##### Table of Contents



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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-Q

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



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|                               |  |                       
|------------------------------ |  | ----------------------
|For The Quarterly Period Ended |  | Commission File Number
|                              
|                              
|                              
|                              
|March 30, 2002                 |  | 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                                                |  | 07866                               
|                                                              
|                                                              
|                                                              
|                                                              
|Rockaway, New Jersey                                           |  | (Zip Code)                          
|                                                              
|                                                              
|                                                              
|                                                              
|(Address of Principal Executive Offices)                       |  |                                     

973-983-0888
(Registrants telephone number, including area code)



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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

| |  |                     
| |  | --------------------
| |  | Yes  X BOX  No:  BOX

Indicate the number of shares outstanding of each of the issuers classes
of common stock as of the latest practicable date:

BOX        As
of May 3, 2002, there were outstanding 13,333,518 shares of
Common Stock, $.01 par value.



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TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART 1. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures about Market Risk                           
|PART II OTHER INFORMATION    
|                              | Item 1. Legal Proceedings                                                                    
|                              | Item 2. Changes in Securities and Use of Proceeds                                            
|                              | Item 3. Defaults upon Senior Securities                                                      
|                              | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                              | Item 5. Other Information                                                                    
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|                              | EXHIBIT INDEX                                                                                



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##### Table of Contents



PARTY CITY CORPORATION AND SUBSIDIARY

INDEX

|                              |                                                                                                                                        |  |    |          |  | 
|----------------------------- | -------------------------------------------------------------------------------------------------------------------------------------- |  | -- | -------- |  | 
|                              |                                                                                                                                        |  |    | Page No.
|                              |                                                                                                                                        |  |    |         
|Part I. Financial Information |                                                                                                                                        |  |   
|                             
|                             
|                             
|                             
|Item 1.                       | Condensed Consolidated Financial Statements                                                                                            |  |    |         
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|                              | Condensed Consolidated Balance Sheets  March 30, 2002 (Unaudited),
March 31, 2001 (Unaudited)
and June 30, 2001                       |  |    | 3       
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|                              | Condensed Consolidated Statements of Operations (Unaudited)  For the
quarters and nine months ended March 30, 2002 and March 31, 2001 |  |    | 4       
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|                              | Condensed Consolidated Statements of Cash Flows (Unaudited)  For the
nine months ended March 30, 2002 and March 31, 2001              |  |    | 5       
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|                              | Notes to Condensed Consolidated Financial Statements                                                                                   |  |    | 6       
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Item 2.                       | Managements Discussion and Analysis of Financial Condition and
Results of Operations                                                  |  |    | 11      
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Item 3.                       | Quantitative and Qualitative Disclosures About Market Risk                                                                             |  |    | 17      
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Part II. Other Information    |                                                                                                                                        |  | 18
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Item 1.                       | Legal Proceedings                                                                                                                      |  |    | 18      
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Item 2.                       | Changes in Securities and Use of Proceeds                                                                                              |  |    | 18      
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Item 3.                       | Defaults Upon Senior Securities                                                                                                        |  |    | 18      
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Item 4.                       | Submission of Matters to a Vote of Security Holders                                                                                    |  |    | 19      
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Item 5.                       | Other Information                                                                                                                      |  |    | 19      
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Item 6.                       | Exhibits and Reports on Form 8-K                                                                                                       |  |    | 19      
|                             
|                             
|                             
|                             
|                              |                                                                                                                                        | 
|                             
|                             
|                             
|                             
|Exhibit Index                 |                                                                                                                                        |  |    | 20      

2



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##### Table of Contents






PART 1. FINANCIAL INFORMATION




Item 1.         Financial Statements




PARTY CITY CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |        |        |         | 
|--------------------------------------------- | ---------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ----------- | ------- | ----------- | ------ | -------- | ------- | ------ | ------ | ------ | ------- | 
|                                              |                                                |                                                                                                                               |                                            |        | March 30,   |         | March 31,   |        | June 30,
|                                              |                                                |                                                                                                                               |                                            |        | 2002        |         | 2001        |        | 2001    
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |         
|                                              |                                                |                                                                                                                               |                                            |        | (Unaudited) |         | (Unaudited) |        |          |         |       
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |        |        |         | 
|ASSETS                                        |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                             
|                                             
|                                             
|                                             
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |        |        |         | 
|                                             
|                                             
|                                             
|                                             
|Current assets:                               |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                             
|                                             
|                                             
|                                             
|                                              | Cash and cash equivalents                      |                                                                                                                               | $                                          | 7,455  |             |         | $           | 12,006 |          |         | $      | 9,842  |       
|                                             
|                                             
|                                             
|                                             
|                                              | Merchandise inventory                          |                                                                                                                               |                                            | 60,952 |             |         |             | 54,569 |          |         |        | 48,034 |       
|                                             
|                                             
|                                             
|                                             
|                                              | Deferred income taxes                          |                                                                                                                               |                                            | 5,031  |             |         |             | 5,305  |          |         |        | 3,798  |       
|                                             
|                                             
|                                             
|                                             
|                                              | Other current assets                           |                                                                                                                               |                                            | 13,349 |             |         |             | 14,211 |          |         |        | 12,156 |       
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                              |                                                | Total current assets                                                                                                          |                                            |        | 86,787      |         |             |        | 86,091   |         |        |        | 73,830 |        
|                                             
|                                             
|                                             
|                                             
|Property and equipment, net                   |                                                |                                                                                                                               | 46,024                                     |        |             |         | 42,437      |        |          |         | 46,351 |       
|                                             
|                                             
|                                             
|                                             
|Goodwill, net                                 |                                                |                                                                                                                               | 14,206                                     |        |             |         | 13,950      |        |          |         | 13,647 |       
|                                             
|                                             
|                                             
|                                             
|Other assets                                  |                                                |                                                                                                                               | 5,901                                      |        |             |         | 3,824       |        |          |         | 7,514  |       
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                              |                                                |                                                                                                                               | Total assets                               |        | $           | 152,918 |             |        | $        | 146,302 |        |        | $      | 141,342 | 
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                             
|                                             
|                                             
|                                             
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |        |        |         | 
|                                             
|                                             
|                                             
|                                             
|LIABILITIES AND STOCKHOLDERS EQUITY          |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                             
|                                             
|                                             
|                                             
|Current liabilities:                          |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                             
|                                             
|                                             
|                                             
|                                              | Accounts payable                               |                                                                                                                               | $                                          | 40,846 |             |         | $           | 40,004 |          |         | $      | 27,905 |       
|                                             
|                                             
|                                             
|                                             
|                                              | Accrued expenses and other current liabilities |                                                                                                                               |                                            | 23,191 |             |         |             | 18,726 |          |         |        | 26,274 |       
|                                             
|                                             
|                                             
|                                             
|                                              | Senior Notes, current portion                  |                                                                                                                               |                                            | 7,655  |             |         |             | 14,655 |          |         |        | 11,366 |       
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                              |                                                | Total current liabilities                                                                                                     |                                            |        | 71,692      |         |             |        | 73,385   |         |        |        | 65,545 |        
|                                             
|                                             
|                                             
|                                             
|Deferred rent and other long-term liabilities |                                                |                                                                                                                               | 9,725                                      |        |             |         | 8,531       |        |          |         | 8,701  |       
|                                             
|                                             
|                                             
|                                             
|Senior Notes                                  |                                                |                                                                                                                               | 8,759                                      |        |             |         | 15,488      |        |          |         | 16,006 |       
|                                             
|                                             
|                                             
|                                             
|Commitments and contingencies                 |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                             
|                                             
|                                             
|                                             
|Stockholders equity:                         |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                             
|                                             
|                                             
|                                             
|                                              |                                                | Common stock, $.01 par value, authorized 25,000,000 shares;
issued 13,289,767, 12,722,661 and 12,723,455 shares, respectively |                                            |        | 133         |         |             |        | 127      |         |        |        | 127    |        
|                                             
|                                             
|                                             
|                                             
|                                              | Additional paid-in capital                     |                                                                                                                               |                                            | 38,654 |             |         |             | 37,972 |          |         |        | 38,236 |       
|                                             
|                                             
|                                             
|                                             
|Retained earnings                             |                                                |                                                                                                                               | 25,784                                     |        |             |         | 10,799      |        |          |         | 12,727 |       
|                                             
|                                             
|                                             
|                                             
|Treasury stock, at cost (284,000 shares)      |                                                |                                                                                                                               | (1,829                                     | )      |             |         |            |        |          |         |       |       
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                              |                                                | Total stockholders equity                                                                                                    |                                            |        | 62,742      |         |             |        | 48,898   |         |        |        | 51,090 |        
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       
|                                              |                                                |                                                                                                                               | Total liabilities and stockholders equity |        | $           | 152,918 |             |        | $        | 146,302 |        |        | $      | 141,342 | 
|                                              |                                                |                                                                                                                               |                                            |        |             |         |             |        |          |         |        |       

See accompanying notes to condensed consolidated financial statements.

