##### Table of Contents



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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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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
SEPTEMBER 29, 2001 |  | COMMISSION FILE NUMBER
0-27826



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

|                                                                              |  |                                                
|----------------------------------------------------------------------------- |  | -----------------------------------------------
|DELAWARE
(State or other jurisdiction of
incorporation or organization)       |  | 223033692
(I.R.S. Employer
Identification No.)
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|                                                                              |  |                                                
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|400 COMMONS WAY
ROCKAWAY, NEW JERSEY
(Address of Principal Executive Offices) |  | 07866
(Zip Code)                               

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: (CHECK 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:

As of November 8, 2001, there were outstanding 13,000,017 shares of
Common Stock, $.01 par value.



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1



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TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|INDEX                        
|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                                                                
|                              | ITEM 3. DEFAULTS UNDER SENIOR SECURITIES AND USE OF PROCEEDS                                 
|                              | 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                                                                                
|SIGNATURES                   



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##### Table of Contents



PARTY CITY CORPORATION AND SUBSIDIARY




INDEX

|              |                       |                                                                                       |  |                                                                                                                                |  |          |  | 
|------------- | --------------------- | ------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------ |  | -------- |  | 
|              |                       |                                                                                       |  |                                                                                                                                |  | Page No.
|              |                       |                                                                                       |  |                                                                                                                                |  |         
|Part I.       | Financial Information
|             
|             
|             
|             
|              |                       |                                                                                      
|             
|             
|             
|             
|Item 1.       |                       | Consolidated Financial Statements                                                    
|             
|             
|             
|             
|              |                       |                                                                                       |  | Condensed Consolidated Balance Sheets  September 29, 2001 (Unaudited),
September 30, 2000 (Unaudited) and June 30, 2001      
|             
|             
|             
|             
|              |                       |                                                                                       |  | Condensed Consolidated Statements of Operations (Unaudited) 
For the quarters ended September 29, 2001 and September 30, 2000
|             
|             
|             
|             
|              |                       |                                                                                       |  | Condensed Consolidated Statements of Cash Flows (Unaudited) 
For the quarters ended September 29, 2001 and September 30, 2000
|             
|             
|             
|             
|              |                       |                                                                                       |  | 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                                                                
|             
|             
|             
|             
|Item 3.       |                       | Defaults Under 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

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

(in thousands)

|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |        |         |         | 
|------------------------------------ | --------------------------------------------- | ------------------------------------------ | ------------ | ------ | ------------------ | ------- | ------------------ | ------ | ------------- | ------- | ------ | ------ | ------- | ------- | 
|                                     |                                               |                                            |              |        | September 29, 2001 |         | September 30, 2000 |        | June 30, 2001
|                                     |                                               |                                            |              |        |                    |         |                    |        |              
|                                     |                                               |                                            |              |        | (Unaudited)        |         | (Unaudited)        |        |               |         |       
|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                    
|                                    
|                                    
|                                    
|ASSETS                               |                                               |                                            |              |        |                    |         |                    |        |               |         |        |        |        
|                                    
|                                    
|                                    
|                                    
|Current assets:                      |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                    
|                                    
|                                    
|                                    
|                                     | Cash and cash equivalents                     |                                            | $            | 5,095  |                    |         | $                  | 8,211  |               |         | $      | 9,842  |        
|                                    
|                                    
|                                    
|                                    
|                                     | Merchandise inventory                         |                                            |              | 77,584 |                    |         |                    | 72,827 |               |         |        | 48,034 |        
|                                    
|                                    
|                                    
|                                    
|                                     | Deferred income taxes                         |                                            |              | 6,278  |                    |         |                    | 5,976  |               |         |        | 3,798  |        
|                                    
|                                    
|                                    
|                                    
|                                     | Other current assets                          |                                            |              | 15,578 |                    |         |                    | 18,686 |               |         |        | 12,156 |        
|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                     |                                               | Total current assets                       |              |        | 104,535            |         |                    |        | 105,700       |         |        |        | 73,830  |        
|                                    
|                                    
|                                    
|                                    
|Property and equipment, net          |                                               |                                            | 47,226       |        |                    |         | 41,280             |        |               |         | 46,351 |       
|                                    
|                                    
|                                    
|                                    
|Goodwill, net                        |                                               |                                            | 14,150       |        |                    |         | 14,553             |        |               |         | 13,647 |       
|                                    
|                                    
|                                    
|                                    
|Other assets                         |                                               |                                            | 6,149        |        |                    |         | 6,932              |        |               |         | 7,514  |       
|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                     |                                               |                                            | Total assets |        | $                  | 172,060 |                    |        | $             | 168,465 |        |        | $       | 141,342 | 
|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                    
|                                    
|                                    
|                                    
|LIABILITIES AND STOCKHOLDERS EQUITY |                                               |                                            |              |        |                    |         |                    |        |               |         |        |        |        
|                                    
|                                    
|                                    
|                                    
|Current liabilities:                 |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                    
|                                    
|                                    
|                                    
|                                     | Accounts payable                              |                                            | $            | 54,702 |                    |         | $                  | 52,432 |               |         | $      | 27,905 |        
|                                    
|                                    
|                                    
|                                    
|                                     | Accrued expenses                              |                                            |              | 27,082 |                    |         |                    | 19,971 |               |         |        | 26,274 |        
|                                    
|                                    
|                                    
|                                    
|                                     | Advances under Loan Agreement                 |                                            |              | 5,424  |                    |         |                    | 14,573 |               |         |        |       |        
|                                    
|                                    
|                                    
|                                    
|                                     | Senior Notes, current portion                 |                                            |              | 10,484 |                    |         |                    | 5,103  |               |         |        | 11,366 |        
|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                     |                                               | Total current liabilities                  |              |        | 97,692             |         |                    |        | 92,079        |         |        |        | 65,545  |        
|                                    
|                                    
|                                    
|                                    
|Long-term liabilities:               |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                    
|                                    
|                                    
|                                    
|                                     | Deferred rent and other long-term liabilities |                                            |              | 9,422  |                    |         |                    | 8,144  |               |         |        | 8,701  |        
|                                    
|                                    
|                                    
|                                    
|                                     | Senior Notes                                  |                                            |              | 16,133 |                    |         |                    | 29,732 |               |         |        | 16,006 |        
|                                    
|                                    
|                                    
|                                    
|Commitments
and contingencies       
|                                    
|                                    
|                                    
|                                    
|Stockholders equity:                |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                    
|                                    
|                                    
|                                    
|                                     | Common stock                                  |                                            |              | 132    |                    |         |                    | 127    |               |         |        | 127    |        
|                                    
|                                    
|                                    
|                                    
|                                     | Additional paid-in capital                    |                                            |              | 38,386 |                    |         |                    | 37,968 |               |         |        | 38,236 |        
|                                    
|                                    
|                                    
|                                    
|                                     | Retained earnings                             |                                            |              | 10,941 |                    |         |                    | 415    |               |         |        | 12,727 |        
|                                    
|                                    
|                                    
|                                    
|                                     | Treasury stock, at cost (100,000 shares)      |                                            |              | (646   | )                  |         |                    |      |               |         |        |      |        
|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|Total stockholders equity           |                                               |                                            | 48,813       |        |                    |         | 38,510             |        |               |         | 51,090 |       
|                                    
|                                    
|                                    
|                                    
|                                     |                                               |                                            |              |        |                    |         |                    |        |               |         |        |       
|                                    
|                                    
|                                    
|                                    
|                                     |                                               | Total liabilities and stockholders equity |              | $      | 172,060            |         |                    | $      | 168,465       |         |        | $      | 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)

