<PAGE>   1

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549
                                -----------------
                                    FORM 10-Q

                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

                     OF THE SECURITIES EXCHANGE ACT OF 1934
                                -----------------
      FOR THE QUARTERLY PERIOD ENDED              COMMISSION FILE NUMBER
               MARCH 31, 1999                             0-27826
                                -----------------

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

                  DELAWARE                              22--3033692
     (State or other jurisdiction of                 (I.R.S. Employer
      incorporation or organization)                 Identification No.)

           400 COMMONS WAY                                 07866
         ROCKAWAY, NEW JERSEY                            (Zip Code)
                   (Address of Principal Executive Offices)

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

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

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

                                 Yes / / No: /X/

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

         As of May 8, 2000, there were outstanding 12,722,205 shares of
                          Common Stock, $.01 par value.

1

<PAGE>   2


                             PARTY CITY CORPORATION

                                      INDEX

 <TABLE>
 <CAPTION>
                                                                                                             Page No.
 Part I.      Financial Information                                                                          --------
<S>                                                                                                           <C>
         Item 1.  Consolidated Financial Statements
                    Consolidated Balance Sheets (Unaudited) - March 31, 1999 and December 31, 1998                 3
                    Consolidated Statements of Operations (Unaudited) - For the Quarters Ended
                       March 31, 1999 and March 31, 1998                                                           4
                    Consolidated Statements of Cash Flows (Unaudited) - For the Quarters Ended
                       March 31, 1999 and March 31, 1998                                                           5
                    Notes to Consolidated Financial Statements                                                     6
         Item 2.     Management's Discussion and Analysis of Financial Condition and Results
         of Operations                                                                                            12

 Part II.    Other Information                                                                                    16
         Item 2.  Changes in Securities
         Item 6.  Exhibits and Reports on Form 8-K
         Exhibit Index
</TABLE>






2

<PAGE>   3

PART 1.  FINANCIAL INFORMATION

Item 1. Financial Statements

                      PARTY CITY CORPORATION AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS

                           (IN THOUSANDS) (UNAUDITED)

<TABLE>
<CAPTION>
                                                                             MARCH 31,        DECEMBER 31,
                                                                             ---------        ------------
                                                                                  1999                1998
                                                                                  ----                ----
                                     ASSETS

<S>                                                                              <C>            <C>
Current assets:
   Cash and cash equivalents                                                     $  3,023       $  6,558
   Merchandise inventory                                                           66,461         58,247
   Refundable income taxes                                                          6,500             --
   Other current assets                                                            14,586         14,800
                                                                                 --------       --------
      Total current assets                                                         90,570         79,605
Property and equipment, net                                                        52,240         49,657
Goodwill, net                                                                      18,591         18,939
Other assets                                                                        1,245          1,758
                                                                                 --------       --------
      Total assets                                                               $162,646       $149,959
                                                                                 ========       ========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Accounts payable - trade                                                      $ 45,791       $ 38,302
   Accrued expenses                                                                 7,958          8,660
   Borrowings under Credit Agreement                                               56,500         46,800
   Other current liabilities                                                        1,314          1,239
                                                                                 --------       --------
      Total current liabilities                                                   111,563         95,001
Deferred rent                                                                       6,331          5,585
Other long-term liabilities                                                           770            880

Commitments and contingencies

Stockholders' equity:
   Common stock, 12,455,538 and 12,455,538 shares
   outstanding, respectively                                                          125            125
   Additional paid-in capital                                                      34,024         33,991
   Retained earnings                                                                9,833         14,377
                                                                                 --------       --------
       Total stockholders' equity                                                  43,982         48,493
                                                                                 --------       --------
         Total liabilities and stockholders' equity                              $162,646       $149,959
                                                                                 ========       ========
</TABLE>

          See accompanying notes to consolidated financial statements.

3

<PAGE>   4





                      PARTY CITY CORPORATION AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF OPERATIONS

                (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)

<TABLE>
<CAPTION>
                                                                      QUARTERS ENDED
                                                                 -------------------------
                                                                 MARCH 31,       MARCH 31,
                                                                   1999            1998
                                                                   ----            ----
<S>                                                              <C>             <C>
Revenues:
       Net sales                                                 $ 70,420        $ 38,651
       Royalty fees                                                 2,131           2,021
       Franchise fees                                                 164              42
                                                                 --------        --------
             Total revenues                                        72,715          40,714
Expenses:
       Cost of goods sold and occupancy costs                      51,191          28,548
       Company-owned stores operating and selling expense          20,055          10,752
       Franchise expense                                              938             941
       General and administrative expense                           6,203           2,371
                                                                 --------        --------
                Total expenses                                     78,387          42,612
                                                                 --------        --------
Loss before interest and income tax benefit                        (5,672)         (1,898)
       Interest expense                                               915             202
                                                                 --------        --------
Loss before income tax benefit                                     (6,587)         (2,100)
       Income tax benefit                                          (2,043)           (830)
                                                                 --------        --------
Net loss                                                         $ (4,544)       $ (1,270)
                                                                 ========        ========

