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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF 1934


For the Fiscal Year Ended June 29,
2002

Commission File Number 0-27826



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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                                      |  | 07866                                   
|(Address of principal executive
    offices)                       |  | (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 or any
amendment to this
Form 10-K. o

The aggregate market value of voting stock held
by non-affiliates of the Registrant on September 16, 2002,
based on the closing sale price on such date, was approximately
$163,036,905.

The number of outstanding shares of the
Registrants classes of common stock, $0.01 par value, as
of September 16, 2002 was 16,511,070.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrants Proxy
Statement for the 2002 Annual Meeting of Stockholders are
incorporated by reference into Part III.



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TABLE OF CONTENTS



|                                                                                        |                                                                                               |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|TABLE OF CONTENTS                                                                      
|PART I                                                                                 
|                                                                                        | Item 1. Business                                                                             
|                                                                                        | Item 2. Properties                                                                           
|                                                                                        | Item 3. Legal Proceedings                                                                    
|                                                                                        | Item 4. Submission of Matters to a Vote of Security Holders                                  
|PART II                                                                                
|                                                                                        | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                
|                                                                                        | Item 6. Selected Financial Data                                                              
|                                                                                        | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                                                        | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                          
|                                                                                        | Item 8. Financial Statements and Supplementary Data                                          
|                                                                                        | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 
|PART III                                                                               
|PART IV                                                                                
|                                                                                        | Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K                    
|SIGNATURES                                                                             
|PARTY CITY CORPORATION AND SUBSIDIARY                                                  
|CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (in thousands, except number of shares)
|PARTY CITY CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS       
|EX-23.1: CONSENT OF DELOITTE & TOUCHE LLP                                              



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TABLE OF CONTENTS

|         |  |                                                                                           |  |      |    | 
|-------- |  | ----------------------------------------------------------------------------------------- |  | ---- | -- | 
|         |  |                                                                                           |  | Page
|         |  |                                                                                           |  |     
|PART I  
|Item 1   |  | Business                                                                                  |  |      | 2  | 
|Item 2   |  | Properties                                                                                |  |      | 12 | 
|Item 3   |  | Legal Proceedings                                                                         |  |      | 12 | 
|Item 4   |  | Submission of Matters to a Vote of Security
    Holders                                   |  |      | 12 | 
|PART II 
|Item 5   |  | Market for Registrants Common Equity and
    Related Stockholder Matters                 |  |      | 13 | 
|Item 6   |  | Selected Financial Data                                                                   |  |      | 15 | 
|Item 7   |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |  |      | 18 | 
|Item 7A  |  | Quantitative and Qualitative Disclosures About
    Market Risk                            |  |      | 25 | 
|Item 8   |  | Financial Statements and Supplementary Data                                               |  |      | 25 | 
|Item 9   |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure  |  |      | 25 | 
|PART III
|Item 10  |  | Directors and Executive Officers of the Registrant                                        |  |      | 25 | 
|Item 11  |  | Executive Compensation                                                                    |  |      | 25 | 
|Item 12  |  | Security Ownership of Certain Beneficial Owners
    and Management                        |  |      | 25 | 
|Item 13  |  | Certain Relationships and Related Transactions                                            |  |      | 25 | 
|PART IV 
|Item 14  |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                      |  |      | 25 | 

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PART I

Forward-Looking Statements

This Form 10-K (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 that
projected or suggested herein. Additional information concerning
certain risks and uncertainties that could cause our actual
results to differ materially from that projected or suggested
may be identified from time to time in our Securities and
Exchange Commission filings and our public announcements.




Item 1.     Business

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 in Puerto
Rico, Portugal and Spain. The franchise stores located in Canada
were closed during early 2002.

General

We are a specialty retailer of party supplies
with a network of 481 stores. At September 16, 2002, we
owned and operated 234 stores in the United States and our
franchisees operated an additional 247 stores in the United
States, and in Puerto Rico, Portugal and Spain. 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 generally 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 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 refers to the 52 or 53 weeks, as
applicable, ending the Saturday nearest to June 30, unless
otherwise noted.

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. According to industry sources, the
market for party and special occasion merchandise, comprised of
party supplies, greeting cards, gift wrap, and related items was
estimated at $12.8 billion in sales in 2001.

2



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Business Strategy

Our objective is to maintain our position as a
leading national chain of party supplies stores. In order to
maintain continued store growth, our management intends to
continue to invest in our human resources and management
information systems to further improve the infrastructure
necessary to manage continued growth. 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 approximately
16,000 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 which we offer in order
to create consumer loyalty and generate repeat business by
striving to maintain a new and exciting product selection.

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, complementary retailers, storefront visibility
and presence (either in a stand-alone building or in dominant
power strip 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 481 Company-owned and franchise stores 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. 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. We
intend to balance growth between opening Company-owned stores
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. We currently plan to open twenty-five to
thirty Company-owned stores during Fiscal Year 2003. Franchise
store growth is subject to the ability and interest on the part
of the franchisees to open stores according to our expansion
plans.

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Store Locations

As of September 16, 2002, there were 481
Party City stores open in the United States, and in Puerto Rico,
Portugal and Spain. Of these, 234 were Company-owned and 247
were operated by our franchisees. The following table shows the
growth in Party Citys network of stores for the Fiscal
Years 1998 through 2002.

|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |     |  
|---------------------------------- | --------------------------------------- | ----------- | --- | ---- | - | ---- | --- | ---- | - | ---- | --- | --- | - |  | --- | --- | - |  | --- | --- | -
|                                   |                                         |            
|                                   |                                         | Fiscal Year
|                                   |                                         |            
|                                   |                                         | 1998        |     | 1999 |   | 2000 |     | 2001 |   | 2002
|                                   |                                         |             |     |      |   |      |     |      |   |     
|Company-owned:                     |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|                                   | Stores open at beginning of fiscal year |             |     | 57   |   |      |     | 148  |   |      |     | 215 |   |  |     | 197 |   |  |     | 193 |  
|                                   | Stores opened                           |             |     | 69   |   |      |     | 63   |   |      |     | 2   |   |  |     |    |   |  |     | 13  |  
|                                   | Stores closed                           |             |     |     |   |      |     |     |   |      |     | (2  | ) |  |     | (2  | ) |  |     |    |  
|                                   | Stores acquired from franchisees        |             |     | 22   |   |      |     | 5    |   |      |     |    |   |  |     | 1   |   |  |     | 3   |  
|                                   | Stores sold to franchisees              |             |     |     |   |      |     | (1   | ) |      |     | (18 | ) |  |     | (3  | ) |  |     |    |  
|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|                                   | Stores open at end of fiscal year       |             |     | 148  |   |      |     | 215  |   |      |     | 197 |   |  |     | 193 |   |  |     | 209 |  
|Franchise:                         |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|                                   | Stores open at beginning of fiscal year |             |     | 168  |   |      |     | 160  |   |      |     | 178 |   |  |     | 211 |   |  |     | 261 |  
|                                   | Stores opened                           |             |     | 15   |   |      |     | 23   |   |      |     | 18  |   |  |     | 51  |   |  |     | 19  |  
|                                   | Stores closed(a)                        |             |     | (1   | ) |      |     | (1   | ) |      |     | (3  | ) |  |     | (3  | ) |  |     | (35 | )
|                                   | Stores purchased by the Company         |             |     | (22  | ) |      |     | (5   | ) |      |     |    |   |  |     | (1  | ) |  |     | (3  | )
|                                   | Stores sold to franchisees              |             |     |     |   |      |     | 1    |   |      |     | 18  |   |  |     | 3   |   |  |     |    |  
|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|                                   | Stores open at end of fiscal year       |             |     | 160  |   |      |     | 178  |   |      |     | 211 |   |  |     | 261 |   |  |     | 242 |  
|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    
|Total Company and franchise stores |                                         |             | 308 |      |   |      | 393 |      |   |      | 408 |     |   |  | 454 |     |   |  | 451 |    
|                                   |                                         |             |     |      |   |      |     |      |   |      |     |     |   |  |     |     |   |  |     |    



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

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As of June 29, 2002, Party City stores are
located in the following states and geographic regions:

|               |       |        |    |     | 
|-------------- | ----- | ------ | -- | --- | 
|               |       | Fiscal
|               |       | Year  
|               |       |       
|Alabama        |       |        | 6  |    
|Arizona        |       |        | 8  |    
|Arkansas       |       |        | 2  |    
|California     |       |        | 52 |    
|Colorado       |       |        | 3  |    
|Connecticut    |       |        | 9  |    
|Delaware       |       |        | 1  |    
|Florida        |       |        | 49 |    
|Georgia        |       |        | 23 |    
|Hawaii         |       |        | 1  |    
|Illinois       |       |        | 17 |    
|Indiana        |       |        | 5  |    
|Kansas         |       |        | 3  |    
|Kentucky       |       |        | 1  |    
|Louisiana      |       |        | 11 |    
|Maryland       |       |        | 12 |    
|Massachusetts  |       |        | 3  |    
|Michigan       |       |        | 9  |    
|Minnesota      |       |        | 5  |    
|Mississippi    |       |        | 2  |    
|Missouri       |       |        | 5  |    
|Nevada         |       |        | 5  |    
|New Jersey     |       |        | 32 |    
|New Mexico     |       |        | 3  |    
|New York       |       |        | 46 |    
|North Carolina |       |        | 15 |    
|Ohio           |       |        | 11 |    
|Oregon         |       |        | 4  |    
|Pennsylvania   |       |        | 24 |    
|Rhode Island   |       |        | 1  |    
|South Carolina |       |        | 7  |    
|Tennessee      |       |        | 10 |    
|Texas          |       |        | 32 |    
|Utah           |       |        | 2  |    
|Virginia       |       |        | 13 |    
|Washington     |       |        | 6  |    
|Wisconsin      |       |        | 1  |    
|Puerto Rico    |       |        | 5  |    
|Portugal       |       |        | 2  |    
|Spain          |       |        | 5  |    
|               |       |        |    |    
|               | Total |        |    | 451 | 
|               |       |        |    |    

We typically seek sites for new stores that are
located in a strip or power shopping center near high traffic
routes. We seek to lease sites rather than purchase sites. Our
site selection criteria include, among other things: population
density, demographics, traffic count, complementary retailers,
storefront visibility and presence, competition, lease rates and
accessible parking. In addition, we carefully consider the
presence of existing competition in the market when selecting a
site. We believe there is an extensive number of suitable
domestic locations available for future sites.

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 15,560 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.



| |                    
| | -------------------
| | Product Categories.

The typical Party City store offers a broad
selection of brand name and private label merchandise consisting
of over 16,000 SKUs divided into the following categories:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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. We believe that the
    importance of Halloween is growing significantly among both
    young children and adults.
|
| | 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
    seasonal category includes products for the Super Bowl,
    Valentines Day, St. Patricks Day, Passover,
    Easter, First Communion, the Fourth of July, Christmas, Hanukkah
    and                                                                                                                                                                                                                                                                                                                                                                                    

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 event invitations are carried from the
    leading invitation stationers at discounted prices.                                                                          
|
| | Candy.The candy
    product category includes novelty and packaged candy sold to
    enhance childrens 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.                                                                                                                                                                                                                                                                                                     



| |                                                 
| | ------------------------------------------------
| | Product Selection, Purchasing and
    Suppliers.

We purchase from four suppliers which in the
aggregate constituted approximately 44% of our purchases for the
Fiscal Year 2002. The loss of any of these suppliers would
adversely affect our operations. 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.

6



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| |                 
| | ----------------
| | Store Operations

Customer Service.Customer service and shopping
convenience are integral components of our one-stop shopping
concept. We view the quality of our customers shopping
experience as critical to our continued success. For example, at
Halloween, our most important selling season, each store
significantly increases the number of sales associates in the
store.

Our management believes that the compensation of
our store managers and other personnel is competitive and
enables us to attract and retain well-qualified, highly
motivated employees who are committed to providing excellent
customer service.



| |                     
| | --------------------
| | Franchise Operations

As of September 16, 2002, the Company had
247 franchise stores throughout the United States, and in Puerto
Rico, Portugal and Spain. 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 1.0% of net sales to a
Party City group advertising fund to cover common advertising
materials related to the Party City store concept. 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 recently added staff to increase 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.

As of September 16, 2002, we had fourteen
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

The party supplies retailing business is highly
competitive. 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. Many of these competitors have
substantially 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.

7



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| |           
| | ----------
| | 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.

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 also must 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 be accessible to
customers with disabilities.



| |          
| | ---------
| | Employees

As of September 16, 2002, we employed
approximately 1,525 full-time and 3,050 part-time employees. We
consider our relationships with our employees to be good. None
of our employees is covered by a collective bargaining agreement.

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.

8



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

We have grown rapidly primarily through opening
new Company-owned stores, with the addition of 13 Company-owned
stores during fiscal 2002. We plan to open approximately 25 to
30 new Company-owned stores, net of store closings, in fiscal
2003. Our continued growth will depend, significantly, 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 and our franchisees ability to identify
    and secure suitable store sites on a timely basis;             
|
| |  | our and our franchisees ability to
    negotiate advantageous lease terms;                                     
|
| |  | our 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 sales 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.

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

9



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##### Table of Contents



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 fiscal year 2002, we purchased approximately 44%
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 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 which are beyond our control.

In addition, we believe many of our vendors
source their products from China, Mexico and other foreign
countries. A vendor could discontinue selling to us 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. We
compete against 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. Major chain competitors in our
markets include Paper Warehouse, iparty, Factory Card Outlet and
Party America. 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
convenience of location and store layout, product mix,
selection, customer convenience and price. Many of our
competitors have greater financial resources than we do.

As a result of this competition, we may also 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

10



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##### Table of Contents



of existing competitors into our markets could be
detrimental to 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.

We have historically experienced and expect to
continue to experience seasonal fluctuations in our net sales,
operating income and net income. Our net sales, operating income
and net income are typically higher in the second fiscal quarter
due to sales increases stemming from Halloween and other
calendar year end holidays. 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.

In addition, we plan to open approximately 25 to
30 new Company-owned stores, net of store closings, in fiscal
2003. 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 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 would harm our business.

Our success depends to a large extent on the
continued service of our executive management team. We have
employment agreements with two executive officers, but it is
possible that members of management may leave us. 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. 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.                                          

11



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##### Table of Contents








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

As of September 16, 2002, we leased all of
our 234 Company-owned stores. We also lease our corporate
headquarters property in Rockaway, New Jersey. We occupy
approximately 31,000 square feet of office space for our
headquarters under leases expiring in 2004.

Of the leases for the Company owned stores, two
expire in Fiscal Year 2003, eight expire in Fiscal Year 2004,
twelve expire in Fiscal Year 2005 and the balance expire in
Fiscal Year 2006 or thereafter. We have options to extend each
of such leases for a minimum of five years.