|                                      |                                                    |                |                                                         |        |               |        |               |        |        |        | 
|------------------------------------- | -------------------------------------------------- | -------------- | ------------------------------------------------------- | ------ | ------------- | ------ | ------------- | ------ | ------ | ------ | 
|                                      |                                                    |                |                                                         |        | Quarter ended
|                                      |                                                    |                |                                                         |        |              
|                                      |                                                    |                |                                                         |        | September 29, |        | September 30,
|                                      |                                                    |                |                                                         |        | 2001          |        | 2000         
|                                      |                                                    |                |                                                         |        |               |        |              
|                                      |                                                    |                |                                                         |        | (Unaudited)  
|                                      |                                                    |                |                                                         |        |               |        |               |       
|                                     
|                                     
|                                     
|                                     
|Revenues:                             |                                                    |                |                                                         |        |               |        |               |       
|                                     
|                                     
|                                     
|                                     
|                                      | Net sales                                          |                | $                                                       | 80,795 |               |        | $             | 76,853 |       
|                                     
|                                     
|                                     
|                                     
|                                      | Royalty fees                                       |                |                                                         | 3,246  |               |        |               | 2,809  |       
|                                     
|                                     
|                                     
|                                     
|                                      | Franchise fees                                     |                |                                                         | 343    |               |        |               | 426    |       
|                                      |                                                    |                |                                                         |        |               |        |               |       
|Total revenues                        |                                                    |                | 84,384                                                  |        |               |        | 80,088        |       
|                                     
|                                     
|                                     
|                                     
|Expenses:                             |                                                    |                |                                                         |        |               |        |               |       
|                                     
|                                     
|                                     
|                                     
|                                      | Cost of goods sold and occupancy costs             |                |                                                         | 57,667 |               |        |               | 55,462 |       
|                                     
|                                     
|                                     
|                                     
|                                      | Company-owned stores operating and
selling expense |                |                                                         | 20,228 |               |        |               | 19,749 |       
|                                     
|                                     
|                                     
|                                     
|                                      | Franchise expense                                  |                |                                                         | 1,547  |               |        |               | 1,254  |       
|                                     
|                                     
|                                     
|                                     
|                                      | General and administrative expense                 |                |                                                         | 6,164  |               |        |               | 5,177  |       
|                                      |                                                    |                |                                                         |        |               |        |               |       
|                                      |                                                    | Total expenses |                                                         |        | 85,606        |        |               |        | 81,642 |       
|                                      |                                                    |                |                                                         |        |               |        |               |       
|Loss before interest and income taxes |                                                    |                | (1,222                                                  | )      |               |        | (1,554        | )     
|                                     
|                                     
|                                     
|                                     
|                                      | Interest expense, net                              |                |                                                         | 1,755  |               |        |               | 2,282  |       
|                                      |                                                    |                |                                                         |        |               |        |               |       
|Loss before income taxes              |                                                    |                | (2,977                                                  | )      |               |        | (3,836        | )     
|                                     
|                                     
|                                     
|                                     
|                                      | Provision for income tax benefit                   |                |                                                         | (1,191 | )             |        |               | (1,485 | )     
|                                      |                                                    |                |                                                         |        |               |        |               |       
|Net loss                              |                                                    | $              | (1,786                                                  | )      |               | $      | (2,351        | )     
|                                      |                                                    |                |                                                         |        |               |        |               |       
|                                      |                                                    |                |                                                         |        |               |        |               |       
|                                     
|                                     
|                                     
|                                     
|                                      | Basic and diluted loss per share                   |                | $                                                       | (0.14  | )             |        | $             | (0.18  | )     
|                                     
|                                     
|                                     
|                                     
|                                      |                                                    |                |                                                         |        |               |        |               |       
|                                     
|                                     
|                                     
|                                     
|                                      |                                                    |                | Weighted average shares
outstanding  basic and diluted |        |               | 12,753 |               |        |        | 12,722 | 
|                                      |                                                    |                |                                                         |        |               |        |               |       