       Basic loss per share                                      ($  0.36)       ($  0.10)
                                                                 ========        ========
             Weighted average shares outstanding - basic           12,458          12,327
                                                                 ========        ========

       Diluted loss per share                                    ($  0.36)       ($  0.10)
                                                                 ========        ========
             Weighted average shares outstanding - diluted         12,458          12,327
                                                                 ========        ========
</TABLE>

          See accompanying notes to consolidated financial statements.

4

<PAGE>   5



                      PARTY CITY CORPORATION AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                           (IN THOUSANDS) (UNAUDITED)

<TABLE>
<CAPTION>

                                                                                      QUARTERS ENDED
                                                                                ---------------------------
                                                                                   MARCH 31,      MARCH 31,
                                                                                     1999           1998
                                                                                     ----           ----
<S>                                                                               <C>             <C>
Cash flow from operating activities:
Net loss                                                                          $ (4,544)       $ (1,270)
Adjustments to reconcile net loss to net cash used in operating activities:
       Depreciation and amortization                                                 2,487           1,286
       Deferred rent                                                                   746             470
       Changes in assets and liabilities:
         Merchandise inventory                                                      (8,214)         (8,037)
         Refundable income taxes                                                    (6,500)           (544)
         Other current assets                                                          214          (1,788)
         Other assets                                                                  513            (164)
         Accounts payable - trade                                                    7,489          (3,590)
         Accrued expenses                                                             (702)         (4,832)
         Other current liabilities                                                      75            (173)
         Other long term liabilities                                                  (110)            142
                                                                                  --------        --------
            Net cash  used in operating activities                                  (8,546)        (18,500)
Cash flow from investment activities:
       Purchases of property and equipment                                          (4,719)         (4,200)
       Stores acquired from franchisees                                                 (3)           (198)
                                                                                  --------        --------
             Net cash used in investment activities                                 (4,722)         (4,398)
Cash flow provided by financing activities:
       Proceeds from exercise of stock options                                          33             358
       Net proceeds from Credit Agreement                                            9,700          19,770
                                                                                  --------        --------
               Net cash provided from financing activities                           9,733          20,128
                                                                                  --------        --------
Net decrease in cash and cash equivalents                                           (3,535)         (2,770)
Cash and cash equivalents, beginning of period                                       6,558           3,235
                                                                                  --------        --------
Cash and cash equivalents, end of period                                          $  3,023        $    465
                                                                                  ========        ========
Supplemental disclosure of cash flow information:
       Income taxes paid                                                          $  7,254        $  2,659
       Interest paid                                                              $    833        $    215
</TABLE>

          See accompanying notes to consolidated financial statements.

5

<PAGE>   6



                      PARTY CITY CORPORATION AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.     BASIS OF PRESENTATION

      The consolidated financial statements are unaudited. In the opinion of
management, the accompanying consolidated financial statements contain all
adjustments (consisting only of normal recurring accruals) necessary to present
fairly the financial position of the Company as of December 31, 1998 and March
31, 1999 and the results of operations and cash flows for the quarters then
ended March 31, 1999 and 1998. All significant intercompany accounts and
transactions have been eliminated. Because of the seasonality of the party goods
industry, operating results of the Company on a quarterly basis may not be
indicative of operating results for the full year.

      These consolidated financial statements should be read in conjunction with
the Company's audited consolidated financial statements for the eighteen-month
period ended July 3, 1999, included in the Company's Annual Report of Form 10-K
filed with the Securities and Exchange Commission.

2.    SEGMENT INFORMATION

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

        <TABLE>
        <CAPTION>

                                                                          Quarters Ended
                                                                  --------------------------------
                                                                  March 31,              March 31,
                                                                     1999                   1998
                                                                     ----                   ----
<S>                                                                 <C>                  <C>
        RETAIL:
        Net revenue                                                 $70,420              $38,651
        Operating loss                                                (826)                (649)
        Identifiable assets                                         151,128               95,179
        Depreciation/amortization                                     2,054                1,132
        Capital expenditures                                          3,299                3,187

        FRANCHISING:
        Net revenue                                                  $2,295               $2,063
        Operating earnings                                            1,357                1,122
        Identifiable assets                                           1,930                1,085
        Depreciation/amortization                                        --                   --
        Capital expenditures                                             --                   --

        CORPORATE/OTHER:
        Net revenue                                                     $--                  $--
        Operating expenses                                            6,203                2,371
        Identifiable assets                                           9,588                4,058
        Depreciation/amortization                                       433                  154
        Capital expenditures                                          1,420                1,013

