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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For The Fiscal Year Ended February 1, 2003 OR

For the Transition Period from                               to                              

Commission File Number: 21859

FACTORY CARD & PARTY OUTLET CORP.

(Exact name of registrant as specified in our charter)

2727 Diehl Road, Naperville, IL 60563-2371

(Address of principal executive offices) (Zip Code)

(630) 579-2000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes  ¨  No  x

The aggregate market value of the Common Stock held by non-affiliates of the Registrant as of August 3, 2002 was approximately $8,894,000 computed on the basis of the last reported bid price per share $6.25 of such stock on the Over the Counter Bulletin Board system.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes  x  No  ¨

The number of shares of the Registrant’s Common Stock outstanding as of April 22, 2003 was 1,512,053.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for Factory Card & Party Outlet Corp.’s 2003 Annual Meeting of Stockholders are incorporated by reference into Part III of the Form 10K.

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Factory Card & Party Outlet Corp.

Annual Report on Form 10-K

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CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS

As used herein, unless the context otherwise requires, the “Company,” “we,” “our” or “us” refers to Factory Card & Party Outlet Corp. and our subsidiary. As used herein, the term “fiscal year” refers to the 52 or 53 weeks, as applicable, ending the Saturday nearest to January 31st, unless otherwise noted.

Statements made in this Form 10-K, and in our other public filings and releases, which are not historical facts contain “forward-looking” statements (as defined in the Private Securities Litigation Reform Act of 1995) that involve risks and uncertainties and are subject to change at any time. 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.

The forward-looking statements involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond our control. You are cautioned that these statements are only good at time made and are not guarantees of future performance and that actual results and trends in the future may differ materially.

Factors that could cause actual results to differ materially include, but are not limited to the following:

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PART I

ITEM 1.    BUSINESS

General

Factory Card & Party Outlet Corp. and our subsidiary, Factory Card Outlet of America Ltd. are a specialty retailer offering a wide selection of party supplies, greeting cards, giftwrap, balloons, everyday and seasonal merchandise and other special occasion merchandise at everyday value prices. As of April 22, 2003, we operated 171 stores in 20 states. Based on the published number of stores of our competitors as compiled by various business publications and other publicly available information, we believe we are one of the largest chains of company-owned stores in the party supply, greeting card, and special occasion industry. Our fiscal year ends on the 52 or 53 weeks, as applicable, ending the Saturday nearest to January 31st. We currently have plans to open up to seven additional stores in fiscal 2003. We closed one store in fiscal 2002, three stores in fiscal 2001 and seven stores in fiscal 2000.

Our stores provide customers with a value-oriented, “one-stop” shopping destination for party supply, greeting card and special occasion merchandise for all major holidays and celebratory events, including birthdays, graduations, weddings and baby showers as well as seasonal events including Valentine’s Day, St. Patrick’s Day, Easter, Mother’s Day, Father’s Day, Fourth of July, Halloween, Thanksgiving, Christmas and New Year’s Day and other family, religious and special occasions. Our stores average approximately 12,000 square feet, with approximately 80% of the space devoted to selling space, and are designed to provide ease of shopping within an attractive, spacious and festive environment.

Industry Overview

Traditionally, the retail party supplies business has been fragmented, with consumers purchasing party-related products from party supply stores and designated departments in drug stores, general mass merchandisers, supermarkets and department stores of local, regional and national chains. According to industry sources, the market for party and special occasion merchandise, comprised of party supplies, greeting cards, gift-wrap, and related items, was estimated at $12 billion in sales in 2001.

Proceedings Under Chapter 11 of the Bankruptcy Code and Reorganization

On March 23, 1999, we filed with the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) petitions for reorganization under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”). On March 20, 2002, the Bankruptcy Court confirmed our Amended Plan of Reorganization (the “Plan”) that was filed with the Bankruptcy Court on February 5, 2002. On April 9, 2002 (the “Effective Date”) the Plan of Reorganization became effective and we successfully emerged from Chapter 11.

Certain of the principal provisions of the Plan are as follows:

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We entered into a $40 million secured financing facility with Wells Fargo Retail Finance, LLC, which became effective concurrent with the Plan, to repay the outstanding amounts owed under our debtor in possession revolving financing agreement and fund our obligations under the Plan and our ongoing operations following emergence from bankruptcy.

Copies of the Disclosure Statement of our Amended Joint Plan of Reorganization is attached hereto as Exhibit 2.1 and is incorporated herein by reference.

Business Strategy

Our goal is to become a leading national specialty retailer in the party supply, greeting card, and special occasion industry.

The key elements of our current strategy are as follows:

Merchandise Offering.    We offer a wide selection of greeting cards, giftwrap, balloons, everyday and seasonal party supplies and special occasion merchandise. With over 23,000 SKUs in each of our stores, our stores provide a single destination for a customer’s special occasion product needs. The stores offer product selections for all major holidays and seasonal events, such as Valentine’s Day, St. Patrick’s Day, Passover, Easter, Administrative Assistant’s Day, Mother’s Day, Father’s Day, Grandparent’s Day, Fourth of July, Rosh Hashanah, Halloween, Thanksgiving, Christmas, Hanukkah, Kwanzaa and New Year’s; celebratory events,

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including birthdays, graduations, weddings and baby showers; and other family, religious and special occasions. The following five major product categories comprise our merchandise offering:

Everyday Value Pricing.    Our strategy of everyday value pricing is designed to provide customers with consistent value on purchases. Our stores feature a “power aisle” offering a wide selection of opportunistic buys and manufacturers’ seasonal over-runs, all priced at deep discounts and frequently changed to create continued customer interest.

Attractive, Spacious and Festive Superstore Format.    We have an attractive and festive atmosphere within a spacious “easy to shop” store. The superstores are designed to provide a comfortable and convenient shopping experience, with bright lights and fixtures that offer customers easy access to merchandise. Our average store size is approximately 12,000 square feet.

Targeted Advertising.    We utilize a storewide direct mail program to reach targeted customers and highlight the breadth and value of our merchandise. The direct mail pieces are printed in color and range from four to twelve pages depending on the season. We plan to continue this direct mail program and support all holidays and special events.

Distribution Center and Office Complex.    Our three-story office building and 300,000 square-foot distribution center is on 39 acres. The lease agreement provides for the expansion of the warehouse to 600,000 square feet, as needed. We believe we are one of a few special occasion store chains to have a distribution facility. We believe the distribution facility can provide us with purchasing, inventory management, store operating and distribution efficiencies.