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)

|                                                                          |                                     |                                         |                                             |        |               |        |               |       |         |        |  
|------------------------------------------------------------------------- | ----------------------------------- | --------------------------------------- | ------------------------------------------- | ------ | ------------- | ------ | ------------- | ----- | ------- | ------ | -
|                                                                          |                                     |                                         |                                             |        | Quarter ended
|                                                                          |                                     |                                         |                                             |        |              
|                                                                          |                                     |                                         |                                             |        | September 29, |        | September 30,
|                                                                          |                                     |                                         |                                             |        | 2001          |        | 2000         
|                                                                          |                                     |                                         |                                             |        |               |        |              
|                                                                          |                                     |                                         |                                             |        | (Unaudited)  
|Cash flow from operating activities:                                      |                                     |                                         |                                             |        |               |        |               |      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Net loss                                                                  |                                     | $                                       | (1,786                                      | )      |               | $      | (2,351        | )    
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Adjustment to reconcile net loss to net cash used in
operating activities |                                     |                                         |                                             |        |               |        |               |      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Depreciation and amortization       |                                         |                                             | 2,825  |               |        |               | 2,534 |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Deferred taxes                      |                                         |                                             | (1,301 | )             |        |               |     |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Non-cash interest                   |                                         |                                             | 428    |               |        |               | 414   |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Deferred rent                       |                                         |                                             | 721    |               |        |               | 156   |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Issuance of options as compensation |                                         |                                             | 79     |               |        |               |     |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Provision for doubtful accounts     |                                         |                                             | 30     |               |        |               | 92    |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          | Changes in assets and liabilities   |                                         |                                             |        |               |        |               |       |        
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Merchandise inventory                   |                                             |        | (29,253       | )      |               |       | (30,541 | )     
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Other current assets                    |                                             |        | (3,452        | )      |               |       | (2,013  | )     
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Other assets                            |                                             |        | 2             |        |               |       | (125    | )     
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Accounts payable and accrued expenses   |                                             |        | 27,606        |        |               |       | 23,815  |       
|                                                                          |                                     |                                         |                                             |        |               |        |               |      
|                                                                          |                                     |                                         | Net cash used in operating activities       |        |               | (4,101 | )             |       |         | (8,019 | )
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Cash flow from investment activities                                      |                                     |                                         |                                             |        |               |        |               |      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Purchases of property and equipment     |                                             |        | (3,602        | )      |               |       | (1,777  | )     
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Stores acquired from franchisees        |                                             |        | (897          | )      |               |       | (516    | )     
|                                                                          |                                     |                                         |                                             |        |               |        |               |      
|                                                                          |                                     |                                         | Net cash used in investment activities      |        |               | (4,499 | )             |       |         | (2,293 | )
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Cash flow provided from financing activities                              |                                     |                                         |                                             |        |               |        |               |      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Net proceeds from Loan Agreement        |                                             |        | 5,424         |        |               |       | 14,573  |       
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Payments of Senior Notes                |                                             |        | (1,000        | )      |               |       |       |       
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Purchase of treasury stock              |                                             |        | (646          | )      |               |       |       |       
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|                                                                          |                                     | Proceeds from exercise of stock options |                                             |        | 75            |        |               |       |       |       
|                                                                          |                                     |                                         |                                             |        |               |        |               |      
|                                                                          |                                     |                                         | Net cash provided from financing activities |        |               | 3,853  |               |       |         | 14,573 |  
|                                                                          |                                     |                                         |                                             |        |               |        |               |      
|Net (decrease) increase in cash and cash equivalents                      |                                     |                                         | (4,747                                      | )      |               |        | 4,261         |      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Cash and cash equivalents, beginning of period                            |                                     |                                         | 9,842                                       |        |               |        | 3,950         |      
|                                                                          |                                     |                                         |                                             |        |               |        |               |      
|Cash and cash equivalents, end of period                                  |                                     | $                                       | 5,095                                       |        |               | $      | 8,211         |      
|                                                                          |                                     |                                         |                                             |        |               |        |               |      
|Supplemental disclosure of cash flow information                          |                                     |                                         |                                             |        |               |        |               |      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Income taxes paid                                                         |                                     | $                                       | 301                                         |        |               | $      | 1,053         |      
|                                                                         
|                                                                         
|                                                                         
|                                                                         
|Interest paid                                                             |                                     |                                         | 1,400                                       |        |               |        | 1,533         |      

