility and term loans bear interest at the
bank's prime rate minus 1/2 of 1% and are collateralized by all assets of the
Company. The Company must pay a quarterly commitment fee of 1/4 of 1% of the
unused amount of the available facility. The credit facility contains various
covenants including, among others, restriction on capital expenditures, the
maintenance of a
 
                                       F-9
<PAGE>   37
 
                             PARTY CITY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 4 -- DEBT -- (CONTINUED)
defined minimum tangible net worth, interest coverage ratio, total liabilities
to tangible net worth ratio and current ratio. At December 31, 1996, the Company
was in compliance with such loan agreement covenants. There was no outstanding
balance under the facility at December 31, 1996.
 
NOTE 5 -- STOCK OPTIONS
 
     In September 1994, the Company adopted the Party City Corporation 1994
Stock Option Plan (the "Plan") pursuant to which options may be granted to
employees for the purchase of common stock. The Plan, which was amended and
restated in December 1996, permits the Company to grant incentive and non-
qualified stock options to purchase an aggregate of 600,000 shares of the
Company's common stock. Such options may be incentive stock options or
non-qualified options. The term of an option is determined by the Stock Option
Committee. The exercise price of the shares covered by an incentive stock option
may not be less than the fair value of the shares at the time of grant. The
exercise price of the shares covered by a non-qualified option need not be equal
to the fair value of the stock at the date of grant, but may be granted with an
exercise price as determined by the Stock Option Committee. The options granted
generally vest one-third each year, over a period of three years.
 
     A summary of the Plan's status and changes during the years then ended, is
presented below:
 
<TABLE>
<CAPTION>
                                                                     DECEMBER 31,
                                                -------------------------------------------------------
                                                           1995                         1996
                                                --------------------------   --------------------------
                                                          WEIGHTED-AVERAGE            WEIGHTED-AVERAGE
                                                SHARES     EXERCISE PRICE    SHARES     EXERCISE PRICE
                                                -------   ----------------   -------   ----------------
<S>                                             <C>       <C>                <C>       <C>
Outstanding at January 1......................  102,240        $ 2.50        180,000        $ 4.08
Granted.......................................   79,760          6.10        281,500         14.31
Exercised.....................................        0             0        (36,666)         4.77
Cancelled.....................................   (2,000)         3.50        (66,501)         8.69
                                                -------         -----        -------        ------
Outstanding December 31.......................  180,000        $ 4.08        358,333        $11.19
                                                =======         =====        =======        ======
Options exercisable at December 31............        0                       31,666
Weighted average fair value of options granted
  during the year ended December 31, (per
  option).....................................  $  1.84                      $  7.32
</TABLE>
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              -------------------------
                                                                 1995           1996
                                                              ----------     ----------
        <S>                                                   <C>            <C>
        Expected volatility.................................           0            35%
        Expected lives......................................     6 years        6 years
        Risk-free interest rate.............................       6.40%          6.50%
        Expected dividend yield.............................          0%             0%
</TABLE>
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              -------------------------
                                                                 1995           1996
                                                              ----------     ----------
        <S>                                                   <C>            <C>
        Net Income:
          As reported.......................................  $1,299,965     $3,755,525
          Pro-forma.........................................  $1,294,791     $3,345,385
 
        Net income per share:
          As reported.......................................        0.24           0.56
          Pro-forma.........................................        0.24           0.52
</TABLE>
 
                                      F-10
<PAGE>   38
 
                             PARTY CITY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 5 -- STOCK OPTIONS (CONTINUED)
     The pro forma effect of applying FAS 123 is not necessarily indicative of
the effect on reported net income for future years.
 
     The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in the periods ended December 31, 1995 and 1996.
 
     The following table summarizes information about options outstanding under
the Plan as follows:
 
<TABLE>
<CAPTION>
                                                 OPTIONS OUTSTANDING                   OPTIONS EXERCISABLE
                                    ---------------------------------------------   --------------------------
                                        NUMBER                           WEIGHTED       NUMBER        WEIGHTED
                                      OUTSTANDING     WEIGHTED AVERAGE   AVERAGE      EXERCISABLE     AVERAGE
                                    AT DECEMBER 31,      REMAINING       EXERCISE   AT DECEMBER 31,   EXERCISE
     RANGE OF EXERCISE PRICES            1996         CONTRACTUAL LIFE    PRICE          1996          PRICE
                                    ---------------   ----------------   --------   ---------------   --------
<S>                                 <C>               <C>                <C>        <C>               <C>
$2.50 to $5.00....................       98,333           8.3 years       $ 2.58         31,666        $ 2.55
$10.00 to $15.00..................      126,500           9.3 years        11.42             --            --
$15.25 to $20.00..................      113,500           9.6 years        16.74             --            --
$21.00 to $22.00..................       20,000           9.6 years        21.11             --            --
                                        -------                           ------         ------         -----
$2.50 to $22.00...................      358,333                           $11.19         31,666        $ 2.55
                                        =======                           ======         ======         =====
</TABLE>
 