Growth Strategy

Our current growth strategy is to:

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Store Locations.

As of April 22, 2003, we operated 171 stores in 20 states, all of which are leased. Our store leases typically have an average initial term of 10 years with two five-year renewal options. We currently have plans to open up to seven additional stores in fiscal 2003. As of April 22, 2003, we executed three lease agreements to open new stores in Indiana and Illinois during fiscal 2003.

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Set forth below is a list of our store locations by state as of April 22, 2003:

New store sites are selected on the basis of several factors, including physical location, demographic characteristics of the local market, co-tenants, visibility, population density, traffic counts, proximity to superstore competitors, access to highway and other major roadways and available lease terms. We look for co-tenants that are likely to draw customers whom we would otherwise target within the site’s relevant market.

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Product Sourcing

We have historically been able to take advantage of volume purchase discounts due to our size and the use of our distribution center. We purchase our inventory from more than 300 vendors worldwide, with the largest supplier, Amscan, Inc., representing approximately 12% and the ten largest suppliers representing approximately 43% of our aggregate purchases for the fiscal year ended February 1, 2003. Approximately 11% of our merchandise is imported from foreign manufacturers or their agents, principally from the Far East and England. As is customary in our industry, we generally do not have long-term contracts with any suppliers, however, pursuant to the Plan, we entered into agreements with certain trade vendors to provide us with payment terms, including extended payment terms and seasonal advances.

We believe our well-established relationships with overseas suppliers have historically provided us with an advantage over many of our competitors by enabling us to offer an extensive selection of distinctive products at higher gross margins.

Management Information Systems

We believe that our management information systems are an important factor in supporting our business and enhancing our competitive position in the industry. Over the past three years, we have invested significant resources in systems and infrastructure to support our business and make us more efficient. We use a management information and control system, which is based on the JDA Merchandise Management System software package (“JDA”) and supports the complete range of retail cycle functions in the areas of finance, merchandising and distribution. All stores are linked to our headquarters through personal computers, which interface with an IBM AS/400 and provide auto-replenishment of inventory and the ability to enter payroll information and send and receive electronic mail. These personal computers are also tied into our point-of-sale system (“POS system”). The POS system provides sales information to our stores and central office and is used to enhance merchandise planning and buying programs.

Competition

The greeting card, party supply and special occasion industry is highly competitive. We currently compete against a diverse group of retailers, ranging from other party supply and greeting card retailers to designated departments in drug stores, general mass merchandisers, supermarkets and department stores of local, regional and national chains. Major chain competitors in our markets include Party City, Paper Warehouse and Party Concepts. In addition, a trend toward discounting the cost of party supplies and greeting cards is developing and we may encounter additional competition from new entrants or internet vendors in the future. Our stores compete, among other things, on the basis of convenience of location and store layout, product mix, selection, customer convenience and price. Some of our competitors have substantially greater financial resources and experience than us.

Trademarks

We have registered trademarks under the name of “Factory Card & Party Outlet”^®, “Factory Card Outlet”^® and “Partymania”^® and the “Factory Card & Party Outlet”^® design and the “Partymania”^® design on the Principal Register of the United States Patent and Trademark Office.

Government Regulation

Each of our stores must comply with regulations adopted by Federal agencies and with licensing and other regulations enforced by state and local health, sanitation, safety, fire and other departments. More stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors, and difficulties or failures in obtaining the required licenses or approvals, can delay and sometimes prevent, the

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opening of a new store. In addition, we must comply with the Fair Labor Standards Act and various state laws governing various matters such as minimum wage, overtime and other working conditions. We also must comply with the provisions of the Americans with Disabilities Act of 1990, as amended, which requires generally that employers provide reasonable accommodation for employees with disabilities and that stores be accessible to customers with disabilities.

Employees

We have approximately 2,600 employees as of March 1, 2003, comprising approximately 1,100 full-time and approximately 1,500 part-time employees. The number of store employees increases during peak selling seasons. Our employees are not covered by a collective bargaining agreement. We believe relations with our employees are generally good.

Reorganization

On April 9, 2002, we consummated a joint plan of reorganization under Chapter 11 of the Bankruptcy Code pursuant to a February 5, 2002 order entered by the U.S. Bankruptcy Court for the District of Delaware approving our joint plan of reorganization. We have been operating out of bankruptcy since April 9, 2002. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

ITEM 2.     PROPERTIES

In addition to our stores, all of which are leased, we also lease a distribution center in Naperville, Illinois, with the initial lease term expiring in February 2008. We have the option to renew the initial term of the lease for two additional periods of 5 years. This facility consists of a three-story office building and 300,000 square-foot distribution center that sits on 39 acres of land.

The initial term of our store leases range from 5 to 15 years and generally allow us to renew for up to two additional five-year terms. The terms of a majority of the leases, including renewal terms, extend beyond year 2007.

ITEM 3.     LEGAL PROCEEDINGS

We are from time to time involved in routine litigation incidental to the conduct of our business. As of the date of this Annual Report on Form 10-K, we are not aware of any material existing or threatening litigation to which we are or may be a party.

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

Not Applicable.

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PART II

ITEM 5.     MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

We emerged from bankruptcy on April 9, 2002. Pursuant to our plan of reorganization, all of our pre-petition common stock was cancelled and we issued new common stock. Our new common stock began trading on the OTC Bulletin Board, an electronic quotation service for NASDAQ Market Makers on May 30, 2002 under the symbol “FCPO.OB.” The following table sets forth the high and low closing sale prices of our common stock since it began trading on the OTC Bulletin Board on May 30, 2002:

On April 22, 2003, the number of holders of record of the common stock was approximately 517.

Dividends

We have never paid cash dividends on our common stock and we do not intend to pay cash dividends in the foreseeable future. We expect earnings will be retained for the continued development of our business. In addition, our financing facility prohibits us from paying dividends on our capital stock. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations and Liquidity and Capital Resources.”

Unregistered Securities

On April 9, 2002 we emerged from bankruptcy. In connection with our plan of reorganization, we issued the following securities without registration under the Securities Act of 1933 in reliance on Section 1 of the Bankruptcy Code and the Bankruptcy Court order confirming our plan of reorganization:

In addition, prior to expiration in June 2002 of the warrants to purchase 31,000 shares of our common stock granted to management, certain members of management acquired an aggregate of 12,900 shares of our common stock upon exercise of such warrants. This issuance of shares was exempt from the registration requirements of the Securities Act of 1933 pursuant to Section 4(2) of such Act.