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 September 29, 2001 and
September 30, 2000 and the results of operations and cash flows for the
quarters ended September 29, 2001 and September 30, 2000. 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 condensed consolidated financial statements should be read in
conjunction with the Companys audited consolidated financial statements for
the year ended June 30, 2001, included in the Companys Annual Report on Form
10-K filed with the Securities and Exchange Commission. All significant
intercompany accounts and transactions have been eliminated. The June 30, 2001
consolidated balance sheet amounts derive from the Companys audited
consolidated financial statements.

2.     SECURITIES LITIGATION

The Company has been 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 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. In
October 1999, plaintiffs filed an amended class action complaint and in
February 2000, plaintiffs filed a second amended complaint.

The second amended complaint alleges, 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 seeks 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 the failure to disclose material
facts, the price of Party City 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. Because
this case is in the early stages of the appeal process, no opinion can be
expressed as to its likely final outcome.

A lawsuit was recently filed 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.

6



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##### Table of Contents



3.     SEGMENT INFORMATION

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

|                                 |  |               |         |               |  |   |         |  
|-------------------------------- |  | ------------- | ------- | ------------- |  | - | ------- | -
|                                 |  | Quarter Ended
|                                 |  |              
|                                 |  | September 29, |         | September 30,
|                                 |  | 2001          |         | 2000         
|                                 |  |               |         |              
|                                 |  | (Unaudited)  
|RETAIL                           |  |               |         |               |  |   |         |  
|                                
|                                
|                                
|                                
|Net revenue                      |  | $             | 80,795  |               |  | $ | 76,853  |  
|Operating earnings               |  |               | 2,900   |               |  |   | 1,642   |  
|Identifiable assets              |  |               | 150,969 |               |  |   | 155,707 |  
|Depreciation/amortization        |  |               | 1,801   |               |  |   | 1,916   |  
|Capital expenditures             |  |               | 1,895   |               |  |   | 915     |  
|                                
|                                
|                                
|                                
|FRANCHISING                      |  |               |         |               |  |   |         |  
|                                
|                                
|                                
|                                
|Net revenue                      |  | $             | 3,589   |               |  | $ | 3,235   |  
|Operating earnings               |  |               | 2,042   |               |  |   | 1,981   |  
|Identifiable assets              |  |               | 3,162   |               |  |   | 2,595   |  
|Depreciation/amortization        |  |               |       |               |  |   |       |  
|Capital expenditures             |  |               |       |               |  |   |       |  
|                                
|                                
|                                
|                                
|CORPORATE/OTHER                  |  |               |         |               |  |   |         |  
|                                
|                                
|                                
|                                
|Net revenue                      |  | $             |       |               |  | $ |       |  
|Operating loss                   |  |               | (6,164  | )             |  |   | (5,177  | )
|Identifiable assets              |  |               | 17,929  |               |  |   | 10,163  |  
|Depreciation/amortization        |  |               | 1,024   |               |  |   | 618     |  
|Capital expenditures             |  |               | 1,813   |               |  |   | 1,378   |  
|                                
|                                
|                                
|                                
|CONSOLIDATED TOTALS              |  |               |         |               |  |   |         |  
|                                
|                                
|                                
|                                
|Net revenue                      |  | $             | 84,384  |               |  | $ | 80,088  |  
|Operating loss                   |  |               | (1,222  | )             |  |   | (1,554  | )
|Interest expense, net            |  |               | 1,755   |               |  |   | 2,282   |  
|                                 |  |               |         |               |  |   |         |  
|Loss before income tax benefit   |  |               | (2,977  | )             |  |   | (3,836  | )
|Provision for income tax benefit |  |               | (1,191  | )             |  |   | (1,485  | )
|                                 |  |               |         |               |  |   |         |  
|Net loss                         |  | $             | (1,786  | )             |  | $ | (2,351  | )
|                                 |  |               |         |               |  |   |         |  
|                                
|                                
|                                
|                                
|Identifiable assets              |  | $             | 172,060 |               |  | $ | 168,465 |  
|Depreciation/amortization        |  |               | 2,825   |               |  |   | 2,534   |  
|Capital expenditures             |  |               | 3,708   |               |  |   | 2,293   |  

