Morry Weiss joined American Greetings in 1961 and hadhas held various responsibilitiespositions with the Corporation since joining in 1961, including Group Vice President of Sales, Marketing and Creative. In June 1978, Mr. Morry Weiss was appointed President and Chief Operating Officer. From October 1987 until June 1, 2003, he wasmost recently Chief Executive Officer of the Corporation. In February 1992,Corporation from October 1987 until June 2003. Mr. Morry Weiss became Chairman.has been Chairman since February 1992.

Zev Weiss was Regional Sales Director forhas held various positions with the Corporation’s Carlton Cards Retail, Inc. unit from July 1994 to May 1995; Regional Sales Manager for the Corporation’s U.S. Greeting Card Division from May 1995 to May 1997; Executive Director of National Accounts for the Corporation’s U.S. Greeting Card Division from May 1997 until March 2000; Vice President, Strategic Business Units from March 2000 until March 2001; Senior Vice President from March 2001 until December 2001; andCorporation since joining in 1992, including most recently Executive Vice President from December 2001 until June 2003 when he was named Chief Executive Officer.

Jeffrey Weiss was Vice President, Materials Management ofhas held various positions with the Corporation’s U.S. Greeting Card Division from October 1996 until May 1997; Vice President, Product Management of the Corporation’s U.S. Greeting Card Division from May 1997 until January 1998; Senior Vice President from January 1998 until March 2000; andCorporation since joining in 1988, including most recently Executive Vice President, North American Greeting Card Division of the Corporation from March 2000 until June 2003 when he was named President and Chief Operating Officer.

John S. N. Charlton was Managing Director of the Consumer Products Division of Pentland Group plc in the United Kingdom from 1988 until 1998, and Managing Director of UK Greetings Ltd. (a wholly-owned subsidiary of American Greetings which owns certain of our operating subsidiaries in the United Kingdom) from 1998 until becoming Senior Vice President, International in October 2000.

Michael L. Goulder was a Vice President in the management consulting firm of Booz Allen Hamilton from October 1998 until September 2002. He became a Senior Vice President of the Corporation in November 2002 and is currently the Senior Vice President, Executive Supply Chain Officer.

Thomas H. Johnston was Chairman, President and Chief Executive Officer of Sutton Place Gourmet, a Gourmet food retailer, from July 1995 until July 2000, where he remained as Chairman until February 2001. He was Managing Director of Gruppo, Levey & Co., an investment banking firm focused on the direct marketing and specialty retail industries, from November 2001 until May 2004, when he became Senior Vice President and President of Carlton Cards Retail. Mr. Johnston became Senior Vice President, Creative and Merchandising in December 2004.

Catherine M. Kilbane was a partner with the law firm of Baker & Hostetler LLP until becoming Senior Vice President, General Counsel and Secretary in October 2003.

William R. Mason washas held various positions with the Corporation since joining in 1970, including most recently Senior Vice President, General Sales Manager from June 1991 until becoming Senior Vice President, Wal-Mart Team in September 2002.

Brian T. McGrath has held various positions with the Corporation since joining in 1989, including most recently Vice President, Human Resources, from November 1998 until July 2006, when he became Senior Vice President, Human Resources.

Stephen J. Merriman, Jr., has served asSmith was Vice President and Treasurer of General Cable Corporation, a wire and cable company, from 1999 until 2002. He became Vice President, Treasurer and Investor Relations of the Corporation in April 2003, and became Senior Vice President and Chief Financial Officer of American Greetings since September 2005. Prior to joining American Greetings, Mr. Merriman was a private investor since April 2004, the President and Chief Executive Officer of Royal Appliance Mfg. Co., a publicly-held manufacturer and marketer of Dirt Devil vacuum cleaners, from 1995 until April 2004 and was its Chief Financial Officer from 1992 to 1995. Prior to working with Royal Appliance, Mr. Merriman was a partner in the audit practice of Arthur Andersen & Co.November 2006.

Erwin Weiss has held various positions with the Corporation since joining in 1977, including most recently as Senior Vice President, Consumer Products, from June 1999 to June 2001 and Senior Vice President, Program Realization from June 2001 to June 2003, and Senior Vice President, Specialty Business from June 2003 until becoming Senior Vice President, Specialty BusinessEnterprise Resource Planning in June 2003.February 2007.

PART II

(a)Market Information.    Our Class A common shares are listed on the New York Stock Exchange under the symbol AM. The high and low sales prices, as reported in the New York Stock Exchange listing, for the years ended February 28, 20062007 and 2005,2006, were as follows:

There is no public market for our Class B common shares. Pursuant to our Amended Articles of Incorporation, a holder of Class B common shares may not transfer such Class B common shares (except to permitted transferees, a group that generally includes members of the holder’s extended family, family trusts and charities) unless such holder first offers such shares to American Greetings for purchase at the most recent closing price for our Class A common shares. If we do not purchase such Class B common shares, the holder must convert such shares, on a share for share basis, into Class A common shares prior to any transfer.

National City Bank, Cleveland, Ohio, is our registrar and transfer agent.

Shareholders.    At February 28, 2006,2007, there were approximately 32,60023,200 holders of Class A common shares and 150 holders of Class B common shares of record and individual participants in security position listings.

Dividends.    The following table sets forth the dividends paid by us in 20062007 and 2005.2006.

We did not pay cash dividends onIn April 2007, we announced that the Board of Directors increased our common shares during the first and second quarters of 2005.quarterly dividend from $0.08 to $0.10 per share. Although we expect to continue paying dividends, payment of future dividends will be determined by the Board of Directors in light of appropriate business conditions. In addition, our senior secured credit facility restricts our ability to pay shareholder dividends. Our credit facility also contains certain other restrictive covenants that are customary for similar credit arrangements, including covenants relating to financial reporting and notification, compliance with laws, preservation of existence, maintenance of books and records, use of proceeds, maintenance of properties and insurance, and limitations on liens, dispositions, issuance of debt, investments, repurchases of capital stock, acquisitions and transactions with affiliates. There are also financial covenants that require us to maintain a maximum leverage ratio (consolidated indebtedness minus unrestricted cash over consolidated EBITDA), and a minimum interest coverage ratio (consolidated EBITDA over consolidated interest expense). These restrictions are subject to customary baskets and financial covenant tests. For a further description of the limitations imposed by our senior secured credit facility, see the discussion in Part II, Item 7, under the heading “Liquidity and Capital Resources,” and NotesNote 11 and 19 to the Consolidated Financial Statements included in Part II, Item 8.

COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN AMONG

AMERICAN GREETINGS CORPORATION, THE S&P 400 INDEX AND PEER GROUP INDEX

Set forth below is a line graph comparing the cumulative total return of a hypothetical investment in our Class A Common Shares with the cumulative total return of hypothetical investments in the S&P 400 Index and the Peer Group based on the respective market price of each investment at February 28, 2002, February 28, 2003, February 27, 2004, February 28, 2005, February 28, 2006 and February 28, 2007.

The Peer Group Index takes into account companies selling cyclical nondurable consumer goods with the following attributes, among others, that are similar to those of American Greetings: customer demographics, sales, market capitalizations and distribution channels.

Securities Authorized for Issuance Under Equity Compensation Plans.    Please refer to the information set forth under the heading “Equity Compensation Plan Information” included in Item 12 of this Annual Report on Form 10-K.

(b) Not Applicable.applicable.

(c) The following table provides information with respect to our purchases of our common shares made during the three months ended February 28, 2006.2007.

Item 6.

Selected Financial Data

Thousands of dollars except share and per share amounts

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the audited consolidated financial statements. This discussion and analysis, and other statements made in this Report, contain forward-looking statements, see “Factors That May Affect Future Results” at the end of this discussion and analysis for a discussion of the uncertainties, risks and assumptions associated with these statements. Unless otherwise indicated or the context otherwise requires, the “Corporation,” “we,” “our,” “us” and “American Greetings” are used in this report to refer to the businesses of American Greetings Corporation and its consolidated subsidiaries.

OVERVIEW

Founded in 1906, we are the world’s largest publicly owned creator, manufacturer and distributor of social expression products. Headquartered in Cleveland, Ohio, we employ approximately 19,20018,800 associates around the world and are home to one of the world’s largest creative studios.

Our major domestic greeting card brands are American Greetings, Carlton Cards and Gibson and other domestic products include DesignWare party goods, GuildHouse candles, Plus Mark gift-wrap and boxed cards, DateWorks calendars Learning Horizons educational products and AGI Schutz display fixtures. We also create and license our intellectual properties such as the “Care Bear” and “Strawberry Shortcake” characters. The Internet and wireless business unit, AG Interactive, is a leading provider of electronic greetings ringtones for cellular telephones and other content for the digital marketplace. As of February 28, 2006,2007, the Retail Operations segment owned and operated 503436 card and gift shopsretail stores throughout North America.

Our international operations include wholly owned subsidiaries in the United Kingdom (“U.K.”), Canada, Australia, New Zealand Mexico and South Africa,Mexico, as well as licensees in approximately 50 other countries.

Our business exhibits seasonality, which is typical for most companies in the retail industry. Sales are higher in the second half of the year due to the concentration of major holidays during that period. Net earnings are highest during the months of September through December when sales volumes provide significant operating leverage. Working capital requirements needed to finance operations fluctuate during the year and reach their highest levels during the second and third fiscal quarters as inventory is increased in preparation for the peak selling season.

We recognized net income of $42.4 million in 2007 compared to $84.4 million in 2006, on net sales of $1.74 billion in 2007 compared to $95.3 million$1.88 billion in 2005. Included2006.

As 2007 began, we focused on executing the two key operating and financial strategies outlined at the end of last year. Our primary operating strategy focuses on investing in growth through improving our core greeting card business and our principal financial strategy was to optimize our capital structure. In addition, after optimizing our capital structure, we began executing against our goal of improving the results this year is thereturn on net loss from discontinued operationscapital employed by divesting of $5.7 million resulting primarily from the planned divestiturebusinesses and product lines that are not providing adequate returns. Each of these activities impacted our South African business. The prior year results included income from discontinued operations of $25.8 million primarily from our divestiture of the Magnivision reading glasses subsidiary in October 2004.

Cash flow generation remained strong and we ended the year with a combined balance of cash, cash equivalents and short-term investments of $422.4 million.consolidated financial statements during 2007.

During the year, andour financial results were impacted by the implementation of our strategy to invest in our planning for next year, we continue to focus on two key operational and financial strategies. Our operational strategy of investing in growth is focused on strengthening our core greeting card business. This strategy targets improved card productbusiness (“investment in cards strategy”) and the merchandising ofSBT implementations. As we noted in our 2006 Annual Report on Form 10-K, we estimated that product to enrich our consumers’ shopping experience. This representswe would spend at least $100 million over the next steptwo years for these initiatives, including approximately $75 million in the processcurrent year. These activities have significantly reduced our sales and operating earnings during 2007. Net sales were reduced approximately $38 million for actions related to our investment in cards strategy and approximately $21 million for SBT implementations. The investment in cards strategy reduces net sales as credits issued to customers exceed new product shipments. Pre-tax income was approximately $66 million lower in the current year due to actions related to our investment in cards strategy and SBT implementations. Based on our current estimates, we have been followingexpect the past few years as we workedtotal spend on these two initiatives to stabilizeapproximate the infrastructureoriginally planned amount of at least $100 million by the business, reduce costs, modify business processes relative to product development, sourcing and delivery systems and become a consumer driven organization.end of 2008.

In executing this next step, we have committed approximately $75 million to converting customers to scan-based trading, refreshing product at retail, implementing new delivery systems and improving the merchandising of our product, including new and enhanced display fixtures. These expenditures, which we expect to be weighted toward the second half of the year, will significantly reduce our operating earnings during fiscal 2007.

Our financial strategy focuses on optimizingto optimize our capital structure, which includes investingwe completed a debt restructure and continued to invest in our own stock asduring 2007. During the year, we continue to believe thatretired 90% of our shares are trading at6.10% senior notes,

entered into a discount to their intrinsic valuenew credit agreement and refinancing our debt. During 2006, we completed theissued $200 million stock repurchase program announced in April 2005 and initiated another $200 million stock repurchase program in February. For7.375% senior notes. During the year, we repurchased approximately 10.311.1 million shares of our Class A common stockshares under our share repurchase programs and avoided issuing approximately 7 million shares through our exchange offer for our 7.00% convertible subordinated notes. Including the convertible debt, we reduced our total debt by approximately $243$250 million and increased our financial flexibility going forward.

In an effort to improve long-term return on net capital employed and focus on our core social expression business, during the fourth quarter of 2007, we sold our candle product lines and signed an agreement to sell Learning Horizons, our educational products subsidiary. We recognized a pre-tax loss of approximately $16 million in connection with the sale of our candle product lines. We also recognized an after-tax loss of approximately $3 million upon signing an agreement to sell Learning Horizons. This loss was included within discontinued operations. The sale of Learning Horizons was completed during the first quarter of 2008. In addition, we closed 60 underperforming retail stores during the fourth quarter and recorded a pre-tax charge of approximately $7 million.

