##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




---

Form 10-K/ A

(Amendment No. 1)


ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934


For the fiscal year ended June 28,
2003

Commission file number 0-27826



---

Party City Corporation

(Exact name of registrant as specified in its
charter)


|                                                                          |  |                                     
|------------------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                                  |  | 22-3033692                          
|(State or other jurisdiction of incorporation
    or organization)        |  | (I.R.S. Employer Identification No.)
|                                                                         
|400 Commons Way, Rockaway, NJ(Address of principal executive
    offices) |  | 07866(Zip Code)                     

Registrants telephone number, including
area code:

(973) 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


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

Indicate
by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K 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/ A or any amendment to this Form 10-K/
A.     o

The
aggregate market value of voting stock held by non-affiliates of
the Registrant on December 28, 2002, based on the closing
sale price on such date, was approximately $162,007,200.

The
number of outstanding shares of the Registrants classes of
common stock, $0.01 par value, as of September 19,
2003 and June 4, 2004 were 16,741,225 and 17,053,694,
respectively.

DOCUMENTS INCORPORATED BY REFERENCE

Portions
of the Registrants Proxy Statement for the 2003 Annual
Meeting of Stockholders are incorporated by reference into
Part III.



---






---










TABLE OF CONTENTS

|                                          |  |                                                                                           |  |      |    | 
|----------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                          |  |                                                                                           |  | Page
|                                          |  |                                                                                           |  |     
|PART I                                   
|Item 1                                    |  | Business                                                                                  |  |      | 3  | 
|Item 2                                    |  | Properties                                                                                |  |      | 12 | 
|Item 3                                    |  | Legal Proceedings                                                                         |  |      | 12 | 
|Item 4                                    |  | Submission of Matters to a Vote of Security
    Holders                                   |  |      | 13 | 
|PART II                                  
|Item 5                                    |  | Market for Registrants Common Equity and
    Related Stockholder Matters                 |  |      | 13 | 
|Item 6                                    |  | Selected Financial Data                                                                   |  |      | 16 | 
|Item 7                                    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |      | 21 | 
|Item 7A                                   |  | Quantitative and Qualitative Disclosures About
    Market Risk                            |  |      | 29 | 
|Item 8                                    |  | Financial Statements and Supplementary Data                                               |  |      | 29 | 
|Item 9                                    |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure  |  |      | 30 | 
|Item 9A                                   |  | Controls and Procedures                                                                   |  |      | 30 | 
|PART III                                 
|Item 10                                   |  | Directors and Executive Officers of the
    Registrant                                    |  |      | 31 | 
|Item 11                                   |  | Executive Compensation                                                                    |  |      | 31 | 
|Item 12                                   |  | Security Ownership of Certain Beneficial Owners
    and Management                        |  |      | 31 | 
|Item 13                                   |  | Certain Relationships and Related Transactions                                            |  |      | 31 | 
|Item 14                                   |  | Principal Accountant Fees and Services                                                    |  |      | 31 | 
|PART IV                                  
|Item 15                                   |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                      |  |      | 31 | 
|EX-23.1: CONSENT OF DELOITTE & TOUCHE LLP
|EX-31.1: CERTIFICATION                   
|EX-31.2: CERTIFICATION                   
|EX-32.1: CERTIFICATION                   
|EX-32.2: CERTIFICATION                   



1



---



##### Table of Contents






PART I

Explanatory Note

We are filing this Amendment No. 1 on
Form 10-K/A (the Form 10-K/A), which
amends and restates our Annual Report on Form 10-K for the
year ended June 28, 2003 that was originally filed on
September 26, 2003 (the Original 10-K),
primarily to reflect a restatement of our consolidated
statements of cash flows related to our cash overdraft.
Previously, the change in the cash overdraft account was
classified from year to year in net cash provided by (used in)
operating activities, rather than being classified in net cash
provided by (used in) financing activities. The prior treatment
resulted in (i) higher net cash provided by operating
activities and higher net cash used in financing activities of
approximately $1,041,000 and $3,085,000 for the years ended
June 28, 2003 and June 29, 2002, respectively, and
(ii) lower net cash provided by operating activities and
lower net cash used in financing activities of approximately
$4,221,000 for the year ended June 30, 2001. In this
Form 10-K/A, we have restated our consolidated statements
of cash flows for the years ended June 28, 2003,
June 29, 2002 and June 30, 2001 to reflect the change
in cash overdraft account as a financing activity rather than an
operating activity. For further discussion, see Item 8
Financial Statements and Supplementary Data 
Note 17. Restatement of Statements of Cash Flows and
Item 9A. Controls and Procedures.

In addition, pursuant to comments from the
Securities and Exchange Commission (the SEC), we
agreed to make certain revisions in our future filings, which we
made in our Quarterly Report on Form 10-Q for the three
months ended March 27, 2004 and have made in this
Form 10-K/A. We have also updated a limited set of
disclosure statements throughout this Form 10-K/A that we
previously provided in the Original 10-K as of
September 19, 2003, the latest practicable date for which
such information was available as of the filing of the Original
10-K. The explanatory caption at the beginning of each revised
item of this Form 10-K/A sets forth the limited nature of
the revisions therein.

The following sections of this Form 10-K/A
have been revised from the Original 10-K:



| |   |                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------
| |  | Item 1  Business                                                                                     
|
| |  | Item 3  Legal Proceedings                                                                            
|
| |  | Item 6  Selected Financial Data                                                                      
|
| |  | Item 7  Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations
|
| |  | Item 8  Financial Statements and
    Supplementary Data                                              
|
| |  | Item 9A  Controls and Procedures                                                                     
|
| |  | Report of Independent Registered Public
    Accounting Firm                                           
|
| |  | Signature Page                                                                                        
|
| |  | Exhibit 31 and 32 Certifications                                                                      

Except as set forth above, this Form 10-K/A
continues to speak as of the date of the filing of the Original
10-K, September 26, 2003, and we have not updated the
disclosures contained herein to reflect any events that have
occurred thereafter. For a discussion of events and developments
thereafter, please see our reports filed with the SEC since
September 26, 2003.

Our Quarterly Reports on Form 10-Q for the
fiscal quarters ended September 27, 2003 and
December 27, 2003 will also be restated in a similar
fashion and will be filed simultaneously with this
Form 10-K/A. We are not amending any reports affected by
the restatement prior to the Original 10-K; therefore, the
consolidated statements of cash flows and related financial
information included in such reports should no longer be relied
upon and are hereby superseded.

2



---



##### Table of Contents



Forward-Looking Statements

This Form 10-K/A (including the information
incorporated herein by reference) contains forward-looking
statements within the meaning of The Private Securities
Litigation Reform Act of 1995. The statements are made a number
of times throughout the document and may be identified by
forward-looking terminology as estimate,
project, expect, believe,
may, will, intend or similar
statements or variations of such terms. Such forward-looking
statements are based on many assumptions that are subject to
certain risks and uncertainties, and include among others, the
following: levels of sales, store traffic, acceptance of product
offerings, competitive pressures from other party supplies
retailers and other retailers, availability of qualified
personnel, availability of suitable future store locations,
schedules of store expansion plans and other factors beyond our
control. As a result of the foregoing risks and uncertainties,
actual results and performance may differ materially from those
projected or suggested herein. Additional information concerning
certain risks and uncertainties that could cause our actual
results to differ materially from those projected or suggested
may be identified from time to time in our Securities and
Exchange Commission filings and our public announcements.






|        |         
|------- | --------
|Item 1. | Business

A limited set of disclosure statements have
been updated in this section as of June 4, 2004 that we
previously provided in the Original 10-K as of
September 19, 2003, the latest practicable date for which
such information was available as of the filing of the Original
10-K. We have also updated the Risk Factor entitled We
depend on key personnel and may not be able to retain these
employees or recruit additional qualified personnel, which could
harm our business on page 11 to reflect the hiring of
Nancy Pedot as our permanent Chief Executive Officer.

Party City Corporation is based in Rockaway, New
Jersey and was incorporated in the State of Delaware in 1996. We
operate retail party supplies stores within the continental
United States and we sell franchises on an individual store and
area franchise basis throughout the United States and Puerto
Rico. As of December 2002, the franchise stores in Portugal and
Spain are no longer franchises and no longer operate with the
Party City name or logo.

General

We are a specialty retailer of party supplies
with a network of more than 500 stores. At September 19,
2003, we owned and operated 247 stores in the United States and
our franchisees operated an additional 253 stores in the United
States, including 5 stores in Puerto Rico. At June 4, 2004,
we owned and operated 249 stores in the United States and our
franchisees operated an additional 256 stores in the United
States, including 5 stores in Puerto Rico. We believe that we
are Americas largest party goods chain. We authorized our
first franchise store in 1989 and opened our first Company-owned
store in January 1994.

We operate and franchise party supplies stores
that typically range in size from 10,000 square feet to
12,000 square feet. These stores offer a broad selection of
brand name and private label merchandise for a wide variety of
celebratory occasions, including birthday parties, weddings and
baby showers, as well as holiday and 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. We seek to offer customers a
one-stop party store that provides a wide selection
of merchandise at a compelling value. 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.

Effective July 3, 1999, we changed our
fiscal year end for financial reporting from December 31,
to the Saturday nearest to June 30. As used herein, the
term Fiscal Year or Fiscal refers to the
52 or 53 weeks, as applicable, ending the Saturday nearest
to June 30, unless otherwise noted.

3



---



##### Table of Contents



Industry Overview

Traditionally, the retail party supplies business
has been fragmented, 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.

Business Strategy

Our objective is to maintain our position as a
leading national chain of party supplies stores. Key components
of our current strategy are:

Offer a Broad Selection of Merchandise in an
Exciting Shopping Environment.We try
to provide party-planners and party-goers with convenient
one-stop shopping for party supplies and offer what we believe
is one of the most extensive selections of party supplies
available. A typical Party City store contains over 20,000 SKUs
and offers a wide variety of patterns, colors and styles within
each of the product categories that we carry. We have been
expanding the range of items that we offer in order to create
consumer loyalty and generate repeat business.

Establish Convenient Store
Locations.While we believe that our
stores typically are destination shopping locations, we seek to
maximize customer traffic and quickly build the visibility of
new stores by situating our stores in high traffic areas. Site
selection criteria include: population density, demographics,
traffic counts, location of complementary retailers, storefront
visibility and presence (either in a stand-alone building or in
dominant power strip shopping centers, which are generally
anchored by a nationally recognized retailer, like Wal-Mart,
Target or Kohls Department Stores), competition, lease
rates and accessible parking. We believe there are an extensive
number of suitable domestic locations available for future
stores.

Maintain Value Price
Position.We use the aggregate buying
power of our more than 500 Company-owned and franchise store
network which allows the stores to offer a broad line of high
quality merchandise at competitive prices. We believe we
reinforce customers expectations of savings by prominently
displaying signs announcing our value pricing and savings
opportunities. We also maintain a lowest price guaranty policy
in Company-owned stores, and we suggest our franchisees adhere
to such a policy. This policy guarantees that Party City stores
will meet and discount the advertised prices of a
competitors products. We believe that this policy has
helped foster our image of offering consumers exceptional value
for their money.

Provide Excellent Customer
Service.We view the quality of our
customers shopping experience as critical to our continued
success and we are committed to making shopping in our stores an
enjoyable experience. For example, at Halloween, our most
important selling season, each store significantly increases the
number of sales associates to ensure prompt service. We believe
that the compensation of our store managers and other personnel
is competitive and enables us to attract and retain
well-qualified, motivated employees who are committed to
providing excellent customer service.

Expansion Plans.Our
long-term goal is to increase our market share in existing
markets and penetrate new markets in order to expand our
position as a leading retailer of party supplies merchandise.
Our growth strategy is planned through the opening of both
Company and franchise stores. We plan to open Company-owned and
franchise stores to meet our growth objectives. In addition, the
fragmented nature of the retail party supplies business may
provide opportunities to grow through acquisition. We
continuously evaluate acquisition opportunities; however, we
have no present commitments or agreements with respect to
material acquisitions. Franchise store growth is subject to the
ability and interest on the part of the franchisees to open
stores according to our expansion plans. In order to manage
continued store growth, our management intends to continue to
invest in our human resources and management information systems
to further improve the infrastructure.

Store Locations

As of September 19, 2003, there were 500
Party City stores open in the United States and Puerto Rico. Of
these, 247 were Company-owned and 253 were operated by our
franchisees. As of June 4, 2004, there were 505 Party City
stores open in the United States and Puerto Rico. Of these, 249
were Company-owned and 256

4



---



##### Table of Contents



were operated by our franchisees The following
table shows the growth in Party Citys network of stores
for the Fiscal Years 1999 through 2003.


|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |     |  
|---------------------------------- | --------------------------------------- | ----------- | --- | ---- | - | ---- | --- | ---- | - | ---- | --- | --- | - |  | --- | --- | - |  | --- | --- | -
|                                   |                                         |            
|                                   |                                         | Fiscal Year
|                                   |                                         |            
|                                   |                                         | 2003        |     | 2002 |   | 2001 |     | 2000 |   | 1999
|                                   |                                         |             |     |      |   |      |     |      |   |     
|Company-owned:                     |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|                                   | Stores open at beginning of fiscal year |             |     | 209  |   |      |     | 193  |   |      |     | 197 |   |  |     | 215 |   |  |     | 148 |  
|                                   | Stores opened                           |             |     | 22   |   |      |     | 13   |   |      |     |    |   |  |     | 2   |   |  |     | 63  |  
|                                   | Stores closed                           |             |     | (2   | ) |      |     |     |   |      |     | (2  | ) |  |     | (2  | ) |  |     |    |  
|                                   | Stores acquired from franchisees        |             |     | 2    |   |      |     | 3    |   |      |     | 1   |   |  |     |    |   |  |     | 5   |  
|                                   | External acquisitions                   |             |     | 11   |   |      |     |     |   |      |     |    |   |  |     |    |   |  |     |    |  
|                                   | Stores sold to franchisees              |             |     |     |   |      |     |     |   |      |     | (3  | ) |  |     | (18 | ) |  |     | (1  | )
|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|                                   | Stores open at end of fiscal year       |             |     | 242  |   |      |     | 209  |   |      |     | 193 |   |  |     | 197 |   |  |     | 215 |  
|Franchise:                         |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|                                   | Stores open at beginning of fiscal year |             |     | 242  |   |      |     | 261  |   |      |     | 211 |   |  |     | 178 |   |  |     | 160 |  
|                                   | Stores opened                           |             |     | 9    |   |      |     | 19   |   |      |     | 51  |   |  |     | 18  |   |  |     | 23  |  
|                                   | Stores closed(a)                        |             |     | (8   | ) |      |     | (35  | ) |      |     | (3  | ) |  |     | (3  | ) |  |     | (1  | )
|                                   | Stores purchased by the Company         |             |     | (2   | ) |      |     | (3   | ) |      |     | (1  | ) |  |     |    |   |  |     | (5  | )
|                                   | Stores purchased by franchisees         |             |     |     |   |      |     |     |   |      |     | 3   |   |  |     | 18  |   |  |     | 1   |  
|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|                                   | Stores open at end of fiscal year       |             |     | 241  |   |      |     | 242  |   |      |     | 261 |   |  |     | 211 |   |  |     | 178 |  
|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|Total Company and franchise stores |                                         |             | 483 |      |   |      | 451 |      |   |      | 454 |     |   |  | 408 |     |   |  | 393 |    
|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    



---



|    |  |                                                                                                                             
|--- |  | ----------------------------------------------------------------------------------------------------------------------------
|(a) |  | Our Canadian master franchisee filed for
    bankruptcy protection under Canadian law, closing 28 stores in
    fiscal 2002.

As of June 28, 2003, Party City stores were
located in the following states and geographic regions:

|               |       |        |    |     | 
|-------------- | ----- | ------ | -- | --- | 
|               |       | # of  
|               |       | Stores
|               |       |       
|Alabama        |       |        | 6  |    
|Arizona        |       |        | 9  |    
|Arkansas       |       |        | 3  |    
|California     |       |        | 65 |    
|Colorado       |       |        | 5  |    
|Connecticut    |       |        | 9  |    
|Delaware       |       |        | 1  |    
|Florida        |       |        | 50 |    
|Georgia        |       |        | 24 |    
|Hawaii         |       |        | 1  |    
|Illinois       |       |        | 20 |    
|Indiana        |       |        | 5  |    
|Kansas         |       |        | 4  |    
|Kentucky       |       |        | 1  |    
|Louisiana      |       |        | 11 |    
|Maryland       |       |        | 12 |    
|Massachusetts  |       |        | 5  |    
|Michigan       |       |        | 10 |    
|Minnesota      |       |        | 5  |    
|Mississippi    |       |        | 2  |    
|Missouri       |       |        | 5  |    
|Nevada         |       |        | 5  |    
|New Jersey     |       |        | 32 |    
|New Mexico     |       |        | 3  |    
|New York       |       |        | 46 |    
|North Carolina |       |        | 15 |    
|Ohio           |       |        | 10 |    
|Oregon         |       |        | 4  |    
|Pennsylvania   |       |        | 24 |    
|Rhode Island   |       |        | 1  |    
|South Carolina |       |        | 7  |    
|Tennessee      |       |        | 11 |    
|Texas          |       |        | 33 |    
|Utah           |       |        | 2  |    
|Virginia       |       |        | 13 |    
|Washington     |       |        | 18 |    
|Wisconsin      |       |        | 1  |    
|Puerto Rico    |       |        | 5  |    
|               |       |        |    |    
|               | Total |        |    | 483 | 
|               |       |        |    |    

Merchandising

Store
Layout

Our stores are designed to give the shopper a
feeling of excitement and create a festive atmosphere. Our goal
is for the customer to be pleased by his or her shopping
experience. To achieve this goal, we maintain a wide selection
of party supplies in-stock. Party City stores range in size from
6,750 to 19,800 square feet with a typical store size
between 10,000 and 12,000 square feet. The stores are
divided into various sections of different categories of party
supplies, displayed to emphasize value pricing and breadth of
merchandise available. The floor plan is designed to impress the
customer with the broad selection in each product category.

5



---



##### Table of Contents



Product
Categories

The typical Party City store offers a broad
selection of brand name and private label merchandise consisting
of over 20,000 SKUs. Our product categories include the
following:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Halloween.As a key
    component of our sales strategy, our Party City stores provide
    an extensive selection of costumes for Halloween through our
    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 stores display Halloween-related
    merchandise throughout the year to position us as the
    customers Halloween shopping resource.
|
| | Graduation.Customer
    purchases for graduation parties in the United States primarily
    occur during April, May and June. These purchases include
    decorations and tableware related to graduation parties.                                                                                                                                                                                                                                                                                                                                                                
|
| | Other Seasonal.Customer purchases made for seasonal holiday events compose a
    significant part of our business. The other seasonal category
    includes products for the Super Bowl, Valentines Day, St.
    Patricks Day, Fall, Thanksgiving, Passover, Easter, First
    Communion, 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.                                                                       
|
| | Baby Shower.We
    maintain a baby shower department, which includes tableware,
    decorations, balloons, favors, centerpieces and garlands.                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| | Balloons.The
    balloon department carries a wide selection of basic and
    decorative latex balloons in various sizes, qualities, colors
    and package sizes. The balloon department also carries Mylar
    balloons in numerous sizes, shapes and designs relating to
    birthday, seasonal, anniversary and other themes.                                                                                                                                                                                                                                                 
|
| | 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, piñatas and candies.                                                                                                                    
|
| | Bridal/Wedding/Anniversary.This product category includes personalized invitations,
    tableware, balloons, favors, place setting cards, confetti,
    honeycomb bells and personalized ribbons. Personalized
    invitation books containing numerous samples of customizable
    invitations are carried from the leading invitation stationers
    at discounted prices.                                                                                                                                                                                                      
|
| | Candy.The candy
    product category includes novelty and packaged candy sold to
    enhance parties or to be used as piñata fillers. Candy is
    sold both in individual units and in bulk packaging for
    customers convenience.                                                                                                                                                                                                                                                                                                                                            
|
| | Catering Supplies.Our 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, printed bags and wrapping paper.                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| | Greeting Cards.This
    product category includes greeting cards from quality national
    card vendors at discount prices.                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| | Party Favors.We
    maintain a party favors department that includes a broad
    selection of packaged and bulk favors appealing to different age
    groups. The assortment includes different product lines varying
    in prices designed to offer customers a variety of purchasing
    options.                                                                                                                                                                                                                                                                              
|
| | General.We carry a
    range of brand name and private label merchandise, including
    tableware, table covers, cutlery, crepe paper, cups and tumblers.                                                                                                                                                                                                                                                                                                                                                                                                                         

6



---



##### Table of Contents



Product
Selection, Purchasing and Suppliers

The following represents suppliers from whom we
purchased at least 5% of our merchandise:

|                        |  |             |    |             |  |             |    |   |  |  |    |  
|----------------------- |  | ----------- | -- | ----------- |  | ----------- | -- | - |  |  | -- | -
|Supplier                |  | Fiscal 2003 |    | Fiscal 2002 |  | Fiscal 2001
|                        |  |             |    |             |  |            
|Amscan, Inc.            |  |             | 23 | %           |  |             | 23 | % |  |  | 23 | %
|Unique Industries, Inc. |  |             | 8  | %           |  |             | 7  | % |  |  | 7  | %
|Hallmark Marketing Corp |  |             | 6  | %           |  |             | 6  | % |  |  | 6  | %
|Rubies Costumes Co. Inc |  |             | 6  | %           |  |             | 7  | % |  |  | 7  | %
|                        |  |             |    |             |  |             |    |   |  |  |    |  
|Total                   |  |             | 43 | %           |  |             | 43 | % |  |  | 43 | %
|                        |  |             |    |             |  |             |    |   |  |  |    |  

The loss of any of these suppliers could
materially adversely affect our business, results of operations
and financial condition. We consider numerous factors in
supplier selection, including, but not limited to, price, credit
terms, product offerings and quality. We negotiate pricing with
suppliers on behalf of all stores in our network (Company-owned
and franchise). We believe that our buying power enables us to
receive favorable pricing terms and enhances our ability to
obtain high demand merchandise.

In order to maintain consistency throughout our
store network, we have established an approved list of items
that are permitted to be sold in Party City stores. Franchise
stores must adhere to these guidelines according to the terms of
their franchise agreements. We establish a standard store
merchandise layout and presentation format to be followed by
Company-owned and franchise stores. Any layout or format changes
developed by us are communicated to the managers of stores on a
periodic basis. All of the merchandise purchased by stores is
shipped directly from suppliers to the stores.

Franchise Operations

As of September 19, 2003, the Company had
253 franchise stores throughout the United States and Puerto
Rico. As of June 4, 2004, the Company had 256 franchise
stores throughout the United States and Puerto Rico. A Party
City store run by a franchisee utilizes the Companys
format, design specifications, methods, standards, operating
procedures, systems and trademarks.

We receive revenue from our franchisees,
consisting of an initial, one-time fee and an ongoing royalty
fee. In addition, each franchisee has a mandated advertising
budget, which consists of a minimum initial store opening
promotion and ongoing local advertising and promotions. Further,
the franchisee must pay an additional 1% of net sales to a Party
City group advertising fund to cover common advertising
materials related to the Party City store concept. Receipts and
disbursements are not recorded as income or expense since the
Company does not have full discretion over the use of the funds.
We do not offer financing to our franchisees.

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 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 stores.

Although such locations are generally obtained
and secured by the franchisee, pursuant to the franchise
agreement we must approve all site locations. As franchisor, we
also supply valuable and proprietary information pertaining to
the operation of the Party City store business, as well as
advice regarding location, improvements and promotion. We also
supply consultation in the areas of purchasing, inventory
control, pricing, marketing, merchandising, hiring, training,
improvements and new developments in the franchisees
business operations, and we provide assistance in opening and
initially promoting the store.

We have increased our focus on the management of
our franchise operations. Additionally, franchisees have been
represented on several key operating committees, addressing
issues such as merchandising, advertising and information
systems initiatives.

7



---



##### Table of Contents



As of September 19, 2003, we had nine
territory agreements with certain franchisees. As of
June 4, 2004, we had thirteen territory agreements with
certain franchisees. These agreements grant the holder of the
territory the right to open one or more stores within a stated
time period.

Competition

We operate in highly competitive markets. Our
stores compete with a variety of smaller and larger retailers,
including, but not limited to, 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 and catalog and Internet sites.
Major chain competitors in our markets include iparty, Factory
Card Outlet and Party America. Party America recently purchased
62 Paper Warehouse corporate stores and the franchising
division. In addition, other stores or internet vendors may
enter the market and become significant competitors in the
future. Our stores compete, among other things, on the basis of
location and store layout, product mix, selection, customer
convenience and price. Many of our non-chain competitors in our
markets have greater financial resources than we do.

Management believes that Party City stores
maintain a leading position in the party supplies business by
offering a wider breadth of merchandise, greater selection
within merchandise classes and discount prices on most items in
the stores. We believe that our significant buying power, which
results from the size of our Party City store network, is an
integral advantage.

Trademarks

We license a number of trademarks and service
marks registered with the United States Patent and Trademark
Office from our wholly owned subsidiary, including the marks
Party City®, The Discount Party Super Store® and
Halloween Costume Warehouse®.

Government Regulation

As a franchisor, we must comply with regulations
adopted by the Federal Trade Commission, such as the Trade
Regulation Rule on Franchising, which requires us to
furnish prospective franchisees with a franchise offering
circular. We also must comply with a number of state laws that
regulate certain substantive aspects of the
franchisor-franchisee relationship. For instance, state laws
that regulate the offer and sale of franchises require us 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. In some cases, 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 not precluded us from
seeking franchisees in any given area and have not had a
material adverse effect on our operations.

Each Party City store must comply with applicable
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 or shut
down an existing store.

Party City stores must comply with applicable
federal and state environmental regulations, but the cost of
complying with those regulations to date 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.

8



---



##### Table of Contents



We and our 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. We and our franchisees must also comply with the
provisions of the Americans with Disabilities Act. The Act
requires that employers provide reasonable accommodation for
employees with disabilities and that stores must be accessible
to customers with disabilities.