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



| |                      
| | ---------------------
| | 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. Our former Chief Executive Officer and
our former Chief Financial Officer and 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
course 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 are contained in the agreement in principle, and
include the settlement amount we are to pay, which is not
material to our results of operations or financial condition.
The settlement provided for in the agreement in principle is
subject to certain conditions, including the negotiation of a
definitive settlement agreement and the approval of the terms of
the settlement agreement by the District Court after notice to
the members of the class who have the right to object. There can
be no assurance that all these conditions will be satisfied.

Other

A lawsuit was filed on September 25, 2001
against Party City 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 seek the disgorgement of overtime wages
allegedly owed by us 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 us.

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






|        |                                                        
|------- | -------------------------------------------------------
|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 29, 2002.

12



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##### Table of Contents






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 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
closing sale prices of the common stock through June 29,
2002.

|                   |  |      |       |     |  |   |       | 
|------------------ |  | ---- | ----- | --- |  | - | ----- | 
|                   |  | High |       | Low
|                   |  |      |       |    
|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  | 
|Quarter Ended:     |  |      |       |     |  |   |       | 
|June 30, 2001      |  | $    | 6.00  |     |  | $ | 3.26  | 
|March 31, 2001     |  |      | 3.73  |     |  |   | 2.90  | 
|December 30, 2000  |  |      | 4.50  |     |  |   | 3.05  | 
|September 30, 2000 |  |      | 4.00  |     |  |   | 2.40  | 

At September 16, 2002, the number of holders
of record of the common stock was approximately 3,125.

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 Congress
Financial, 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.

Unregistered Securities

Pursuant to separate Securities Purchase
Agreements, each dated as of August 16, 1999 (the
Purchase Agreements), we issued the Notes and the
Warrants (each as defined below) to the investors set forth
therein (the Investors) for an aggregate purchase
price of $30 million. Under the terms of an amendment to
the Securities Purchase Agreements, dated as of January 14,
2000 (the First Amendment), the Amended Warrants
were exercisable for an aggregate of 6,880,000 shares of common
stock at an exercise price of $1.07 per share and may be
exercised at any time through August 16, 2006. In fiscal
2002, there were 3,696,000 warrants exercised. Upon the cashless
exercises, the warrant holders received 3,381,624 shares of
common stock. The remaining 314,376 shares with a market value
of $3,954,720 were surrendered in connection with this exercise.
The shares of common stock remaining for issuance under the
Amended Warrants represent approximately 16% of the shares of
common stock outstanding after giving effect to the full
exercise of the Amended Warrants. The private placement of the
issuance and sale of the Notes and the Amended Warrants to the
Investors was exempt from the registration requirements of the
Securities Act of 1933, as amended, pursuant to
Section 4(2) of such Act.

13



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##### Table of Contents



Equity Compensation Plan Information

The following sets forth certain information as
of June 29, 2002 concerning our equity compensation plans:

|                                                                |  |                            |           |                   |  |                         |      |  |  |  |           |  
|--------------------------------------------------------------- |  | -------------------------- | --------- | ----------------- |  | ----------------------- | ---- |  |  |  | --------- | -
|                                                                |  |                            |           |                   |  | Number of securities   
|                                                                |  |                            |           |                   |  | remaining available for
|                                                                |  |                            |           | Weighted-average  |  | future issuance under  
|                                                                |  | Number of securities to    |           | exercise price of |  | equity compensation    
|                                                                |  | be issued upon exercise of |           | outstanding       |  | plans (excluding       
|                                                                |  | outstanding options,       |           | options, warrants |  | securities reflected in
|                                                                |  | warrants and rights        |           | and rights        |  | column (a))            
|                                                                |  |                            |           |                   |  |                        
|Plan Category                                                   |  | (a)                        |           | (b)               |  | (c)                    
|                                                                |  |                            |           |                   |  |                        
|Equity compensation plans approved by security
    holders1     |  |                            | 2,046,699 | 2                 |  | $                       | 6.58 |  |  |  | 1,015,552 | 3
|Equity compensation plans not approved by
    security holders4 |  |                            | 85,028    | 5                 |  | $                       | 5.79 |  |  |  | 314,972   |  
|                                                                |  |                            |           |                   |  |                         |      |  |  |  |           |  
|Total                                                           |  |                            | 2,131,727 |                   |  | $                       | 6.55 |  |  |  | 1,330,524 |  
|                                                                |  |                            |           |                   |  |                         |      |  |  |  |           |  




| |     |                                                                                                                                                                                                            
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (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).



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Includes 821,976 outstanding options for our
    common stock pursuant to the 1994 Plan, 1,182,900 outstanding
    options for our common stock pursuant to the 1999 Plan and
    41,823 shares of our common stock which will be issued on
    January 1, 2003 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 2003 will have a purchase
    price of $6.34 per share.
|   
|(3) | The 1994 Plan terminated on September 4,
    2000 so no additional options may be issued thereunder,
    807,375 options remain available for issuance pursuant to
    the 1999 Plan and 208,177 shares of our common stock remain
    available for issuance pursuant to the ESPP.                                                                                                                                                                                                                                                                 
|   
|(4) | Consists of our Management Stock Purchase Plan. A
    description of our Management Stock Purchase Plan is contained
    in Note 10 to the consolidated financial statements located
    herein.                                                                                                                                                                                                                                                                                                                                                    
|   
|(5) | These shares will be issued in future periods as
    provided for in the Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

14



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

We have derived the selected financial data
presented below from our audited consolidated financial
statements for the fiscal years ended December 31, 1997 and
1998, July 1, 2000, June 30, 2001 and June 29,
2002 and the six months ended July 3, 1999. The selected
financial information presented below should be read in
conjunction with such financial statements and notes thereto.
The six months ended June 30, 1998 is unaudited and
presented for comparative purposes.

SELECTED FINANCIAL DATA

|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |         | 
|------------------------------------------------- | ---------------------------------------- | ----------------------------------------------- | ------- | -------- |  | ------- | ------- | ------------ |  | ------------ | ------- | ------- |  | - | ------- | ------- |  | - | ------- | ------- | 
|                                                  |                                          |                                                
|                                                  |                                          | Year Ended                                     
|                                                  |                                          |                                                
|                                                  |                                          | June 29,                                        |         | June 30, |  | July 1, |         | December 31, |  | December 31,
|                                                  |                                          | 2002                                            |         | 2001     |  | 2000    |         | 1998         |  | 1997        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |             
|                                                  |                                          |                                                
|                                                  |                                          | (in thousands, except per share and store data)
|Statement of Operations Data:                     |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Total revenue                                     |                                          | $                                               | 423,510 |          |  | $       | 395,900 |              |  | $            | 363,399 |         |  | $ | 294,334 |         |  | $ | 141,714 |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Company-owned stores:                             |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|                                                  | Net sales                                |                                                 | $       | 405,821  |  |         | $       | 380,671      |  |              | $       | 349,722 |  |   | $       | 282,923 |  |   | $       | 131,028 | 
|                                                  | Cost of goods sold and occupancy costs   |                                                 |         | 263,980  |  |         |         | 252,320      |  |              |         | 240,356 |  |   |         | 194,761 |  |   |         | 86,372  | 
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|                                                  | Gross profit                             |                                                 |         | 141,841  |  |         |         | 128,351      |  |              |         | 109,366 |  |   |         | 88,162  |  |   |         | 44,656  | 
|                                                  | Store operating and selling expense      |                                                 |         | 91,576   |  |         |         | 88,128       |  |              |         | 83,470  |  |   |         | 73,970  |  |   |         | 31,880  | 
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|                                                  | Company-owned stores profit contribution |                                                 |         | 50,265   |  |         |         | 40,223       |  |              |         | 25,896  |  |   |         | 14,192  |  |   |         | 12,776  | 
|                                                  | General and administrative expenses      |                                                 |         | 27,086   |  |         |         | 26,603       |  |              |         | 30,399  |  |   |         | 15,939  |  |   |         | 7,049   | 
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Retail profit contribution (loss)                 |                                          |                                                 | 23,179  |          |  |         | 13,620  |              |  |              | (4,503  | )       |  |   | (1,747  | )       |  |   | 5,727   |        
|Franchise stores:                                 |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|                                                  | Royalty fees                             |                                                 |         | 17,048   |  |         |         | 14,604       |  |              |         | 13,187  |  |   |         | 10,841  |  |   |         | 10,224  | 
|                                                  | Franchise fees                           |                                                 |         | 641      |  |         |         | 625          |  |              |         | 490     |  |   |         | 570     |  |   |         | 462     | 
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|                                                  | Total franchise revenues                 |                                                 |         | 17,689   |  |         |         | 15,229       |  |              |         | 13,677  |  |   |         | 11,411  |  |   |         | 10,686  | 
|                                                  | Total franchise expense                  |                                                 |         | 6,563    |  |         |         | 4,937        |  |              |         | 4,406   |  |   |         | 4,114   |  |   |         | 3,998   | 
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|                                                  | Franchise profit contribution            |                                                 |         | 11,126   |  |         |         | 10,292       |  |              |         | 9,271   |  |   |         | 7,297   |  |   |         | 6,688   | 
|Income before interest and income taxes           |                                          |                                                 | 34,305  |          |  |         | 23,912  |              |  |              | 4,768   |         |  |   | 5,550   |         |  |   | 12,415  |        
|Interest expense (income), net                    |                                          |                                                 | 5,610   |          |  |         | 7,949   |              |  |              | 8,423   |         |  |   | 2,636   |         |  |   | (212    | )      
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Income (loss) before income taxes                 |                                          |                                                 | 28,695  |          |  |         | 15,963  |              |  |              | (3,655  | )       |  |   | 2,914   |         |  |   | 12,627  |        
|Income tax provision (benefit)(a)                 |                                          |                                                 | 11,503  |          |  |         | 6,002   |              |  |              | (4,636  | )       |  |   | 1,127   |         |  |   | 4,957   |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Net income                                        |                                          | $                                               | 17,192  |          |  | $       | 9,961   |              |  | $            | 981     |         |  | $ | 1,787   |         |  | $ | 7,670   |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Basic earnings per share                          |                                          | $                                               | 1.32    |          |  | $       | 0.78    |              |  | $            | 0.08    |         |  | $ | 0.14    |         |  | $ | 0.65    |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Diluted earnings per share                        |                                          | $                                               | 0.89    |          |  | $       | 0.56    |              |  | $            | 0.07    |         |  | $ | 0.14    |         |  | $ | 0.64    |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Weighted average shares outstanding 
    basic   |                                          |                                                 | 13,068  |          |  |         | 12,723  |              |  |              | 12,611  |         |  |   | 12,411  |         |  |   | 11,749  |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Weighted average shares outstanding 
    diluted |                                          |                                                 | 19,313  |          |  |         | 17,819  |              |  |              | 14,283  |         |  |   | 12,704  |         |  |   | 12,039  |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|EBITDA(b)                                         |                                          | $                                               | 46,461  |          |  | $       | 36,618  |              |  | $            | 24,486  |         |  | $ | 12,148  |         |  | $ | 15,209  |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Cash flows provided from (used in):               |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Operating activities                              |                                          | $                                               | 34,127  |          |  | $       | 29,655  |              |  | $            | 9,334   |         |  | $ | (2,697  | )       |  | $ | 9,048   |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Investing activities                              |                                          |                                                 | (20,008 | )        |  |         | (15,664 | )            |  |              | 6,184   |         |  |   | (39,094 | )       |  |   | (39,925 | )      
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        
|Financing activities                              |                                          |                                                 | (20,494 | )        |  |         | (8,099  | )            |  |              | (23,038 | )       |  |   | 45,448  |         |  |   | 19,162  |        
|                                                  |                                          |                                                 |         |          |  |         |         |              |  |              |         |         |  |   |         |         |  |   |         |        

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|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |        |  
|------------------- | -------------------------------------------- | ----------------------------------------------- | - | -------- | - | ------- | - | ------------ | - | ------------ | - | ------- | - |  | - | ------- | - |  | - | ------ | -
|                    |                                              |                                                
|                    |                                              | Year Ended                                     
|                    |                                              |                                                
|                    |                                              | June 29,                                        |   | June 30, |   | July 1, |   | December 31, |   | December 31,
|                    |                                              | 2002                                            |   | 2001     |   | 2000    |   | 1998         |   | 1997        
|                    |                                              |                                                 |   |          |   |         |   |              |   |             
|                    |                                              |                                                
|                    |                                              | (in thousands, except per share and store data)
|Operating Data:     |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Number of Company-owned stores (end of year) |                                                 |   | 209      |   |         |   | 193          |   |              |   | 197     |   |  |   | 207     |   |  |   | 117    |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Increase in Company-owned same store sales   |                                                 |   | 4.9      | % |         |   | 10.3         | % |              |   | 3.8     | % |  |   | 11.3    | % |  |   | 15.5   | %
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Number of franchise stores (end of year)     |                                                 |   | 242      |   |         |   | 261          |   |              |   | 211     |   |  |   | 167     |   |  |   | 158    |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Increase in franchise same store sales       |                                                 |   | 4.5      | % |         |   | 4.3          | % |              |   | 7.9     | % |  |   | 6.8     | % |  |   | 14.8   | %
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Average sales per Company-owned store        |                                                 | $ | 2,044    |   |         | $ | 1,961        |   |              | $ | 1,810   |   |  | $ | 1,684   |   |  | $ | 1,740  |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Depreciation and amortization                |                                                 |   | 12,156   |   |         |   | 10,431       |   |              |   | 10,757  |   |  |   | 6,598   |   |  |   | 2,794  |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Special charges(c)                           |                                                 |   |         |   |         |   |             |   |              |   | 7,789   |   |  |   |        |   |  |   |       |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Impairment                                   |                                                 |   |         |   |         |   | 2,275        |   |              |   | 1,172   |   |  |   |        |   |  |   |       |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|Balance Sheet Data: |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Working capital (deficiency)                 |                                                 | $ | 14,707   |   |         | $ | 8,784        |   |              | $ | 15,069  |   |  | $ | (15,039 | ) |  | $ | 13,931 |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Total assets                                 |                                                 |   | 149,054  |   |         |   | 141,342      |   |              |   | 132,086 |   |  |   | 144,032 |   |  |   | 89,615 |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Bank borrowings(d)                           |                                                 |   | 8,915    |   |         |   | 16,006       |   |              |   | 29,547  |   |  |   |        |   |  |   | 3,150  |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       
|                    | Stockholders equity                         |                                                 |   | 67,599   |   |         |   | 51,090       |   |              |   | 40,861  |   |  |   | 49,368  |   |  |   | 45,783 |  
|                    |                                              |                                                 |   |          |   |         |   |              |   |              |   |         |   |  |   |         |   |  |   |       