The decline in consolidated net sales, in addition to the impact of the investment in cards strategy and SBT implementations, was primarily due to our North American Social Expression Products segment, which experienced lower sales of gift packaging products, party goods, everyday cards and seasonal cards. We also had lower sales in our Retail Operations segment, despite positive year over year comparative store sales growth, due to a reduced number of stores. Lower sales in the AG Interactive segment were driven by the $11 million of net sales from the extra two months in the prior year as discussed below and reduced offerings in the mobile product group, partially offset by sales from the acquisition of an online greeting card business during the second quarter of 2007 and growth in the online product group.

The results for the year included an after-tax loss of approximately $1 million from discontinued operations. In addition to Learning Horizons, discontinued operations included the results of The Hatchery, LLC; our South African business unit for which the sale closed in the second quarter of 2007; and Magnivision. An after-tax gain of $3.1 million was recorded in the third quarter based on the final closing balance sheet adjustments for the sale of Magnivision.

The results for 2007 also included a gain of approximately $20 million as a result of retailer consolidations, wherein, multiple long-term supply agreements were terminated and a new agreement was negotiated with a new legal entity with substantially different terms and sales commitments. We received cash of approximately $60 million during the fourth quarter of 2007 as a result of this transaction.

On April 6,March 1, 2006, we announcedadopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) (“SFAS 123R”), “Share-Based Payments,” using the “modified prospective” transition method. As a result, stock-based compensation expense recognized during 2007 was $7.6 million and is included in “Administrative and general” expenses on the Consolidated Statement of Income.

We also adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” effective February 28, 2007. The adoption of SFAS No. 158 had no effect on our plan to significantly changeConsolidated Statement of Income and it will not affect our debt structure. We expect that these changes, along with our continued strong cash generation, will permit us to simultaneously execute these strategies.operating results in subsequent periods. Refer to Note 1912 to the Consolidated Financial Statements for additional information related to the debt refinancing plan.

During 2006, we continued the implementationa summary of the 2005 initiatives, includingimpact the implementationadoption of a new merchandising strategy for seasonal space management, an overhead reduction program and the closureSFAS No. 158 had on our Consolidated Statement of the Franklin, Tennessee manufacturing facility. The operational benefits and cost savings from these initiatives favorably impacted 2006 results and we anticipate will provide an even greater impact in the future. Continuing our commitment to improve efficiency and cost reduction, in 2006, we announced the planned closure of the Lafayette, Tennessee facility and made additional reductions to overhead at a total cost of approximately $4 million.

In reporting our 2005 results, we noted that due to declining results and cash flows during the past two years, the fair value of the Retail Operations segment and our Australian business, determined for the purpose of testing goodwill for impairment, had declined and as a result we established performance metrics to monitor these businesses for potential indicators of impairment. During the third quarter of 2006, indicators emerged within these businesses that led us to conclude that an interim goodwill impairment test was required. As a result of this testing, we recorded an impairment charge to write-off the goodwill of these business units, totaling $43.2 million. Refer to Note 9 to the Consolidated Financial Statements for additional information related to the impairment charge.

Net sales for 2006 were flat compared to the prior year, however the 2005 amounts included the impact of converting a major customer to scan-based trading and the implementation of a new strategy for seasonal space management, which reduced net sales by approximately $32 million and $13 million, respectively. Net sales in the International Social Expression Products segment, primarily in the U.K., the Retail Operations segment and the fixtures business were down, while net sales in the AG Interactive segment improved.Position.

For 2006, AG Interactive changed its fiscal year-end from December 31 to February 28. Due to this change, our results in 2006 included fourteen months of activity for AG Interactive, which added approximately $11 million to net sales for the year with no impact on net income. In addition, we purchasedThe prior year also included a pre-tax charge of $43.2 million for the remaining outstanding minority interestsimpairment of goodwill in AG Interactive during the yearour Retail Operations segment and now own 100% of this subsidiary.our Australian business unit.

RESULTS OF OPERATIONS

Comparison of the years ended February 28, 2007 and 2006

In 2007, net income was $42.4 million, or $0.71 per diluted share, compared to net income of $84.4 million, or $1.16 per diluted share, in 2006.

Our results for 2007 and 2006 are summarized below:

Net Sales Overview

Consolidated net sales in 2007 were $1.74 billion, a decrease of $130.5 million from the prior year. This decrease was primarily the result of lower sales in the North American Social Expression Products segment. Lower sales in our Retail Operations segment, our International Social Expression Products segment and AG Interactive were substantially offset by an increase in our fixtures business and a favorable foreign currency translation impact.

The North American Social Expression Products segment decreased approximately $130 million. Approximately $38 million of the decrease was due to the implementation of our investment in cards strategy and approximately $21 million resulted from SBT implementations during 2007. The remaining decrease was attributable to a significant decline in gift packaging sales of approximately $30 million as well as lower sales of everyday cards, party goods, seasonal cards and ornaments.

The Retail Operations segment decreased approximately $13 million due to fewer stores while our International Social Expression Products segment was down approximately $4 million, primarily in the U.K. These decreases were partially offset by an increase of approximately $8 million in our fixtures business as well as favorable foreign currency of approximately $17 million.

The reduction of approximately $4 million in AG Interactive’s net sales was due to the additional two months included in the prior year as a result of the fiscal year change partially offset by growth in the online product group, including the current year acquisition of an online greeting card business. The additional two months in the prior year added approximately $11 million to net sales in 2006.

The contribution of each major product category as a percentage of net sales for the past two fiscal years was as follows:

Wholesale Unit and Pricing Analysis for Greeting Cards

Unit and pricing comparatives (on a sales less returns basis) for 2007 and 2006 are summarized below:

During 2007, combined everyday and seasonal greeting card sales less returns fell 5.7% compared to the prior year. Approximately 18% of this decrease was the result of the SBT buybacks during the period.

Everyday card unit volume, down 10.6%, and selling prices, up 4.8%, were significantly impacted during the year by the SBT buybacks. Approximately 39% of the decrease in everyday card unit volume and approximately 65% of the increase in selling prices was the direct result of the product mix of the SBT buybacks. The remaining everyday card sales less returns decreased 4.8%, including a decline in unit volume of 6.4% and an increase in selling prices of 1.7%. Of the remaining unit decrease, approximately 25% was related to the investment in cards strategy with the balance due to shortfalls in North America and the U.K. Selling prices increased due to a lower overall mix of value cards compared to the prior year period.