Employees

As of September 19, 2003, we employed
approximately 1,600 full-time and 4,300 part-time
employees. We consider our relationships with our employees to
be good. None of our employees are covered by a collective
bargaining agreement.

Available Information

Our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and
all amendments to those reports are made available free of
charge through the Investor Relations section of the
Companys website at http://www.partycity.com as soon as
reasonably practicable after such material is electronically
filed with, or furnished to, the Securities and Exchange
Commission.

Risk Factors

In addition to other matters identified or
described by us from time to time in filings with the Securities
and Exchange Commission, there are several important factors
that could cause our future results to differ materially from
historical results or trends, results anticipated or planned by
us, or results that are reflected from time to time in any
forward-looking statement that may be made by us or on our
behalf. Some of these important factors, but not necessarily all
of the important factors, are described below.

We may be
unable to achieve our expansion plans for future
growth

During Fiscal 2003, we added 35 Company-owned
stores by opening 22 stores and acquiring 13 stores, two of
which we acquired from franchisees. Our continued growth will
depend, in significant part, upon our ability to open such new
stores in a timely manner and to operate them profitably. Our
expansion is also dependent on the effective continuation and
development of our franchise program. Furthermore, successful
expansion is subject to various contingencies, many of which are
beyond our control. These contingencies include, among others:



| |   |                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------
| |  | our ability and our franchisees ability to
    identify and secure suitable store sites on a timely basis;                 
|
| |  | our ability and our franchisees ability to
    negotiate advantageous lease terms;                                         
|
| |  | our ability and our franchisees ability to
    complete any necessary construction or refurbishment of these
    sites; and
|
| |  | the successful integration of new stores into
    existing operations.                                                      

As our business grows, we will need to attract
and retain additional qualified personnel in a timely manner and
develop, train and manage an increasing number of management
level and other employees. We cannot assure you that we will be
able to attract and retain personnel as needed in the future. If
we are not able to hire capable store managers and other store
level personnel, we will not be able to open new stores as
planned and our revenue growth and operating results will suffer.

We cannot give any assurances that we will be
able to continue our expansion plans successfully, that we will
be able to achieve results similar to those achieved with prior
locations, or that we will be able to continue to manage our
growth effectively. Our failure to achieve our expansion plans
could materially adversely affect our business, results of
operations and financial condition. In addition, we expect our
operating margins will be impacted by new store openings because
of the addition of pre-opening expenses and the lower sales
volume characteristic of new stores. Furthermore, the opening of
additional stores in existing markets may attract some of our
customers away from our other stores already in operation and
diminish their sales.

9



---



##### Table of Contents



We may need
to raise additional capital to fund our operations

If we are unable to generate sufficient cash from
operations, we may be required to adopt one or more alternatives
to raise cash, such as incurring more indebtedness, selling our
assets, seeking to raise additional debt or equity capital or
restructuring. If adequate financing is unavailable or is
unavailable on acceptable terms, we may be unable to develop or
enhance our operations, products and services, take advantage of
future opportunities or respond to competitive pressures.

An effective
franchise program is key to our success

Our growth and success depends in part upon our
ability to contract with and retain qualified franchisees, as
well as the ability of those franchisees to operate their stores
and promote and develop our store concept. Although we have
established criteria to evaluate prospective franchisees and our
franchise agreements include certain operating standards, each
franchisee operates independently. Various laws limit our
ability to influence the day-to-day operations of franchise
stores. We cannot assure you that our franchisees will be able
to operate stores in a manner consistent with our concept and
standards. As a result, our franchisees may operate their stores
in a manner that reduces the gross revenues of these stores and
therefore reduces our franchise revenue.



| |                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------
| | A downturn in the economy may affect
    consumer purchases of discretionary items, which could reduce
    our sales

In general, our sales represent discretionary
spending by our customers. Discretionary spending is affected by
many factors, including, among others, general business
conditions, interest rates, the availability of consumer credit,
taxation and consumer confidence in future economic conditions.
Our customers purchases of discretionary items, including
our products, could decline during periods when disposable
income is lower or during periods of actual or perceived
unfavorable economic conditions. If this occurs, our revenues
and profitability will decline. In addition, our sales could be
adversely affected by a downturn in the economic conditions in
the markets in which we operate.



| |                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our inability to identify and anticipate
    changes in consumer demands and preferences and our inability to
    respond to such consumer demands in a timely manner could reduce
    our sales

Our products appeal to a broad range of consumers
whose preferences cannot be predicted with certainty and are
subject to rapid change. Our success depends on our ability to
identify product trends as well as to anticipate and respond to
changing merchandise trends and consumer demand in a timely
manner. We cannot assure you that we will be able to continue to
offer assortments of products that appeal to our customers or
that we will satisfy changing consumer demands in the future.
Accordingly, if:



| |   |                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------
| |  | we are unable to identify and respond to emerging
    trends;                                                      
|
| |  | we miscalculate either the market for the
    merchandise in our stores or our customers purchasing
    habits; or
|
| |  | consumer demand dramatically shifts away from
    disposable party supplies                                        

our business, results of operations and financial
condition could be materially adversely affected. In addition,
we may be faced with significant excess inventory of some
products and missed opportunities for other products, which
would decrease our profitability.



| |                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we lose any of our key vendors or any of
    our key vendors fail to supply us with merchandise, we may not
    be able to meet the demands of our customers and our sales could
    decline

Our business is dependent to a significant degree
upon close relationships with vendors and our ability to
purchase brand name and private label merchandise at competitive
prices. During the fiscal year 2003, we purchased approximately
43% of the aggregate amount of our merchandise from four
vendors. The loss of any of these key vendors could have a
material adverse effect on our business, results of operations
and financial

10



---



##### Table of Contents



condition. We cannot guarantee that we will be
able to acquire such merchandise at competitive prices or on
competitive terms in the future. In this regard, certain
merchandise that is in high demand may be allocated by vendors
based upon the vendors internal criteria that are beyond
our control, and consequently we may receive less product than
we anticipated.


In addition, we believe many of our vendors
source their products from China, Mexico and other foreign
countries. A vendor could discontinue selling products
manufactured in foreign countries at any time for reasons that
may or may not be in our control, including foreign government
regulations, political unrest, war, disruption or delays in
shipments, changes in local economic conditions and trade
issues. Our sales and profitability could decline if we are
unable to promptly replace a vendor who is unwilling or unable
to satisfy our requirements with a vendor providing equally
appealing products.

We face a
high level of competition in our markets

We operate in highly competitive markets. Our
stores compete with a variety of smaller and larger retailers,
including, but not limited to, 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 and catalog and Internet sites.
Major chain competitors in our markets include iparty, Factory
Card Outlet and Party America. Party America recently purchased
62 Paper Warehouse corporate stores and its franchising
division. In addition, other stores or internet vendors may
enter the market and become significant competitors in the
future. Our stores compete, among other things, on the basis of
location and store layout, product mix, selection, customer
convenience and price. Many of our non-chain competitors in our
markets have greater financial resources than we do.

As a result of this competition, we may need to
spend more on advertising and promotion than we anticipate. We
cannot guarantee that we will continue to be able to compete
successfully against existing or future competitors. Expansion
into markets served by our competitors, entry of new competitors
or expansion of existing competitors into our markets could
materially adversely affect our business, results of operations
and financial condition.



| |                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | Our operating results are subject to
    seasonal and quarterly fluctuations, which could cause the
    market price of our common stock to decline

Our business is subject to substantial seasonal
variations. Historically, we have realized a significant portion
of our net sales, operating income, cash flow and net income in
the second fiscal quarter of the year, principally due to the
sales in October for the Halloween season and, to a lesser
extent, due to sales for end of year holidays. We believe this
general pattern will continue in the future. An economic
downturn during this period could adversely affect us to a
greater extent than if such downturn occurred at other times of
the year. Our results of operations may also fluctuate
significantly as a result of a variety of other factors,
including the timing of new store openings, store closings and
timing of the acquisition and disposition of stores.

In addition, we opened six new Company-owned
stores and closed one Company store in Fiscal 2004 through
September 19, 2003. We opened eight new Company-owned
stores and closed one Company store in Fiscal 2004 through
June 4, 2004 and plan to open two more new Company-owned
stores for the remainder of Fiscal 2004. Our results of
operations may vary significantly as a result of the timing of
new store openings, the amount and timing of net sales
contributed by new stores, the level of pre-opening expenses
associated with new stores and the relative proportion of new
stores to mature stores. Any significant decline in our results
of operations as a result of these variations could adversely
affect our stock price.



| |                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------
| | Failure to successfully utilize our
    information systems could cause interruptions to our business
    and impair our future growth

We need quality and scalable management
information systems to efficiently operate our stores and to
successfully implement our new store growth strategy. Our
systems include point of sale, integrated merchandising and
financial systems. We anticipate that our systems initiatives,
such as the installation of

11



---



##### Table of Contents



merchandising systems and inventory control
systems, will serve to optimize our results by improving our
data analysis. However, there can be no assurances that the
systems will be as beneficial as predicted.




| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | We depend on key personnel and may not be
    able to retain these employees or recruit additional qualified
    personnel, which could harm our business

Our success depends to a large extent on the
continued service of our executive management team. Departures
by our executive officers could have a negative impact on our
business, as we may not be able to find suitable management
personnel to replace departing executives on a timely basis. At
the time we filed the Original 10-K, our Acting Chief Executive
Officer, Nancy Pedot, who was appointed in April 2003 upon the
resignation of the then current Chief Executive Officer James
Shea, had informed the Companys Board of Directors that
she did not wish to be a candidate for the Chief Executive
Officer position on a permanent basis. However, as of January
2004, Ms. Pedot accepted the position of Chief Executive
Officer on a permanent basis. We do not maintain key-man life
insurance on any of our executive officers.

In addition, as our business expands, we believe
that our future success will depend greatly on our continued
ability to attract and retain highly skilled and qualified
personnel. Although we generally have been able to meet our
staffing requirements in the past, our inability to do so in the
future at costs that are favorable to us, or at all, could
impair our ability to increase revenue, and our customers could
experience lower levels of customer care.

Our stock
price may be volatile and could decline
substantially

The stock market has, from time to time,
experienced extreme price and volume fluctuations. Many factors
may cause the market price for our common stock to decline,
including:



| |   |                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------
| |  | our operating results failing to meet the
    expectations of securities analysts or investors in any quarter;
|
| |  | downward revisions in securities analysts
    estimates;                                                     
|
| |  | material announcements by us or our competitors;                                                              
|
| |  | governmental regulatory action; or                                                                            
|
| |  | adverse changes in general market conditions or
    economic trends.                                          






|        |           
|------- | ----------
|Item 2. | Properties

As of September 19, 2003, we leased all of
our 247 Company-owned stores. We also lease our corporate
headquarters property in Rockaway, New Jersey which lease will
expire in 2004.

Of the leases for the Company owned stores, eight
expire in Fiscal 2004, eleven expire in Fiscal 2005, six expire
in Fiscal 2006 and the balance expire in Fiscal 2007 or
thereafter. We have options to extend most of these leases for a
minimum of five years.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

This section has been updated for events and
developments occurring subsequent to the filing of the Original
10-K through June 4, 2004.

Securities Litigation

We were named as a defendant in twelve class
action complaints in the United States District Court for the
District of New Jersey. A former Chief Executive Officer and a
former Chief Financial Officer/ Executive Vice President of
Operations were also named as defendants in these complaints.
The complaints were filed as class actions on behalf of persons
who purchased or acquired Party City common stock during various
time periods between February 26, 1998 and March 18,
1999 (the Class Period). In October 1999,
plaintiffs filed an amended class action complaint and, in
February 2000, plaintiffs filed a second amended complaint,
which alleged, among other things, violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934,

12



---



##### Table of Contents



as amended, and Rule 10b-5 promulgated
thereunder, and sought unspecified damages. The plaintiffs
alleged that defendants issued a series of false and misleading
statements and failed to disclose material facts concerning,
among other things, Party Citys financial condition,
adequacy of internal controls and compliance with certain loan
covenants during the Class period. The plaintiffs further
alleged that because of the issuance of a series of false and
misleading statements and/or the failure to disclose material
facts, the price of Party Citys common stock was
artificially inflated.


In early 2000, defendants moved to dismiss the
second amended complaint on the ground that it failed to state a
cause of action. On May 29, 2001, the District Court issued
an Opinion and Order dismissing the Complaint against all
defendants with prejudice. On June 27, 2001, plaintiffs
filed a Notice of Appeal to the United States Court of Appeals
for the Third Circuit. In April 2002, the parties reached an
agreement in principle to settle the action, and the Court of
Appeals remanded the case to the District Court to supervise the
implementation of the settlement. The terms of the settlement
were contained in the agreement in principle, and included the
settlement amount, of which our settlement contribution of
$380,000 was not material to our results of operations, cash
flow or financial condition.

On May 14, 2003, the District Court approved
the terms of the definitive settlement agreement. Accordingly,
in May 2003, we paid our contribution pursuant to the terms of
the settlement agreement to close this matter.

Other

A lawsuit was filed on September 25, 2001
against us in Los Angeles Superior Court by an assistant manager
in one of our California stores for himself and on behalf of
other members of an alleged class of Party City store managers
(the Class) who claim we misclassified the Class
members as exempt from California overtime wage and hour laws.
The Class members sought the disgorgement of overtime wages
allegedly owed by us to them but not paid and they also sought
punitive damages and statutory penalties.

On March 30, 2004, the parties reached an
agreement-in-principle to settle this lawsuit for
$5.5 million on a claims made basis, which
means that a payout to class members will only occur when claims
are actually made by Class members. Previously, the Company
recorded a pre-tax charge of $1.4 million related to this
lawsuit. In connection with the agreement-in-principle, the
Company recorded an additional pre-tax charge of
$4.1 million during the third quarter of Fiscal 2004 to
fully cover the settlement payments, attorneys fees and
the estimated expenses of administering the settlement. The
settlement provided for pursuant to the agreement-in-principle
is subject to certain conditions, including the negotiation and
execution of a definitive settlement agreement and the approval
of the terms of the definitive settlement agreement by the
Superior Court after notice to the members of the class who have
the right to object. There can be no assurance that all of these
conditions will be satisfied. If a final settlement is not
consummated and the lawsuit is continued, a class is certified,
liability is found and a judgment is entered, such judgment may
adversely affect the Company.

In addition to the foregoing, from time to time
the Company is involved in routine litigation incidental to the
conduct of the business, which is not, individually or in the
aggregate, material to the Company






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

No matters were submitted to a vote of security
holders during the fourth quarter of the fiscal year ended
June 28, 2003.




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Our common stock has traded on the Nasdaq
National Market under the symbol PCTY since its
re-listing in July 2001. From July 1999 until its re-listing on
the Nasdaq National Market, our common stock was

13



---



##### Table of Contents



traded on the OTC Bulletin Board, an electronic
quotation service for NASD Market Makers. From March 1996 until
July 1999 our common stock was traded on the Nasdaq National
Market.


The following table sets forth the high and low
trading prices of our common stock for each quarter of the
latest two fiscal years.

|                   |  |      |       |     |  |   |       | 
|------------------ |  | ---- | ----- | --- |  | - | ----- | 
|                   |  | High |       | Low
|                   |  |      |       |    
|Quarter Ended:     |  |      |       |     |  |   |       | 
|June 28, 2003      |  | $    | 10.91 |     |  | $ | 8.00  | 
|March 29, 2003     |  |      | 12.70 |     |  |   | 7.17  | 
|December 28, 2002  |  |      | 14.59 |     |  |   | 9.63  | 
|September 28, 2002 |  |      | 16.98 |     |  |   | 12.73 | 
|Quarter Ended:     |  |      |       |     |  |   |       | 
|June 29, 2002      |  | $    | 18.30 |     |  | $ | 12.61 | 
|March 30, 2002     |  |      | 14.42 |     |  |   | 7.31  | 
|December 29, 2001  |  |      | 7.75  |     |  |   | 5.50  | 
|September 29, 2001 |  |      | 8.78  |     |  |   | 4.80  | 

At September 19, 2003, the number of holders
of record of our common stock was approximately 2,914.

Dividends

We have never paid cash dividends on our capital
stock and do not intend to pay cash dividends in the foreseeable
future. We expect that earnings will be retained for the
continued growth and development of our business. Future
dividends, if any, will depend upon our earnings, financial
condition, working capital requirements, compliance with
covenants in agreements to which we are or may be subject,
future prospects and any other factors deemed relevant by our
Board of Directors. Under various agreements to which we are a
party, principally under the Loan Agreement with Wells Fargo, we
currently are not permitted to pay any dividends. See
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Liquidity and
Capital Resources.

Equity Compensation Plan Information

The following sets forth certain information as
of June 28, 2003 concerning our equity compensation plans:

|                                                                  |  |                            |           |                   |  |                         |      |  |  |  |         |    
|----------------------------------------------------------------- |  | -------------------------- | --------- | ----------------- |  | ----------------------- | ---- |  |  |  | ------- | ---
|                                                                  |  |                            |           |                   |  | Number of Securities   
|                                                                  |  |                            |           | Weighted-Average  |  | Available for Future   
|                                                                  |  | Number of Securities to    |           | Exercise Price of |  | Issuance under Equity  
|                                                                  |  | be Issued upon Exercise of |           | Outstanding       |  | Compensation Plans     
|                                                                  |  | Outstanding Options,       |           | Options, Warrants |  | (Excluding Securities  
|                                                                  |  | Warrants and Rights        |           | and Rights        |  | Reflected in Column(a))
|                                                                  |  |                            |           |                   |  |                        
|Plan Category                                                     |  | (a)                        |           | (b)               |  | (c)                    
|                                                                  |  |                            |           |                   |  |                        
|Equity compensation plans approved by security
    holders(1)     |  |                            | 2,249,276 | (2)               |  | $                       | 8.78 |  |  |  | 553,078 | (3)
|Equity compensation plans not approved by
    security holders(4) |  |                            | 27,168    | (5)               |  | $                       | 8.18 |  |  |  | 277,321 |    
|                                                                  |  |                            |           |                   |  |                         |      |  |  |  |         |    
|Total                                                             |  |                            | 2,276,444 |                   |  | $                       | 8.78 |  |  |  | 830,399 |    
|                                                                  |  |                            |           |                   |  |                         |      |  |  |  |         |    



---



|    |                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Consists of our Amended and Restated 1994 Stock
    Option Plan (the 1994 Plan), Amended and Restated
    1999 Stock Incentive Plan (the 1999 Plan), and
    Employee Stock Purchase Plan (the ESPP).

14



---



##### Table of Contents





|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Consists of 638,349 outstanding options for our
    common stock pursuant to the 1994 Plan, 1,583,140 outstanding
    options for our common stock pursuant to the 1999 Plan and
    27,787 shares of our common stock which will be issued on
    January 1, 2004 pursuant to the ESPP. Under the ESPP, our
    employees have the opportunity to purchase shares of our common
    stock at a discount through accumulated payroll deductions. The
    shares which will be issued in January 2004 will have a purchase
    price of $8.78 per share.
|   
|(3) | Consists of 407,135 options that remain available
    for issuance pursuant to the 1999 Plan and 145,943 shares
    of our common stock that remain available for issuance pursuant
    to the ESPP. No additional options may be issued under the 1994
    Plan after September 4, 2000.                                                                                                                                                                                                                                                              
|   
|(4) | Consists of our Management Stock Purchase Plan. A
    description of our Management Stock Purchase Plan is contained
    in Note 9 to the consolidated financial statements located
    herein.                                                                                                                                                                                                                                                                                                                                                        
|   
|(5) | These shares will be issued in future periods as
    provided for in the Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

15



---



##### Table of Contents








|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

We have derived the selected financial data
presented below from our audited consolidated financial
statements (restated) for the Fiscal Years ended
June 28, 2003, June 29, 2002, June 30, 2001,
July 1, 2000 and December 31, 1998 and the six months
ended July 3, 1999. The selected financial data gives
effect to the restatement as discussed in Note 17 to the
consolidated financial statements. The selected financial
information presented below should be read in conjunction with
such consolidated financial statements and notes thereto. The
six months ended June 30, 1998 is presented for comparative
purposes.

SELECTED FINANCIAL DATA

|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |         | 
|------------------------------------------------- | ---------------------------------------- | ----------------------------------------------- | ------- | ------------- |  | ------------- | ------- | ------------- |  | ------------- | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- | 
|                                                  |                                          |                                                
|                                                  |                                          | Year Ended                                     
|                                                  |                                          |                                                
|                                                  |                                          | June 28,                                        |         | June 29,      |  | June 30,      |         | July 1,       |  | December 31, 
|                                                  |                                          | 2003(d)                                         |         | 2002(d)       |  | 2001(d)       |         | 2000(d)       |  | 1998(e)      
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |              
|                                                  |                                          |                                                
|                                                  |                                          | (In thousands, except per share and store data)
|                                                  |                                          | (As restated)                                   |         | (As restated) |  | (As restated) |         | (As restated) |  | (As restated)
|Statement of Operations Data:                     |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Total revenues                                    |                                          | $                                               | 482,620 |               |  | $             | 423,510 |               |  | $             | 395,900 |         |  | $ | 363,399 |         |  | $ | 294,334 |        
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Company-owned stores:                             |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|                                                  | Net sales                                |                                                 | $       | 464,258       |  |               | $       | 405,821       |  |               | $       | 380,671 |  |   | $       | 349,722 |  |   | $       | 282,923 | 
|                                                  | Cost of goods sold and occupancy costs   |                                                 |         | 311,170       |  |               |         | 263,980       |  |               |         | 252,320 |  |   |         | 240,356 |  |   |         | 194,761 | 
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|                                                  | Gross profit                             |                                                 |         | 153,088       |  |               |         | 141,841       |  |               |         | 128,351 |  |   |         | 109,366 |  |   |         | 88,162  | 
|                                                  | Store operating and selling expense      |                                                 |         | 108,294       |  |               |         | 91,576        |  |               |         | 88,128  |  |   |         | 83,470  |  |   |         | 73,970  | 
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|                                                  | Company-owned stores profit contribution |                                                 |         | 44,794        |  |               |         | 50,265        |  |               |         | 40,223  |  |   |         | 25,896  |  |   |         | 14,192  | 
|                                                  | General and administrative expense       |                                                 |         | 32,475        |  |               |         | 27,086        |  |               |         | 26,603  |  |   |         | 30,399  |  |   |         | 15,939  | 
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Retail profit (loss) contribution                 |                                          |                                                 | 12,319  |               |  |               | 23,179  |               |  |               | 13,620  |         |  |   | (4,503  | )       |  |   | (1,747  | )      
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Franchise stores:                                 |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|                                                  | Royalty fees                             |                                                 |         | 18,007        |  |               |         | 17,048        |  |               |         | 14,604  |  |   |         | 13,187  |  |   |         | 10,841  | 
|                                                  | Franchise fees                           |                                                 |         | 355           |  |               |         | 641           |  |               |         | 625     |  |   |         | 490     |  |   |         | 570     | 
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|                                                  | Total franchise revenues                 |                                                 |         | 18,362        |  |               |         | 17,689        |  |               |         | 15,229  |  |   |         | 13,677  |  |   |         | 11,411  | 
|                                                  | Total franchise expense                  |                                                 |         | 6,538         |  |               |         | 6,563         |  |               |         | 4,937   |  |   |         | 4,406   |  |   |         | 4,114   | 
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|                                                  | Franchise profit contribution            |                                                 |         | 11,824        |  |               |         | 11,126        |  |               |         | 10,292  |  |   |         | 9,271   |  |   |         | 7,297   | 
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Operating income                                  |                                          |                                                 | 24,143  |               |  |               | 34,305  |               |  |               | 23,912  |         |  |   | 4,768   |         |  |   | 5,550   |        
|Interest expense, net                             |                                          |                                                 | 3,990   |               |  |               | 5,610   |               |  |               | 7,949   |         |  |   | 8,423   |         |  |   | 2,636   |        
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Income (loss) before income taxes                 |                                          |                                                 | 20,153  |               |  |               | 28,695  |               |  |               | 15,963  |         |  |   | (3,655  | )       |  |   | 2,914   |        
|Provision (benefit) for income taxes(a)           |                                          |                                                 | 8,061   |               |  |               | 11,503  |               |  |               | 6,002   |         |  |   | (4,636  | )       |  |   | 1,127   |        
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Net income                                        |                                          | $                                               | 12,092  |               |  | $             | 17,192  |               |  | $             | 9,961   |         |  | $ | 981     |         |  | $ | 1,787   |        
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Basic earnings per share                          |                                          | $                                               | 0.73    |               |  | $             | 1.32    |               |  | $             | 0.78    |         |  | $ | 0.08    |         |  | $ | 0.14    |        
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Diluted earnings per share                        |                                          | $                                               | 0.62    |               |  | $             | 0.89    |               |  | $             | 0.56    |         |  | $ | 0.07    |         |  | $ | 0.14    |        
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Weighted average shares outstanding 
    basic   |                                          |                                                 | 16,602  |               |  |               | 13,068  |               |  |               | 12,723  |         |  |   | 12,611  |         |  |   | 12,411  |        
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        
|Weighted average shares outstanding 
    diluted |                                          |                                                 | 19,646  |               |  |               | 19,313  |               |  |               | 17,819  |         |  |   | 14,283  |         |  |   | 12,704  |        
|                                                  |                                          |                                                 |         |               |  |               |         |               |  |               |         |         |  |   |         |         |  |   |         |        