3



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##### Table of Contents



PARTY CITY CORPORATION AND SUBSIDIARY




CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)

|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |         |         | 
|---------------------------------------------- | -------------------------------------------------- | --------------------------------------------- | ---- | ------------- | ------ | ----------------- | ------- | --------- | ------ | --------- | ------ | ------- | ------- | - | ------ | ------- | ------- | 
|                                               |                                                    |                                               |      | Quarter ended |        | Nine months ended
|                                               |                                                    |                                               |      |               |        |                  
|                                               |                                                    |                                               |      | March 30,     |        | March 31,         |         | March 30, |        | March 31,
|                                               |                                                    |                                               |      | 2002          |        | 2001              |         | 2002      |        | 2001     
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |          
|Revenues:                                      |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|                                              
|                                              
|                                              
|                                              
|                                               | Net sales                                          |                                               | $    | 86,252        |        |                   | $       | 74,298    |        |           | $      | 309,026 |         |   | $      | 289,186 |        
|                                              
|                                              
|                                              
|                                              
|                                               | Royalty fees                                       |                                               |      | 3,652         |        |                   |         | 2,911     |        |           |        | 13,031  |         |   |        | 11,184  |        
|                                              
|                                              
|                                              
|                                              
|                                               | Franchise fees                                     |                                               |      | 200           |        |                   |         |          |        |           |        | 543     |         |   |        | 609     |        
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|                                               |                                                    | Total revenues                                |      |               | 90,104 |                   |         |           | 77,209 |           |        |         | 322,600 |   |        |         | 300,979 | 
|                                              
|                                              
|                                              
|                                              
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |       
|                                              
|                                              
|                                              
|                                              
|Expenses:                                      |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|                                              
|                                              
|                                              
|                                              
|                                               | Cost of goods sold and occupancy costs             |                                               |      | 60,816        |        |                   |         | 53,364    |        |           |        | 202,411 |         |   |        | 192,254 |        
|                                              
|                                              
|                                              
|                                              
|                                               | Company-owned stores operating and selling expense |                                               |      | 20,031        |        |                   |         | 18,329    |        |           |        | 69,724  |         |   |        | 67,442  |        
|                                              
|                                              
|                                              
|                                              
|                                               | Franchise expense                                  |                                               |      | 1,612         |        |                   |         | 1,436     |        |           |        | 4,826   |         |   |        | 3,849   |        
|                                              
|                                              
|                                              
|                                              
|                                               | General and administrative expense                 |                                               |      | 6,707         |        |                   |         | 8,150     |        |           |        | 19,409  |         |   |        | 18,361  |        
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|                                               |                                                    | Total expenses                                |      |               | 89,166 |                   |         |           | 81,279 |           |        |         | 296,370 |   |        |         | 281,906 | 
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|Income (loss) before interest and income taxes |                                                    |                                               | 938  |               |        |                   | (4,070  | )         |        |           | 26,230 |         |         |   | 19,073 |        
|                                              
|                                              
|                                              
|                                              
|                                               | Interest expense, net                              |                                               |      | 1,099         |        |                   |         | 1,752     |        |           |        | 4,508   |         |   |        | 6,038   |        
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|Income (loss) before income taxes              |                                                    |                                               | (161 | )             |        |                   | (5,822  | )         |        |           | 21,722 |         |         |   | 13,035 |        
|                                              
|                                              
|                                              
|                                              
|                                               | Provision for income taxes (benefit)               |                                               |      | (65           | )      |                   |         | (2,295    | )      |           |        | 8,665   |         |   |        | 5,002   |        
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|Net income (loss)                              |                                                    |                                               | ($96 | )             |        |                   | ($3,527 | )         |        | $         | 13,057 |         |         | $ | 8,033  |        
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|                                               | Basic earnings (loss) per share                    |                                               |      | ($0.01        | )      |                   |         | ($0.28    | )      |           | $      | 1.01    |         |   | $      | 0.63    |        
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|                                               |                                                    | Weighted average shares outstanding  basic   |      |               | 12,982 |                   |         |           | 12,723 |           |        |         | 12,909  |   |        |         | 12,722  | 
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|                                               | Diluted earnings (loss) per share                  |                                               |      | ($0.01        | )      |                   |         | ($0.28    | )      |           | $      | 0.69    |         |   | $      | 0.46    |        
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        
|                                               |                                                    | Weighted average shares outstanding  diluted |      |               | 12,982 |                   |         |           | 12,723 |           |        |         | 18,972  |   |        |         | 17,646  | 
|                                               |                                                    |                                               |      |               |        |                   |         |           |        |           |        |         |         |   |        |        

See accompanying notes to condensed consolidated financial statements.

4



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##### Table of Contents



PARTY CITY CORPORATION AND SUBSIDIARY




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |        |         |        | 
|-------------------------------------------------------------------------------- | ---------------------------------------------------------- | ---------------------------------------------- | ----------------------------------------- | ------- | ----------------- | ------ | --------- | ------ | ------- | ------ | 
|                                                                                 |                                                            |                                                |                                           |         | Nine months ended
|                                                                                 |                                                            |                                                |                                           |         |                  
|                                                                                 |                                                            |                                                |                                           |         | March 30,         |        | March 31,
|                                                                                 |                                                            |                                                |                                           |         | 2002              |        | 2001     
|                                                                                 |                                                            |                                                |                                           |         |                   |        |          
|                                                                                 |                                                            |                                                |                                           |         | (Unaudited)      
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |        |         |        | 
|Cash flow from operating activities:                                             |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Net income                                                                       |                                                            | $                                              | 13,057                                    |         |                   | $      | 8,033     |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Adjustments to reconcile net income to net cash provided by operating
activities |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Depreciation and amortization                              |                                                |                                           | 8,944   |                   |        |           | 7,769  |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Impairment of assets                                       |                                                |                                           |        |                   |        |           | 2,103  |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Deferred taxes                                             |                                                |                                           | 462     |                   |        |           | 3,196  |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Non-cash interest                                          |                                                |                                           | 1,128   |                   |        |           | 1,275  |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Deferred rent and other long-term liabilities              |                                                |                                           | 1,024   |                   |        |           | 651    |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Equity-based compensation                                  |                                                |                                           | 257     |                   |        |           |       |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Provision for doubtful accounts                            |                                                |                                           | 59      |                   |        |           | 160    |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Changes in assets and liabilities:                         |                                                |                                           |         |                   |        |           |        |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                            | Merchandise inventory                          |                                           |         | (12,620           | )      |           |        | (13,141 | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                            | Other current assets and other assets          |                                           |         | (1,242            | )      |           |        | 2,400   |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                            | Accounts payable and other current liabilities |                                           |         | 9,858             |        |           |        | 10,057  |       
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                 |                                                            |                                                | Net cash provided by operating activities |         |                   | 20,927 |           |        |         | 22,503 | 
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |        |         |        | 
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash flow from investment activities:                                            |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Purchases of property and equipment                        |                                                |                                           | (8,493  | )                 |        |           | (9,989 | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Proceeds from sale of stores to franchisees                |                                                |                                           |        |                   |        |           | 1,157  |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Stores and non-compete agreement acquired from franchisees |                                                |                                           | (1,504  | )                 |        |           | (516   | )      
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                 |                                                            | Net cash used in investment activities         |                                           |         | (9,997            | )      |           |        | (9,348  | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |        |         |        | 
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash flow from financing activities:                                             |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Payments of Senior Notes                                   |                                                |                                           | (11,655 | )                 |        |           | (5,103 | )      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Purchases of treasury stock                                |                                                |                                           | (1,829  | )                 |        |           |       |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Proceeds from exercise of stock options                    |                                                |                                           | 167     |                   |        |           | 4      |        
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                 |                                                            | Net cash used in financing activities          |                                           |         | (13,317           | )      |           |        | (5,099  | )     
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |       
|Net increase (decrease) in cash and cash equivalents                             |                                                            |                                                | (2,387                                    | )       |                   |        | 8,056     |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash and cash equivalents, beginning of period                                   |                                                            |                                                | 9,842                                     |         |                   |        | 3,950     |       
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |       
|Cash and cash equivalents, end of period                                         |                                                            | $                                              | 7,455                                     |         |                   | $      | 12,006    |       
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                                            |                                                |                                           |         |                   |        |           |        |         |        | 
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Supplemental disclosure of cash flow information:                                |                                                            |                                                |                                           |         |                   |        |           |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Income taxes paid                                          |                                                | $                                         | 9,785   |                   |        | $         | 5,217  |        
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Interest paid                                              |                                                |                                           | 4,098   |                   |        |           | 5,019  |        

See accompanying notes to condensed consolidated financial statements.