Seasonal card unit volume decreased 9.6% compared to the prior year. Approximately 60% of this decrease relates to the timing of shipments for the upcoming Easter, Mother’s Day and Graduation seasons compared to the prior year and the impact of ongoing SBT conversions. The implementation of SBT impacts the timing of sales with these customers compared to the prior year because, under SBT, American Greetings owns the product delivered to the retail customer until the product is sold by the retailer to the ultimate consumer, at which time we record the sale. From a timing perspective, we expect a recovery during the first quarter of 2008. The remaining decrease in units relates to weakness in all other seasons, particularly Christmas and Valentine’s Day. Seasonal selling prices increased 5.7% compared to the prior year. The overall increase in pricing from the prior year is driven by the timing of shipments discussed above and the mix of price points that shipped in the current year relative to the total pricing of those seasons. We expect this favorable average price to reverse in the first quarter of 2008. In addition, favorable pricing from changes in mix from the current year Mother’s Day and Graduation seasons were partially offset by slight decreases from the Christmas and Valentine’s Day seasons, both driven by changes in product mix.

Expense Overview

Material, labor and other production costs (“MLOPC”) for 2007 were $826.8 million, a decrease from $847.0 million in 2006. As a percentage of sales, these costs were 47.4% in 2007 compared to 45.2% in 2006. The $20.2 million decrease from the prior year is due to favorable volume variances ($59 million) due to the lower sales volume in the current year partially offset by unfavorable product and business mix ($12 million) and

unfavorable spending ($27 million). The spending increases are attributable to higher inventory and SBT scrap costs ($15 million), increased creative content costs and royalties ($7 million) and severance charges ($3 million) primarily due to the facility closure in Australia.

Selling, distribution and marketing expenses were $627.9 million in 2007, decreasing from $631.9 million in the prior year. The decrease of $4.0 million is due primarily to reductions in order filling and freight expense ($8 million) and field sales expenses ($2 million). Also contributing to the decrease was our Retail Operations segment. The Retail Operations segment was favorably impacted by reduced store expenses ($6 million) and lower depreciation expense and fixed asset impairment charges ($4 million) due to fewer doors compared to the prior year, but did incur incremental store exit costs ($5 million) associated with the 60 stores closed in the fourth quarter of 2007. These decreases were partially offset by higher advertising expenses ($5 million) and unfavorable foreign currency translation impacts ($6 million).

Administrative and general expenses were $251.1 million in 2007, compared to $242.7 million in 2006. The $8.4 million increase in expense in 2007 is due primarily to stock-based compensation expense in the current year in accordance with SFAS 123R ($8 million). Increases in severance charges ($3 million), payroll and benefits related expenses ($2 million), amortization of intangible assets ($1 million), postretirement benefit obligation expense ($1 million) and non-income related business taxes ($1 million) were substantially offset by reduced profit-sharing plan expense ($6 million) and bad debt expense ($3 million) due primarily to recoveries recorded in the current year. Unfavorable foreign currency translation impacts ($1 million) also contributed to the increased expense.

A goodwill impairment charge of $43.2 million was recorded in the third quarter of 2006, as indicators emerged during that period that led us to conclude that an impairment test was required prior to the annual test. As a result, impairment was recorded in one reporting unit in the International Social Expression Products segment, located in Australia ($25 million), and in our Retail Operations segment ($18 million). These amounts represented all of the goodwill of these reporting units.

Interest expense was $35.0 million in 2007, compared to $35.1 million in 2006. The decrease of $0.1 million is attributable to interest savings ($21 million) associated with the reduced balance of outstanding 6.10% notes and the 7.00% convertible notes, the net gain recognized on the interest rate derivative entered into and settled during 2007 ($2 million) and the prior year expenses for the retirement of $10.2 million of the 11.75% notes ($1 million). Partially offsetting these decreases are expenses including the consent payment, fees paid and the write-off of deferred financing costs related to the early retirement of the 6.10% notes ($5 million) and additional interest expense ($14 million) associated with the new 7.375% notes and the borrowings under the credit and receivable facilities during the year. Expenses associated with both the new and old credit facilities ($5 million), which included the write-off of deferred financing fees for the old facility, increased commitment fees for the new facility and the write-off of deferred financing fees for the term loan facility due to the reduction in the available borrowing, also offset the decreases.

Other income—net was $65.5 million in 2007 compared to $64.7 million in 2006. The increase of $0.8 million from 2006 was due in part to a gain ($20 million) related to terminations of long-term supply agreements associated with retailer consolidations offset by the loss ($16 million) on the sale of our GuildHouse candle product lines. In addition, our royalty revenue decreased in 2007 compared to 2006 ($3 million).

The effective tax rates for 2007 and 2006 were 37.6% and 34.9%, respectively. These rates reflect the United States statutory rate of 35% combined with the additional net impact of the various foreign, state and local income tax rates. See Note 16 to the Consolidated Financial Statements for causes of the differences between tax expense at the federal statutory rate and actual tax expense.

Loss from discontinued operations was $0.9 million for 2007 compared to $6.6 million in 2006. The 2007 amount included losses from Learning Horizons ($3 million after tax) and the Hatchery ($3 million after tax) partially offset by a gain based on the closing balance sheet adjustments for the sale of Magnivision ($3 million after tax) and a tax benefit on the South African business unit sale ($2 million). The Learning Horizons loss

included goodwill and fixed asset impairment charges ($1 million) while the Hatchery loss included a goodwill impairment charge ($2 million). Loss from discontinued operations for 2006 included losses from the South African business unit ($8 million) and the Hatchery ($2 million) partially offset by income from Learning Horizons ($1 million) and a tax benefit from the Magnivision sale ($2 million). The losses from the South African business unit included a goodwill impairment charge ($2 million) and a long-lived asset impairment charge ($6 million). The charges and impairments for Learning Horizons and the South African business unit were primarily recorded as a result of the intention to sell the businesses, and therefore, present the operations at their estimated fair value.

Segment Results

The Corporation’s management reviews segment results using consistent exchange rates between years to eliminate the impact of foreign currency fluctuations. For additional segment information, see Note 15 to the Consolidated Financial Statements.

North American Social Expression Products Segment

In 2007, net sales of the North American Social Expression Products segment, excluding the impact of foreign exchange and intersegment items, decreased $130.1 million, or 10.3%, from 2006. The implementation of our investment in cards strategy and SBT conversions reduced net sales by approximately $38 million and $21 million, respectively, during the current year. The remainder of the decrease was due to significantly lower gift packaging sales as well as lower sales of party goods, everyday cards, seasonal cards and ornaments.

