##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)







---

|                                                 |  |                               
|------------------------------------------------ |  | ------------------------------
|FOR THE QUARTERLY PERIOD ENDED
DECEMBER 29, 2001 |  | COMMISSION FILE NUMBER
0-27826



---

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)

---



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 (XBOX)    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 February 8, 2002, there were
outstanding 13,264,017 shares of
Common Stock, $.01 par value.





---

TABLE OF CONTENTS



|                              |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART 1. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS       
|                              |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|PART II OTHER INFORMATION    
|                              | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                              | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                              | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                      
|                              | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                              | ITEM 5. OTHER INFORMATION                                                                    
|                              | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|                              | EXHIBIT INDEX                                                                                
|SIGNATURES                   



---



##### Table of Contents



PARTY CITY CORPORATION AND SUBSIDIARY

INDEX

|                              |                                                                                               |                                                                                                                                           |  |          |   | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------- |  | -------- | - | 
|                              |                                                                                               |                                                                                                                                           |  | Page No.
|                              |                                                                                               |                                                                                                                                           |  |         
|Part I. Financial Information
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                              | Item 1.
Condensed Consolidated Financial Statements                                          
|                             
|                             
|                             
|                             
|                              |                                                                                               | Condensed Consolidated Balance Sheets  December 29, 2001 (Unaudited), December
30, 2000 (Unaudited) and June 30, 2001                    |  |          | 3
|                             
|                             
|                             
|                             
|                              |                                                                                               | Condensed Consolidated Statements of Earnings (Unaudited)  For the quarters and
six months ended December 29, 2001 and December 30, 2000 |  |          | 4
|                             
|                             
|                             
|                             
|                              |                                                                                               | Condensed Consolidated Statements of Cash Flows (Unaudited)  For the six months
ended December 29, 2001 and December 30, 2000            |  |          | 5
|                             
|                             
|                             
|                             
|                              |                                                                                               | Notes to Condensed Consolidated Financial Statements                                                                                      |  |          | 6
|                             
|                             
|                             
|                             
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations |                                                                                                                                           |  | 11      
|                             
|                             
|                             
|                             
|                              | Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |                                                                                                                                           |  | 16      
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|Part II. Other Information   
|                             
|                             
|                             
|                             
|                              | Item 1. Legal Proceedings                                                                     |                                                                                                                                           |  | 16      
|                             
|                             
|                             
|                             
|                              | Item 2.
Changes in Securities and Use of Proceeds                                             |                                                                                                                                           |  | 17      
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                              | Item 3.
Defaults Upon Senior Securities                                                       |                                                                                                                                           |  | 17      
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                             
|                              | Item 4. Submission of Matters to a Vote of Security Holders                                   |                                                                                                                                           |  | 17      
|                             
|                             
|                             
|                             
|                              | Item 5. Other Information                                                                     |                                                                                                                                           |  | 17      
|                             
|                             
|                             
|                             
|                              | Item 6. Exhibits and Reports on Form 8-K                                                      |                                                                                                                                           |  | 17      
|                             
|                             
|                             
|                             
|                              | Exhibit Index                                                                                 |                                                                                                                                           |  | 18      

2



---



##### Table of Contents






PART 1. FINANCIAL INFORMATION




Item 1. Financial Statements




PARTY CITY CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |        |         |   |         | 
|----------------------------- | --------------------------------------------- | ------------------------------------------ | ------------------------------------ | -------------------------- | ------- | ----------------- | ------- | ----------------- | ------- | ------------- | ------- | ------ | ------- | - | ------- | 
|                              |                                               |                                            |                                      |                            |         | December 29, 2001 |         | December 30, 2000 |         | June 30, 2001
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |              
|                              |                                               |                                            |                                      |                            |         | (Unaudited)       |         | (Unaudited)       |         |               |         |       
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                              |                                               |                                            |                                      | ASSETS                     |         |                   |         |                   |         |               |         |        |         |   |         | 
|                             
|                             
|                             
|                             
|Current assets:               |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                             
|                             
|                             
|                             
|                              | Cash and cash equivalents                     |                                            | $                                    | 21,530                     |         |                   | $       | 31,961            |         |               | $       | 9,842  |        
|                             
|                             
|                             
|                             
|                              | Merchandise inventory                         |                                            |                                      | 55,574                     |         |                   |         | 50,404            |         |               |         | 48,034 |        
|                             
|                             
|                             
|                             
|                              | Deferred income taxes                         |                                            |                                      | 8,105                      |         |                   |         | 2,964             |         |               |         | 3,798  |        
|                             
|                             
|                             
|                             
|                              | Other current assets                          |                                            |                                      | 16,786                     |         |                   |         | 13,434            |         |               |         | 12,156 |        
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                              |                                               | Total current assets                       |                                      |                            | 101,995 |                   |         |                   | 98,763  |               |         |        | 73,830  |  
|                             
|                             
|                             
|                             
|Property and equipment, net   |                                               |                                            | 45,524                               |                            |         |                   | 41,332  |                   |         |               | 46,351  |       
|                             
|                             
|                             
|                             
|Goodwill, net                 |                                               |                                            | 14,206                               |                            |         |                   | 14,251  |                   |         |               | 13,647  |       
|                             
|                             
|                             
|                             
|Other assets                  |                                               |                                            | 6,351                                |                            |         |                   | 4,132   |                   |         |               | 7,514   |       
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                              |                                               |                                            |                                      | Total assets               |         | $                 | 168,076 |                   |         | $             | 158,478 |        |         | $ | 141,342 | 
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                              |                                               |                                            | LIABILITIES AND STOCKHOLDERS EQUITY |                            |         |                   |         |                   |         |               |         |       
|                             
|                             
|                             
|                             
|Current liabilities:          |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                             
|                             
|                             
|                             
|                              | Accounts payable                              |                                            | $                                    | 40,197                     |         |                   | $       | 42,471            |         |               | $       | 27,905 |        
|                             
|                             
|                             
|                             
|                              | Accrued expenses                              |                                            |                                      | 34,232                     |         |                   |         | 20,240            |         |               |         | 26,274 |        
|                             
|                             
|                             
|                             
|                              | Advances under Loan Agreement                 |                                            |                                      |                          |         |                   |         | 11                |         |               |         |       |        
|                             
|                             
|                             
|                             
|                              | Senior Notes, current portion                 |                                            |                                      | 5,058                      |         |                   |         | 5,103             |         |               |         | 11,366 |        
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                              |                                               | Total current liabilities                  |                                      |                            | 79,487  |                   |         |                   | 67,825  |               |         |        | 65,545  |  
|                             
|                             
|                             
|                             
|                              | Deferred rent and other long-term liabilities |                                            |                                      | 9,607                      |         |                   |         | 8,301             |         |               |         | 8,701  |        
|                             
|                             
|                             
|                             
|                              | Senior Notes                                  |                                            |                                      | 16,269                     |         |                   |         | 29,931            |         |               |         | 16,006 |        
|                             
|                             
|                             
|                             
|Commitments
and contingencies
|                             
|                             
|                             
|                             
|Stockholders equity:         |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                             
|                             
|                             
|                             
|                              | Common stock                                  |                                            |                                      | 132                        |         |                   |         | 127               |         |               |         | 127    |        
|                             
|                             
|                             
|                             
|                              | Additional paid-in capital                    |                                            |                                      | 38,530                     |         |                   |         | 37,968            |         |               |         | 38,236 |        
|                             
|                             
|                             
|                             
|                              | Retained earnings                             |                                            |                                      | 25,880                     |         |                   |         | 14,326            |         |               |         | 12,727 |        
|                             
|                             
|                             
|                             
|                              | Treasury stock, at cost                       |                                            |                                      | (1,829                     | )       |                   |         |                 |         |               |         |      |        
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                              |                                               |                                            |                                      | Total stockholders equity |         |                   | 62,713  |                   |         |               | 52,421  |        |         |   | 51,090  | 
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       
|                              |                                               | Total liabilities and stockholders equity |                                      | $                          | 168,076 |                   |         | $                 | 158,478 |               |         | $      | 141,342 |  
|                              |                                               |                                            |                                      |                            |         |                   |         |                   |         |               |         |       

See accompanying notes to condensed consolidated financial statements.