16



---



##### Table of Contents



|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |         |  
|------------------------------------------- | -------------------------------------------- | ----------------------------------------------- | ------ | ------------- | - | ------------- | ------ | ------------- | - | ------------- | ------ | ------- | - | - | ------ | ------- | - | - | ------ | ------- | -
|                                            |                                              |                                                
|                                            |                                              | Year Ended                                     
|                                            |                                              |                                                
|                                            |                                              | June 28,                                        |        | June 29,      |   | June 30,      |        | July 1,       |   | December 31, 
|                                            |                                              | 2003(d)                                         |        | 2002(d)       |   | 2001(d)       |        | 2000(d)       |   | 1998(d)      
|                                            |                                              |                                                 |        |               |   |               |        |               |   |              
|                                            |                                              |                                                
|                                            |                                              | (In thousands, except per share and store data)
|                                            |                                              | (As restated)                                   |        | (As restated) |   | (As restated) |        | (As restated) |   | (As restated)
|Operating Data:                             |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Number of Company-owned stores (end of year) |                                                 |        | 242           |   |               |        | 209           |   |               |        | 193     |   |   |        | 197     |   |   |        | 207     |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Increase in Company-owned same store sales   |                                                 |        | 2.2           | % |               |        | 4.9           | % |               |        | 10.3    | % |   |        | 3.8     | % |   |        | 11.3    | %
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Number of franchise stores (end of year)     |                                                 |        | 241           |   |               |        | 242           |   |               |        | 261     |   |   |        | 211     |   |   |        | 167     |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Increase in franchise same store sales       |                                                 |        | 3.7           | % |               |        | 4.5           | % |               |        | 4.3     | % |   |        | 7.9     | % |   |        | 6.8     | %
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Average sales per Company-owned store        |                                                 | $      | 2,090         |   |               | $      | 2,044         |   |               | $      | 1,961   |   |   | $      | 1,810   |   |   | $      | 1,684   |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|Other Information:                          |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Depreciation and amortization                |                                                 | $      | 16,229        |   |               | $      | 12,156        |   |               | $      | 10,431  |   |   | $      | 10,757  |   |   | $      | 6,598   |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|Cash flow provided by (used in):            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Investing activities                         |                                                 | $      | (22,234       | ) |               | $      | (20,008       | ) |               | $      | (15,664 | ) |   | $      | 6,184   |   |   | $      | (39,094 | )
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Financing activities                         |                                                 |        | (949          | ) |               |        | (17,409       | ) |               |        | (12,320 | ) |   |        | (18,845 | ) |   |        | 48,648  |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|Balance Sheet Data:                         |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Working capital (deficiency)                 |                                                 | $      | 12,867        |   |               | $      | 14,707        |   |               | $      | 8,784   |   |   | $      | 15,069  |   |   | $      | (15,039 | )
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Total assets                                 |                                                 |        | 167,999       |   |               |        | 149,054       |   |               |        | 141,342 |   |   |        | 132,086 |   |   |        | 149,343 |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Bank borrowings(c)                           |                                                 |        | 11,229        |   |               |        | 8,915         |   |               |        | 16,006  |   |   |        | 29,547  |   |   |        |        |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Stockholders equity                         |                                                 |        | 79,422        |   |               |        | 67,599        |   |               |        | 51,090  |   |   |        | 40,861  |   |   |        | 49,368  |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|EBITDA:                                     |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|EBITDA(b)                                   |                                              | $                                               | 40,372 |               |   | $             | 46,461 |               |   | $             | 34,343 |         |   | $ | 15,525 |         |   | $ | 12,148 |        
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|Most directly comparable GAAP
    measures: |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Net income                                   |                                                 | $      | 12,092        |   |               | $      | 17,192        |   |               | $      | 9,961   |   |   | $      | 981     |   |   | $      | 1,787   |  
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        
|                                            | Cash flows provided by (used in):            |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |         |  
|                                            | Operating activities                         |                                                 | $      | 23,088        |   |               | $      | 31,042        |   |               | $      | 33,876  |   |   | $      | 5,141   |   |   | $      | (2,697  | )
|                                            |                                              |                                                 |        |               |   |               |        |               |   |               |        |         |   |   |        |         |   |   |        |        

17



---



##### Table of Contents



|                                                            |                                                 |                                       |         |               |   |   |        |         |  
|----------------------------------------------------------- | ----------------------------------------------- | ------------------------------------- | ------- | ------------- | - | - | ------ | ------- | -
|                                                            |                                                 |                                      
|                                                            |                                                 | Six Months Ended                     
|                                                            |                                                 |                                      
|                                                            |                                                 | July 3,                               |         | June 30,     
|                                                            |                                                 | 1999(e)                               |         | 1998         
|                                                            |                                                 |                                       |         |              
|                                                            |                                                 |                                      
|                                                            |                                                 | (In thousands, except per share data)
|                                                            |                                                 | (As restated)                         |         | (As restated)
|Statement of Operations Data:                               |                                                 |                                       |         |               |   |   |        |        
|Total revenues                                              |                                                 | $                                     | 156,509 |               |   | $ | 97,272 |        
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Company-owned stores:                                       |                                                 |                                       |         |               |   |   |        |        
|                                                            | Net sales                                       |                                       | $       | 151,349       |   |   | $      | 92,718  |  
|                                                            | Cost of goods sold and occupancy costs          |                                       |         | 109,858       |   |   |        | 65,246  |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|                                                            | Gross profit                                    |                                       |         | 41,491        |   |   |        | 27,472  |  
|                                                            | Store operating and selling expenses            |                                       |         | 42,052        |   |   |        | 24,111  |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|                                                            | Company-owned stores (loss) profit contribution |                                       |         | (561          | ) |   |        | 3,361   |  
|                                                            | General and administrative expenses             |                                       |         | 15,856        |   |   |        | 5,615   |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Retail loss                                                 |                                                 |                                       | (16,417 | )             |   |   | (2,254 | )      
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Franchise stores:                                           |                                                 |                                       |         |               |   |   |        |        
|                                                            | Royalty fees                                    |                                       |         | 4,907         |   |   |        | 4,379   |  
|                                                            | Franchise fees                                  |                                       |         | 253           |   |   |        | 175     |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|                                                            | Total franchise revenues                        |                                       |         | 5,160         |   |   |        | 4,554   |  
|                                                            | Total franchise expense                         |                                       |         | 1,906         |   |   |        | 1,803   |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|                                                            | Franchise profit contribution                   |                                       |         | 3,254         |   |   |        | 2,751   |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Operating (loss) income                                     |                                                 |                                       | (13,163 | )             |   |   | 497    |        
|Interest expense, net                                       |                                                 |                                       | 2,378   |               |   |   | 873    |        
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Loss before income taxes                                    |                                                 |                                       | (15,541 | )             |   |   | (376   | )      
|Benefit for income taxes(a)                                 |                                                 |                                       | (2,125  | )             |   |   | (146   | )      
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Net loss                                                    |                                                 | $                                     | (13,416 | )             |   | $ | (230   | )      
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Basic and diluted loss per share                            |                                                 | $                                     | (1.08   | )             |   | $ | (0.02  | )      
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Weighted average shares outstanding 
    basic and diluted |                                                 |                                       | 12,455  |               |   |   | 12,376 |        
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Other information:                                          |                                                 |                                       |         |               |   |   |        |        
|                                                            | Depreciation and amortization                   |                                       | $       | 5,229         |   |   | $      | 3,634   |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Cash flows provided by (used in):                           |                                                 |                                       |         |               |   |   |        |        
|                                                            | Investing activities                            |                                       | $       | (7,933        | ) |   | $      | (12,832 | )
|                                                            |                                                 |                                       |         |               |   |   |        |        
|                                                            | Financing activities                            |                                       |         | 6,449         |   |   |        | 34,329  |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|Balance Sheet Data:                                         |                                                 |                                       |         |               |   |   |        |        
|                                                            | Working capital (deficiency)                    |                                       | $       | (26,694       | ) |   | $      | 40,805  |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|                                                            | Total assets                                    |                                       |         | 161,347       |   |   |        | 119,168 |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|                                                            | Bank borrowings(c)                              |                                       |         |              |   |   |        | 40,182  |  
|                                                            |                                                 |                                       |         |               |   |   |        |        
|                                                            | Stockholders equity                            |                                       |         | 35,934        |   |   |        | 46,103  |  
|                                                            |                                                 |                                       |         |               |   |   |        |        

18



---



##### Table of Contents



|                                            |                                   |                                       |        |               |     |   |       |      |         |  
|------------------------------------------- | --------------------------------- | ------------------------------------- | ------ | ------------- | --- | - | ----- | ---- | ------- | -
|                                            |                                   |                                      
|                                            |                                   | Six Months Ended                     
|                                            |                                   |                                      
|                                            |                                   | July 3,                               |        | June 30,     
|                                            |                                   | 1999                                  |        | 1998         
|                                            |                                   |                                       |        |              
|                                            |                                   |                                      
|                                            |                                   | (In thousands, except per share data)
|                                            |                                   | (As restated)                         |        | (As restated)
|EBITDA:                                     |                                   |                                       |        |               |     |   |       |     
|EBITDA(b)                                   |                                   | $                                     | (7,934 | )             |     | $ | 4,131 |     
|                                            |                                   |                                       |        |               |     |   |       |     
|Most directly comparable GAAP
    measures: |                                   |                                       |        |               |     |   |       |     
|                                            | Net loss                          |                                       | $      | (13,416       | )   |   | $     | (230 | )      
|                                            | Cash flows provided by (used in): |                                       |        |               |     |   |       |      |        
|                                            |                                   | Operating activities                  |        | $             | 779 |   |       | $    | (21,984 | )
|                                            |                                   |                                       |        |               |     |   |       |     



---



|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | The fiscal year ended July 1, 2000 includes
    $3.7 million of benefit related to the reversal of
    valuation reserves on deferred tax assets established in the six
    months ended July 3, 1999 due to the uncertainty at that
    time that our net operating loss carryforwards would be realized.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|(b) |  | Our definition of EBITDA is earnings before
    interest, taxes, depreciation and amortization. We believe
    EBITDA provides additional information for determining our
    ability to meet future debt service requirements. EBITDA should
    not be construed as a substitute for income from operations, net
    income or cash flow from operating activities (all as determined
    in accordance with generally accepted accounting principles) for
    the purpose of analyzing our operating performance, financial
    position and cash flows as EBITDA is not defined by generally
    accepted accounting principles. We have presented EBITDA,
    however, because it is commonly used by certain investors and
    analysts to analyze and compare companies on the basis of
    operating performance and to determine a companys ability
    to service and/or incur debt. Our computation of EBITDA may not
    be comparable to similar titled measures of other companies.

A reconciliation of EBITDA to net income follows
for the periods indicated:

|                                     |  |                |         |                  |  |          |         |         |  |              |         |         |  |          |         |   |  |   |        |   |  |   |         |   |  |   |        |  
|------------------------------------ |  | -------------- | ------- | ---------------- |  | -------- | ------- | ------- |  | ------------ | ------- | ------- |  | -------- | ------- | - |  | - | ------ | - |  | - | ------- | - |  | - | ------ | -
|                                     |  |                |         |                 
|                                     |  | Year Ended     |         | Six Months Ended
|                                     |  |                |         |                 
|                                     |  | June 28,       |         | June 29,         |  | June 30, |         | July 1, |  | December 31, |         | July 1, |  | June 30,
|                                     |  | 2003           |         | 2002             |  | 2001     |         | 2000    |  | 1998         |         | 1999    |  | 1998    
|                                     |  |                |         |                  |  |          |         |         |  |              |         |         |  |         
|                                     |  |               
|                                     |  | (In thousands)
|EBITDA                               |  | $              | 40,372  |                  |  | $        | 46,461  |         |  | $            | 34,343  |         |  | $        | 15,525  |   |  | $ | 12,148 |   |  | $ | (7,934  | ) |  | $ | 4,131  |  
|Depreciation and amortization        |  |                | (16,229 | )                |  |          | (12,156 | )       |  |              | (10,431 | )       |  |          | (10,757 | ) |  |   | (6,598 | ) |  |   | (5,229  | ) |  |   | (3,634 | )
|Interest expense, net                |  |                | (3,990  | )                |  |          | (5,610  | )       |  |              | (7,949  | )       |  |          | (8,423  | ) |  |   | (2,636 | ) |  |   | (2,378  | ) |  |   | (873   | )
|(Provision) benefit for income taxes |  |                | (8,061  | )                |  |          | (11,503 | )       |  |              | (6,002  | )       |  |          | 4,636   |   |  |   | (1,127 | ) |  |   | 2,125   |   |  |   | 146    |  
|                                     |  |                |         |                  |  |          |         |         |  |              |         |         |  |          |         |   |  |   |        |   |  |   |         |   |  |   |        |  
|Net income (loss)                    |  | $              | 12,092  |                  |  | $        | 17,192  |         |  | $            | 9,961   |         |  | $        | 981     |   |  | $ | 1,787  |   |  | $ | (13,416 | ) |  | $ | (230   | )
|                                     |  |                |         |                  |  |          |         |         |  |              |         |         |  |          |         |   |  |   |        |   |  |   |         |   |  |   |        |  

19



---



##### Table of Contents



Because we also consider EBITDA useful as a
liquidity measure, we present the following reconciliation of
EBITDA to our cash flow from operating activities:

|                                                   |                                                                      |                                                         |        |                  |        |          |         |         |        |              |        |         |        |          |        |        |       |   |        |         |        |   |        |        |     |   |       |         |         |  
|-------------------------------------------------- | -------------------------------------------------------------------- | ------------------------------------------------------- | ------ | ---------------- | ------ | -------- | ------- | ------- | ------ | ------------ | ------ | ------- | ------ | -------- | ------ | ------ | ----- | - | ------ | ------- | ------ | - | ------ | ------ | --- | - | ----- | ------- | ------- | -
|                                                   |                                                                      |                                                         |        |                 
|                                                   |                                                                      | Year Ended                                              |        | Six Months Ended
|                                                   |                                                                      |                                                         |        |                 
|                                                   |                                                                      | June 28,                                                |        | June 29,         |        | June 30, |         | July 1, |        | December 31, |        | July 1, |        | June 30,
|                                                   |                                                                      | 2003                                                    |        | 2002             |        | 2001     |         | 2000    |        | 1998         |        | 1999    |        | 1998    
|                                                   |                                                                      |                                                         |        |                  |        |          |         |         |        |              |        |         |        |         
|                                                   |                                                                      |                                                        
|                                                   |                                                                      | (In thousands)                                         
|EBITDA                                             |                                                                      | $                                                       | 40,372 |                  |        | $        | 46,461  |         |        | $            | 34,343 |         |        | $        | 15,525 |        |       | $ | 12,148 |         |        | $ | (7,934 | )      |     | $ | 4,131 |        
|Interest expense, net                              |                                                                      |                                                         | (3,990 | )                |        |          | (5,610  | )       |        |              | (7,949 | )       |        |          | (8,423 | )      |       |   | (2,636 | )       |        |   | (2,378 | )      |     |   | (873  | )      
|(Provision) benefit for income taxes               |                                                                      |                                                         | (8,061 | )                |        |          | (11,503 | )       |        |              | (6,002 | )       |        |          | 4,636  |        |       |   | (1,127 | )       |        |   | 2,125  |        |     |   | 146   |        
|Non-cash interest                                  |                                                                      |                                                         | 1,624  |                  |        |          | 1,395   |         |        |              | 1,815  |         |        |          | 1,506  |        |       |   |       |         |        |   |       |        |     |   |      |        
|Deferred taxes                                     |                                                                      |                                                         | (2,131 | )                |        |          | 819     |         |        |              | 1,543  |         |        |          | (6,213 | )      |       |   | (933   | )       |        |   | (2,338 | )      |     |   | (6    | )      
|Deferred rent                                      |                                                                      |                                                         | 556    |                  |        |          | 765     |         |        |              | 1,148  |         |        |          | 978    |        |       |   | 2,459  |         |        |   | 1,082  |        |     |   | 1,024 |        
|Stock based compensation                           |                                                                      |                                                         | 342    |                  |        |          | 463     |         |        |              | 264    |         |        |          |       |        |       |   |       |         |        |   |       |        |     |   |      |        
|(Provision for) benefit from doubtful accounts     |                                                                      |                                                         | (498   | )                |        |          | (67     | )       |        |              | (65    | )       |        |          | 975    |        |       |   | 127    |         |        |   | 204    |        |     |   |      |        
|Tax effect of non-qualified stock options          |                                                                      |                                                         | 556    |                  |        |          | 37      |         |        |              |       |         |        |          |       |        |       |   |       |         |        |   |       |        |     |   |      |        
|Impairment charge                                  |                                                                      |                                                         | 1,505  |                  |        |          |        |         |        |              | 2,275  |         |        |          | 1,172  |        |       |   |       |         |        |   | 300    |        |     |   |      |        
|Loss (gain) on dispositions and sale of
    stores |                                                                      |                                                         | 162    |                  |        |          |        |         |        |              | (131   | )       |        |          | 1,386  |        |       |   |       |         |        |   | 234    |        |     |   |      |        
|Changes in assets and liabilities:                 |                                                                      |                                                         |        |                  |        |          |         |         |        |              |        |         |        |          |        |        |       |   |        |         |        |   |        |        |     |   |       |        
|                                                   | Accounts payable, accrued expenses and other
    current liabilities |                                                         |        | 3,608            |        |          |         | 4,894   |        |              |        | 11,522  |        |          |        | (3,416 | )     |   |        | 5,353   |        |   |        | 1,392  |     |   |       | (8,977  | )      
|                                                   | Merchandise inventory                                                |                                                         |        | (9,634           | )      |          |         | (7,310  | )      |              |        | (6,606  | )      |          |        | 186    |       |   |        | (15,618 | )      |   |        | 11,897 |     |   |       | (11,997 | )      
|                                                   | Other long-term liabilities                                          |                                                         |        | 121              |        |          |         | 833     |        |              |        | (326    | )      |          |        | (306   | )     |   |        | (630    | )      |   |        | (89    | )   |   |       |        |        
|                                                   | Other current assets and other assets                                |                                                         |        | (1,444           | )      |          |         | (135    | )      |              |        | 2,045   |        |          |        | (2,865 | )     |   |        | (1,840  | )      |   |        | (3,716 | )   |   |       | (5,432  | )      
|                                                   |                                                                      |                                                         |        |                  |        |          |         |         |        |              |        |         |        |          |        |        |       |   |        |         |        |   |        |        |     |   |       |        
|                                                   |                                                                      | Net cash provided by (used in) operating
    activities |        | $                | 23,088 |          |         | $       | 31,042 |              |        | $       | 33,876 |          |        | $      | 5,141 |   |        | $       | (2,697 | ) |        | $      | 779 |   |       | $       | (21,984 | )
|                                                   |                                                                      |                                                         |        |                  |        |          |         |         |        |              |        |         |        |          |        |        |       |   |        |         |        |   |        |        |     |   |       |        

We use EBITDA to determine our executive
compensation plan which bases incentive compensation payments on
our EBITDA performance measured against budget. EBITDA is also
widely used by us and others in our industry to evaluate and
price potential acquisitions.

EBITDA has limitations as an analytical tool, and
you should not consider it in isolation, or as a substitute for
analysis of our results as reported under GAAP. Some of these
limitations are:



| |   |                                                                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | EBITDA does not reflect our cash expenditures, or
    future requirements, for capital expenditures or contractual
    commitments;                                                                                                       
|
| |  | EBITDA does not reflect changes in, or cash
    requirements for, our working capital needs;                                                                                                                                              
|
| |  | EBITDA does not reflect the significant interest
    expense, or the cash requirements necessary to service interest
    or principal payments, on our debts;                                                                             
|
| |  | Although depreciation and amortization are
    non-cash charges, the assets being depreciated and amortized
    will often have to be replaced in the future, and EBITDA does
    not reflect any cash requirements for such replacements;

20



---



##### Table of Contents





| |   |                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | EBITDA does not reflect the impact of earnings or
    charges resulting from matters we consider not to be indicative
    of our ongoing operations; and
|
| |  | Other companies in our industry may calculate
    EBITDA differently than we do, limiting its usefulness as a
    comparative measure.                  

Because of these limitations, EBITDA should not
be considered as a measure of discretionary cash available to us
to invest in the growth of our business. We compensate for these
limitations by relying primarily on our GAAP results and using
EBITDA only supplementally.

(c) Excludes borrowings under our previous
credit agreement of $58.6 million and $46.8 million
included in current liabilities at July 3, 1999 and
December 31, 1998, respectively. Bank borrowings and other
long-term liabilities at June 29, 2002, June 30, 2001
and July 1, 2000 is net of an unamortized debt discount of
$1.3 million, $1.9 million and $3.0 million,
respectively.

(d) As restated, see Note 17 to the
consolidated financial statements included in Item 8.

(e) We determined that the cash overdraft
should have been classified as a liability rather than a
reduction of cash and cash equivalents. As a result, the
consolidated balance sheets and consolidated statements of cash
flows for the years ended December 31, 1998 and the six
months ended July 3, 1999 have been restated to reflect
(i) the cash overdraft as a liability rather than a
reduction in cash and cash equivalents and (ii) the cash
flows related to the Companys cash overdraft as a
financing activity rather than a reduction in cash and cash
equivalents.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

This section has been updated to give effect
to the restatement as discussed in Note 17 to the audited
consolidated financial statements included in Item 8, and
should be read in conjunction with the accompanying audited
consolidated financial statements prepared in accordance with
accounting principles generally accepted in the United States of
America.

Pursuant to SEC comments, we agreed to make
certain revisions in our future filings, which we made in our
Quarterly Report on Form 10-Q for the three months ended
March 27, 2004 and have made herein. Except for the
formatting revisions we made pursuant to SEC comments, we did
not alter the presentation herein to conform to the improved
format we set forth in our Quarterly Report on Form 10-Q
for the three months ended March 27, 2004. We have also
updated certain disclosure statements in Liquidity and
Capital Resources that were made as of September 19,
2003, the latest practicable date for which such information was
available as of the filing of the Original 10-K.

Critical Accounting Policies and
Estimates

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America requires the appropriate application of
certain accounting policies, many of which require estimates and
assumptions about future events and their impact on amounts
reported in the financial statements and related notes. Since
future events and their impact cannot be determined with
certainty, the actual results will inevitably differ from our
estimates. Such differences could be material to the
consolidated financial statements.

We believe our application of accounting
policies, and the estimates inherently required by the policies,
are reasonable. These accounting policies and estimates are
constantly reevaluated and adjustments are made when facts and
circumstances dictate a change. Historically, we have found the
application of accounting policies to be appropriate, and actual
results generally do not differ materially from those determined
using necessary estimates.

Our accounting policies are more fully described
in Note 1 to the consolidated financial statements
contained herein. We have identified certain critical accounting
policies that are described below.

Merchandise
inventory.Inventory is valued using
the cost method which values inventory at the lower of the
actual cost or market, at the individual item level. Cost is
determined using the weighted average method. Inventory levels
are reviewed to identify slow-moving and closeout merchandise
that will no longer be carried. Market is determined by the
estimated net realizable value, based upon the merchandise
selling price.

21



---



##### Table of Contents



Finite long-lived
assets.In the evaluation of the fair
value and future benefits of finite long-lived assets, we
perform an analysis of the anticipated undiscounted future net
cash flows of the related finite long-lived assets. If the
carrying value of the related asset exceeds the undiscounted
cash flows, the carrying value is reduced to its fair value.
Various factors including future sales growth and profit margins
are included in this analysis. To the extent these future
projections or strategies change, the conclusion regarding
impairment may differ from the current estimates.

Insurance accruals.Our consolidated balance sheets include liabilities with respect
to self-insured workers compensation and general liability
claims. We estimate the required liability of such claims on a
discounted basis utilizing an actuarial method, based upon
various assumptions, which include, but are not limited to, our
historical loss experience, projected loss development factors,
actual payroll and other data. The required liability is also
subject to adjustment in the future based upon the changes in
claims experience, including changes in the number of incidents
(frequency) and changes in the ultimate cost per incident
(severity).

Goodwill.All of our
goodwill is associated with our retail segment. We evaluate
goodwill annually or whenever events and changes in
circumstances suggest that the carrying amount may not be
recoverable from its estimated future cash flows. In making this
assessment, management relies on a number of factors including
operating results, business plans, economic projections,
anticipated future cash flows and marketplace data. A change in
these underlying assumptions may cause a change in the results
of the tests and, as such, could cause fair value to be less
than the carrying value. In such event, we would then be
required to record a charge, which would impact earnings.

Sales Returns.We
estimate future sales returns and, when material, record a
provision in the period that the related sales are recorded
based on historical information. Should actual returns differ
from our estimates, we would be required to revise estimated
sales returns.

Store Closure Costs.We record estimated store closure costs, estimated lease
commitment costs net of estimated sublease income and other
miscellaneous store closing costs, when the liability is
incurred. Such estimates may be subject to change should actual
costs differ.

General

Net Sales.Net sales
include same store sales and new store sales. Same store sales
include sales for those stores that were in operation for a full
period in both the current month and the corresponding month for
the prior year. New store sales include sales in the current
fiscal year from stores opened during the previous fiscal year
before they are considered same stores and new stores opened in
the current fiscal year.

Cost of goods sold and occupancy
costs.Cost of goods sold and
occupancy costs includes the cost of merchandise, freight to the
stores and store occupancy costs. Store occupancy costs include
rent, common area maintenance, real estate taxes, repairs and
maintenance, depreciation, insurance and utilities.

Store operating and selling
expenses.Store operating and selling
expenses consist of selling and store management payroll,
employee benefits, medical insurance, employment taxes,
advertising, pre-opening expenses which are expensed when
incurred and other store level expenses.

General and administrative
expenses.General and administrative
expenses include payroll and employee benefits, employment
taxes, management information systems, marketing, insurance,
legal and other corporate level expenses. Corporate level
expenses are primarily attributable to our corporate office in
Rockaway, New Jersey.

Franchising.Franchise revenue is composed of the initial franchise fees,
which are recorded as revenue when a franchise store opens, and
ongoing royalty fees, generally 4.0% of the stores net
sales.

Interest expense.Interest and debt expense includes interest relating to our
senior notes and credit facility. Interest also includes
amortization of financing intangibles, bank service charges and
interest on capital lease obligations.