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|                                                            |                                                    |                  |         |               |   |   |         |         | 
|----------------------------------------------------------- | -------------------------------------------------- | ---------------- | ------- | ------------- | - | - | ------- | ------- | 
|                                                            |                                                    |                 
|                                                            |                                                    | Six Months Ended
|                                                            |                                                    |                 
|                                                            |                                                    | July 3, 1999     |         | June 30, 1998
|                                                            |                                                    |                  |         |              
|                                                            |                                                    |                  |         | (unaudited)  
|Statement of Operations Data:                               |                                                    |                  |         |               |   |   |         |        
|Total revenue                                               |                                                    | $                | 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 expense                |                  |         | 42,052        |   |   |         | 24,111  | 
|                                                            |                                                    |                  |         |               |   |   |         |        
|                                                            | Company-owned stores profit contribution (loss)    |                  |         | (561          | ) |   |         | 3,361   | 
|                                                            | General and administrative expenses                |                  |         | 15,856        |   |   |         | 5,615   | 
|                                                            |                                                    |                  |         |               |   |   |         |        
|Retail profit 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   | 
|Income (loss) before interest and income
    taxes          |                                                    |                  | (13,163 | )             |   |   | 497     |        
|Interest expense, net                                       |                                                    |                  | 2,378   |               |   |   | 873     |        
|                                                            |                                                    |                  |         |               |   |   |         |        
|Loss before income taxes                                    |                                                    |                  | (15,541 | )             |   |   | (376    | )      
|Income tax benefit(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  |        
|                                                            |                                                    |                  |         |               |   |   |         |        
|EBITDA(b)                                                   |                                                    | $                | (1,776  | )             |   | $ | 4,131   |        
|                                                            |                                                    |                  |         |               |   |   |         |        
|Cash flows provided from (used in):                         |                                                    |                  |         |               |   |   |         |        
|Operating activities                                        |                                                    | $                | 779     |               |   | $ | (21,754 | )      
|                                                            |                                                    |                  |         |               |   |   |         |        
|Investing activities                                        |                                                    | $                | (7,933  | )             |   | $ | (12,832 | )      
|                                                            |                                                    |                  |         |               |   |   |         |        
|Financing activities                                        |                                                    | $                | 11,732  |               |   | $ | 36,440  |        
|                                                            |                                                    |                  |         |               |   |   |         |        
|Other information:                                          |                                                    |                  |         |               |   |   |         |        
|                                                            | Depreciation and amortization                      |                  |         | 5,229         |   |   |         | 3,634   | 
|                                                            | Special charges(c)                                 |                  |         | 5,858         |   |   |         |        | 
|                                                            | Impairment charge                                  |                  |         | 300           |   |   |         |        | 
|Balance Sheet Data:                                         |                                                    |                  |         |               |   |   |         |        
|                                                            | Working capital (deficiency)                       |                  | $       | (26,694       | ) |   | $       | 40,805  | 
|                                                            |                                                    |                  |         |               |   |   |         |        
|                                                            | Total assets                                       |                  |         | 161,319       |   |   |         | 119,168 | 
|                                                            |                                                    |                  |         |               |   |   |         |        
|                                                            | Bank borrowings and other long-term liabilities(d) |                  |         |              |   |   |         | 40,182  | 
|                                                            |                                                    |                  |         |               |   |   |         |        
|                                                            | Stockholders equity                               |                  |         | 35,934        |   |   |         | 46,103  | 
|                                                            |                                                    |                  |         |               |   |   |         |        



---



|    |                                                                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | The 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, amortization and impairment
    charge and exclusive of special charges. We believe EBITDA
    provides additional information for                                                                                  

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | 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.
|   
|(c) | Special charges relate to consulting services,
    accounting fees, bank fees, legal fees and other expenses
    related to our financial restructuring.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   
|(d) | 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.                                                                                                                                                                                                                                                                                                                                                                                                                       






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

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.

Long-lived assets excluding
goodwill.In the evaluation of the
fair value and future benefits of long-lived assets, we perform
an analysis of the anticipated undiscounted future net cash
flows of the related 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 our
strategies change, the conclusion regarding impairment may
differ from the current estimates.

Insurance accruals.The determination of insurance accruals is done using the
services of an actuary, applying certain historical experience
factors. Should a greater amount of claims occur compared to
what was estimated or costs increase beyond what was
anticipated, reserves recorded may not be sufficient and
additional costs to the consolidated financial statements could
be required.

Goodwill.We
evaluate goodwill whenever events and changes in circumstances
suggest that the carrying amount may not be recoverable from its
estimated future cash flows. To the extent these future
projections or our strategies change, the conclusion regarding
impairment may differ from the current estimates.

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General

Net Sales.Net sales
include same store sales and new store sales. Same store sales
include sales for those stores which 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 sales.Cost
of sales 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 and utilities.

Store operating and selling
expenses.Store operating and selling
expenses consist of selling and store management payroll,
employee benefits, 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 offices 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.

Results of Operations

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

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 which 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 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

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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.



| |                                                                                                     
| | ----------------------------------------------------------------------------------------------------
| | Year Ended June 30, 2001 (Fiscal
    2001) Compared to Year Ended July 1, 2000
    (Fiscal 2000)

Retail.Net sales
from Company-owned stores increased 8.8% to $380.7 million in
Fiscal 2001 from $349.7 million in Fiscal 2000. The Fiscal
2001 results include 197 stores which were open at the beginning
of that year plus one store acquired during the year, less three
stores sold and two stores closed during the year. Same store
sales increased 10.3% in Fiscal 2001. Gross profit reflects the
cost of goods sold and store occupancy costs including rent,
common area maintenance, real estate taxes, repair and
maintenance, depreciation and utilities. Gross profit for Fiscal
2001 increased 17.4% to $128.4 million compared to
$109.4 million for Fiscal 2000. The increase in Fiscal 2001
was primarily due to increased sales volume and improvement in
gross margin. Gross margin was 33.7% and 31.3% of sales for
Fiscal 2001 and Fiscal 2000, respectively. The increase in gross
margin was related primarily to stronger controls over inventory
resulting in reduced inventory loss and improved buying.

Store operating and selling expenses increased
5.6% to $88.1 million for Fiscal 2001, compared to
$83.5 million in Fiscal 2000. The increase in store
operating expenses is primarily attributable to an increase in

20



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##### Table of Contents



sales. Store operating expenses were 23.2% and
23.9% of sales for Fiscal 2001 and Fiscal 2000, respectively,
due to efficiencies occurring in staffing and advertising
resulting from an increase in average store sales. Company-owned
store profit contribution increased to $40.2 million for
Fiscal 2001, compared to $25.9 million for Fiscal 2000.


Pre-opening expenses of $78,000 were recorded in
Fiscal 2001 for four stores scheduled to open in the first
quarter of Fiscal 2002. No pre-opening expenses were recorded in
Fiscal 2000.

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. Royalty fees increased 10.7% to
$14.6 million in Fiscal 2001 from $13.2 million in
Fiscal 2000. Franchise fees recognized on 51 store openings
during Fiscal 2001 increased 27.6% to $625,000 compared to
$490,000 during Fiscal 2000 recognized on 23 store openings.
Franchise same store sales increased 4.3% in Fiscal 2001.

Expenses directly related to franchise revenue
increased 12.1% to $4.9 million for Fiscal 2001 from
$4.4 million for Fiscal 2000. This increase is primarily
attributable to additional franchise personnel required to
operate this portion of the Companys business and the
infrastructure to support such employees. As a percentage of
franchise revenue, franchise expenses were 32.4% and 32.2% for
Fiscal 2001 and Fiscal 2000, respectively.

Franchise profit contribution was increased 11.0%
to $10.3 million for Fiscal 2001 compared to
$9.3 million for Fiscal 2000. 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.

General and Administrative.General and administrative expenses
decreased 12.5% to $26.6 million in Fiscal 2001, compared
to $30.4 million in Fiscal 2000. The decrease is primarily
attributable to $7.8 million in special charges, relating
to consulting, accounting, banking and other expenses resulting
from our refinancing arrangements in Fiscal 2000, with no
comparable special charges in Fiscal 2001. An impairment charge
of $2.3 million related to store registers replaced in our
information system initiative was recorded in Fiscal 2001,
compared to an impairment charge of $1.2 million in Fiscal
2000 related to long-lived assets in certain underperforming
stores. Excluding special charges and impairment, general and
administrative expenses increased 13.5% to $24.3 million in
Fiscal 2001 compared to $21.4 million in Fiscal 2000.
Payroll and benefits increased $1.9 million or 19.1%, to
$12.0 million in Fiscal 2001 from $10.1 million in Fiscal
2000 as a result of additional headquarters personnel and
increased bonus payments. Exclusive of special charges and the
impairment charge discussed above, general and administrative
expenses were 6.4% and 6.1% of sales in Fiscal 2001 and Fiscal
2000, respectively.

Interest Expense.Interest expense decreased to
$7.9 million for Fiscal 2001 from $8.4 million in
Fiscal 2000. This is attributable to a reduction in principal
balance following a scheduled payment of $5.1 million in
January 2001. We expensed approximately $100,000 in the
write-off of debt-issue costs, included in interest expense,
related to an additional prepayment of $3.0 million made in June
2001.

Income Taxes.Income
taxes of $6.0 million, or 37.6% of pre-tax income, were
provided in Fiscal 2001. Tax benefits of $4.6 million
related primarily to deferred tax valuation allowance reversals
were recognized in Fiscal 2000.

Net Income.As a
result of the above factors, net income increased to
$10.0 million or $0.78 per basic share and $0.56 per
diluted share in Fiscal 2001, as compared to net income of
$981,000, or $0.08 per basic share and $0.07 per diluted share
in Fiscal 2000.

Liquidity and Capital Resources

Cash provided by operating activities was
$34.1 million in Fiscal 2002 compared to $29.7 million
in Fiscal 2001. The increase is primarily due to an increase in
net income in Fiscal 2002 of $17.2 million and extended
terms in accounts payable granted by vendors in connection with
new store openings.

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Net cash of $20.0 million was used in
investing activities in Fiscal 2002 as a result of investments
in new systems and new stores, compared to $16.9 million used in
investing in new systems and acquisitions offset by $1.2 million
received from the sale of stores in Fiscal 2001.

Net cash used in financing activities was
$20.5 million, primarily the result of the scheduled
repayment of $11.7 million of the Notes during the 2002
fiscal year and the prepayment of $7.7 million of the Notes
in June 2002 compared to $8.1 million used primarily for
payment of the Notes in Fiscal 2001.

As of June 29, 2002, we had no balance
outstanding under our Loan and Security Agreement dated
January 14, 2000 (the Loan Agreement), with
Congress Financial Corporation. Pursuant to the Loan Agreement,
we have a standby letter of credit of $1,430,000 at
June 29, 2002. Under the terms of the Loan Agreement, we
may from time to time borrow, based on a percentage of eligible
inventory, up to a maximum of $40 million at any time
outstanding. Advances bear interest, at our option, (i) at
the adjusted Eurodollar rate plus the applicable margin, which
was 2.25% per annum at June 29, 2002, or (ii) at the
rate of  3/4% per annum above the prime rate, totaling
5.50% at June 29, 2002. The term of the Loan Agreement is
three years with yearly renewals thereafter and is secured by a
lien on substantially all of our assets. We feel that financing
through the renewal of this Loan Agreement or through other
sources is available. At September 16, 2002, there was
$19.4 million outstanding including the letter of credit
and $20.6 million available to be borrowed under the Loan
Agreement.

In August, 1999, we 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, 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 are secured by a junior lien on
substantially all of our assets. The Warrants were valued at
$2.0 million based on managements estimate using
certain fair value methodologies and represent an original issue
discount to the C Notes and D Notes. The Warrants may
be exercised on or before the close of business on
August 16, 2006. The proceeds from the $30 million in
new financing were used for the purchase of seasonal inventory,
the payment of amounts due under our previous Credit Agreement,
certain transaction fees and working capital.

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 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 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 Amended Warrants were
valued at $3.2 million based on managements estimate
using certain fair value methodologies and represent an original
issue discount to the C Notes and D Notes. This
discount is being amortized using the effective interest method.
The effective yield was 28.6% on the C Notes and is 28.9%
on the D Notes. As of June 29, 2002, we had
approximately $10.2 million in notes payable to investors.

22



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The amounts of each Note outstanding are as
follows:

|         |  |                                             |  |          |        |          |  |   |         |  
|-------- |  | ------------------------------------------- |  | -------- | ------ | -------- |  | - | ------- | -
|         |  |                                             |  | June 29, |        | June 30,
|Note     |  | Description                                 |  | 2002     |        | 2001    
|         |  |                                             |  |          |        |         
|Series A |  | 12.5% Secured Notes due 2003                |  | $        |       |          |  | $ | 5,104   |  
|Series B |  | 13.0% Secured Notes due 2003                |  |          |       |          |  |   | 5,103   |  
|Series C |  | 13.0% Secured Notes due 2002                |  |          |       |          |  |   | 5,103   |  
|Series D |  | 14.0% Secured Notes due 2004                |  |          | 10,207 |          |  |   | 10,207  |  
|Series E |  | 14.0% Senior Secured Notes due 2002         |  |          |       |          |  |   | 4,000   |  
|         |  |                                             |  |          |        |          |  |   |         |  
|         |  |                                             |  |          | 10,207 |          |  |   | 29,517  |  
|         |  | Unamortized debt discount                   |  |          | (1,292 | )        |  |   | (2,145  | )
|         |  |                                             |  |          |        |          |  |   |         |  
|         |  | Less: Current portion, net of debt discount |  |          |       |          |  |   | (11,366 | )
|         |  |                                             |  |          |        |          |  |   |         |  
|         |  |                                             |  | $        | 8,915  |          |  | $ | 16,006  |  
|         |  |                                             |  |          |        |          |  |   |         |  

As of June 29, 2002, the aggregate
maturities of Secured Notes are due as follows:

|                                |  |   |        |  
|------------------------------- |  | - | ------ | -
|January 2003                    |  | $ |       |  
|January 2004                    |  |   | 10,207 |  
|                                |  |   |        |  
|                                |  |   | 10,207 |  
|                                |  |   |        |  
|Less: Unamortized debt discount |  |   | (1,292 | )
|                                |  |   |        |  
|                                |  | $ | 8,915  |  
|                                |  |   |        |  

We were in violation of a covenant under the
Securities Purchase Agreements (as amended) related to the
amount of capital expenditures during the fiscal years ended
June 29, 2002 and June 30, 2001. We exceeded the
capital expenditures limit primarily because of additional costs
related to expanded functionality in the merchandise management
system, acquisitions and new store expansion. We received
waivers at no cost from the Investors for these violations.

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. As of June 29, 2002, we had
repurchased 284,000 shares for an aggregate amount of
$1.8 million, or 12.2% of the total amount authorized to be
purchased. No stock repurchases have been made subsequent to
June 29, 2002.

Our management currently believes that the cash
generated by operations, together with the borrowing
availability under the Loan Agreement, will be sufficient to
meet our working capital infrastructure and new store growth
needs for the next twelve months.

