<PAGE>   1
                       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

                                -----------------
     FOR THE QUARTERLY PERIOD ENDED                COMMISSION FILE NUMBER
            OCTOBER 2, 1999                                 0-27826

                                -----------------
                             PARTY CITY CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

              DELAWARE                                 22--3033692
     (State or other jurisdiction of                 (I.R.S. Employer
      incorporation or organization)                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)

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

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 / / No: /X/

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

       As of November 12, 1999, there were outstanding 12,455,538 shares
                        of Common Stock, $.01 par value.



                                      1
<PAGE>   2


                             PARTY CITY CORPORATION

                                      INDEX

<TABLE>
<CAPTION>
 Part I.      Financial Information                                            Page No.
                                                                               --------
<S>                                                                               <C>
      Item 1.  Consolidated financial statements

           Consolidated balance sheets - October 2, 1999 (Unaudited) and
             July 3, 1999                                                          3
           Consolidated statements of operations (Unaudited) - For the
             quarters ended October 2, 1999 and September 30, 1998                 4
           Consolidated statements of cash flows (Unaudited) - For the
             quarters ended October 2, 1999 and September 30, 1998                 5
           Notes to Consolidated Financial Statements                              6

      Item 2.  Management's Discussion and Analysis of Financial Condition
      and Results of Operations                                                    10

 Part II.     Other Information

      Item 2.  Changes in Securities                                               14
      Item 3.  Defaults Under Senior Securities                                    14
      Item 6.  Exhibits and Reports on Form 8-K                                    15
      Exhibit Index                                                                15
</TABLE>

                                       2
<PAGE>   3


PART 1.  FINANCIAL INFORMATION

Item 1. Financial Statements

                      PARTY CITY CORPORATION AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS

                                 (IN THOUSANDS)

<TABLE>
<CAPTION>

                                                OCTOBER 2, 1999    JULY 3, 1999
                                                ----------------   ------------
                                                   (UNAUDITED)
<S>                                                   <C>            <C>
                   ASSETS
Current assets:

   Cash and cash equivalents                          $ 4,824        $ 11,470
   Merchandise inventory                               69,444          47,016
   Refundable income taxes                              1,919           6,848
   Advance merchandise payments                         6,794           9,439
   Other current assets                                17,741          13,327
                                                       ------          ------
      Total current assets                            100,722          88,101
Property and equipment, net                            46,619          50,557
Goodwill, net                                          15,754          18,483
Other assets                                            1,393             906
                                                     --------        --------
      Total assets                                   $164,488        $158,047
                                                     ========        ========

         LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:

   Accounts payable - trade                           $48,460         $45,114
   Accrued expenses                                    13,544          10,145
   Borrowings under Credit Agreement                   39,922          58,550
   Senior Notes                                        28,078               -
   Other current liabilities                            1,566             986
                                                     --------        --------
      Total current liabilities                       131,570         114,795
Long-term liabilities:
Deferred rent                                           6,571           6,527
Other long-term liabilities                               707             791

Commitments and contingencies

Stockholders' equity:

   Common stock                                           125             125
   Additional paid-in capital                          35,989          34,024
   Retained earnings                                 (10,474)           1,785
                                                     --------        --------
       Total stockholders' equity                      25,640          35,934
                                                     --------        --------
       Total liabilities and stockholders'
       equity                                        $164,488        $158,047
                                                     ========        ========
</TABLE>

          See accompanying notes to consolidated financial statements.

                                       3
<PAGE>   4



                      PARTY CITY CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF OPERATIONS

                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>

                                                          QUARTER ENDED
                                                 -------------------------------
                                                 OCTOBER 2,        SEPTEMBER 30,
                                                    1999               1998
                                                    ----               ----
                                                           (Unaudited)
<S>                                                <C>           <C>
Revenues:
     Net sales                                      $67,813       $56,006
     Royalty fees                                     2,316         2,008
     Franchise fees                                     322           360
                                                    -------       -------
        Total revenues                               70,451        58,374
Expenses:
     Cost of goods sold and occupancy costs          50,717        39,513
     Company-owned stores operating and selling
     expense                                         20,059        17,034
     Franchise expense                                1,124         1,060
     General and administrative expense               8,376         3,195
                                                    -------       -------
           Total expenses                            80,276        60,802
                                                    -------       -------
Loss before interest and income taxes               (9,825)       (2,427)
     Interest expense                                 2,434         1,147
                                                    -------       -------
Loss before income taxes                           (12,259)       (3,575)

     Income tax benefit                                   -       (1,414)
                                                    -------       -------
Net loss                                          $(12,259)      $(2,161)
                                                  =========      ========