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Equity Compensation Plan Information

The following table sets forth information regarding equity compensation plans under which our equity securities were authorized for issuance as of February 1, 2003.

Equity Compensation Plans

ITEM 6.     SELECTED FINANCIAL DATA

The following table sets forth certain selected historical financial data on a consolidated basis. The selected consolidated financial data was derived from the consolidated financial statements of the Company. The selected financial data presented on the next page under the captions “Statement of Operations Data” and “Balance Sheet Data” as of January 30, 1999, January 29, 2000, February 3, 2001 and February 2, 2002 and for the 52-weeks ended January 30, 1999, the 52-weeks ended January 29, 2000, the 53-weeks ended February 3, 2001 and the 52-weeks ended February 2, 2002 are derived from the consolidated financial statements of the Company, which have been audited by KPMG LLP, independent certified public accountants.

The fiscal 2002 data has been separated into the Successor Company 2002 43-weeks ended February 1, 2003 and the Predecessor Company 2002 nine weeks ended April 6, 2002 and is derived from the consolidated financial statements of the Company, which have been audited by Deloitte & Touche LLP, independent certified public accountants. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K.

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SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

(Dollar amounts in thousands, except per share data)

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ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a specialty retailer offering a wide selection of party supplies, greeting cards, giftwrap, balloons, and other special occasion merchandise at everyday value prices. As of April 22, 2003, we operated 171 stores in 20 states. We currently have plans to open up to seven additional stores in fiscal 2003.

Chapter 11 Proceedings and Reorganization

On March 23, 1999, we filed with the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) petitions for reorganization under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”). On March 20, 2002, the Bankruptcy Court confirmed our Amended Plan of Reorganization (the “Plan”) that was filed with the Bankruptcy Court on February 5, 2002. On April 9, 2002 (the “Effective Date”) the Plan of Reorganization became effective and we successfully emerged from Chapter 11.

Juvenile Party Expansion

We have entered into agreements with Party Express by Hallmark and Designware by American Greetings to sell licensed party tableware and accessories. This new assortment will increase the selection of our juvenile party patterns by approximately 30% and increase the selection of licensed party patterns and accessories by more than 150%. We expect to implement this initiative in the first quarter of fiscal year 2003. Additionally, the expected costs of this program will adversely impact our first quarter 2003 results.

Critical Accounting Policies

Critical Accounting Policies are defined as those that are reflective of significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. We have prepared the accompanying financial statements in conformity with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates under different assumptions or conditions. We have identified the following critical accounting policies utilized in the preparation of these financial statements.

Fresh Start Accounting

As is more fully discussed in Note 2—“Fresh Start Accounting” in our Notes to Consolidated Financial Statements, we adopted fresh start accounting pursuant to the American Institute of Certified Public Accountants Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code” (“SOP 90-7”), during the first quarter of fiscal 2002 resulting in a change in the basis of accounting of our underlying assets and liabilities at the Effective Date. Accordingly, our financial statements before and after the Effective Date are not comparable. The operating results for the nine weeks ended April 6, 2002 were significantly impacted by items associated with emerging from bankruptcy including debt forgiveness, restructuring activities and certain changes to record the excess of book value over enterprise value. Upon implementation of fresh start accounting, our total assets and total liabilities and stockholders’ equity were adjusted downward by approximately $17 million.

Merchandise Inventories

As discussed in Note 3 “Summary of Significant Accounting Polices” in the Notes to the Consolidated Financial Statements, merchandise inventories are stated at the lower of average cost or estimated net realizable

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value utilizing the retail method. We perform periodic evaluations of the net realizable value of merchandise, including merchandise which is to be discontinued from our ongoing inventory assortment as well as inventory with excess quantities on hand and certain seasonal inventory remaining from past holidays. Based upon these evaluations, a provision for the excess of inventory cost over the net realizable value is recorded as a reduction to the net inventory balance. At February 1, 2003 and February 2, 2002, we had provisions of $1.5 million and $1.2 million, respectively, for certain merchandise, which is to be discontinued from our ongoing inventory assortment, as well as inventory with excess quantities on hand, and certain seasonal inventory from past holidays.

Prior to our emergence from bankruptcy, we capitalized certain buying and warehousing costs as a component of inventory. As of the emergence date, we discontinued this practice, recording all of the aforementioned costs in cost of sales. Going forward, we do not anticipate that the change will have a significant impact on periodic earnings.

We receive vendor allowances principally as a result of meeting defined purchase levels or promoting vendors’ products. Those received as a result of purchase levels are accrued as a reduction of merchandise purchase price over the incentive period and result in a reduction of cost of sales. Those received for promoting vendors’ products are offset against advertising expense and result in a reduction of selling, general and administrative expenses. Markdown allowances reduce cost of goods sold in the period the related markdown is taken. Placement allowances are offset against incremental expenses incurred and the remainder, if any, over the contract period. In September 2002, the Emerging Issues Task Force (“EITF”) issued 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor”, which addressed the accounting for cash retailers receive from vendors. Our accounting policies relating to cash received from vendors are consistent with the conclusions reached by the EITF.

Results of Operations

The following table sets forth, for the periods indicated, selected statements of operations data expressed as a percentage of net sales and the number of stores open at the end of each period. Effective April 9, 2002, we emerged from Chapter 11 bankruptcy proceedings and implemented fresh-start accounting. Accordingly, all assets and liabilities were restated to reflect their respective fair values. The consolidated financial statements after that date are those of a new reporting entity and are not comparable to pre-confirmation periods. However, for purposes of this discussion, the 43-weeks ended February 1, 2003 (Successor Company) has been combined with the nine weeks ended April 6, 2002 (Predecessor Company) and then compared to the 52-weeks ended February 2, 2002 and the 53-weeks ended February 3, 2001. Differences between periods due to fresh-start accounting adjustments are explained when necessary.

The lack of comparability in the accompanying consolidated financial statements is most apparent in our capital costs (lease, interest, depreciation and amortization), as well as income taxes, debt restructuring and reorganization costs. The following table is included solely for use in comparative analysis of results of operations and to complement management’s discussion and analysis.

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52-Weeks Ended February 1, 2003 (Combined Fiscal 2002) Compared to 52-Weeks Ended February 2, 2002 (Fiscal 2001)

Net Sales.    Net sales decreased $1.4 million, or 0.6%, to $226.5 million in Combined Fiscal 2002 from $227.9 million in Fiscal 2001. Net sales increases in the basic party and gift categories of 3.0% were offset by decreases in all other categories by 3.9%. Comparable store sales increased $0.8 million or 0.4%, which is indicative of a challenging retail environment. No new stores opened in Combined Fiscal 2002 or Fiscal 2001 and one store closed in Combined Fiscal 2002. Three stores closed in Fiscal 2001. Closed store’s sales are excluded from the calculation of comparable store sales in the fiscal month of the store closing.

