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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For The Fiscal Year Ended January 31, 2004 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

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The aggregate market value of the Common Stock held by non-affiliates of the Registrant as of August 2, 2003 was approximately $20,466,000 computed on the basis of the last reported bid price per share $8.25 of such stock on the NASDAQ National Market. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

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 14, 2004 was 3,074,082.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for Factory Card & Party Outlet Corp.’s 2004 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. Unless otherwise required by applicable securities laws, the Company assumes no obligation to update its forward-looking statements to reflect subsequent events or circumstances.

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, gifts, seasonal merchandise and other special occasion merchandise at everyday value prices. As of April 14, 2004, we operated 179 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. Fiscal 2003 is the period February 2, 2003 to January 31, 2004. Fiscal 2002 is the period February 3, 2002 to February 1, 2003 and fiscal 2001 is the period February 4, 2001 to February 2, 2002. We opened six new stores in fiscal 2003 and we currently have plans to open up to ten additional stores in fiscal 2004. These are the first store openings in over five years. We did not close any stores in fiscal 2003, closed one store in fiscal 2002, and closed three stores in fiscal 2001.

Our stores provide customers with a value-oriented, “one-stop” shopping solution 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.

On September 10, 2003, we announced a two-for-one stock split effective October 21, 2003 for holders of record on October 7, 2003. Accordingly, data related to our Common Stock (number of shares, average shares outstanding and earnings per share) have been adjusted for the prior periods subsequent to emergence to reflect the impact of this stock split.

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 $14 billion in sales in 2002.

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 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. Borrowings under this agreement are secured by substantially all of our assets.

Business Strategy

Our goal is to become a leading national specialty retailer and top of the mind customer solution in the party supply, greeting card, and special occasion industry through merchandising innovation, value orientation and controlled growth.

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 solution 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 and New Year’s; celebratory events, including

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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. We have also used radio advertising to support selected major holiday selling seasons.

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.

Store Locations.

As of April 14, 2004, we operated 179 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 ten additional stores in fiscal 2004. We were happy to announce the opening of six new stores in fiscal 2003. These new store openings were the first in five years.

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Set forth below is a list of our store locations by state as of April 14, 2004:

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 20% and the ten largest suppliers representing approximately 47% of our aggregate purchases for the fiscal year ended January 31, 2004. Approximately 9% 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 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, dollar stores and department stores of local, regional and national chains. Major chain competitors in our markets include Party City, Party America and Party Concepts. We also compete with internet and catalog businesses with similar merchandise and product offerings. In addition, a trend toward discounting the cost of party supplies and greeting cards has developed 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”^®, “Partymania”^®, 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 2,400 employees as of April 14, 2004, comprising approximately 1,100 full-time and approximately 1,300 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 an additional period 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 10 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

On March 3, 2004, Midwest One Distribution Company filed a lawsuit against us in the Circuit Court of the Eighteen Judicial Circuit of DuPage County, Illinois, captioned Midwest One Distribution Co. vs. Factory Card & Party Outlet Corp. and Factory Card Outlet of America, Ltd. The lawsuit alleges that we breached a distribution agreement between the parties that terminated on January 31, 2004 by failing to pay certain invoices from Midwest One for certain services and/or expenses allegedly performed or incurred by Midwest One. Midwest One seeks damages of approximately $4.8 million and an accounting of all distribution services for which Midwest One was entitled to compensation under the distribution agreement. We believe that we have meritorious defenses and counterclaims and intend to pursue them vigorously.

Additionally, 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 other 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

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.” In November 2003 the symbol for our Common Stock was changed to “FCPO” as a result of the re-listing on the NASDAQ National Market. The following table sets forth the high and low closing sale prices of our Common Stock as reported on the NASDAQ National Market for the periods indicated.

On April 14, 2004, the number of holders of record of the Common Stock was approximately 460.

On September 10, 2003, we announced a two-for-one stock split effective October 21, 2003 for holders of record on October 7, 2003. Accordingly, data related to our Common Stock price has been adjusted to reflect the impact of this stock split.

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:

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In addition, prior to expiration in June 2002 of the warrants to purchase 62,000 shares of our Common Stock granted to management, certain members of management acquired an aggregate of 25,800 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.