NOTE 6 -- PROVISION FOR TAXES
 
     The provision for taxes consisted of the following:
 
<TABLE>
<CAPTION>
                                                                      YEAR ENDED
                                                                     DECEMBER 31,
                                                          ----------------------------------
                                                            1994        1995         1996
                                                          --------   ----------   ----------
    <S>                                                   <C>        <C>          <C>
    Current:
      Federal...........................................  $416,000   $  751,427   $1,962,511
      State.............................................   146,000      272,272      558,294
                                                          ---------- ----------   ----------
                                                           562,000    1,023,699    2,520,805
                                                          ---------- ----------   ----------
    Deferred:
      Federal...........................................   (76,000)    (120,967)    (127,311)
      State.............................................   (20,000)     (39,532)     (24,294)
                                                          ---------- ----------   ----------
                                                           (96,000)    (160,499)    (151,605)
                                                          ---------- ----------   ----------
                                                          $466,000   $  863,200   $2,369,200
                                                          ========== ==========   ==========
</TABLE>
 
     The deferred income tax provision results from temporary differences
     between amounts of assets and liabilities for financial reporting purposes
     and amounts as measured by tax laws.
 
                                      F-11
<PAGE>   39
 
                             PARTY CITY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 6 -- PROVISION FOR TAXES -- (CONTINUED)

     The components of the net deferred tax assets at December 31, 1995 and 1996
are as follows:
 
<TABLE>
<CAPTION>
                                                                        DECEMBER 31,
                                                                   -----------------------
                                                                     1995          1996
                                                                   ---------     ---------
    <S>                                                            <C>           <C>
    Current Assets:
      Inventory..................................................  $      --     $ 123,751
      Severance pay accrual......................................     79,847            --
      Vacation pay accrual.......................................     30,282        35,104
      Start-up costs.............................................     14,582        14,958
      Reserve for doubtful accounts..............................     16,240        30,085
      Advertising accrual........................................      9,680            --
                                                                   ---------     ---------
    Current Liabilities:
      Advertising accrual........................................         --       (10,710)
                                                                   ---------     ---------
      Current Deferred Tax Asset.................................  $ 150,631     $ 193,188
                                                                   =========     =========
    Non-current Assets:
      Deferred rent..............................................  $ 188,650     $ 471,240
      Start-up costs.............................................     45,249        28,008
    Non-current Liabilities:
      Property and equipment.....................................   (124,723)     (281,024)
                                                                   ---------     ---------
      Non-current Deferred Tax Asset.............................  $ 109,176     $ 218,224
                                                                   =========     =========
</TABLE>
 
     The Company's effective income tax rate differs from the statutory federal
rate as follows:
 
<TABLE>
<CAPTION>
                                                                          DECEMBER 31,
                                                                     ----------------------
                                                                     1994     1995     1996
                                                                     ----     ----     ----
    <S>                                                              <C>      <C>      <C>
    Federal statutory rate.........................................  34.0%    34.0%    34.0%
    State income taxes net of federal benefit......................   8.2      7.1      5.6
    Other..........................................................   2.0     (1.2)     (.9)
    Nondeductible S-corporation losses.............................   2.0        0        0
                                                                     ----     ----     ----
    Effective tax rate.............................................  46.2%    39.9%    38.7%
                                                                     ====     ====     ====
</TABLE>
 
NOTE 7 -- RELATED PARTY TRANSACTIONS
 
     The President, a major stockholder of the Company, owns all of the
outstanding shares of two party supplies stores for which no royalty fees are
charged. This individual is also the majority owner of two additional franchise
stores and was a 50% owner of one franchise through 1995. The Company receives
royalty fees based on 3.0% of net sales from the majority owned stores. In
addition, a Director of the Company owns two franchises and was a 50% owner of
one franchise through 1995, for which he pays royalty fees of 2.0% on net sales.
 