</TABLE>


6

<PAGE>   7



<TABLE>
<CAPTION>

<S>                                                                 <C>                  <C>
        CONSOLIDATED TOTALS:
        Net revenue                                                 $72,715              $40,714
        Operating loss                                              (5,672)              (1,898)
        Interest expense                                                915                  202
        Loss before income tax benefit                              (6,587)              (2,100)
        Income tax benefit                                          (2,043)                (830)
        Net loss                                                   ($4,544)             ($1,270)

        Identifiable assets                                        $162,646             $100,322
        Depreciation/amortization                                    $2,487               $1,286
        Capital expenditures                                         $4,719               $4,200

</TABLE>

3.    SUBSEQUENT EVENTS - FINANCING AND LIQUIDITY

      On April 24, 1998, the Company refinanced and replaced its then existing
$20 million loan facility with a $60 million secured revolving line of credit
agreement with a group of banks maturing April 24, 2001 (as amended, the "Credit
Agreement"). Advances under the Credit Agreement originally bore interest, at
the Company's option, at the agent bank's base rate (the higher of the bank's
prime rate or the federal funds rate plus 1/2% per annum) or LIBOR plus an
applicable margin. The Company did not meet certain of its financial and
reporting covenants, including those relating to timely filing of consolidated
financial statements, minimum levels of profitability, net worth, liquidity,
fixed charge coverage and others. Consequently, the Company's debt under the
Credit Agreement was subject to acceleration and is classified as a current
liability in the consolidated balance sheets at March 31, 1999 and December 31,
1998. The Credit Agreement was secured by all the assets of the Company.
Additionally, the Credit Agreement restricted the payment of dividends.

      On August 16, 1999, the Company entered into the following agreements with
its existing bank lenders under the Credit Agreement (the "Banks"), a new group
of investors (the "Investors") and its trade vendors. The Banks and the Company
entered into a Standstill and Forbearance Agreement (the "Bank Forbearance
Agreement"). Under the Bank Forbearance Agreement, the Banks agreed not to
exercise rights and remedies based upon any existing defaults until June 30,
2000 unless a further event of default occurred. The interest rate on its bank
debt was increased to 2% over the bank's prime interest rate, and the Company
paid a forbearance fee of $580,000.

      On August 17, 1999, the Company received $30 million in financing from the
Investors. The Investors purchased senior secured notes and warrants pursuant to
separate securities purchase agreements (the "Securities Purchase Agreements")
each dated as of August 16, 1999. Under these Securities Purchase Agreements,
the Company issued (i) $10 million of its 12.5% Secured Notes due 2003 (the "A
Notes"); (ii) $5 million of its 13.0% Secured Notes due 2003 (the "B Notes");
(iii) $5 million of its 13.0% Secured Notes due 2002 (the "C Notes"); (iv) $10
million of its 14.0% Secured Notes due 2004 (the "D Notes", and together with
the A Notes, the B Notes and the C Notes, the "Notes"); and (v) warrants (the
"Warrants") to purchase 6,880,000 shares of the Company's common stock at an
initial exercise price of $3.00 per share. See Note 4 for subsequent
transaction. Up to $15 million of the Notes was secured by a first lien that was
pari pasu with the liens under the Credit Agreement. The Notes are also secured
by a second lien on all of the Company's assets. The Company issued the Warrants
in connection with the sale of the C Notes and the D Notes. The Warrants may be
exercised before the close of business on August 16, 2006. The shares of Common
Stock reserved for issuance under the Warrants represent approximately 35% of
the shares of Common Stock outstanding assuming the exercise of the Warrants.
The warrants were valued at $1,965,000 based on management's estimate using
certain fair value methodologies and represent an original issue discount to the
C and D notes. This discount is being amortized using the effective interest

7
<PAGE>   8

method. The effective yield is 18.3% and 18.9% on the C Notes and D Notes,
respectively. The proceeds from the $30 million in new financing were used for
the purchase of seasonal inventory, payment of amounts due under the Credit
Agreement, transaction fees and working capital.