ITEM 6.     SELECTED FINANCIAL DATA

The following table sets forth certain selected historical financial data that was derived from the consolidated financial statements of the Company. The selected financial data presented under the captions “Statement of Operations Data” and “Balance Sheet Data” as of January 31, 2004, February 1, 2003 and April 6, 2002 and for the 52-weeks ended January 31, 2004, the 43-weeks ended February 1, 2003 and the Nine weeks ended April 6, 2002 are derived from the consolidated financial statements of the Company, which have been audited by Deloitte & Touche LLP, independent certified public accountants.

The selected financial data presented on the next page under the captions “Statement of Operations Data” and “Balance Sheet Data” as of February 2, 2002, February 3, 2001 and January 29, 2000 and for the 52-weeks ended February 2, 2002, the 53-weeks ended February 3, 2001 and the 52-weeks ended January 29, 2000 are derived from the consolidated financial statements of the Company, which have been audited by KPMG 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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Overview

We are a specialty retailer offering a wide selection of party supplies, greeting cards, giftwrap, gifts, balloons, and other special occasion merchandise at everyday value prices. As of April 14, 2004, we operated 179 stores in 20 states. We currently have plans to open up to ten additional stores in fiscal 2004. Please note all Company filings with the Securities & Exchange Commission can be viewed by visiting our website under Press Releases at www.factorycard.com.

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

In fiscal 2003 we entered into agreements with Party Express by Hallmark and Designware by American Greetings to sell licensed party tableware and accessories. This new assortment has increased the selection of our juvenile party patterns by approximately 30% and increased the selection of licensed party patterns and accessories by more than 150%. We believe this new assortment puts us in a favorable position to compete in the expanding market of juvenile party.

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 3— “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.

Revenue Recognition

Revenues include the selling price of party goods sold, net of returns and discounts, and are recognized at the point of sale. We estimate returns based upon historical return rates and such amounts have not been significant.

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Impairment of Long-Lived Assets

We adopted Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets in fiscal 2002, which requires that long-lived assets be measured at the lower of carrying amount or fair value less cost to sell. The adoption of SFAS No. 144 did not have a material impact on our consolidated results of operations in 2002.

We review each store for impairment indicators annually, considering operating results and cash flows. We are not aware of any impairment indicators for any of our stores at January 31, 2004.

Merchandise Inventories

As discussed in Note 4 “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 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 January 31, 2004 and February 1, 2003, we had reserves of $1.1 and $1.5 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 rebates retailers receive from vendors. Our accounting policies relating to cash received from vendors are consistent with the conclusions reached by the EITF.

Liabilities for Insurance Claims

Provision for these losses to the extent not insured are recorded based upon our estimated losses for claims incurred. The provisions are based upon our historical cost.

Income Taxes

Historically, we have not recognized an income tax benefit for our losses. We have recorded a valuation allowance to fully reserve for the value of the net deferred tax assets that existed upon emergence from bankruptcy. This allowance on pre-emergence deferred tax assets is necessary, as the utilization of our net loss carryforwards is dependent upon sufficient future taxable income. Under fresh start accounting, reversals of valuation reserves recorded against deferred tax assets that existed as of the emergence date will result in an increase to paid-in capital. Consequently, we will recognize cash tax savings in the year of asset recognition without the corresponding benefit to income tax expense.

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We have recorded new deferred tax assets since emergence from bankruptcy. We believe we will realize the benefit of new net deferred tax assets in future periods and therefore have not recorded a valuation allowance on these new deferred tax assets.

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 January 31, 2004 and the 52-weeks ended February 2, 2002. 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.

52-Weeks Ended January 31, 2004 (Fiscal 2003) Compared to 52-Weeks Ended February 1, 2003 (Combined Fiscal 2002)

Net Sales.    Net sales decreased $3.9 million, or 1.7%, to $222.6 million in Fiscal 2003 from $226.5 million in Combined Fiscal 2002. Fiscal 2003 net sales include 171 stores that were open at the beginning of the year plus six stores opened during the second half of the fiscal year. The six new stores contributed $1.5 million in net sales and were the first new store openings in five years. Sales in the Basic Party and Seasonal category experienced an overall increase in sales as we rolled out the expanded party initiative and offered a wider assortment of seasonal Halloween merchandise. However, the other five categories experienced a decrease in sales. Comparable store sales decreased $4.5 million or 2.0%. Because of the timing of store openings in Fiscal 2003, the new stores were excluded from the calculation of comparable store sales. We include stores opened 13 or 14 months after their opening date in the calculation of comparable store sales. Declines in sales were attributable to a highly competitive and promotional retail environment and the effect of a softening economy.