7



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##### Table of Contents



4.     EARNINGS PER SHARE

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

|                                                  |  |               |        |               |  |   |        |  
|------------------------------------------------- |  | ------------- | ------ | ------------- |  | - | ------ | -
|                                                  |  | Quarter Ended
|                                                  |  |              
|                                                  |  | September 29, |        | September 30,
|                                                  |  | 2001          |        | 2000         
|                                                  |  |               |        |              
|                                                  |  | (Unaudited)  
|Net loss                                          |  | $             | (1,786 | )             |  | $ | (2,351 | )
|                                                 
|                                                 
|                                                 
|                                                 
|Average common shares outstanding                 |  |               | 12,753 |               |  |   | 12,722 |  
|                                                 
|                                                 
|                                                 
|                                                 
|Loss per share  basic                            |  |               | (0.14  | )             |  |   | (0.18  | )
|                                                 
|                                                 
|                                                 
|                                                 
|Dilutive effect of stock options                  |  |               | (a     | )             |  |   | (b     | )
|                                                 
|                                                 
|                                                 
|                                                 
|Dilutive effect of warrants                       |  |               | (a     | )             |  |   | (b     | )
|                                                 
|                                                 
|                                                 
|                                                 
|Average common and common equivalents
outstanding |  |               | 12,753 |               |  |   | 12,722 |  
|                                                 
|                                                 
|                                                 
|                                                 
|Loss per share  diluted                          |  |               | (0.14  | )             |  |   | (0.18  | )



|(a) |  | Options to purchase 1,795,078
shares of common stock at prices ranging
from $1.95 to $31.13 per share were outstanding at September 29,
2001 and warrants to purchase 6,280,000 shares of common stock at $1.07 per
share were outstanding at September 29, 2001 but were not included
in the computation of earnings per share because to do so would have
been antidilutive.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(b) |  | Options to purchase 1,038,626
shares of common stock at prices ranging
from $1.67 to $31.13 per share were outstanding at September 30,
2000 and warrants to purchase 6,880,000 shares of common stock at $1.07 per
share were outstanding at September 30, 2000 but were not included
in the computation of earnings per share because to do so would have
been antidilutive.

5.     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
timing of stock repurchases is made at the discretion of management.
As of September 29, 2001 the Company had repurchased 100,000 shares for $646,000 or
4.3% of the total amount authorized to be repurchased. Through November 8, 2001,
the Company repurchased 255,000 shares for $1.6 million or 10.9% of the total
amount authorized to be repurchased.

6.     GOODWILL AND OTHER INTANGIBLE ASSETS

On
July 1, 2001, the Company adopted Statement of Financial Accounting Standard
(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.

8



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##### Table of Contents



The
following financial information is presented as if the statement was
adopted at the beginning of the quarter ended September 30,
2000:

|                                          |  |                                           |        |                    |  |   |        |  
|----------------------------------------- |  | ----------------------------------------- | ------ | ------------------ |  | - | ------ | -
|                                          |  | Adoption of FAS 142 for the Quarter ended
|                                          |  | (in
thousands, except per share amounts) 
|                                          |  |                                          
|                                          |  | September 29, 2001                        |        | September 30, 2000
|                                          |  |                                           |        |                   
|Reported net loss                         |  | $                                         | (1,786 | )                  |  | $ | (2,351 | )
|                                         
|                                         
|                                         
|                                         
|Add back:                                 |  |                                           |        |                    |  |   |        |  
|                                         
|                                         
|                                         
|                                         
|Goodwill amortization, net of taxes       |  |                                           |      |                    |  |   | 185    |  
|                                          |  |                                           |        |                    |  |   |        |  
|Pro forma net loss                        |  | $                                         | (1,786 | )                  |  | $ | (2,166 | )
|                                          |  |                                           |        |                    |  |   |        |  
|Basic and diluted loss per share reported |  | $                                         | (0.14  | )                  |  | $ | (0.18  | )
|                                         
|                                         
|                                         
|                                         
|Goodwill amortization                     |  |                                           |      |                    |  |   | 0.01   |  
|                                          |  |                                           |        |                    |  |   |        |  
|Pro forma net loss                        |  | $                                         | (0.14  | )                  |  | $ | (0.17  | )
|                                          |  |                                           |        |                    |  |   |        |  

The changes in the carrying amount of goodwill for the quarter ended September
29, 2001, by operating segment, are as follows:

|                                    |  |                |        | 
|----------------------------------- |  | -------------- | ------ | 
|                                    |  | (in
thousands)
|Retail:                             |  |                |        | 
|Balance as of June 30, 2001         |  | $              | 13,647 | 
|                                   
|                                   
|                                   
|                                   
|Goodwill acquired during the period |  |                | 503    | 
|                                    |  |                |        | 
|Balance as of September 29, 2001    |  | $              | 14,150 | 
|                                    |  |                |        | 

7.     RECENT ACCOUNTING STANDARDS

On
June 29, 2001, the Financial Accounting Standards Board
(FASB or the
Board) completed Statement No. 141 (FAS 141), Business Combinations. Which
requires all business combinations initiated after June 30, 2001 to be
accounted for under the purchase method. FAS 141 also sets forth guidelines
for applying the purchase method of accounting in the determination of
intangible assets, including goodwill acquired in a business combination and
expands financial disclosures concerning business combinations consummated
after June 30, 2001.

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. 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.