      The Company also entered into an Investor Rights Agreement (the "Investor
Rights Agreement") with the Investors and the previous chief executive officer
of the Company. In this agreement, the Company granted registration rights with
respect to shares of common stock. Under the Investor Rights Agreement, the
Investors agree that they will not, without the prior written consent of the
Board of Directors, (i) acquire or agree to acquire, publicly offer or make any
public proposal with respect to the possible acquisition of (a) beneficial
ownership of any securities of the Company, (b) any substantial part of the
Company's assets, or (c) any rights or options to acquire any of the foregoing
from any person; (ii) make or in any way participate in any "solicitation" of
"proxies" (as such terms are defined in the rules of the Securities Exchange Act
of 1934, as amended) to vote, or seek to advise or influence any person with
respect to the voting of any voting securities of the Company; or (iii) make any
public announcement with respect to any transaction between the Company or any
of its securities holders and the Investors, including without limitation, any
tender or exchange offer, merger or other business combination of a material
portion of the assets of the Company. These standstill provisions terminate if
the Company's consolidated earnings before interest, taxes, depreciation and
amortization and exclusive of special charges ("EBITDA"), as defined in the
Investor Rights Agreement, does not meet specified targets. The Company achieved
its target EBITDA for the calendar year 1999. Also, in connection with these
transactions, one outside director of the Company resigned and two
representatives of the Investors joined the Board of Directors.

      Party City's trade vendors representing approximately $36.4 million of
trade debt also entered into an agreement with the Company. Pursuant to a Vendor
Standstill and Forbearance Agreement ("Vendor Forbearance Agreement"), these
trade vendors agreed to forbear from taking any action against Party City until
January 15, 2000. The trade vendors received promissory notes from Party City
totaling approximately $12.2 million representing one-third of their unpaid
balances as of May 1, 1999 (the "Trade Notes"). The Trade Notes bore interest at
a rate of 10% per year and were scheduled to mature on November 15, 1999.
Interest on the Trade Notes was due on January 15, 2000. Substantially all the
remaining two-thirds of the unpaid balances that were due as of May 1, 1999,
were satisfied through individual arrangements with such vendors. See Note 4 for
further discussion.

      In order to meet the cash flow requirements of the Halloween seasonal
purchase of inventory and to meet the requirements of the Bank Forbearance
Agreement, the Company identified stores for sale to existing franchisees to
generate working capital. Eighteen stores with a net book value of approximately
$9.8 million were sold to franchisees. In order to facilitate the sale of these
stores, franchise fees were negotiated at lower than normal rates for specific
periods. The total proceeds from the sales of these stores was approximately
$9.9 million. Under the Bank Forbearance Agreement, the net proceeds from the
sale of stores was required to be used to pay down the outstanding borrowings
under the Credit Agreement.

8

<PAGE>   9



4.    SUBSEQUENT EVENTS - REFINANCING TRANSACTIONS

      On January 14, 2000, the Company replaced the Credit Agreement with a new
Loan and Security Agreement (the "Loan Agreement") with Congress Financial
Corporation ("Congress"), as lender. 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 will initially be 2.75% per annum
(subject to possible reduction to a margin as low as 2.25% from and after June
30, 2001, based on the Company's pre-tax income and excess availability) or (ii)
at the rate of 3/4% per annum above the prime rate. The term of the Loan
Agreement is three years, and is secured by a lien on substantially all of the
assets of the Company.

      On January 14, 2000, Party City also received $7 million in cash proceeds
from the sale to certain of its existing investors (the "Investor Group") of a
new series of senior secured notes pursuant to a First Amendment (the "First
Amendment") to the Securities Purchase Agreement dated as of August 16, 1999.
Pursuant to the First Amendment, the Company issued $7,000,000 in aggregate
principal amount of its 14.0% Secured Notes due 2002 (the "E Notes"). The E
Notes are secured by a lien on substantially all of the Company's assets. The
Investor Group, together with other existing investors and Congress, have
entered into an intercreditor agreement. In consideration for waivers and
forbearances granted by the Investors to various defaults under the terms of the
Company's existing senior secured notes, the Company also agreed to amend and
restate the terms of existing warrants (the "Existing Warrants") held by such
investors to acquire 6,880,000 shares of the Company's Common Stock. The amended
and restated warrants (the "Amended Warrants") will provide for an exercise
price of $1.07 per share and were issued upon surrender of the Existing
Warrants, which had an exercise price of $3.00 per share. The shares issuable
upon the exercise of the Warrants represent approximately 35% of the shares then
outstanding. The Warrants were valued at $3,156,000 based on management's
estimate using certain fair market methodologies and represent an original issue
discount to the C and D notes. This discount is being amortized using the
effective interest method. The effective yield is 28.6% and 28.9% on the C Notes
and D Notes, respectively.

      The Company used the proceeds from the sale of the E Notes and initial
amounts borrowed under the Loan Agreement (i) to pay off all amounts owing under
its current credit facility, (ii) to pay all amounts owing on the trade notes
issued to certain of its vendors in August 1999 and (iii) to pay the remaining
amounts owed to various seasonal trade vendors for credit extended for inventory
purchased by the Company for the 1999 Halloween, Thanksgiving and Christmas
seasons.