3



---



##### Table of Contents






PARTY CITY CORPORATION AND SUBSIDIARY

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

|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |         |         |        | 
|--------------------------------------- | -------------------------------------------------- | -------------- | --------------------------------------------- | ------- | ------------- | ------ | ---------------- | ------- | ------------ | ------ | ------------ | ------- | ------- | ------ | ------- | ------- | ------- | ------ | 
|                                        |                                                    |                |                                               |         | Quarter ended |        | Six months ended
|                                        |                                                    |                |                                               |         |               |        |                 
|                                        |                                                    |                |                                               |         | December 29,  |        | December 30,     |         | December 29, |        | December 30,
|                                        |                                                    |                |                                               |         | 2001          |        | 2000             |         | 2001         |        | 2000        
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |             
|Revenues:                               |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|                                       
|                                       
|                                       
|                                       
|                                        | Net sales                                          |                | $                                             | 141,979 |               |        | $                | 138,035 |              |        | $            | 222,774 |         |        | $       | 214,888 |        
|                                       
|                                       
|                                       
|                                       
|                                        | Royalty fees                                       |                |                                               | 6,133   |               |        |                  | 5,464   |              |        |              | 9,379   |         |        |         | 8,273   |        
|                                       
|                                       
|                                       
|                                       
|                                        | Franchise fees                                     |                |                                               |       |               |        |                  | 183     |              |        |              | 343     |         |        |         | 609     |        
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|Total revenues                          |                                                    |                | 148,112                                       |         |               |        | 143,682          |         |              |        | 232,496      |         |         |        | 223,770 |        
|                                       
|                                       
|                                       
|                                       
|Expenses:                               |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|                                       
|                                       
|                                       
|                                       
|                                        | Cost of goods sold and occupancy costs             |                |                                               | 83,928  |               |        |                  | 83,428  |              |        |              | 141,595 |         |        |         | 138,890 |        
|                                       
|                                       
|                                       
|                                       
|                                        | Company-owned stores operating and selling expense |                |                                               | 29,465  |               |        |                  | 29,364  |              |        |              | 49,693  |         |        |         | 49,113  |        
|                                       
|                                       
|                                       
|                                       
|                                        | Franchise expense                                  |                |                                               | 1,667   |               |        |                  | 1,159   |              |        |              | 3,214   |         |        |         | 2,413   |        
|                                       
|                                       
|                                       
|                                       
|                                        | General and administrative expense                 |                |                                               | 6,538   |               |        |                  | 5,034   |              |        |              | 12,702  |         |        |         | 10,211  |        
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|                                        |                                                    | Total expenses |                                               |         | 121,598       |        |                  |         | 118,985      |        |              |         | 207,204 |        |         |         | 200,627 |       
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|Income before interest and income taxes |                                                    |                | 26,514                                        |         |               |        | 24,697           |         |              |        | 25,292       |         |         |        | 23,143  |        
|                                       
|                                       
|                                       
|                                       
|                                        | Interest expense, net                              |                |                                               | 1,654   |               |        |                  | 2,004   |              |        |              | 3,409   |         |        |         | 4,286   |        
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|Income before income taxes              |                                                    |                | 24,860                                        |         |               |        | 22,693           |         |              |        | 21,883       |         |         |        | 18,857  |        
|                                       
|                                       
|                                       
|                                       
|                                        | Provision for income taxes                         |                |                                               | 9,921   |               |        |                  | 8,782   |              |        |              | 8,730   |         |        |         | 7,297   |        
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|Net income                              |                                                    | $              | 14,939                                        |         |               | $      | 13,911           |         |              | $      | 13,153       |         |         | $      | 11,560  |        
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|                                        | Basic earnings per share                           |                | $                                             | 1.15    |               |        | $                | 1.09    |              |        | $            | 1.02    |         |        | $       | 0.91    |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                                    |                | Weighted average shares outstanding  basic   |         |               | 12,991 |                  |         |              | 12,722 |              |         |         | 12,872 |         |         |         | 12,722 | 
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        
|                                        | Diluted earnings per share                         |                | $                                             | 0.79    |               |        | $                | 0.78    |              |        | $            | 0.70    |         |        | $       | 0.65    |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                                    |                | Weighted average shares outstanding  diluted |         |               | 18,798 |                  |         |              | 17,823 |              |         |         | 18,700 |         |         |         | 17,681 | 
|                                        |                                                    |                |                                               |         |               |        |                  |         |              |        |              |         |         |        |         |        

See accompanying notes to condensed consolidated financial statements.

4



---



##### Table of Contents






PARTY CITY CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

|                                                                                 |                                               |                                             |                                                       |        |                  |        |              |       |        |        |  
|-------------------------------------------------------------------------------- | --------------------------------------------- | ------------------------------------------- | ----------------------------------------------------- | ------ | ---------------- | ------ | ------------ | ----- | ------ | ------ | -
|                                                                                 |                                               |                                             |                                                       |        | Six months ended
|                                                                                 |                                               |                                             |                                                       |        |                 
|                                                                                 |                                               |                                             |                                                       |        | December 29,     |        | December 30,
|                                                                                 |                                               |                                             |                                                       |        |                  |        |             
|                                                                                 |                                               |                                             |                                                       |        | 2001             |        | 2000        
|                                                                                 |                                               |                                             |                                                       |        |                  |        |             
|                                                                                 |                                               |                                             |                                                       |        | (Unaudited)     
|Cash flow from operating activities:                                             |                                               |                                             |                                                       |        |                  |        |              |      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Net income                                                                       |                                               | $                                           | 13,153                                                |        |                  | $      | 11,560       |      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Adjustments to reconcile net income to net cash
provided by operating activities |                                               |                                             |                                                       |        |                  |        |              |      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Depreciation and amortization                 |                                             |                                                       | 5,871  |                  |        |              | 5,172 |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Deferred taxes                                |                                             |                                                       | (2,941 | )                |        |              | 5,537 |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Non-cash interest                             |                                             |                                                       | 843    |                  |        |              | 841   |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Deferred rent and other long-term liabilities |                                             |                                                       | 907    |                  |        |              | 421   |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Stock option compensation                     |                                             |                                                       | 221    |                  |        |              |     |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Provision for doubtful accounts               |                                             |                                                       | 269    |                  |        |              | 176   |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Gain on sales of stores to franchisees        |                                             |                                                       |      |                  |        |              | (131  | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 | Changes in assets and liabilities:            |                                             |                                                       |        |                  |        |              |       |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Merchandise inventory                       |                                                       |        | (7,243           | )      |              |       | (8,976 | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Other current assets                        |                                                       |        | (4,898           | )      |              |       | 3,155  |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Other assets                                |                                                       |        | (547             | )      |              |       | (79    | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Accounts payable and accrued expenses       |                                                       |        | 20,250           |        |              |       | 14,037 |       
|                                                                                 |                                               |                                             |                                                       |        |                  |        |              |      
|                                                                                 |                                               |                                             | Net cash provided by operating activities             |        |                  | 25,885 |              |       |        | 31,713 |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash flow from investment activities:                                            |                                               |                                             |                                                       |        |                  |        |              |      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Purchases of property and equipment         |                                                       |        | (4,950           | )      |              |       | (4,389 | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Proceeds from sale of stores to franchisees |                                                       |        |                |        |              |       | 1,157  |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Stores acquired from franchisees            |                                                       |        | (954             | )      |              |       | (516   | )     
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Disposals of property and equipment         |                                                       |        | 10               |        |              |       | 35     |       
|                                                                                 |                                               |                                             |                                                       |        |                  |        |              |      
|                                                                                 |                                               |                                             | Net cash used in investment activities                |        |                  | (5,894 | )            |       |        | (3,713 | )
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash flow from financing activities:                                             |                                               |                                             |                                                       |        |                  |        |              |      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Net proceeds from Loan Agreement            |                                                       |        |                |        |              |       | 11     |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Payments of Senior Notes                    |                                                       |        | (6,552           | )      |              |       |      |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Purchase of treasury stock                  |                                                       |        | (1,829           | )      |              |       |      |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Proceeds from exercise of stock options     |                                                       |        | 78               |        |              |       |      |       
|                                                                                 |                                               |                                             |                                                       |        |                  |        |              |      
|                                                                                 |                                               |                                             | Net cash provided from
(used in) financing activities |        |                  | (8,303 | )            |       |        | 11     |  
|                                                                                 |                                               |                                             |                                                       |        |                  |        |              |      
|Net increase in cash and cash equivalents                                        |                                               |                                             | 11,688                                                |        |                  |        | 28,011       |      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Cash and cash equivalents, beginning of period                                   |                                               |                                             | 9,842                                                 |        |                  |        | 3,950        |      
|                                                                                 |                                               |                                             |                                                       |        |                  |        |              |      
|Cash and cash equivalents, end of period                                         |                                               | $                                           | 21,530                                                |        |                  | $      | 31,961       |      
|                                                                                 |                                               |                                             |                                                       |        |                  |        |              |      
|Supplemental disclosure of cash flow information:                                |                                               |                                             |                                                       |        |                  |        |              |      
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Income taxes paid                           |                                                       | $      | 433              |        |              | $     | 1,494  |       
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|                                                                                 |                                               | Interest paid                               |                                                       |        | 2,926            |        |              |       | 3,357  |       