Contractual Obligations and Commercial
Commitments

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

|                              |                           |                                       |         |         |  |           |        |           |  |               |        |        |  |   |        |        |  |   |        |        | 
|----------------------------- | ------------------------- | ------------------------------------- | ------- | ------- |  | --------- | ------ | --------- |  | ------------- | ------ | ------ |  | - | ------ | ------ |  | - | ------ | ------ | 
|                              |                           |                                      
|                              |                           | Payments Due By Period (in thousands)
|                              |                           |                                      
|                              |                           | Total                                 |         | 1 Year  |  | 2-3 Years |        | 4-5 Years |  | After 5 years
|                              |                           |                                       |         |         |  |           |        |           |  |              
|Contractual Obligations       |                           |                                       |         |         |  |           |        |           |  |               |        |        |  |   |        |        |  |   |        |       
|                              | Senior Notes              |                                       | $       | 10,207  |  |           | $      |          |  |               | $      | 10,207 |  |   | $      |       |  |   | $      |       | 
|                              | Capital lease obligations |                                       |         | 56      |  |           |        | 34        |  |               |        | 22     |  |   |        |       |  |   |        |       | 
|                              | Operating leases          |                                       |         | 281,840 |  |           |        | 42,904    |  |               |        | 85,344 |  |   |        | 77,527 |  |   |        | 76,065 | 
|                              |                           |                                       |         |         |  |           |        |           |  |               |        |        |  |   |        |        |  |   |        |       
|Total Contractual Obligations |                           | $                                     | 292,103 |         |  | $         | 42,938 |           |  | $             | 95,573 |        |  | $ | 77,527 |        |  | $ | 76,065 |       
|                              |                           |                                       |         |         |  |           |        |           |  |               |        |        |  |   |        |        |  |   |        |       

23



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Accounting and Reporting Changes

In June 2001, the Financial Accounting Standards
Board (FASB) issued two new pronouncements:
Statement of Financial Accounting Standards (SFAS)
No. 141, Business Combinations, and SFAS No. 142,
Goodwill and Other Intangible Assets.

SFAS No. 141 addresses financial accounting
and reporting for business combinations and supersedes APB
No. 16 Business Combinations and FASB Statement
No. 38, Accounting for Preacquisition Contingencies
of Purchased Enterprises. All business combinations in the
scope of this Statement are to be accounted for using one
method, the purchase method. SFAS 141 is effective as
follows: a) use of the pooling-of-interest method is
prohibited for business combinations initiated after
June 30, 2001; and b) the provisions of SFAS 141
also apply to all business combinations accounted for by the
purchase method that are completed after June 30, 2001
(that is, the date of the acquisition is July 2001 or later).
The adoption of this statement did not have a material impact on
our results of operations or financial condition.

SFAS No. 142 addresses financial accounting
and reporting for acquired goodwill and other intangible assets
and supersedes APB No. 17, Intangible Assets.
On July 1, 2001, we adopted SFAS No. 142,
Goodwill and Other Intangible Assets. As a result,
we no longer amortize goodwill, but periodically we evaluate
goodwill for recoverability. We also evaluate goodwill whenever
events and changes in circumstance suggest that the carrying
amount may not be recoverable from its estimated future cash
flows. In Fiscal 2001, we recorded $1.0 million of
goodwill amortization which decreased net earnings by $725,000.

Accounting Standards Not Yet Adopted

In August 2001, the FASB issued SFAS
No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires entities to record
the fair value of a liability for an asset retirement obligation
in the period in which it is incurred. The provisions of SFAS
No. 143 are effective for fiscal years beginning after
June 15, 2002. We will adopt SFAS No. 143 beginning in
the first fiscal quarter of fiscal 2003. We believe that the
adoption of SFAS No. 143 will not have a material impact on
our results of operations or financial condition.

In October 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS No. 144 supersedes SFAS
No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. The
primary objectives of SFAS No. 144 were to develop one
accounting model based on the framework established in SFAS
No. 121 and to address significant implementation issues.
The provisions of SFAS No. 144 are effective for fiscal
years beginning after December 15, 2001. We will adopt SFAS
No. 144 in the first fiscal quarter of fiscal 2003. We
believe that the adoption of SFAS No. 144 will not have a
material impact on our results of operations or financial
condition.

In April 2002, the FASB issued SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 rescinds the provisions of
SFAS No. 4 that requires companies to classify certain
gains and losses from debt extinguishments as extraordinary
items, eliminates the provisions of SFAS No. 44 regarding
the Motor Carrier Act of 1980 and amends the provisions of
SFAS No. 13 to require that certain lease
modifications be treated as sale leaseback transactions. The
provisions of SFAS No. 145 related to classification of
debt extinguishment is effective for fiscal years beginning
after May 15, 2002. The adoption of SFAS No. 145 is
not expected to have a material impact on our results of
operations or financial condition.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or
disposal activities and nullifies 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. This
statement also established that fair value is the objective for
initial measurement of the liability. The provisions of SFAS
No. 146 are effective for exit or

24



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##### Table of Contents



disposal activities that are initiated after
December 31, 2002. We are currently evaluating the impact
of SFAS No. 146 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 for the year during
the fourth calendar 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. Our
results of operations may also fluctuate significantly as a
result of a variety of other factors, including the timing of
new store openings.






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

We, in the normal course of doing business, are
theoretically 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
the prime rate) may, during peak borrowing, have a negative
impact on short-term results.






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

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






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

None.




PART III

In accordance with general instruction G(3)
of Form 10-K, the information called for by Items 10,
11, 12 and 13 of Part III is incorporated by reference from our
definitive Proxy Statement for our 2002 Annual Meeting of
Stockholders.




PART IV






|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 14. | Exhibits, Financial Statement Schedules,
    and Reports on Form 8-K

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

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

Independent Auditors Report 
Deloitte & Touche LLP.

Consolidated Balance Sheets as of June 29,
2002 and June 30, 2001.



| |                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------
| | Consolidated Statements of Income for the years
    ended June 29, 2002, June 30, 2001 and July 1,
    2000.              
|
| | Consolidated Statements of Stockholders
    Equity for the years ended June 29, 2002, June 30,
    2001 and July 1, 2000.
|
| | Consolidated Statements of Cash Flows for the
    years ended June 29, 2002, June 30, 2001 and
    July 1, 2000.          

25



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##### Table of Contents





| |                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------
| | Notes to Consolidated Financial Statements for
    the years ended June 29, 2002, June 30, 2001 and
    July 1, 2000.

2. Financial Statement Schedules 
Not Applicable.

3. List of Exhibits.

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

| |          |  |  |   |  |                                                                                                                                                              
| | -------- |  |  | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 3.1(1)   |  |  |  |  | Certificate of Incorporation of the Company.                                                                                                                 
| | 3.2(4)   |  |  |  |  | Bylaws of the Company, as amended.                                                                                                                           
| | 4.1(1)   |  |  |  |  | Specimen stock certificate evidencing the Common
    Stock.                                                                                                  
| | 4.2(3)   |  |  |  |  | Form of Amended and Restated Warrant.                                                                                                                        
| | 4.3(4)   |  |  |  |  | Form of A Note.                                                                                                                                              
| | 4.4(4)   |  |  |  |  | Form of B Note.                                                                                                                                              
| | 4.5(4)   |  |  |  |  | Form of C Note.                                                                                                                                              
| | 4.6(4)   |  |  |  |  | Form of D Note.                                                                                                                                              
| | 4.7(3)   |  |  |  |  | Form of E Note.                                                                                                                                              
| | 4.8(4)   |  |  |  |  | Form of Securities Purchase Agreement, dated as
    of August 16, 1999, by and between the Company and each of
    the Investors.                            
| | 4.9(3)   |  |  |  |  | First Amendment to Securities Purchase Agreement,
    dated as of January 14, 2000, by and between the Company
    and each of the Investors.                
| | 4.10(5)  |  |  |  |  | Second Amendment to Securities Purchase
    Agreement, dated as of April 1, 2001, by and among the
    Company and each of the Investors.                    
| | 10.1(1)  |  |  |  |  | Form of Unit Franchise Agreement entered into by
    the Company and franchisees.                                                                            
| | 10.2(6)  |  |  |  |  | Amended and Restated 1999 Stock Incentive Plan of
    the Company.                                                                                           
| | 10.3(7)  |  |  |  |  | Option Agreement, dated as of June 8, 1999,
    between Steven Mandell and Jack Futterman.                                                                   
| | 10.4(7)  |  |  |  |  | Stock Pledge Agreement, dated as of June 8,
    1999, between Steven Mandell and Jack Futterman.                                                             
| | 10.5(7)  |  |  |  |  | Employment Agreement, dated as of June 8,
    1999, between the Company and Jack Futterman.                                                                  
| | 10.6(4)  |  |  |  |  | Investor Rights Agreement, dated as of
    August 16, 1999, by and among the Company, the Investors
    and Jack Futterman.                                  
| | 10.7(4)  |  |  |  |  | Standstill and Forbearance Agreement, dated as of
    August 16, 1999, by and among the Company, PNC Bank,
    National Association, as Agent, and the Banks.
| | 10.8(4)  |  |  |  |  | Vendor Forbearance and Standstill Agreement,
    dated as of August 16, 1999, by and among the Company and
    the Trade Vendors.                            
| | 10.9(5)  |  |  |  |  | First Amendment to Investor Rights Agreement,
    dated as of October 11, 2000, by and among the Company, the
    Investors and Jack Futterman.              
| | 10.10(5) |  |  |  |  | Second Amendment to Investor Rights Agreement,
    dated as of November 20, 2000, by and among the Company,
    the Investors and Jack Futterman.            
| | 10.11(3) |  |  |  |  | Loan and Security Agreement, dated
    January 14, 2000, by and between the Company and Congress
    Financial Corporation.                                  
| | 10.12(6) |  |  |  |  | Description of oral consulting agreement between
    the Company and Ralph Dillon.                                                                           
| | 10.13(6) |  |  |  |  | Employment Agreement of James Shea, dated as of
    December 10, 1999, by and between the Company and James
    Shea.                                        
| | 10.14(6) |  |  |  |  | Employment Agreement of Andrew Bailen, dated as
    of August 7, 2000, by and between the Company and Andrew
    Bailen.                                     
| | 10.15(6) |  |  |  |  | Employment Agreement of Thomas Larson, dated as
    of June 18, 1999, by and between the Company and Thomas
    Larson.                                      

26



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##### Table of Contents



| |          |  |  |   |  |                                                                                                                                                                                                                                     
| | -------- |  |  | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 10.16(8) |  |  |  |  | Management Stock Purchase Plan of the Company                                                                                                                                                                                       
| | 10.17(9) |  |  |  |  | Employee Stock Purchase Plan of the Company                                                                                                                                                                                         
| | 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.                                                                                                                                                                                                   



---

Notes



|    |                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to our Registration
    Statement as amended on Form S-1 Number 333-00350 as filed
    with the Commission on January 18, 1996.
|   
|(2) | Incorporated by reference to our Current Report
    on Form 8-K as filed with the Commission on June 8,
    2000.                                        
|   
|(3) | Incorporated by reference to our Current Report
    on Form 8-K as filed with the Commission on
    January 19, 2000.                                    
|   
|(4) | Incorporated by reference to our Current Report
    on Form 8-K as filed with the Commission on August 25,
    1999.                                     
|   
|(5) | Incorporated by reference to our Quarterly Report
    on Form 10-Q as filed with the Commission on May 15,
    2001.                                     
|   
|(6) | Incorporated by reference to our Quarterly Report
    on Form 10-Q as filed with the Commission on
    February 13, 2001.                                
|   
|(7) | Incorporated by reference to Amendment No. 1
    to Schedule 13D as filed by Jack Futterman with the
    commission on June 17, 1999.                    
|   
|(8) | Incorporated by reference to our Registration
    Statement on Form S-8 as filed with the Commission on
    July 23, 2001.                               



| |     |                     
| | --- | --------------------
| | (b) | Reports on Form 8-K.

No reports on Form 8-K have been filed
during the fourth quarter.



|    |                                                                                                                               
|--- | ------------------------------------------------------------------------------------------------------------------------------
|(9) | Incorporated by reference to our Registration
    Statement on Form S-8 as filed with the Commission on
    December 12, 2001.

27



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##### 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 September 27,
2002.



| |                       
| | ----------------------
| | 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 DILLONRalph Dillon                   |  | Non-Executive Chairman of the Board and Director |  | September 27, 2002
|   
|By: |  | /s/ JACK FUTTERMANJack Futterman               |  | Director                                         |  | September 27, 2002
|   
|By: |  | /s/ MICHAEL GATTOMichael Gatto                 |  | Director                                         |  | September 27, 2002
|   
|By: |  | /s/ RICHARD H. GRINERRichard H. Griner         |  | Director                                         |  | September 27, 2002
|   
|By: |  | /s/ L.R. JALENAK, JR.L.R. Jalenak, Jr.         |  | Director                                         |  | September 27, 2002
|   
|By: |  | /s/ HOWARD LEVKOWITZHoward Levkowitz           |  | Director                                         |  | September 27, 2002
|   
|By: |  | /s/ NANCY PEDOTNancy Pedot                     |  | Director                                         |  | September 27, 2002
|   
|By: |  | /s/ WALTER SALMONWalter Salmon                 |  | Director                                         |  | September 27, 2002
|   
|By: |  | /s/ MICHAEL E. TENNENBAUMMichael E. Tennenbaum |  | Director                                         |  | September 27, 2002
|   
|By: |  | /s/ JAMES SHEAJames Shea                       |  | Chief Executive Officer
    and Director         |  | September 27, 2002
|   
|By: |  | /s/ LINDA M. SILUKLinda M. Siluk               |  | Chief Financial Officer                          |  | September 27, 2002

28



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##### Table of Contents



CERTIFICATIONS

I, James Shea, certify that:

1.     I have reviewed
this annual report on Form 10-K of Party City Corporation;

2.     Based on my
knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report; and

3.     Based on my
knowledge, the financial statements, and other financial
information included in this annual report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this annual report.

|                         |  |                                                     
|------------------------ |  | ----------------------------------------------------
|Date: September 27, 2002 |  | /s/ JAMES SHEAJames Shea
    Chief Executive Officer

I, Linda M. Siluk, certify that:

1.     I have reviewed
this annual report on Form 10-K of Party City Corporation;

2.     Based on my
knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report; and

3.     Based on my
knowledge, the financial statements, and other financial
information included in this annual report, fairly present in
all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the
periods presented in this annual report.

|                         |  |                                                             
|------------------------ |  | ------------------------------------------------------------
|Date: September 27, 2002 |  | /s/ LINDA M. SILUKLinda M. Siluk
    Chief Financial Officer

29



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##### Table of Contents



INDEPENDENT AUDITORS REPORT

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 29, 2002 and June 30, 2001, and the related
consolidated statements of income, stockholders equity,
and cash flows for each of the three fiscal years ended
June 29, 2002. These consolidated financial statements are
the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States of
America. 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 June 29, 2002 and June 30, 2001, and the
consolidated results of their operations and their cash flows
for each of the fiscal years ended June 29, 2002,
June 30, 2001 and July 1, 2000 in conformity with
accounting principles generally accepted in the United States of
America.

As discussed in Note 5 to the consolidated
financial statements, the Company changed its method of
accounting for goodwill amortization in fiscal 2002.