22



---



##### Table of Contents



Results of Operations

Our revenues and earnings are generated primarily
from our two business segments  Retail and
Franchising.



| |                                                                                                      
| | -----------------------------------------------------------------------------------------------------
| | Year Ended June 28, 2003 (Fiscal
    2003) Compared to Year Ended June 29, 2002
    (Fiscal 2002)

Retail.Net sales
from Company-owned stores increased 14.4% to $464.3 million
in Fiscal 2003 from $405.8 million in Fiscal 2002. The
Fiscal 2003 results include 209 stores that were open at the
beginning of that year, plus 13 stores acquired during the year,
22 stores opened during the year and two stores closed during
the year. Same store sales increased 2.2% in Fiscal 2003 and the
remaining 12.2% increase in sales relates to the stores that
have been open for less than one year. The customer count in
company-owned stores, on a same store basis, decreased 1.2%, and
the average sale, on a same store basis, increased 3.4%. With
nine stores joining the same store sales group during Fiscal
2003, same store sales increased 2.8% in the eastern region,
2.1% in the central region and 1.4% in the western region.

Gross profit, which is net sales minus cost of
goods sold and occupancy costs, increased 7.9% to
$153.1 million in Fiscal 2003 from $141.8 million in
Fiscal 2002. The increase in gross profit of $11.3 million
is due to increases in gross profit from new stores of
$12.0 million and an increase in gross profit in mature
stores (i.e., stores open for 24 months or longer) of
$1.7 million offset by $2.4 million of markdown
charges. This $12.0 million increase in gross profit from
35 new stores was produced at a reduced gross profit rate due to
the higher occupancy costs ratio in new stores, including stores
acquired in the Seattle market which were opened in early Fiscal
2003. The new store gross margin rate for Fiscal 2003 was 23.5%
compared to the mature store gross margin rate for Fiscal 2003
of 34.4%. In addition, we increased promotional efforts to clear
slower moving merchandise which caused us to recognize markdown
charges of approximately $2.4 million related to products
identified for clearance. As a percent of sales, these markdown
charges decreased gross profit by approximately 0.6%. Gross
profit as a percentage of sales was 33.0% and 35.0% for Fiscal
2003 and Fiscal 2002, respectively.

Store operating and selling expenses increased
18.3% to $108.3 million for Fiscal 2003 from
$91.6 million in Fiscal 2002. The increase in store
operating expenses of $16.7 million is primarily
attributable to increased expenses of $16.4 million related
to 35 new stores, including $4.2 million of additional
advertising expense and $12.2 million of new store
operating expenses. Store operating expenses were 23.3% of sales
for Fiscal 2003 compared with 22.6% of sales in Fiscal 2002 due
to the impact of new stores not having achieved mature store
sales levels. For Fiscal 2003, operating expenses as a percent
of sales were 22.2% for mature stores compared to 32.3% for our
stores open for less than 24 months, including stores
acquired in the Seattle market.

Pre-opening expenses of $1.6 million were
recorded in Fiscal 2003 for 22 new stores opened during the
year and for eight stores scheduled to open in the first quarter
of Fiscal 2004. Pre-opening expenses of $753,000 were recorded
in Fiscal 2002 for 13 new stores opened during the year and
for eight stores scheduled to open in the first quarter of
Fiscal 2003.

Company-owned store profit contribution, which is
gross profit minus store operating and selling expenses,
decreased to $44.8 million in Fiscal 2003 compared with
$50.3 million in Fiscal 2002 for the reasons set forth
above.

General and administrative expenses increased
19.9% to $32.5 million in Fiscal 2003, compared with
$27.1 million in Fiscal 2002. The increase of
$5.4 million is primarily attributable to an increased
store base which required investments in new systems and new
logistics initiatives and related consulting services. Our
investments resulted in additional depreciation of approximately
$1.0 million, and we incurred $1.4 million of
professional and consulting fees related to the implementation
of these systems and logistics initiatives. Furthermore, we
recorded fixed asset and goodwill impairment charges of
approximately $1.5 million associated with five
under-performing stores, and executive severance and other
payroll charges of $700,000.

Retail profit contribution, which is store profit
contribution minus general and administrative expenses,
decreased by 46.9% to $12.3 million in Fiscal 2003,
compared with $23.2 million in Fiscal 2002. Retail profit

23



---



##### Table of Contents



contribution as a percent of sales was 2.7% in
Fiscal 2003 compared with 5.7% in Fiscal 2002 for the reasons
set forth above.


Franchising.Royalty
fees increased 5.6% to $18.0 million in Fiscal 2003
compared with $17.0 million in Fiscal 2002. Franchise fees,
recognized on nine store openings during Fiscal 2003, decreased
44.6% to $355,000 compared with $641,000 during Fiscal 2002
recognized on 19 store openings. Franchise same store sales
increased 3.7% in Fiscal 2003 as compared with a 4.5% increase
in Fiscal 2002.

Expenses related to franchise revenue decreased
0.4% to $6.5 million in Fiscal 2003 from $6.6 million
in Fiscal 2002. As a percentage of franchise revenue, franchise
expenses were 35.6% and 37.1% for Fiscal 2003 and Fiscal 2002,
respectively. Franchise expenses include direct and indirect
expenses. The direct expenses include salaries, travel and other
direct expenses of the franchise operations department in
addition to legal fees, bad debt expense, insurance expense and
other miscellaneous charges. The indirect expenses include
pro-rata allocations of corporate expenses for salaries,
including bonuses, occupancy and depreciation based on time
spent on franchise support.

Franchise profit contribution, which is franchise
revenue minus expenses related to franchise revenue, increased
6.3% to $11.8 million in Fiscal 2003 from
$11.1 million in Fiscal 2002. The increase in franchise
profit contribution is due to the increase in royalty fees along
with a decrease in franchise expenses, offset in part by a
decrease in franchise fee income, as discussed above.

Interest Expense.Interest expense decreased 28.9% to $4.0 million for Fiscal
2003 from $5.6 million in Fiscal 2002. This decrease in
interest expense is due to the repurchase of outstanding senior
notes during the later part of the second quarter that had an
effective interest rate of 29%, with a cash interest rate of
18.5%. The repurchase of these notes was completed using cash
from operations and borrowings under the credit agreement at
significantly lower interest costs. The repurchase of the notes
resulted in a pre-tax charge of $2.2 million related to a
pre-payment premium. As a result of the cash needed to
repurchase the notes, the average borrowings under the Credit
Agreement in Fiscal 2003 were $12.2 million compared with
average borrowings under the Credit Agreement of
$3.4 million in Fiscal 2002.

Income Taxes.Income
taxes of $8.1 million, or 40.0% of pre-tax income, were
provided in Fiscal 2003 compared to income taxes of
$11.5 million, or 40.1% of pre-tax income recorded in
Fiscal 2002.

Net Income.As a
result of the above factors, net income decreased to
$12.1 million or $0.73 per basic share and
$0.62 per diluted share in Fiscal 2003, as compared to net
income of $17.2 million, or $1.32 per basic share and
$0.89 per diluted share in Fiscal 2002. Weighted average
basic shares outstanding increased from 13.1 million in
Fiscal 2002 to 16.6 million in Fiscal 2003 due to the
exercise of 672,459 warrants during Fiscal 2003. Weighted
average diluted shares increased from 19.3 million in
Fiscal 2002 to 19.6 million in Fiscal 2003.



| |                                                                                                      
| | -----------------------------------------------------------------------------------------------------
| | Year Ended June 29, 2002 (Fiscal
    2002) Compared to Year Ended June 30, 2001
    (Fiscal 2001)

Retail.Net sales
from Company-owned stores increased 6.6% to $405.8 million
in Fiscal 2002 from $380.7 million in Fiscal 2001. The
Fiscal 2002 results include 193 stores that were open at the
beginning of that year, plus three stores acquired during the
year and 13 stores opened during the year. Same store sales
increased 4.9% in Fiscal 2002.

Gross profit for Fiscal 2002 increased 10.5% to
$141.8 million compared to $128.4 million for Fiscal
2001. The increase in Fiscal 2002 was primarily due to increased
sales volume and improvements in gross margin. Gross margin was
35.0% and 33.7% of sales for Fiscal 2002 and Fiscal 2001,
respectively. The increase in gross margin was related primarily
to stronger controls over inventory resulting in reduced
inventory loss, improved buying and leveraged occupancy costs.

Store operating and selling expenses increased
3.9% to $91.6 million for Fiscal 2002, compared to
$88.1 million in Fiscal 2001. The increase in store
operating expenses is primarily attributable to increased
expenses related to new stores. Store operating expenses were
22.6% of sales for Fiscal 2002 compared to 23.2% of sales for
Fiscal 2001 due to efficiencies occurring in staffing and
advertising resulting from an

24



---



##### Table of Contents



increase in average store sales. Company-owned
store profit contribution increased to $50.3 million for
Fiscal 2002, compared to $40.2 million for Fiscal 2001.


Pre-opening expenses of $753,000 were recorded in
Fiscal 2002 for 13 new stores opened during the year and for
eight stores scheduled to open in the first quarter of Fiscal
2003. Pre-opening expenses of $78,000 were recorded in Fiscal
2001 for four stores opened in the first quarter of Fiscal 2002.

General and administrative expenses increased
1.8% to $27.1 million in Fiscal 2002, compared to
$26.6 million in Fiscal 2001. The increase is primarily
attributable to an increased store base and depreciation related
to the investments in centralized systems and programs that
provide efficiencies at the store level. An impairment charge of
$2.3 million related to store registers replaced in our
information system initiative was recorded in Fiscal 2001.
Excluding this impairment charge, general and administrative
expenses increased 11.3% in Fiscal 2002 compared to Fiscal 2001.
Payroll and benefits increased $1.2 million or 10.4%, to
$13.2 million in Fiscal 2002 from $12.0 million in
Fiscal 2001 as a result of additional headquarters personnel and
increased bonus payments. Exclusive of the impairment charge
discussed above, general and administrative expenses were 6.7%
and 6.4% of sales in Fiscal 2002 and Fiscal 2001, respectively.

Retail profit contribution increased by 70.2% to
$23.2 million in Fiscal 2002, compared to
$13.6 million in Fiscal 2001. Retail profit contribution as
a percent of sales was 5.7% in Fiscal 2002 compared to 3.6% in
Fiscal 2001 reflecting improvements and efficiencies from
increased sales volume, a developing central support staff and
margin improvements.

Franchising.Royalty
fees increased 16.7% to $17.0 million in Fiscal 2002 from
$14.6 million in Fiscal 2001. Franchise fees, recognized on
19 store openings during Fiscal 2002 increased 2.6% to $641,000
compared to $625,000 during Fiscal 2001 recognized on 51 store
openings. The 51 store openings in Fiscal 2001 include 23 new
Party Supermarket stores, for which the initial franchise fee
was not collected and 10 new Canadian stores, for which only a
reduced initial franchise fee was collected. Franchise same
store sales increased 4.5% in Fiscal 2002.

Expenses directly related to franchise revenue
increased 32.9% to $6.6 million for Fiscal 2002 from
$4.9 million for Fiscal 2001. This increase is primarily
attributable to additional franchise personnel required to
operate this portion of our business, and the recording of a
provision for bad debt related to our Canadian franchisee. As a
percentage of franchise revenue, franchise expenses were 37.1%
and 32.4% for Fiscal 2002 and Fiscal 2001, respectively.

Franchise profit contribution increased 8.1% to
$11.1 million for Fiscal 2002 compared to
$10.3 million for Fiscal 2001. The increase in franchise
profit contribution is due to the increase in royalty and
franchise fees offset in part by an increase in franchise
expenses, as discussed above.

Interest Expense.Interest expense decreased to $5.6 million for Fiscal 2002
from $7.9 million in Fiscal 2001. This is attributable to a
reduction in principal balance in Fiscal 2002 as compared to
Fiscal 2001. We expensed approximately $19,000 in the write-off
of debt-issue costs, included in interest expense, related to an
additional prepayment of $7.7 million made in June 2002.

Income Taxes.Income
taxes of $11.5 million, or 40.1% of pre-tax income, were
provided in Fiscal 2002 compared to income taxes of
$6.0 million, or 37.6% of pre-tax income recorded in Fiscal
2001. The effective income tax rate increased as a result of the
increases in our marginal federal rate and state tax rates.

Net Income.As a
result of the above factors, net income increased to
$17.2 million or $1.32 per basic share and
$0.89 per diluted share in Fiscal 2002, as compared to net
income of $10.0 million, or $0.78 per basic share and
$0.56 per diluted share in Fiscal 2001.

Liquidity and Capital Resources

The Companys cash requirements are
primarily for working capital, the opening of new stores, the
improvement and expansion of existing facilities and the
improvement of information systems. Historically, these cash
requirements have been met through cash flow from operating
activities and borrowings under

25



---



##### Table of Contents



credit facilities. At June 28, 2003, working
capital was $12.9 million compared with $14.7 million
at June 29, 2002.


Operating
Activities.Net cash provided by
operating activities was $23.1 million in Fiscal 2003
compared with $31.0 million in Fiscal 2002. The decrease is
primarily due to a decrease in net income of $5.1 million
in Fiscal 2003 and an increase in inventories of
$9.6 million due mainly to the opening of 35 new
stores offset by the closing of two stores.

Investing
Activities.Net cash used in investing
activities was $22.2 million in Fiscal 2003 as compared to
$20.0 million in Fiscal 2002. In Fiscal 2003, we made
investments of $13.8 million for 22 new store
openings, $1.8 million for acquired stores,
$2.8 million in our existing store base, and
$3.8 million for other corporate capital and systems. In
Fiscal 2002, our investments were $7.0 million for 13 new
store openings, $5.9 million for acquired stores,
$1.5 million in our existing store base, and
$5.6 million for other corporate capital and systems.

Financing
Activities.Net cash used in financing
activities was $949,000 primarily due to a payment in November
2002 of $10.2 million in Senior Notes in advance of
maturity, the purchase of $4.1 million of treasury stock as
part of the Companys stock buy-back plan and $524,000 in
financing costs. This is offset in part by $11.2 million in
borrowings under the Loan Agreement, $1.6 million from
proceeds of stock options and warrants and $1.0 million in
cash overdrafts.

Loan Agreement.In
January 2003, the Company entered into a $65 million
revolving credit facility (the Loan Agreement) with
Wells Fargo Retail Finance, LLC, as the arranger, collateral
agent and administrative agent, and Fleet Retail Finance, Inc.,
as the documentation agent. Under the terms of the Loan
Agreement, the Company may borrow amounts based on a percentage
of its eligible inventory and credit card receivables, subject
to certain borrowing conditions and customary sub-limits,
reserves and other limitations. Interest on advances is charged,
at the Companys option, (i) at the adjusted
Eurodollar rate plus the applicable margin, which was set
initially at 1.50% per annum, and is currently at
1.25% per annum, or (ii) at the prime rate less the
applicable margin, which was set initially and is currently at
0.25% per annum. The term of the Loan Agreement is through
April 30, 2006 and is secured by a lien on substantially
all of the Companys assets. Pursuant to the
Loan Agreement, we have a standby letter of credit of
$3.1 million at June 28, 2003 and September 19,
2003. At June 28, 2003, September 19, 2003 and
June 4, 2004, the Company had $11.2 million,
$20.2 million and $0 in borrowings outstanding under the
Loan Agreement, respectively. The Company had $41.7 million
and $19.4 million available to be borrowed under the Loan
Agreement at September 19, 2003 and June 4, 2004,
respectively.

In August, 1999, we received $30 million in
financing from certain investors (the Investors),
who purchased senior secured notes and warrants pursuant to a
Securities Purchase Agreement (the Purchase
Agreement). Under the Purchase Agreement, we issued
(i) $10 million 12.5% Secured Notes due 2003 (the
A Notes); (ii) $5 million 13.0%
Secured Notes due 2003 (the B Notes);
(iii) $5 million 13.0% Secured Notes due 2002 (the
C Notes); (iv) $10 million 14.0%
Secured Notes due 2004 (the D Notes and,
together with the A Notes, the B Notes and the
C Notes, the Notes); and (v) warrants (the
Warrants) to purchase 6,880,000 shares of
our common stock at an initial exercise price of $3.00 per
share issued in connection with the sale and issuance of the
C Notes and the D Notes. The Notes were secured by a
junior lien on substantially all of our assets.

Pursuant to the First Amendment, on
January 14, 2000, we received $7 million in cash
proceeds from the sale to certain of the Investors (the
Investor Group) of a new series of senior secured
notes. Under the First Amendment, we issued $7 million in
aggregate principal amount of 14.0% Senior Secured Notes
due 2002 (the E Notes). The E Notes were
secured by a junior lien on substantially all of our assets.
Under the terms of the First Amendment, the interest rate on the
A Notes, the B Notes, the C Notes and the
D Notes was increased by 4.5%. The Investor Group, together
with the Investors and Congress, entered into an intercreditor
agreement. In consideration for waivers and forbearances granted
by the Investors to various defaults under the terms of our
A Notes, B Notes, C Notes and D Notes, we
also agreed to amend and restate the terms of the Warrants held
by the Investors to acquire 6,880,000 shares of our common
stock. The amended and

26



---



##### Table of Contents



restated warrants (the Amended
Warrants) provide for an exercise price of $1.07 per
share and were issued upon surrender of the Warrants, which had
an exercise price of $3.00 per share.


The Company repaid $10.2 million,
$19.3 million and $8.1 million of the Senior Notes in
the fiscal years ended June 28, 2003, June 29, 2002
and June 30, 2001, respectively. The Notes were secured by
a junior lien on substantially all of the Companys assets.
The fiscal 2003 repurchase resulted in an additional payment of
$1.4 million, comprised of interest and an incentive
premium, and resulted in an after-tax charge of
$1.3 million, or $0.07 per diluted share.

Stock Repurchase.In
September 2001, the Board of Directors authorized us to
repurchase up to $15 million of our outstanding common
stock. The stock repurchases are made at the discretion of
management. During Fiscal 2002, we repurchased
284,000 shares for an aggregate amount of
$1.8 million, or 12.2% of the total amount authorized to be
purchased. During Fiscal 2003, we repurchased
463,000 shares for an aggregate amount of
$4.1 million, or 27.4% of total amount authorized to be
purchased. As of June 4, 2004, we have purchased a total of
747,012 shares for an aggregate amount of
$5.9 million, or 39.6% of the total amount to be purchased.

Our management currently believes that the cash
generated by operating activities, together with the borrowing
availability under the Loan Agreement, will be sufficient to
meet our working capital needs for the next twelve months,
including investments made and expenses incurred in connection
with systems development, logistic initiatives and store
improvements. We are currently free of debt, which permits us to
consider a wide variety of corporate initiatives intended to
improve shareholder value, although there is no assurance that
any specific initiative will be pursued or consummated

Contractual Obligations and Commercial
Commitments

To facilitate an understanding of our contractual
obligations and commercial commitments, the following data is
provided as of June 28, 2003:

|                              |                               |                        |         |         |  |           |        |           |  |               |        |        |  |   |        |        |  |   |        |        | 
|----------------------------- | ----------------------------- | ---------------------- | ------- | ------- |  | --------- | ------ | --------- |  | ------------- | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ | 
|                              |                               |                       
|                              |                               | Payments Due By Period
|                              |                               |                       
|                              |                               | Total                  |         | 1 Year  |  | 2-3 Years |        | 4-5 Years |  | After 5 Years
|                              |                               |                        |         |         |  |           |        |           |  |              
|                              |                               |                       
|                              |                               | (In thousands)        
|Contractual Obligations       |                               |                        |         |         |  |           |        |           |  |               |        |        |  |   |        |        |  |   |        |       
|                              | Operating leases              |                        | $       | 266,233 |  |           | $      | 45,968    |  |               | $      | 87,607 |  |   | $      | 69,595 |  |   | $      | 63,063 | 
|                              | Advances under Loan Agreement |                        |         | 11,229  |  |           |        | 11,229    |  |               |        |       |  |   |        |       |  |   |        |       | 
|                              | Severance arrangements        |                        |         | 199     |  |           |        | 199       |  |               |        |       |  |   |        |       |  |   |        |       | 
|                              | Capital lease obligations     |                        |         | 32      |  |           |        | 32        |  |               |        |       |  |   |        |       |  |   |        |       | 
|                              |                               |                        |         |         |  |           |        |           |  |               |        |        |  |   |        |        |  |   |        |       
|Total Contractual Obligations |                               | $                      | 277,693 |         |  | $         | 57,428 |           |  | $             | 87,607 |        |  | $ | 69,595 |        |  | $ | 63,063 |       
|                              |                               |                        |         |         |  |           |        |           |  |               |        |        |  |   |        |        |  |   |        |       

As of June 28, 2003 and September 19,
2003, we had a contingent liability related to severance
payments to 11 employees which ranged from zero to approximately
$1.1 million. As of June 4, 2004, we had a contingent
liability related to severance payments to 15 employees
which ranged from zero to approximately $2.1 million. As of
June 28, 2003 and September 19, 2003, we had a standby
letter of credit of $3.1 million pursuant to the Loan
Agreement. As of June 4, 2004, we were contingently liable
under a standby letter of credit of $3.7 million pursuant
to the Loan Agreement.

Off-Balance Sheet Arrangements

We have not created, and are not party to, any
special-purpose or off-balance sheet entities for the purpose of
raising capital, incurring debt or operating our business. We do
not have any off-balance sheet arrangements or relationships
with entities that are not consolidated into our financial
statements that are reasonably likely to materially affect our
liquidity or the availability of capital resources.

27



---



##### Table of Contents



Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards
Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities (SFAS No. 146), replacing
Emerging Issues Task Force (EITF) Issue
No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).
SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when
the liability is incurred instead of at the date an entity
commits to an exit plan. This statement also established that
fair value is the objective for the initial measurement of the
liability. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31,
2002. The adoption of SFAS No. 146 has not had and is
not expected to have a material impact on our consolidated
financial statements.

In November 2002, the FASB issued FASB
Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45). FIN 45 requires
that upon issuance of a guarantee, a guarantor must recognize a
liability for the fair value of an obligation assumed under a
guarantee. FIN 45 also requires additional disclosures by a
guarantor in its interim and annual financial statements about
the obligations associated with guarantees issued. The
recognition provisions of FIN 45 are effective for any
guarantees that are issued or modified after December 31,
2002. The disclosure requirement is effective for our fiscal
year ended June 28, 2003. We have evaluated the accounting
provisions of the interpretations and there was no material
impact on our financial condition, results of operations or cash
flows for the fiscal year ended June 28, 2003. We have made
the required disclosures in the consolidated financial
statements as of June 28, 2003.

In November 2002, the EITF reached a consensus on
issues raised in EITF 02-16, Accounting by a Reseller
for Cash Consideration Received from a Vendor
(EITF 02-16). EITF 02-16 addresses the
timing of recognition for rebates that are earned by resellers
based on specified levels of purchases or over specified
periods. This guidance, related to timing of recognition, is to
be applied prospectively to new rebate arrangements entered into
in fiscal periods beginning after January 1, 2003.
EITF 02-16 also addresses the classification of cash
consideration received from vendors in a resellers
statement of operations. The guidance related to income
statement classification is to be applied in annual and interim
financial statements for periods beginning after January 1,
2003. The adoption of EITF 02-16 has not had and is not
expected to have a material impact on our consolidated financial
statements, as the Companys historical policy is
consistent with EITF 02-16.

In December 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based
Compensation (SFAS No. 148).
SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123, Accounting For
Stock-Based Compensation
(SFAS No. 123) to require more prominent
and more frequent disclosures in financial statements about the
effects of stock-based compensation. SFAS No. 148 is
effective for fiscal years ending after December 31, 2002.
We will continue to account for stock-based equity compensation
using the intrinsic value method of APB Opinion 25. We are
required to follow the prescribed disclosure format and have
provided the additional disclosures required by
SFAS No. 148 for the fiscal year ended June 28,
2003.

In January 2003, the FASB issued Interpretation
No. 46 Consolidation of Variable Interest
Entities (FIN 46), with the objective of
improving financial reporting by companies involved with
variable interest entities. A variable interest entity is a
corporation, partnership, trust, or any other legal structure
used for business purposes that either (a) does not have
equity investors with voting rights, or (b) has equity
investors that do not provide sufficient financial resources for
the entity to support its activities. Historically, entities
generally were not consolidated unless the entity was controlled
through voting interests. FIN 46 changes that by requiring
a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from
the variable interest entitys activities or entitled to
receive a majority of the entitys residual returns or
both. A company that consolidates a variable interest entity is
called the primary beneficiary of that entity.
FIN 46 also requires disclosures about variable interest
entities that a company is

28



---



##### Table of Contents



not required to consolidate but in which it has a
significant variable interest. The consolidation requirements of
FIN 46 apply immediately to variable interest entities
created after January 31, 2003. The consolidation
requirements of FIN 46 apply to existing entities in the
first fiscal year or interim period after January 31, 2003,
regardless of when the variable interest entity was established.
We have evaluated the accounting provisions of the
interpretations and there was no material impact on our
financial condition, results of operations or cash flows, since
the Company is not the primary beneficiary of any variable
interest entities.


In April 2003, the FASB issued
SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. This
statement amends and clarifies financial reporting for
derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities. This
statement is effective for contracts entered into or modified
after June 30, 2003. We are currently evaluating the impact
of adopting this statement on our consolidated financial
position and results of operations.

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. This statement establishes standards for how a
company classifies and measures certain financial instruments
with characteristics of both liabilities and equity. This
statement is effective for financial instruments entered into or
modified after May 31, 2003 and otherwise is effective at
the beginning of the first interim period beginning after
June 15, 2003. The statement will be implemented by
reporting the cumulative effect of a change in accounting
principle for financial instruments created before the issuance
date of the statement and still existing at the beginning of the
period of adoption. Although we are still in the process of
reviewing the new statement, we believe this statement will have
no material impact on our consolidated financial statements.



| |                    
| | -------------------
| | Impact of Inflation

We believe that inflation did not have a material
impact on our operations for the periods reported. Significant
increases in cost of merchandise purchased, labor, employee
benefits and other operating expenses could have a material
adverse effect on our results of operations and financial
condition.



| |            
| | -----------
| | Seasonality

Our business is subject to substantial seasonal
variations. Historically, we have realized a significant portion
of our net sales, cash flow and net income in the second fiscal
quarter of the year principally due to the sales in October for
the Halloween season and, to a lesser extent, due to holiday
sales for end of year holidays. We expect that this general
pattern will continue. Our results of operations may also
fluctuate significantly as a result of a variety of other
factors, including the timing of new store openings and store
closings and the timing of the acquisition and disposition of
stores.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    about Market Risk

We, in the normal course of doing business, are
exposed to interest rate change and market risk. As borrowing
patterns are cyclical, we are not dependent on borrowing
throughout the year. Therefore, a sudden increase in interest
rates (which under the Loan Agreement is dependent on, at the
Companys option, (i) at the adjusted Eurodollar rate
plus the applicable margin, which was set initially at
1.50% per annum, and is currently at 1.25% per annum,
or (ii) at the prime rate less the applicable margin, which
was set initially at 0.25% per annum) may, during peak
borrowing, have a negative impact on short-term results.






|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

This section has been updated to give effect
to the restatement as discussed in Note 17 to the
consolidated financial statements, and should be read in
conjunction with the accompanying audited consolidated financial
statements prepared in accordance with accounting principles
generally accepted in the United States of America. While the
restatement did not have any effect on our operating or net
income or on our consolidated balance sheets, it did affect two
line items in our consolidated statements of cash flows:
(i) accounts payable,

29



---



##### Table of Contents



accrued expenses and other current liabilities
relating to net cash provided by operating activities and
(ii) cash overdrafts relating to net cash used in financing
activities.