See accompanying notes to condensed consolidated financial statements.

5



---



##### 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 December 29, 2001 and
December 30, 2000 and the results of operations for the quarters and six months
ended December 29, 2001 and December 30, 2000 and cash flows for the six months
ended December 29, 2001 and December 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 fiscal year.

These condensed consolidated financial statements should be read in
conjunction with the Companys audited consolidated financial statements for
the fiscal year ended June 30, 2001, which are included in the Companys Annual Report on Form
10-K with respect to such period filed with the Securities and Exchange Commission. 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.     RECENT ACCOUNTING STANDARDS

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

6



---



##### Table of Contents



3.     EARNINGS PER SHARE

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

|                                                        |  |               |        |                  |  |              |        |              |  |   |        |  |  |   |        | 
|------------------------------------------------------- |  | ------------- | ------ | ---------------- |  | ------------ | ------ | ------------ |  | - | ------ |  |  | - | ------ | 
|                                                        |  | Quarter ended |        | Six
months ended
|                                                        |  |               |        |                 
|                                                        |  | December 29,  |        | December 30,     |  | December 29, |        | December 30,
|                                                        |  |               |        |                  |  |              |        |             
|                                                        |  | 2001          |        | 2000             |  | 2001         |        | 2000        
|                                                        |  |               |        |                  |  |              |        |             
|                                                        |  | (Unaudited)   |        | (Unaudited)     
|Net income                                              |  | $             | 14,939 |                  |  | $            | 13,911 |              |  | $ | 13,153 |  |  | $ | 11,560 | 
|                                                       
|                                                       
|                                                       
|                                                       
|Earnings per share  basic                              |  | $             | 1.15   |                  |  | $            | 1.09   |              |  | $ | 1.02   |  |  | $ | 0.91   | 
|                                                       
|                                                       
|                                                       
|                                                       
|Earnings per share  diluted                            |  | $             | 0.79   |                  |  | $            | 0.78   |              |  | $ | 0.70   |  |  | $ | 0.65   | 
|                                                       
|                                                       
|                                                       
|                                                       
|Average common shares outstanding                       |  |               | 12,991 |                  |  |              | 12,722 |              |  |   | 12,872 |  |  |   | 12,722 | 
|                                                       
|                                                       
|                                                       
|                                                       
|Dilutive effect of warrants                             |  |               | 5,300  |                  |  |              | 4,818  |              |  |   | 5,326  |  |  |   | 4,701  | 
|                                                       
|                                                       
|                                                       
|                                                       
|Dilutive effect of stock options (a)                    |  |               | 420    |                  |  |              | 283    |              |  |   | 437    |  |  |   | 258    | 
|                                                       
|                                                       
|                                                       
|                                                       
|Restricted shares                                       |  |               | 87     |                  |  |              |      |              |  |   | 65     |  |  |   |      | 
|                                                        |  |               |        |                  |  |              |        |              |  |   |        |  |  |   |        | 
|Average common and common
equivalent shares outstanding |  |               | 18,798 |                  |  |              | 17,823 |              |  |   | 18,700 |  |  |   | 17,681 | 
|                                                        |  |               |        |                  |  |              |        |              |  |   |        |  |  |   |        | 
|Average stock price used for
treasury method            |  | $             | 6.86   |                  |  | $            | 3.57   |              |  | $ | 7.05   |  |  | $ | 3.41   | 

|    |  |                                                                                                                                                                                                                                                                                                                                      
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Options to purchase 779,280 and 711,567 common
shares at prices ranging from $7.00 to $31.13 were outstanding but were not
included in the computation of dilutive earnings per share for the
quarter and six months ended December 29, 2001, respectively, because to
do so would have been anti-dilutive for the periods presented.

4.     STOCK REPURCHASE

On
September 19, 2001, the Board of Directors authorized the Company to
repurchase up to $15 million of the Companys outstanding common stock. The
stock repurchases are made at the discretion of management. As of
December 29, 2001, the Company had repurchased 284,000 shares
for an aggregate amount of $1.8 million,
or 12.2% of the total amount authorized to be repurchased. No stock
repurchases were made subsequent to December 29, 2001.

5.     DEBT MATURITIES

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

|                                             |  |                                                                                                                                                                     |  |                   |                             |                   |  |               |                                 |  |  |   |                                |  
|-------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | --------------------------- | ----------------- |  | ------------- | ------------------------------- |  |  | - | ------------------------------ | -
|Note                                         |  | Description                                                                                                                                                         |  | December 29, 2001 |                             | December 30, 2000 |  | June 30, 2001
|                                             |  |                                                                                                                                                                     |  |                   |                             |                   |  |              
|Series A
Series B
Series C
Series D
Series E |  | 12.5%(i) Secured Notes due 2003
13.0%(i) Secured Notes due 2003
13.0%(i) Secured Notes due 2002
14.0%(i) Secured Notes due 2004
14.0% Senior Secured Notes due 2002 |  | $                 | 2,552
5,103
5,103
10,207
 |                   |  | $             | 10,207
5,103
5,103
10,207
7,000 |  |  | $ | 5,104
5,103
5,103
10,207
4,000 |  
|                                             |  |                                                                                                                                                                     |  |                   |                             |                   |  |               |                                 |  |  |   |                                |  
|                                             |  |                                                                                                                                                                     |  |                   | 22,965                      |                   |  |               | 37,620                          |  |  |   | 29,517                         |  
|                                            
|                                            
|                                            
|                                            
|                                             |  | Unamortized debt discount                                                                                                                                           |  |                   | (1,638                      | )                 |  |               | (2,586)                         |  |  |   | (2,145                         | )
|                                            
|                                            
|                                            
|                                            
|                                             |  | Less: Current portion, net of debt discount(ii)                                                                                                                     |  |                   | (5,058                      | )                 |  |               | (5,103)                         |  |  |   | (11,366                        | )
|                                             |  |                                                                                                                                                                     |  |                   |                             |                   |  |               |                                 |  |  |   |                                |  
|                                             |  |                                                                                                                                                                     |  | $                 | 16,269                      |                   |  | $             | 29,931                          |  |  | $ | 16,006                         |  

|     |  |                                                                                                           
|---- |  | ----------------------------------------------------------------------------------------------------------
|(i)  |  | Interest rate was increased by 450 basis points
for all amounts outstanding on and after January 13, 1999.
|(ii) |  | The current portion outstanding at
December 29, 2001 was paid in January 2002.                            