     Basic loss per share                           $(0.98)       $(0.17)
                                                    =======       =======
        Weighted average shares outstanding -
        basic                                        12,456        12,441
                                                     ======        ======

     Diluted loss per share                         $(0.98)       $(0.17)
                                                    =======       =======
        Weighted average shares outstanding -
        diluted                                      12,456        12,441
                                                     ======        ======
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       4

<PAGE>   5



                      PARTY CITY CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 (IN THOUSANDS)

<TABLE>
<CAPTION>

                                                       QUARTER ENDED
                                                 ------------------------
                                                 OCTOBER 2,    SEPTEMBER 30,
                                                    1999            1998
                                                    ----            ----
                                                       (Unaudited)
<S>                                               <C>            <C>
Cash flow from operating activities:
Net loss                                          $(12,259)      $(2,161)
Adjustments to reconcile net loss to net cash
used in operating activities:
     Depreciation and amortization                    2,694         1,907
     Non-cash interest                                  195             -
     Deferred rent                                       44           854
     Loss on sale of stores to franchisees            1,042             -
     Changes in assets and liabilities:
      Merchandise inventory                        (26,962)      (33,786)
      Refundable income taxes                         4,929       (1,875)
      Advance merchandise payments                    2,645             -
      Other current assets                          (4,787)           356
      Other assets                                     (98)          (72)
      Accounts payable - trade                        3,346        31,494
      Accrued expenses                                3,399         5,171
      Income taxes payable                                -           270
      Other current liabilities                       (520)         (205)
      Other long term liabilities                      (84)          (36)
                                                   --------       -------
        Net cash provided by (used in) operating
        activities                                 (26,416)        1,917
Cash flow from investment activities:

     Purchases of property and equipment              (807)      (16,632)
     Proceeds from sale of stores to franchisees      9,877             -
     Stores acquired from franchisees                     -       (4,951)
                                                   --------       -------
        Net cash provided by (used in) investment
        activities                                    9,070      (21,583)
Cash flow provided by financing activities:

     Proceeds from exercise of stock options              -           120
     Proceeds from Senior Notes                      30,000             -
     Payment of Senior Note issuance costs            (673)             -
     Net proceeds from (payments on) Credit
     Agreement                                     (18,628)        15,020
                                                    ------         ------
          Net cash provided from financing

          activities                                 10,699        15,140
                                                     ------        ------
Net increase (decrease) in cash and cash
equivalents                                         (6,646)         4,526
Cash and cash equivalents, beginning of period       11,470         5,089
                                                     ------         -----
Cash and cash equivalents, end of period             $4,824        $  563
                                                     ======        ======

Supplemental disclosure of cash flow information:

     Income taxes paid (refunded)                  ($5,030)        $  193
     Interest paid                                   $1,038          $993
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       5
<PAGE>   6



                      PARTY CITY CORPORATION AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  BASIS OF PRESENTATION

      The consolidated financial statements, except for the July 3, 1999
consolidated balance sheet, are unaudited. In the opinion of management, the
accompanying consolidated financial statements contain all adjustments
(consisting only of normal recurring accruals) necessary to present fairly the
financial position of the Company as of October 2, 1999 and September 30, 1998
and the results of operations and cash flows for the respective quarter then
ended. 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 year.

    These consolidated financial statements should be read in conjunction with
the Company's audited consolidated financial statements for the eighteen-month
period ended July 3, 1999, included in the Company's Annual Report of Form 10-K
filed with the Securities and Exchange Commission. All significant intercompany
accounts and transactions have been eliminated. The July 3, 1999 consolidated
balance sheet amounts have been derived from the Company's audited consolidated
balance sheet amounts.

    Effective July 3, 1999, the Company changed its fiscal year end for
financial reporting from December 31 to the Saturday nearest to June 30. The
Company continues to use December 31 as its tax year end. The change to a 52-53
week calendar was made to facilitate comparable store sales computations. The
term "Fiscal Year" refers to the 52-53 weeks ending the Saturday nearest June
30, unless otherwise noted.

2.   FINANCING ACTIVITIES

     On April 24, 1998, the Company refinanced and replaced its then existing
$20 million loan facility with a $60 million secured revolving line of credit
agreement with a group of banks maturing April 24, 2001 (as amended, the "Credit
Agreement"). Advances under the Credit Agreement originally bore interest, at
the Company's option, at the agent bank's base rate (the higher of the bank's
prime rate or the federal funds rate plus 1/2% per annum) or LIBOR plus an
applicable margin. The Company's previous failure to issue its consolidated
financial statements on a timely basis was a default under the Credit Agreement.
In addition to this default, the Company did not meet certain of its financial
covenants, including those relating to minimum levels of profitability, net
worth, liquidity, fixed charge coverage and others. Consequently, the Company's
debt under the Credit Agreement was subject to acceleration and is classified as
a current liability in the consolidated balance sheets at October 2, 1999 and
July 3, 1999. The Credit Agreement is secured by all the assets of the Company.
Additionally, the Credit Agreement restricts the payment of dividends.