Gross Profit.    Cost of sales includes merchandise, distribution and occupancy costs. Gross profit decreased $1.0 million, or 1.2%, to $77.1 million in Combined Fiscal 2002 from $78.1 million in Fiscal 2001. The decrease in Gross Profit is primarily due to increases in distribution and occupancy costs of $1.7 million offset by an increase in the mark-on percentage of merchandise available for sale. As a percentage of net sales, gross profit was 34.0% in Combined Fiscal 2002 and 34.2% in Fiscal 2001.

Selling, General and Administrative Expenses.    Selling, general and administrative expenses include store payroll, advertising, and other store operating and corporate administrative expenses. Selling, general and administrative expenses increased $0.8 million, or 1.1%, to $68.1 million in Combined Fiscal 2002 from $67.3 million in Fiscal 2001. The increase is related to increases in store and advertising expenses of $1.0 million offset by decreases in administrative expenses of $0.2 million. As a percentage of net sales, selling, general and administrative expenses increased to 30.0% in Combined Fiscal 2002 from 29.5% in Fiscal 2001.

Depreciation Expense.    Depreciation Expense was $2.5 million in Combined Fiscal 2002 compared to $6.8 million in Fiscal 2001. The decrease is primarily due to the fresh-start adjustment on fixed assets of $11.8 million resulting from the write down of fixed assets for the excess of book value over enterprise value.

Reorganization Items.    Reorganization Items fluctuated $25.5 million in Combined Fiscal 2002 from an expense of $6.7 million in Fiscal 2001 to a gain of $18.8 million for Combined Fiscal 2002. The fluctuation relates to the gain related to the discharge of indebtedness that resulted from the forgiveness of certain liabilities and distribution of ownership in the Reorganized Company in accordance with our Plan of Reorganization offset by fresh-start adjustments. The major components of Reorganization Items are as follows:

The Successor Company did not record any Reorganization Items.

Interest Expense.    Interest expense was $1.7 million in Combined Fiscal 2002 compared to $2.8 million in Fiscal 2001. This decrease resulted from decreased borrowing levels due to lower inventory purchases and an increase in vender terms coupled with lower effective interest rates.

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Income Taxes (Benefit).    We recognized income tax expense of $2.0 million for the 43-weeks ended February 1, 2003 which results in an increase in stockholders’ equity due to our ability to utilize pre-emergence net operating loss benefits. Until the benefits of the net operating loss carry forwards are fully utilized, we do not expect to pay federal income tax. We recognized an income tax benefit of $0.4 million for the nine weeks ended April 6, 2002 which resulted from the cash realization of net operating loss carry backs due the enactment of the Job Creation and Workers Assistance Act of 2002. We did not record any tax expense in Fiscal 2001 and fully reserved for the net deferred tax assets that were accumulating because of the net operating losses.

52-Weeks Ended February 2, 2002 (Fiscal 2001) Compared to 53-Weeks Ended February 3, 2001  (Fiscal 2000)

Net Sales.    Net sales increased $1.8 million, or 0.8%, to $227.9 million in Fiscal 2001 from $226.1 million in Fiscal 2000. Net sales in our candy, party, seasonal and gift categories increased 3.5% while our greeting card, giftwrap and balloon categories declined 4.9%. Comparable store sales increased $11.1 million or 5.1%. No new stores were opened in Fiscal 2001 or Fiscal 2000 and three stores closed in Fiscal 2001. Closed store’s sales are excluded from the calculation of comparable store sales in the fiscal month of the store closing.

Gross Profit.    Cost of sales includes merchandise, distribution and occupancy costs. Gross profit increased $2.7 million, or 3.6%, to $78.1 million in Fiscal 2001 from $75.4 million in Fiscal 2000. As a result of effectively managing our inventory we were able to reduce markdowns, damages and shrinkage by $9.1 million which allowed for the realization of better margins in all sales categories except for cards and balloons. Additionally, a decrease in occupancy costs of $0.4 million was offset by an increase in distribution costs of $1.2 million. As a percentage of net sales, gross profit was 34.2% in Fiscal 2001 and 33.4% in Fiscal 2000.

Selling, General and Administrative Expenses.    Selling, general and administrative expenses include store payroll, advertising, other store operating and corporate administrative expenses. Selling, general and administrative expenses increased $1.7 million, or 2.6%, to $67.3 million in Fiscal 2001 from $65.6 million in Fiscal 2000. The fluctuation is attributable to increases in store and administrative expenses of $2.6 million offset by decreases in advertising costs of $0.9 million. As a percentage of net sales, selling, general and administrative expenses increased to 29.5% in Fiscal 2001 from 29.0% in Fiscal 2000.

Depreciation Expense.    Depreciation expense decreased 5.6% to $6.8 million in Fiscal 2001 from $7.2 million in Fiscal 2000. The decrease was a function of an older fixed asset base.

Reorganization Items.    Reorganization Items decreased $1.3 million in Fiscal 2001 from $8.0 million in Fiscal 2000. The major components of Reorganization Items are as follows:

In Fiscal 2001 we closed and conducted closing sales at three stores that were in markets we did not intend to continue to operate in or were underperforming or unprofitable. During Fiscal 2001, we recorded a provision for reorganization costs relating to these store closings of approximately $0.8 million. This provision included the write-down of fixed assets, estimated lease rejection claims and the loss on the disposition of merchandise inventory. Furthermore, in accordance with Statement of Financial Accounting Standard No. 121 (“SFAS No. 121”), “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of”,  we wrote off $0.7 million of impaired long-lived assets that related to prior year store closings—which is included in Other.

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In Fiscal 2000, we closed and conducted closing sales at seven stores that were in markets we did not intend to continue to operate in or were underperforming or unprofitable. During Fiscal 2000, we recorded a provision for reorganization costs relating to these store closings of approximately $1.6 million. This provision included the write-down of fixed assets, estimated lease rejection claims and the loss on the disposition of merchandise inventory.

Interest Expense.    Interest expense was $2.8 million in Fiscal 2001 compared to $3.3 million in Fiscal 2000. This decrease resulted from lower effective interest rates.