9

<PAGE>   10



5.    LITIGATION

      The Company has been named as a defendant in the following twelve class
action complaints: (1) Weber v. Party City Corp., Steven Mandell, and David
Lauber, Civ. Action No. 99-CV-1252; (2) Opus GT Partners LP v. Party City Corp.
and Steven Mandell, Civ. Action No. 99-CV-1327; (3) Klein and Shiffrin v. Party
City Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1325; (4)
Flynn v. Party City Corp., David Lauber and Steven Mandell, Civ. Action No.
99-CV-1328; (5) Catanzarite v. Party City Corp., Steven Mandell and David
Lauber, Civ. Action No. 99-CV-1317; (6) Tabbert v. Party City Corp. and Steven
Mandell, Civ. Action No. 99-CV-1353; (7) Maietta v. Steven Mandell and Party
City Corp., Civ. Action No. 99-CV-1386; (8) Barry v. Party City Corp., Steven
Mandell and David Lauber, Civ. Action No. 99-CV-1453; (9) Kurzweil v. Party City
Corp., Steven Mandell and David Lauber, Civ. Action No. 99-CV-1396; (10) Hormel
v. Party City Corp., Steven Mandell and David Lauber, Civ. Action No.
99-CV-1689; (11) Sacher v. Party City Corp., Steven Mandell and David Lauber,
Civ. Action No. 99-CV-2238: and (12) Gross v. Party City Corp., Steven Mandell
and David Lauber, Civ. Action No. 99-CV-2355. The Company's former Chief
Executive Officer and former Chief Financial Officer and Executive Vice
President of Operations have also been named as defendants. The complaints have
all been filed in the United States District Court for the District of New
Jersey. The complaints were filed as class actions on behalf of persons who
purchased or acquired Party City common stock during various time periods
between February 1998 and March 19, 1999.

      The complaints allege, among other things, violations of sections 10(b)
and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder, and seek unspecified damages. The plaintiffs allege that defendants
issued a series of false and misleading statements and failed to disclose
material facts concerning, among other things, the Company's financial
condition, adequacy of internal controls and compliance with certain loan
covenants. The plaintiffs further allege that because of the issuance of a
series of false and misleading statements and/or failure to disclose material
facts, the price of Party City common stock was artificially inflated.

On September 13, 1999, the Court signed an Order appointing lead plaintiffs and
lead counsel to represent the classes alleged in the complaints. Plaintiffs
filed a first amended complaint in October 1999 and a second amended complaint
in February 2000.

            The defendants have made a motion to dismiss the complaint.

  Other

      The Company was named as a defendant in a complaint filed with the Supreme
Court of the State of New York, County of New York, on January 16, 1998 (the
"Complaint"), by each of Party City of Greenbrook, Inc., Party City of Watchung,
Inc., Party City of 22, Inc., Party City of Ralph Avenue and Party City of
Jersey City, Inc., each a franchisee of the Company. Four of the plaintiffs in
the suit have existing Party City franchise stores, with the remaining plaintiff
possessing a right of first refusal to develop a Party City store in Watchung,
New Jersey.

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

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

10

<PAGE>   11

deceptive advertising. Plaintiff seeks damages of $2 million, as well as treble
and punitive damages for certain counts.

      On January 6, 2000, Plaintiff amended its Complaint by adding another
plaintiff, Ron's: The Party Super Store, Inc. The Company has answered the
Complaint, and discovery has commenced.

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

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

6.    EARNINGS PER SHARE

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

<TABLE>
<CAPTION>

                                                                               QUARTERS ENDED
                                                                               --------------
                                                                 March 31, 1999             March 31, 1998
                                                                 --------------             --------------
<S>                                                              <C>                         <C>
             Net loss                                              ($4,544)                    ($1,271)
             Average shares outstanding                              12,454                      12,327
             Loss per share - basic                                 ($0.36)                     ($0.10)
             Dilutive effect of stock options                           (a)                         (a)
             Average common and common equivalent
             shares outstanding                                      12,454                      12,327
             Loss per share - diluted                               ($0.36)                     ($0.10)

</TABLE>

         (a)       In periods of losses, options were excluded from the
            computation of diluted earnings per share because they would be
            antidilutive.

11

<PAGE>   12



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)
<TABLE>
<CAPTION>
                                                                             QUARTERS ENDED
                                                                             --------------
                                                                         MARCH 31,       MARCH 31,
                                                                         --------       ---------
                                                                           1999            1998
                                                                           ----            ----
                                                                               (UNAUDITED)

<S>                                                                     <C>               <C>
STATEMENT OF OPERATIONS DATA
Total revenue                                                           $   72,715        $ 40,714
                                                                        ==========================
Company-owned stores
   Net sales                                                            $   70,420        $ 38,651
   Cost of goods sold and occupancy costs                                   51,191          28,548
                                                                        ----------        --------
   Gross profit                                                             19,229          10,103
   Store operating and selling expense                                      20,055          10,752
                                                                        ----------        --------
   Company-owned stores loss                                                  (826)           (649)