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

Parsippany, New Jersey

August 14, 2002


F-1



---



##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY

CONSOLIDATED BALANCE SHEETS


(in thousands except share data)


|                                         |                                                                                                                            |                                            |        |          |         |  |        |        |         | 
|---------------------------------------- | -------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | ------ | ------- | 
|                                         |                                                                                                                            | June 29,                                   |        | June 30,
|                                         |                                                                                                                            | 2002                                       |        | 2001    
|                                         |                                                                                                                            |                                            |        |         
|ASSETS                                  
|Current assets:                          |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         | Cash and cash equivalents                                                                                                  |                                            | $      | 3,467    |         |  | $      | 9,842  |        
|                                         | Merchandise inventory                                                                                                      |                                            |        | 55,867   |         |  |        | 48,034 |        
|                                         | Deferred income taxes                                                                                                      |                                            |        | 5,827    |         |  |        | 3,798  |        
|                                         | Other current assets, net                                                                                                  |                                            |        | 11,789   |         |  |        | 12,156 |        
|                                         |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         |                                                                                                                            | Total current assets                       |        |          | 76,950  |  |        |        | 73,830  | 
|Property and equipment, net              |                                                                                                                            |                                            | 49,356 |          |         |  | 46,351 |       
|Goodwill                                 |                                                                                                                            |                                            | 18,016 |          |         |  | 13,647 |       
|Other assets                             |                                                                                                                            |                                            | 4,732  |          |         |  | 7,514  |       
|                                         |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         |                                                                                                                            | Total assets                               |        | $        | 149,054 |  |        | $      | 141,342 | 
|                                         |                                                                                                                            |                                            |        |          |         |  |        |       
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         | Accounts payable                                                                                                           |                                            | $      | 35,499   |         |  | $      | 27,905 |        
|                                         | Accrued expenses and other current liabilities                                                                             |                                            |        | 26,744   |         |  |        | 25,775 |        
|                                         | Senior Notes, current portion                                                                                              |                                            |        |         |         |  |        | 11,366 |        
|                                         | Advances under Loan Agreement                                                                                              |                                            |        |         |         |  |        |       |        
|                                         |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         |                                                                                                                            | Total current liabilities                  |        |          | 62,243  |  |        |        | 65,046  | 
|Long-term liabilities:                   |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         | Deferred rent and other long-term liabilities                                                                              |                                            |        | 10,297   |         |  |        | 9,200  |        
|                                         | Senior Notes                                                                                                               |                                            |        | 8,915    |         |  |        | 16,006 |        
|Commitments and contingencies            |                                                                                                                            |                                            |        |          |         |  |        |       
|Stockholders equity:                    |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         | Common stock, $.01 par value; authorized,
    25,000,000 shares; issued 16,239,081 and 12,723,455 shares,
    respectively |                                            |        | 162      |         |  |        | 127    |        
|                                         | Additional paid-in capital                                                                                                 |                                            |        | 39,347   |         |  |        | 38,236 |        
|                                         | Retained earnings                                                                                                          |                                            |        | 29,919   |         |  |        | 12,727 |        
|                                         | Treasury shares, at cost (284,000 shares)                                                                                  |                                            |        | (1,829   | )       |  |        |       |        
|                                         |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         |                                                                                                                            | Total stockholders equity                 |        |          | 67,599  |  |        |        | 51,090  | 
|                                         |                                                                                                                            |                                            |        |          |         |  |        |       
|                                         |                                                                                                                            | Total liabilities and stockholders equity |        | $        | 149,054 |  |        | $      | 141,342 | 
|                                         |                                                                                                                            |                                            |        |          |         |  |        |       

See accompanying notes to consolidated financial
statements.

F-2



---



##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME


(in thousands, except per share
data)


|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |         |         | 
|--------------------------------------- | -------------------------------------------------- | ------------------------------------------------- | ------ | ------------- | ------- | ------------ | ------ | ------- | ------- | - | ------ | ------- | ------- | 
|                                        |                                                    |                                                  
|                                        |                                                    | Year Ended                                       
|                                        |                                                    |                                                  
|                                        |                                                    | June 29, 2002                                     |        | June 30, 2001 |         | July 1, 2000
|                                        |                                                    |                                                   |        |               |         |             
|Revenues:                               |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|                                        | Net sales                                          |                                                   | $      | 405,821       |         |              | $      | 380,671 |         |   | $      | 349,722 |        
|                                        | Royalty fees                                       |                                                   |        | 17,048        |         |              |        | 14,604  |         |   |        | 13,187  |        
|                                        | Franchise fees                                     |                                                   |        | 641           |         |              |        | 625     |         |   |        | 490     |        
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|                                        |                                                    | Total revenues                                    |        |               | 423,510 |              |        |         | 395,900 |   |        |         | 363,399 | 
|Expenses:                               |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|                                        | Cost of goods sold and occupancy costs             |                                                   |        | 263,980       |         |              |        | 252,320 |         |   |        | 240,356 |        
|                                        | Company-owned stores operating and selling expense |                                                   |        | 91,576        |         |              |        | 88,128  |         |   |        | 83,470  |        
|                                        | Franchise expense                                  |                                                   |        | 6,563         |         |              |        | 4,937   |         |   |        | 4,406   |        
|                                        | General and administrative expense                 |                                                   |        | 27,086        |         |              |        | 26,603  |         |   |        | 30,399  |        
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|                                        |                                                    | Total expenses                                    |        |               | 389,205 |              |        |         | 371,988 |   |        |         | 358,631 | 
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|Income before interest and income taxes |                                                    |                                                   | 34,305 |               |         |              | 23,912 |         |         |   | 4,768  |        
|                                        | Interest expense, net                              |                                                   |        | 5,610         |         |              |        | 7,949   |         |   |        | 8,423   |        
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|Income (loss) before income taxes       |                                                    |                                                   | 28,695 |               |         |              | 15,963 |         |         |   | (3,655 | )      
|                                        | Provision (benefit) for income taxes               |                                                   |        | 11,503        |         |              |        | 6,002   |         |   |        | (4,636  | )      
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|Net income                              |                                                    | $                                                 | 17,192 |               |         | $            | 9,961  |         |         | $ | 981    |        
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|                                        | Basic earnings per share                           |                                                   | $      | 1.32          |         |              | $      | 0.78    |         |   | $      | 0.08    |        
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|                                        |                                                    | Weighted average shares outstanding 
    basic   |        |               | 13,068  |              |        |         | 12,723  |   |        |         | 12,611  | 
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|                                        | Diluted earnings per share                         |                                                   | $      | 0.89          |         |              | $      | 0.56    |         |   | $      | 0.07    |        
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        
|                                        |                                                    | Weighted average shares outstanding 
    diluted |        |               | 19,313  |              |        |         | 17,819  |   |        |         | 14,283  | 
|                                        |                                                    |                                                   |        |               |         |              |        |         |         |   |        |        

See accompanying notes to consolidated financial
statements.

F-3



---



##### Table of Contents






PARTY CITY CORPORATION AND
SUBSIDIARY






CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY


(in thousands, except number of
shares)


|                                                                    |  |              |            |            |  |          |     |          |  |          |        |       |  |   |        |   |  |   |        |  |  |   |        |  
|------------------------------------------------------------------- |  | ------------ | ---------- | ---------- |  | -------- | --- | -------- |  | -------- | ------ | ----- |  | - | ------ | - |  | - | ------ |  |  | - | ------ | -
|                                                                    |  |              |            |            |  |          |     |          |  |         
|                                                                    |  | Common Stock |            | Additional |  | Treasury |     |          |  |         
|                                                                    |  |              |            | Paid-In-   |  | Stock at |     | Retained |  |         
|                                                                    |  | Shares       |            | Amounts    |  | Capital  |     | Cost     |  | Earnings |        | Total
|                                                                    |  |              |            |            |  |          |     |          |  |          |        |      
|Balance at July 3, 1999                                             |  |              | 12,455,538 |            |  | $        | 125 |          |  | $        | 34,024 |       |  | $ |       |   |  | $ | 1,785  |  |  | $ | 35,934 |  
|Issuance of common shares in exchange for
    professional services |  |              | 266,667    |            |  |          | 2   |          |  |          | 788    |       |  |   |       |   |  |   |       |  |  |   | 790    |  
|Issuance of warrants in connection with Senior
    Notes            |  |              |           |            |  |          |    |          |  |          | 3,156  |       |  |   |       |   |  |   |       |  |  |   | 3,156  |  
|Net income                                                          |  |              |           |            |  |          |    |          |  |          |       |       |  |   |       |   |  |   | 981    |  |  |   | 981    |  
|                                                                    |  |              |            |            |  |          |     |          |  |          |        |       |  |   |        |   |  |   |        |  |  |   |        |  
|Balance at July 1, 2000                                             |  |              | 12,722,205 |            |  |          | 127 |          |  |          | 37,968 |       |  |   |        |   |  |   | 2,766  |  |  |   | 40,861 |  
|Exercise of stock options                                           |  |              | 1,250      |            |  |          |    |          |  |          | 4      |       |  |   |       |   |  |   |       |  |  |   | 4      |  
|Issuance of options as 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 |       |  | $ | (1,829 | ) |  | $ | 29,919 |  |  | $ | 67,599 |  
|                                                                    |  |              |            |            |  |          |     |          |  |          |        |       |  |   |        |   |  |   |        |  |  |   |        |  

See accompanying notes to consolidated financial
statements.

F-4



---



##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(in thousands)


|                                                            |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |         |         |       | 
|----------------------------------------------------------- | ------------------------------------------------------------------------------------- | ---------------------------------------------- | ------------------------------------------------------- | ------------- | ------ | ------------ | ------ | ------- | ------ | ------- | ------- | ------- | ------- | ----- | 
|                                                            |                                                                                       |                                               
|                                                            |                                                                                       | Year Ended                                    
|                                                            |                                                                                       |                                               
|                                                            |                                                                                       | June 29, 2002                                  |                                                         | June 30, 2001 |        | July 1, 2000
|                                                            |                                                                                       |                                                |                                                         |               |        |             
|Cash flow from operating activities:                        |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|                                                            | Net income                                                                            |                                                | $                                                       | 17,192        |        |              | $      | 9,961   |        |         | $       | 981     |        
|                                                            | Adjustments to reconcile net income to net cash
    provided by operating activities: |                                                |                                                         |               |        |              |        |         |        |         |         |         |        
|                                                            |                                                                                       | Depreciation and amortization                  |                                                         |               | 12,156 |              |        |         | 10,431 |         |         |         | 10,757  |      
|                                                            |                                                                                       | Non-cash interest and financing costs          |                                                         |               | 1,395  |              |        |         | 1,815  |         |         |         | 1,506   |      
|                                                            |                                                                                       | Deferred tax asset                             |                                                         |               | 819    |              |        |         | 1,543  |         |         |         | (6,213  | )    
|                                                            |                                                                                       | Deferred rent                                  |                                                         |               | 765    |              |        |         | 1,148  |         |         |         | 978     |      
|                                                            |                                                                                       | Non-cash equity compensation                   |                                                         |               | 463    |              |        |         | 264    |         |         |         |        |      
|                                                            |                                                                                       | Provision for doubtful accounts                |                                                         |               | (67    | )            |        |         | (65    | )       |         |         | 975     |      
|                                                            |                                                                                       | Tax effect of non-qualified stock options      |                                                         |               | 37     |              |        |         |       |         |         |         |        |      
|                                                            |                                                                                       | Impairment charge                              |                                                         |               |       |              |        |         | 2,275  |         |         |         | 1,172   |      
|                                                            |                                                                                       | Loss (gain) on disposition and sale of stores  |                                                         |               |       |              |        |         | (131   | )       |         |         | 1,386   |      
|                                                            | Changes in assets and liabilities                                                     |                                                |                                                         |               |        |              |        |         |        |         |         |         |        
|                                                            |                                                                                       | Accounts payable                               |                                                         |               | 7,594  |              |        |         | (2,284 | )       |         |         | (22,417 | )    
|                                                            |                                                                                       | Merchandise inventory                          |                                                         |               | (7,310 | )            |        |         | (6,606 | )       |         |         | 186     |      
|                                                            |                                                                                       | Other long-term liabilities                    |                                                         |               | 833    |              |        |         | (326   | )       |         |         | (306    | )    
|                                                            |                                                                                       | Other assets                                   |                                                         |               | (654   | )            |        |         | (833   | )       |         |         | (223    | )    
|                                                            |                                                                                       | Other current assets                           |                                                         |               | 519    |              |        |         | 2,878  |         |         |         | 3,442   |      
|                                                            |                                                                                       | Accrued expenses and other current liabilities |                                                         |               | 470    |              |        |         | 7,789  |         |         |         | 10,041  |      
|                                                            |                                                                                       | Advance merchandise payments                   |                                                         |               | (85    | )            |        |         | 1,796  |         |         |         | 7,069   |      
|                                                            |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|                                                            |                                                                                       |                                                | Net cash provided by operating activities               |               |        | 34,127       |        |         |        | 29,655  |         |         |         | 9,334 | 
|Cash flow from investment activities:                       |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|                                                            | Purchases of property and equipment                                                   |                                                |                                                         | (14,085       | )      |              |        | (16,305 | )      |         |         | (4,109  | )      
|                                                            | Stores acquired                                                                       |                                                |                                                         | (5,923        | )      |              |        | (516    | )      |         |         |        |        
|                                                            | Proceeds from sales of stores                                                         |                                                |                                                         |              |        |              |        | 1,157   |        |         |         | 10,293  |        
|                                                            |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|                                                            |                                                                                       |                                                | Net cash (used in) provided by investing
    activities |               |        | (20,008      | )      |         |        | (15,664 | )       |         |         | 6,184 | 
|Cash flow from financing activities:                        |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|                                                            | Proceeds from issuance of (payments on) Senior
    Notes with warrants                |                                                |                                                         | (19,311       | )      |              |        | (8,103  | )      |         |         | 37,000  |        
|                                                            | Purchase of treasury shares                                                           |                                                |                                                         | (1,829        | )      |              |        |        |        |         |         |        |        
|                                                            | Proceeds from exercise of stock options                                               |                                                |                                                         | 646           |        |              |        | 4       |        |         |         |        |        
|                                                            | Net payments on Credit Agreement                                                      |                                                |                                                         |              |        |              |        |        |        |         |         | (58,550 | )      
|                                                            | Debt issue costs                                                                      |                                                |                                                         |              |        |              |        |        |        |         |         | (2,278  | )      
|                                                            | Proceeds from sale of stock                                                           |                                                |                                                         |              |        |              |        |        |        |         |         | 790     |        
|                                                            |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|Net cash used in financing activities                       |                                                                                       |                                                | (20,494                                                 | )             |        |              | (8,099 | )       |        |         | (23,038 | )      
|                                                            |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|Net (decrease) increase in cash and cash
    equivalents    |                                                                                       |                                                | (6,375                                                  | )             |        |              | 5,892  |         |        |         | (7,520  | )      
|Cash and cash equivalents, beginning of year                |                                                                                       |                                                | 9,842                                                   |               |        |              | 3,950  |         |        |         | 11,470  |        
|                                                            |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|Cash and cash equivalents, end of year                      |                                                                                       | $                                              | 3,467                                                   |               |        | $            | 9,842  |         |        | $       | 3,950   |        
|                                                            |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|Supplemental disclosure of cash flow information:           |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|                                                            | Income taxes paid                                                                     |                                                | $                                                       | 9,990         |        |              | $      | 5,315   |        |         | $       | 653     |        
|                                                            | Interest paid                                                                         |                                                |                                                         | 5,283         |        |              |        | 6,648   |        |         |         | 5,443   |        
|Supplemental disclosure of non-cash financing
    activity: |                                                                                       |                                                |                                                         |               |        |              |        |         |        |         |         |        
|                                                            | Warrant exercise                                                                      |                                                |                                                         |              |        |              |        |        |        |         |         |        |        

See accompanying notes to consolidated financial
statements

F-5



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##### 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 in Puerto Rico, Portugal and
Spain. At June 29, 2002, the Company had 209 Company-owned
stores and 242 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 refers to the 52 weeks ending 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, liability for
incurred but not reported medical claims and accrued workers
compensation and general liability claims and lives of
long-lived assets.