     On August 16, 1999 the Company entered into the following agreements with
its existing bank lenders under the Credit Agreement (the "Banks"), a new group
of investors (the "Investors") and its trade vendors. The bank lenders and the
Company entered into a Standstill and Forbearance Agreement (the "Bank
Forbearance Agreement"). Under the Bank Forbearance Agreement, the Banks agreed
not to exercise rights and remedies based upon any existing defaults until June
30, 2000 unless a further event of default occurs. The Company agreed to reduce
its outstanding bank borrowings from the $58.6 million outstanding at July 3,
1999, to $15 million at October 30, 1999, to increase the interest rate on its
bank debt to 2% over the bank's prime interest rate and to pay a forbearance fee
of $580,000. The Company has reduced its outstanding bank borrowings to $15
million at October 30, 1999. Company management intends to refinance its
outstanding indebtedness to the Banks with an asset-based lending arrangement.
There is no assurance such a lending arrangement can be obtained. The $15
million outstanding at October 30, 1999 is due June 30, 2000 unless the Bank
Forbearance Agreement is extended or amended.

     On August 17, 1999, the Company received $30 million in financing from the
Investors. The Investors purchased senior secured notes and warrants pursuant to
separate securities purchase agreements (the "Securities Purchase Agreements")
each dated as of August 16, 1999. Under these Securities Purchase Agreements,
the Company issued (i) $10 million of its 12.5% Secured Notes due 2003 (the "A
Notes"); (ii)


                                       6
<PAGE>   7

$5 million of its 13.0% Secured Notes due 2003 (the "B Notes"); (iii) $5 million
of its 13.0% Secured Notes due 2002 (the "C Notes"); (iv) $10 million of its
14.0% Secured Notes due 2004 (the "D Notes", and together with the A Notes, the
B Notes and the C Notes, the "Notes"); and (v) warrants (the "Warrants") to
purchase 6,880,000 shares of the Company's common stock at an initial exercise
price of $3.00 per share. Up to $15 million of the Notes is secured by a first
lien that is pari pasu with the liens under the Credit Agreement. The Notes are
also secured by a second lien on all of the Company's assets. The Company issued
the Warrants in connection with the sale of the C Notes and the D Notes. The
Warrants may be exercised before the close of business on August 16, 2006. The
shares of Common Stock reserved for issuance under the Warrants represent
approximately 35% of the shares of Common Stock outstanding assuming the
exercise of the Warrants. The warrants were valued at $1,965,000 based on
management's estimate using certain fair value methodologies and represent an
original issue discount to the C and D notes. This discount is being amortized
using the effective interest method. The effective yield is 18.3% and 18.9% on
the C Notes and D Notes, respectively.

     The Company also entered into an Investor Rights Agreement (the "Investor
Rights Agreement") with the Investors and the chief executive officer of the
Company. In this agreement, the Company granted registration rights with respect
to shares of common stock. The Company has agreed to nominate two individuals
designated by the Investors to its Board of Directors. Under the Investor Rights
Agreement, the Investors agree that they will not, without the prior written
consent of the Board of Directors, (i) acquire or agree to acquire, publicly
offer or make any public proposal with respect to the possible acquisition of
(a) beneficial ownership of any securities of the Company, (b) any substantial
part of the Company's assets, or (c) any rights or options to acquire any of the
foregoing from any person; (ii) make or in any way participate in any
"solicitation" of "proxies" (as such terms are defined in the rules of the
Securities Exchange Act of 1934, as amended) to vote, or seek to advise or
influence any person with respect to the voting of any voting securities of the
Company; or (iii) make any public announcement with respect to any transaction
between the Company or any of its securities holders and the Investors,
including without limitation, any tender or exchange offer, merger or other
business combination of a material portion of the assets of the Company. These
standstill provisions terminate if the Company's consolidated earnings before
interest, taxes, depreciation and amortization and exclusive of special charges,
as defined in the Investor Rights Agreement, do not meet specified targets.