Income Taxes (Benefit).    At the end of Fiscal 2001, management did not believe it was more likely than not that deferred tax assets created by net-operating losses in Fiscal 2001 would be realized through future taxable income. Therefore, we increased our valuation allowance, which was established in Fiscal 1999, to fully reserve for the potential tax benefits resulting from these net-operating losses. As a result, the effective tax rate for Fiscal 2001 and 2000 was zero.

Liquidity and Capital Resources

Our uses of capital for Fiscal 2003 are expected to include working capital for operating expenses and satisfaction of current liabilities, expenditures related to maintaining and refurbishing existing stores, new stores and interest payments on outstanding borrowings.

On April 9, 2002, obligations relating to our debtor-in-possession financing facility were paid in full and our secured financing facility with Wells Fargo Retail Finance, LLC (the “New Loan Agreement”) became effective. The New Loan Agreement, which is a line of credit, currently provides up to $40 million, (including $10 million for letters of credit) to fund working capital needs and for general corporate purposes. Borrowings under the facility are limited by a percent of inventory levels. The New Loan Agreement expires on April 8, 2005 and has a variable interest rate based upon the Prime rate or at our option, a variable rate based upon earnings performance and the London Interbank Offered Rate (“LIBOR”) with a minimum threshold of 5.00%. The interest rate on our borrowings was 5.00% at February 1, 2003. Borrowings under the New Loan Agreement are secured by substantially all of our assets.

The New Loan Agreement contains certain restrictive covenants, which, among other things, require us to maintain certain inventory levels and achieve specified operating results. The restrictive covenants also limit our capital expenditures, asset sales and dividends and our ability to grant liens and incur additional indebtedness.

Pursuant to the Plan of Reorganization, we converted $3.1 million of post petition trade payables into a trade conversion note, which will be payable within four years of the Effective Date. In addition, we recorded at fair value the $2.6 million extended creditor payment payable to the general unsecured creditors. We intend to pay down the trade conversion note within three years of the Effective Date.

As of February 1, 2003, we had $17.5 million in borrowings outstanding under the New Loan Agreement and had utilized approximately $0.4 million to issue letters of credit.

Contractual Obligations

As discussed in Note 3 “Summary of Significant Accounting Polices” in the Notes to the Consolidated Financial Statements, we conduct substantially all of our activities using leased premises. Store and office leases generally provide that real estate taxes, insurance, maintenance, and operating expenses are our obligations. Certain store leases also provide for contingent rentals based on sales in excess of specified minimums.

The approximate cost of fixed assets held under capital leases included in fixed assets was $1.1 million and $7.6 million at February 1, 2003 and February 2, 2002, respectively. Accumulated depreciation related to such fixed assets was approximately $0.2 million and $4.5 million at February 1, 2003 and February 2, 2002, respectively. Fixed assets held under capital leases consist primarily of technology, office and warehouse equipment.

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To facilitate an understanding of our contractual obligations, the following data is provided which summarizes future payments:

Included in Fiscal Year 2003 Debt and Capital Leases is the $17.5 million line of credit agreement with Wells Fargo Retail Finance, LLP.

The following table sets forth certain consolidated statements of cash flows data:

At February 1, 2003 our working capital was $15.1 million. Net cash provided by operating activities in Combined Fiscal 2002 was $12.7 million compared to $0.3 million of net cash used in operating activities during Fiscal Year 2001. The fluctuation is related to improved operating results, decreases in inventory, and increases in accounts payable coupled with our ability to utilize pre-confirmation net operating tax losses in the 43-weeks ended February 1, 2003.

Net cash used in investing activities in Combined Fiscal 2002 and Fiscal Year 2001 was $2.7 million and $1.1 million, respectively. Net cash used in investing activities was primarily for capital expenditures for store remodeling, computer equipment, and warehouse equipment for the distribution center.

Net cash used in financing activities in Combined Fiscal 2002 was $10.0 million compared to $1.3 million net cash provided by financing activities in Fiscal Year 2001. Amounts are attributable to the level of borrowings and repayments.

We do not intend to pay cash dividends in the foreseeable future and under our current Loan Agreement we are restricted from paying dividends on our capital stock.

Our ability to make scheduled payments of principal of, or to pay the interest on, or to refinance, indebtedness or to fund planned capital expenditures, will depend upon future performance, which, in turn, is subject to general economic, financial, competitive and other factors that are beyond our control. Based upon our current level of operations and anticipated growth, we believe that future cash flows from operations, together with available borrowings under the New Loan Agreement, will be adequate to meet anticipated requirements for capital expenditures, working capital, interest payments and scheduled principal payments. There can be no assurance that our business will continue to generate sufficient cash flow from operations in the future to service our debt and make necessary capital expenditures after satisfying certain liabilities arising in the ordinary course of business. If unable to do so, we may be required to refinance all or a portion of our existing debt, sell assets or obtain additional financing. There can be no assurance that any refinancing would be available or that any sales of assets or additional financing could be obtained.

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New Accounting Pronouncements

In June 2001, the FASB (“Financial Accounting Standards Board”) issued SFAS No. 142 “Goodwill and Other Intangible Assets”, which establishes financial accounting and reporting for acquired goodwill and other intangible assets and supercedes Accounting Principles Board Opinion (“APB”) No. 17, “Intangible Assets”. The provisions of SFAS No. 142 are effective for fiscal years beginning after December 15, 2001. As we do not have goodwill recorded in the financial statements, the adoption of SFAS No. 142 during the first quarter of Fiscal 2002 did not have an impact on our financial condition or results of operations.

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) normal use of the asset. We have adopted the provisions of SFAS No. 143 and it did not have a material impact on our consolidated financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long Lived Assets”, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”, although it retains many of the fundamental provisions of that Statement. The provisions of SFAS No. 144 are effective for fiscal years beginning after December 15, 2001, thereby applying to Fiscal 2002. In conjunction with fresh-start reporting, we recorded a $11,760 adjustment to fixed assets to reflect the excess of book value over enterprise value. We have adopted the provisions of SFAS No. 144 and it did not have a material impact on our consolidated financial position or results of operations.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. Specifically, SFAS 145 rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt, an amendment of APB Opinion No. 30” and SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”, as these two standards required that all gains and losses from the extinguishment of debt be aggregated and, if material, classified as an extraordinary item. Consequently, such gains and losses will now be classified as extraordinary only if they meet the criteria for extraordinary treatment set forth in APB Opinion No. 30, “Reporting the Results of Operations— Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.” SFAS No. 145 also rescinds SFAS No. 44 “Accounting for Intangible Assets of Motor Carriers, an amendment of Chapter 5 of ARB No. 43 and an interpretation of APB Opinions 17 and 30”, because the event to which that Statement relates is no longer relevant. SFAS No. 145 amends SFAS No. 13, “Accounting for Leases”, to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as such transactions, and also makes certain technical corrections to a number of existing pronouncements. We were required to adopt this statement due to the application of fresh-start accounting. The effect of this statement on us is that the net gain associated with the plan of reorganization and fresh-start adjustments are reported as a component of operations.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This statement changes the timing of recognition for certain exit costs associated with restructuring activities, so that certain exit costs would be recognized over the period in which the restructuring activities occur. Currently, exit costs are recognized when we commit to a restructuring plan. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002 and could result in us recognizing the cost of future restructuring activities over a period of time as opposed to as a single event.