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, and accounts payable. The
carrying amounts reported in the balance sheets of such
financial instruments approximate their fair market values due
to their short-term maturity.

The estimated fair values of financial
instruments which 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. The fair value of the Companys
Series D 14.0% Secured Notes due 2004 is based on
discounted future cash flows using current interest rates for
financial instruments with similar characteristics and maturity.
The fair value of the Companys Series D 14.0% Secured
Notes due 2004 at June 29, 2002 was approximately its face
value.

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.

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 in
their use 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 years ended June 29, 2002,
June 30, 2001 and July 1, 2000, Ad Fund management
fees of $439,000, $401,000 and $360,000, 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 were 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
Long-lived Assets

The Company follows Statement of Financial
Accounting Standards (SFAS) No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, which requires impairment losses to be
recorded on long-lived assets used in operations when indicators
of impairment are present and the undiscounted cash flows
estimated to be generated by those assets are less than the
assets carrying amount. In evaluating the fair value and
future benefits of long-lived assets, the Company performs an
analysis of the anticipated undiscounted future net cash flows
of the related long-lived assets and if an impairment exists,
the Company reduces the carrying value of the asset based upon
the discounted future net cash flows. No impairment charges were
recorded in fiscal 2002. In fiscal 2001, the Company recorded an
impairment charge of $2.3 million related to store
registers replaced in the Companys information system
initiative. In fiscal 2000, the Company recorded an impairment
charge of $1.2 million related to long-lived assets in
certain underperforming stores. Management believes at this time
that the carrying value and useful life of goodwill and fixed
assets continue to be appropriate.

Intangibles

Intangibles, including a non-compete agreement,
are included in other assets and are being amortized using the
straight-line method over the estimated useful lives of the
agreements.

Goodwill

Goodwill is the excess of purchase price over
fair value of the net assets acquired in connection with the
purchase of stores. For a further explanation of the
Companys accounting for goodwill, see Footnote No. 5,
Goodwill and other intangibles.

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

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.

Stock
Options

As permitted under SFAS No. 123,
Accounting for Stock-Based Compensation, the Company
has elected not to adopt the fair value based method of
accounting for its stock-based compensation plans. The Company
will continue to apply the provisions of Accounting Principles
Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees. See Note No. 10.

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.

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 franchise fees and royalties. Revenue from
individual franchise sales, recorded as franchise fees, is
recognized by the Company upon completion of certain initial
services, which normally coincide with the opening of the
franchisees store. 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.
Royalty fees are recorded on a monthly basis as a percentage of
the franchisees net sales.

Area franchise sales represent agreements with
franchisees to open a specified number of franchises within
defined geographic areas and development periods. The
Companys policy is to receive 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 242 and 261 franchise stores at June 29,
2002 and June 30, 2001, respectively.

Store Opening
Costs

New store opening costs are expensed as incurred.

Effect of New
Accounting Standards

In June 2001, the Financial Accounting Standards
Board (FASB) issued two new pronouncements:
Statement of Financial Accounting Standards (SFAS)
No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible
Assets.

F-8



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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

SFAS No. 141 addresses financial accounting
and reporting for business combinations and supersedes APB
No. 16,Business Combinations, and FASB
Statement No. 38, Accounting for Preacquisition
Contingencies of Purchased Enterprises. All business
combinations in the scope of this Statement are to be accounted
for using one method, the purchase method. SFAS 141 is
effective as follows: a) use of the pooling-of-interest
method is prohibited for business combinations initiated after
June 30, 2001; and b) the provisions of SFAS 141
also apply to all business combinations accounted for by the
purchase method that are completed after June 30, 2001
(that is, the date of the acquisition is July 2001 or later).
The adoption of this statement did not have a material impact on
our results of operations or financial condition.

SFAS No. 142 addresses financial accounting
and reporting for acquired goodwill and other intangible assets
and supersedes APB No. 17, Intangible Assets.
On July 1, 2001, we adopted SFAS No. 142,
Goodwill and Other Intangible Assets. As a result,
we no longer amortize goodwill, but periodically we evaluate
goodwill for recoverability. The Company also evaluates goodwill
whenever events and changes in circumstance suggest that the
carrying amount may not be recoverable from its estimated future
cash flows. In Fiscal 2001, the Company recorded $1,015,000 of
goodwill amortization which decreased net earnings by $725,000.

Accounting Standards Not Yet Adopted

In August 2001, the FASB issued SFAS
No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires entities to record
the fair value of a liability for an asset retirement obligation
in the period in which it is incurred. The provisions of SFAS
No. 143 are effective for fiscal years beginning after
June 15, 2002. The Company will adopt SFAS No. 143
beginning in the first fiscal quarter of fiscal 2003. The
Company believes that the adoption of SFAS No. 143 will not
have a material impact on its results of operations or financial
condition.

In October 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS No. 144 supersedes SFAS
No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. The
primary objectives of SFAS No. 144 were to develop one
accounting model based on the framework established in SFAS
No. 121 and to address significant implementation issues.
The provisions of SFAS No. 144 are effective for fiscal
years beginning after December 15, 2001. The Company will
adopt SFAS No. 144 in the first fiscal quarter of fiscal
2003. The Company believes that the adoption of SFAS
No. 144 will not have a material impact on its results of
operations or financial condition.

In April 2002, the FASB issued SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 rescinds the
provisions of SFAS No. 4 that requires companies to
classify certain gains and losses from debt extinguishments as
extraordinary items, eliminates the provisions of SFAS
No. 44 regarding the Motor Carrier Act of 1980 and amends
the provisions of SFAS No. 13 to require that certain lease
modifications be treated as sale leaseback transactions. The
provisions of SFAS No. 145 related to classification of
debt extinguishment is effective for fiscal years beginning
after May 15, 2002. The adoption of SFAS No. 145 is
not expected to have a material impact on the Companys
results of operations or financial condition.

In June 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities. SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or
disposal activities and nullifies 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. This
statement also established that fair value is the objective for
initial measurement of the liability. The provisions of SFAS
No. 146 are effective for exit or

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

disposal activities that are initiated after
December 31, 2002. The Company is currently evaluating the
impact of SFAS No. 146 on its consolidated financial
statements.

Seasonality

The Companys business is subject to
substantial seasonal variations. Historically, the Company has
realized a significant portion of its net sales during the
fourth calendar 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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. The Company believes this general pattern will
continue in the future.



| |              
| | -------------
| | Concentration

The Company has four suppliers who in the
aggregate constituted approximately 44% of the Companys
purchases for the year ended June 29, 2002. The loss of any
of these suppliers would 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 October 2000, the Company signed an agreement
with The Party Supermarket, Inc. (Party Supermarket)
whereby Party Supermarket would become a franchisee. Under that
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. The consolidated
balance sheets include allocations of the purchase price
relating to these acquisitions resulting in the recording of
approximately $11,000 in goodwill, $218,000 in inventory and
$287,000 in fixed assets.



| |            
| | -----------
| | 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 completed the
acquisition of thirteen stores in the Seattle, Washington market
from Paper Warehouse, Inc. The conversion of these locations to
the Party City store format has been completed with all stores
to be opened in the first quarter of fiscal 2003.

The aggregate consideration paid in connection
with such acquisitions amounted to $5,923,000. The consolidated
balance sheets include allocations of the purchase price
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.

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

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Assuming the stores acquired during the year
ended June 29, 2002 and June 30, 2001 were acquired on
July 2, 2000, the pro forma results would have been as
follows (in thousands, except per share amounts) (unaudited):

|                           |  |            |         |          |  |   |         | 
|-------------------------- |  | ---------- | ------- | -------- |  | - | ------- | 
|                           |  |           
|                           |  | Year Ended
|                           |  |           
|                           |  | June 29,   |         | June 30,
|                           |  | 2002       |         | 2001    
|                           |  |            |         |         
|Total revenues             |  | $          | 439,989 |          |  | $ | 412,379 | 
|Net income                 |  |            | 17,618  |          |  |   | 10,387  | 
|Basic earnings per share   |  | $          | 1.35    |          |  | $ | 0.81    | 
|Diluted earnings per share |  | $          | 0.91    |          |  | $ | 0.58    | 



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

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

|                                          |  |          |        |          |  |   |        |  
|----------------------------------------- |  | -------- | ------ | -------- |  | - | ------ | -
|                                          |  | June 29, |        | June 30,
|                                          |  | 2002     |        | 2001    
|                                          |  |          |        |         
|Restricted cash from advertising fund     |  | $        | 1,082  |          |  | $ | 1,476  |  
|Receivables from franchisees              |  |          | 2,562  |          |  |   | 2,250  |  
|Advance merchandise payments              |  |          | 708    |          |  |   | 623    |  
|Prepaid expenses and other current assets |  |          | 8,222  |          |  |   | 8,659  |  
|                                          |  |          |        |          |  |   |        |  
|                                          |  |          | 12,574 |          |  |   | 13,008 |  
|Less: Allowance for doubtful accounts     |  |          | (785   | )        |  |   | (852   | )
|                                          |  |          |        |          |  |   |        |  
|                                          |  | $        | 11,789 |          |  | $ | 12,156 |  
|                                          |  |          |        |          |  |   |        |  



|   |                       
|-- | ----------------------
|4. | Property and Equipment

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

|                               |  |          |         |          |  |   |         |  
|------------------------------ |  | -------- | ------- | -------- |  | - | ------- | -
|                               |  | June 29, |         | June 30,
|                               |  | 2002     |         | 2001    
|                               |  |          |         |         
|Equipment                      |  | $        | 43,648  |          |  | $ | 35,852  |  
|Furniture                      |  |          | 26,411  |          |  |   | 22,060  |  
|Leasehold improvements         |  |          | 19,469  |          |  |   | 16,689  |  
|                               |  |          |         |          |  |   |         |  
|                               |  |          | 89,528  |          |  |   | 74,601  |  
|Less: accumulated depreciation |  |          | (40,172 | )        |  |   | (28,250 | )
|                               |  |          |         |          |  |   |         |  
|                               |  | $        | 49,356  |          |  | $ | 46,351  |  
|                               |  |          |         |          |  |   |         |  

Depreciation expense of $12.1 million,
$9.2 million and $9.5 million was recorded in Fiscal
2002, 2001 and 2000, respectively, on equipment, furniture and
leasehold improvements.



|   |                               
|-- | ------------------------------
|5. | Goodwill and Other Intangibles

On July 1, 2001, the Company adopted SFAS
No. 142, Goodwill and Other Intangible Assets.
As a result, the Company no longer amortizes goodwill, but
periodically the Company evaluates goodwill for impairment. The
Company also evaluates goodwill whenever events and changes in
circumstance suggest that the carrying amount may not be
recoverable from its estimated future cash flows. Upon adoption,
the Company established reporting units based on its current
reporting structure. The Company then assigned all

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

goodwill as well as other assets and liabilities
to the reporting units, to the extent that they relate to the
reporting unit. The Company completed the transitional goodwill
impairment test and has determined that no potential impairment
exists. As a result, no transitional impairment loss was
recorded in fiscal 2002 in connection with the adoption of SFAS
No. 142.

The following pro forma financial information is
presented as if the statement were adopted at the beginning of
fiscal 2000 (in thousands, except per share amounts):

|                                               |  |            |        |          |  |         |        |  |  |   |       | 
|---------------------------------------------- |  | ---------- | ------ | -------- |  | ------- | ------ |  |  | - | ----- | 
|                                               |  |           
|                                               |  | Year Ended
|                                               |  |           
|                                               |  | June 29,   |        | June 30, |  | July 1,
|                                               |  | 2002       |        | 2001     |  | 2000   
|                                               |  |            |        |          |  |        
|Reported net income                            |  | $          | 17,192 |          |  | $       | 9,961  |  |  | $ | 981   | 
|Add back:                                      |  |            |        |          |  |         |        |  |  |   |       | 
|Goodwill amortization, net of taxes            |  |            |       |          |  |         | 725    |  |  |   | 758   | 
|                                               |  |            |        |          |  |         |        |  |  |   |       | 
|Pro forma net income                           |  | $          | 17,192 |          |  | $       | 10,686 |  |  | $ | 1,739 | 
|                                               |  |            |        |          |  |         |        |  |  |   |       | 
|Earnings per share reported  basic            |  | $          | 1.32   |          |  | $       | 0.78   |  |  | $ | 0.08  | 
|Goodwill amortization, net of taxes            |  |            |       |          |  |         | 0.06   |  |  |   | 0.06  | 
|                                               |  |            |        |          |  |         |        |  |  |   |       | 
|Pro forma earnings per share  basic           |  | $          | 1.32   |          |  | $       | 0.84   |  |  | $ | 0.14  | 
|                                               |  |            |        |          |  |         |        |  |  |   |       | 
|Earnings per share reported  diluted          |  | $          | 0.89   |          |  | $       | 0.56   |  |  | $ | 0.07  | 
|Goodwill amortization, net of taxes            |  |            |       |          |  |         | 0.04   |  |  |   | 0.05  | 
|                                               |  |            |        |          |  |         |        |  |  |   |       | 
|Pro forma net earnings per share 
    diluted |  | $          | 0.89   |          |  | $       | 0.60   |  |  | $ | 0.12  | 
|                                               |  |            |        |          |  |         |        |  |  |   |       | 

The changes in the carrying amount of goodwill
for the fiscal year ended June 29, 2002, by operating
segment, are as follows (in thousands):

|                            |                                     |   |        |       | 
|--------------------------- | ----------------------------------- | - | ------ | ----- | 
|Retail:                     |                                     |   |        |      
|Balance as of June 30, 2001 |                                     | $ | 13,647 |      
|                            | Goodwill acquired during the period |   |        | 4,369 | 
|                            |                                     |   |        |      
|Balance as of June 29, 2002 |                                     | $ | 18,016 |      
|                            |                                     |   |        |      



|   |             
|-- | ------------
|6. | Other Assets

Other assets consist of the following (in
thousands):

|                               |  |          |       |          |  |   |       | 
|------------------------------ |  | -------- | ----- | -------- |  | - | ----- | 
|                               |  | June 29, |       | June 30,
|                               |  | 2002     |       | 2001    
|                               |  |          |       |         
|Non-compete agreement          |  | $        | 617   |          |  | $ |      | 
|Deferred income taxes          |  |          | 2,249 |          |  |   | 5,097 | 
|Loan commitment fees and other |  |          | 1,866 |          |  |   | 2,417 | 
|                               |  |          |       |          |  |   |       | 
|                               |  | $        | 4,732 |          |  | $ | 7,514 | 
|                               |  |          |       |          |  |   |       | 

The non-compete agreement consisted of amounts
paid to a franchisee in connection with a seven year agreement
not to compete. This intangible asset is being amortized over a
seven-year period. Estimated amortization expense for other
intangibles was $33,000 for the fiscal year ended June 29,
2002.