7



---



##### Table of Contents



6.     SECURITIES LITIGATION

The Company was named as a defendant in twelve class action complaints.
The Companys former Chief Executive Officer and the former Chief Financial
Officer and Executive Vice President of Operations were also named as
defendants. All of the complaints were filed in the United States District
Court for the District of New Jersey. The complaints were filed as class
actions on behalf of persons who purchased or acquired Party City common stock
during various time periods between February 1998 and March 19, 1999 (the
Class Period). In October 1999, plaintiffs filed an amended class action
complaint and in February 2000, plaintiffs filed a second amended complaint.

The second amended complaint alleged, among other things, violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended,
and Rule 10b-5 promulgated thereunder, and sought unspecified damages. The
plaintiffs alleged that defendants issued a series of false and misleading
statements and failed to disclose material facts concerning, among other
things, the Companys financial condition, adequacy of internal controls and
compliance with certain loan covenants during the Class Period. The plaintiffs
further alleged that because of the issuance of a series of false and
misleading statements and/or the failure to disclose material facts, the price
of Party City 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. Argument
of the appeal is presently scheduled to be heard on March 19, 2002. It is not
possible to predict the likely outcome of the appeal at this time.

A
lawsuit was filed on September 25, 2001 against the Company in Los Angeles Superior Court by
an assistant manager in one of the Companys California stores for himself and
on behalf of other members of an alleged class of Party City store managers
(the Class) who claim the Company misclassified the Class as exempt from
California overtime wage and hour laws. The lawsuit seeks relief in the form
of disgorgement of overtime wages allegedly owed by the Company to the Class
but not paid. The plaintiffs also seek punitive damages and statutory
penalties. The Company denies the allegations and is vigorously defending
against the claim.

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

8



---



##### Table of Contents



7.     SEGMENT INFORMATION

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

|                                 |  |               |         |                  |  |              |         |              |  |   |         |   |  |   |         |  
|-------------------------------- |  | ------------- | ------- | ---------------- |  | ------------ | ------- | ------------ |  | - | ------- | - |  | - | ------- | -
|                                 |  | Quarter ended |         | Six months ended
|                                 |  |               |         |                 
|                                 |  | December 29,  |         | December 30,     |  | December 29, |         | December 30,
|                                 |  |               |         |                  |  |              |         |             
|                                 |  | 2001          |         | 2000             |  | 2001         |         | 2000        
|                                 |  |               |         |                  |  |              |         |             
|                                 |  | (Unaudited)   |         | (Unaudited)     
|RETAIL                           |  |               |         |                  |  |              |         |              |  |   |         |   |  |   |         |  
|                                
|                                
|                                
|                                
|Net revenue                      |  | $             | 141,979 |                  |  | $            | 138,035 |              |  | $ | 222,774 |   |  | $ | 214,888 |  
|                                
|                                
|                                
|                                
|Operating earnings               |  |               | 28,586  |                  |  |              | 25,243  |              |  |   | 31,486  |   |  |   | 26,885  |  
|                                
|                                
|                                
|                                
|Identifiable assets              |  |               | 146,290 |                  |  |              | 145,393 |              |  |   | 146,290 |   |  |   | 145,393 |  
|                                
|                                
|                                
|                                
|Depreciation/amortization        |  |               | 1,809   |                  |  |              | 1,920   |              |  |   | 3,610   |   |  |   | 3,836   |  
|                                
|                                
|                                
|                                
|Capital expenditures             |  |               | 466     |                  |  |              | 1,636   |              |  |   | 2,361   |   |  |   | 2,323   |  
|                                
|                                
|                                
|                                
|FRANCHISING                      |  |               |         |                  |  |              |         |              |  |   |         |   |  |   |         |  
|                                
|                                
|                                
|                                
|Net revenue                      |  | $             | 6,133   |                  |  | $            | 5,647   |              |  | $ | 9,722   |   |  | $ | 8,882   |  
|                                
|                                
|                                
|                                
|Operating earnings               |  |               | 4,466   |                  |  |              | 4,488   |              |  |   | 6,508   |   |  |   | 6,469   |  
|                                
|                                
|                                
|                                
|Identifiable assets              |  |               | 4,222   |                  |  |              | 2,480   |              |  |   | 4,222   |   |  |   | 2,480   |  
|                                
|                                
|                                
|                                
|Depreciation/amortization        |  |               |       |                  |  |              |       |              |  |   |       |   |  |   |       |  
|                                
|                                
|                                
|                                
|Capital expenditures             |  |               |       |                  |  |              |       |              |  |   |       |   |  |   |       |  
|                                
|                                
|                                
|                                
|CORPORATE/OTHER                  |  |               |         |                  |  |              |         |              |  |   |         |   |  |   |         |  
|                                
|                                
|                                
|                                
|Net revenue                      |  | $             |       |                  |  | $            |       |              |  | $ |       |   |  | $ |       |  
|                                
|                                
|                                
|                                
|Operating loss                   |  |               | (6,538  | )                |  |              | (5,034  | )            |  |   | (12,702 | ) |  |   | (10,211 | )
|                                
|                                
|                                
|                                
|Identifiable assets              |  |               | 17,564  |                  |  |              | 10,605  |              |  |   | 17,564  |   |  |   | 10,605  |  
|                                
|                                
|                                
|                                
|Depreciation/amortization        |  |               | 1,237   |                  |  |              | 718     |              |  |   | 2,261   |   |  |   | 1,336   |  
|                                
|                                
|                                
|                                
|Capital expenditures             |  |               | 874     |                  |  |              | 975     |              |  |   | 2,687   |   |  |   | 2,353   |  
|                                
|                                
|                                
|                                
|CONSOLIDATED TOTALS              |  |               |         |                  |  |              |         |              |  |   |         |   |  |   |         |  
|                                
|                                
|                                
|                                
|Net revenue                      |  | $             | 148,112 |                  |  | $            | 143,682 |              |  | $ | 232,496 |   |  | $ | 223,770 |  
|                                
|                                
|                                
|                                
|Operating income                 |  |               | 26,514  |                  |  |              | 24,697  |              |  |   | 25,292  |   |  |   | 23,143  |  
|                                
|                                
|                                
|                                
|Interest expense, net            |  |               | 1,654   |                  |  |              | 2,004   |              |  |   | 3,409   |   |  |   | 4,286   |  
|                                 |  |               |         |                  |  |              |         |              |  |   |         |   |  |   |         |  
|Income before income tax benefit |  |               | 24,860  |                  |  |              | 22,693  |              |  |   | 21,883  |   |  |   | 18,857  |  
|                                
|                                
|                                
|                                
|Provision for income taxes       |  |               | 9,921   |                  |  |              | 8,782   |              |  |   | 8,730   |   |  |   | 7,297   |  
|                                 |  |               |         |                  |  |              |         |              |  |   |         |   |  |   |         |  
|Net income                       |  | $             | 14,939  |                  |  | $            | 13,911  |              |  | $ | 13,153  |   |  | $ | 11,560  |  
|                                 |  |               |         |                  |  |              |         |              |  |   |         |   |  |   |         |  
|Identifiable assets              |  | $             | 168,076 |                  |  | $            | 158,478 |              |  | $ | 168,076 |   |  | $ | 158,478 |  
|                                
|                                
|                                
|                                
|Depreciation/amortization        |  |               | 3,046   |                  |  |              | 2,638   |              |  |   | 5,871   |   |  |   | 5,172   |  
|                                
|                                
|                                
|                                
|Capital expenditures             |  |               | 1,340   |                  |  |              | 2,611   |              |  |   | 5,048   |   |  |   | 4,676   |  