                                      F-12
<PAGE>   40
 
                             PARTY CITY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 7 -- RELATED PARTY TRANSACTIONS -- (CONTINUED)
     Furthermore, an individual who was a Senior Vice President of the Company
through August 1995 owns two franchises. The amounts included in the
accompanying financial statements relating to the above are:
 
<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                         ----------------------------------
                                                           1994         1995         1996
                                                         --------     --------     --------
    <S>                                                  <C>          <C>          <C>
    Royalty fees.......................................  $259,130     $260,818     $208,227
    Royalty fees receivable (at end of period).........  $ 27,581     $ 16,572     $ 18,551
</TABLE>
 
     The Company shared office space with an affiliate until July 1, 1995. The
affiliate charged the Company for rent and real estate taxes, utilities,
insurance and telephone. The Company was charged approximately $63,000 and
$30,400 for the years ended December 31, 1994 and 1995, respectively, of which,
approximately $12,300 and $27,000, respectively, was for rent. Beginning January
1, 1996, the Company shared warehouse space with an affiliate. The Company
charged the affiliate approximately $19,200 for rent for the year end December
31, 1996. In addition, the Company and its affiliates employ common bookkeeping
personnel, for which the Company charged its affiliates approximately $70,500,
$74,200 and $94,500 for the years ended December 31, 1994, 1995 and 1996,
respectively. Office expenses allocated from the affiliate to the Company are
based upon the square footage occupied by the Company. Personnel costs allocated
to the affiliate are based upon an analysis of the percentage of time
individuals devote to services for the affiliate stores. Management believes
that both allocation methods are reasonable to determine the appropriate
expenses to be allocated.
 
     Amounts receivable and payable from related companies represent
non-interest bearing advances between affiliates with no specific repayment
terms. Amounts outstanding at December 31, 1995 and 1996 were paid in January
1996 and 1997, respectively.
 
     In August 1992, the Company sold shares of its Common Stock for $172,000 to
the Company's Executive Vice President. The Company received a cash payment of
$32,391 and a promissory note for $139,609 for such shares. This note which bore
interest at 6.0%, was paid in three annual installments of $52,391 and was
collateralized by the shares sold. The final payment was made in October 1995.
 
NOTE 8 -- COMMITMENTS
 
     Employment Agreements -- The Company has entered into various employment
agreements with two of its senior executives for periods of up to three years
expiring no later than June 12, 1998. Under the agreements, the covered
individuals are entitled to specified salaries over the contract periods;
bonuses are provided contingent upon certain Company and individual performance
criteria devised by the Company for each period. The commitments relating to
future services from such executives under the contracts as of December 31, 1996
are approximately $1,196,800.
 
OPERATING LEASES
 
     Real Estate -- The Company leases real estate in connection with the
operation of corporate retail stores as well as its corporate office. The store
leases are for properties ranging in size from 6,750 to 13,320 square feet. The
terms range from ten years to twenty years, and expire by 2016. The leases
contain escalation clauses, renewal options from five years to ten years and
obligations for reimbursement of common area maintenance and real estate taxes.
Certain leases contain contingent rent based upon specified sales volume. For
the years ended December 31, 1994, 1995 and 1996, no such contingent rent was
paid.
 
     Other -- The Company leases a motor vehicle, expiring July 1999 and a
telephone system for the corporate office, expiring December 1997.
 
                                      F-13
<PAGE>   41
 
                             PARTY CITY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
 
NOTE 8 -- COMMITMENTS -- (CONTINUED)
     Rent expense for all operating leases was $384,825, $1,554,015 and
$3,779,292 for the years ended December 31, 1994, 1995 and 1996, respectively.
Future minimum payments under operating leases at December 31, 1996 are as
follows:
 
<TABLE>
        <S>                                                               <C>
        1997............................................................  $ 5,473,737
        1998............................................................    5,585,650
        1999............................................................    5,637,546
        2000............................................................    5,780,208
        2001............................................................    5,990,092
        Thereafter......................................................   28,930,546
                                                                          -----------
                                                                          $57,397,779
                                                                          ===========
</TABLE>
 
     The Company has guaranteed a lease obligation of three of its franchises.
One lease, expiring in 2001, has future minimum payments of $687,225, the second
lease, expiring in 2007, has future minimum payments of $2,686,667 and the
remaining lease, expiring in 2007, has future minimum payments of $1,646,957.
 