Segment earnings, excluding the impact of foreign exchange and intersegment items, decreased $97.3 million, or 38.3%, in 2007 compared to the prior year. The implementation of our investment in cards strategy and SBT conversions reduced segment earnings by approximately $66 million during the current year. The decrease in sales also contributed to the lower segment earnings in the current year. Segment earnings in 2007 benefited from the gain related to terminations of long-term supply agreements associated with retailer consolidations ($20 million), but was unfavorably impacted by the loss incurred on the sale of the GuildHouse candle product lines ($16 million), increased severance charges ($3 million) and higher advertising expenses ($4 million).

International Social Expression Products Segment

Net sales of the International Social Expression Products segment, excluding the impact of foreign exchange, decreased $4.5 million, or 1.8%, in 2007 compared to 2006. This decrease was due to continued weak economic conditions in the U.K., which drove down sales in both everyday and seasonal card categories. This decrease was partially offset by a slight increase in net sales in Australia.

Segment earnings, excluding the impact of foreign exchange, increased $21.1 million compared to 2006. This overall increase is due to the goodwill impairment charge in the Australian reporting unit of approximately $25 million that occurred in 2006. Partially offsetting the favorable impact of the prior year goodwill impairment on segment earnings was the lower sales in the current year and severance charges recorded in 2007 ($3 million). The severance charges were incurred in the current year primarily as a result of facility closures, including the manufacturing facility in Australia.

Retail Operations Segment

The Retail Operations segment exhibits considerable seasonality, which is typical for most retail store operations. A significant amount of the net sales and segment earnings occur during the fourth quarter in conjunction with the major holiday season.

Net sales in our Retail Operations segment, excluding the impact of foreign exchange, decreased $13.4 million, or 6.5%, year over year. Net sales at stores open one year or more were up approximately 0.7% from 2006 but were more than offset by the reduction in store doors. The average number of stores decreased approximately 7.0% compared to the prior year, which reduced net sales approximately $15 million.

Segment loss, excluding the impact of foreign exchange, was $17.6 million in 2007 compared to $33.2 million in 2006. The current year included charges associated with the closure of 60 underperforming stores during the fourth quarter ($7 million) and fixed asset impairment charges ($2 million). The prior year loss included charges for goodwill impairment ($18 million) and fixed asset impairment ($4 million). Also, 2006 was unfavorably impacted by certain noncapitalizable implementation costs associated with a systems infrastructure upgrade. Lower store expenses including depreciation expense due to fewer doors favorably impacted segment earnings, but was substantially offset by the impact of the decrease in sales.

AG Interactive Segment

For 2006, AG Interactive changed its fiscal year-end from December 31 to February 28. As a result, 2006 included fourteen months of AG Interactive’s operations.

Net sales, excluding the impact of foreign exchange, decreased $4.3 million, or 4.9%, from 2006. This decrease is the result of the additional two months of activity ($11 million) in 2006 and lower sales in the mobile product group ($5 million) due to reduced offerings in 2007. This is partially offset by advertising and subscription revenue growth in the online product group due to both ongoing business operations ($8 million) and the current year acquisition of an online greeting card business ($4 million). At the end of 2007, AG Interactive had approximately 3.5 million paid subscribers versus 2.6 million in 2006. Approximately 0.6 million of the subscriber increase was due to the current year acquisition.

Segment earnings, excluding the impact of foreign exchange, increased $1.6 million in 2007 compared to 2006. The improvement is attributable to the prior year including costs associated with the fiscal 2005 acquisitions, higher technology costs and the costs of new business initiatives. Segment earnings also benefited from the current year acquisition. The additional two months of activity in the prior year had no significant impact on segment earnings.

Unallocated Items

Centrally incurred and managed costs, excluding the impact of foreign exchange and totaling $106.3 million and $100.6 million in 2007 and 2006, respectively, are not allocated back to the operating segments. The unallocated items included interest expense of $35.0 million and $35.1 million in 2007 and 2006, respectively, for centrally incurred debt and domestic profit-sharing expense of $6.8 million and $12.4 million in 2007 and 2006, respectively. Unallocated items in 2007 also included stock-based compensation expense in accordance with SFAS 123R of $7.6 million. In addition, unallocated items included costs associated with corporate operations including the senior management staff, corporate finance, legal and human resource functions, as well as insurance programs and other strategic costs. These costs totaled $56.9 million and $53.1 million in 2007 and 2006, respectively.

Comparison of the years ended February 28, 2006 and 2005

In 2006, netNet income was $84.4 million, or $1.16 per diluted share, in 2006 compared to net income of $95.3 million, or $1.25 per diluted share, in 2005.

Our results for 2006 and 2005 are summarized below:

Net Sales Overview

Consolidated net sales in 2006 were $1.89$1.88 billion, an increase of $2.3$3.9 million from the prior year. However, the scan-based tradingSBT buyback as well as the returns costs for the revised merchandising strategy reduced prior year net sales by $45 million. Including the impact of these prior year items, consolidated net sales decreased approximately $43$41 million in 2006 from 2005. This decrease was primarily the result of lower sales in the Retail Operations segment, North American Social Expression Products segment, International Social Expression Products segment and the fixtures business.

The Retail Operations segment decreased approximately $31 million, which is attributable to a decrease in same-store sales and fewer stores. The North American Social Expression Products segment, considering the $45 million prior year net sales reduction, decreased approximately $22 million due to significantly lower sales of promotional gift-wrap and calendars, partially offset by strengthening in the greeting card business. The fixtures business decreased approximately $14 million as this business unit has focused on eliminating lower margin sales. The International Social Expression Products segment decreased approximately $14 million, primarily due to continued weak economic conditions in the U.K. These decreases are partially offset by increased net sales in the AG Interactive segment of approximately $32 million as well as approximately $5 million of favorable foreign currency translation. The increases in the AG Interactive segment are primarily attributable to sales from the additional two months of activity resulting from the fiscal year change, the 2005 mid-year acquisitions and a growing subscription revenue base.

The contribution of each major product category as a percentage of net sales for the past two fiscal years was as follows:

Wholesale Unit and Pricing Analysis for Greeting Cards

Unit and pricing comparatives (on a sales less returns basis) for 2006 and 2005 are summarized below:

During 2006, combined everyday and seasonal greeting card sales less returns increased 0.5% compared to 2005. However, the prior year included reductions associated with thean SBT implementation of scan-based trading at a major customer and the execution of a revised merchandising strategy for seasonal space management. Exclusive of these prior year events, combined everyday and seasonal greeting card sales less returns decreased 2.2% in 2006 compared to 2005, including an overall decrease in unit volume of approximately 4.1%.