     Party City's trade vendors representing approximately $36.4 million of
trade debt have also entered into an agreement with the Company. Pursuant to a
Vendor Standstill and Forbearance Agreement ("Vendor Forbearance Agreement"),
these trade vendors agreed to forbear from taking any action against Party City
until January 15, 2000, unless an event of default occurs. The trade vendors
have received promissory notes from Party City representing one-third of their
unpaid balances as of May 1, 1999 (the "Trade Notes"). The Trade Notes bear
interest at a rate of 10% per year and mature on November 15, 1999. Interest on
the Trade Notes is due on January 15, 2000, unless the bank debt is refinanced
before then. On or about January 15, 2000, the Company management believes it
will reach agreement to resume normal credit terms with substantially all its
vendors. Upon such event, management believes the remaining two-thirds of the
unpaid claims that were due as of May 1, 1999, will be satisfied through
individual arrangements with its vendors. However, there can be no assurance
that the Company will successfully negotiate normal credit terms or conclude
these arrangements. Separately, certain seasonal trade vendors have agreed to
extend credit to Party City for 30% of purchases for the Halloween, Thanksgiving
and end of year holiday seasons. Vendors that have agreed to extend credit will
receive a shared lien that is pari passu with the liens of the Credit Agreement
on the Company's inventory for the amount of the credit extended. See Note 4 for
further discussion.

     Also, in connection with these transactions, one outside director of the
Company resigned and two representatives of the Investors joined the Board of
Directors.


                                       7
<PAGE>   8



     The proceeds from the $30 million in new financing have been used as
follows (in thousands):

<TABLE>
<CAPTION>
<S>                                                                <C>
    Purchase of seasonal inventory                                  $20,000
    Payment of amounts under the Credit
    Agreement                                                         4,000
    Transactions fees                                                   673
    Working capital                                                   5,327
                                                                      -----
    Total proceeds                                                  $30,000
                                                                    =======
</TABLE>

      In order to meet the cash flow requirements of the Halloween seasonal
purchase of inventory and to meet the requirements of the Bank Forbearance
Agreement, the Company began a program to identify stores for sale to existing
franchisees to generate working capital. Eighteen stores with a net book value
of approximately $9,150,000 were sold to franchisees, of which seventeen stores
with a net book value of approximately $8,750,000 were sold subsequent to July
3, 1999. In connection with the sales, normal franchise fees were waived for
negotiated periods up to five years. The total proceeds from the sales of these
stores are approximately $9,883,000, of which $9,683,000 was received subsequent
to July 3, 1999. The net proceeds from the sale of stores is required under the
Bank Forbearance Agreement to be used to pay down the outstanding borrowings
under the Credit Agreement.

3.      SECURITIES LITIGATION

     The Company has been named as a defendant in the following twelve class
action complaints: (1) Weber v. Party City Corp., Steven Mandell, and David
Lauber, Civ. Action No. 99-CV-1252; (2) Opus GT Partners LP v. Party City Corp.
and Steven Mandell, Civ. Action No. 99-CV-1327; (3) Klein and Shiffrin v. Party
City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1325; (4)
Flynn v. Party City Corp., David Lauber and Steven Mandell, Civ. Action No.
99-CV-1328; (5) Catanzarite v. Party City Corp., Steven Mandell and David
Lauber, Civ. Action No. 99-CV-1317; (6) Tabbert v. Party City Corp. and Steven
Mandell, Civ. Action No. 99-CV-1353; (7) Maietta v. Steven Mandell and Party
City Corp., Civ. Action No. 99-CV-1386; (8) Barry v. Party City Corp., Steven
Mandell and David Lauber, Civ. Action No. 99-CV-1453; (9) Kurzweil v. Party
City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1396; (10)
Hormel v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No.
99-CV-1689; (11) Sacher v. Party City Corp., Steven Mandell and David Lauber,
Civ. Action No. 99-CV-2238: and (12) Gross v. Party City Corp., Steven Mandell
and David Lauber, Civ. Action No. 99-CV-2355. The Company's former Chief
Executive Officer and former Chief Financial Officer and Executive Vice
President of Operations have also been named as defendants. The complaints have
all been 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 1998 and March 19, 1999.

     The complaints allege, among other things, violations of sections 10(b) and
20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder, and seek unspecified damages. The plaintiffs allege 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. The plaintiffs further allege that because of the issuance of a
series of false and misleading statements and/or failure to disclose material
facts, the price of Party City common stock was artificially inflated.

     On September 13, 1999, the Court signed an Order appointing lead plaintiffs
and lead counsel to represent the classes alleged in the complaints. The Order
directed plaintiffs to file a consolidated and amended complaint in October
1999, which the plaintiffs did and which was served on the Company on or about
October 18, 1999.