In September 2002, the Emerging Issues Task Force (“EITF”) issued 02-16 “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” which addresses the accounting for cash retailers receive from vendors. The EITF concluded cash received from a vendor is presumed to be a

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reduction of purchase price of goods unless the vendor receives an identifiable benefit or there is reimbursement of a specific incremental identifiable cost. Additionally, rebates are to be recorded when it is probable and reasonably estimable and allocated to transactions giving rise to the rebate. Our accounting policies relating to cash received from vendors are consistent with the conclusions reached by the EITF.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”—an amendment of FASB Statement 123. SFAS No. 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation” and provides alternative methods for accounting for a change by registrants to the fair value method of accounting for stock-based compensation. Additionally, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require disclosure in the significant accounting policy footnote of both the annual and interim financial statements of the method of accounting for stock-based compensation and the related pro-forma disclosures when the intrinsic value method continues to be used. SFAS No. 148 is effective for fiscal years ended after December 15, 2002, and disclosures are effective for the first quarter beginning after December 15, 2002. We have adopted the disclosure provisions of SFAS No. 148.

Trends, Risks And Uncertainties

In addition to other matters identified or described by us from time to time in filings with the Securities and Exchange Commission, there are several important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or results that are reflected from time to time in any forward-looking statement that may be made by us or on our behalf. Some of these important factors, but not necessarily all of the important factors, are as follows:

Intense competition in our industry could prevent us from increasing or sustaining our revenues and prevent us from achieving or sustaining profitability.

The greeting card, party supply and special occasion retailing business is highly competitive. Increased competition by existing or future competitors may reduce our sales and cause us to incur a loss. As a result of competition from other specialty party supplies and paper goods retailers, we may need to incur additional marketing and promotional expenses to achieve sales growth in our existing stores. Our stores compete with a variety of smaller and larger retailers, including:

Many of our competitors have substantially greater financial and personnel resources than we do. Some of our competitors have been, or may be, funded by certain members of the vendor community. We may encounter additional competition from new entrants in the future in our existing markets. Our competitors may be able to respond more quickly or adjust prices more effectively to take advantage of new opportunities or customer requirements. Increased competition could result in pricing pressures, reduced sales, reduced margins or failure to achieve or maintain widespread market acceptance, any of which could prevent us from increasing or sustaining our revenues and achieving or sustaining profitability.

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Customers’ requirements are likely to evolve, and we will not retain customers or attract new customers if we do not anticipate and meet specific customer requirements and changes in merchandising trends.

Our core operations rely on a stable customer base. Failure to maintain existing customers and obtain new customers will adversely affect our market position.

Our success depends, in part, on our ability to anticipate and respond to changing merchandise trends and consumer demands in a timely manner. Accordingly, any delay or failure by us in identifying and responding to emerging trends could adversely affect consumer acceptance of the merchandise in our stores. If we are required to sell a significant amount of unsold inventory at below average mark-ups over our cost or below cost, such action could have an adverse effect on our financial condition and results of operations.

We make merchandising decisions well in advance of the seasons during which we will sell the merchandise. As a result, if we fail to identify and respond quickly to emerging trends, consumer acceptance of the merchandise in our stores could diminish and we may experience a reduction in revenues. We sell certain licensed products that are in great demand for short time periods, making it difficult to project our inventory needs for these products. Significantly greater or less-than-projected product demand could lead to one or more of the following:

If consumer demand for single-use, disposable party goods were to diminish, the party supplies and paper goods industry and our revenues would be negatively affected. For example, if cost increases in raw materials such as paper, plastic, cardboard or petroleum were to cause our prices to increase significantly, consumers might decide to forgo the convenience associated with single-use, disposable products. Similarly, changes in consumer preferences away from disposable products and in favor of reusable products for environmental or other reasons could reduce the demand for our products.

A continued downturn in the economy may affect consumer purchases of discretionary items, which could reduce our sales.

In general, our sales represent discretionary spending by our customers. Discretionary spending is affected by many factors, including, among others, general business conditions, interest rates, the availability of consumer credit, taxation and consumer confidence in future economic conditions. Our customers’ purchases of discretionary items, including our products, could decline during periods when disposable income is lower or during periods of actual or perceived unfavorable economic conditions. If this occurs, our revenues and profitability will decline. In addition, our sales could be adversely affected by a continued downturn in the economic conditions of the markets in which we operate.

Our business depends on continued good relations with our suppliers.

Our failure to maintain good relationships with our principal suppliers or the loss of our principal suppliers would hurt our business. We purchase our inventory from more than 300 vendors world-wide, with the largest supplier representing approximately 12% and the ten largest suppliers representing approximately 43% of our aggregate purchases in Fiscal 2002. Many of our principal suppliers currently provide us with incentives like volume purchasing allowances and trade discounts. If our suppliers were to reduce or discontinue these incentives, prices from our suppliers would increase and our profitability would be reduced. As is customary in our industry, we generally do not have long-term contracts with any suppliers and any supplier could discontinue selling to us at any time; however, pursuant to our bankruptcy plan of reorganization, we entered into agreements with certain of our trade vendors to provide us with competitive trade terms, including, extended credit limits, extended payment terms and seasonal advances. While we are not aware of any reasons to question the operational or financial ability of such vendors either to ship or provide such terms, the inability of any of such

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vendors to do so could adversely affect our competitive financial performance. Our arrangements with overseas suppliers are subject to risks of doing business abroad, such as import duties, trade restrictions, work stoppages, political instability and other factors which could have an adverse effect on our business.

We may need to raise additional capital to fund our operations and support our long-term growth strategy.