9



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##### Table of Contents






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

Results of Operations

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

|                                                         |                                          |   |                    |        |                    |   |        |        | 
|-------------------------------------------------------- | ---------------------------------------- | - | ------------------ | ------ | ------------------ | - | ------ | ------ | 
|                                                         |                                          |   | Quarter Ended     
|                                                         |                                          |   |                   
|                                                         |                                          |   | September 29, 2001 |        | September 30, 2000
|                                                         |                                          |   |                    |        |                   
|                                                         |                                          |   | (Unaudited)       
|Statement of Operations Data                             |                                          |   |                    |        |                    |   |        |       
|                                                        
|                                                        
|                                                        
|                                                        
|Total revenue                                            |                                          | $ | 84,384             |        |                    | $ | 80,088 |       
|                                                         |                                          |   |                    |        |                    |   |        |       
|Company-owned stores:                                    |                                          |   |                    |        |                    |   |        |       
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         | Net sales                                |   | $                  | 80,795 |                    |   | $      | 76,853 | 
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         | Cost of goods sold and occupancy costs   |   |                    | 57,667 |                    |   |        | 55,462 | 
|                                                         |                                          |   |                    |        |                    |   |        |       
|                                                         | Gross profit                             |   |                    | 23,128 |                    |   |        | 21,391 | 
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         | Store operating and selling expense      |   |                    | 20,228 |                    |   |        | 19,749 | 
|                                                         |                                          |   |                    |        |                    |   |        |       
|                                                         | Company-owned stores profit contribution |   |                    | 2,900  |                    |   |        | 1,642  | 
|                                                        
|                                                        
|                                                        
|                                                        
|                                                        
|Franchise stores:                                        |                                          |   |                    |        |                    |   |        |       
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         | Royalty fees                             |   |                    | 3,246  |                    |   |        | 2,809  | 
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         | Franchise fees                           |   |                    | 343    |                    |   |        | 426    | 
|                                                         |                                          |   |                    |        |                    |   |        |       
|                                                         | Total franchise revenues                 |   |                    | 3,589  |                    |   |        | 3,235  | 
|                                                        
|                                                        
|                                                        
|                                                        
|                                                         | Total franchise expense                  |   |                    | 1,547  |                    |   |        | 1,254  | 
|                                                         |                                          |   |                    |        |                    |   |        |       
|                                                         | Franchise profit contribution            |   |                    | 2,042  |                    |   |        | 1,981  | 
|                                                        
|                                                        
|                                                        
|                                                        
|                                                        
|General and administrative expense:                      |                                          |   | 6,164              |        |                    |   | 5,177  |       
|                                                        
|                                                        
|                                                        
|                                                        
|Loss before interest and income tax benefit              |                                          |   | (1,222             | )      |                    |   | (1,554 | )     
|                                                        
|                                                        
|                                                        
|                                                        
|Interest expense, net                                    |                                          |   | 1,755              |        |                    |   | 2,282  |       
|                                                         |                                          |   |                    |        |                    |   |        |       
|Loss before income tax benefit                           |                                          |   | (2,977             | )      |                    |   | (3,836 | )     
|                                                        
|                                                        
|                                                        
|                                                        
|Provision for income tax benefit                         |                                          |   | (1,191             | )      |                    |   | (1,485 | )     
|                                                         |                                          |   |                    |        |                    |   |        |       
|Net loss                                                 |                                          | $ | (1,786             | )      |                    | $ | (2,351 | )     
|                                                         |                                          |   |                    |        |                    |   |        |       
|Basic and diluted loss per share(a)                      |                                          | $ | (0.14              | )      |                    | $ | (0.18  | )     
|                                                        
|                                                        
|                                                        
|                                                        
|Weighted average shares outstanding  Basic and Diluted |                                          |   | 12,753             |        |                    |   | 12,722 |       
|                                                        
|                                                        
|                                                        
|                                                        
|EBITDA(b)                                                |                                          |   | 1,603              |        |                    |   | 980    |       
|                                                        
|                                                        
|                                                        
|                                                        
|Depreciation and amortization                            |                                          |   | 2,825              |        |                    |   | 2,534  |       