F-12



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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                   
|-- | --------------------------------------------------
|7. | Accrued Expenses and Other Current
    Liabilities

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

|                     |  |          |        |          |  |   |        | 
|-------------------- |  | -------- | ------ | -------- |  | - | ------ | 
|                     |  | June 29, |        | June 30,
|                     |  | 2002     |        | 2001    
|                     |  |          |        |         
|Accrued compensation |  | $        | 7,419  |          |  | $ | 6,397  | 
|Sales and use taxes  |  |          | 1,512  |          |  |   | 1,681  | 
|Other                |  |          | 17,813 |          |  |   | 17,697 | 
|                     |  |          |        |          |  |   |        | 
|                     |  | $        | 26,744 |          |  | $ | 25,775 | 
|                     |  |          |        |          |  |   |        | 



|   |                     
|-- | --------------------
|8. | Financing Agreements

As of June 29, 2002, the Company had no
balance outstanding under our Loan and Security Agreement dated
January 14, 2000 (the Loan Agreement), with
Congress Financial Corporation. Pursuant to the Loan Agreement,
the Company has a standby letter of credit of $1,430,000 at
June 29, 2002. Under the terms of the Loan Agreement, the
Company may from time to time borrow, based on a percentage of
eligible inventory, up to a maximum of $40 million at any
time outstanding. Advances bear interest, at the Companys
option, (i) at the adjusted Eurodollar rate plus the
applicable margin, which was 2.25% per annum at June 29,
2002, or (ii) at the rate of  3/4% per annum above the
prime rate, totaling 5.50% at June 29, 2002. The term of
the Loan Agreement is three years with renewals at the
Companys discretion thereafter and is secured by a lien on
substantially all of our assets. The Company feels that
financing through the renewal of this Loan Agreement or through
other sources is available.

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 are secured by a
junior lien on substantially all of the Companys assets.
The Warrants were valued at $2.0 million based on
managements estimate using certain fair value
methodologies and represent an original issue discount to the
C Notes and D Notes. The Warrants may be exercised on
or before the close of business on August 16, 2006. The
proceeds from the $30 million in new financing were used
for the purchase of seasonal inventory, the payment of amounts
due under the Companys previous Credit Agreement, certain
transaction fees and working capital.

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
are 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 Amended Warrants were valued at $3.2 million
based on managements estimate using certain fair value
methodologies and represent an original issue discount to the C
Notes and D Notes. This discount is being amortized using the
effective interest method. The effective yield

F-13



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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

on the C Notes was 28.6% and is 28.9% on the
D Notes. As of June 29, 2002, the Company had approximately
$10.2 million in notes payable to investors.

The Company was in violation of a covenant under
the Securities Purchase Agreements (as amended) related to the
amount of capital expenditures during the fiscal years ended
June 29, 2002 and June 30, 2001. The Company exceeded
the capital expenditures limit primarily because of additional
costs related to expanded functionality in the merchandise
management system, acquisitions and new store expansion. The
Company received waivers at no cost from the Investors for these
violations.

As of June 29, 2002, the Company had
approximately $10.2 million in notes payable to investors.
The Company made a required payment of $11.7 million due on
these Notes during the fiscal year. An additional
$7.7 million (due in January 2003) was prepaid in June
2002. The Company expensed approximately $19,000 in the
write-off of debt-issue costs, included in interest expense,
related to this prepayment.

The amounts of each Note outstanding are as
follows:

|         |  |                                             |  |          |        |          |  |   |         |  
|-------- |  | ------------------------------------------- |  | -------- | ------ | -------- |  | - | ------- | -
|         |  |                                             |  | June 29, |        | June 30,
|Note     |  | Description                                 |  | 2002     |        | 2001    
|         |  |                                             |  |          |        |         
|Series A |  | 12.5% Secured Notes due 2003                |  | $        |       |          |  | $ | 5,104   |  
|Series B |  | 13.0% Secured Notes due 2003                |  |          |       |          |  |   | 5,103   |  
|Series C |  | 13.0% Secured Notes due 2002                |  |          |       |          |  |   | 5,103   |  
|Series D |  | 14.0% Secured Notes due 2004                |  |          | 10,207 |          |  |   | 10,207  |  
|Series E |  | 14.0% Senior Secured Notes due 2002         |  |          |       |          |  |   | 4,000   |  
|         |  |                                             |  |          |        |          |  |   |         |  
|         |  |                                             |  |          | 10,207 |          |  |   | 29,517  |  
|         |  | Unamortized debt discount                   |  |          | (1,292 | )        |  |   | (2,145  | )
|         |  |                                             |  |          |        |          |  |   |         |  
|         |  | Less: Current portion, net of debt discount |  |          |       |          |  |   | (11,366 | )
|         |  |                                             |  |          |        |          |  |   |         |  
|         |  |                                             |  | $        | 8,915  |          |  | $ | 16,006  |  
|         |  |                                             |  |          |        |          |  |   |         |  

As of June 29, 2002, the aggregate
maturities of Notes are due as follows:

|                                |  |   |        |  
|------------------------------- |  | - | ------ | -
|January 2003                    |  | $ |       |  
|January 2004                    |  |   | 10,207 |  
|                                |  |   |        |  
|                                |  |   | 10,207 |  
|                                |  |   |        |  
|Less: Unamortized debt discount |  |   | (1,292 | )
|                                |  |   |        |  
|                                |  | $ | 8,915  |  
|                                |  |   |        |  

F-14



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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

9.     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 29,   |         | June 30, |  | July 1,
|                                                            |  | 2002       |         | 2001     |  | 2000   
|                                                            |  |            |         |          |  |        
|Net income                                                  |  | $          | 17,192  |          |  | $       | 9,961   |  |  | $ | 981       | 
|Earnings per share  basic                                  |  | $          | 1.32    |          |  | $       | 0.78    |  |  | $ | 0.08      | 
|Earnings per share  diluted                                |  | $          | 0.89    |          |  | $       | 0.56    |  |  | $ | 0.07      | 
|Average shares outstanding                                  |  |            | 13,068  |          |  |         | 12,723  |  |  |   | 12,611    | 
|Dilutive effect of stock options                            |  |            | 650     |          |  |         | 244     |  |  |   | 13        | 
|Dilutive effect of warrants                                 |  |            | 5,531   |          |  |         | 4,852   |  |  |   | 1,659     | 
|Restricted stock units                                      |  |            | 64      |          |  |         |        |  |  |   |          | 
|                                                            |  |            |         |          |  |         |         |  |  |   |           | 
|Average common and common equivalent shares
    outstanding |  |            | 19,313  |          |  |         | 17,819  |  |  |   | 14,283    | 
|                                                            |  |            |         |          |  |         |         |  |  |   |           | 
|Options excluded from dilutive calculation                  |  |            | 260,555 |          |  |         | 907,794 |  |  |   | 1,150,064 | 

Options to purchase common shares at prices
ranging from $1.71 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.

10.     Stockholders
Equity and Stock Options

Shares
Outstanding

The Company has 25,000,000 shares authorized of
its $.01 par value common stock. Shares issued and outstanding
were 16,239,081 and 12,723,455 at June 29, 2002 and
June 30, 2001, respectively.

Stock
Repurchase

In September 2001, the Board of Directors
authorized the Company to repurchase up to $15 million of
the Companys outstanding common stock. The stock
repurchases are made at the discretion of management. As of
June 29, 2002, the Company had repurchased 284,000 shares
for an aggregate amount of $1.8 million, or 12.2% of the
total amount authorized to be purchased. No stock repurchases
have been made subsequent to June 29, 2002.

Warrants

In Fiscal 2002, there were 3,696,000 warrants
exercised. Upon the cashless exercises, the warrant holders
received 3,381,624 shares of common stock. The remaining 314,376
shares with a market value of $3,954,720 were surrendered in
connection with this exercise.

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.

F-15



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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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
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 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 will 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-qualified stock options to purchase a total of 1,800,000
shares of the Companys common stock at an exercise price
not less than fair value at date of grant. On September 4,
2000, the 1994 Plan terminated. From that time forward, no
additional grants of options under the 1994 Plan are permitted.
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 through which the Company may
attract highly qualified persons to enter into and remain in the
employ 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 after the determination date. The
amortization of the discount is charged to compensation expense
over the three-year period. There was no compensation expense
attributable to fiscal 2001 for the MSPP. The compensation
expense attributable for Fiscal 2002 for the MSPP was $33,000.

During 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 2002 were $265,000 resulting in the obligation to
issue 41,823 shares of common stock.

F-16



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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|                         |  |           |           |                  |  |   |       | 
|------------------------ |  | --------- | --------- | ---------------- |  | - | ----- | 
|                         |  |           |           | Weighted        
|                         |  | Number of |           | Average Exercise
|                         |  | Shares    |           | Price           
|                         |  |           |           |                 
|Balance at July 3, 1999  |  |           | 1,026,826 |                  |  | $ | 12.47 | 
|Granted                  |  |           | 780,250   |                  |  |   | 2.28  | 
|Canceled                 |  |           | (285,950  | )                |  |   | 12.23 | 
|                         |  |           |           |                  |  |   |       | 
|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  | 
|                         |  |           |           |                  |  |   |       | 
|Options Exercisable at:  |  |           |           |                  |  |   |       | 
|July 1, 2000             |  |           | 559,123   |                  |  |   | 11.34 | 
|June 30, 2001            |  |           | 839,316   |                  |  |   | 8.49  | 
|June 29, 2002            |  |           | 1,076,631 |                  |  |   | 7.41  | 

|                         |  |                     |           |                     |  |          |      |                |  |          |       |  |  |  |           |  |  |   |       | 
|------------------------ |  | ------------------- | --------- | ------------------- |  | -------- | ---- | -------------- |  | -------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|                         |  |                     |           |                     |  |         
|                         |  | Options Outstanding |           |                    
|                         |  |                     |           | Options Exercisable
|                         |  |                     |           | Weighted            |  |          |      |               
|                         |  |                     |           | Average             |  | Weighted |      |                |  | Weighted
|                         |  | Number              |           | Remaining           |  | Average  |      | Number         |  | Average 
|                         |  | Outstanding at      |           | Contractual         |  | Exercise |      | Exercisable at |  | Exercise
|Range of Exercise Prices |  | June 29, 2002       |           | Life                |  | Price    |      | June 29, 2002  |  | Price   
|                         |  |                     |           |                     |  |          |      |                |  |         
|$1.71 to $2.00           |  |                     | 438,000   |                     |  |          | 7.46 |                |  | $        | 1.99  |  |  |  | 285,248   |  |  | $ | 1.99  | 
|$2.25 to $3.84           |  |                     | 461,200   |                     |  |          | 7.95 |                |  |          | 3.33  |  |  |  | 193,375   |  |  |   | 3.38  | 
|$4.13 to $7.38           |  |                     | 472,900   |                     |  |          | 8.85 |                |  |          | 6.78  |  |  |  | 141,566   |  |  |   | 6.24  | 
|$7.42 to $16.00          |  |                     | 546,276   |                     |  |          | 6.72 |                |  |          | 10.44 |  |  |  | 375,942   |  |  |   | 10.89 | 
|$16.33 to $32.50         |  |                     | 86,500    |                     |  |          | 5.74 |                |  |          | 22.04 |  |  |  | 80,500    |  |  |   | 22.15 | 
|                         |  |                     |           |                     |  |          |      |                |  |          |       |  |  |  |           |  |  |   |       | 
|                         |  |                     | 2,004,876 |                     |  |          | 7.63 |                |  | $        | 6.59  |  |  |  | 1,076,631 |  |  | $ | 7.41  | 

The Company measures compensation cost under APB
No. 25, Accounting for Stock Issued to
Employees. Accordingly, no compensation cost has been
recognized in connection with the 1999 and 1994 Plan in the
accompanying consolidated financial statements. In accordance
with SFAS No. 123, Accounting for Stock-Based
Compensation, 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 29,   |           | June 30, |  | July 1,
|                        |  | 2002       |           | 2001     |  | 2000   
|                        |  |            |           |          |  |        
|Expected volatility     |  |            | 50%       |          |  |         | 97%       |  |  |  | 137%      | 
|Expected lives          |  |            | 4.7 years |          |  |         | 4.0 years |  |  |  | 5.0 years | 
|Risk-free interest rate |  |            | 3.3%      |          |  |         | 4.3%      |  |  |  | 6.2%      | 
|Expected dividend yield |  |            | 0%        |          |  |         | 0%        |  |  |  | 0%        | 

The weighted average fair value of options
granted during the fiscal years 2002, 2001 and 2000 were $2.53,
$2.23 and $1.44 respectively.