5



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##### Table of Contents



PARTY CITY CORPORATION AND SUBSIDIARY




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.      BASIS OF PRESENTATION

The condensed consolidated financial statements, except for the June 30,
2001 consolidated balance sheet, are unaudited. In the opinion of management,
the accompanying condensed consolidated financial statements contain all
adjustments (consisting only of normal recurring accruals) necessary to present
fairly the financial position of the Company as of March 30, 2002 and March 31,
2001 and the results of operations for the quarters and nine months ended March
30, 2002 and March 31, 2001 and cash flows for the nine months ended March 30,
2002 and March 31, 2001. Because of the seasonality of the party goods
industry, operating results of the Company on a quarterly basis may not be
indicative of operating results for the full fiscal year.

These condensed consolidated financial statements should be read in
conjunction with the Companys audited consolidated financial statements for
the fiscal year ended June 30, 2001, which are included in the Companys Annual
Report on Form 10-K with respect to such period filed with the Securities and
Exchange Commission on September 27, 2001. All significant intercompany accounts and transactions
have been eliminated. The June 30, 2001 consolidated balance
sheet amounts are
derived from the Companys audited consolidated financial statements.

2.      RECENT ACCOUNTING STANDARDS

In October of 2001, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standard (SFAS) No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. This statement supersedes
SFAS No. 121 Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of, but retains the fundamental provisions of
SFAS No. 121 for recognition and measurement of the impairment of long-lived
assets to be held and used and measurement of long-lived assets to be disposed
of by sale. However, SFAS No. 144 applies the fair value method for testing of
impairment, which differs from SFAS No. 121. SFAS No. 144 also supersedes the
accounting and reporting provisions of APB Opinion No. 30 as it pertains to
disposal of a business segment but retains the requirement of that opinion to
report discontinued operations separately from continuing operations and
extends that reporting to a component of an entity that either has been
disposed of or is classified as held for sale. SFAS No. 144 is effective for
fiscal years beginning after December 15, 2001, thereby applying
to the Company upon the commencement of its fiscal 2003 fiscal year. The Company is evaluating the
impact of the adoption of this standard and has not yet determined the effect
of adoption on its financial position and results of operations.

6



---



##### Table of Contents



PARTY CITY CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|3. |  | EARNINGS PER SHARE
|-- |  | ------------------

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

|                                                        |  |               |        |                   |  |           |        |           |  |   |        |  |  |   |        | 
|------------------------------------------------------- |  | ------------- | ------ | ----------------- |  | --------- | ------ | --------- |  | - | ------ |  |  | - | ------ | 
|                                                        |  | Quarter ended |        | Nine months ended
|                                                        |  |               |        |                  
|                                                        |  | March 30,     |        | March 31,         |  | March 30, |        | March 31,
|                                                        |  | 2002          |        | 2001              |  | 2002      |        | 2001     
|                                                        |  |               |        |                   |  |           |        |          
|                                                        |  | (Unaudited)   |        | (Unaudited)      
|                                                        |  |               |        |                   |  |           |        |           |  |   |        |  |  |   |        | 
|Net income (loss)                                       |  | $             | (96    | )                 |  | $         | (3,527 | )         |  | $ | 13,057 |  |  | $ | 8,033  | 
|                                                       
|                                                       
|                                                       
|                                                       
|Earnings (loss) per share  basic                       |  | $             | (0.01  | )                 |  | $         | (0.28  | )         |  | $ | 1.01   |  |  | $ | 0.63   | 
|                                                       
|                                                       
|                                                       
|                                                       
|Earnings (loss) per share  diluted                     |  | $             | (0.01  | )                 |  | $         | (0.28  | )         |  | $ | 0.69   |  |  | $ | 0.46   | 
|                                                       
|                                                       
|                                                       
|                                                       
|Average common shares outstanding                       |  |               | 12,982 |                   |  |           | 12,723 |           |  |   | 12,909 |  |  |   | 12,722 | 
|                                                       
|                                                       
|                                                       
|                                                       
|Dilutive effect of warrants                             |  |               | (a     | )                 |  |           | (b     | )         |  |   | 5,461  |  |  |   | 4,694  | 
|                                                       
|                                                       
|                                                       
|                                                       
|Dilutive
effect of stock options(c)                     |  |               | (a     | )                 |  |           | (b     | )         |  |   | 532    |  |  |   | 230    | 
|                                                       
|                                                       
|                                                       
|                                                       
|Restricted shares                                       |  |               |       |                   |  |           |       |           |  |   | 70     |  |  |   |       | 
|                                                        |  |               |        |                   |  |           |        |           |  |   |        |  |  |   |        | 
|Average common and common equivalent shares
outstanding |  |               | 12,982 |                   |  |           | 12,723 |           |  |   | 18,972 |  |  |   | 17,646 | 
|                                                        |  |               |        |                   |  |           |        |           |  |   |        |  |  |   |        | 
|Average
common stock price used for treasury method     |  | $             | 10.53  |                   |  | $         | 3.35   |           |  | $ | 8.21   |  |  | $ | 3.39   | 
|                                                        |  |               |        |                   |  |           |        |           |  |   |        |  |  |   |        | 



---

|(a) |  | Options to purchase 1,009,888 shares of
common stock at prices ranging from $2.00
to $32.50 per share and warrants to purchase 6,280,000 shares of
common stock at
$1.07 per share were outstanding at March 30, 2002 but were not included
in the computation of dilutive loss per share for the quarter ended March
30, 2002 because to do so would have been anti-dilutive.                                                       
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   
|   
|   
|   
|(b) |  | Options to purchase 1,075,481 shares of
common stock at prices ranging from $2.25 to $32.50 per share and warrants to purchase 6,880,000 shares of
common stock at $1.07 per share were outstanding at March 31, 2001 but were not included
in the computation of dilutive loss per share for the quarter ended March
31, 2001 because to do so would have been anti-dilutive.                                                       
|   
|   
|   
|   
|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(c) |  | Options to purchase 578,541
shares of common stock at prices ranging from $7.00 to $32.50 and
options to purchase 913,638 shares of common stock at prices ranging
from $2.85 to $32.50 were outstanding but were not included in the
computation of dilutive earnings per share for the nine months ended
March 30, 2002 and March 31, 2001, respectively, because to
do so would have been anti-dilutive for the periods presented.

7



---



##### Table of Contents





|4. |  | STOCK REPURCHASE
|-- |  | ----------------

On September 19, 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 March 30,
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 repurchased. No
stock repurchases were made during the quarter ended, or subsequent
to, March 30, 2002.



|5. |  | DEBT MATURITIES
|-- |  | ---------------

The
amounts of Senior Notes (as defined below) outstanding are as follows (in thousands):

|         |  |                                             |  |      |        |           |        |           |         |          |        |   |         |   |        | 
|-------- |  | ------------------------------------------- |  | ---- | ------ | --------- | ------ | --------- | ------- | -------- | ------ | - | ------- | - | ------ | 
|         |  |                                             |  |      |        | March 30, |        | March 31, |         | June 30,
|Note     |  | Description                                 |  | 2002 |        | 2001      |        | 2001     
|         |  |                                             |  |      |        |           |        |          
|Series A |  | 12.5%(i) Secured Notes due 2003             |  | $    | 2,552  |           |        | $         | 5,104   |          |        | $ | 5,104   |  
|        
|        
|        
|        
|Series B |  | 13.0%(i) Secured Notes due 2003             |  |      | 5,103  |           |        |           | 5,103   |          |        |   | 5,103   |  
|        
|        
|        
|        
|Series C |  | 13.0%(i) Secured Notes due 2002             |  |      |      |           |        |           | 5,103   |          |        |   | 5,103   |  
|        
|        
|        
|        
|Series D |  | 14.0%(i) Secured Notes due 2004             |  |      | 10,207 |           |        |           | 10,207  |          |        |   | 10,207  |  
|        
|        
|        
|        
|Series E |  | 14.0% Senior Secured Notes due 2002         |  |      |      |           |        |           | 7,000   |          |        |   | 4,000   |  
|         |  |                                             |  |      |        |           |        |           |         |          |        |   |         |   |        | 
|         |  |                                             |  |      |        |           | 17,862 |           |         |          | 32,517 |   |         |   | 29,517 | 
|        
|        
|        
|        
|         |  | Unamortized debt discount                   |  |      | (1,448 | )         |        |           | (2,374  | )        |        |   | (2,145  | )
|        
|        
|        
|        
|         |  | Less:
Current portion, net of debt discount |  |      | (7,655 | )         |        |           | (14,655 | )        |        |   | (11,366 | )
|         |  |                                             |  |      |        |           |        |           |         |          |        |   |         |   |        | 
|         |  |                                             |  |      |        | $         | 8,759  |           |         | $        | 15,488 |   |         | $ | 16,006 | 
|         |  |                                             |  |      |        |           |        |           |         |          |        |   |         |   |        | 



|(i) |  | Interest rate was increased by 450 basis points for all amounts outstanding
on and after January 13, 1999.
|--- |  | ----------------------------------------------------------------------------------------------------------
|   
|6.  |  | LITIGATION                                                                                                

The Company was named as a defendant in twelve class action complaints.
The Companys former Chief Executive Officer and the former Chief Financial
Officer and Executive Vice President of Operations were also named as
defendants. All of the complaints were filed in the United States District
Court for the District of New Jersey. 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.