10



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##### Table of Contents



|                                           |                                   |                                    |                        |                                  |     |                    |      |                    |     |     |    |  
|------------------------------------------ | --------------------------------- | ---------------------------------- | ---------------------- | -------------------------------- | --- | ------------------ | ---- | ------------------ | --- | --- | -- | -
|                                           |                                   |                                    |                        |                                  |     | Quarter Ended     
|                                           |                                   |                                    |                        |                                  |     |                   
|                                           |                                   |                                    |                        |                                  |     | September 29, 2001 |      | September 30, 2000
|                                           |                                   |                                    |                        |                                  |     |                    |      |                   
|                                           |                                   |                                    |                        |                                  |     | (Unaudited)       
|Store Data:                                |                                   |                                    |                        |                                  |     |                    |      |                   
|                                          
|                                          
|                                          
|                                          
|                                           | Company-owned:                    |                                    |                        |                                  |     |                    |      |                    |    
|                                          
|                                          
|                                          
|                                          
|                                           |                                   | Stores open at beginning of period |                        |                                  | 193 |                    |      |                    | 197 |    
|                                          
|                                          
|                                          
|                                          
|                                           |                                   |                                    |                        | Stores opened                    |     |                    | 4    |                    |     |     |  |  
|                                          
|                                          
|                                          
|                                          
|                                           |                                   |                                    |                        | Stores acquired from franchisees |     |                    | 1    |                    |     |     | 1  |  
|                                           |                                   |                                    |                        |                                  |     |                    |      |                   
|                                           |                                   | Stores open at end of period       |                        |                                  | 198 |                    |      |                    | 198 |    
|                                          
|                                          
|                                          
|                                          
|                                           | Franchise:                        |                                    |                        |                                  |     |                    |      |                    |    
|                                          
|                                          
|                                          
|                                          
|                                           |                                   | Stores open at beginning of period |                        |                                  | 261 |                    |      |                    | 211 |    
|                                          
|                                          
|                                          
|                                          
|                                           |                                   |                                    |                        | Stores opened                    |     |                    | 13   |                    |     |     | 18 |  
|                                          
|                                          
|                                          
|                                          
|                                           |                                   |                                    |                        | Stores acquired from franchisees |     |                    | (1   | )                  |     |     | (1 | )
|                                           |                                   |                                    |                        |                                  |     |                    |      |                   
|                                           |                                   | Stores open at end of period       |                        |                                  | 273 |                    |      |                    | 228 |    
|                                           |                                   |                                    |                        |                                  |     |                    |      |                   
|                                           |                                   |                                    |                        |                                  |     |                    |      |                   
|                                          
|                                          
|                                          
|                                          
|                                           |                                   |                                    | Total stores chainwide |                                  |     | 471                |      |                    |     | 426 |   
|                                           |                                   |                                    |                        |                                  |     |                    |      |                   
|                                           |                                   |                                    |                        |                                  |     |                    |      |                   
|                                          
|                                          
|                                          
|                                          
|Increase in Company-owned same store sales |                                   |                                    | 5.7                    | %                                |     |                    | 17.2 | %                 
|                                          
|                                          
|                                          
|                                          
|Increase in franchise same store sales     |                                   |                                    | 3.7                    | %                                |     |                    | 6.8  | %                 
|                                          
|                                          
|                                          
|                                          
|Average sales per Company-owned store      |                                   | $                                  | 415                    |                                  |     | $                  | 387  |                   
|                                          
|                                          
|                                          
|                                          
|                                           |                                   |                                    |                        |                                  |     |                    |      |                   
|                                          
|                                          
|                                          
|                                          
|Balance Sheet Data:                        |                                   |                                    |                        |                                  |     |                    |      |                   
|                                          
|                                          
|                                          
|                                          
|                                           | Working capital                   |                                    | $                      | 6,843                            |     |                    | $    | 13,621             |    
|                                          
|                                          
|                                          
|                                          
|                                           | Total assets                      |                                    |                        | 172,060                          |     |                    |      | 168,465            |    
|                                          
|                                          
|                                          
|                                          
|                                           | Bank borrowings and other debt(c) |                                    |                        | 32,041                           |     |                    |      | 49,408             |    
|                                          
|                                          
|                                          
|                                          
|                                           | Capital lease obligation          |                                    |                        | 318                              |     |                    |      | 623                |    
|                                          
|                                          
|                                          
|                                          
|                                           | Stockholders equity              |                                    |                        | 48,808                           |     |                    |      | 38,510             |    



|(a) |  | Options, warrants and restricted stock units related to the Management Stock Purchase Plan were not
included in the computation of diluted earnings per share for the quarter ended September 29, 2001 and
September 30, 2000 because to do so would have been antidilutive.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(b) |  | The Companys definition of EBITDA is earnings before interest, taxes, depreciation and amortization.                                                                                                                                                                       
|   
|   
|   
|   
|(c) |  | The bank borrowings and other debt at September 29, 2001 and September 30, 2000 is net of an unamortized
debt discount of $1.9 million and $2.8 million, respectively.                                                                                                      

Quarter Ended September 29, 2001 Compared to Quarter Ended September 30, 2000

Retail.Net sales from Company-owned stores increased 5.1% to $80.8 million
for the first quarter of fiscal 2002 from $76.9 million for the first quarter
of the last fiscal year. Same store sales increased 5.7% in the first 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 first
quarter of fiscal 2002 increased 8.1% to $23.1 million from $21.4 million for
the first quarter of the last fiscal year. The increase was primarily due to increased
sales volume and leverage on occupancy costs. Gross margin was 28.6%
for the first quarter of fiscal 2002 compared with 27.8% for the first quarter
of the last fiscal year.

Store operating and selling expenses increased 2.4% to $20.2 million for
the first quarter of fiscal 2002 from $19.7 million in the first quarter of the
last fiscal year. The increase in store operating expenses is attributable to
the increase in sales. Store operating and selling expenses were 25.0% and
25.7% of sales for the first quarter of fiscal 2002 and fiscal 2001,
respectively. The decrease is due to improvements in efficiency in the
management of store labor hours. Company-owned stores recorded a contribution
of $2.9 million for the first quarter of fiscal 2002 compared to $1.6 million
for the first quarter of the last fiscal year. The Company believes
that the improvement over the prior
year is primarily the result of improved gross margin as well as improved
operating efficiencies.