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Gross Profit.    Cost of sales includes merchandise, distribution and occupancy costs. Gross profit increased $0.2 million, or 0.2%, to $77.3 million in Fiscal 2003 from $77.1 in Combined Fiscal 2002. The increase in Gross Profit is primarily due to an increase in the mark-on percentage of merchandise available for sale and decrease in distribution costs of $0.3 million partially offset by declining sales volume and an increase in occupancy costs of $0.4 million. As a percentage of net sales, gross profit was 34.7% in Fiscal 2003 and 34.0% in Combined Fiscal 2002.

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 $3.8 million, or 5.6%, to $71.9 million in Fiscal 2003 from $68.1 million in Combined Fiscal 2002. The increase is related to additional advertising expenses of $2.7 million as we attempted to drive sales in a difficult retail environment coupled with $1.1 million increase in corporate administrative expenses related to higher insurance costs, the listing on NASDAQ, professional fees as well as additional staff to support the new store openings. As a percentage of net sales, selling, general and administrative expenses increased to 32.3% in Fiscal 2003 from 30.0% in Combined Fiscal 2002.

Depreciation Expense.    Depreciation Expense was $2.0 million in Fiscal 2003 compared to $2.5 million in Combined Fiscal 2002. 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.    We did not recognize any reorganization items in Fiscal 2003 compared to $18.8 million gain in Combined Fiscal 2002. No reorganization items have been recorded since we emerged from bankruptcy in April 2002. See discussion of reorganization items related to Combined Fiscal 2002 in the following section.

Interest Expense.    Interest expense was $1.2 million in Fiscal 2003 compared to $1.7 million in Combined Fiscal 2002. This decrease resulted from decreased borrowing levels due to lower inventory purchases and in increase in vendor terms.

Income Taxes (Benefit).    We recognized income tax expense of $0.9 million in Fiscal 2003 compared to income tax expense of $1.6 in Combined Fiscal 2002. Amounts booked after emergence from bankruptcy represent approximately 40% of pre-tax income for the period described. Due to the fact we are able to use pre-emergence net operating losses, we did not pay federal income tax and the expense recorded in each period resulted, net of the impact of deferred taxes, in a direct increase to stockholders’ equity. 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 carrybacks due to the enactment of the Job Creation and Workers Assistance Act of 2002.

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 stores’ 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

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increase in the mark-on percentage on 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 vendor terms coupled with lower effective interest rates.

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 to 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.

Liquidity and Capital Resources

Our uses of capital for Fiscal 2004 are expected to include working capital for operating expenses and satisfaction of current liabilities, expenditures related to maintaining and refurbishing existing stores, opening new stores, the required prepayment of the Trade Conversion Note and extended creditor payment and interest

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payments on outstanding borrowings. Historically, these cash requirements have been met through cash flow from operations and borrowings under our credit facility.

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

At January 31, 2004 our working capital was $15.1 million. Net cash provided by operating activities in Fiscal 2003 was $10.6 million compared to $12.7 million of net cash provided by operating activities during Combined Fiscal 2002. The decrease is related to fluctuations in inventory and accounts payable balances coupled with lower levels of operating income.

Net cash used in investing activities was $2.7 million in both Fiscal 2003 and Combined Fiscal 2002. Net cash used in investing activities was primarily for capital expenditures for store remodeling, computer equipment, and warehouse equipment for the distribution center. Additionally, we used approximately $0.9 million for furniture and fixtures and leasehold improvements relating to the new store openings in Fiscal 2003.

Net cash used in financing activities in Fiscal 2003 was $7.9 million compared to $10.0 million used in financing activities in Combined Fiscal 2002. Amounts are attributable to the level of borrowings and repayments.

We are party to a secured financing facility, dated April 8, 2002, with Wells Fargo Retail Finance, LLC (as amended, the “Loan Agreement”). The Loan Agreement, which is a line of credit expiring on April 8, 2007, currently provides up to $30 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. At April 14, 2004, the interest rate on our borrowings was 4.0%. Borrowings under the Loan Agreement are secured by substantially all of our assets.

The Loan Agreement contains certain restrictive covenants, which, among other things, require us to 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.

In April 2003, we paid $0.2 million in interest to the Trade Participants of the Trade Conversion Notes. Additionally, on March 17, 2004, we elected to prepay, net of discount, a portion of the Trade Conversion Notes and extended creditor payment. The payment made on March 17, 2004 was $1.1 million.