The second amended complaint 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, the Companys financial condition, adequacy of internal controls and
compliance with certain loan covenants during the Class Period. The plaintiffs
further alleged that because of the issuance of a series of false and
misleading statements and/or the failure to disclose material facts, the price
of Party Citys common stock was artificially inflated.

In early 2000, defendants moved to dismiss the second amended complaint on
the ground that it failed to state a cause of action. On May 29, 2001, the
District Court issued an Opinion and Order dismissing the Complaint against all
defendants with prejudice. On June 27, 2001, plaintiffs filed a Notice of
Appeal to the United States Court of Appeals for the Third Circuit. Prior to
the argument of the appeal, the parties reached an agreement in principle to
settle the action. The parties have requested that the Court of Appeals remand
the case to the District Court to supervise the implementation of the
settlement. The proposed amount to be paid by the Company under the settlement
is not material and is subject to various conditions.
These include the completion of 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.

8



---



##### Table of Contents



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.

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.



|7. |  | SEGMENT INFORMATION
|-- |  | -------------------

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

|                                            |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|------------------------------------------- |  | ------------- | ------- | ----------------- |  | --------- | ------- | --------- |  | - | ------- | - |  | - | ------- | -
|                                            |  | Quarter ended |         | Nine months ended
|                                            |  |               |         |                  
|                                            |  | March 30,     |         | March 31,         |  | March 30, |         | March 31,
|                                            |  | 2002          |         | 2001              |  | 2002      |         | 2001     
|                                            |  |               |         |                   |  |           |         |          
|                                            |  | (Unaudited)   |         | (Unaudited)      
|                                            |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|RETAIL                                      |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|                                           
|                                           
|                                           
|                                           
|Net revenue                                 |  | $             | 86,252  |                   |  | $         | 74,298  |           |  | $ | 309,026 |   |  | $ | 289,186 |  
|                                           
|                                           
|                                           
|                                           
|Operating earnings                          |  |               | 5,405   |                   |  |           | 2,605   |           |  |   | 36,891  |   |  |   | 29,490  |  
|                                           
|                                           
|                                           
|                                           
|Identifiable assets                         |  |               | 131,779 |                   |  |           | 130,543 |           |  |   | 131,779 |   |  |   | 130,543 |  
|                                           
|                                           
|                                           
|                                           
|Depreciation/amortization                   |  |               | 1,829   |                   |  |           | 2,262   |           |  |   | 5,439   |   |  |   | 6,098   |  
|                                           
|                                           
|                                           
|                                           
|Capital expenditures                        |  |               | 1,663   |                   |  |           | 2,090   |           |  |   | 4,024   |   |  |   | 4,413   |  
|                                           
|                                           
|                                           
|                                           
|FRANCHISING                                 |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|                                           
|                                           
|                                           
|                                           
|Net revenue                                 |  | $             | 3,852   |                   |  | $         | 2,911   |           |  | $ | 13,574  |   |  | $ | 11,793  |  
|                                           
|                                           
|                                           
|                                           
|Operating earnings                          |  |               | 2,240   |                   |  |           | 1,475   |           |  |   | 8,748   |   |  |   | 7,944   |  
|                                           
|                                           
|                                           
|                                           
|Identifiable assets                         |  |               | 2,923   |                   |  |           | 2,215   |           |  |   | 2,923   |   |  |   | 2,215   |  
|                                           
|                                           
|                                           
|                                           
|Depreciation/amortization                   |  |               |        |                   |  |           |        |           |  |   |        |   |  |   |        |  
|                                           
|                                           
|                                           
|                                           
|Capital expenditures                        |  |               |        |                   |  |           |        |           |  |   |        |   |  |   |        |  
|                                           
|                                           
|                                           
|                                           
|CORPORATE/OTHER                             |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|                                           
|                                           
|                                           
|                                           
|Net revenue                                 |  | $             |        |                   |  | $         |        |           |  | $ |        |   |  | $ |        |  
|                                           
|                                           
|                                           
|                                           
|Operating loss                              |  |               | (6,707  | )                 |  |           | (8,150  | )         |  |   | (19,409 | ) |  |   | (18,361 | )
|                                           
|                                           
|                                           
|                                           
|Identifiable assets                         |  |               | 18,216  |                   |  |           | 13,544  |           |  |   | 18,216  |   |  |   | 13,544  |  
|                                           
|                                           
|                                           
|                                           
|Depreciation/amortization                   |  |               | 1,244   |                   |  |           | 335     |           |  |   | 3,505   |   |  |   | 1,671   |  
|                                           
|                                           
|                                           
|                                           
|Capital expenditures                        |  |               | 1,897   |                   |  |           | 3,510   |           |  |   | 4,584   |   |  |   | 5,863   |  
|                                           
|                                           
|                                           
|                                           
|CONSOLIDATED TOTALS                         |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|                                           
|                                           
|                                           
|                                           
|Net revenue                                 |  | $             | 90,104  |                   |  | $         | 77,209  |           |  | $ | 322,600 |   |  | $ | 300,979 |  
|                                           
|                                           
|                                           
|                                           
|Operating income (loss)                     |  |               | 938     |                   |  |           | (4,070  | )         |  |   | 26,230  |   |  |   | 19,073  |  
|                                           
|                                           
|                                           
|                                           
|Interest expense, net                       |  |               | 1,099   |                   |  |           | 1,752   |           |  |   | 4,508   |   |  |   | 6,038   |  
|                                            |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|Income (loss) before income taxes (benefit) |  |               | (161    | )                 |  |           | (5,822  | )         |  |   | 21,722  |   |  |   | 13,035  |  
|                                           
|                                           
|                                           
|                                           
|Provision for income taxes (benefit)        |  |               | (65     | )                 |  |           | (2,295  | )         |  |   | 8,665   |   |  |   | 5,002   |  
|                                            |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|Net income (loss)                           |  |               | ($96    | )                 |  |           | ($3,527 | )         |  | $ | 13,057  |   |  | $ | 8,033   |  
|                                            |  |               |         |                   |  |           |         |           |  |   |         |   |  |   |         |  
|Identifiable assets                         |  | $             | 152,918 |                   |  | $         | 146,302 |           |  | $ | 152,918 |   |  | $ | 146,302 |  
|                                           
|                                           
|                                           
|                                           
|Depreciation/amortization                   |  |               | 3,073   |                   |  |           | 2,597   |           |  |   | 8,944   |   |  |   | 7,769   |  
|                                           
|                                           
|                                           
|                                           
|Capital expenditures                        |  |               | 3,560   |                   |  |           | 5,600   |           |  |   | 8,608   |   |  |   | 10,276  |  

9



---



##### Table of Contents



PARTY CITY CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



|8. |  | GOODWILL AND OTHER INTANGIBLE ASSETS
|-- |  | ------------------------------------

On July 1, 2001, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets. As a result, the Company no longer amortizes goodwill.
Instead the Company periodically evaluates 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. Upon adoption, the Company established reporting units based
on its current reporting structure. The Company then assigned all goodwill to
the reporting units, as well as other assets and liabilities, to the extent
that they relate to the reporting unit. The Company completed the first step of
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 the quarter ended September 30, 2000
(in thousands, except per share amounts):