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






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

None.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

This section has been updated for events and
developments occurring subsequent to the filing of the Original
10-K through June 4, 2004.

We maintain disclosure controls and procedures
that are designed to ensure that information required to be
disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the
Securities and Exchange Commissions (the SEC)
rules and forms and that such information is accumulated and
communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow
for timely decisions regarding required disclosure. In designing
and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control
objectives, and management is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls
and procedures.

We regularly evaluate our internal control over
financial reporting and discuss these matters with our
independent accountants, Deloitte & Touche LLP,
and our audit committee. We concluded in May 2004 that there was
a reportable condition (as defined under standards
established by the American Institute of Certified Public
Accountants) in our internal control over financial reporting
relating to the classification of a financing activity on the
cash flow statement. Previously, the change in the cash
overdraft account was classified from year to year in net cash
provided by (used in) operating activities, rather than being
classified in net cash provided by (used in) financing
activities. The prior treatment resulted in (i) higher net
cash provided by operating activities and higher net cash used
in financing activities of approximately $1,041,000 and
$3,085,000 for the years ended June 28, 2003 and
June 29, 2002, respectively, and (ii) lower net cash
provided by operating activities and lower net cash used in
financing activities of approximately $4,221,000 for the year
ended June 30, 2001. Although the dollar amounts relating
to the reportable condition were immaterial to our results of
operations, financial condition and liquidity, our management,
the audit committee and our independent accountants reviewed and
analyzed our internal controls, procedures and policies in
response to this reportable condition. As a result, we enhanced
our internal controls over financial reporting, including hiring
additional financing and accounting staff, enhancing the
training of our finance and accounting staff and requiring
periodic review of a wider variety of current technical
accounting literature.

In this Annual Report on Form 10-K/ A, we
have restated our consolidated statements of cash flows for the
years ended June 28, 2003, June 29, 2002 and
June 30, 2001 to reflect the cash flow related to our cash
overdraft in the consolidated statements of cash flows as a
financing activity rather than an operating activity. While the
restatement did not have any effect on our operating or net
income or on our consolidated balance sheets, it did affect two
line items in our consolidated statements of cash flows:
(i) accounts payable, accrued expenses and other current
liabilities relating to net cash provided by operating
activities and (ii) cash overdrafts relating to net cash
used in financing activities.

As required by Rule 13a-15(b) under the
Exchange Act and in light of the restatement of our consolidated
statements of cash flows, we conducted an evaluation, under the
supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial
Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the period
covered by this report and as of June 4, 2004. Based on the
foregoing, our management, including our Chief Executive Officer
and Chief Financial Officer, concluded that the reportable
condition had been remediated

30



---



##### Table of Contents



and that our disclosure controls and procedures
were effective at the reasonable assurance level as of the end
of the period covered by this report and as of June 4, 2004.


Other than as described above, there has been no
change in our internal control over financial reporting during
the fourth quarter ended June 28, 2003 that has materially
affected, or is reasonably likely to materially affect, our
internal control over financial reporting. In addition, other
than as described above, since the most recent evaluation date,
there have been no significant changes in our internal control
structure, policies and procedures or in other areas that could
significantly affect our internal control over financial
reporting.




PART III

In accordance with general instruction G(3)
for an Annual Report on Form 10-K/A, the information called
for by Items 10, 11, 12, 13 and 14 of Part III is
incorporated by reference from our definitive Proxy Statement
for our 2003 Annual Meeting of Stockholders.




PART IV






|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | 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/A.



| |                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------
| | 1. The following consolidated financial
    statements listed below are filed as a separate section of this
    Report commencing on page F-1.



| |                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------
| | Report of Independent Registered Public
    Accounting Firm  Deloitte & Touche LLP.                                           
|
| | Consolidated Balance Sheets as of June 28,
    2003 and June 29, 2002.                                                         
|
| | Consolidated Statements of Income for the years
    ended June 28, 2003, June 29, 2002 and June 30,
    2001.                  
|
| | Consolidated Statements of Stockholders
    Equity for the years ended June 28, 2003, June 29,
    2002 and June 30, 2001.    
|
| | Consolidated Statements of Cash Flows for the
    years ended June 28, 2003, June 29, 2002 and
    June 30, 2001 (As Restated).
|
| | Notes to Consolidated Financial Statements for
    the years ended June 28, 2003, June 29, 2002 and
    June 30, 2001.         



| |                                                                                                            
| | -----------------------------------------------------------------------------------------------------------
| | 2. Financial Statement Schedule for the
    years ended June 28, 2003, June 29, 2002 and
    June 30, 2001.
|
| | 3. List of Exhibits.                                                                                       

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

EXHIBIT INDEX

|            |     |  |  |                                                                                                                                                                                                                                       
|----------- | --- |  |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |     | 
|            |     | 
|            | 3.1 |  |  | Certificate of Incorporation of the Company,
    incorporated by reference from the Companys Registration
    Statement as amended on Form S-1 Number 333-00350 as
    filed with the Commission on January 18, 1996 (the
    S-1).
|            | 3.2 |  |  | Bylaws of the Company as amended.                                                                                                                                                                                                     

31



---



##### Table of Contents



|            |       |  |  |                                                                                                                                                                                                                                                                                                     
|----------- | ----- |  |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | 
|            |       | 
|            | 4.1   |  |  | Specimen stock certificate evidencing the Common
    Stock, incorporated by reference from the S-1.                                                                                                                                                                                                 
|            | 4.2   |  |  | Form of Amended and Restated Warrant,
    incorporated by reference from the Companys Current Report
    on Form 8-K as filed with the Commission on
    January 19, 2000 (the January 2000 8-K).                                                                                                
|            | 4.3   |  |  | Form of Securities Purchase Agreement, dated as
    of August 16, 1999, by and between the Company and each of
    the Investors, incorporated by reference from the Companys
    Current Report on Form 8-K as filed with the Commission on
    August 25, 1999 (the August 1999 8-K).          
|            | 4.4   |  |  | First Amendment to Securities Purchase Agreement,
    dated as of January 14, 2000, by and between the Company
    and each of the Investors, incorporated by reference from the
    January 2000 8-K.                                                                                              
|            | 4.5   |  |  | Second Amendment to Securities Purchase
    Agreement, dated as of April 1, 2001, by and among the
    Company and each of the Investors, incorporated by reference
    from the Companys Quarterly Report on Form 10-Q as
    filed with the Commission on May 15, 2001 (the May
    2001 10-Q).
|            | 10.1  |  |  | Form of Unit Franchise Agreement entered into by
    the Company and franchisees, incorporated by reference from the
    S-1.                                                                                                                                                                       
|            | 10.2  |  |  | Option Agreement, dated as of June 8, 1999,
    between Steven Mandell and Jack Futterman, incorporated by
    reference from Amendment No. 1 to Schedule 13D as
    filed by Jack Futterman with the Commission on June 17,
    1999 (Futtermans 13D).                                          
|            | 10.3  |  |  | Stock Pledge Agreement, dated as of June 8,
    1999, between Steven Mandell and Jack Futterman, incorporated by
    reference from Futtermans 13D.                                                                                                                                                
|            | 10.4  |  |  | Amended and Restated Investor Rights Agreement,
    dated as of August 18, 2003, by and among the Company and
    the Investors.                                                                                                                                                                    
|            | 10.5  |  |  | Description of oral consulting agreement between
    the Company and Ralph Dillon, incorporated by reference from the
    Companys Quarterly Report on Form 10-Q as filed with
    the Commission on February 13, 2001 (the February
    2001 10-Q).                                             
|            | 10.6  |  |  | General Release and Severance Agreement of James
    Shea, dated as of May 28, 2003, by and between the Company
    and James Shea.                                                                                                                                                                 
|            | 10.7  |  |  | Separation Agreement of Andrew Bailen, dated as
    of July 14, 2003, by and between the Company and Andrew
    Bailen.                                                                                                                                                                             
|            | 10.8  |  |  | Separation Agreement of Thomas Larson, dated as
    of August 26, 2002, by and between the Company and Thomas
    Larson.                                                                                                                                                                           
|            | 10.9  |  |  | Employment Agreement of Steven Skiba, dated as of
    November 29, 2002, by and between the Company and Steven
    Skiba.                                                                                                                                                                           
|            | 10.10 |  |  | Management Stock Purchase Plan of the Company,
    incorporated by reference from the Registration of Form S-8
    as filed with the Commission on July 23, 2001.                                                                                                                                   
|            | 10.11 |  |  | Employee Stock Purchase Plan of the Company,
    incorporated by reference from the Companys Definitive
    Proxy Statement for the 2001 Annual Meeting of Stockholders,
    included within Form 14-A as filed with the Commission on
    October 18, 2001.                                       
|            | 10.12 |  |  | Amended and Restated 1994 Stock Option Plan,
    incorporated by reference from the Registration of Form S-8
    as filed with the Commission on January 9, 1997.                                                                                                                                   
|            | 10.13 |  |  | 1999 Stock Incentive Plan (Amended and Restated
    as of October 25, 2000), incorporated by reference from the
    February 2001 10-Q.                                                                                                                                                             

32



---



##### Table of Contents



|            |       |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------- | ----- |  |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |       | 
|            |       | 
|            | 10.14 |  |  | Loan and Security Agreement (the Loan
    Agreement), dated January 9, 2003, by and between the
    Company and Wells Fargo Retail Finance, LLC (WFRF),
    as the arranger, collateral agent and administrative agent, and
    Fleet Retail Finance, Inc., as the documentation agent,
    incorporated by reference from the Companys Current Report
    on Form 8-K as filed with the Commission on
    January 10, 2003.
|            | 10.15 |  |  | Stock Pledge Agreement, dated January 9,
    2003, by and among the Company, Party City Michigan, Inc.
    (PCMI) and WFRF, as the arranger, collateral agent
    and administrative agent for the lender group under the Loan
    Agreement.                                                                                                                                                                                  
|            | 10.16 |  |  | Trademark Security Agreement, dated
    January 9, 2003, by and between the Company and WFRF, as
    the arranger, collateral agent and administrative agent for the
    lender group under the Loan Agreement.                                                                                                                                                                                                                  
|            | 10.17 |  |  | Copyright Security Agreement, dated
    January 9, 2003, by and between the Company and WFRF, as
    the arranger, collateral agent and administrative agent for the
    lender group under the Loan Agreement.                                                                                                                                                                                                                  
|            | 10.18 |  |  | Guaranty and Security Agreement, dated
    January 9, 2003, by and between PCMI and WFRF, as the
    arranger, collateral agent and administrative agent for the
    lender group under the Loan Agreement.                                                                                                                                                                                                                      
|            | 21.1  |  |  | Subsidiaries. The wholly owned subsidiary of the
    Company is Party City Michigan, Inc. incorporated on
    October 23, 1997, in the State of Delaware. This subsidiary
    does business under the name Party City Michigan, Inc.                                                                                                                                                                                             
|            | *23.1 |  |  | Consent of Deloitte & Touche LLP.                                                                                                                                                                                                                                                                                                                                                                                                
|            | *31.1 |  |  | Certification of Chief Executive Officer pursuant
    to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                       
|            | *31.2 |  |  | Certification of Chief Financial Officer pursuant
    to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                       
|            | *32.1 |  |  | Certification of Chief Executive Officer pursuant
    to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                       
|            | *32.2 |  |  | Certification of Chief Financial Officer pursuant
    to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                       



---



|  |                
|- | ---------------
|* | Included herein

(b) Reports on Form 8-K.



| |                                                                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. On April 11, 2003, the Company filed
    a Current Report on Form 8-K announcing that James Shea had
    resigned as Chief Executive Officer and that Nancy Pedot was
    replacing him, serving as Acting Chief Executive Officer. In
    addition, the Company announced its sales for the third fiscal
    quarter ended March 29, 2003.
|
| | 2. On May 9, 2003, the Company filed a
    Current Report on Form 8-K announcing its operating results
    for the third fiscal quarter ended March 29, 2003.                                                                                                                                                                                 

33



---



##### Table of Contents



SIGNATURES

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, on July 9, 2004.



| |                       
| | ----------------------
| | PARTY CITY CORPORATION



| |     |                   
| | --- | ------------------
| | By: | /s/ LINDA M. SILUK

| |                        
| | -----------------------
| |                        
| | Linda M. Siluk         
| | Chief Financial Officer

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

|     |  |                                                |  |                                                  |  |             
|---- |  | ---------------------------------------------- |  | ------------------------------------------------ |  | ------------
|     |  |                                                |  |                                                 
|Name |  | Title                                          |  | Date                                            
|     |  |                                                |  |                                                 
|By:  |  | /s/ RALPH D. DILLONRalph D. Dillon             |  | Non-Executive Chairman of the Board and Director |  | July 9, 2004
|    
|By:  |  | /s/ MICHAEL E. TENNENBAUMMichael E. Tennenbaum |  | Vice Chairman and Director                       |  | July 9, 2004
|    
|By:  |  | /s/ L.R. JALENAK, JR.L.R. Jalenak, Jr.         |  | Director                                         |  | July 9, 2004
|    
|By:  |  | /s/ FRANKLIN R. JOHNSONFranklin R. Johnson     |  | Director                                         |  | July 9, 2004
|    
|By:  |  | /s/ HOWARD LEVKOWITZHoward Levkowitz           |  | Director                                         |  | July 9, 2004
|    
|By:  |  | /s/ WALTER SALMONWalter Salmon                 |  | Director                                         |  | July 9, 2004
|    
|By:  |  | /s/ NANCY PEDOTNancy Pedot                     |  | Chief Executive Officer and Director             |  | July 9, 2004
|    
|By:  |  | /s/ LINDA M. SILUKLinda M. Siluk               |  | Chief Financial Officer                          |  | July 9, 2004

34



---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Party City Corporation


Rockaway, New Jersey


We have audited the accompanying consolidated
balance sheets of Party City Corporation and subsidiary as of
June 28, 2003 and June 29, 2002, and the related
consolidated statements of income, stockholders equity,
and cash flows for each of the three fiscal years in the period
ended June 28, 2003. Our audits also included the
consolidated financial statement schedule listed in the Index at
Item 15a. These consolidated financial statements and
consolidated financial statement schedule are the responsibility
of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements
and consolidated financial statement schedule based on our
audits.

We conducted our audits in accordance with
standards of the Public Company Accounting Oversight Board
(United States). 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, the consolidated financial
statements referred to above present fairly, in all material
respects, the financial position of Party City Corporation and
subsidiary as of June 28, 2003 and June 29, 2002, and
the results of their operations and their cash flows for each of
the three fiscal years in the period ended June 28, 2003 in
conformity with accounting principles generally accepted in the
United States of America. Also, in our opinion such consolidated
financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole,
presents fairly, all material respects, the information set
forth therein.

As discussed in Note 1 to the consolidated
financial statements, the Company changed its method of
accounting for goodwill and other intangible assets as of
July 1, 2001 to conform with Statement of Financial
Accounting Standards No. 142.

As discussed in Note 17, the consolidated
statements of cash flows for each of the three fiscal years in
the period ended June 28, 2003, have been restated.



| |                      
| | ---------------------
| | DELOITTE & TOUCHE LLP

Parsippany, New Jersey

August 21, 2003 (June 30, 2004 as to
the effects 
 of the restatement discussed in Note 17)


F-1



---



##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

|                                                        |                                                                                                                             |                                            |        |          |         |  |        |        |         | 
|------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | ------ | ------- | 
|                                                        |                                                                                                                             |                                           
|                                                        |                                                                                                                             | As of                                     
|                                                        |                                                                                                                             |                                           
|                                                        |                                                                                                                             | June 28,                                   |        | June 29,
|                                                        |                                                                                                                             | 2003                                       |        | 2002    
|                                                        |                                                                                                                             |                                            |        |         
|                                                        |                                                                                                                             |                                           
|                                                        |                                                                                                                             | (In thousands, except                     
|                                                        |                                                                                                                             | share data)                               
|ASSETS                                                 
|Current assets:                                         |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        | Cash and cash equivalents                                                                                                   |                                            | $      | 3,372    |         |  | $      | 3,467  |        
|                                                        | Merchandise inventory                                                                                                       |                                            |        | 65,908   |         |  |        | 55,867 |        
|                                                        | Other current assets, net                                                                                                   |                                            |        | 21,900   |         |  |        | 17,616 |        
|                                                        |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        |                                                                                                                             | Total current assets                       |        |          | 91,180  |  |        |        | 76,950  | 
|Property and equipment, net                             |                                                                                                                             |                                            | 52,819 |          |         |  | 49,356 |       
|Goodwill                                                |                                                                                                                             |                                            | 18,614 |          |         |  | 18,016 |       
|Other assets                                            |                                                                                                                             |                                            | 5,386  |          |         |  | 4,732  |       
|                                                        |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        |                                                                                                                             | Total assets                               |        | $        | 167,999 |  |        | $      | 149,054 | 
|                                                        |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                       
|LIABILITIES AND STOCKHOLDERS
    EQUITY               
|Current liabilities:                                    |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        | Accounts payable                                                                                                            |                                            | $      | 37,960   |         |  | $      | 32,414 |        
|                                                        | Cash overdraft                                                                                                              |                                            |        | 4,126    |         |  |        | 3,085  |        
|                                                        | Accrued expenses and other current liabilities                                                                              |                                            |        | 24,998   |         |  |        | 26,744 |        
|                                                        | Advances under Loan Agreement                                                                                               |                                            |        | 11,229   |         |  |        |       |        
|                                                        |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        |                                                                                                                             | Total current liabilities                  |        |          | 78,313  |  |        |        | 62,243  | 
|Long-term liabilities:                                  |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        | Deferred rent and other long-term liabilities                                                                               |                                            |        | 10,264   |         |  |        | 10,297 |        
|                                                        | Senior Notes                                                                                                                |                                            |        |         |         |  |        | 8,915  |        
|Commitments and contingencies Stockholders
    equity: |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        | Common stock, $0.01 par value; authorized,
    25,000,000 shares; issued 17,296,807 and
    16,239,081 shares, respectively |                                            |        | 173      |         |  |        | 162    |        
|                                                        | Additional paid-in capital                                                                                                  |                                            |        | 43,178   |         |  |        | 39,347 |        
|                                                        | Retained earnings                                                                                                           |                                            |        | 42,011   |         |  |        | 29,919 |        
|                                                        | Treasury shares, at cost (747,012 and
    284,000 shares, respectively)                                                     |                                            |        | (5,940   | )       |  |        | (1,829 | )      
|                                                        |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        |                                                                                                                             | Total stockholders equity                 |        |          | 79,422  |  |        |        | 67,599  | 
|                                                        |                                                                                                                             |                                            |        |          |         |  |        |       
|                                                        |                                                                                                                             | Total liabilities and stockholders equity |        | $        | 167,999 |  |        | $      | 149,054 | 
|                                                        |                                                                                                                             |                                            |        |          |         |  |        |       

See accompanying notes to consolidated financial
statements.

F-2



---



##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |         |         | 
|-------------------------- | -------------------------------------------------- | ------------------------------------------------- | ------ | ------------- | ------- | ------------- | ------ | ------- | ------- | - | ------ | ------- | ------- | 
|                           |                                                    |                                                  
|                           |                                                    | Year Ended                                       
|                           |                                                    |                                                  
|                           |                                                    | June 28, 2003                                     |        | June 29, 2002 |         | June 30, 2001
|                           |                                                    |                                                   |        |               |         |              
|                           |                                                    |                                                  
|                           |                                                    | (In thousands, except per share data)            
|Revenues:                  |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           | Net sales                                          |                                                   | $      | 464,258       |         |               | $      | 405,821 |         |   | $      | 380,671 |        
|                           | Royalty fees                                       |                                                   |        | 18,007        |         |               |        | 17,048  |         |   |        | 14,604  |        
|                           | Franchise fees                                     |                                                   |        | 355           |         |               |        | 641     |         |   |        | 625     |        
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           |                                                    | Total revenues                                    |        |               | 482,620 |               |        |         | 423,510 |   |        |         | 395,900 | 
|Expenses:                  |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           | Cost of goods sold and occupancy costs             |                                                   |        | 311,170       |         |               |        | 263,980 |         |   |        | 252,320 |        
|                           | Company-owned stores operating and selling expense |                                                   |        | 108,294       |         |               |        | 91,576  |         |   |        | 88,128  |        
|                           | Franchise expense                                  |                                                   |        | 6,538         |         |               |        | 6,563   |         |   |        | 4,937   |        
|                           | General and administrative expense                 |                                                   |        | 32,475        |         |               |        | 27,086  |         |   |        | 26,603  |        
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           |                                                    | Total expenses                                    |        |               | 458,477 |               |        |         | 389,205 |   |        |         | 371,988 | 
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|Operating income           |                                                    |                                                   | 24,143 |               |         |               | 34,305 |         |         |   | 23,912 |        
|                           | Interest income                                    |                                                   |        | (175          | )       |               |        | (176    | )       |   |        | (545    | )      
|                           | Interest expense                                   |                                                   |        | 4,165         |         |               |        | 5,786   |         |   |        | 8,494   |        
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           | Interest expense, net                              |                                                   |        | 3,990         |         |               |        | 5,610   |         |   |        | 7,949   |        
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|Income before income taxes |                                                    |                                                   | 20,153 |               |         |               | 28,695 |         |         |   | 15,963 |        
|                           | Provision for income taxes                         |                                                   |        | 8,061         |         |               |        | 11,503  |         |   |        | 6,002   |        
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|Net income                 |                                                    | $                                                 | 12,092 |               |         | $             | 17,192 |         |         | $ | 9,961  |        
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           | Basic earnings per share                           |                                                   | $      | 0.73          |         |               | $      | 1.32    |         |   | $      | 0.78    |        
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           |                                                    | Weighted average shares outstanding 
    basic   |        |               | 16,602  |               |        |         | 13,068  |   |        |         | 12,723  | 
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           | Diluted earnings per share                         |                                                   | $      | 0.62          |         |               | $      | 0.89    |         |   | $      | 0.56    |        
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        
|                           |                                                    | Weighted average shares outstanding 
    diluted |        |               | 19,646  |               |        |         | 19,313  |   |        |         | 17,819  | 
|                           |                                                    |                                                   |        |               |         |               |        |         |         |   |        |        

See accompanying notes to consolidated financial
statements.

F-3



---



##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

|                                                         |  |                                         |            |            |  |          |     |          |  |      |        |       |  |   |        |  |  |   |        |   |  |   |        |  
|-------------------------------------------------------- |  | --------------------------------------- | ---------- | ---------- |  | -------- | --- | -------- |  | ---- | ------ | ----- |  | - | ------ |  |  | - | ------ | - |  | - | ------ | -
|                                                         |  |                                         |            |            |  |          |     |          |  |     
|                                                         |  | Common Stock                            |            | Additional |  |          |     | Treasury |  |     
|                                                         |  |                                         |            | Paid-In-   |  | Retained |     | Stock at |  |     
|                                                         |  | Shares                                  |            | Amounts    |  | Capital  |     | Earnings |  | Cost |        | Total
|                                                         |  |                                         |            |            |  |          |     |          |  |      |        |      
|                                                         |  |                                        
|                                                         |  | (In thousands, except number of shares)
|Balance at July 1, 2000                                  |  |                                         | 12,722,205 |            |  | $        | 127 |          |  | $    | 37,968 |       |  | $ | 2,766  |  |  | $ |       |   |  | $ | 40,861 |  
|Exercise of stock options                                |  |                                         | 1,250      |            |  |          |    |          |  |      | 4      |       |  |   |       |  |  |   |       |   |  |   | 4      |  
|Equity compensation                                      |  |                                         |           |            |  |          |    |          |  |      | 264    |       |  |   |       |  |  |   |       |   |  |   | 264    |  
|Net income                                               |  |                                         |           |            |  |          |    |          |  |      |       |       |  |   | 9,961  |  |  |   |       |   |  |   | 9,961  |  
|                                                         |  |                                         |            |            |  |          |     |          |  |      |        |       |  |   |        |  |  |   |        |   |  |   |        |  
|Balance at June 30, 2001                                 |  |                                         | 12,723,455 |            |  |          | 127 |          |  |      | 38,236 |       |  |   | 12,727 |  |  |   |       |   |  |   | 51,090 |  
|Warrant exercise                                         |  |                                         | 3,381,624  |            |  |          | 34  |          |  |      | (34    | )     |  |   |       |  |  |   |       |   |  |   |       |  
|Equity compensation                                      |  |                                         |           |            |  |          |    |          |  |      | 463    |       |  |   |       |  |  |   |       |   |  |   | 463    |  
|Tax effect of non-qualified options                      |  |                                         |           |            |  |          |    |          |  |      | 37     |       |  |   |       |  |  |   |       |   |  |   | 37     |  
|Exercise of stock options                                |  |                                         | 134,002    |            |  |          | 1   |          |  |      | 645    |       |  |   |       |  |  |   |       |   |  |   | 646    |  
|Repurchase of common shares (284,000 shares)             |  |                                         |           |            |  |          |    |          |  |      |       |       |  |   |       |  |  |   | (1,829 | ) |  |   | (1,829 | )
|Net income                                               |  |                                         |           |            |  |          |    |          |  |      |       |       |  |   | 17,192 |  |  |   |       |   |  |   | 17,192 |  
|                                                         |  |                                         |            |            |  |          |     |          |  |      |        |       |  |   |        |  |  |   |        |   |  |   |        |  
|Balance at June 29, 2002                                 |  |                                         | 16,239,081 |            |  |          | 162 |          |  |      | 39,347 |       |  |   | 29,919 |  |  |   | (1,829 | ) |  |   | 67,599 |  
|Warrant exercise                                         |  |                                         | 672,459    |            |  |          | 7   |          |  |      | 484    |       |  |   |       |  |  |   |       |   |  |   | 491    |  
|Equity compensation                                      |  |                                         |           |            |  |          |    |          |  |      | 342    |       |  |   |       |  |  |   |       |   |  |   | 342    |  
|Tax effect of non-qualified options                      |  |                                         |           |            |  |          |    |          |  |      | 556    |       |  |   |       |  |  |   |       |   |  |   | 556    |  
|Exercise of stock options                                |  |                                         | 213,486    |            |  |          | 2   |          |  |      | 1,130  |       |  |   |       |  |  |   |       |   |  |   | 1,132  |  
|Issuance of shares of Management Stock Purchase
    Plan |  |                                         | 95,511     |            |  |          | 1   |          |  |      | 707    |       |  |   |       |  |  |   |       |   |  |   | 708    |  
|Issuance of shares of Employee Stock Purchase Plan       |  |                                         | 76,270     |            |  |          | 1   |          |  |      | 612    |       |  |   |       |  |  |   |       |   |  |   | 613    |  
|Repurchase of common shares (463,012 shares)             |  |                                         |           |            |  |          |    |          |  |      |       |       |  |   |       |  |  |   | (4,111 | ) |  |   | (4,111 | )
|Net income                                               |  |                                         |           |            |  |          |    |          |  |      |       |       |  |   | 12,092 |  |  |   |       |   |  |   | 12,092 |  
|                                                         |  |                                         |            |            |  |          |     |          |  |      |        |       |  |   |        |  |  |   |        |   |  |   |        |  
|Balance at June 28, 2003                                 |  |                                         | 17,296,807 |            |  | $        | 173 |          |  | $    | 43,178 |       |  | $ | 42,011 |  |  | $ | (5,940 | ) |  | $ | 79,422 |  
|                                                         |  |                                         |            |            |  |          |     |          |  |      |        |       |  |   |        |  |  |   |        |   |  |   |        |  

See accompanying notes to consolidated financial
statements.