Both the Trade Conversion Note and extended creditor payment are subject to prepayment provisions if our average excess availability on the Loan Agreement exceeds $12 million during the prior fiscal year. In such event, 40% of the excess availability greater than $12 million shall be paid, subject to certain maximum payment amounts, on a pro rata basis to the Trade Conversion Note holders and general unsecured creditors related to the extended creditor payable. Based upon our average excess availability during Fiscal 2003, we are subject to the maximum prepayment amount of $0.7 million, which is due May 31, 2004.

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As of January 31, 2004, we had $9.8 million in borrowings outstanding under the Loan Agreement and had utilized approximately $1.4 million to issue letters of credit.

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 Loan Agreement, will be adequate for the next twelve months 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.

Contractual Obligations

As discussed in Note 4 “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, common area 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 at January 31, 2004 and February 1, 2003. Accumulated depreciation related to such fixed assets was approximately $0.4 million and $0.2 million at January 31, 2004 and February 1, 2003, respectively. Fixed assets held under capital leases consist primarily of technology, office and warehouse equipment.

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

Included in Fiscal Year 2004 Debt & Capital Leases is the $9.8 million in borrowings outstanding under the Loan Agreement at January 31, 2004.

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Off-Balance Sheet Arrangements

We have not created, and are not party to, any special-purpose or off-balance sheet entities for the purposes of raising capital, incurring debt or operating our business. We do not have any off-balance sheet arrangements or relationships with entities that are not consolidated into our financial statements that are reasonably likely to materially affect our liquidity or the availability of capital resources.

New Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“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 or intangible assets 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 consolidated financial position 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 the nine weeks ended April 6, 2002.

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

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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. There were no exit activities in Fiscal 2003.

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 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 November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements of Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). FIN 45 requires the recognition of a liability for certain guarantee obligations issued or modified after December 31, 2002. FIN 45 also clarifies disclosure requirements to be made by a guarantor of certain guarantees. The disclosure provisions of FIN 45 were effective for fiscal years ending after December 15, 2002. We adopted the disclosure provisions and the accounting requirements of FIN 45 as of February 1, 2003 and it did not have an impact of our consolidated financial position or results of operations.

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.

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 addresses how to identify variable interest entities and provides guidance as to how a company may assess its interest in a variable interest entity for purposes of deciding whether consolidation of that entity is required. FIN 46 is effective for all variable interest entities created after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim period or annual period beginning after June 15, 2003. However, in October 2003, the FASB deferred the effective date of FIN 46 to the end of the first interim or annual period ending after December 15, 2003 for those arrangements involving special purpose entities entered into prior to February 1, 2003. All other arrangements with the scope of FIN 46 are subject to its provisions beginning in 2004. Additionally the FASB issued Interpretation No. 46R, “Consolidation of Variable Interest Entities—A Modification of FASB Interpretation No. 46”, which amends Interpretation No. 46. As we do not have any interests in a variable interest entity, the adoption of this provision did not have an impact on our consolidated financial position or results of operations.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The statement is effective for contracts entered into or modified after June 30, 2003. As we have not entered into any such agreements after June 30, 2003, the adoption of this provision did not have an impact on our consolidated financial position or results of operations.

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In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. As we have not issued any financial instruments which meet this criteria, the adoption of this provision did not have an impact on our consolidated financial position or results of operations.

In December 2003, the FASB issued SFAS No. 132 (revised 2003), “Employers Disclosures about Pensions and Other Postretirement Benefits” to improve financial statement disclosures for defined benefit plans. SFAS 132 requires more detailed disclosures about plan assets, benefit obligations, cash flows, benefit costs and other relevant information. The disclosures are generally effective for fiscal years ending after December 31, 2003. As we do not offer Pension and Other Postretirement Benefits as described under SFAS 132, the adoption of this provision did not have an impact on our consolidated financial position or results of operations.

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 20% and the ten largest suppliers representing approximately 47% of our aggregate purchases in Fiscal 2003. 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,

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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 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 best 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 these periods, 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 new stores could put additional strain on our existing infrastructure and may limit our ability to effectively leverage our fixed cost.

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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 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.

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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 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. In April 2003, we made an interest payment of $188 to the Trade Participants of the Trade Conversion Notes. Additionally, we made a $1.0 million prepayment, net of discount, to one of the Trade Participants on March 17, 2004. These prepayments reduced the percentage of Common Stock that can be converted into our Common Stock outstanding to 21.1%.