Franchise stores:
   Royalty fees                                                              2,131           2,021
   Franchise fees                                                              164              42
                                                                        ----------        --------                -
   Total franchise revenues                                                  2,295           2,063
   Total franchise expense                                                     938             941
                                                                        ----------        --------
   Franchise profit contribution                                             1,357           1,122

General and administrative expense:

   Special charges (a)                                                       1,151              --
   Other general and administrative expenses                                 5,052           2,371
                                                                        ----------        --------
                                                                             6,203           2,371
                                                                        ----------        --------
Loss before interest and income tax benefit                                 (5,672)         (1,898)
Interest expense, net                                                          915             202
                                                                        ----------        --------
Loss before income tax benefit                                              (6,587)         (2,100)
Income tax benefit                                                          (2,043)           (830)
                                                                        ----------        --------
Net loss                                                                $   (4,544)       $ (1,270)
                                                                        ==========        ========

Basic earnings per share                                                  ($  0.36)       $  (0.10)
                                                                        ==========        ========
Diluted earnings per share                                                ($  0.36)       $  (0.10)
                                                                        ==========        ========
Weighted average shares outstanding -- Basic                                12,454          12,327
                                                                        ==========        ========
Weighted average shares outstanding -- Diluted                              12,454          12,327
                                                                        ==========        ========
EBITDA (b)                                                                ($ 2,034)       ($   612)
                                                                        ==========        ========
   Depreciation and amortization                                          $  2,487        $  1,286
                                                                        ==========        ========

</TABLE>

12

<PAGE>   13



<TABLE>
<CAPTION>

                                                                               QUARTERS ENDED
                                                                               --------------
                                                                         MARCH 31,          MARCH 31,
                                                                           1999                1998
                                                                           ----                ----
                                                                                  (Unaudited)
<S>                                                                <C>                  <C>
STORE DATA:
    COMPANY-OWNED:
      Stores open at beginning of period                                   207                  117
      Stores opened                                                          7                   12
      Stores closed                                                          -                    -
      Stores acquired from franchisees                                       -                    1
      Stores sold to franchisees                                            --                    -
                                                                           ---                  ---
      Stores open at end of period                                         214                  130
    FRANCHISE:
      Stores open at beginning of period                                   167                  158
      Stores opened                                                          7                    2
      Stores closed                                                          -                    -
      Stores acquired from franchisees                                       -                  (1)
      Stores acquired from Company                                           -                    -
                                                                           ---                  ---
      Stores open at end of period                                         174                  159
                                                                           ===                  ===

    Increase in company-owned same store sales                           15.0%                11.6%
    Increase  in franchise same store sales                              10.4%                10.2%
    Average sales per Company-owned store                                  357                  308

BALANCE SHEET DATA:
    Working capital (deficiency)                                     ($20,993)              $30,187
    Total assets                                                       162,646              100,322
    Bank borrowings and other debt                                      56,500               24,062
    Capital lease obligation                                             1,036                1,381
    Stockholders' equity                                               $43,982              $44,870

</TABLE>

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

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

Quarter Ended March 31, 1999 ("1999 Quarter") Compared to Quarter Ended March
31, 1998 ("1998 Quarter)

Retail. Net sales from Company-owned stores increased 82.2% to $70.4 million for
three months ended March 31, 1999, from $38.7 million for the comparable 1998
Quarter. Same store sales decreased 4.5% in the 1999 Quarter. Gross profit
reflects the cost of goods sold and store occupancy costs including rent, common
area maintenance, real estate taxes, repair and maintenance, depreciation and
utilities. Gross profit for the 1999 Quarter increased 90.3% to $19.2 million
from $10.1 million for the comparable 1998 Quarter. The increase in the 1999
Quarter was primarily due to increased sales volume. Gross margin was 27.3% for
the 1999 Quarter compared with 26.1% for the comparable 1998 Quarter. The
increase in gross margin is related primarily to an increase in discounts and
rebates in the 1999 Quarter due to the size of the organization.

      Store operating and selling expenses increased 86.5% to $20.1 million for
the 1999 Quarter from $10.8 million in the comparable 1998 Quarter. The increase
in store operating expenses is attributable to the increased number of stores
operated by the Company during the 1999 Quarter. Store operating and selling
expenses were 28.5% and 27.8% of sales for the 1999 Quarter and 1998 Quarter,
respectively. Pre-opening expenses in the 1999 Quarter were $182,000 relating to
seven Company-owned stores opened in the quarter compared to pre-opening
expenses of $402,000 incurred in the 1998 Quarter. Company-owned stores recorded
an operating loss of $826,000 for the 1999 Quarter, compared to an operating
loss of



13

<PAGE>   14

$649,000 for the 1998 Quarter. The increased loss was primarily the
result of increased gross margin offset by the increase in pre-opening expenses.