11



---



##### Table of Contents



The Company opened four new stores during the first quarter of fiscal
2002. No new stores were opened in the first quarter of the prior fiscal year.
Pre-opening expenses for these stores were $205,000. The Company expenses all
costs of pre-opening 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 13
store openings were $343,000 for the first quarter of fiscal 2002 compared to
$426,000 for the first quarter of the last fiscal year, relating to 18 store
openings. Royalty fees increased 15.6% to $3.2 million in the first quarter of
fiscal 2002 from $2.8 million in the first quarter of the last
fiscal year which is
primarily due to an increase in the number of stores and a same store sales
increase of 3.7% for the franchise stores in the first quarter of fiscal 2002.

Expenses directly related to franchise revenue increased 23.4% to $1.5
million for the first quarter of fiscal 2002 from $1.3 million for the first
quarter of the last fiscal year. As a percentage of franchise revenue,
franchise expenses were 43.1% and 38.8% for the first quarter of fiscal 2002
and fiscal 2001, respectively.

Franchise profit contribution increased 3.1% to $2.0 million for the first
quarter of fiscal 2002. The increase in franchise profit contribution is due
to higher revenues and the increased number of franchise stores.

General and Administrative Expenses.General and administrative expenses
increased 19.1% to $6.2 million in the first quarter of fiscal 2002 from $5.2
million in the first quarter of the last fiscal year. The increase is
attributable to an increase of $ 378,000 in payroll to $3.1 million from $2.7
million in the prior fiscal year related to salary increases, bonus programs
and increased staff in merchandising areas; an increase of $406,000 in
depreciation related to new systems to $799,000 from $393,000 in the prior
fiscal year; and an $84,000 increase in expense due to expenses related to
non-cash compensation. General and administrative expenses were 7.6% and 6.7%
of sales for the first quarter of fiscal 2002 and fiscal 2001, respectively,
reflecting investments in management and systems.

Interest Expense.Interest expense decreased 23.1% to $1.8 million for the
first quarter of fiscal 2002 from $2.3 million in the first quarter of the last
fiscal year. This decreased expense is primarily attributable to lower average
borrowings outstanding under the Loan Agreement and reduced principal
balances on Senior Notes outstanding due
to payments made over the last twelve months.

Income Tax Benefit.The effective income tax rate was 40.0.% in the first
quarter of fiscal 2002 compared to 38.7% in the first quarter of the last
fiscal year.

Net Loss.As a result of the above factors, net loss for the first quarter of
fiscal 2002 was $1.8 million, or $(0.14) loss per basic and diluted share, as
compared to a net loss of $2.4 million, or $(0.18) loss per basic and diluted
share in first quarter of the last fiscal year.

Liquidity and Capital Resources

For the first quarter of fiscal 2002, cash used in operating activities
was $4.1 million, compared to $8.0 million for the first quarter of the last
fiscal year. The decrease in cash used in operating activities was primarily
attributable to an increase in accounts payable and accrued expenses of $27.6
million in the current fiscal quarter compared to an increase in accounts
payable and accrued expenses of $23.8 million in the comparable quarter in the
prior fiscal year; an increase in inventory of $29.3 million in the
current fiscal quarter compared to an increase in inventory of $30.5
million in the comparable quarter in the prior fiscal year; and, a net
loss of $1.8 million in the current fiscal quarter compared to a net
loss of $2.4 million in the comparable quarter of the prior fiscal
year.

Cash used in investing activities for the first quarter of fiscal 2002 was
$4.5 million compared to $2.3 million in the first quarter in the last fiscal
year. The increase in cash used in investing activities was primarily
attributable to the continued investment in new systems and new stores.

Cash provided by financing activities was $3.8 million for the first
quarter of fiscal 2002 compared to $14.6 million in the first quarter of the
last fiscal year. The decrease is due to reduced borrowings on the Loan Agreement, a payment of $1 million on Senior Notes in advance of maturity
and purchases of treasury stock of $646,000.

12



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At September 29, 2001, the Company had a balance of $5.4 million
outstanding under its Loan and Security Agreement dated January 14, 2000 (the
Loan Agreement), with Congress Financial Corporation. 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 2.75% per annum
(subject to possible reduction to an interest rate as low as 2.25% from and
after June 30, 2001, based on the Companys pre-tax income and excess
availability, which the Company has satisfied) or (ii) at the rate of 3/4% per annum above the prime rate,
totaling 7.25% at September 29, 2001. 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 November 8, 2001, the Company had no balance outstanding and $29.1
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 the repayment of $10.5 million of Senior Notes, due in
January 2002.

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. 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.

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
theoretically 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 rate (which under the Loan Agreement is dependent on
the prime rate) may, during peak borrowing, have a negative impact on
short-term results.

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PART II OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

The Company has been 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 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. In
October 1999, plaintiffs filed an amended class action complaint and in
February 2000, plaintiffs filed a second amended complaint.

The second amended complaint alleges, 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 seeks 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 the failure to disclose material
facts, the price of Party City 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. Because
this case is in the early stages of the appeal process, no opinion can be
expressed as to its likely final outcome.

A lawsuit was recently filed 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

None




ITEM 3. DEFAULTS UNDER SENIOR SECURITIES AND USE OF PROCEEDS

None

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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)  Report on Form 8-K



| |     
| | ----
| | None




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.                                                                                                       
| | 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 Registration of Form S-8
        as filed with the Commission on July 23, 2001.                                                           

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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/ 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: November 13, 2001

16