The reduction in seasonal card unit volume was the result of year over year decreases in all major seasonal programs with the exception of Father’s Day. The 5.2% increase in average selling price of seasonal cards was due to improved product mix of Mother’s Day, Christmas and Valentine’s Day cards, driven primarily by a lower volume of value priced cards and a richer mix within the non-value line of cards.

Everyday cards unit volume was lower due to the soft economic conditions in the international greeting card businesses, particularly in the U.K., while everyday unit volume was relatively flat in the North American businesses. Consistent with the trend seen throughout the year, selling prices improved compared to the prior year. This price improvement was due primarily to our international business operations as the mix of cards sold shifted to higher priced cards. Partially offsetting the gains were lower selling prices in North America with a shift in mix to a higher volume of value priced cards.

Expense Overview

Material, labor and other production costs (“MLOPC”)MLOPC for 2006 were $850.2$847.0 million, a decrease from $895.1$890.9 million in 2005. As a percentage of sales, these costs were 45.1%45.2% in 2006 compared to 47.5%47.6% in 2005. Almost the entire change, as a percentage of sales, is the result of the prior year impact of the scan-based tradingSBT buyback and the implementation of a new merchandising strategy for seasonal space management. The decrease in dollars of $44.9$43.9 million is due partially to the severance and closure costs recorded in 2005 for an overhead reduction program and the Franklin, Tennessee plant closure ($15 million). The remaining decrease is attributable to favorable volume variances due to the change in sales volume ($17 million) and favorable mix ($36 million). Improved margins due to less promotional pricing in the Retail Operations segment and production improvements in our fixtures business both favorably impacted MLOPC. These improvements were only

partially offset by unfavorable spending ($23 million). These spending increases included higher creative content costs ($6 million) and increased costs for AG Interactive primarily related to the additional two months of activity and the 2005 mid-year acquisitions ($4 million). The current year period also included severance charges for the planned Lafayette plant closure ($2 million) and shutdown and relocation costs for the Franklin plant closure ($5 million).

Selling, distribution and marketing expenses were $637.5$631.9 million in 2006, decreasing from $648.1$642.7 million in the prior year. As a percentage of sales, these costs were 33.8% in 2006 compared to 34.4% for 2005. The decrease of $10.6$10.8 million is due primarily to reduced store expenses in the Retail Operations segment due to fewer stores and the prior year correction in the accounting treatment for certain operating leases ($18 million), 2005 severance costs ($6 million) and reduced licensing related expenses attributable to lower royalty revenue ($5 million) partially offset by increased costs in the AG Interactive segment primarily as a result of the additional two months of activity and the 2005 mid-year acquisitions ($14 million) and fixed asset impairment charges in the Retail Operations segment ($4 million).

Administrative and general expenses were $245.6$242.7 million in 2006, compared to $250.0$249.2 million in 2005. The $4.4$6.5 million decrease in expense in 2006 is due primarily to 2005 severance and plant closure costs ($9 million) partially offset by higher information technology related expenses ($2 million), domestic profit-sharing expense ($1 million) and employee development expenses ($1 million).

A goodwill impairment charge of $43.2 million was recorded in the current year2006 as indicators emerged during the period that led us to conclude that an impairment test was required prior to the annual test. As a result, impairment was recorded in one reporting unit in the International Social Expression Products segment, located in Australia ($25 million), and in our Retail Operations segment ($18 million). These amounts represent all of the goodwill of these reporting units.

Interest expense was $35.1 million in 2006, compared to $79.4 million in 2005. The decrease of $44.3 million in interest expense is due primarily to the debt repurchase in 2005. The 2005 interest expense included the payment of the premium and other fees and the write-off of deferred financing costs associated with theour 11.75% senior subordinated notes repurchased ($39 million). Interest savings ($5 million) was realized due to our reduced level of debt.

Other income—net was $64.8$64.7 million in 2006 compared to $96.1$96.0 million in 2005. The decrease of $31.3 million from 2005 was due in part to the one-time receipt related to our licensing activities ($10 million) and the gain on the sale of an investment ($3 million) both in 2005. In addition, our royalty revenue decreased in 2006 compared to 2005 ($11 million) and we had additional losses on fixed asset disposals ($3 million).

The effective tax rates for 2006 and 2005 were 35.1%34.9% and 34.9%35.5%, respectively. These rates reflect the United States statutory rate of 35% combined with the additional net impact of the various foreign, state and local income tax rates. See Note 1716 to the Consolidated Financial Statements for causes of the differences between tax expense at the federal statutory rate and actual tax expense.

Income from discontinued operations was a loss of $6.6 million for 2006 compared to income of $27.6 million in 2005. The loss in 2006 included losses from the South African business unit ($8 million) and the Hatchery ($2 million) partially offset by income from Learning Horizons ($1 million) and a tax benefit from the Magnivision sale ($2 million). The losses from the South African business unit included a goodwill impairment charge ($2 million) and a long-lived asset impairment charge ($6 million). The charges and impairments were primarily recorded as a result of the intention to sell the business, and therefore, present the operation at its estimated fair value. Income from discontinued operations for 2005 was primarily attributable to the gain on the sale of Magnivision.

Segment Results

During the fourth quarter of 2006, we adjusted our segment reporting to reflect changes in how our operations are managed, viewed and evaluated. The most significant change was the disaggregation of the former Social Expression Products segment into the North American Social Expression Products and the International Social Expression Products segments. Prior periods have been reclassified to conform to the new segment disclosures. We

review segment results using consistent exchange rates between years to eliminate the impact of foreign currency fluctuations. For additional segment information, see Note 1615 to the Consolidated Financial Statements.

North American Social Expression Products Segment

In 2006, net sales of the North American Social Expression Products segment, excluding the impact of foreign exchange and intersegment items, increased $22.4 million, or 1.8%, from 2005. However, the scan-based tradingSBT buyback as well as the returns costs for the revised merchandising strategy reduced prior year net sales by $45 million. Including the impact of these prior year items, net sales decreased approximately $22 million in 2006 from 2005. This decrease was due to significantly lower sales of promotional gift-wrap and calendars, partially offset by improvement in the greeting card business due to improved pricing of cards.

Segment earnings, excluding the impact of foreign exchange and intersegment items, increased $62.7 million, or 32.8%, in 2006 compared to the prior year. This increase is due to the prior year charges for the scan-based tradingSBT buyback ($30 million), the implementation of the new merchandising strategy ($13 million), severance costs ($15 million) and plant closure costs ($11 million) partially offset by current year charges for severance ($3 million) and plant closure costs ($5 million).