Our ability to make scheduled payments of principal of, or to pay the interest on, or to refinance, indebtedness or to fund planned capital expenditures, will depend upon our future performance, which, in turn, is subject to general economic, financial, competitive and other factors that are beyond our control. Based upon our current level of operations and anticipated growth, we believe that future cash flow from operations, together with available borrowings under our new financing facility, will be adequate to meet our anticipated requirements for capital expenditures, working capital, interest payments and scheduled principal payments. There can be no assurance that our business will continue to generate sufficient cash flow from operations in the future to service our debt and make necessary capital expenditures after satisfying certain liabilities arising in the ordinary course of business. If unable to do so, we may be required to refinance all or a portion of our existing debt, sell assets or obtain additional financing. There can be no assurance that any refinancing would be available or available on favorable terms or that any sales of assets or additional financing could be obtained or obtained on favorable terms. If adequate funds are not available or are not available on acceptable terms, we may be unable to develop or enhance our products and services, implement our long-term growth strategy, take advantage of future opportunities or respond in a timely manner to competitive pressures.

We are substantially leveraged and our financing facility contains covenants that could adversely affect our business.

Our indebtedness restricts our ability to obtain additional financing in the future and, because we may be more leveraged than some of our competitors, may place us at a competitive disadvantage. Also, the financing facility that we entered into as part of our emergence from bankruptcy contains covenants that impose operating and financial restrictions on us. These covenants could adversely affect our ability to finance future operations, potential acquisitions or capital needs or to engage in other business activities that may be in our interest.

The seasonal nature of our business could adversely impact our operations.

Our business is highly seasonal, with operating results varying from quarter to quarter. We have historically experienced higher sales during the second and fourth quarters primarily due to increased demand by customers for our products attributable to special occasions and holiday seasons during these periods. Lower sales than expected by us during this period, a lack of availability of product, or a general economic downturn in sales could have a material adverse effect on our business, financial condition and results of operations for the full year. In addition, the timing of new store openings, related pre-opening expenses and the amount of revenue contributed by new and existing stores may cause our quarterly results of operations to fluctuate. Any or all of these factors could also cause the price of our common stock to decline.

We may not be able to profitably grow our business.

In order to profitably grow our business, we need to increase sales in our existing markets and open additional stores. Opening additional stores in existing markets could reduce sales from our stores located in or near those markets and stores opened in new markets may not be profitable. In addition, the opening of additional stores could put additional strain on our existing store base to leverage the new stores’ fixed cost structure.

We may not be able to effectively execute our long-term growth strategy.

Our long-term growth strategy requires effective planning and management. Once a new geographic market is identified, we must obtain suitable store sites on acceptable terms. Also, the competitive and merchandising

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challenges we face in new geographic markets may be different from the challenges we face in our existing geographic markets. We may have to adapt to regional tastes and customs and compete against established and familiar local businesses with innovative or unique techniques for marketing party supplies and paper goods. Entering new markets may also place significant demands on our management, financial controls, operations and information systems. This may cause us to incur higher costs relating to marketing and operations. Expansion will require an increase in our personnel, particularly store managers and sales associates, to operate our new stores.

Higher administrative expenses could adversely affect our business and operations.

Higher selling, general and administrative expenses occasioned by the potential need for additional advertising, marketing, administrative or management information systems expenditures could negatively impact our business and operations.

Adverse publicity could adversely affect our business.

We generally operate in medium sized towns and suburban neighborhoods. Adverse publicity or news coverage relating to us could negatively impact our efforts to establish and promote name recognition and a positive image.

If we do not comply with the numerous laws and regulations that govern our business, our business could be harmed.

Each of our stores must comply with regulations adopted by Federal agencies and with licensing and other regulations enforced by state and local health, sanitation, safety, fire and other departments. More stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors, and difficulties or failures in obtaining the required licenses or approvals, can delay and sometimes prevent, the opening of a new store. In addition, we comply with the Fair Labor Standards Act and various state laws governing various matters such as minimum wage, overtime and other working conditions. We also comply with the provisions of the Americans with Disabilities Act of 1990, as amended, which requires generally that employers provide reasonable accommodation for employees with disabilities and that stores be accessible to customers with disabilities. We believe that the procedures currently in effect at our stores are in general compliance with such laws and regulations. However, future violations of such laws, the enactment of stricter laws or regulations or the implementation of more aggressive enforcement policies could adversely affect our operations or financial condition.

If we are unable to hire additional qualified personnel or retain existing personnel, we may not be able to operate our business successfully.

Our success depends upon the efforts of our senior management and other key personnel. The loss of the services of any member of our management team or a key employee, or a failure to timely retain a replacement officer could have a material adverse effect on us. Our future success will also depend in part on attracting and retaining quality employees. Many of our employees are in entry level or part-time positions with historically high rates of turnover. Our ability to meet our labor needs while controlling costs is subject to external factors, such as unemployment levels, minimum wage legislation and changing demographics. There can be no assurance that we will be successful in retaining our existing key personnel or in attracting and retaining additional employees we may require. Any difficulties in obtaining, retaining and training qualified personnel could have a material adverse effect on us.

Interruption or obsolescence of our management information systems could have a negative effect on our competitive ability and our business generally.

We believe that our management information systems are an important factor in supporting our business and enhancing our competitive position in the industry. Over the past three years, we have invested significant

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resources in systems and infrastructure to support our business and make it more efficient. We use a management information and control system, which is based on the JDA Merchandise Management System software package (“JDA”) and supports the complete range of retail cycle functions in the areas of finance, merchandising and distribution. All stores are linked to our headquarters through personal computers, which interface with an IBM AS/400 and provide auto-replenishment of inventory and the ability to enter payroll information and send and receive electronic mail. These personal computers are also tied into our point-of-sale system (“POS system”). The POS system provides sales information to our stores and central office and is used to enhance merchandise planning and buying programs. Any obsolescence or continuing interruption in the functioning of these systems could have a negative effect on our ability to compete effectively in the industry and on our business.

Our trade conversion notes, warrants and stock options may have significant dilutive effects on holders of common stock generally.

In connection with our bankruptcy plan of reorganization, we issued trade conversion notes in an aggregate amount equal to $3.13 million to certain of our trade creditors which will be payable on the fourth anniversary of April 9, 2002. The trade conversion notes are convertible at the option of the holders into an aggregate of up to 29.35% of our common stock outstanding (including for such calculation common stock, warrants and options issued pursuant to our bankruptcy plan and assuming the conversion of all such trade conversion notes) at any time between April 9, 2005 and April 9, 2006, subject to adjustments to reflect any prepayments made by us. Although we currently intend to and anticipate paying such notes, failure to meet our projected financial performance could prevent us from making such payments in which event then-existing holders of common stock may be significantly diluted by a conversion of the trade conversion notes.