F-4



---



##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                            |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |         |        |         |  
|----------------------------------------------------------- | ------------------------------------------------------------------------------------- | -------------------------------------------------------------------- | ----------------------------------------- | ------------- | ------ | ------------- | ------- | ------- | ------ | ------- | ------- | ------- | ------ | ------- | -
|                                                            |                                                                                       |                                                                     
|                                                            |                                                                                       | Year Ended                                                          
|                                                            |                                                                                       |                                                                     
|                                                            |                                                                                       | June 28, 2003                                                        |                                           | June 29, 2002 |        | June 30, 2001
|                                                            |                                                                                       |                                                                      |                                           |               |        |              
|                                                            |                                                                                       |                                                                     
|                                                            |                                                                                       | (In thousands)                                                      
|                                                            |                                                                                       | (As Restated,                                                        |                                           | (As Restated, |        | (As Restated,
|                                                            |                                                                                       | see Note 17)                                                         |                                           | see Note 17)  |        | see Note 17) 
|Cash flow from operating activities:                        |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|                                                            | Net income                                                                            |                                                                      | $                                         | 12,092        |        |               | $       | 17,192  |        |         | $       | 9,961   |       
|                                                            | Adjustments to reconcile net income to net cash
    provided by operating activities: |                                                                      |                                           |               |        |               |         |         |        |         |         |         |       
|                                                            |                                                                                       | Depreciation and amortization                                        |                                           |               | 16,229 |               |         |         | 12,156 |         |         |         | 10,431 |        
|                                                            |                                                                                       | Non-cash interest and financing costs                                |                                           |               | 1,624  |               |         |         | 1,395  |         |         |         | 1,815  |        
|                                                            |                                                                                       | Deferred taxes                                                       |                                           |               | (2,131 | )             |         |         | 819    |         |         |         | 1,543  |        
|                                                            |                                                                                       | Deferred rent                                                        |                                           |               | 556    |               |         |         | 765    |         |         |         | 1,148  |        
|                                                            |                                                                                       | Stock based compensation                                             |                                           |               | 342    |               |         |         | 463    |         |         |         | 264    |        
|                                                            |                                                                                       | Provision for doubtful accounts                                      |                                           |               | (498   | )             |         |         | (67    | )       |         |         | (65    | )      
|                                                            |                                                                                       | Tax effect of non-qualified stock options                            |                                           |               | 556    |               |         |         | 37     |         |         |         |       |        
|                                                            |                                                                                       | Impairment charge                                                    |                                           |               | 1,505  |               |         |         |       |         |         |         | 2,275  |        
|                                                            |                                                                                       | Loss (gain) on disposition and sale of stores                        |                                           |               | 162    |               |         |         |       |         |         |         | (131   | )      
|                                                            | Changes in assets and liabilities:                                                    |                                                                      |                                           |               |        |               |         |         |        |         |         |         |       
|                                                            |                                                                                       | Accounts payable, accrued expenses and other
    current liabilities |                                           |               | 3,608  |               |         |         | 4,894  |         |         |         | 11,522 |        
|                                                            |                                                                                       | Merchandise inventory                                                |                                           |               | (9,634 | )             |         |         | (7,310 | )       |         |         | (6,606 | )      
|                                                            |                                                                                       | Other long-term liabilities                                          |                                           |               | 121    |               |         |         | 833    |         |         |         | (326   | )      
|                                                            |                                                                                       | Other current assets and other assets                                |                                           |               | (1,444 | )             |         |         | (135   | )       |         |         | 2,045  |        
|                                                            |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|                                                            |                                                                                       |                                                                      | Net cash provided by operating activities |               |        | 23,088        |         |         |        | 31,042  |         |         |        | 33,876  |  
|Cash flow from investing activities:                        |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|                                                            | Purchases of property and equipment                                                   |                                                                      |                                           | (20,476       | )      |               |         | (14,085 | )      |         |         | (16,305 | )     
|                                                            | Stores acquired                                                                       |                                                                      |                                           | (1,758        | )      |               |         | (5,923  | )      |         |         | (516    | )     
|                                                            | Proceeds from sales of stores                                                         |                                                                      |                                           |              |        |               |         |        |        |         |         | 1,157   |       
|                                                            |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|                                                            |                                                                                       |                                                                      | Net cash used in investing activities     |               |        | (22,234       | )       |         |        | (20,008 | )       |         |        | (15,664 | )
|Cash flow from financing activities:                        |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|                                                            | Payments on Senior Notes                                                              |                                                                      |                                           | (10,207       | )      |               |         | (19,311 | )      |         |         | (8,103  | )     
|                                                            | Purchase of treasury shares                                                           |                                                                      |                                           | (4,111        | )      |               |         | (1,829  | )      |         |         |        |       
|                                                            | Proceeds from exercise of stock options and
    warrants                              |                                                                      |                                           | 1,623         |        |               |         | 646     |        |         |         | 4       |       
|                                                            | Cash overdrafts                                                                       |                                                                      |                                           | 1,041         |        |               |         | 3,085   |        |         |         | (4,221  | )     
|                                                            | Payment of financing costs                                                            |                                                                      |                                           | (524          | )      |               |         |        |        |         |         |        |       
|                                                            | Net proceeds from Loan Agreement                                                      |                                                                      |                                           | 11,229        |        |               |         |        |        |         |         |        |       
|                                                            |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|Net cash used in financing activities                       |                                                                                       |                                                                      | (949                                      | )             |        |               | (17,409 | )       |        |         | (12,320 | )      
|                                                            |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|Net (decrease) increase in cash and cash
    equivalents    |                                                                                       |                                                                      | (95                                       | )             |        |               | (6,375  | )       |        |         | 5,892   |        
|Cash and cash equivalents, beginning of year                |                                                                                       |                                                                      | 3,467                                     |               |        |               | 9,842   |         |        |         | 3,950   |        
|                                                            |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|Cash and cash equivalents, end of year                      |                                                                                       | $                                                                    | 3,372                                     |               |        | $             | 3,467   |         |        | $       | 9,842   |        
|                                                            |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|Supplemental disclosure of cash flow information:           |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|                                                            | Income taxes paid                                                                     |                                                                      | $                                         | 9,895         |        |               | $       | 9,990   |        |         | $       | 5,315   |       
|                                                            | Interest paid                                                                         |                                                                      | $                                         | 2,978         |        |               | $       | 5,283   |        |         | $       | 6,648   |       
|Supplemental disclosure of non-cash financing
    activity: |                                                                                       |                                                                      |                                           |               |        |               |         |         |        |         |         |        
|                                                            | Issuance of warrants                                                                  |                                                                      | $                                         | 245           |        |               | $       | 3,955   |        |         | $       |        |       
|                                                            | Issuance of shares under management stock
    purchase plan                           |                                                                      | $                                         | 708           |        |               | $       |        |        |         | $       |        |       
|                                                            | Issuance of shares under employee stock purchase
    plan                             |                                                                      | $                                         | 613           |        |               | $       |        |        |         | $       |        |       

See accompanying notes to consolidated financial
statements.

F-5



---



##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|   |                                               
|-- | ----------------------------------------------
|1. | Summary of Significant Accounting
    Policies



| |                                      
| | -------------------------------------
| | Consolidated Financial
    Statements

Party City Corporation (the Company)
is incorporated in the State of Delaware and operates retail
party supplies stores within the continental United States and
sells franchises on an individual store and area franchise basis
throughout the United States and Puerto Rico. At June 28,
2003, the Company had 242 Company-owned stores and 241 franchise
stores in its network. The consolidated financial statements of
the Company include the accounts of the Company and its
wholly-owned subsidiary, Party City Michigan, Inc. All
significant intercompany balances and transactions have been
eliminated.

The Companys fiscal year ends on the
Saturday nearest June 30. As used herein, the term
Fiscal Year or Fiscal refers to the
52-week or 53-week period ending on the Saturday nearest to
June 30, unless otherwise noted.

Use of
Estimates

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America 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. Significant estimates
include provision for slow-moving inventory, insurance accruals,
finite-lived assets, recoverability of goodwill, sales returns
and store closure costs.

Cash and Cash
Equivalents

The Company considers its highly liquid
investments purchased, with an original maturity of three months
or less, as part of daily cash management activities to be cash
equivalents.

Fair Value of
Financial Instruments

Financial instruments consist of cash
equivalents, accounts receivable, accounts payable and advances
under the Loan Agreement. The carrying amounts reported in the
balance sheets of such financial instruments approximate their
fair market values due to their short-term maturities.

The estimated fair values of financial
instruments that are presented herein have been determined by
the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is
required in interpreting market data to develop estimates of
fair value. Accordingly, the estimates presented herein are not
necessarily indicative of amounts the Company could realize in a
current market exchange.

Merchandise
Inventory

Inventory is valued using the cost method which
values inventory at the lower of the actual cost or market, at
the individual item level. Cost is determined using the weighted
average method. Inventory levels are reviewed to identify
slow-moving and close out merchandise that will no longer be
carried. Market is determined based on the estimated net
realizable value based upon the merchandise selling price.

Vendor
Allowances

The Company and certain vendors have arrangements
whereby the vendors provide merchandise allowances based on
purchases. The Company accounts for these allowances as a
reduction of inventory cost. The Company also receives vendor
allowances as reimbursement for advertising. Advertising
allowances are recorded as reductions to advertising expense as
they do not affect inventory or gross margin. These allowances
represent reimbursements of specific, incremental, identifiable
costs incurred by the Company in selling the

F-6



---



##### Table of Contents



vendors product and therefore are
characterized as a reduction of that cost when recognized in the
income statement.


Advertising
Costs

Advertising costs, including print and other
media advertising, are expensed as incurred and were
$22.4 million, $16.7 million and $17.6 million
for Fiscal 2003, Fiscal 2002 and Fiscal 2001, respectively.

Advertising
Fund

Pursuant to its franchise agreements, the Company
collects 1% of the net sales of its franchise stores for
contribution into the Advertising Fund (the Ad
Fund). The Company also contributes 1% of net sales of its
owned stores into the Ad Fund. These amounts are restricted to
be used for advertising. Receipts and disbursements are not
recorded as income or expense since the Company does not have
full discretion over the use of the funds. To cover the expenses
of fund administration, the Company charges the Ad Fund a
management fee equal to 5% of the funds contributed by
franchisees. For the fiscal years ended June 28, 2003,
June 29, 2002 and June 30, 2001, Ad Fund management
fees of $484,000, $439,000 and $401,000, respectively, were
collected by the Company and credited to general and
administrative expense.

Property and
Equipment

Property and equipment are recorded at cost.
Depreciation and amortization are provided using the
straight-line method over the estimated useful lives of the
assets or, where applicable, the terms of the respective leases,
whichever is shorter. The Company uses estimated useful lives of
five to seven years for furniture, fixtures and equipment.
Capitalized software costs are amortized on a straight-line
basis over their estimated lives of three to five years.
Depreciation begins in the year the assets are placed into
service.

Maintenance and repairs are charged directly to
expense as incurred. Major renewals or replacements of fixed
assets are capitalized after making the necessary adjustments to
the asset and accumulated depreciation of the items renewed or
replaced.

Impairment of
Finite-Lived Assets

The Company evaluates Finite-Lived Assets in
accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets
(SFAS No. 144). This statement supersedes
SFAS No. 121, Accounting for Impairment of
Long-lived Assets and for Long-lived Assets to Be Disposed
of. Finite-lived assets are evaluated for recoverability
in accordance with SFAS No. 144 whenever events or
changes in circumstances indicate that an asset may have been
impaired. In evaluating an asset for recoverability, the Company
estimates the future cash flows expected to result from the use
of the asset and eventual disposition. If the sum of the
expected future cash flows (undiscounted and without interest
charges) is less than the carrying amount of the asset, an
impairment loss, equal to the excess of the carrying amount over
the fair market value of the asset is recognized. The Company
evaluated its finite-lived assets and based on current and
projected performance, determined that the fixed assets must be
impaired for four stores in the Seattle market and one other
store. Therefore, a pre-tax charge of $946,000 was recognized in
Fiscal 2003. After adjusting for this impairment charge,
management believes the carrying value and useful lives are
appropriate.

Non-Compete
Agreement

The Company has two non-compete agreements. One
is with a franchise owner and the other is with Paper Warehouse,
Inc. These agreements are included in other assets and are being
amortized using the straight-line method over the life of the
agreement. Amortization expense for other intangibles was
$131,000, $33,000 and $0 for the fiscal years ended
June 28, 2003, June 29, 2002 and June 30, 2001,
respectively.

F-7



---



##### Table of Contents



Goodwill

The Company adopted SFAS No. 142,
Goodwill and Other Intangible Assets
(SFAS No. 142) effective July 1,
2001. It changes the accounting for goodwill from an
amortization method to an impairment only approach.
Under SFAS No. 142, goodwill is no longer amortized
but reviewed for impairment annually or more frequently if
certain indicators arise. The Company evaluated the goodwill
associated with its acquisitions and based on current and
projected performance, determined that the goodwill associated
with one acquisition had little to no carrying value. Therefore,
the carrying amount of goodwill was impaired and a charge for
$558,000 was taken in Fiscal 2003. After adjusting for this
impairment charge, management believes the carrying value is
appropriate. All of the Companys recorded goodwill is
associated with its retail segment.

The following financial information is presented
as if the statement were adopted at the beginning of Fiscal 2001
(in thousands, except per share amounts):

|                                    |  |            |        |          |  |          |        |  |  |   |        | 
|----------------------------------- |  | ---------- | ------ | -------- |  | -------- | ------ |  |  | - | ------ | 
|                                    |  |           
|                                    |  | Year Ended
|                                    |  |           
|                                    |  | June 28,   |        | June 29, |  | June 30,
|                                    |  | 2003       |        | 2002     |  | 2001    
|                                    |  |            |        |          |  |         
|Reported net income                 |  | $          | 12,092 |          |  | $        | 17,192 |  |  | $ | 9,961  | 
|Add back:                           |  |            |        |          |  |          |        |  |  |   |        | 
|Goodwill amortization, net of taxes |  |            |       |          |  |          |       |  |  |   | 725    | 
|                                    |  |            |        |          |  |          |        |  |  |   |        | 
|Adjusted net income                 |  | $          | 12,092 |          |  | $        | 17,192 |  |  | $ | 10,686 | 
|                                    |  |            |        |          |  |          |        |  |  |   |        | 
|Basic earnings per share reported   |  | $          | 0.73   |          |  | $        | 1.32   |  |  | $ | 0.78   | 
|Goodwill amortization, net of taxes |  |            |       |          |  |          |       |  |  |   | 0.06   | 
|                                    |  |            |        |          |  |          |        |  |  |   |        | 
|Adjusted basic earnings per share   |  | $          | 0.73   |          |  | $        | 1.32   |  |  | $ | 0.84   | 
|                                    |  |            |        |          |  |          |        |  |  |   |        | 
|Diluted earnings per share reported |  | $          | 0.62   |          |  | $        | 0.89   |  |  | $ | 0.56   | 
|Goodwill amortization, net of taxes |  |            |       |          |  |          |       |  |  |   | 0.04   | 
|                                    |  |            |        |          |  |          |        |  |  |   |        | 
|Adjusted diluted earnings per share |  | $          | 0.62   |          |  | $        | 0.89   |  |  | $ | 0.60   | 
|                                    |  |            |        |          |  |          |        |  |  |   |        | 

Income
Taxes

The Company files a consolidated Federal income
tax return. Separate state income tax returns are filed with
each state in which the Company conducts business. The Company
accounts for its income taxes using the asset and liability
method. Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to the differences
between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and
operating loss and tax credit carryforwards. Deferred tax assets
and liabilities are measured using enacted tax rates expected to
apply to taxable income in the year in which those temporary
differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates
is recognized in earnings in the period that includes the
enactment date.

F-8



---



##### Table of Contents



Stock-Based
Compensation

In accordance with SFAS No. 123,
Accounting for Stock-Based Compensation,
(SFAS No. 123) the fair value of each
option grant is estimated on the date of grant using the
Black-Scholes option-pricing model using the following
assumptions for grants in the respective periods:

|                        |  |            |           |          |  |          |           |   |  |  |           |  
|----------------------- |  | ---------- | --------- | -------- |  | -------- | --------- | - |  |  | --------- | -
|                        |  |           
|                        |  | Year Ended
|                        |  |           
|                        |  | June 28,   |           | June 29, |  | June 30,
|                        |  | 2003       |           | 2002     |  | 2001    
|                        |  |            |           |          |  |         
|Expected volatility     |  |            | 55        | %        |  |          | 50        | % |  |  | 97        | %
|Expected lives          |  |            | 5.4 years |          |  |          | 4.7 years |   |  |  | 4.0 years |  
|Risk-free interest rate |  |            | 2.3       | %        |  |          | 3.3       | % |  |  | 4.3       | %
|Expected dividend yield |  |            | 0.0       | %        |  |          | 0.0       | % |  |  | 0.0       | %

The weighted average fair value of options
granted during the fiscal years 2003, 2002 and 2001 were $7.47,
$2.53 and $2.23 respectively.

The Company periodically grants stock options to
employees. Pursuant to Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to
Employees (APB 25), the Company accounts
for stock-based employee compensation arrangements using the
intrinsic value method. If the options are granted to employees
below fair market value, compensation expense is recognized. The
Company has adopted the disclosure only provisions of Statement
of Financial Accounting Standards (SFAS)
No. 123, Accounting for Stock Based
Compensation (SFAS No. 123), as
amended by SFAS No. 148, Accounting for Stock
Based Compensation  Transition and Disclosure, an
Amendment of SFAS No. 123. If compensation cost
for the Companys stock option plans had been determined in
accordance with the fair value method prescribed by
SFAS No. 123 the Companys net income would have
been:

|                            |                                                                                                                    |                                       |   |          |   |          |   |        |   |  |   |        |  
|--------------------------- | ------------------------------------------------------------------------------------------------------------------ | ------------------------------------- | - | -------- | - | -------- | - | ------ | - |  | - | ------ | -
|                            |                                                                                                                    |                                      
|                            |                                                                                                                    | Year Ended                           
|                            |                                                                                                                    |                                      
|                            |                                                                                                                    | June 28,                              |   | June 29, |   | June 30,
|                            |                                                                                                                    | 2003                                  |   | 2002     |   | 2001    
|                            |                                                                                                                    |                                       |   |          |   |         
|                            |                                                                                                                    |                                      
|                            |                                                                                                                    | (In thousands, except per share data)
|Net income:                 |                                                                                                                    |                                       |   |          |   |          |   |        |   |  |   |       
|                            | As reported                                                                                                        |                                       | $ | 12,092   |   |          | $ | 17,192 |   |  | $ | 9,961  |  
|                            | Add: Stock-based employee compensation determined
    under APB25, net of taxes                                    |                                       |   | 205      |   |          |   | 278    |   |  |   | 166    |  
|                            | Deduct: Total stock based employee compensation
    expense determined under fair value based method, net of taxes |                                       |   | (1,247   | ) |          |   | (2,423 | ) |  |   | (1,232 | )
|                            |                                                                                                                    |                                       |   |          |   |          |   |        |   |  |   |       
|                            | Pro-forma                                                                                                          |                                       | $ | 11,050   |   |          | $ | 15,047 |   |  | $ | 8,895  |  
|                            |                                                                                                                    |                                       |   |          |   |          |   |        |   |  |   |       
|Basic earnings per share:   |                                                                                                                    |                                       |   |          |   |          |   |        |   |  |   |       
|                            | As reported                                                                                                        |                                       | $ | 0.73     |   |          | $ | 1.32   |   |  | $ | 0.78   |  
|                            | Pro-forma                                                                                                          |                                       |   | 0.67     |   |          |   | 1.16   |   |  |   | 0.70   |  
|Diluted earnings per share: |                                                                                                                    |                                       |   |          |   |          |   |        |   |  |   |       
|                            | As reported                                                                                                        |                                       | $ | 0.62     |   |          | $ | 0.89   |   |  | $ | 0.56   |  
|                            | Pro-forma                                                                                                          |                                       |   | 0.56     |   |          |   | 0.78   |   |  |   | 0.50   |  

Earnings Per
Share

Basic earnings per share is computed by dividing
net income by the weighted-average number of common shares
outstanding for the period. Diluted earnings per common share
also includes the dilutive effect of potential common shares
(dilutive stock options and warrants) outstanding during the
period.

F-9



---



##### Table of Contents



Revenue
Recognition

The Company operates predominately as a retailer
through its Company owned stores. The retail segment recognizes
revenue at the point of sale. Allowances for sales returns are
recorded as a component of net sales in the periods in which the
related sales are recognized.

The Companys franchise segment generates
revenues through one-time franchise fees and ongoing royalties.
Revenue from the sale of individual franchises, recorded as
franchise fees, is recognized by the Company upon completion of
certain initial services, which normally coincides with the
opening of the franchisees store. Royalty fees are
recorded on a monthly basis as a percentage of the
franchisees net sales. 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. On an ongoing basis, the Company provides assistance
regarding sources of supply, pricing, advertising and promotion
programs.

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 a deposit in advance 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.
The Company had 241 and 242 franchise stores at June 28,
2003 and June 29, 2002, respectively.

Operating
Leases

The Companys rent expense under operating
leases provides for step rent provisions, escalation clauses,
capital improvement funding and other lease concessions as
applicable in each lease. The minimum lease payments are
recognized on a straight-line basis over the term of each
individual underlying lease.

Store Opening
and Closing Costs

New store opening costs are expensed as incurred.
Closed store costs, such as future rent and real estate taxes
net of expected sublease recovery, are accrued when an agreement
is entered into to close a store.

Recent
Accounting Pronouncements

In June 2002, the Financial Accounting Standards
Board (FASB) issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities (SFAS No. 146), replacing
Emerging Issues Task Force (EITF) Issue
No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).
SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when
the liability is incurred instead of at the date an entity
commits to an exit plan. This statement also established that
fair value is the objective for the initial measurement of the
liability. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31,
2002. The adoption of SFAS 146 has not had and is not
expected to have a material impact on the consolidated financial
statements.

In November 2002, the FASB issued FASB
Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (FIN 45). FIN 45 requires
that upon issuance of a guarantee, a guarantor must recognize a
liability for the fair value of an obligation assumed under a
guarantee. FIN 45 also requires additional disclosures by a
guarantor in its interim and annual financial statements about
the obligations associated with guarantees issued. The
recognition provisions of FIN 45 will be effective for any
guarantees that are issued or modified after December 31,
2002. The disclosure requirement is effective for the
Companys Fiscal Year ended June 28, 2003. The Company
has evaluated the accounting provisions of the interpretation
and there was no material impact on the financial condition,
results of operations or cash flows for the fiscal year ended
June 28, 2003. The Company has made the required
disclosures in the consolidated financial statements as of
June 28, 2003 (see Note 13).

F-10



---



##### Table of Contents



In November 2002, the EITF reached a consensus on
issues raised in EITF 02-16, Accounting by a Reseller
for Cash Consideration Received from a Vendor
(EITF 02-16). This EITF issue addresses the
timing of recognition for rebates that are earned by resellers
based on specified levels of purchases or over specified
periods. This guidance, related to timing of recognition, is to
be applied prospectively to new rebate arrangements entered into
in fiscal periods beginning after January 1, 2003. This
EITF issue also addresses the classification of cash
consideration received from vendors in a resellers
statement of operations. The guidance related to income
statement classification is to be applied in annual and interim
financial statements for periods beginning after January 1,
2003. The adoption of EITF 02-16 has not had and is not
expected to have a material impact on the consolidated financial
statements.