International Social Expression Products Segment

Net sales of the International Social Expression Products segment, excluding the impact of foreign exchange, decreased $13.6$12.7 million, or 4.7%4.8%, in 2006 compared to 2005. This decrease was due to weak economic conditions, particularly in the U.K., which drove down sales in most product categories. This decrease was partially offset by the impact of the acquisition of Collage Designs Limited (“Collage”) in the fourth quarter of 2005, which added approximately $12 million to net sales in 2006.

Segment earnings, excluding the impact of foreign exchange, decreased $56.1$53.6 million compared to 2005. This decrease is due to the goodwill impairment charge in the Australian reporting unit, higher inventory costs due to slower turn rates, higher creative content costs, increased product development costs and implementation costs for new customers partially offset by the earnings contributed by Collage.

Retail Operations Segment

The Retail Operations segment exhibits considerable seasonality, which is typical for most retail store operations. A significant amount of the net sales and segment earnings occur during the fourth quarter in conjunction with the major holiday season.

Net sales in our Retail Operations segment, excluding the impact of foreign exchange, decreased $31.4 million, or 13.2%, year over year. Net sales at stores open one year or more were down approximately 5.9% in 2006 from 2005 and the average number of stores decreased 9.2% compared to the prior year. The decline in same-store sales was driven primarily by a 7% decrease in the average number of transactions per store.

Segment loss, excluding the impact of foreign exchange, was $33.2 million in 2006 compared to $20.7 million in 2005. The current year loss included the goodwill impairment ($18 million) and fixed asset impairments ($4 million). Also, 2006 was unfavorably impacted by certain noncapitalizable implementation costs associated with a systems infrastructure upgrade. The impact of lower sales on segment results was softened due to less promotional activity and favorable product mix that improved gross margins by approximately 5.2 percentage points. Segment results benefited from lower store rent and associate costs due to fewer stores. In 2005, segment results included a charge for the correction in the accounting treatment for certain operating leases ($5 million).

AG Interactive Segment

For 2006, AG Interactive changed its fiscal year-end from December 31 to February 28. As a result, 2006 included fourteen months of AG Interactive’s operations.

Net sales, excluding the impact of foreign exchange, increased $31.9 million, or 55.2%, in 2006 over 2005. This substantial increase is the result of the additional two months of activity ($11 million), the 2005 mid-year business acquisitions of MIDIRingTones, LLC and K-Mobile S.A. ($11 million) and growth in our subscription revenue base ($7 million). At the end of 2006, AG Interactive had approximately 2.6 million paid subscribers versus 2.2 million in 2005.

Segment earnings, excluding the impact of foreign exchange, was $4.2 million in 2006 compared to a loss of $1.0 million in 2005. This increase is primarily the result of contribution by the online product group ($9 million) partially offset by acquisition costs, higher technology costs and the costs of new business initiatives ($4 million). The additional two months of activity had no significant impact on segment earnings.

Unallocated Items

Centrally incurred and managed costs, excluding the impact of foreign exchange and totaling $100.6 million and $139.4 million in 2006 and 2005, respectively, are not allocated back to the operating segments. The unallocated items included interest expense of $35.1 million and $79.4 million in 2006 and 2005, respectively, for centrally incurred debt and domestic profit-sharing expense of $12.4 million and $11.3 million in 2006 and 2005, respectively. In addition, unallocated items included costs associated with corporate operations including the senior management staff, corporate finance, legal and human resource functions, as well as insurance programs and other strategic costs. These costs totaled $53.4$53.1 million and $49.3$48.7 million in 2006 and 2005, respectively.

Comparison of the years ended February 28, 2005 and February 29, 2004

Net income was $95.3 million, or $1.25 per diluted share, in 2005 compared to net income of $104.7 million, or $1.40 per diluted share, in 2004.

Our results for 2005 and 2004 are summarized below:

Net Sales Overview

Consolidated net sales in 2005 were $1.88 billion, a decrease of $54.2 million from the prior year. This decrease includes $45 million of sales reductions associated with the scan-based trading buyback ($32 million) which occurred in the fourth quarter, as well as returns costs for a revised merchandising strategy ($13 million) implemented in the third quarter. The remaining decrease is primarily the result of reduced sales in our Retail Operations segment ($35 million) approximately half of which is the result of reduced store count and half from declining same-store sales, combined with reduced third party sales ($22 million) in our display fixtures business, partially offset by favorable foreign currency translation ($35 million) and additional revenues from two acquisitions completed mid-year by AG Interactive ($16 million).

The contribution of each major product category as a percentage of net sales for the past two fiscal years was as follows:

Wholesale Unit and Pricing Analysis for Greeting Cards

Unit and pricing comparatives (on a sales less returns basis) for 2005 and 2004 are summarized below:

During 2005, combined everyday and seasonal greeting card sales less returns fell 3.9% compared to 2004. The shortfall was heavily skewed toward everyday cards where the impact of the scan-based trading buyback and revised merchandising strategy drove net unit volume down 3.9%. The remaining everyday card business was down 2.1% to prior year. The entire decrease in average selling prices for everyday is the result of a shift in product mix driven by accelerated growth of the value card market.

Seasonal card sales less returns improved 0.7% over 2004 levels reflecting some success in our seasonal marketing initiatives. A combination of specific caption refinements by holiday and a broader offering of value priced products resulted in a strong unit volume increase of 4.7%. In addition, average return rates fell 0.6% driving additional benefits throughout the supply chain. The reduction in average selling price of 3.7% is entirely the result of expansion of value cards in the overall mix.

Expense Overview

Material, labor and other production costs for 2005 were 47.5% of net sales, an increase from 46.7% in 2004. Virtually the entire change, as a percentage of sales, is the result of the impact of the scan-based trading buyback and the implementation of a new merchandising strategy for seasonal space management. The decrease in dollars from the prior year was primarily the result of reduced spending due to successful supply chain initiatives ($22 million) and overlapping prior year inventory costs ($13 million), partially offset by increased costs related primarily to a plant closure ($13 million), higher product content costs ($12 million) and incremental costs due to acquisitions ($5 million).

Selling, distribution and marketing expenses were 34.4% of net sales for 2005 compared to 32.5% in 2004, a 1.9 percentage point increase. Spending increases consisted of agency fees for licensing ($10 million), incremental costs due to acquisitions ($14 million), correction for operating lease accounting in our Retail Operations segment ($5 million) and severance charges ($6 million), partially offset by savings resulting from supply chain initiatives ($6 million) and reduced store operating expenses in our Retail Operations segment ($9 million) as a result of fewer store locations.