8.     GOODWILL AND OTHER INTANGIBLE ASSETS

On July 1, 2001, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets. As a result, the
Company no longer amortizes goodwill. Instead the Company periodically
evaluates goodwill for recoverability. The Company also evaluates goodwill
whenever events and changes in circumstance suggest that the carrying amount
may not be recoverable from its estimated future cash flows. Upon adoption,
the Company established reporting units based on its current reporting
structure. The Company then assigned all goodwill to the reporting units, as
well as other assets and liabilities, to the extent that they relate to the
reporting unit. The Company completed the first step of the transitional
goodwill impairment test and has determined that no potential impairment
exists. As

9



---



##### Table of Contents



a result, no transitional impairment loss was recorded in fiscal 2002 in
connection with the adoption of SFAS No. 142.

The following pro forma financial information is
presented as if the statement were
adopted at the beginning of the quarter ended September 30, 2000 ($ in
thousands, except per share amounts):

|                                           |  |                   |        |                   |  |                   |        |                   |  |   |        |  |  |   |        | 
|------------------------------------------ |  | ----------------- | ------ | ----------------- |  | ----------------- | ------ | ----------------- |  | - | ------ |  |  | - | ------ | 
|                                           |  | Quarter ended     |        | Six months ended 
|                                           |  |                   |        |                  
|                                           |  | December 29, 2001 |        | December 30, 2000 |  | December 29, 2001 |        | December 30, 2000
|                                           |  |                   |        |                   |  |                   |        |                  
|                                           |  | (Unaudited)       |        | (Unaudited)      
|                                           |  |                   |        |                  
|Reported net income                        |  | $                 | 14,939 |                   |  | $                 | 13,911 |                   |  | $ | 13,153 |  |  | $ | 11,560 | 
|                                          
|                                          
|                                          
|                                          
|Add back:                                  |  |                   |        |                   |  |                   |        |                   |  |   |        |  |  |   |        | 
|                                          
|                                          
|                                          
|                                          
|Goodwill amortization, net of taxes        |  |                   |      |                   |  |                   | 181    |                   |  |   |      |  |  |   | 366    | 
|                                           |  |                   |        |                   |  |                   |        |                   |  |   |        |  |  |   |        | 
|Pro forma net income                       |  | $                 | 14,939 |                   |  | $                 | 14,092 |                   |  | $ | 13,153 |  |  | $ | 11,926 | 
|                                           |  |                   |        |                   |  |                   |        |                   |  |   |        |  |  |   |        | 
|Earnings per share reported  basic        |  | $                 | 1.15   |                   |  | $                 | 1.09   |                   |  | $ | 1.02   |  |  | $ | 0.91   | 
|                                          
|                                          
|                                          
|                                          
|Goodwill amortization                      |  |                   |      |                   |  |                   | 0.02   |                   |  |   |      |  |  |   | 0.03   | 
|                                           |  |                   |        |                   |  |                   |        |                   |  |   |        |  |  |   |        | 
|Pro forma earnings per share  basic       |  | $                 | 1.15   |                   |  | $                 | 1.11   |                   |  | $ | 1.02   |  |  | $ | 0.94   | 
|                                          
|                                          
|                                          
|                                          
|Earnings per share reported  diluted     |  | $                 | 0.79   |                   |  | $                 | 0.78   |                   |  | $ | 0.70   |  |  | $ | 0.65   | 
|                                          
|                                          
|                                          
|                                          
|Goodwill amortization                      |  |                   |      |                   |  |                   | 0.01   |                   |  |   |      |  |  |   | 0.02   | 
|                                           |  |                   |        |                   |  |                   |        |                   |  |   |        |  |  |   |        | 
|Pro forma net earnings per share -
diluted |  | $                 | 0.79   |                   |  | $                 | 0.79   |                   |  | $ | 0.70   |  |  | $ | 0.67   | 
|                                           |  |                   |        |                   |  |                   |        |                   |  |   |        |  |  |   |        | 

The changes in the carrying
amount of goodwill and other intangibles for the six months ended December 29,
2001, by operating segment, are as follows (in thousands):

|                                |  |                                     |        |  |     |  |  |  |  |  |  |  |  |  |  | 
|------------------------------- |  | ----------------------------------- | ------ |  | --- |  |  |  |  |  |  |  |  |  |  | 
|Retail:                         |  |                                     |        | 
|                               
|                               
|                               
|                               
|Balance as of June 30, 2001     |  | $                                   | 13,647 | 
|                               
|                               
|                               
|                               
|                                |  | Goodwill acquired during the period |        |  | 559 | 
|                               
|                               
|                               
|                               
|                                |  | Other intangibles                   |        |  | 550 | 
|                                |  |                                     |        |  |     | 
|Balance as of December 29, 2001 |  | $                                   | 14,206 | 
|                                |  |                                     |        |  |     | 

Other intangibles, included in Other
assets, consisted of amounts paid to a
franchisee in connection with a seven year agreement not to compete. This intangible
asset will be amortized over a seven year period.

Estimated amortization expense for other
intangibles is approximately $6,000 for the quarter and six months
ended December 29, 2001.