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 seven
store openings were $164,000 for the 1999 Quarter compared to $42,000 for the
comparable 1998 Quarter, which derived from two store openings. Royalty fees
increased 5.5% to $2.1 million in the 1999 Quarter from $2.0 million in the
comparable 1998 Quarter due primarily to an increase in the number of stores.

      Expenses directly related to franchise revenue decreased to $938,000 for
the 1999 Quarter from $941,000 for the 1998 Quarter. As a percentage of
franchise revenue, franchise expenses were 40.9% and 45.6% for the 1999 Quarter
and 1998 Quarter, respectively.

      Franchise profit contribution increased 20.9% to $1.4 million for the 1999
Quarter from $1.1 million for the 1998 Quarter. The increase in franchise profit
contribution is due primarily to higher revenues from the increased number of
franchise stores.

 General and Administrative. General and administrative expenses increased 162%
to $6.2 million in the 1999 Quarter from $2.4 million in the 1998 Quarter. This
increase is attributable in part to $1.2 million in special charges relating to
consulting accounting, banking and other expense resulting from the Company's
refinancing arrangements. In addition, during the 1999 Quarter there was an
increase in corporate expenses primarily attributable to an increase in payroll
and related benefits and increased travel and occupancy costs as a result of
establishing the necessary organizational infrastructure to allow the Company to
maintain the Company-owned store base and for planned future growth. Exclusive
of the $1.2 million in special charges discussed above, general and
administrative expenses were 6.9% and 5.8% of total revenue for the 1999 Quarter
and 1998 Quarter, respectively.

Interest Expense. Interest expense increased 353% to $915,000 for the 1999
Quarter from $202,000 in the comparable 1998 Quarter. The increased expense is
primarily attributable to higher average borrowings outstanding and, to a lesser
extent, higher interest rates.

Income Tax Benefit. The income tax benefit for the 1999 Quarter was $2.0
million, an increase of 146% over the $830,000 benefit in 1998. This increase is
primarily due to the increase in the loss before income tax benefit in the 1999
Quarter.

Net Loss. As a result of the above factors, net loss for the 1999 Quarter was
$4.5 million, or $0.36 per basic and diluted share, as compared to a net loss of
$1.3 million, or $0.10 per basic and diluted share in the 1998 Quarter.

LIQUIDITY AND CAPITAL RESOURCES

      For the 1999 Quarter, cash used in operating activities was $8.5 million,
compared to $18.5 million for the 1998 Quarter. The decrease in cash used in
operating activities was primarily attributable to increases in merchandise
inventory of $8.2 million, other current assets of $214.000, and net loss of
$4.5 million, partially offset by depreciation and amortization of $2.5 million,
deferred rent of $746,000, increases in accounts payable of $7.5 million and
decreases in accrued expenses of $702,000 as well as other net changes in
operating assets and liabilities.

      Cash used in investing activities for the 1999 Quarter was $4.7 million
compared to $4.4 million in the comparable 1998 Quarter. The increase in cash
used in investing activities was primarily attributable to the expanded store
base offset by a decrease in acquisitions.

      Cash provided by financing activities was $9.7 million for the 1999
Quarter compared to $20.1 million in the comparable 1998 Quarter. This amount is
primarily attributable to the increase in borrowings of $9.7 million under the
Credit Agreement.


14

<PAGE>   15

      The Company did not meet certain of its financial and reporting covenants,
including those relating to timely filing of consolidated financial statements,
minimum levels of profitability, net worth, liquidity, fixed charge coverage and
others. Consequently, the Company's debt under the Credit Agreement was subject
to acceleration and is classified as a current liability in the consolidated
balance sheets at March 31, 1999 and December 31, 1998. The Credit Agreement was
secured by all the assets of the Company. Additionally, the Credit Agreement
restricted the payment of dividends.

      Party City's trade vendors representing approximately $36.4 million of
trade debt also entered into an agreement with the Company. Pursuant to a Vendor
Standstill and Forbearance Agreement ("Vendor Forbearance Agreement"), these
trade vendors agreed to forbear from taking any action against Party City until
January 15, 2000. The trade vendors received promissory notes from Party City
totaling approximately $12.2 million representing one-third of their unpaid
balances as of May 1, 1999 (the "Trade Notes"). The Trade Notes bore interest at
a rate of 10% per year and were scheduled to mature on November 15, 1999.
Interest on the Trade Notes was due on January 15, 2000. Substantially all the
remaining two-thirds of the unpaid balances that were due as of May 1, 1999,
were satisfied through individual arrangements with such vendors.