|                                                  |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 
|------------------------------------------------- |  | ------------- | ----- | ----------------- |  | --------- | ------ | --------- |  | - | ------ |  |  | - | ----- | 
|                                                  |  | Quarter ended |       | Nine months ended
|                                                  |  |               |       |                  
|                                                  |  | March 30,     |       | March 31,         |  | March 30, |        | March 31,
|                                                  |  | 2002          |       | 2001              |  | 2002      |        | 2001     
|                                                  |  |               |       |                   |  |           |        |          
|                                                  |  | (Unaudited)   |       | (Unaudited)      
|                                                  |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 
|Reported net income (loss)                        |  | $             | (96   | )                 |  | $         | (3,527 | )         |  | $ | 13,057 |  |  | $ | 8,033 | 
|                                                 
|                                                 
|                                                 
|                                                 
|Add back:                                         |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 
|                                                 
|                                                 
|                                                 
|                                                 
|Goodwill amortization, net of taxes               |  |               |      |                   |  |           | 181    |           |  |   |       |  |  |   | 547   | 
|                                                  |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 
|Pro forma net income (loss)                       |  | $             | (96   | )                 |  | $         | (3,346 | )         |  | $ | 13,057 |  |  | $ | 8,580 | 
|                                                  |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 
|Earnings (loss) per share reported  basic        |  | $             | (0.01 | )                 |  | $         | (0.28  | )         |  | $ | 1.01   |  |  | $ | 0.63  | 
|                                                 
|                                                 
|                                                 
|                                                 
|Goodwill amortization                             |  |               |      |                   |  |           | 0.01   |           |  |   |       |  |  |   | 0.04  | 
|                                                  |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 
|Pro forma earnings (loss) per share  basic       |  | $             | (0.01 | )                 |  | $         | (0.27  | )         |  | $ | 1.01   |  |  | $ | 0.67  | 
|                                                  |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 
|Earnings (loss) per share reported  diluted      |  | $             | (0.01 | )                 |  | $         | (0.28  | )         |  | $ | 0.69   |  |  | $ | 0.46  | 
|                                                 
|                                                 
|                                                 
|                                                 
|Goodwill amortization                             |  |               |      |                   |  |           | 0.01   |           |  |   |       |  |  |   | 0.03  | 
|                                                  |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 
|Pro forma net earnings (loss) per share  diluted |  | $             | (0.01 | )                 |  | $         | (0.27  | )         |  | $ | 0.69   |  |  | $ | 0.49  | 
|                                                  |  |               |       |                   |  |           |        |           |  |   |        |  |  |   |       | 

The changes in the carrying amount of goodwill and other intangibles for
the nine months ended March 30, 2002, by operating segment, are as follows (in
thousands):

|                             |                                     |   |        |     |  |  |  |  |  |  |  |  |  |  |  |  | 
|---------------------------- | ----------------------------------- | - | ------ | --- |  |  |  |  |  |  |  |  |  |  |  |  | 
|Retail:                      |                                     |   |        |    
|                            
|                            
|                            
|                            
|Balance as of June 30, 2001  |                                     | $ | 13,647 |    
|                            
|                            
|                            
|                            
|                             | Goodwill acquired during the period |   |        | 559 | 
|                            
|                            
|                            
|                            
|                             | Other intangibles                   |   |        | 550 | 
|                             |                                     |   |        |    
|Balance as of March 30, 2002 |                                     | $ | 14,756 |    
|                             |                                     |   |        |    

Other intangibles, included in Other assets, 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 is approximately
$21,000 and $27,000 for the quarter and nine months ended March 30, 2002,
respectively.

10



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##### Table of Contents





|9. |  | SUBSEQUENT EVENTS
|-- |  | -----------------

On April 25, 2002, the Company announced that it had completed the
acquisition of thirteen stores in the Seattle, Washington market from Paper
Warehouse, Inc. The Company plans to convert these locations to the Party City
format. Management currently plans to open these stores in its first fiscal
quarter ending September 28, 2002.

On
May 7, 2002, the Company assumed the lease of a franchisee for
a store in Sacramento, California under the default terms of the
franchisee's lease agreement. The Company plans to reopen the store in
June 2002.




Item 2.         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 generally accepted
accounting principles 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 estimates.
Such differences could be material to the consolidated financial statements.

Management believes 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, management has found the
application of accounting policies to be appropriate, and actual results
generally do not differ materially from those determined using necessary
estimates.

The Companys accounting policies are more fully described in Note 1 to the
consolidated financial statements set forth in the Companys
Annual Report on Form 10-K,
filed with the Securities and Exchange Commission on
September 27, 2001. Management has identified
certain material accounting policies that are more fully described below.

Merchandise inventory- Merchandise inventory is carried at the lower of cost
or market on a first-in, first-out basis. Inventory is written down for
estimated obsolescence or unmarketable inventory equal to the difference
between the cost of inventory and the estimated market value based upon
assumptions about future demand and market conditions. If actual market
conditions are less favorable than those projected by management, additional
inventory write-downs may be required.

Long-lived assets. In the evaluation of the fair value and future benefits of
long-lived assets, management performs 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, which is generally calculated
using discounted cash flows. Various factors including future sales growth and
profit margins are included in this analysis. To the extent these future
projections or strategies change, the conclusion regarding impairment may
differ from the current estimates.

11



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##### Table of Contents



Results of Operations

SELECTED FINANCIAL DATA
(in thousands, except per share and store data)

|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |         | 
|--------------------------------------------- | ----------------------------------------- | - | ------------- | ------ | ----------------- | - | --------- | ------ | --------- | - | ------- | ------- |  | - | ------- | ------- | 
|                                              |                                           |   | Quarter ended |        | Nine months ended
|                                              |                                           |   |               |        |                  
|                                              |                                           |   | March 30,     |        | March 31,         |   | March 30, |        | March 31,
|                                              |                                           |   | 2002          |        | 2001              |   | 2002      |        | 2001     
|                                              |                                           |   |               |        |                   |   |           |        |          
|                                              |                                           |   | (Unaudited)   |        | (Unaudited)      
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |         | 
|Statement of Operations Data                  |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                             
|                                             
|                                             
|                                             
|Total revenue                                 |                                           | $ | 90,104        |        |                   | $ | 77,209    |        |           | $ | 322,600 |         |  | $ | 300,979 |        
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|Company-owned stores:                         |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                             
|                                             
|                                             
|                                             
|                                              | Net sales                                 |   | $             | 86,252 |                   |   | $         | 74,298 |           |   | $       | 309,026 |  |   | $       | 289,186 | 
|                                             
|                                             
|                                             
|                                             
|                                              | Cost of goods sold and occupancy costs    |   |               | 60,816 |                   |   |           | 53,364 |           |   |         | 202,411 |  |   |         | 192,254 | 
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                              | Gross profit                              |   |               | 25,436 |                   |   |           | 20,934 |           |   |         | 106,615 |  |   |         | 96,932  | 
|                                             
|                                             
|                                             
|                                             
|                                              | Store operating and selling expense       |   |               | 20,031 |                   |   |           | 18,329 |           |   |         | 69,724  |  |   |         | 67,442  | 
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                              | Company-owned stores profit contribution  |   |               | 5,405  |                   |   |           | 2,605  |           |   |         | 36,891  |  |   |         | 29,490  | 
|                                             
|                                             
|                                             
|                                             
|Franchise stores:                             |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                             
|                                             
|                                             
|                                             
|                                              | Royalty fees                              |   |               | 3,652  |                   |   |           | 2,911  |           |   |         | 13,031  |  |   |         | 11,184  | 
|                                             
|                                             
|                                             
|                                             
|                                              | Franchise fees                            |   |               | 200    |                   |   |           |       |           |   |         | 543     |  |   |         | 609     | 
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                              | Total franchise revenues                  |   |               | 3,852  |                   |   |           | 2,911  |           |   |         | 13,574  |  |   |         | 11,793  | 
|                                             
|                                             
|                                             
|                                             
|                                              | Total franchise expense                   |   |               | 1,612  |                   |   |           | 1,436  |           |   |         | 4,826   |  |   |         | 3,849   | 
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                              | Franchise profit contribution             |   |               | 2,240  |                   |   |           | 1,475  |           |   |         | 8,748   |  |   |         | 7,944   | 
|                                             
|                                             
|                                             
|                                             
|General and administrative expense:           |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                             
|                                             
|                                             
|                                             
|                                              | Impairment provision                      |   |               |       |                   |   |           | 2,113  |           |   |         |        |  |   |         | 2,113   | 
|                                             
|                                             
|                                             
|                                             
|                                              | Other general and administrative expenses |   |               | 6,707  |                   |   |           | 6,037  |           |   |         | 19,409  |  |   |         | 16,248  | 
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|                                              |                                           |   | 6,707         |        |                   |   | 8,150     |        |           |   | 19,409  |         |  |   | 18,361  |        
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|Income (loss) before interest and income      |                                           |   | 938           |        |                   |   | (4,070    | )      |           |   | 26,230  |         |  |   | 19,073  |        
|                                             
|                                             
|                                             
|                                             
|Interest expense, net                         |                                           |   | 1,099         |        |                   |   | 1,752     |        |           |   | 4,508   |         |  |   | 6,038   |        
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|Income (loss) before income taxes (benefit)   |                                           |   | (161          | )      |                   |   | (5,822    | )      |           |   | 21,722  |         |  |   | 13,035  |        
|                                             
|                                             
|                                             
|                                             
|Provision for income taxes (benefit)          |                                           |   | (65           | )      |                   |   | (2,295    | )      |           |   | 8,665   |         |  |   | 5,002   |        
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|Net income (loss)                             |                                           |   | ($96          | )      |                   |   | ($3,527   | )      |           | $ | 13,057  |         |  | $ | 8,033   |        
|                                              |                                           |   |               |        |                   |   |           |        |           |   |         |         |  |   |         |        
|Basic earnings (loss) per share               |                                           |   | ($0.01        | )      |                   |   | ($0.28    | )      |           | $ | 1.01    |         |  | $ | 0.63    |        
|                                             
|                                             
|                                             
|                                             
|Diluted earnings (loss) per share             |                                           |   | ($0.01        | )      |                   |   | ($0.28    | )      |           | $ | 0.69    |         |  | $ | 0.46    |        
|                                             
|                                             
|                                             
|                                             
|Weighted average shares outstanding basic    |                                           |   | 12,982        |        |                   |   | 12,723    |        |           |   | 12,909  |         |  |   | 12,722  |        
|                                             
|                                             
|                                             
|                                             
|Weighted average shares outstanding 
diluted |                                           |   | 12,982        |        |                   |   | 12,723    |        |           |   | 18,972  |         |  |   | 17,646  |        
|                                             
|                                             
|                                             
|                                             
|EBITDA (a)                                    |                                           |   | 4,011         |        |                   |   | 640       |        |           |   | 35,174  |         |  |   | 28,955  |        
|                                             
|                                             
|                                             
|                                             
|Depreciation and amortization                 |                                           |   | 3,073         |        |                   |   | 2,597     |        |           |   | 8,944   |         |  |   | 7,769   |        