In December 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based
Compensation (SFAS No. 148).
SFAS No. 148 provides alternative methods of
transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123, Accounting For
Stock-Based Compensation
(SFAS No. 123) to require more prominent
and more frequent disclosures in financial statements about the
effects of stock-based compensation. The Company will continue
to account for stock-based equity compensation using the
intrinsic value method of APB Opinion 25. The Company is
required to follow prescribed disclosure format and has provided
the additional disclosures required by SFAS No. 148
for the fiscal year ended June 28, 2003.

In January 2003, the FASB issued Interpretation
No. 46 Consolidation of Variable Interest
Entities (FIN 46), with the objective of
improving financial reporting by companies involved with
variable interest entities. A variable interest entity is a
corporation, partnership, trust, or any other legal structure
used for business purposes that either (a) does not have
equity investors with voting rights, or (b) has equity
investors that do not provide sufficient financial resources for
the entity to support its activities. Historically, entities
generally were not consolidated unless the entity was controlled
through voting interests. FIN 46 changes that by requiring
a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from
the variable interest entitys activities or entitled to
receive a majority of the entitys residual returns or
both. A company that consolidates a variable interest entity is
called the primary beneficiary of that entity.
FIN 46 also requires disclosures about variable interest
entities that a company is not required to consolidate but in
which it has a significant variable interest. The consolidation
requirements of FIN 46 apply immediately to variable
interest entities created after January 31, 2003. The
consolidation requirements of FIN 46 apply to existing
entities in the first fiscal year or interim period after
January 31, 2003, regardless of when the variable interest
entity was established. The Company has evaluated the accounting
provisions of the interpretations and determined that there was
no material impact on its financial condition, results of
operations or cash flows, since the Company is not the primary
beneficiary of any variable interest entities.

In April 2003, the FASB issued
SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. This
statement amends and clarifies financial reporting for
derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities. This
statement is effective for contracts entered into or modified
after June 30, 2003. The Company is currently evaluating
the impact of adopting this statement on its consolidated
financial position and results of operations.

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. This statement establishes standards for how a
company classifies and measures certain financial instruments
with characteristics of both liabilities and equity. This
statement is effective for financial instruments entered into or
modified after May 31, 2003 and otherwise is effective at
the beginning of the first interim period beginning after
June 15, 2003. The statement will be implemented by
reporting the cumulative effect of a change in accounting
principle for financial instruments created before the issuance
date of the statement and still existing at the beginning of the
period of adoption. Although the Company is still in the process
of reviewing the new statement, the Company believes this
statement will have no material impact on its consolidated
financial statements.

F-11



---



##### Table of Contents



Seasonality

The Companys business is subject to
substantial seasonal variations. Historically, the Company has
realized a significant portion of its net sales, operating
income and net income in the second fiscal quarter of the year,
principally due to the sales in October for the Halloween season
and, to a lesser extent, due to sales for end of year holidays.
The Company believes this general pattern will continue in the
future. An economic downturn during this period could adversely
affect the Company to a greater extent than if such downturn
occurred at other times of the year. The Companys results
of operations may also fluctuate significantly as a result of a
variety of other factors, including the timing of new store
openings, store closings and store sales.

Concentration

The Company has four suppliers who in the
aggregate constituted approximately 43% of the Companys
purchases for each of the three fiscal years ended June 28,
2003. The loss of any of these suppliers could adversely affect
the Companys operations.

Reclassifications

Certain reclassifications have been made to the
consolidated financial statements in prior periods to conform to
the current period presentation.



|   |                                           
|-- | ------------------------------------------
|2. | Acquisitions and Disposition of
    Stores



| |            
| | -----------
| | Fiscal 2001

In Fiscal 2001, The Party Supermarket, Inc.
(Party Supermarket) became a franchisee. Under the
related franchise agreement, Party Supermarket purchased three
stores in Florida from the Company for approximately
$1.2 million. A gain of $131,000 was recorded by the
Company on this sale.

In Fiscal 2001, the Company acquired one store
from a franchisee. The aggregate consideration paid in
connection with this acquisition was $516,000.

Fiscal
2002

In Fiscal 2002, the Company acquired three stores
from franchisees. One of these locations was acquired by the
Company by assuming the lease of a franchise store under the
default terms of the franchisees lease agreement.

Also in Fiscal 2002, the Company acquired 13
stores in the Seattle, Washington market from Paper Warehouse,
Inc. The conversion of these locations to the Party City store
format was completed and all stores were opened in the first
quarter of Fiscal 2003.

The aggregate consideration paid in connection
with the Fiscal 2002 acquisitions was $5.9 million. The
consolidated balance sheets include allocations of the purchase
prices relating to these acquisitions resulting in the recording
of approximately $4.4 million in goodwill, $523,000 in
inventory and $1.0 million in fixed assets, of which
$558,000 of goodwill was impaired during Fiscal 2003.

Fiscal
2003

In Fiscal 2003, the Company acquired two stores
from a franchisee. The aggregate consideration paid in
connection with this acquisition was $1.6 million. The
consolidated balance sheets include allocations of the purchase
price related to this transaction resulting in the recording of
approximately $1.0 million in goodwill, $407,000 in
inventory and $195,000 in fixed assets.

The acquisitions have been accounted for under
the purchase method of accounting. The results of operations of
the acquired stores are included in the financial statements
from the date the stores were opened.

The purchase price of these acquisitions was
determined by applying a multiple to the acquired
businesss proforma earnings before depreciation,
amortization, and taxes. The range of multiples the Company uses
has

F-12



---



##### Table of Contents



generally resulted in an acceptable return on our
investment compared to the opening of a new site as the customer
and sales base is established.


Assuming the stores acquired during the Fiscal
Year ended June 28, 2003 and June 29, 2002 were
acquired on June 30, 2001, the pro forma results would have
been as follows (in thousands, except per share amounts)
(unaudited):

|                           |  |            |         |          |  |   |         | 
|-------------------------- |  | ---------- | ------- | -------- |  | - | ------- | 
|                           |  |           
|                           |  | Year Ended
|                           |  |           
|                           |  | June 28,   |         | June 29,
|                           |  | 2003       |         | 2002    
|                           |  |            |         |         
|Net sales                  |  | $          | 484,068 |          |  | $ | 439,989 | 
|Net income                 |  |            | 12,168  |          |  |   | 17,618  | 
|Basic earnings per share   |  | $          | 0.73    |          |  | $ | 1.35    | 
|Diluted earnings per share |  |            | 0.62    |          |  |   | 0.91    | 

All of the Companys recorded goodwill is
associated with its retail segment. The changes in the carrying
amount of goodwill for the Fiscal Year ended June 28, 2003
and June 29, 2002 are as follows (in thousands):

|                            |                                       |   |        |       |  
|--------------------------- | ------------------------------------- | - | ------ | ----- | -
|Balance as of June 30, 2001 |                                       | $ | 13,647 |      
|                            | Goodwill acquired during the period   |   |        | 4,369 |  
|                            |                                       |   |        |      
|Balance as of June 29, 2002 |                                       |   | 18,016 |      
|                            | Goodwill acquired during the period   |   |        | 1,156 |  
|                            | Goodwill impairment during the period |   |        | (558  | )
|                            |                                       |   |        |      
|Balance as of June 28, 2003 |                                       | $ | 18,614 |      
|                            |                                       |   |        |      



|   |                     
|-- | --------------------
|3. | Other Current Assets

Other current assets consist of the following (in
thousands):

|                                          |  |          |        |          |  |   |        |  
|----------------------------------------- |  | -------- | ------ | -------- |  | - | ------ | -
|                                          |  | June 28, |        | June 29,
|                                          |  | 2003     |        | 2002    
|                                          |  |          |        |         
|Deferred taxes                            |  | $        | 7,428  |          |  | $ | 5,827  |  
|Prepaid expenses and other current assets |  |          | 4,764  |          |  |   | 4,095  |  
|Prepaid rent                              |  |          | 4,722  |          |  |   | 4,127  |  
|Receivables from franchisees              |  |          | 2,454  |          |  |   | 2,562  |  
|Advance merchandise payments              |  |          | 1,513  |          |  |   | 708    |  
|Restricted cash from advertising fund     |  |          | 1,307  |          |  |   | 1,082  |  
|                                          |  |          |        |          |  |   |        |  
|                                          |  |          | 22,188 |          |  |   | 18,401 |  
|Less: Allowance for doubtful accounts     |  |          | (288   | )        |  |   | (785   | )
|                                          |  |          |        |          |  |   |        |  
|                                          |  | $        | 21,900 |          |  | $ | 17,616 |  
|                                          |  |          |        |          |  |   |        |  

F-13



---



##### Table of Contents



4.     Property and
Equipment

Property and equipment consists of the following
(in thousands):

|                               |  |          |         |          |  |   |         |  
|------------------------------ |  | -------- | ------- | -------- |  | - | ------- | -
|                               |  | June 28, |         | June 29,
|                               |  | 2003     |         | 2002    
|                               |  |          |         |         
|Equipment                      |  | $        | 48,647  |          |  | $ | 43,648  |  
|Furniture                      |  |          | 34,147  |          |  |   | 26,411  |  
|Leasehold improvements         |  |          | 25,426  |          |  |   | 19,469  |  
|                               |  |          |         |          |  |   |         |  
|                               |  |          | 108,220 |          |  |   | 89,528  |  
|Less: accumulated depreciation |  |          | (55,401 | )        |  |   | (40,172 | )
|                               |  |          |         |          |  |   |         |  
|                               |  | $        | 52,819  |          |  | $ | 49,356  |  
|                               |  |          |         |          |  |   |         |  

Depreciation expense of $16.1 million,
$12.1 million and $9.2 million was recorded in Fiscal
2003, 2002 and 2001, respectively, on equipment, furniture and
leasehold improvements.

5.     Other
Assets

Other assets consist of the following (in
thousands):

|                               |  |          |       |          |  |   |       | 
|------------------------------ |  | -------- | ----- | -------- |  | - | ----- | 
|                               |  | June 28, |       | June 29,
|                               |  | 2003     |       | 2002    
|                               |  |          |       |         
|Deferred income taxes          |  | $        | 2,779 |          |  | $ | 2,249 | 
|Loan commitment fees and other |  |          | 2,114 |          |  |   | 1,866 | 
|Non-compete agreement          |  |          | 493   |          |  |   | 617   | 
|                               |  |          |       |          |  |   |       | 
|                               |  | $        | 5,386 |          |  | $ | 4,732 | 
|                               |  |          |       |          |  |   |       | 

6.     Accrued
Expenses and Other Current Liabilities

Accrued expenses and other current liabilities
consist of the following (in thousands):

|                     |  |          |        |          |  |   |        | 
|-------------------- |  | -------- | ------ | -------- |  | - | ------ | 
|                     |  | June 28, |        | June 29,
|                     |  | 2003     |        | 2002    
|                     |  |          |        |         
|Accrued compensation |  | $        | 5,649  |          |  | $ | 7,419  | 
|Accrued insurance    |  |          | 3,500  |          |  |   | 2,580  | 
|Sales and use taxes  |  |          | 1,749  |          |  |   | 1,512  | 
|Other                |  |          | 14,100 |          |  |   | 15,233 | 
|                     |  |          |        |          |  |   |        | 
|                     |  | $        | 24,998 |          |  | $ | 26,744 | 
|                     |  |          |        |          |  |   |        | 

7.     Financing
Agreements

In January 2003, the Company entered into a
$65 million revolving credit facility (Loan
Agreement) with Wells Fargo Retail Finance, LLC, as the
arranger, collateral agent and administrative agent, and Fleet
Retail Finance, Inc., as the documentation agent. Under the
terms of the Loan Agreement, the Company may borrow amounts
based on a percentage of its eligible inventory and credit card
receivables, subject to certain borrowing conditions and
customary sub-limits, reserves and other limitations. Interest
on advances is charged, at the Companys option,
(i) at the adjusted Eurodollar rate plus the applicable
margin, which was set initially at 1.50%, currently at 1.25%,
per annum or (ii) at the prime rate less the applicable margin,
which was initially set at and is currently 0.25% per annum. The
term of the Loan Agreement is through April 30, 2006 and is
secured by a lien on substantially all of the Companys
assets. The Company has a standby letter of credit of
$3.1 million outstanding at June 28, 2003. At
June 28, 2003, the Company had $11.2 million in
borrowings outstanding under the Loan Agreement, respectively.

F-14



---



##### Table of Contents



In August, 1999, the Company received
$30 million in financing from certain investors (the
Investors), who purchased senior secured notes and
warrants pursuant to the Securities Purchase Agreement. Under
the Purchase Agreement, the Company issued
(i) $10 million 12.5% Secured Notes due 2003 (the
A Notes); (ii) $5 million 13.0%
Secured Notes due 2003 (the B Notes);
(iii) $5 million of its 13.0% Secured Notes due 2002
(the C Notes); (iv) $10 million 14.0%
Secured Notes due 2004 (the D Notes and,
together with the A Notes, the B Notes and the C Notes, the
Notes); and (v) warrants (the
Warrants) to purchase 6,880,000 shares of our
common stock at an initial exercise price of $3.00 per share
issued in connection with the sale and issuance of the
C Notes and the D Notes. The Notes were secured by a
junior lien on substantially all of the Companys assets.

Pursuant to the First Amendment, on
January 14, 2000, the Company received $7 million in
cash proceeds from the sale to certain of the Investors (the
Investor Group) of a new series of senior secured
notes. Under the First Amendment, the Company issued
$7 million in aggregate principal amount of 14.0% Senior
Secured Notes due 2002 (the E Notes). The
E Notes were secured by a lien on substantially all of the
Companys assets. Under the terms of the First Amendment,
the interest rate on the A Notes, the B Notes, the
C Notes and the D Notes was increased by 4.5%. The
Investor Group, together with the Investors and Congress,
entered into an intercreditor agreement. In consideration for
waivers and forbearances granted by the Investors to various
defaults under the terms of our A Notes, B Notes,
C Notes and D Notes, the Company also agreed to amend
and restate the terms of the Warrants held by the Investors to
acquire 6,880,000 shares of Company common stock. The
amended and restated warrants (the Amended Warrants)
provide for an exercise price of $1.07 per share and were issued
upon surrender of the Warrants, which had an exercise price of
$3.00 per share.

The Company repaid $10.2 million,
$19.3 million and $8.1 million of the Senior Notes in
the fiscal years ended June 28, 2003, June 29, 2002
and June 30, 2001, respectively. The Notes were secured by
a junior lien on substantially all of the Companys assets.
The fiscal 2003 repurchase resulted in an additional payment of
$1.4 million, comprised of interest and an incentive
premium, and resulted in an after-tax charge of
$1.3 million, or $0.07 per diluted share.

8.     Earnings per
Share

The following table sets forth the computations
of basic and diluted earnings per share (in thousands, except
per share amounts):

|                                                                            |  |            |         |          |  |          |         |  |  |   |         | 
|--------------------------------------------------------------------------- |  | ---------- | ------- | -------- |  | -------- | ------- |  |  | - | ------- | 
|                                                                            |  |           
|                                                                            |  | Year Ended
|                                                                            |  |           
|                                                                            |  | June 28,   |         | June 29, |  | June 30,
|                                                                            |  | 2003       |         | 2002     |  | 2001    
|                                                                            |  |            |         |          |  |         
|Net income                                                                  |  | $          | 12,092  |          |  | $        | 17,192  |  |  | $ | 9,961   | 
|Earnings per share  basic                                                  |  | $          | 0.73    |          |  | $        | 1.32    |  |  | $ | 0.78    | 
|Earnings per share  diluted                                                |  | $          | 0.62    |          |  | $        | 0.89    |  |  | $ | 0.56    | 
|Weighted average common shares outstanding                                  |  |            | 16,602  |          |  |          | 13,068  |  |  |   | 12,723  | 
|Dilutive effect of stock options                                            |  |            | 637     |          |  |          | 650     |  |  |   | 244     | 
|Dilutive effect of warrants                                                 |  |            | 2,323   |          |  |          | 5,531   |  |  |   | 4,852   | 
|Restricted stock units                                                      |  |            | 84      |          |  |          | 64      |  |  |   |        | 
|                                                                            |  |            |         |          |  |          |         |  |  |   |         | 
|Weighted average common shares and common
    equivalent shares outstanding |  |            | 19,646  |          |  |          | 19,313  |  |  |   | 17,819  | 
|                                                                            |  |            |         |          |  |          |         |  |  |   |         | 
|Options excluded from dilutive calculation                                  |  |            | 686,285 |          |  |          | 260,555 |  |  |   | 907,794 | 
|                                                                            |  |            |         |          |  |          |         |  |  |   |         | 

Options to purchase common shares at prices
ranging from $11.83 to $32.50 per share were outstanding but
were not included in the computation of dilutive earnings per
share because to do so would have been anti-dilutive for the
periods presented.

F-15



---



##### Table of Contents



9.     Stockholders
Equity and Stock Options



| |                   
| | ------------------
| | Shares Outstanding

The Companys authorized capital stock is
25,000,000 shares of its common stock, $0.01 par value per
share. Shares of common stock issued and outstanding were
17,296,807 and 16,239,081 at June 28, 2003 and
June 29, 2002, respectively.



| |                 
| | ----------------
| | Stock Repurchase

In September 2001, the Board of Directors
authorized the Company to repurchase up to $15 million of
its outstanding common stock. The stock repurchases are made at
the discretion of management. During Fiscal 2002, the Company
repurchased 284,000 shares for an aggregate amount of
$1.8 million, or 12.2% of the total amount authorized to be
purchased. During Fiscal 2003, the Company repurchased
463,012 shares for an aggregate amount of $4.1 million
or 27.4% of total amount authorized to be purchased. As of
June 28, 2003, the Company had purchased
747,012 shares for an aggregate amount of $5.9 million
or 39.6% of the total amount authorized to be purchased.



| |         
| | --------
| | Warrants

In Fiscal 2003, 688,000 warrants to purchase the
Companys common stock were exercised. This included an
exercise of 458,667 warrants for which proceeds of $490,774 were
received and a cashless exercise of the remaining 229,333
warrants, in which the warrant holders received
213,792 shares of common stock. The remaining
15,541 shares were surrendered in connection with this
exercise. These 15,541 shares of the Companys common
stock had a market value of $245,386 at the time of surrender.



| |              
| | -------------
| | Stock Options

On October 19, 1999, the Companys
Board of Directors adopted the Companys 1999 Stock
Incentive Plan (1999 Plan). This adoption was
approved by the companys stockholders on November 15,
1999. A total of 500,000 shares of the Companys
common stock were reserved for issuance under the 1999 Plan.

On October 5, 2000, the Board approved an
amendment and restatement of the 1999 Plan, increasing the
number of shares of common stock reserved for issuance
thereunder from 500,000 to 2,000,000. This adoption was approved
by the Companys stockholders on November 15, 2000. A
total of 2,000,000 shares are reserved for issuance under
the 1999 Plan. There have been 1,866,000 options issued of which
74,085 have been exercised and 1,583,140 are outstanding. There
have been cancellations of 208,775 options, therefore there are
342,775 options remaining to issue.

The purpose of the 1999 Plan is to promote the
long-term financial success of the Company by enhancing the
ability of the Company to attract, retain and reward individuals
who can and do contribute to such success and to further align
the interest of the Companys key personnel with its
stockholders. Key employees, directors and consultants of the
Company and its subsidiary are eligible to receive options under
the 1999 Plan.

The 1999 Plan provides for the grants of options
and restricted stock and other stock-based awards as the
compensation committee of the Board of Directors may from time
to time deem appropriate. Such awards may include stock
appreciation rights, phantom stock awards, bargain purchase of
stock and stock bonuses. Vesting and other terms of stock
options awarded are set out in the agreements between the
Company and the individuals receiving such awards. The exercise
price of the options is determined by the compensation committee
at the time of grant and may not be less than the fair market
value of the Companys common stock on the date of grant.
Options granted under the 1999 Plan vest over four to seven
years from date of grant, and expire in ten years.

The Company also maintains the Amended and
Restated 1994 Stock Option Plan (1994 Plan) pursuant
to which options were granted to employees, directors and
consultants for the purchase of common stock of the Company. The
1994 Plan, as amended, permitted the Company to grant incentive
and non-

F-16



---



##### Table of Contents



qualified stock options to purchase a total of up
to 1,800,000 shares of the Companys common stock at
an exercise price not less than fair value at date of grant. As
of September 4, 2000, no additional grants of options under
the 1994 Plan are permitted. There were 2,330,875 options issued
of which 541,701 have been exercised, 1,150,825 have been
cancelled and 638,349 remain outstanding. The original terms of
the agreements between the Company and the individuals receiving
the grants under the 1994 Plan with respect to vesting,
expiration and exercise price remain unchanged.


During June 2001, the Company established a
Management Stock Purchase Plan (MSPP). The MSPP is
designed to provide a means by which the Company may attract
highly qualified persons to enter into and remain in the
employment of the Company. In addition, the MSPP provides a
means whereby employees of the Company can defer a portion of
their compensation to be used to acquire and maintain ownership
of the Companys common stock, thereby strengthening their
commitment to the welfare of the Company and promoting an
identity of interest among Company stockholders and these
employees. The amount deferred by the individual is held in
restricted stock units. These restricted stock units are
purchased at a discount of 20% or 25% depending on the amount of
the individual deferral from the average price of Companys
common stock on the determination date. Such discounts vest at
the end of three years or seven years, selected by the
participant, after the determination date. The amortization of
the discount is charged to compensation expense over the
three-year period or seven year period. The compensation expense
attributable to the MSPP for Fiscal 2003, 2002 and 2001, was
$188,000, $33,000 and $0 respectively.

In June 2001, the Company established an Employee
Stock Purchase Plan (ESPP). The ESPP provides
employees of the Company with an opportunity to purchase shares
of the Companys commons stock at a discount of 15% through
accumulated payroll deductions. This plan qualifies as an
Employee Stock Purchase Plan under Section 423
of the Code. Contributions to the plan during Fiscal 2003 and
2002 were $593,000 and $265,000, resulting in the obligation to
issue 62,234 and 41,823 shares of common stock,
respectively.

The following tables summarize information about
stock option transactions for the 1999 Plan and the 1994 Plan:

|                         |  |           |           |          |  |   |       | 
|------------------------ |  | --------- | --------- | -------- |  | - | ----- | 
|                         |  |           |           | Weighted
|                         |  |           |           | Average 
|                         |  | Number of |           | Exercise
|                         |  | Shares    |           | Price   
|                         |  |           |           |         
|Balance at July 1, 2000  |  |           | 1,521,126 |          |  | $ | 7.29  | 
|Granted                  |  |           | 398,000   |          |  |   | 4.14  | 
|Exercised                |  |           | (1,250    | )        |  |   | 3.00  | 
|Canceled                 |  |           | (266,500  | )        |  |   | 8.62  | 
|                         |  |           |           |          |  |   |       | 
|Balance at June 30, 2001 |  |           | 1,651,376 |          |  |   | 6.29  | 
|Granted                  |  |           | 591,750   |          |  |   | 8.03  | 
|Exercised                |  |           | (134,002  | )        |  |   | 4.82  | 
|Canceled                 |  |           | (104,248  | )        |  |   | 10.72 | 
|                         |  |           |           |          |  |   |       | 
|Balance at June 29, 2002 |  |           | 2,004,876 |          |  |   | 6.59  | 
|Granted                  |  |           | 638,000   |          |  |   | 14.85 | 
|Exercised                |  |           | (212,486  | )        |  |   | 5.28  | 
|Canceled                 |  |           | (208,901  | )        |  |   | 9.71  | 
|                         |  |           |           |          |  |   |       | 
|Balance at June 28, 2003 |  |           | 2,221,489 |          |  | $ | 8.78  | 
|                         |  |           |           |          |  |   |       | 
|Options Exercisable at:  |  |           |           |          |  |   |       | 
|June 30, 2001            |  |           | 839,316   |          |  | $ | 8.49  | 
|June 29, 2002            |  |           | 1,076,631 |          |  |   | 7.41  | 
|June 28, 2003            |  |           | 1,399,241 |          |  |   | 7.94  | 

F-17



---



##### Table of Contents



|                         |  |                     |           |                     |  |          |      |             |  |          |       |  |  |  |           |  |  |   |       | 
|------------------------ |  | ------------------- | --------- | ------------------- |  | -------- | ---- | ----------- |  | -------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|                         |  |                     |           |                     |  |         
|                         |  | Options Outstanding |           |                    
|                         |  |                     |           | Options Exercisable
|                         |  |                     |           | Weighted            |  |          |      |            
|                         |  | Number              |           | Average             |  | Weighted |      | Number      |  | Weighted
|                         |  | Outstanding         |           | Remaining           |  | Average  |      | Exercisable |  | Average 
|                         |  | at June 28,         |           | Contractual         |  | Exercise |      | at June 28, |  | Exercise
|Range of Exercise Prices |  | 2003                |           | Life                |  | Price    |      | 2003        |  | Price   
|                         |  |                     |           |                     |  |          |      |             |  |         
|$1.71 to $3.00           |  |                     | 491,512   |                     |  |          | 4.70 |             |  | $        | 2.19  |  |  |  | 455,205   |  |  | $ | 2.13  | 
|$3.15 to $7.38           |  |                     | 602,726   |                     |  |          | 7.62 |             |  |          | 5.38  |  |  |  | 315,494   |  |  |   | 5.17  | 
|$7.42 to $13.58          |  |                     | 478,501   |                     |  |          | 6.61 |             |  |          | 10.13 |  |  |  | 315,792   |  |  |   | 10.01 | 
|$13.63 to $16.00         |  |                     | 451,750   |                     |  |          | 8.57 |             |  |          | 14.60 |  |  |  | 138,625   |  |  |   | 14.24 | 
|$16.37 to $32.50         |  |                     | 197,000   |                     |  |          | 7.51 |             |  |          | 19.02 |  |  |  | 174,125   |  |  |   | 19.33 | 
|                         |  |                     |           |                     |  |          |      |             |  |          |       |  |  |  |           |  |  |   |       | 
|                         |  |                     | 2,221,489 |                     |  |          | 6.94 |             |  | $        | 8.78  |  |  |  | 1,399,241 |  |  | $ | 7.94  | 
|                         |  |                     |           |                     |  |          |      |             |  |          |       |  |  |  |           |  |  |   |       | 

10.     Income
Taxes

The provision for income tax expense (benefit)
consists of the following (in thousands):

|          |         |            |        |          |   |          |        |       |   |   |       |       | 
|--------- | ------- | ---------- | ------ | -------- | - | -------- | ------ | ----- | - | - | ----- | ----- | 
|          |         |           
|          |         | Year Ended
|          |         |           
|          |         | June 28,   |        | June 29, |   | June 30,
|          |         | 2003       |        | 2002     |   | 2001    
|          |         |            |        |          |   |         
|Current:  |         |            |        |          |   |          |        |       |   |   |       |      
|          | Federal |            | $      | 8,036    |   |          | $      | 7,760 |   |   | $     | 3,720 | 
|          | State   |            |        | 1,925    |   |          |        | 2,673 |   |   |       | 470   | 
|          | Foreign |            |        | 232      |   |          |        | 251   |   |   |       | 269   | 
|          |         |            |        |          |   |          |        |       |   |   |       |      
|          |         |            | 10,193 |          |   |          | 10,684 |       |   |   | 4,459 |      
|Deferred: |         |            |        |          |   |          |        |       |   |   |       |      
|          | Federal |            |        | (1,730   | ) |          |        | 1,329 |   |   |       | 1,154 | 
|          | State   |            |        | (401     | ) |          |        | (510  | ) |   |       | 389   | 
|          |         |            |        |          |   |          |        |       |   |   |       |      
|          |         |            | (2,131 | )        |   |          | 819    |       |   |   | 1,543 |      
|          |         |            |        |          |   |          |        |       |   |   |       |      
|          |         | $          | 8,062  |          |   | $        | 11,503 |       |   | $ | 6,002 |      
|          |         |            |        |          |   |          |        |       |   |   |       |      

Deferred income taxes reflect the net tax effects
of temporary differences between the carrying value of assets
and liabilities for financial reporting purposes and amounts
used for income tax purposes.