  Other

     The Company was named as a defendant in a complaint filed with the Supreme
Court of the State of New York, County of New York, on January 16, 1998 (the
"Complaint"), by each of Party City of


                                       8
<PAGE>   9

Greenbrook, Inc., Party City of Watchung, Inc., Party City of 22, Inc., Party
City of Ralph Avenue and Party City of Jersey City, Inc., each a franchisee of
the Company. Four of the plaintiffs in the suit have existing Party City
franchise stores, with the remaining plaintiff possessing a right of first
refusal to develop a Party City store in Watchung, New Jersey.

     The Complaint stated various causes of action, including unjust enrichment,
unfair competition, fraud and misrepresentation, breach of contract,
misappropriation of information and violations of the New Jersey Franchise
Practices Act and the New York State Franchise Sales Act. The crux of the
Complaint was that the Company undertook a course of conduct intentionally
designed to adversely impact the value of the Plaintiffs' franchise stores in
order to permit the Company to purchase such stores at a substantially reduced
value. The Company settled the lawsuit on June 30, 1999, at no cost to the
Company. In connection with the settlement, the Company agreed to sell the
plaintiff one store at its fair value.

     On April 23, 1999, plaintiff Emil Asch, Inc. filed a Complaint in the
United States District Court for the Eastern District of New York against the
Company and co-defendants Amscan, Inc., Hallmark, Inc., and Rubie's Costume. The
Complaint alleges five violations of the Robinson-Patman Act, which pertains to
price discrimination, unfair competition tortious interference with contractual
relations, and false and deceptive advertising.

     Plaintiff seeks damages of $2 million, as well as treble and punitive
damages for certain counts. The Company has answered the Complaint, and
discovery should proceed shortly.

     Although the Company's management is unable to express a view on the likely
outcome of these litigations because they are in their early stages, they could
have a material adverse effect on the Company's business and results of
operations.

     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.

4.      SUBSEQUENT EVENTS

     The Company entered into an agreement with a crisis management firm in
April 1999 to assist the Company in restructuring its operations as well as with
negotiations with its vendors and banks. Based on the attainment of certain
goals in the first quarter of Fiscal 2000, the crisis management firm earned a
success fee, which at the option of the crisis management firm is to be paid
either in cash or a combination of cash and stock. The Company recorded a
liability for the success fee in the first quarter of Fiscal 2000. Subsequent to
October 2, 1999, the crisis management firm agreed to accept 80% of its success
fee in stock and as such the Company expects to issue approximately 266,667
shares of common stock in the second quarter of Fiscal 2000.

     Pursuant to agreements reached with various vendors in August, 1999, the
Company is obligated to make certain payments to its vendors on November 15,
1999. The Company will not satisfy these obligations in full by November 15. The
failure to satisfy these obligations constitutes a default under the Bank
Forebearance Agreement, Securities Purchase Agreement, Investor Rights Agreement
and Vendor Forebearance Agreements to which the Company is a party. The Company
is engaged in discussions with its vendors and its lenders in connection with
these defaults. There is no assurance that the Company will be able to reach
agreement with the vendors and its lenders. As of October 30, 1999, the Company
met its requirements to reduce its outstanding bank borrowings under the Credit
Agreement to $15 million.


                                       9
<PAGE>   10



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

<TABLE>
<CAPTION>

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

                                                   QUARTER ENDED
                                            OCTOBER 2,       SEPTEMBER 30,
                                               1999               1998
                                               ----               ----
                                                     (UNAUDITED)
<S>                                          <C>             <C>
STATEMENT OF OPERATIONS DATA
Total revenue                                  $ 70,451        $ 58,374
                                               ========        --------
Company-owned stores
  Net sales                                    $ 67,813        $ 56,006
  Cost of goods sold and occupancy costs         50,717          39,513
                                               --------        --------
  Gross profit                                   17,096          16,493
  Store operating and selling expense            20,059          17,034
                                               --------        --------
  Company-owned stores profit
  contribution (loss)                            (2,963)           (541)
Franchise stores:
  Royalty fees                                    2,316           2,008
  Franchise fees                                    322             360
                                               --------        --------
  Total franchise revenues                        2,638           2,368
  Total franchise expense                         1,124           1,060
                                               --------        --------
  Franchise profit contribution                   1,514           1,308
General and administrative expense:
  Special charges (a)                             4,868               -
  Other general and administrative
  expenses                                        3,508           3,195
                                               --------        --------
                                                  8,376           3,195
                                               --------        --------
Loss before interest and income tax
  benefit                                        (9,825)         (2,428)
Interest expense, net                             2,434           1,147
                                               --------        --------
Loss before income tax benefit                  (12,259)         (3,575)
Income tax benefit                                    -          (1,414)
                                               --------        --------
Net loss                                       $(12,259)       $ (2,161)
                                               ========        ========