10



---



##### 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 |         | Six months ended
|                                               |                                     |                              |                                          |       |               |         |                 
|                                               |                                     |                              |                                          |       | December 29,  |         | December 30,     |       | December 29, |         | December 30,
|                                               |                                     |                              |                                          |       | 2001          |         | 2000             |       | 2001         |         | 2000        
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |             
|                                               |                                     |                              |                                          |       | (Unaudited)   |         | (Unaudited)     
|                                               |                                     | Statement of Operations Data |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |        |         |        
|                                              
|                                              
|                                              
|                                              
|                                               |                                     | Total revenue                |                                          | $     | 148,112       |         |                  | $     | 143,682      |         |              | $      | 232,496 |         |        | $      | 223,770 |        
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|                                               |                                     | Company-owned stores:        |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |        |         |        
|                                              
|                                              
|                                              
|                                              
|                                               |                                     |                              | Net sales                                |       | $             | 141,979 |                  |       | $            | 138,035 |              |        | $       | 222,774 |        |        | $       | 214,888 | 
|                                              
|                                              
|                                              
|                                              
|                                               |                                     |                              | Cost of goods sold and occupancy costs   |       |               | 83,928  |                  |       |              | 83,428  |              |        |         | 141,595 |        |        |         | 138,890 | 
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|                                               |                                     |                              | Gross profit                             |       |               | 58,051  |                  |       |              | 54,607  |              |        |         | 81,179  |        |        |         | 75,998  | 
|                                              
|                                              
|                                              
|                                              
|                                               |                                     |                              | Store operating and selling expense      |       |               | 29,465  |                  |       |              | 29,364  |              |        |         | 49,693  |        |        |         | 49,113  | 
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|                                               |                                     |                              | Company-owned stores profit contribution |       |               | 28,586  |                  |       |              | 25,243  |              |        |         | 31,486  |        |        |         | 26,885  | 
|                                              
|                                              
|                                              
|                                              
|                                               | Franchise stores:                   |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |        |        
|                                              
|                                              
|                                              
|                                              
|                                               |                                     |                              | Royalty fees                             |       |               | 6,133   |                  |       |              | 5,464   |              |        |         | 9,379   |        |        |         | 8,273   | 
|                                              
|                                              
|                                              
|                                              
|                                               |                                     |                              | Franchise fees                           |       |               |       |                  |       |              | 183     |              |        |         | 343     |        |        |         | 609     | 
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|                                               |                                     |                              | Total franchise revenues                 |       |               | 6,133   |                  |       |              | 5,647   |              |        |         | 9,722   |        |        |         | 8,882   | 
|                                              
|                                              
|                                              
|                                              
|                                               |                                     |                              | Total franchise expense                  |       |               | 1,667   |                  |       |              | 1,159   |              |        |         | 3,214   |        |        |         | 2,413   | 
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|                                               |                                     |                              | Franchise profit contribution            |       |               | 4,466   |                  |       |              | 4,488   |              |        |         | 6,508   |        |        |         | 6,469   | 
|                                              
|                                              
|                                              
|                                              
|                                               | General and administrative expense: |                              |                                          | 6,538 |               |         |                  | 5,034 |              |         |              | 12,702 |         |         |        | 10,211 |        
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|Income before interest and income taxes        |                                     |                              | 26,514                                   |       |               |         | 24,697           |       |              |         | 25,292       |        |         |         | 23,143 |       
|                                              
|                                              
|                                              
|                                              
|Interest expense, net                          |                                     |                              | 1,654                                    |       |               |         | 2,004            |       |              |         | 3,409        |        |         |         | 4,286  |       
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|Income before income taxes                     |                                     |                              | 24,860                                   |       |               |         | 22,693           |       |              |         | 21,883       |        |         |         | 18,857 |       
|                                              
|                                              
|                                              
|                                              
|Provision for income taxes                     |                                     |                              | 9,921                                    |       |               |         | 8,782            |       |              |         | 8,730        |        |         |         | 7,297  |       
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|Net income                                     |                                     | $                            | 14,939                                   |       |               | $       | 13,911           |       |              | $       | 13,153       |        |         | $       | 11,560 |       
|                                               |                                     |                              |                                          |       |               |         |                  |       |              |         |              |        |         |         |        |       
|Basic earnings per share                       |                                     | $                            | 1.15                                     |       |               | $       | 1.09             |       |              | $       | 1.02         |        |         | $       | 0.91   |       
|                                              
|                                              
|                                              
|                                              
|Diluted earnings per share                     |                                     | $                            | 0.79                                     |       |               | $       | 0.78             |       |              | $       | 0.70         |        |         | $       | 0.65   |       
|                                              
|                                              
|                                              
|                                              
|Weighted average shares outstanding  basic   |                                     |                              | 12,991                                   |       |               |         | 12,722           |       |              |         | 12,872       |        |         |         | 12,722 |       
|                                              
|                                              
|                                              
|                                              
|Weighted average shares outstanding  diluted |                                     |                              | 18,798                                   |       |               |         | 17,823           |       |              |         | 18,700       |        |         |         | 17,681 |       
|                                              
|                                              
|                                              
|                                              
|EBITDA (a)                                     |                                     |                              | 29,560                                   |       |               |         | 27,335           |       |              |         | 31,163       |        |         |         | 28,315 |       
|                                              
|                                              
|                                              
|                                              
|Depreciation and amortization                  |                                     |                              | 3,046                                    |       |               |         | 2,638            |       |              |         | 5,871        |        |         |         | 5,172  |       

11



---



##### Table of Contents



|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |         |     |     |    |  
|--------------------------------------- | ---------------------------------- | ------------------------------------------- | ---------------------------------- | -------------------------------- | --- | ------------- | ------- | ---------------- | --- | ------------ | ------- | ------------ | --- | --- | ------- | ------- | --- | --- | -- | -
|                                        |                                    |                                             |                                    |                                  |     | Quarter ended |         | Six months
ended |     |              |         |             
|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |             
|                                        |                                    |                                             |                                    |                                  |     | December 29,  |         | December 30,     |     | December 29, |         | December 30,
|                                        |                                    |                                             |                                    |                                  |     | 2001          |         | 2000             |     | 2001         |         | 2000        
|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |             
|                                        |                                    |                                             |                                    |                                  |     | (Unaudited)   |         | (Unaudited)      |     |              |         |             
|Store Data:                             |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                    | Company-owned:                              |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |         |     |    
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             | Stores open at beginning of period |                                  |     | 198           |         |                  |     | 198          |         |              |     | 193 |         |         |     | 197 |   
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    | Stores opened                    |     |               |       |                  |     |              |       |              |     |     | 4       |         |     |     |  |  
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    | Stores acquired from franchisees |     |               |       |                  |     |              |       |              |     |     | 1       |         |     |     | 1  |  
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    | Stores sold to franchisees       |     |               |       |                  |     |              | (3      | )            |     |     |       |         |     |     | (3 | )
|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|                                        |                                    |                                             | Stores open at end of period       |                                  |     | 198           |         |                  |     | 195          |         |              |     | 198 |         |         |     | 195 |   
|                                       
|                                       
|                                       
|                                       
|                                        |                                    | Average Company-owned stores open in period |                                    |                                  | 198 |               |         |                  | 197 |              |         |              | 196 |     |         |         | 196 |    
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                    | Franchise:                                  |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |         |     |    
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             | Stores open at beginning of period |                                  |     | 273           |         |                  |     | 228          |         |              |     | 261 |         |         |     | 211 |   
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    | Stores opened                    |     |               |       |                  |     |              | 28      |              |     |     | 13      |         |     |     | 46 |  
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    | Stores closed                    |     |               | (1      | )                |     |              |       |              |     |     | (1      | )       |     |     |  |  
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    | Stores sold to Company           |     |               |       |                  |     |              |       |              |     |     | (1      | )       |     |     | (1 | )
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    | Stores acquired from Company     |     |               |       |                  |     |              | 3       |              |     |     |       |         |     |     | 3  |  
|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|                                        |                                    |                                             | Stores open at end of period       |                                  |     | 272           |         |                  |     | 259          |         |              |     | 272 |         |         |     | 259 |   
|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|Average franchise stores open in period |                                    |                                             | 273                                |                                  |     |               | 244     |                  |     |              | 267     |              |     |     | 235     |        
|                                       
|                                       
|                                       
|                                       
|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|                                       
|                                       
|                                       
|                                       
|Total stores chainwide                  |                                    |                                             | 470                                |                                  |     |               | 454     |                  |     |              | 470     |              |     |     | 454     |        
|                                        |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|Chainwide sales                         |                                    | $                                           | 321,024                            |                                  |     | $             | 300,826 |                  |     | $            | 498,509 |              |     | $   | 458,572 |        
|                                       
|                                       
|                                       
|                                       
|Same store sales increase:              |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|                                       
|                                       
|                                       
|                                       
|Company-owned stores                    |                                    |                                             | 1.7                                | %                                |     |               | 6.0     | %                |     |              | 3.2     | %            |     |     | 9.7     | %      
|                                       
|                                       
|                                       
|                                       
|Franchise stores                        |                                    |                                             | 1.7                                | %                                |     |               | 0.4     | %                |     |              | 2.4     | %            |     |     | 2.4     | %      
|                                       
|                                       
|                                       
|                                       
|Average sales per Company-owned store   |                                    | $                                           | 717                                |                                  |     | $             | 701     |                  |     | $            | 1,137   |              |     | $   | 1,102   |        
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|                                       
|Balance Sheet Data:                     |                                    |                                             |                                    |                                  |     |               |         |                  |     |              |         |              |     |     |         |        
|                                       
|                                       
|                                       
|                                       
|                                        | Working capital                    |                                             | $                                  | 22,508                           |     |               | $       | 30,938           |     |              | $       | 22,508       |     |     |         | 30,938  |    
|                                       
|                                       
|                                       
|                                       
|                                        | Total assets                       |                                             |                                    | 168,076                          |     |               |         | 158,478          |     |              |         | 168,076      |     |     |         | 158,478 |    
|                                       
|                                       
|                                       
|                                       
|                                        | Bank borrowings and other debt (b) |                                             |                                    | 21,327                           |     |               |         | 35,045           |     |              |         | 21,327       |     |     |         | 35,045  |    
|                                       
|                                       
|                                       
|                                       
|                                        | Capital lease obligation           |                                             |                                    | 220                              |     |               |         | 536              |     |              |         | 220          |     |     |         | 536     |    
|                                       
|                                       
|                                       
|                                       
|                                        | Stockholders equity               |                                             |                                    | 62,713                           |     |               |         | 52,421           |     |              |         | 62,713       |     |     |         | 52,421  |    