F-18



---



##### Table of Contents



Significant components of the net deferred tax
asset at June 28, 2003 and June 29, 2002 are as
follows (in thousands):

|             |                                   |                                |   |          |       |  |   |        |       | 
|------------ | --------------------------------- | ------------------------------ | - | -------- | ----- |  | - | ------ | ----- | 
|             |                                   | June 28,                       |   | June 29,
|             |                                   | 2003                           |   | 2002    
|             |                                   |                                |   |         
|Current:     |                                   |                                |   |          |       |  |   |       
|             | Inventory                         |                                | $ | 6,484    |       |  | $ | 4,731  |      
|             | Vacation pay accrual              |                                |   | 467      |       |  |   | 453    |      
|             | Reserves not currently deductible |                                |   | 1,030    |       |  |   | 965    |      
|             | Bonus accrual                     |                                |   | 94       |       |  |   | 209    |      
|             | Deferred state taxes              |                                |   | (647     | )     |  |   | (531   | )    
|             |                                   |                                |   |          |       |  |   |       
|             |                                   | Net current deferred tax asset |   | $        | 7,428 |  |   | $      | 5,827 | 
|             |                                   |                                |   |          |       |  |   |       
|Non-current: |                                   |                                |   |          |       |  |   |       
|             | Deferred rent                     |                                | $ | 4,188    |       |  | $ | 3,952  |      
|             | Start-up costs                    |                                |   | (456     | )     |  |   | (447   | )    
|             | Property and equipment            |                                |   | (1,394   | )     |  |   | (2,161 | )    
|             | Amortization of goodwill          |                                |   | (1,470   | )     |  |   | (1,075 | )    
|             | Other liabilities                 |                                |   | 1,911    |       |  |   | 1,980  |      
|             |                                   |                                |   |          |       |  |   |       
|             |                                   | Non-current deferred tax asset |   | $        | 2,779 |  |   | $      | 2,249 | 
|             |                                   |                                |   |          |       |  |   |       

The following table reconciles the statutory
Federal income tax rate with the effective rate of the Company
for the periods ended:

|                                                         |  |            |      |          |  |          |      |   |  |  |      |  
|-------------------------------------------------------- |  | ---------- | ---- | -------- |  | -------- | ---- | - |  |  | ---- | -
|                                                         |  |           
|                                                         |  | Year Ended
|                                                         |  |           
|                                                         |  | June 28,   |      | June 29, |  | June 30,
|                                                         |  | 2003       |      | 2002     |  | 2001    
|                                                         |  |            |      |          |  |         
|Federal statutory rate                                   |  |            | 35.0 | %        |  |          | 35.0 | % |  |  | 34.0 | %
|State income taxes net of Federal income tax
    benefit |  |            | 4.9  |          |  |          | 4.9  |   |  |  | 3.6  |  
|Valuation allowance                                      |  |            |     |          |  |          |     |   |  |  | (1.3 | )
|Other                                                    |  |            | 0.1  |          |  |          | 0.2  |   |  |  | 1.3  |  
|                                                         |  |            |      |          |  |          |      |   |  |  |      |  
|Effective tax rate                                       |  |            | 40.0 | %        |  |          | 40.1 | % |  |  | 37.6 | %
|                                                         |  |            |      |          |  |          |      |   |  |  |      |  

11.     Employee
Benefit Plans

The Company has a defined contribution 401(k)
savings plan (the 401(k) Plan) covering all eligible
employees. Participants may defer between 1% and 15% of annual
pre-tax compensation subject to statutory limitations. The
Company contributes an amount as determined by the Board of
Directors. Such amount has been established as 50% of the first
4% of the employees contribution up to $1,000.

For the fiscal years ended June 28, 2003,
June 29, 2002 and June 30, 2001, matching
contributions of $301,000, $309,000 and $300,000, respectively,
were made by the Company under the 401(k) Plan.

12.     Related Party
Transactions

In June 1999, Steven Mandell, the former
president of the Company and a major stockholder granted an
option to acquire 1,000,000 shares of the
shareholders common stock to Jack Futterman, then the
Companys chief executive officer and a member of the Board
of Directors. The option vested immediately and has an exercise
price of $3.00 a share, the fair value of the common stock at
date of grant. The option expires in June 2004.

On August 16, 1999, Special Value Bond
Fund II, LLC, (SVBF II) purchased
$10.0 million in aggregate principal amount of the
Companys 12.5% Secured Notes due 2003 (the
A Notes) and

F-19



---



##### Table of Contents



$5.0 million in aggregate principal amount
of the Companys 13.0% Secured Notes due 2003 (the
B Notes). Subsequently on November 20,
2000, SVBF II sold $5.0 million in aggregate principal
amount of the A Notes and $2.5 million in aggregate
principal amount of the B Notes to other Company investors.
In addition, on August 16, 1999, Tennenbaum & Co., LLC
(TCO) purchased $2,250,000 in aggregate principal
amount of the Companys 13.0% Secured Notes due 2002,
$4.5 million in aggregate principal amount of the
Companys 14.0% Secured Notes due 2004 and Warrants to
purchase 3,096,000 shares of the Companys stock. TCO
then transferred all of these Secured Notes and the Warrants to
Special Value Bond Fund, LLC (SVBF) effective as of
September 1, 1999. Then on January 14, 2000, SVBF
purchased $3,250,000 in aggregate principal amount of the
Companys 14.0% Secured Notes due 2002. The managing member
of SVBF II is SVIM/MSM II, LLC (SVIM/MSM II) and the
managing member of SVIM/MSM II is TCO. The managing member of
SVBF is SVIM/MSM, LLC (SVIM/MSM) and the managing
member of SVIM/MSM is TCO. The managing member of TCO is Michael
E. Tennenbaum, the Companys Vice Chairman of the Board of
Directors. During Fiscal 2003, Fiscal 2002 and Fiscal 2001,
Secured Notes totaling $3.9 million, $9.3 million and
$5.0 million were repaid, respectively. For the fiscal
years ended June 28, 2003, June 29, 2002 and
June 30, 2001, the Company paid $1.0 million,
$2.3 million and $2.8 million of interest related to
these Notes, respectively.


On November 2, 1999, Ralph Dillon, the
Companys non-executive chairman of the board of directors,
purchased $167,000 in aggregate principal amount of the
Companys 13.0% Secured Notes due 2002, $333,000 in
aggregate principal amount of the Companys 14.0% Secured
Notes due 2004, and Warrants to purchase 229,333 shares of
the Companys stock from one of the Investors for a total
purchase price of $498,000. During Fiscal 2003 and Fiscal 2002,
the Secured Notes totaling $333,000 and $167,000 were repaid,
respectively. For the years ended June 28, 2003,
June 29, 2002 and June 30, 2001, the Company paid
$78,000, $80,000 and $93,000 of interest related to these Notes,
respectively.

As of July 3, 1999, Erik Mandell, a former
officer of the Company and the son of Steven Mandell, owned one
franchise store. During the year ended July 1, 2000, Steven
Mandell acquired this store from Erik Mandell. On July 27,
2000, the Company purchased this store from Steven Mandell.
Total consideration for the purchase was $516,000. Neither
Steven Mandell nor Erik Mandell owns any other Party City
franchise stores.

On June 22, 2001, the Company granted
options for 90,000 shares of the Companys common stock to
Ralph Dillon as compensation for his services to the Company.
These options were granted at $6.25 per share and vested upon
issuance. In addition, on each of January 12, 2002,
July 12, 2002 and January 12, 2003 additional grants
of options for 50,000 shares of the Companys common stock
were made to Mr. Dillon, which options had an exercise
price of $9.38, $17.00 and $17.00, respectively. An additional
grant of 50,000 options for shares will be made to
Mr. Dillon on July 12, 2004 with an exercise price of
$17.00 provided that Mr. Dillon remains as the
non-executive chairman of the board of directors of the Company
through such date and certain other requirements are met. All of
these options vest upon issuance. For the fiscal years ended
June 28, 2003 and June 29, 2002, $154,000 and $430,000
were charged to operations as compensation expense, respectively.

13.     Lease
Commitments and Contractual Obligations

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 19,800 square feet. The terms range from
five 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. The Company
paid $26,000 for contingent rent for Fiscal 2003, and no
contingent rent for Fiscal 2002 and 2001.

At June 28, 2003, the Company leased 37
motor vehicles, primarily for its district managers and regional
management. The terms are for 36 months and expire through
December 2005.

In 1997, the Company entered into a five-year
capital lease with a present value of approximately
$1.6 million for computer hardware and software. The
Company has the option to purchase the equipment for

F-20



---



##### Table of Contents



a nominal cost at the termination of the lease.
The leased hardware is included in property and equipment at a
net book value of approximately $71,000 at June 28, 2003.
The leased software has been fully depreciated.


Future minimum lease payments under outstanding
leases, severance arrangements and advances under loan
agreements at June 28, 2003, are as follows (in thousands):

|                             |  |           |         |         |  |              |    |           |  |   |     |  |  |   |        | 
|---------------------------- |  | --------- | ------- | ------- |  | ------------ | -- | --------- |  | - | --- |  |  | - | ------ | 
|                             |  |           |         |         |  |              |    | Advances 
|                             |  |           |         |         |  |              |    | Under    
|                             |  | Operating |         | Capital |  | Severance    |    | Loan     
|                             |  | Leases    |         | Lease   |  | Arrangements |    | Agreement
|                             |  |           |         |         |  |              |    |          
|Fiscal year ending:          |  |           |         |         |  |              |    |           |  |   |     |  |  |   |        | 
|2004                         |  | $         | 45,968  |         |  | $            | 32 |           |  | $ | 199 |  |  | $ | 11,229 | 
|2005                         |  |           | 44,519  |         |  |              |   |           |  |   |    |  |  |   |       | 
|2006                         |  |           | 43,088  |         |  |              |   |           |  |   |    |  |  |   |       | 
|2007                         |  |           | 38,956  |         |  |              |   |           |  |   |    |  |  |   |       | 
|2008                         |  |           | 30,639  |         |  |              |   |           |  |   |    |  |  |   |       | 
|Thereafter                   |  |           | 63,063  |         |  |              |   |           |  |   |    |  |  |   |       | 
|                             |  |           |         |         |  |              |    |           |  |   |     |  |  |   |        | 
|Total minimum lease payments |  | $         | 266,233 |         |  | $            | 32 |           |  | $ | 199 |  |  | $ | 11,229 | 
|                             |  |           |         |         |  |              |    |           |  |   |     |  |  |   |        | 

Rent expense for all operating leases was
$43.4 million, $35.9 million and $35.1 million
for the fiscal years ended June 28, 2003, June 29,
2002 and June 30, 2001 respectively.

The Company is obligated for guarantees,
subleases or assigned lease obligations for 25 of its
franchisees through 2011. The majority of the guarantees were
given when the Company sold stores in 1999 as part of its
restructuring. The guarantees continue until the leases expire.
The maximum amount of the guarantees may vary, but is limited to
the sum of the total amount due under the lease. As of
June 28, 2003, the maximum amount of the guarantees was
approximately $20.6 million.

Pursuant to the Loan Agreement, the Company has a
standby letter of credit of $3,130,000 outstanding at
June 28, 2003. This standby letter of credit relates to
general liability and workers compensation insurance and expired
on April 17, 2004.

14.     Commitments
and Contingencies

Securities
Litigation

The Company was named as a defendant in twelve
class action complaints in the United States District Court for
the District of New Jersey. A former Chief Executive Officer, a
former Chief Financial Officer/ Executive Vice President of
Operations were also named as defendants in these complaints.
The complaints were filed as class actions on behalf of persons
who purchased or acquired Party City common stock during various
time periods between February 26, 1998 and March 18,
1999 (the Class Period). In October 1999,
plaintiffs filed an amended class action complaint and, in
February 2000, plaintiffs filed a second amended complaint,
which alleged, among other things, violations of Sections 10(b)
and 20(a) of the Securities Exchange Act of 1934, as amended,
and Rule 10b-5 promulgated thereunder, and sought unspecified
damages. The plaintiffs alleged that defendants issued a series
of false and misleading statements and failed to disclose
material facts concerning, among other things, Party Citys
financial condition, adequacy of internal controls and
compliance with certain loan covenants during the Class period.
The plaintiffs further alleged that because of the issuance of a
series of false and misleading statements and/or the failure to
disclose material facts, the price of Party Citys common
stock was artificially inflated.

In early 2000, defendants moved to dismiss the
second amended complaint on the ground that it failed to state a
cause of action. On May 29, 2001, the District Court issued
an Opinion and Order dismissing the Complaint against all
defendants with prejudice. On June 27, 2001, plaintiffs
filed a Notice of Appeal to the United States Court of Appeals
for the Third Circuit. In April 2002, the parties reached an
agreement in principle to settle the action, and the Court of
Appeals has remanded the case to the District Court to supervise
the implementation of the settlement. The terms of the
settlement were contained in the agreement

F-21



---



##### Table of Contents



in principle, and included the settlement amount,
of which the Companys settlement contribution of $380,000
was not material to the results of operations or financial
condition.


On May 14, 2003, the District Court approved
the terms of the definitive settlement agreement. Accordingly,
in May 2003, the Company paid its contribution pursuant to the
terms of the settlement agreement to close this matter.

Other

A lawsuit was filed on September 25, 2001
against the Company in Los Angeles Superior Court by an
assistant manager in one of the Companys California stores
for himself and on behalf of other members of an alleged class
of Party City store managers (the Class) who claim
the Company misclassified the Class members as exempt from
California overtime wage and hour laws. The Class members seek
the disgorgement of overtime wages allegedly owed by the Company
to them but not paid and they also seek punitive damages and
statutory penalties. If a class is certified, liability is found
and a judgment is entered, such a judgment may adversely affect
the Company.

In addition to the foregoing, from time to time
the Company is involved in routine litigation incidental to the
conduct of the business. The Company is aware of no other
material existing or threatened litigation to which the Company
is or may be a party.

15.     Segment
Information

The Company owns, operates and franchises party
supplies stores in North America. As of December 2002, the
franchise stores in Portugal and Spain are no longer franchises
and no longer operate with the Party City name or logo. The
Companys management reporting system evaluates performance
based on a number of factors; however, the primary measure of
performance is the pre-tax operating profit of each segment.
Accordingly, the Company reports two segments  retail
and franchising. The retail segment generates revenue through
the sale of primarily third-party branded party goods through
Company-owned stores. The franchising segment generates revenue
through the imposition of an initial one-time franchise fee and
ongoing royalty payments based on retail sales. The accounting
policies are described in the summary of significant accounting
policies. The Company has no intersegment sales. No single
customer accounts for 10% or more of total revenues. The
revenues from the Spain and Portugal franchisee were not
significant in all the periods presented. All assets of the
Company are located in North America.

F-22



---



##### Table of Contents



The following table contains key financial
information of the Companys business segments (in
thousands):

|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|---------------------------------------- |  | ------------------------------------- | ------- | -------- |  | -------- | ------- |  |  | - | ------- | 
|                                         |  |                                      
|                                         |  | Year Ended                           
|                                         |  |                                      
|                                         |  | June 28,                              |         | June 29, |  | June 30,
|                                         |  | 2003                                  |         | 2002     |  | 2001    
|                                         |  |                                       |         |          |  |         
|                                         |  |                                      
|                                         |  | (In thousands, except per share data)
|Retail:                                  |  |                                       |         |          |  |          |         |  |  |   |         | 
|Net sales                                |  | $                                     | 464,258 |          |  | $        | 405,821 |  |  | $ | 380,671 | 
|Cost of goods sold and occupancy costs   |  |                                       | 311,170 |          |  |          | 263,980 |  |  |   | 252,320 | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|Gross profit                             |  |                                       | 153,088 |          |  |          | 141,841 |  |  |   | 128,351 | 
|Store operating and selling expense      |  |                                       | 108,294 |          |  |          | 91,576  |  |  |   | 88,128  | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|Company-owned stores profit contribution |  |                                       | 44,794  |          |  |          | 50,265  |  |  |   | 40,223  | 
|General and administrative expense       |  |                                       | 32,475  |          |  |          | 27,086  |  |  |   | 26,603  | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|Retail profit contribution               |  | $                                     | 12,319  |          |  | $        | 23,179  |  |  | $ | 13,620  | 
|Identifiable assets                      |  | $                                     | 165,833 |          |  | $        | 147,277 |  |  | $ | 139,944 | 
|Depreciation/amortization                |  | $                                     | 16,229  |          |  | $        | 12,156  |  |  | $ | 10,431  | 
|Capital expenditures                     |  | $                                     | 22,234  |          |  | $        | 14,085  |  |  | $ | 16,305  | 
|                                        
|Franchise:                               |  |                                       |         |          |  |          |         |  |  |   |         | 
|Royalty fees                             |  | $                                     | 18,007  |          |  | $        | 17,048  |  |  | $ | 14,604  | 
|Franchise fees                           |  |                                       | 355     |          |  |          | 641     |  |  |   | 625     | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|Total franchise revenues                 |  |                                       | 18,362  |          |  |          | 17,689  |  |  |   | 15,229  | 
|Total franchise expense                  |  |                                       | 6,538   |          |  |          | 6,563   |  |  |   | 4,937   | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|Franchise profit contribution            |  |                                       | 11,824  |          |  |          | 11,126  |  |  |   | 10,292  | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|Identifiable assets                      |  | $                                     | 2,166   |          |  | $        | 1,777   |  |  | $ | 1,398   | 
|Depreciation/amortization                |  | $                                     |        |          |  | $        |        |  |  | $ |        | 
|Capital expenditures                     |  | $                                     |        |          |  | $        |        |  |  | $ |        | 
|Operating income                         |  |                                       | 24,143  |          |  |          | 34,305  |  |  |   | 23,912  | 
|Interest expense, net                    |  |                                       | 3,990   |          |  |          | 5,610   |  |  |   | 7,949   | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|Income before income taxes               |  |                                       | 20,153  |          |  |          | 28,695  |  |  |   | 15,963  | 
|Provision for income taxes               |  |                                       | 8,061   |          |  |          | 11,503  |  |  |   | 6,002   | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 
|Net income                               |  | $                                     | 12,092  |          |  | $        | 17,192  |  |  | $ | 9,961   | 
|                                         |  |                                       |         |          |  |          |         |  |  |   |         | 

F-23



---



##### Table of Contents



16.     Selected
Quarterly Information (Unaudited) (in thousands, except per
share data)

|                                       |  |               |        |          |  |       |         |      |  |   |        |   |  |   |         | 
|-------------------------------------- |  | ------------- | ------ | -------- |  | ----- | ------- | ---- |  | - | ------ | - |  | - | ------- | 
|                                       |  |              
|                                       |  | Quarter Ended
|                                       |  |              
|                                       |  | September     |        | December |  | March |         | June
|                                       |  |               |        |          |  |       |         |     
|Year Ended June 29, 2002               |  |               |        |          |  |       |         |      |  |   |        |   |  |   |         | 
|Total revenues                         |  | $             | 84,384 |          |  | $     | 148,112 |      |  | $ | 90,104 |   |  | $ | 100,910 | 
|Cost of goods sold and occupancy costs |  |               | 57,667 |          |  |       | 83,928  |      |  |   | 60,816 |   |  |   | 61,569  | 
|Net (loss) income                      |  |               | (1,786 | )        |  |       | 14,939  |      |  |   | (96    | ) |  |   | 4,135   | 
|Basic (loss) earnings per share        |  | $             | (0.14  | )        |  | $     | 1.15    |      |  | $ | (0.01  | ) |  | $ | 0.31    | 
|Diluted (loss) earnings per share      |  |               | (0.14  | )        |  |       | 0.79    |      |  |   | (0.01  | ) |  |   | 0.21    | 
|                                      
|Year Ended June 28, 2003               |  |               |        |          |  |       |         |      |  |   |        |   |  |   |         | 
|Total revenues                         |  | $             | 95,006 |          |  | $     | 168,191 |      |  | $ | 99,533 |   |  | $ | 119,890 | 
|Cost of goods sold and occupancy costs |  |               | 64,425 |          |  |       | 95,974  |      |  |   | 70,164 |   |  |   | 80,607  | 
|Net (loss) income                      |  |               | (1,736 | )        |  |       | 15,050  |      |  |   | (1,808 | ) |  |   | 586     | 
|Basic (loss) earnings per share        |  | $             | (0.11  | )        |  | $     | 0.90    |      |  | $ | (0.11  | ) |  | $ | 0.04    | 
|Diluted (loss) earnings per share      |  |               | (0.11  | )        |  |       | 0.76    |      |  |   | (0.11  | ) |  |   | 0.03    | 

The per share amounts are calculated
independently for each quarter. The sum of the quarters may not
equal the full year per share amounts.

17.     Restatement
of Statements of Cash Flows

Subsequent to the issuance of the consolidated
financial statements for the period ended June 28, 2003 the
Company determined that the cash flow related to the
Companys cash overdraft should have been classified as a
financing activity rather than as an operating activity. As a
result, the consolidated statements of cash flows for the years
ended June 28, 2003, June 29, 2002 and June 30, 2001
have been restated to reflect the cash flows related to the
Companys cash overdraft as a financing activity rather
than an operating activity. A summary of the effect of the
restatement on cash flows provided by (used in) operating and
financing activities is as follows (in thousands):

|                                            |  |               |         |             |  |   |         |  
|------------------------------------------- |  | ------------- | ------- | ----------- |  | - | ------- | -
|                                            |  | As Previously |         |            
|                                            |  | Reported      |         | As Restated
|                                            |  |               |         |            
|Year ended June 28, 2003:                   |  |               |         |             |  |   |         |  
|Cash flows provided by operating activities |  | $             | 24,129  |             |  | $ | 23,088  |  
|Cash flows used in financing activities     |  | $             | (1,990  | )           |  | $ | (949    | )
|                                           
|Year ended June 29, 2002:                   |  |               |         |             |  |   |         |  
|Cash flows provided by operating activities |  | $             | 34,127  |             |  | $ | 31,042  |  
|Cash flows used in financing activities     |  | $             | (20,494 | )           |  | $ | (17,409 | )
|                                           
|Year ended June 30, 2001:                   |  |               |         |             |  |   |         |  
|Cash flows provided by operating activities |  | $             | 29,655  |             |  | $ | 33,876  |  
|Cash flows used in financing activities     |  | $             | (8,099  | )           |  | $ | (12,320 | )

F-24



---



##### Table of Contents



PARTY CITY CORPORATION

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

|                                 |  |                |     |                 |  |            |        |         |  |   |        |   |  |   |     | 
|-------------------------------- |  | -------------- | --- | --------------- |  | ---------- | ------ | ------- |  | - | ------ | - |  | - | --- | 
|                                 |  | Balance        |     | Amounts         |  | Write-offs |        | Balance
|                                 |  | Beginning      |     | Charged to Cost |  | Against    |        | End of 
|                                 |  | of Year        |     | and Expenses    |  | Reserve    |        | Year   
|                                 |  |                |     |                 |  |            |        |        
|                                 |  |               
|                                 |  | (In thousands)
|Allowance for Doubtful Accounts: |  |                |     |                 |  |            |        |         |  |   |        |   |  |   |     | 
|Year Ended June 28, 2003         |  | $              | 785 |                 |  | $          | 50     |         |  | $ | (548   | ) |  | $ | 287 | 
|Year Ended June 29, 2002         |  |                | 852 |                 |  |            | 366    |         |  |   | (433   | ) |  |   | 785 | 
|Year Ended June 30, 2001         |  |                | 917 |                 |  |            | 315    |         |  |   | (380   | ) |  |   | 852 | 
|                                
|Reserve for Returns:             |  |                |     |                 |  |            |        |         |  |   |        |   |  |   |     | 
|Year Ended June 28, 2003         |  |                | 547 |                 |  |            | 16,249 |         |  |   | 16,123 |   |  |   | 673 | 
|Year Ended June 29, 2002         |  |                | 253 |                 |  |            | 14,204 |         |  |   | 13,910 |   |  |   | 547 | 
|Year Ended June 30, 2001         |  |                |    |                 |  |            | 13,323 |         |  |   | 13,070 |   |  |   | 253 | 

F-25