Basic earnings per share                       $  (0.98)       $  (0.17)
                                               ========        ========
Diluted earnings per share                     $  (0.98)       $  (0.17)
                                               ========        ========
Weighted average shares outstanding --
  Basic                                          12,456          12,441
Weighted average shares outstanding --
  Diluted                                        12,456          12,441
EBITDA (b)                                     $ (2,263)       $   (520)
Depreciation and amortization                  $  2,694        $  1,907

</TABLE>


                                       10
<PAGE>   11



<TABLE>
<CAPTION>
                                                    QUARTER ENDED
                                                    -------------
                                             OCTOBER 2,    SEPTEMBER 30,
                                                1999           1998
                                                ----           ----
                                                     (Unaudited)
<S>                                           <C>          <C>
STORE DATA:
   COMPANY-OWNED:
     Stores open at beginning of period            215          148
     Stores opened                                   1           40
     Stores closed                                   -            -
     Stores acquired from franchisees                -            5
     Stores sold to franchisees                   (17)            -
                                                 -----        -----
     Stores open at end of period                  199          193
   FRANCHISE:
     Stores open at beginning of period            178          161
     Stores opened                                  12           12
     Stores closed                                   -            1
     Stores acquired from franchisees                -            5
     Stores acquired from Company                   17            -
                                                 -----        -----
     Stores open at end of period                  207          167
                                                   ===          ===
   Increase (decrease) in company-owned
   same store sales                             (4.5%)         9.2%
   Increase (decrease) in franchise same
   store sales                                    6.9%         1.8%
   Average sales per Company-owned store           332          334

BALANCE SHEET DATA:
   Working capital (deficiency)               $(10,848)     $36,104
   Total assets                                164,488      169,427
   Bank borrowings and other debt               68,000       54,299
   Capital lease obligation                        635          903
   Stockholders' equity                        $25,640      $11,023
</TABLE>

(a) Special charges in 1999 relate to consulting services, accounting fees, bank
fees, legal fees and other expenses related to the Company's default on its
Credit Agreement and related financial transactions. The Company engaged the
services of a crisis management consulting firm and numerous other professionals
to advise management during the complex negotiations with the bank, vendors and
potential investors.

(b) Earnings before interest, taxes, depreciation and amortization, and
exclusive of special charges, as defined above.


Quarter Ended October 2, 1999 ("First Quarter") Compared to Quarter Ended
September 30, 1998 ("1998 Quarter")

Retail. Net sales from Company-owned stores increased 21.1% to $67.8 million for
First Quarter, from $56.0 million for the comparable 1998 Quarter. The First
Quarter results include 14 stores which opened during the last calendar quarter
of 1998 plus ten stores which opened during the first three calendar quarters of
1999. The 1998 Quarter represents sales from 193 stores, including 40 stores
which opened during the third calendar quarter of 1998 and five stores acquired
from franchisees during the quarter. Same store sales decreased 4.5% in the
First Quarter. 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 First Quarter
increased 3.6% to $17.1 million from $16.5 million for the comparable 1998
Quarter. The increase in the First Quarter was primarily due to increased sales
volume. Gross margin was 25.2% for the First Quarter compared with 29.4% for the
comparable 1998 Quarter. The decrease in gross margin is related primarily to a
decrease of discounts and rebates in the First Quarter.

      Store operating and selling expenses increased 17.8% to $20.1 million for
the First Quarter from $17.0 million in the comparable 1998 Quarter. The
increase in store operating expenses is attributable to the


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<PAGE>   12

increased number of stores operated by the Company during the First Quarter.
Store operating and selling expenses were 29.6% and 30.4% of sales for the First
Quarter and 1998 Quarter, respectively. Pre-opening expenses in the First
Quarter were $97,000 relating to one Company-owned store opened in the quarter
compared to pre-opening expenses of $1.4 million incurred in the 1998 Quarter.
Company-owned stores recorded a loss of $3.0 million for the First Quarter,
compared to a loss of $ .5 million for the 1998 Quarter. The increased loss was
primarily the result of reduced gross margin offset by the decrease in
pre-opening expenses and the increased profitability of older stores.

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 12 store
openings were $322,000 for the First Quarter compared to $360,000 for the
comparable 1998 Quarter, which also represents 12 store openings. Royalty fees
increased 15.3% to $2.3 million in the First Quarter from $2.0 million in the
comparable 1998 Quarter due primarily to an increase in the number of stores.