Pursuant to our bankruptcy plan of reorganization, we also issued four series of warrants to holders of our old pre-bankruptcy common stock to purchase up to approximately 10% (subject to certain dilution events) of the common stock issued under the bankruptcy plan (assuming exercise of all such warrants). These four series of warrants are exercisable for terms ranging from four to eight years.

We currently have stock option plans pursuant to which we have the authority to issue options to our employees and directors for up to 316,667 shares of our common stock. As of April 22, 2003, there were options issued to purchase 235,000 shares of our common stock outstanding with a weighted average exercise price of $7.26 per share. We adopted the 2003 Equity Incentive Plan on January 27, 2003, subject to stockholder approval at our 2003 Annual Meeting of Stockholders. Under this plan, 250,000 shares of common stock would be available for the settlement of certain types of awards.

The issuance of shares of common stock pursuant to the conversion of the trade conversion notes, the exercise of the four series of warrants, the exercise of stock options, and the antidilution rights protection of the warrants issued to management could significantly dilute the holders of common stock currently issued and outstanding.

Certain provisions of our charter may prevent or delay a change of control of the Company.

Our certificate of incorporation provides for a classified Board of Directors. Any effort to obtain control of our Board of Directors by causing the election of a majority of the board of directors may require more time than would be required without a staggered election structure. Our certificate of incorporation also imposes restrictions on the direct or indirect transferability of our common stock for a period of two (2) years following April 9, 2002, subject to certain exceptions, such that no person or certain groups of persons (x) may acquire or accumulate five percent (5%) or more (as determined under tax law principles governing the application of Section 382 of the Internal Revenue Code of 1986, as amended) of the common stock or (y) who, upon implementation of the Plan, owns 5% or more of the common stock, may acquire additional common stock. These provisions would have the effect of preventing a change of control for the duration of such restrictions.

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Financial information related to our post-emergence operations is limited, and, therefore, it is difficult to compare post-emergence financial information with that of prior periods.

Since we emerged from bankruptcy on April 9, 2002, there is limited operating and financial data available from which to analyze our operating results and cash flow. As a result of fresh-start reporting, it is difficult to compare information reflecting our results of operations and financial condition after our emergence from bankruptcy to the results of prior periods. See “Selected Financial Data.”

Our stock price may be volatile and could decline.

Since the effective date of our bankruptcy restructuring, our common stock has had limited trading activity on the over the counter bulletin board. We cannot predict the extent to which investor interest in our stock will lead to the development of a more active trading market, how liquid that market might become or whether it will be sustained. The trading price of our common stock could be subject to wide fluctuations due to the factors discussed in this risk factors section and elsewhere in this document, including:

In addition, the stock markets in general have experienced extreme price and volume fluctuations. These broad market and industry factors may decrease the market price of our common stock, regardless of our actual operating performance.

We do not anticipate paying dividends.

We have not paid dividends on our common stock and we do not anticipate paying dividends in the foreseeable future. We intend to retain future earnings, if any, to finance the expansion of our operations and for general corporate purposes, including future acquisitions. In addition, our financing facility prohibits us from paying dividends on our capital stock.

ITEM 7a.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

We are subject to market risks from changes in interest rates. The interest rate on our revolving credit facilities, which represents a significant portion of our outstanding debt, is variable based upon earnings performance, the LIBOR and the prime rate with a minimum threshold of 5.00%. A hypothetical 10 percent increase to the average interest rate under the credit facilities applied to the average outstanding balance during the nine week period ended April 6, 2002 and the 43-week period ended February 1, 2003 would not have had a material impact on our financial position or results of operations.

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The response to this item is submitted as a separate section of this Report commencing on page F-1 and is incorporated by reference.

ITEM 9.     CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND

                   FINANCIAL DISCLOSURE

Items to be included in Item 9 are incorporated by reference to the Company Current Report on Form 8-K as filed on June 13, 2002.

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PART III

In accordance with general instruction G(3) of Form 10-K, except as set fourth below, the information called for by Items 10, 11, 12 and 13 of Part III is incorporated by reference to our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders.

PART IV

ITEM 14.     CONTROLS AND PROCEDURES

Based on their most recent evaluation, which was completed within 90 days of the filing of this Form 10-K, our Chief Executive and Chief Financial Officers believe our disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) are effective in timely alerting our management to material information required to be included in the Form 10-K and other Exchange Act filings.

There were no significant changes in our internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation, and there were no significant deficiencies or material weaknesses which required corrective actions.

ITEM 15.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) List of Documents filed as part of this Report on Form 10-K.

1. The following financial statements are filed as a separate section of this Report commencing on page F-1.

Independent Auditors’ Reports

Consolidated Balance Sheets as of February 1, 2003 (Successor Company) and February 2, 2002 (Predecessor Company)

Consolidated Statements of Operations for the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002, the 52-weeks ended February 2, 2002 and the 53-weeks ended February 3, 2001 (Predecessor Company)

Consolidated Statements of Stockholders’ Equity (Deficit) for the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002, the 52-weeks ended February 2, 2002 and the 53-weeks ended February 3, 2001 (Predecessor Company)

Consolidated Statements of Cash Flows for the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002, the 52-weeks ended February 2, 2002 and the 53-weeks ended February 3, 2001 (Predecessor Company)

Notes to Consolidated Financial Statements

2. Financial Statement Schedules

The following financial statement schedule is filed as a separate section of this Report commencing on page S-1.

Independent Auditors’ Report

Condensed Financial Information of Factory Card & Party Outlet Corp.—Balance Sheets as of February 1, 2003 (Successor Company) and February 2, 2002 (Predecessor Company)

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Condensed Financial Information of Factory Card & Party Outlet Corp.—Statements of Operations for the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002, the 52-weeks ended February 2, 2002 and the 53-weeks ended February 3, 2001 (Predecessor Company)

Condensed Financial Information of Factory Card & Party Outlet Corp.—Statements of Cash Flows for the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002, the 52-weeks ended February 2, 2002 and the 53-weeks ended February 3, 2001 (Predecessor Company)

Notes to Condensed Financial Information of Factory Card & Party Outlet Corp.

3. Exhibits.

The exhibits listed in the accompanying Index to Exhibits are filed or incorporated by reference as part of this Annual Report on Form 10-K.