      In order to meet the cash flow requirements of the Halloween seasonal
purchase of inventory and to meet the requirements of the Bank Forbearance
Agreement, the Company identified stores for sale to existing franchisees to
generate working capital. Eighteen stores with a net book value of approximately
$9.8 million were sold to franchisees, of which seventeen stores with a net book
value of approximately $9.4 million were sold in the quarter ended October 2,
1999. In order to facilitate the sale of these stores, franchise fees were
negotiated at lower than normal rates for specific periods. The total proceeds
from the sales of these stores was approximately $9.9 million. Under the Bank
Forbearance Agreement, the net proceeds from the sale of stores was required to
be used to pay down the outstanding borrowings under the Credit Agreement.

      On January 14, 2000, the Company replaced the Credit Agreement with a new
Loan and Security Agreement (the "Loan Agreement") with Congress Financial
Corporation ("Congress"), as lender. 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 will initially be 2.75% per annum
(subject to possible reduction to a margin as low as 2.25% from and after June
30, 2001, based on the Company's pre-tax income and excess availability) or (ii)
at the rate of 3/4% per annum above the prime rate. The term of the Loan
Agreement is three years, and is secured by a lien on substantially all of the
assets of the Company.

      Party City also received $7 million in cash proceeds from the sale to
certain of its existing investors (the "Investor Group") of a new series of
senior secured notes pursuant to a First Amendment (the "First Amendment") to
the Securities Purchase Agreement dated as of August 16, 1999. Pursuant to the
First Amendment, the Company issued $7,000,000 in aggregate principal amount of
its 14.0% Secured Notes due 2002 (the "E Notes"). The E Notes are secured by a
lien on substantially all of the Company's assets.

      The Company used the proceeds from the sale of the E Notes and initial
amounts borrowed under the Loan Agreement (i) to pay off all amounts owing under
its current credit facility, (ii) to pay all amounts owing on the trade notes
issued to certain of its vendors in August 1999 and (iii) to pay the remaining
amounts owed to various seasonal trade vendors for credit extended for inventory
purchased by the Company for the 1999 Halloween, Thanksgiving and Christmas
seasons.

IMPACT OF YEAR 2000 ON THE COMPANY'S COMPUTER OPERATIONS

      The Company prepared for the impact of the arrival of the Year 2000 on its
business. The "Year 2000 Problem" is a term used to describe the problems
created by systems that are unable to accurately interpret dates after December
31, 1999. The Year 2000 Problem created potential risks for the Company,
including the inability to recognize and properly treat dates occurring on or
after January 1, 2000, which may have

15

<PAGE>   16

resulted in computer system failures or miscalculations of critical financial or
operations information.

      As of May 8, 2000, the Company has not incurred any significant business
disruptions as a result of year 2000 issues. However, while no such occurrence
has developed as of the date of this filing, year 2000 issues that may arise
related to material Third Parties may not become apparent immediately and
therefore, there is no assurance that the Company will not be affected by Third
Party noncompliance in the future. The Company will continue to monitor the
issue vigilantly and work to remediate any issues that may arise.

FORWARD-LOOKING STATEMENTS

     This Form 10-Q (including the information incorporated herein by reference)
contains forward-looking statements within the meaning of The Private Securities
Litigation Reform Act of 1995. The statements are made a number of times
throughout the document and may be identified by forward-looking terminology as
"estimate," "project," "expect," "believe," "may," "will," "intend" or similar
statements or variations of such terms. Such forward-looking statements involve
certain risks and uncertainties, and include among others, the following: levels
of sales, store traffic, acceptance of product offerings, competitive pressures
from other party supplies retailers, availability of qualified personnel,
availability of suitable future store locations, schedules of store expansion
plans and year 2000 readiness issues relating to the Company's internal systems
and those of third parties, the ability of the Company to refinance its existing
debt on terms acceptable to it and other factors. As a result of the foregoing
risks and uncertainties, actual results and performance may differ materially
from that projected or suggested herein. Additional information concerning
certain risks and uncertainties that could cause actual results to differ
materially from that projected or suggested may be identified from time to time
in the Company's Securities and Exchange Commission filings and the Company's
public announcements.

PART II OTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES

None.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

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

      (b) No reports on Form 8-K have been filed during the quarter for which
this report has been filed.

16

<PAGE>   17



SIGNATURES

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

                                               PARTY CITY CORPORATION

                                                    By /s/ James Shea
                                              -----------------------
                                                         (James Shea)
                                              Chief Executive Officer

                                              By /s/ Thomas E. Larson
                                              -----------------------
                                                   (Thomas E. Larson)
                                              Chief Financial Officer

                                                By /s/ Linda M. Siluk
                                                ---------------------
                                                     (Linda M. Siluk)
                                             Chief Accounting Officer

Date:  May 16, 2000

17