      Expenses directly related to franchise revenue increased 6.0% to $1.1
million for the First Quarter from $1.06 million for the comparable 1998
quarter. As a percentage of franchise revenue, franchise expenses were 42.6% and
44.8% for the First Quarter and 1998 Quarter, respectively.

      Franchise profit contribution increased 15.7% to $1.5 million for the
First Quarter from $1.3 million for the comparable 1998 Quarter. The increase in
franchise profit contribution is due to higher revenues from the increased
number of franchise stores.

General and Administrative. General and administrative expenses increased 163%
to $8.4 million in the First Quarter from $ 3.2 million in the comparable 1998
Quarter. This increase is attributable in part to $4.9 million in special
charges relating to consulting accounting, banking and other expense resulting
from the Company's refinancing arrangements. In addition, during the First
Quarter there was an increase in corporate expenses primarily attributable to an
increase in payroll and related benefits and increased travel and occupancy
costs as a result of establishing the necessary organizational infrastructure to
allow the Company to maintain the Company-owned store base. Exclusive of the
$4.9 million in special charges discussed above, general and administrative
expenses were 5.0% and 5.5% of revenue for the First Quarter and 1998 Quarter,
respectively.

Interest Expense. Interest expense increased 112% to $2.4 million for the First
Quarter from $1.1 million in the comparable 1998 Quarter. The increased expense
is primarily attributable to increased interest rates, new borrowings and
average borrowings outstanding.

Income Tax Benefit. There was no income tax benefit for the First Quarter as
compared to the $1.4 million benefit reported in the 1998 Quarter. This decrease
is the result of the Company recording a valuation allowance on its deferred tax
assets related to part-year federal and state net operating losses. The
valuation allowance was due to the Company's determination that it was more
likely than not such tax assets would not be realized.

Net Loss. As a result of the above factors, net loss for the First Quarter was
$12.3 million, or $(0.98) per basic and diluted share, in the First Quarter, as
compared to a net loss of $2.2 million, or $(0.17) per basic and diluted share
in the 1998 Quarter.

LIQUIDITY AND CAPITAL RESOURCES

      For the First Quarter, cash used in operating activities was $26.4
million, compared to cash provided by operating activities of $1.9 million for
the comparable 1998 Quarter. The increase in cash used in operating activities
was primarily attributable to increases in merchandise inventory of $27.0
million, other current assets and other assets of $4.9 million, net loss of
$12.3 million, partially offset by depreciation and amortization of $2.7
million, an increase in refundable income taxes of $4.9 million, increases in
accounts payable of $3.3 million, compared to an increase in accounts payable of
$31.5 million in the


                                       12

<PAGE>   13

1998 Quarter, and accrued expenses of $3.4 million as well as other net changes
in operating assets and liabilities.

      Cash provided by (used in) investing activities for the First Quarter was
$9.1 million compared to $21.6 million used in investing in the comparable 1998
Quarter. The change in cash used in investing activities was primarily
attributable to sales of stores to franchisees, fewer new store additions and a
decrease in acquisitions.

     Cash provided by financing activities was $10.7 million for the First
Quarter compared to $15.1 million in the comparable 1998 Quarter. This amount is
primarily attributable to the repayment of borrowings of $18.6 million under the
Credit Agreement and net proceeds of $29.3 million from the issuance of Senior
Notes.

     Pursuant to agreements reached with various vendors in August, 1999, the
Company is obligated to make certain payments to its vendors on November 15,
1999. The Company will not satisfy these obligations in full by November 15. The
failure to satisfy these obligations constitutes a default under various loan
and other agreements to which the Company is a party. The Company is engaged in
discussions with its vendors and its lenders in connection with this default.
There is no assurance that the Company will be able to reach agreement with the
vendors and its lenders. As of October 30, 1999, the Company met its
requirements to reduce its outstanding bank borrowings under the Credit
Agreement to $15 million.

IMPACT OF YEAR 2000 ON THE COMPANY'S COMPUTER OPERATIONS

     The Company is preparing for the impact of the arrival of the Year 2000 on
its business. The "Year 2000 Problem" is a term used to describe the problems
created by systems that are unable to accurately interpret dates after December
31, 1999. These problems are derived predominately from the fact that certain
computer hardware and many software programs historically recorded a date's
"year" in a two digit format (i.e., 98 for 1998) and therefore may recognize
"00" as 1900 instead of the year 2000. The Year 2000 Problem creates potential
risks for the Company, including the inability to recognize and properly treat
dates occurring on or after January 1, 2000, which may result in computer system
failures or miscalculations of critical financial or operations information.