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 1,133,334 shares of our Common Stock. As of April 14, 2004, there were options issued to purchase 702,150 shares of our Common Stock outstanding with a weighted average exercise price of $4.55 per share.

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, subject to certain exceptions, such that

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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.

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. 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 the prime rate or LIBOR. A hypothetical 10 percent increase to the average interest rate under the credit facilities applied to the average outstanding balance during the 52-week week period ended January 31, 2004 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.

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Previously disclosed in our Current Report on Form 8-K filed with the Securities and Exchange Commission on June 13, 2002.

ITEM 9A.     CONTROLS AND PROCEDURES

As required by Rule 13a-15(b), our management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report. As required by Rule 13a-15(d), our management, including the Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of our internal control over financial reporting to determine whether any changes occurred during the fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based upon that evaluation, there has been no such change during the fourth fiscal quarter.

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.

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PART III

Pursuant to Paragraph G(3) of the General Instructions to Form 10-K, portions of the information required by Part III of Form 10-K are incorporated by reference from our Proxy Statement to be filed with the Securities and Exchange Commission in connection with the 2004 Annual Meeting of Stockholders (the Proxy Statement”).

ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information concerning directors, including our audit committee financial expert, appears in our Proxy Statement under “Election of Directors.” This portion of the Proxy Statement is incorporated herein by reference.

Information concerning Executive Officers appears in our Proxy Statement under “Management.” This portion of the Proxy Statement is incorporated herein by reference.

Information concerning Section 16(a) beneficial ownership reporting compliance appears in our Proxy Statement under “Security Ownership of Certain Beneficial Owners and Management.” This portion of the Proxy Statement is incorporated herein by reference.

We have adopted the Standards of Business Conduct, a code of ethics with which every person who works for us is expected to comply. For anyone that would like to receive a copy of our Standards of Business Conduct please contact our Corporate Secretary at: Factory Card & Party Outlet Corp., 2727 Diehl Road, Naperville, Illinois 60563. If any substantive amendments are made to the Standards of Business Conduct or grant any waiver, including any implicit waiver, from a provision of the code to our Chief Executive Officer or Chief Financial Officer, we will disclose the nature of such amendment or waiver in a report on Form 8-K.

ITEM 11.    EXECUTIVE COMPENSATION

Information concerning executive compensation appears in our Proxy Statement under “Executive Compensation and Related Information.” This portion of the Proxy Statement is incorporated herein by reference.

Information concerning the security ownership of certain beneficial owners and management and related stockholder matters appears on our Proxy Statement under “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information.” This portion of the Proxy Statement is incorporated herein by reference.

ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information appearing in our Proxy Statement under the heading “Certain Relationships and Related Transactions” is incorporated herein by reference.

ITEM 14.    PRINCIPAL ACCOUNTING FEES AND SERVICES

Information concerning principal accounting fees and services and the audit committee’s preapproval

policies and procedures appear in our Proxy Statement under the heading “Fees Paid to Independent Auditors for Fiscal 2003 and 2002” and is incorporated herein by reference.

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PART IV

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 January 31, 2004 and February 1, 2003

Consolidated Statements of Operations for the 52-weeks ended January 31, 2004, the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002 and the 52-weeks ended February 2, 2002 (Predecessor Company)

Consolidated Statements of Stockholders’ Equity (Deficit) for the 52-weeks ended January 31, 2004, the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002 and the 52-weeks ended February 2, 2002 (Predecessor Company)

Consolidated Statements of Cash Flows for the 52-weeks ended January 31, 2004, the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002 and the 52-weeks ended February 2, 2002 (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 January 31, 2004 and February 1, 2003 (Successor Company)

Condensed Financial Information of Factory Card & Party Outlet Corp.—Statements of Operations for the 52-weeks ended January 31, 2004, the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002 and the 52-weeks ended February 2, 2002 (Predecessor Company)

Condensed Financial Information of Factory Card & Party Outlet Corp.—Statements of Cash Flows for the 52-weeks ended January 31, 2004, the 43-weeks ended February 1, 2003 (Successor Company), the nine weeks ended April 6, 2002 and the 52-weeks ended February 2, 2002 (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.

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Notes

(b) Reports on Form 8-K.

A Report on Form 8-K was filed on January 9, 2004. The report contained information announcing the Company’s sales results for two months ended January 3, 2004.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on our behalf by the undersigned, thereunto duly authorized.

Dated: April 14, 2004

Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.