12



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##### Table of Contents



|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |         |         |    |  
|--------------------------------------- | ------------------------------------------- | ------------------------------------- | -------------------------------- | ------- | ------------- | --- | ----------------- | ------- | --------- | -- | --------- | ------- | ------- | --- | ------- | ------- | ------- | -- | -
|                                        |                                             |                                       |                                  |         | Quarter ended |     | Nine months ended
|                                        |                                             |                                       |                                  |         |               |     |                  
|                                        |                                             |                                       |                                  |         | March 30,     |     | March 31,         |         | March 30, |    | March 31,
|                                        |                                             |                                       |                                  |         | 2002          |     | 2001              |         | 2002      |    | 2001     
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |          
|                                        |                                             |                                       |                                  |         | (Unaudited)   |     | (Unaudited)      
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |    
|Store Data:                             |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |        
|                                       
|                                       
|                                       
|                                       
|                                        | Company-owned:                              |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |         |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                             | Stores open at beginning of period    |                                  |         | 198           |     |                   |         | 195       |    |           |         | 193     |     |         |         | 197     |   
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       | Stores opened                    |         |               | 2   |                   |         |           |   |           |         |         | 6   |         |         |         |   |  
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       | Stores closed                    |         |               |   |                   |         |           | (2 | )         |         |         |   |         |         |         | (2 | )
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       | Stores acquired from franchisees |         |               |   |                   |         |           |   |           |         |         | 1   |         |         |         | 1  |  
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       | Stores sold to franchisees       |         |               |   |                   |         |           |   |           |         |         |   |         |         |         | (3 | )
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |        
|                                        |                                             | Stores open at end of period          |                                  |         | 200           |     |                   |         | 193       |    |           |         | 200     |     |         |         | 193     |   
|                                       
|                                       
|                                       
|                                       
|                                        | Average Company-owned stores open in
period |                                       |                                  | 199     |               |     |                   | 193     |           |    |           | 195     |         |     |         | 194     |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |    
|                                       
|                                       
|                                       
|                                       
|                                        | Franchise:                                  |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |         |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                             | Stores open at beginning of period    |                                  |         | 272           |     |                   |         | 259       |    |           |         | 261     |     |         |         | 211     |   
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       | Stores opened                    |         |               | 5   |                   |         |           | 2  |           |         |         | 19  |         |         |         | 48 |  
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       | Stores closed                    |         |               | (33 | )(c)              |         |           |   |           |         |         | (35 | )(c)    |         |         |   |  
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       | Stores sold to Company           |         |               |   |                   |         |           |   |           |         |         | (1  | )       |         |         | (1 | )
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       | Stores acquired from Company     |         |               |   |                   |         |           |   |           |         |         |   |         |         |         | 3  |  
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |        
|                                        |                                             | Stores open at end of period          |                                  |         | 244           |     |                   |         | 261       |    |           |         | 244     |     |         |         | 261     |   
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |        
|Average franchise stores open in period |                                             |                                       | 267                              |         |               |     | 260               |         |           |    | 270       |         |         |     | 236     |        
|                                       
|                                       
|                                       
|                                       
|Total stores chainwide                  |                                             |                                       | 444                              |         |               |     | 454               |         |           |    | 444       |         |         |     | 454     |        
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |    
|                                       
|                                       
|                                       
|                                       
|Chainwide sales                         |                                             | $                                     | 185,644                          |         |               | $   | 164,830           |         |           | $  | 684,153   |         |         | $   | 623,402 |        
|                                       
|                                       
|                                       
|                                       
|Same store sales increase:              |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                             | Company-owned stores                  |                                  |         | 13.5          | %   |                   |         | 12.9      | %  |           |         | 5.8     | %   |         |         | 10.5    | % 
|                                       
|                                       
|                                       
|                                       
|                                        |                                             | Franchise stores                      |                                  |         | 9.7           | %   |                   |         | 10.0      | %  |           |         | 4.3     | %   |         |         | 4.3     | % 
|                                       
|                                       
|                                       
|                                       
|                                        |                                             | Average sales per Company-owned store |                                  | $       | 433.4         |     |                   | $       | 384.9     |    |           | $       | 1,584.7 |     |         | $       | 1,486.9 |   
|                                       
|                                       
|                                       
|                                       
|                                        |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |    
|                                       
|                                       
|                                       
|                                       
|Balance Sheet Data:                     |                                             |                                       |                                  |         |               |     |                   |         |           |    |           |         |         |     |         |        
|                                       
|                                       
|                                       
|                                       
|                                        | Working capital                             |                                       | $                                | 15,095  |               |     | $                 | 12,706  |           |    | $         | 15,095  |         |     | $       | 12,706  |        
|                                       
|                                       
|                                       
|                                       
|                                        | Total assets                                |                                       |                                  | 152,918 |               |     |                   | 146,302 |           |    |           | 152,918 |         |     |         | 146,302 |        
|                                       
|                                       
|                                       
|                                       
|                                        | Bank borrowings and other debt (b)          |                                       |                                  | 16,414  |               |     |                   | 30,154  |           |    |           | 16,414  |         |     |         | 30,154  |        
|                                       
|                                       
|                                       
|                                       
|                                        | Capital lease obligation                    |                                       |                                  | 122     |               |     |                   | 540     |           |    |           | 122     |         |     |         | 540     |        
|                                       
|                                       
|                                       
|                                       
|                                        | Stockholders equity                        |                                       |                                  | 62,742  |               |     |                   | 48,898  |           |    |           | 62,742  |         |     |         | 48,898  |        



---

|(a) |  | The Companys definition of EBITDA is earnings before interest, taxes,
depreciation, amortization and impairment provision.                                   
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|    |  |                                                                                                                                                               
|   
|   
|   
|   
|(b) |  | The bank borrowings and other debt at March 30, 2002 and March 31, 2001
is net of an unamortized debt discount of $1.4 million and $2.4 million,
respectively.
|   
|   
|   
|   
|    |  |                                                                                                                                                               
|   
|   
|   
|   
|(c) |  | Includes 28 stores closed as a result of Canadian franchise bankruptcy.                                                                                       

13



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##### Table of Contents



Quarter Ended March 30, 2002 Compared to Quarter Ended March 31, 2001

Retail.Net sales from Company-owned stores increased 16.1% to $86.3
million for the third quarter of fiscal 2002 from $74.3 million for the third
quarter of the last fiscal year. Benefitting from the earlier Easter
holiday, total chain-wide sales (which include aggregate sales for
the collective group of Company-owned and franchise stores) increased
12.6% to $185.6 million from $164.8 million in the
comparable period last year. Same store sales increased 13.5% in the third
quarter of fiscal 2002. 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 the third
quarter of fiscal 2002 increased 21.5% to $25.4 million from $20.9 million for
the third quarter of the last fiscal year. The increase was primarily due to
increased sales volume and improved leverage on occupancy costs. Gross margin
was 29.5% for the third quarter of fiscal 2002 compared with 28.2% for the
third quarter of the last fiscal year.