NOTE 9 -- SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                                 QUARTER ENDED
                                          ------------------------------------------------------------
                  1995                    MARCH 31,       JUNE 30,      SEPTEMBER 30,     DECEMBER 31,
----------------------------------------  ----------     ----------     -------------     ------------
<S>                                       <C>            <C>            <C>               <C>
Net sales of Company-owned stores.......  $1,782,905     $2,659,151      $ 3,051,342      $  8,624,755
Total franchise revenues................   1,068,518      1,506,191        1,673,851         2,753,619
Cost of goods sold and occupancy
  costs.................................   1,257,446      1,822,532        2,228,843         5,449,388
Net Income/(Loss).......................      17,125        207,921         (101,861)        1,176,780
Net Income/(Loss) per share.............  $     0.00     $     0.04      $     (0.02)     $       0.22
</TABLE>
 
<TABLE>
<CAPTION>
                                                                 QUARTER ENDED
                                          ------------------------------------------------------------
                  1996                    MARCH 31,       JUNE 30,      SEPTEMBER 30,     DECEMBER 31,
----------------------------------------  ----------     ----------     -------------     ------------
<S>                                       <C>            <C>            <C>               <C>
Net sales of Company-owned stores.......  $4,562,271     $6,338,685      $ 7,507,165      $ 20,735,504
Total franchise revenues................   1,418,741      1,947,733        2,400,601         3,617,685
Cost of goods sold and occupancy
  costs.................................   3,334,320      4,362,640        5,339,627        12,900,857
Net Income/(Loss).......................    (166,506)       499,168          345,660         3,077,203
Net Income/(Loss) per share.............  $     (.03)    $      .07      $       .05      $        .43
</TABLE>
 
--------------------------------------------------------------------------------
 
SUBSEQUENT EVENTS (UNAUDITED)
 
     On February 28, 1997, the Company acquired six franchise stores. Four of
the stores acquired, having total sales of $9,100,000 in 1996, were owned by
Steven Mandell, the Company's Chairman and President for an aggregate purchase
price of $4,750,000, subject to post-closing adjustments for inventory and
payables. The remaining two stores, having total sales of $3,700,000 in 1996,
were owned by Perry Kaplan, a former executive officer and a Director of the
Company for an aggregate purchase price of $1,150,000, subject to similar
post-closing adjustments.
 
     On March 3, 1997, the Company signed a commitment letter to refinance and
replace the Company's existing $5,000,000 credit facility with a $20,000,000
revolving line of credit maturing June 30, 2000. The terms of the commitment
letter are subject to the negotiation and execution of definitive loan
documents.
 
     On March 5, 1997, the Company and Steven Mandell, the Chairman and
President of the Company, executed an amendment to Mr. Mandell's employment
agreement. The amendment extends the term of Mr. Mandell's employment agreement
one year to December 31, 1998 and provides for an annual salary of $300,000 for
1998.
 
                                      F-14
<PAGE>   42
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
                                                                                       SEQUENTIALLY
EXHIBIT                                                                                  NUMBERED
NUMBER                                      DESCRIPTION                                    PAGE
------         ----------------------------------------------------------------------  ------------
<C>      <C>   <S>                                                                     <C>
  3.1/1     --   Certificate of Incorporation of the Registrant.
  3.2/1     --   Bylaws of the Registrant.
  4.1/1     --   Specimen stock certificate evidencing the Common Stock.
 10.1/1     --   Form of Unit Franchise Agreement entered into by the Registrant and
                 franchisees.
 10.2/1     --   Employment Agreement, dated January 1, 1994 and amended as of January
                 16, 1996, by and between the Registrant and Steve Mandell.
 10.3/3     --   Amendment to Employment Agreement dated March 5, 1997, by and between
                 the Registrant and Steven Mandell.
 10.4/1     --   Employment Agreement, dated January 1, 1994 and amended as of January
                 16, 1996, by and between the Registrant and Perry Kaplan.
 10.5/1     --   Employment Agreement of David Lauber, dated June 12, 1995, by and
                 between Registrant and David Lauber.
 10.6/1     --   Employment Agreement of Lawrence Fine, dated October 13, 1995, by and
                 between Registrant and Lawrence Fine.
 10.7/2     --   Amended Stock Option Plan of the Registrant.
 10.8/2     --   Amended and Restated 1994 Stock Option Plan of the Registrant.
 10.9/1     --   Loan and Security Agreement, dated February 15, 1995 and amended as of
                 October 6, 1995, by and between Registrant and Midlantic Bank, N.A.
 10.10/3    --   Commitment letter between PNC Bank and the Registrant.
 23.1       --   Consent of Deloitte & Touche LLP.
 24.1       --   Power of Attorney (contained on the signature page of this
                 Annual Report on Form 10-K).
 27.1       --   Financial Data Schedule.
</TABLE>
 
---------------
   
1  Incorporated by reference to the Company Registration Statement as amended
   on Form S-1, File Number 333-350 as declared effective by the Commission on
   March 26, 1996.
 
2  Incorporated by reference to the Company's Registration Statement on Form
   S-8 as filed with the Commission on January 9, 1997.

3  Incorporated by reference to the Company's Registration Statement on Form
   S-1 as filed with the Commission on March 6, 1997.