---

|(a) |  | The Companys definition of EBITDA is earnings before interest, taxes, depreciation and amortization.                                                               
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(b) |  | The bank borrowings and other debt at December 29, 2001 and December 30, 2000 is net of an unamortized debt discount of $1.6
million and $2.6 million, respectively.

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

Retail.Net sales from Company-owned stores increased 2.9% to $142.0 million
for the second quarter of fiscal 2002 from $138.0 million for the second
quarter of the last fiscal year. Same store sales increased 1.7% in the second
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
second quarter of fiscal 2002 increased 6.3% to $58.1 million from $54.6
million for the second quarter of the last fiscal year. The increase was
primarily due to increased sales volume and improved merchandise margin. Gross
margin was 40.9% for the second quarter of fiscal 2002 compared with 39.6% for
the second quarter of the last fiscal year.

Store operating and selling expenses increased 0.3% to $29.5 million for
the second quarter of fiscal 2002 from $29.4 million in the second 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 20.8% and
21.3% of sales for the second quarter of fiscal 2002 and fiscal 2001,
respectively. The decrease is due to

12



---



##### Table of Contents



expense savings in advertising and supplies. Company-owned stores recorded a
contribution of $28.6 million for the second quarter of fiscal 2002 compared to
$25.2 million for the second quarter of the last fiscal year. The improvement over the prior year is primarily the result of
improved gross margin as well as improved operating efficiencies.

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. No franchise stores were opened and
no franchise fees were recognized in the second quarter of fiscal 2002.
Franchise fees, recognized on 28 store openings, were $183,000 for the second
quarter of fiscal 2001. Royalty fees increased 12.2% to $6.1 million in the
second quarter of fiscal 2002 from $5.5 million in the second 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 1.7% for the franchise stores in the first
quarter of fiscal 2002.

Expenses directly related to franchise revenue increased 43.8% to $1.7
million for the second quarter of fiscal 2002 from $1.2 million for the second
quarter of the last fiscal year. The Company has recorded a provision for the
bad debt associated with the royalty receivables of its Canadian franchisee. This
franchisee has filed for court protection under bankruptcy proceedings in
Canada. As a percentage of franchise revenue, franchise expenses were 27.2%
and 20.5% for the second quarter of fiscal 2002 and fiscal 2001,
respectively. The increase is due primarily to the bad debt associated with the
Canadian franchisee.

General and Administrative Expenses.General and administrative expenses
increased 29.9% to $6.5 million in the second quarter of fiscal 2002 from $5.0
million in the second quarter of the last fiscal year. This increase is
attributable, in part, to an increase of $506,000 in depreciation related to
new systems placed in service. The balance of the increase is
primarily due to increases in legal
and tax consulting fees and stock option-related compensation. General and administrative
expenses were 4.6% and 3.6% of sales for the second quarter of fiscal 2002 and
fiscal 2001, respectively, reflecting investments in management and systems.

Interest Expense.Interest expense decreased 17.5% to $1.7 million for the
second quarter of fiscal 2002 from $2.0 million in the second quarter of the
last fiscal year. The decreased expense is primarily attributable to lower
average borrowings outstanding under the Company's Loan and Security
Agreement, dated January 14, 2000 (the "Loan Agreement''), with
Congress Financial Corporation and reduced principal
balances on Senior Notes outstanding due to payments made over the last twelve
months.

Income Taxes.The effective income tax rate was 40.0% in the first quarter of
fiscal 2002 compared to 38.7% in the second quarter of the last
fiscal year. The tax rate increased as a result of the increase in
the federal statutory rate.

Net Income.As a result of the above factors, net income for the second
quarter of fiscal 2002 was $14.9 million, or $1.15 earnings per
basic share and $0.79
earnings per diluted share, as compared to net income of $13.9 million, or
$1.09 earnings per basic share and $0.78 earnings per diluted share in second quarter
of the last fiscal year.

13



---



##### Table of Contents



Six Months Ended December 29,
2001 Compared to Six Months Ended December 30, 2000

Retail.Net sales from Company-owned stores increased 3.7% to $222.8 million
for the six months ended December 29, 2001 from $214.9 million for the six
months ended December 30, 2000. Same store sales increased 3.2% in the six
months ended December 29, 2001. Gross profit reflects the cost of goods sold
and store occupancy costs including rent, common area maintenance, real estate
taxes, repair and maintenance, depreciation and utilities. Gross profit for
the six months ended December 29, 2001 increased 6.8% to $81.2 million from
$76.0 million for the six months ended December 30, 2000. The increase was
primarily due to increased sales volume and offset by leverage on fixed
occupancy costs. Gross margin was 36.4% for the six months ended December 29,
2001 compared with 35.4% for the six months ended December 30, 2000.

Store operating and selling expenses increased 1.2% to $49.7 million for
the six months ended December 29, 2001 from $49.1 million in the six months
ended December 30, 2000. The increase in store operating expenses is
attributable to the increase in sales. Store operating and selling expenses
were 22.3% and 22.9% of sales for the six-month period ended December 29, 2001
and December 30, 2000, respectively. The decrease is due to improvements in
efficiency in the management of store labor hours and savings in advertising
and supply expenses. Company-owned stores recorded a contribution of $31.5
million for the six months ended December 29, 2001 compared to $26.9 million
for the six months ended December 30, 2000. The improvement over the prior year is primarily the result of improved gross
margin as well as improved operating efficiencies.

The Company opened four new stores during the six months ended December
29, 2001. No new stores were opened in the six months ended December 30, 2000.
Pre-opening expenses for these stores and stores planned to be opened
later in the fiscal year were $215,000. All costs of
pre-opening are expensed when incurred.

Franchising. Franchise revenue is composed of the initial franchise fees that
are recorded as revenue when the store opens, and ongoing royalty fees,
generally 4.0% of the stores net sales. Franchise fees, recognized on 13
store openings, were $343,000 for the six months ended December 29, 2001,
compared to $609,000 for the six months ended December 30, 2000 relating to 46
store openings. Royalty fees increased 13.4% to $9.4 million in the six months
ended December 29, 2001 from $8.3 million in the six months ended December 30,
2000 which is primarily due to an increase in the number of stores and a same
store sales increase of 2.4% for the franchise stores in the six month period
ended December 29, 2001.

Expenses directly related to franchise revenue increased 33.2% to $3.2
million for the six months ended December 29, 2001 from $2.4 million for the
six months ended December 30, 2000. As a percentage of franchise revenue,
franchise expenses were 33.1% and 27.2% for the six months ended December 29,
2001 and December 30, 2000, respectively. This increase is due to the recording
of a provision for bad debt related to the Companys Canadian franchisee.