Store operating and selling expenses increased 9.3% to $20.0 million for
the third quarter of fiscal 2002 from $18.3 million in the third quarter of the
last fiscal year. The increase in store operating expenses is primarily
attributable to the increase in sales. Store operating and selling expenses
were 23.2% and 24.7% of sales for the third quarter of fiscal 2002 and fiscal
2001, respectively. The decrease as a percentage of sales is
primarily due to increased
store labor productivity. Company-owned stores recorded a contribution of $5.4
million for the third quarter of fiscal 2002, compared to $2.6 million for the
third quarter of the last fiscal year. The improvement over the prior year is
primarily the result of improved gross margin as well as improved operating
efficiencies. The Company opened two new stores during the fiscal quarter ended March
30, 2002. No new stores were opened during the quarter ended March 31, 2001.
Pre-opening expenses for these stores and other stores planned to be opened later in
the fiscal year were $241,000. All costs of pre-opening are expensed when
incurred.

Franchising.Franchise revenue is composed of the initial franchise fees
that are recorded as revenue when the store opens, and ongoing royalty fees,
generally 4.0% of the stores net sales. Five franchise stores were opened and
franchise fees of $200,000 were recognized in the third quarter of fiscal 2002.
No franchise stores were opened and no franchise fees were recognized in the
third quarter of the prior fiscal year. Royalty fees increased 25.5% to $3.7
million in the third quarter of fiscal 2002 from $2.9 million in the third
quarter of the last fiscal year which is primarily due to an increase in the
average number of stores and a same store sales increase of 9.7% for the franchise
stores in the third quarter of fiscal 2002.

Expenses directly related to franchise revenue increased 12.3% to $1.6
million for the third quarter of fiscal 2002 from $1.4 million for the third
quarter of the last fiscal year. As a percentage of franchise revenue,
franchise expenses were 41.9% and 49.3% for the third quarter of fiscal 2002
and fiscal 2001, respectively, due to increased revenue on relatively fixed
operating costs.

General and Administrative Expenses.General and administrative expenses
decreased 17.7% to $6.7 million in the third quarter of fiscal 2002 from $8.2
million in the third quarter of the last fiscal year. This decrease is
primarily due to an impairment provision of $2.1 million which was recorded in
the third quarter of the prior fiscal year related to replacement of store
registers. This was offset in part by an increase of $519,000 in depreciation
related to new systems placed in service. The balance of the increase is
primarily due to increases in legal and tax consulting fees and equity based
compensation. General and administrative expenses were 7.8% and 11.0% of sales
for the third quarter of fiscal 2002 and fiscal 2001. Exclusive of the
impairment provision, general and administrative expenses were 8.1% in the
prior fiscal year.

Interest Expense.Interest expense decreased 37.3% to $1.1 million for the
third quarter of fiscal 2002 from $1.8 million in the third quarter of the last
fiscal year. The decreased expense is primarily attributable to lower
outstanding principal
balances outstanding due to payments made over the last twelve
months on the Companys 12.5% Secured Notes due 2003, 13.0%
Secured Notes due 2003, 13.0% Secured Notes due 2002, 14.0% Secured
Notes due 2004 and 14.0% Senior
Secured Notes due 2002 (collectively, the Senior Notes).

Income
Taxes.The Companys effective income tax rate was 40.0% in the third quarter
of fiscal 2002 compared to 39.4% in the third quarter of the last fiscal year.
The tax rate increased as a result of the increase in the federal statutory
rate.

14



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##### Table of Contents



Net Income.As a result of the above factors, net loss for the third
quarter of fiscal 2002 was $96,000, or $0.01 loss per basic and diluted share,
as compared to net loss of $3.5 million, or $0.28 loss per basic share and
diluted share in the third quarter of the last fiscal year.

Nine Months Ended March 30, 2002 Compared to Nine Months Ended March 31, 2001

Retail.Net sales from Company-owned stores increased 6.9% to $309.0
million for the nine months ended March 30, 2002 from $289.2 million for the
nine months ended March 31, 2001. Same store sales increased 5.8% in the nine
months ended March 30, 2002. 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 the
nine months ended March 30, 2002 increased 10.0% to $106.6 million from $96.9
million for the nine months ended March 31, 2001. The increase was primarily
due to increased sales volume and leverage on fixed occupancy costs. Gross
margin was 34.5% for the nine months ended March 30, 2002 compared with 33.5%
for the nine months ended March 31, 2001.

Store operating and selling expenses increased 3.4% to $69.7 million for
the nine months ended March 30, 2002 from $67.4 million in the nine months
ended March 31, 2001. The increase in store operating expenses is attributable
to the increase in sales. Store operating and selling expenses were 22.6% and
23.3% of sales for the nine-month period ended March 30, 2002 and March 31,
2001, respectively. The decrease as a percentage of sales is
primarily due to
improvements in efficiency in the management of store labor hours and savings
in advertising and supply expenses. Company-owned stores recorded a
contribution of $36.9 million for the nine months ended March 30, 2002 compared
to $29.5 million for the nine months ended March 31, 2001. The improvement over
the prior year is primarily the result of improved gross margin as well as
improved operating efficiencies. The Company opened six new stores during the
nine months ended March 30, 2002. No new stores were opened in the nine months
ended March 31, 2001. Pre-opening expenses for these stores and stores planned
to be opened later in the fiscal year were $456,000. All costs of pre-opening
are expensed when incurred.

Franchising.Franchise revenue is composed of the initial franchise fees
that are recorded as revenue when the store opens, and ongoing royalty fees,
generally 4.0% of the stores net sales. Franchise fees, recognized on 19 store
openings, were $543,000 for the nine months ended March 30, 2002, compared to
$609,000 for the nine months ended March 31, 2001 relating to 48 store
openings. Royalty fees increased 16.5% to $13.0 million in the nine months
ended March 30, 2002 from $11.2 million in the nine months ended March 31, 2001
which is primarily due to an increase in the average number of stores and a same store
sales increase of 4.3% for the franchise stores in the nine month period ended
March 30, 2002.

Expenses directly related to franchise revenue increased 25.4% to $4.8
million for the nine months ended March 30, 2002 from $3.8 million for the nine
months ended March 31, 2001. As a percentage of franchise revenue, franchise
expenses were 35.6% and 32.6% for the nine months ended March 30, 2002 and
March 31, 2001, respectively. This increase is primarily due to the recording of a
provision for bad debt related to the Companys Canadian franchisee.

General and Administrative Expenses.General and administrative expenses
increased 5.7% to $19.4 million in the nine months ended March 30, 2002 from
$18.4 million in the nine months ended March 31, 2001. This increase is
attributable, in part, to an increase of $1.4 million in depreciation related
to new systems placed in service. The balance of the increase is primarily due
to increases in legal and tax consulting fees and equity based compensation.
General and administrative expenses were 6.3% of sales for the nine months
ended March 30, 2002 and March 31, 2001, respectively, reflecting investments
in management and systems. Excluding an impairment provision of $2.1 million
which was recorded in the third quarter of the prior fiscal year related to
replacement of store registers, general and administrative expenses were 5.6%
of sales for the nine months ended March 31, 2001.

Interest Expense.Interest expense decreased 25.3% to $4.5 million for the
nine months ended March 30, 2002 from $6.0 million in the nine months ended
March 31, 2001. The decreased expense is primarily attributable to lower

15



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##### Table of Contents



average borrowings outstanding under the Loan
Agreement, dated January 14, 2000, as amended (the Loan
Agreement) with Congress Financial Corporation and reduced
outstanding principal
balances on Senior Notes due to payments made over the last twelve
months.

Income Taxes.The effective income tax rate was 40.0% in the nine months
ended March 30, 2002 compared to 38.4% in the nine months ended
March 31, 2001. The tax rate increased as a result of the
increase in the federal statutory rate.

Net Income.As a result of the above factors, net income for the nine
months ended March 30, 2002 was $13.1 million, or $1.01 per basic share and
$0.69 per diluted share, as compared to net income of 8.0 million, or $0.63 per
basic share and $0.46 per diluted share for the nine months ended March 31,
2001.

Liquidity and Capital Resources

The
Companys cash requirements are primarily for working capital, the opening of new
stores, the improvement and expansion of existing facilities and the
improvement of information systems. Historically, these cash requirements have
been met through cash flow from operations and borrowings under the Loan
Agreement. At March 30, 2002, working capital was $15.1 million.

For the nine-month period ended March 30, 2002, cash provided by operating
activities was $20.9 million, compared to $22.5 million for the same period of
the last fiscal year. The decrease in cash provided by operating activities was
primarily attributable to a decrease in non-cash impairment charges
compared to the preceding period.