     In addition to its internal systems, the Company relies heavily on third
parties in operating its business. Such third parties include vendors and
utilities that provide electricity, water, natural gas, transportation,
telephone and banking. The Company began formulating a plan in 1998 to address
the Year 2000 Problem and to ensure that all relevant systems had been subject
to a full Year 2000 review and, if necessary, implement remediation, replacement
or upgrades. Under the plan, the Company has focused on (i) internal financial
and operational computer systems and (ii) the Year 2000 compliance of all
material suppliers and vendors doing business with the Company. The Company has
contacted all outside suppliers and vendors with which the Company has material
relationships and engaged in discussions which will continue throughout 1999 in
furtherance of the Company's stated goal of minimizing any adverse impact
relating to the Year 2000 Problem.

     The Company has completed its assessment of all material financial and
operating systems. In connection with this review, the Company upgraded its
financial accounting systems to Year 2000 compliant systems in the first
calendar quarter of 1999. This system is currently being tested to verify Year
2000 compliance, and such testing should be completed by November 30, 1999. As
of November 30, 1999 all computer operating systems in use will be upgraded and
upon 2000 compliant.

     In addition, the Company has assessed all computer hardware, including
servers, microcomputers, POS registers, and peripheral equipment at the store
and corporate levels. Only minor remediation and/or upgrade of these systems has
been required; each will be tested and compliant by November 30, 1999. The
Retail POS software at the store level has been tested and is compliant.


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     The Company estimates that the total costs and expenses associated with
completing the outlined Year 2000 compliance plan will range from $ 1,500,000 to
$ 1,700,000, of which all but approximately $300,000 has been incurred and
expensed. Company management presently believes that it will substantially
complete its internal Year 2000 compliance program prior to January 1, 2000, and
that there should be no material adverse impact at such time related to Year
2000 Problems associated with the Company's systems or software. Based on
communications with its vendors and suppliers, the Company also believes that
each third party with whom the Company has a material relationship is currently
Year 2000 compliant or scheduled to be Year 2000 compliant by January 1, 2000.

     Despite the Company's best efforts, there can be no assurance that (i) the
Company's assessments regarding the Year 2000 Problem are correct; (ii) the
Company will be able to successfully complete its Year 2000 review and implement
such upgrades and/or remediation as is necessary or (iii) third parties or
suppliers with whom the Company does business will avoid Year 2000 Problems
which might adversely affect the Company's business or operations. While the
Company is developing contingency plans to address such failures or unexpected
problems (such plans include identification of alternative suppliers), there can
be no assurance that such contingency plans will be adequate to resolve these
problems. The Company's contingency plan is expected to be completed by November
30, 1999.

     The Year 2000 Problems involves substantial risk to the Company. The
Company believes today that the likely worst case scenario regarding the Year
2000 Problem will involve temporary disruptions in the receipt of merchandise
inventory and temporary disruption in the payment of bills. These events may
also cause lost revenue. The foregoing assessment is based on information
currently available to the Company. The Company can provide no assurances that
applications and equipment believed to be Year 2000 compliant will not
experience difficulties, or the Company will not experience difficulties
obtaining resources needed to make modifications to, or replacement of, the
Company's affected systems and equipment. Failure by the Company or third
parties, on which it relies to resolve Year 2000 issues, could have a material
effect on the Company's results of operations.

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 year 2000 readiness issues relating to the Company's internal systems
and those of third parties, the ability of the Company to refinance its existing
debt on terms acceptable to it 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.

PART II  OTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES

     In connection with the Securities Purchase Agreements, the Company issued
to the holders of the C Notes and D Notes warrants to purchase an aggregate of
6,880,000 shares of Common Stock at an initial exercise price of $3.00 per
share. The Warrants may be exercised at any time before the close of business on
August 16, 2006. The shares of Common Stock reserved for issuance under the
Warrants represent approximately 35% of the shares of Common Stock outstanding
assuming the exercise of the Warrants.


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<PAGE>   15



ITEM 3. DEFAULTS UNDER SENIOR SECURITIES

     See Note 2 to the Notes to the Consolidated Financial Statements.

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) The Company filed the following Current Reports on Form 8-K during
the quarter for which this report has been filed.

          Form 8-K, dated August 25, 1999 (Item 5).

          Form 8-K, dated September 17, 1999 (Item 6).

          Form 8-K, dated September 29, 1999 (Item 8).


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SIGNATURES

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


                                                 PARTY CITY CORPORATION

                                                  By /s/ Jack Futterman
                                                  ---------------------
                                                       (Jack Futterman)
                                                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:  November 12, 1999



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