F-17



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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Set forth below are the Companys net income
and earnings per share presented as reported and pro
forma as if compensation cost had been recognized in accordance
with the provisions of SFAS No. 123 (in thousands, except
per share data):

|                                   |             |            |   |          |  |         |   |       |  |  |   |       |  
|---------------------------------- | ----------- | ---------- | - | -------- |  | ------- | - | ----- |  |  | - | ----- | -
|                                   |             |           
|                                   |             | Year Ended
|                                   |             |           
|                                   |             | June 29,   |   | June 30, |  | July 1,
|                                   |             | 2002       |   | 2001     |  | 2000   
|                                   |             |            |   |          |  |        
|Net income (loss):                 |             |            |   |          |  |         |   |       |  |  |   |      
|                                   | As reported |            | $ | 17,192   |  |         | $ | 9,961 |  |  | $ | 981   |  
|                                   | Pro-forma   |            |   | 15,047   |  |         |   | 8,895 |  |  |   | (383  | )
|Basic earnings (loss) per share:   |             |            |   |          |  |         |   |       |  |  |   |      
|                                   | As reported |            | $ | 1.32     |  |         | $ | 0.78  |  |  | $ | 0.08  |  
|                                   | Pro-forma   |            |   | 1.16     |  |         |   | 0.70  |  |  |   | (0.03 | )
|Diluted earnings (loss) per share: |             |            |   |          |  |         |   |       |  |  |   |      
|                                   | As reported |            | $ | 0.89     |  |         | $ | 0.56  |  |  | $ | 0.07  |  
|                                   | Pro-forma   |            |   | 0.78     |  |         |   | 0.50  |  |  |   | (0.03 | )

11.     Income
Taxes

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

|          |         |            |        |          |   |         |       |       |  |   |        |        |  
|--------- | ------- | ---------- | ------ | -------- | - | ------- | ----- | ----- |  | - | ------ | ------ | -
|          |         |           
|          |         | Year Ended
|          |         |           
|          |         | June 29,   |        | June 30, |   | July 1,
|          |         | 2002       |        | 2001     |   | 2000   
|          |         |            |        |          |   |        
|Current:  |         |            |        |          |   |         |       |       |  |   |        |       
|          | Federal |            | $      | 7,760    |   |         | $     | 3,720 |  |   | $      | 1,575  |  
|          | State   |            |        | 2,673    |   |         |       | 470   |  |   |        | 2      |  
|          | Foreign |            |        | 251      |   |         |       | 269   |  |   |        |       |  
|          |         |            |        |          |   |         |       |       |  |   |        |       
|          |         |            | 10,684 |          |   |         | 4,459 |       |  |   | 1,577  |       
|Deferred: |         |            |        |          |   |         |       |       |  |   |        |       
|          | Federal |            |        | 1,329    |   |         |       | 1,154 |  |   |        | (4,787 | )
|          | State   |            |        | (510     | ) |         |       | 389   |  |   |        | (1,426 | )
|          |         |            |        |          |   |         |       |       |  |   |        |       
|          |         |            | 819    |          |   |         | 1,543 |       |  |   | (6,213 | )     
|          |         |            |        |          |   |         |       |       |  |   |        |       
|          |         | $          | 11,503 |          |   | $       | 6,002 |       |  | $ | (4,636 | )     
|          |         |            |        |          |   |         |       |       |  |   |        |       

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. In the six month period ended
July 3, 1999, the Company recorded a valuation allowance on
certain of the Companys deferred tax assets due to
uncertainties associated with generating taxable income needed
to recover such assets. As of July 1, 2000, the Company
recognized $3.7 million related to the reversal of such
valuation reserves because the Company believed it was more
likely than not that such deferred tax assets would be
recognized.

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Significant components of the net deferred tax
asset at June 29, 2002 and June 30, 2001 are as
follows (in thousands):

|             |                                                |                                |   |          |       |  |   |        |       | 
|------------ | ---------------------------------------------- | ------------------------------ | - | -------- | ----- |  | - | ------ | ----- | 
|             |                                                | June 29,                       |   | June 30,
|             |                                                | 2002                           |   | 2001    
|             |                                                |                                |   |         
|Current:     |                                                |                                |   |          |       |  |   |       
|             | Inventory                                      |                                | $ | 4,731    |       |  | $ | 2,861  |      
|             | Vacation pay accrual                           |                                |   | 453      |       |  |   | 457    |      
|             | Reserves not currently deductible              |                                |   | 965      |       |  |   | 797    |      
|             | Bonus accrual                                  |                                |   | 209      |       |  |   |       |      
|             | Deferred state taxes                           |                                |   | (531     | )     |  |   | (317   | )    
|             |                                                |                                |   |          |       |  |   |       
|             |                                                | Net current deferred tax asset |   | $        | 5,827 |  |   | $      | 3,798 | 
|             |                                                |                                |   |          |       |  |   |       
|Non-current: |                                                |                                |   |          |       |  |   |       
|             | Deferred rent                                  |                                | $ | 3,952    |       |  | $ | 3,307  |      
|             | Start-up costs                                 |                                |   | (447     | )     |  |   | (348   | )    
|             | Property and equipment                         |                                |   | (2,161   | )     |  |   | (2,023 | )    
|             | Foreign tax credit                             |                                |   |         |       |  |   | 440    |      
|             | Amortization of goodwill                       |                                |   | (1,075   | )     |  |   |       |      
|             | Other liabilities                              |                                |   | 1,980    |       |  |   | 1,790  |      
|             | Part year federal and state net operating loss |                                |   |         |       |  |   | 1,309  |      
|             | AMT credit                                     |                                |   |         |       |  |   | 622    |      
|             |                                                |                                |   |          |       |  |   |       
|             |                                                | Non-current deferred tax asset |   | $        | 2,249 |  |   | $      | 5,097 | 
|             |                                                |                                |   |          |       |  |   |       

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

|                                          |  |            |      |          |  |         |      |   |  |  |        |   
|----------------------------------------- |  | ---------- | ---- | -------- |  | ------- | ---- | - |  |  | ------ | --
|                                          |  |           
|                                          |  | Year Ended
|                                          |  |           
|                                          |  | June 29,   |      | June 30, |  | July 1,
|                                          |  | 2002       |      | 2001     |  | 2000   
|                                          |  |            |      |          |  |        
|Federal statutory rate                    |  |            | 35.0 | %        |  |         | 34.0 | % |  |  | (34.0  | )%
|State income taxes net of federal benefit |  |            | 4.9  |          |  |         | 3.6  |   |  |  | 4.0    |   
|Valuation allowance                       |  |            |     |          |  |         | (1.3 | ) |  |  | (102.4 | ) 
|Foreign tax                               |  |            |     |          |  |         |     |   |  |  | 1.9    |   
|Other                                     |  |            | 0.2  |          |  |         | 1.3  |   |  |  | 3.7    |   
|                                          |  |            |      |          |  |         |      |   |  |  |        |   
|Effective tax rate                        |  |            | 40.1 | %        |  |         | 37.6 | % |  |  | (126.8 | )%
|                                          |  |            |      |          |  |         |      |   |  |  |        |   

12.     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
employees contribution up to $1,000.

For the years ended June 29, 2002,
June 30, 2001 and July 1, 2000, matching contributions
of $309,000, $300,000 and $232,000, respectively, were expensed
under the 401(k) Plan.

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

13.     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 current 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 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. For the years ended June 29,
2002, June 30, 2001 and July 1, 2000, the Company paid
$80,000, $93,000 and $72,000 of interest related to these Notes,
respectively.

As of July 3, 1999, Erik Mandell, an 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 in 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 and
July 12, 2002 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 $9.375
and $17, respectively. Additional future grants of 50,000
options for shares will be made to Mr. Dillon on each of
January 12, 2003 and July 12, 2004, each with an
exercise price of $17.00 provided that Mr. Dillon remains
the non-executive chairman of the board of directors of the
Company and certain other requirements are met. All options will
be vested upon issuance. For the years ended June 29, 2002
and June 30, 2001, $430,000 and $264,000, were charged to
operations as compensation expense, respectively.

14.     Lease
Commitments

Leases

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 15,560 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. For the years
ended June 29, 2002, June 30, 2001 and July 1,
2000, no such contingent rent was paid.

At June 29, 2002, the Company leased
33 motor vehicles, primarily for its district managers and
regional management. The terms are for 36 months and expire
through June 2005.

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 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 $253,000 at
June 29, 2002. The leased software has been fully
depreciated.

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Future minimum lease payments under outstanding
leases at June 29, 2002, are as follows (in thousands):

|                                                                   |  |         |    |           |  |   |         | 
|------------------------------------------------------------------ |  | ------- | -- | --------- |  | - | ------- | 
|                                                                   |  | Capital |    | Operating
|                                                                   |  | Lease   |    | Lease    
|                                                                   |  |         |    |          
|Fiscal year ending:                                                |  |         |    |           |  |   |         | 
|2003                                                               |  | $       | 34 |           |  | $ | 42,904  | 
|2004                                                               |  |         | 22 |           |  |   | 43,481  | 
|2005                                                               |  |         |   |           |  |   | 41,863  | 
|2006                                                               |  |         |   |           |  |   | 40,446  | 
|2007                                                               |  |         |   |           |  |   | 37,081  | 
|Thereafter                                                         |  |         |   |           |  |   | 76,065  | 
|                                                                   |  |         |    |           |  |   |         | 
|Total minimum lease payments                                       |  |         | 56 |           |  | $ | 281,840 | 
|                                                                   |  |         |    |           |  |   |         | 
|Less amount representing interest                                  |  |         | (2 | )         |  |   |         | 
|                                                                   |  |         |    |           |  |   |         | 
|Present value of net minimum lease payments                        |  |         | 54 |           |  |   |         | 
|Less current maturities, included in other
    current liabilities |  |         | 32 |           |  |   |         | 
|                                                                   |  |         |    |           |  |   |         | 
|Long-term obligation                                               |  | $       | 22 |           |  |   |         | 
|                                                                   |  |         |    |           |  |   |         | 

Rent expense for all operating leases was
$35.9 million, $35.1 million, and $35.0 million
for the years ended June 29, 2002, June 30, 2001 and
July 1, 2000 respectively. The Company is obligated for
guarantees, subleases or assigned lease obligations for 28 of
its franchisees through 2011. The aggregate future minimum
payments under these leases are approximately $28.5 million.

15.     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. Our former Chief Executive Officer
and our former Chief Financial Officer and 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
course 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 are contained in the agreement in principle, and
include the settlement amount the Company is to pay, and are not
material to the Companys results of operations or
financial condition. The settlement provided for in the
agreement in principle is subject

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

to certain conditions, including the negotiation
of a definitive settlement agreement and the approval of the
terms of the settlement agreement by the District Court after
notice to the members of the class who have the right to object.
There can be no assurance that all these conditions will be
satisfied.

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 as exempt from California
overtime wage and hour laws. The lawsuit seeks relief in the
form of disgorgement of overtime wages allegedly owed by the
Company to the Class but not paid. The plaintiffs also seek
punitive damages and statutory penalties. The Company denies the
allegations and is vigorously defending against the claim. If a
class is certified, liability is found and a judgment is
entered, such a judgment may adversely affect us.

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

16.     Segment
Information

The Company owns, operates and franchises party
supplies stores in North America and, to a limited extent in
Europe. 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 charge for
initial franchise fees and a royalty 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.
Revenues from Europe were not significant in all periods
presented. All assets of the Company are located in North
America.

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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|                                     |  |               |         |               |  |              |         |   |  |   |         |  
|------------------------------------ |  | ------------- | ------- | ------------- |  | ------------ | ------- | - |  | - | ------- | -
|                                     |  |              
|                                     |  | Year Ended   
|                                     |  |              
|                                     |  | June 29, 2002 |         | June 30, 2001 |  | July 1, 2000
|                                     |  |               |         |               |  |             
|Retail:                              |  |               |         |               |  |              |         |   |  |   |         |  
|Net revenue                          |  | $             | 405,821 |               |  | $            | 380,671 |   |  | $ | 349,722 |  
|Operating earnings                   |  |               | 50,265  |               |  |              | 40,223  |   |  |   | 25,896  |  
|Identifiable assets                  |  |               | 129,340 |               |  |              | 122,804 |   |  |   | 121,190 |  
|Depreciation/amortization            |  |               | 7,341   |               |  |              | 8,086   |   |  |   | 8,351   |  
|Capital expenditures                 |  |               | 8,471   |               |  |              | 6,184   |   |  |   | 1,520   |  
|Franchising:                         |  |               |         |               |  |              |         |   |  |   |         |  
|Net revenue                          |  | $             | 17,689  |               |  | $            | 15,229  |   |  | $ | 13,677  |  
|Operating earnings                   |  |               | 11,126  |               |  |              | 10,292  |   |  |   | 9,271   |  
|Identifiable assets                  |  |               | 1,777   |               |  |              | 1,398   |   |  |   | 1,607   |  
|Depreciation/amortization            |  |               |        |               |  |              |        |   |  |   |        |  
|Capital expenditures                 |  |               |        |               |  |              |        |   |  |   |        |  
|Corporate/ Other:                    |  |               |         |               |  |              |         |   |  |   |         |  
|Net revenue                          |  | $             |        |               |  | $            |        |   |  | $ |        |  
|Operating expense                    |  |               | (27,086 | )             |  |              | (26,603 | ) |  |   | (30,399 | )
|Identifiable assets                  |  |               | 17,937  |               |  |              | 17,140  |   |  |   | 9,289   |  
|Depreciation/amortization            |  |               | 4,815   |               |  |              | 2,345   |   |  |   | 2,406   |  
|Capital expenditures                 |  |               | 5,614   |               |  |              | 10,121  |   |  |   | 2,589   |  
|Consolidated Totals:                 |  |               |         |               |  |              |         |   |  |   |         |  
|Net revenue                          |  | $             | 423,510 |               |  | $            | 395,900 |   |  | $ | 363,399 |  
|Operating earnings                   |  |               | 34,305  |               |  |              | 23,912  |   |  |   | 4,768   |  
|Interest expense, net                |  |               | 5,610   |               |  |              | 7,949   |   |  |   | 8,423   |  
|                                     |  |               |         |               |  |              |         |   |  |   |         |  
|Income (loss) before income taxes    |  |               | 28,695  |               |  |              | 15,963  |   |  |   | (3,655  | )
|Provision (benefit) for income taxes |  |               | 11,503  |               |  |              | 6,002   |   |  |   | (4,636  | )
|                                     |  |               |         |               |  |              |         |   |  |   |         |  
|Net income                           |  | $             | 17,192  |               |  | $            | 9,961   |   |  | $ | 981     |  
|                                     |  |               |         |               |  |              |         |   |  |   |         |  
|Identifiable assets                  |  | $             | 149,054 |               |  | $            | 141,342 |   |  | $ | 132,086 |  
|Depreciation/amortization            |  |               | 12,156  |               |  |              | 10,431  |   |  |   | 10,757  |  
|Capital expenditures                 |  |               | 14,085  |               |  |              | 16,305  |   |  |   | 4,109   |  

F-23



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##### Table of Contents



PARTY CITY CORPORATION AND
SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|                                       |  |               |        |          |  |       |         |      |  |   |        |   |  |   |         | 
|-------------------------------------- |  | ------------- | ------ | -------- |  | ----- | ------- | ---- |  | - | ------ | - |  | - | ------- | 
|                                       |  |              
|                                       |  | Quarter Ended
|                                       |  |              
|                                       |  | September     |        | December |  | March |         | June
|                                       |  |               |        |          |  |       |         |     
|Year Ended June 30, 2001               |  |               |        |          |  |       |         |      |  |   |        |   |  |   |         | 
|Total revenues                         |  | $             | 80,088 |          |  | $     | 143,682 |      |  | $ | 77,209 |   |  | $ | 94,921  | 
|Cost of goods sold and occupancy costs |  |               | 55,462 |          |  |       | 83,428  |      |  |   | 53,364 |   |  |   | 60,066  | 
|Net (loss) income                      |  |               | (2,351 | )        |  |       | 13,911  |      |  |   | (3,527 | ) |  |   | 1,928   | 
|Basic (loss) earnings per share        |  |               | (0.18  | )        |  |       | 1.09    |      |  |   | (0.28  | ) |  |   | 0.15    | 
|Diluted (loss) earnings per share      |  |               | (0.18  | )        |  |       | 0.78    |      |  |   | (0.28  | ) |  |   | 0.11    | 
|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    | 

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

F-24