Cash used in investment activities for the nine-month period ended March
30, 2002 was $10.0 million compared to $9.3 million in the same period in the
last fiscal year. The increase in cash used in investing activities was
primarily attributable to the continued investment in new systems, new stores
and payments made for an acquisition. Six Company-owned stores were opened in the period.

Cash used in financing activities was $13.3 million for the nine-month
period ended March 30, 2002. This relates to payments of $11.7 million on
Senior Notes and purchases of treasury stock of $1.8 million.

At March 30, 2002, the Company had a nominal balance outstanding under the
Loan Agreement due to accrued fees. Under the terms of the Loan Agreement, the
Company may from time to time borrow amounts, based on a percentage of its
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
March 30, 2002 or (ii) at the rate
of 3/4% per annum above the prime rate, totaling 5.5% at March 30, 2002. The
term of the Loan Agreement is three years, and is secured by a lien on
substantially all of the assets of the Company. At May 3, 2002, the Company
had no balance outstanding and $33.2 million was available to be borrowed under
the Loan Agreement.

Company management currently believes that the cash generated by
operations, together with the borrowing availability under the Loan Agreement,
will be sufficient to meet the Companys working capital needs for the next
twelve months, including planned new store openings.

Accounting and Reporting Changes

In October of 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. This statement supersedes SFAS
No. 121 but retains the fundamental provisions of SFAS No. 121 for recognition
and measurement of the impairment of long-lived assets to be held and used and
measurement of long-lived assets to be disposed of by sale. However, SFAS No.
144 applies the fair value method for testing of impairment, which differs from
SFAS No. 121. SFAS No. 144 also supersedes the accounting and reporting
provisions of APB Opinion No. 30 as it pertains to disposal of a business
segment but retains the requirement of that opinion to report discontinued
operations separately from continuing operations and extends that reporting to
a component of an entity that either has been disposed of or is classified as
held for sale. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001, thereby applying to the Company upon the
commencement of its fiscal 2003 fiscal year. The Company is evaluating the impact of the adoption of this
standard and has not yet determined the effect of adoption on its financial
position and results of operations.

16



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##### Table of Contents



Forward-Looking Statements

This Form 10-Q (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 involve 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,
availability of qualified personnel, availability of suitable future store
locations, schedules of store expansion plans and other factors. 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 actual
results to differ materially from that projected or suggested may be identified
from time to time in the Companys Securities and Exchange Commission filings
and the Companys public announcements.




Item 3.         Quantitative and Qualitative Disclosures about Market Risk

The Company, in the normal course of doing business, is exposed to
interest rate change market risk. As borrowing patterns are cyclical, the
Company is 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.

17



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##### Table of Contents






PART II OTHER INFORMATION




Item 1.         Legal
Proceedings

The Company was named as a defendant in twelve class action complaints.
The Companys former Chief Executive Officer and the former Chief Financial
Officer and Executive Vice President of Operations were also named as
defendants. All of the complaints were filed in the United States District
Court for the District of New Jersey. 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.

The second amended complaint 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, the Companys financial condition, adequacy of internal controls and
compliance with certain loan covenants during the Class Period. The plaintiffs
further alleged that because of the issuance of a series of false and
misleading statements and/or the failure to disclose material facts, the price
of Party City's common stock was artificially inflated.

In early 2000, defendants moved to dismiss the second amended complaint on
the ground that it failed to state a cause of action. On May 29, 2001, the
District Court issued an Opinion and Order dismissing the Complaint against all
defendants with prejudice. On June 27, 2001, plaintiffs filed a Notice of
Appeal to the United States Court of Appeals for the Third Circuit. Prior to
the argument of the appeal, the parties reached an agreement in principle to
settle the action. The parties have requested that the Court of Appeals remand
the case to the District Court to supervise the implementation of the
settlement. The proposed amount to be paid by the Company under the settlement
is not material and is subject to various conditions. These include the completion of 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.

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.

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.




Item 2.         Changes in Securities and Use of Proceeds

None




Item 3.         Defaults upon Senior Securities

None

18



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##### Table of Contents






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

None




Item 5.         Other Information

None




Item 6.         Exhibits and Reports on Form 8-K

(a) The exhibits required to be filed as part of this report on Form 10-Q
are listed in the attached Exhibit Index.

(b) Reports on Form 8-K

None

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##### Table of Contents






EXHIBIT INDEX

|            |  |   |  |                                                                                                                                                      
|----------- |  | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |   |  |                                                                                                                                                      
|            |  |   |  |                                                                                                                                                      
|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(5)      |  |  |  | Form of Amended and Restated Warrant.                                                                                                                
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|4.3(2)      |  |  |  | Form of A Note.                                                                                                                                      
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|4.4(2)      |  |  |  | Form of B Note.                                                                                                                                      
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|4.5(2)      |  |  |  | Form of C Note.                                                                                                                                      
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|4.6(2)      |  |  |  | Form of D Note.                                                                                                                                      
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|4.7(5)      |  |  |  | Form of E Note.                                                                                                                                      
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|4.8(2)      |  |  |  | Form of Securities Purchase Agreement, dated as of August 16, 1999, by and between the Company and each of the
Investors.                            
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|4.9(5)      |  |  |  | First Amendment to Securities Purchase Agreement, dated as of January 14, 2000, by and between the Company and
each of the Investors.                
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|4.10(7)     |  |  |  | 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(3)     |  |  |  | Option Agreement, dated as of June 8, 1999, between Steven Mandell
and Jack Futterman.                                                               
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|10.4(3)     |  |  |  | Stock Pledge Agreement, dated as of June 8, 1999, between Steven Mandell and Jack Futterman.                                                         
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|10.5(3)     |  |  |  | Employment Agreement, dated as of June 8, 1999, between the Company and Jack Futterman.                                                              
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|10.6(2)     |  |  |  | Investor Rights Agreement, dated as of August 16, 1999, by and among the Company, the Investors and Jack
Futterman.                                  
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                      
|           
|           
|           
|           
|10.7(2)     |  |  |  | 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(2)     |  |  |  | Vendor Forbearance and Standstill Agreement, dated as of August 16, 1999, by and among the Company and the
Trade Vendors.                            

20



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##### Table of Contents



|            |  |   |  |                                                                                                                                                                                                                         
|----------- |  | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |   |  |                                                                                                                                                                                                                         
|            |  |   |  |                                                                                                                                                                                                                         
|           
|           
|           
|           
|10.9(7)     |  |  |  | First Amendment to Investor Rights Agreement, dated as of October 11, 2000, by and among the Company, the
Investors and Jack Futterman.                                                                                 
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                                                                                         
|           
|           
|           
|           
|10.10(7)    |  |  |  | Second Amendment to Investor Rights Agreement, dated as of November 20, 2000, by and among the Company,
the Investors and Jack Futterman.                                                                               
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                                                                                         
|           
|           
|           
|           
|10.11(5)    |  |  |  | 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.                                                                                                         
|           
|           
|           
|           
|            |  |   |  |                                                                                                                                                                                                                         
|           
|           
|           
|           
|10.16(8)    |  |  |  | Management 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.



---

Notes



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

21



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##### Table of Contents



SIGNATURES

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

|                   |  |  |  |                        |  |                          |  |                 
|------------------ |  |  |  | ---------------------- |  | ------------------------ |  | ----------------
|                   |  |  |  | PARTY CITY CORPORATION
|                  
|                  
|                  
|                  
|                   |  |  |  |                        |  |                          |  |                 
|                  
|                  
|                  
|                  
|                   |  |  |  | By                     |  | /s/                      |  | JAMES SHEA      
|                   |  |  |  |                        |  |                         
|                   |  |  |  |                        |  | (James Shea)            
|                  
|                  
|                  
|                  
|                   |  |  |  |                        |  | Chief Executive Officer 
|                  
|                  
|                  
|                  
|                   |  |  |  |                        |  |                          |  |                 
|                  
|                  
|                  
|                  
|                   |  |  |  | By                     |  | /s/                      |  | THOMAS E. LARSON
|                   |  |  |  |                        |  |                         
|                   |  |  |  |                        |  | (Thomas E. Larson)      
|                  
|                  
|                  
|                  
|                   |  |  |  |                        |  | Chief Financial Officer 
|                  
|                  
|                  
|                  
|                   |  |  |  |                        |  |                          |  |                 
|                  
|                  
|                  
|                  
|                   |  |  |  | By                     |  | /s/                      |  | LINDA M. SILUK  
|                   |  |  |  |                        |  |                         
|                   |  |  |  |                        |  | (Linda M. Siluk)        
|                  
|                  
|                  
|                  
|                   |  |  |  |                        |  | Chief Accounting Officer
|                  
|                  
|                  
|                  
|                   |  |  |  |                        |  |                          |  |                 
|                  
|                  
|                  
|                  
|Date: May 14, 2002 |  |  |  |                        |  |                          |  |                 

22