General and Administrative Expenses.General and administrative expenses
increased 24.4% to $12.7 million in the six months ended December 29, 2001 from
$10.2 million in the six months ended December 30, 2000. This increase is
attributable, in part, to an increase of $912,000 in depreciation related to
new systems placed in service. The balance of the increase is
primarily due to increases
in legal and tax consulting fees and stock option-related compensation. General and
administrative expenses were 5.7% and 4.8% of sales for the six months ended
December 29, 2001 and December 30, 2000, respectively, reflecting investments
in management and systems.

Interest Expense.Interest expense decreased 20.5% to $3.4 million for the six
months ended December 29, 2001 from $4.3 million in the six months ended
December 30, 2000. The decreased expense is primarily

14



---



##### Table of Contents



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 Taxes.The effective income tax rate was 40.0% in the six months ended
December 29, 2001 compared to 38.7% in the six months ended December 30, 2000.

Net Income.As a result of the above factors, net income for the six months
ended December 29, 2001 was $13.2 million, or $1.02 per
basic share and $0.70 per
diluted share, as compared to net income of $11.6 million, or $0.91 per basic
share and $0.65 per diluted share for the six months ended December 30, 2000.

Liquidity and Capital Resources

Cash requirements are primarily for working
capital, the opening of new stores, the improvement and expansion of
existing facilities and the improvement of information systems.
Historically, these cash requirements have been met through cash flow
from operations and borrowings under the Loan Agreement. At December 29, 2001, working capital was $22.5 million.

For the six month period ended December 29, 2001, cash provided by
operating activities was $25.9 million, compared to $31.7 million for the same
period of the last fiscal year. The decrease in cash provided by operating
activities was primarily attributable to an increase in deferred tax
assets related
primarily to timing differences and the effect of part-year federal
net operating losses in fiscal 2001.

Cash used in investment activities for the six month period ended December
29, 2001 was $5.9 million compared to $3.7 million in the same period in the
last fiscal year. The increase in cash used in investing activities was
primarily attributable to the continued investment in new systems and new
stores. Four Company-owned stores were opened in the period.

Cash used in financing activities was $8.3 million for the six month
period ended December 29, 2001. This relates to reduced borrowings on the Loan Agreement, a payment of $6.6 million
on Senior Notes in advance of maturity and purchases of treasury stock of $1.8
million.

At December 29, 2001, the Company had no
balance outstanding under the Loan Agreement. Under the terms of the Loan Agreement,
the Company may from time to time borrow amounts based on a percentage of its
eligible inventory, up to a maximum of $40 million at any time outstanding.
Advances bear interest, at the Companys option, (i) at the adjusted Eurodollar
rate plus the applicable margin, which was 2.25% per annum or (ii) at the rate of 3/4% per annum above the prime rate,
totaling 5.75% at December 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 February 8, 2002, the Company had no balance outstanding and
$30.8 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 14 to 18 new stores planned. A payment of
$5.1 million of Senior Notes was made on January 31, 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,

15



---



##### Table of Contents



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 exposed to interest
rate change market risk. As borrowing patterns are cyclical, the Company is
not dependent on borrowing throughout the year. Therefore, a sudden increase
in interest rates (which under the Loan Agreement is dependent on the prime
rate) may, during peak borrowing, have a negative impact on short-term results.




PART II OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

The Company was named as a defendant in twelve class action complaints.
The Companys former Chief Executive Officer and the former Chief Financial
Officer and Executive Vice President of Operations were also named as
defendants. All of the complaints were filed in the United States District
Court for the District of New Jersey. The complaints were filed as class
actions on behalf of persons who purchased or acquired Party City common stock
during various time periods between February 1998 and March 19, 1999 (the
Class Period). In October 1999, plaintiffs filed an amended class action
complaint and in February 2000, plaintiffs filed a second amended complaint.

The second amended complaint alleged, among other things, violations of
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended,
and Rule 10b-5 promulgated thereunder, and sought unspecified damages. The
plaintiffs alleged that defendants issued a series of false and misleading
statements and failed to disclose material facts concerning, among other
things, the Companys financial condition, adequacy of internal controls and
compliance with certain loan covenants during the Class Period. The plaintiffs
further alleged that because of the issuance of a series of false and
misleading statements and/or the failure to disclose material facts, the price
of Party City 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. Argument
of the appeal is presently scheduled to be heard on March 19, 2002. It is not
possible to predict the likely outcome of the appeal at this time.

A
lawsuit was filed on September 25, 2001 against the Company in Los Angeles Superior Court by
an assistant manager in one of the Companys California stores for himself and
on behalf of other members of an alleged class of Party City store managers
(the Class) who claim the Company misclassified the Class as exempt from

16



---



##### Table of Contents



California overtime wage and hour laws. The lawsuit seeks relief in the
form of disgorgement of overtime wages allegedly owed by the Company to the
Class but not paid. The plaintiffs also seek punitive damages and statutory
penalties. The Company denies the allegations and is vigorously defending
against the claim.

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




ITEM 2. CHANGES IN SECURITIES AND USE
OF PROCEEDS

None




ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Companys 2001 Annual Meeting of Stockholders was held on Wednesday,
November 14, 2001 for the following purposes:



| | 1. |  | To elect nine directors to the Board of Directors who shall
serve until the 2002 Annual Meeting of Stockholders, or until their
successors are elected and qualified. (Proposal 1)
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | To approve the Companys Employee Stock Purchase Plan.
(Proposal 2)                                                                                                               

The voting as to each Proposal was as follows:

Proposal 1

|                   |  |     |            |         |  |  |           | 
|------------------ |  | --- | ---------- | ------- |  |  | --------- | 
|Name               |  | For |            | Against
|                   |  |     |            |        
|Ralph Dillon       |  |     | 10,671,234 |         |  |  | 42,190    | 
|                  
|                  
|                  
|                  
|Jack Futterman     |  |     | 8,868,306  |         |  |  | 1,845,118 | 
|                  
|                  
|                  
|                  
|Michael A. Gatto   |  |     | 10,670,934 |         |  |  | 42,490    | 
|                  
|                  
|                  
|                  
|L.R. Jalenak, Jr.  |  |     | 10,676,234 |         |  |  | 37,190    | 
|                  
|                  
|                  
|                  
|Howard Levkowitz   |  |     | 10,670,434 |         |  |  | 42,990    | 
|                  
|                  
|                  
|                  
|Nancy Pedot        |  |     | 10,678,134 |         |  |  | 35,290    | 
|                  
|                  
|                  
|                  
|Walter J. Salmon   |  |     | 10,677,234 |         |  |  | 36,190    | 
|                  
|                  
|                  
|                  
|James Shea         |  |     | 8,897,806  |         |  |  | 1,815,618 | 
|                  
|                  
|                  
|                  
|Michael Tennenbaum |  |     | 10,671,034 |         |  |  | 42,390    | 

Proposal 2

|          |  |         |           |         |  |  |       | 
|--------- |  | ------- | --------- | ------- |  |  | ----- | 
|For       |  | Against |           | Abstain
|          |  |         |           |        
|8,702,332 |  |         | 2,006,019 |         |  |  | 5,073 | 




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.

17



---



##### Table of Contents



(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.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

18



---



##### Table of Contents



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

19



---



##### Table of Contents






SIGNATURES

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

| |  |                                                                    |  |  |  | 
| |  | ------------------------------------------------------------------ |  |  |  | 
| |  | PARTY CITY CORPORATION                                            
|
| |  |                                                                   
|
| |  | By /s/ James Shea
(James Shea)
Chief Executive Officer            
|
| |  |                                                                   
|
| |  | By /s/ Thomas E. Larson
(Thomas E. Larson)
Chief Financial Officer
|
| |  |                                                                   
|
| |  | By /s/ Linda M. Siluk
(Linda M. Siluk)
Chief Accounting Officer   

Date:
February 11, 2002

20