Administrative and general expenses were $250.0 million in 2005, compared to $217.4 million in 2004. The $32.6 million increase in expense in 2005 is due primarily to increased employee-related costs ($20 million), severance charges ($9 million) and increased spending on systems development ($5 million).

Interest expense was $79.4 million in 2005, compared to $85.7 million in 2004. Interest expense over the two year period was impacted by interest savings from the extinguishment of our $118.0 million term loan in the first quarter of 2004 and the repurchase of $63.6 million and $186.2 million of our 11.75% senior subordinated notes during the third quarter of 2004 and first quarter of 2005, respectively. The current year expense included the payment of the premium and other fees and the write-off of deferred financing fees ($39 million) associated with the notes repurchased. The prior year expense included the write-off of deferred financing fees and a premium payment ($18 million) associated with the term loan extinguishment and notes repurchased.

Other income—net was $96.1 million in 2005 compared to $58.3 million in 2004. The 2005 results were due to increased revenue from licensing royalties of “Care Bear” and “Strawberry Shortcake” products ($19 million), a one-time receipt related to our licensing activities ($10 million), increased interest income ($2 million) and a gain on the sale of an investment ($3 million).

The effective tax rates for 2005 and 2004 were 34.9% and 39.0%, respectively. These rates reflect the United States statutory rate of 35% combined with the additional net impact of the various foreign, state and local income tax rates. In 2005, the reduction in the effective tax rate is primarily the result of the favorable benefits associated with recent tax law changes, which allowed us to reduce valuation allowances against certain deferred tax assets. See Note 17 to the Consolidated Financial Statements for causes of the differences between tax expense at the federal statutory rate and actual tax expense.

Segment Results

We review segment results using consistent exchange rates between years to eliminate the impact of foreign currency fluctuations. During the fourth quarter of 2006, we adjusted our segment reporting. Prior periods have been reclassified to conform to the new segment disclosures. For additional segment information, see Note 16 to the Consolidated Financial Statements.

North American Social Expression Products Segment

In 2005, net sales of the North American Social Expression Products segment, excluding the impact of foreign exchange and intersegment items, decreased $62.4 million, or 4.8%, from 2004. This decrease includes $45 million of sales reductions associated with the scan-based trading buyback at a major customer account ($32 million) which occurred in the fourth quarter, as well as returns costs for a revised merchandising strategy ($13 million) implemented in the third quarter. The remaining decrease was primarily due to reduced sales of everyday cards.

Segment earnings, excluding the impact of foreign exchange and intersegment items, decreased $61.3 million, or 24.3%, in 2005 compared to the prior year. This decrease is due to the scan-based trading buyback ($30 million), implementation of the new merchandising strategy ($13 million), severance costs ($15 million) and plant closure costs ($11 million), partially offset by lower field service costs related to the prior year integration of a new major customer ($9 million).

International Social Expression Products Segment

In 2005, net sales of the International Social Expression Products segment, excluding the impact of foreign exchange, increased $2.5 million, or 0.9%, from 2004. This increase was driven primarily by improved mix, with a higher volume of higher priced cards.

Segment earnings, excluding the impact of foreign exchange, decreased $5.9 million, or 11.6%, from 2004. This decrease is attributable to higher merchandiser and distribution costs in the U.K.

Retail Operations Segment

The Retail Operations segment exhibits considerable seasonality, which is typical for most retail store operations. A significant amount of the net sales and segment earnings occur during the fourth quarter in conjunction with the major holiday season.

Net sales, excluding the impact of foreign exchange, in the Retail Operations segment decreased $34.8 million, or 12.7%, in 2005 from 2004, as sales of both everyday and seasonal cards were lower. Net sales at

stores open one year or more were down approximately 7.3% in 2005 from 2004 and the average number of stores decreased 5.7% compared to the prior year. The average number of transactions per store was down from the prior year by approximately 6%, in part a reflection of continued reduced overall consumer traffic in retail shopping malls.

Segment earnings, excluding the impact of foreign exchange, decreased $25.0 million in 2005 from the prior year. This decrease was due to lower net sales and a $4.9 million charge for a correction in the accounting treatment for certain operating leases. For the year, markdowns to reduce inventory levels were, as a percentage of sales, 3.3 percentage points higher than in the prior year.

During 2005, we undertook a major initiative to address the disappointing performance in our retail operations. With new divisional management in place, we executed initiatives to revise merchandising strategies, close marginally performing stores and invest in point-of-sale infrastructure upgrades.

AG Interactive Segment

Net sales, excluding the impact of foreign exchange, in the AG Interactive segment increased $21.3 million, or 58.5%, in 2005 over 2004. This substantial increase is the result of the mid-year business acquisitions of MIDIRingTones, LLC and K-Mobile S.A. ($16 million) and increased subscription revenue ($5 million). At the end of 2005, AG Interactive had approximately 2.2 million paid subscribers versus 2.1 million in 2004.

Segment earnings, excluding the impact of foreign exchange, of $4.5 million in 2004 decreased to a loss of $1.0 million in 2005. This decrease is primarily the result of acquisition costs, new business integration costs, higher technology costs and the cost of new business initiatives, which more than offset the benefits from increased sales.

Unallocated Items

Centrally incurred and managed costs are not allocated back to the operating segments. The unallocated items included interest expense of $79.4 million and $85.7 million in 2005 and 2004, respectively, for centrally incurred debt and domestic profit-sharing expense of $11.3 million and $7.1 million in 2005 and 2004, respectively. In addition, unallocated items included costs associated with corporate operations including the senior management staff, corporate finance, legal and human resource functions, as well as insurance programs and other strategic costs. These costs totaled $49.3 million and $67.2 million in 2005 and 2004, respectively.

Liquidity and Capital Resources

Cash flow generation remained strong in 20062007 and we ended the year with a combined balance of cash and cash equivalents and short-term investments of $422.4$144.7 million. In the past two years, we have reduced our debt by approximately $191$262 million, improving our debt to total capital ratio from 34.4%26.0% in 20042005 to 28.0%18.2% in 2006.2007.

Operating Activities

During the year, cash flow from operating activities provided cash of $277.4$267.0 million compared to $366.2$269.4 million in 2005,2006, a decrease of $88.8$2.4 million. ThisCash flow from operating activities for 2006 compared to 2005 resulted in a decrease of $77.7 million from $347.1 million in 2005. The decrease from 2005 to 2006 was primarily the result of a lower decrease in net deferred costs of approximately $46 million and the decrease in accounts payable and other liabilities of approximately $33 million, compared to an increase of approximately $29 million in 2005. Cash flow from

operating activities for 2005 compared to 2004 resulted in an improvement of $82.0 million from $284.2 million in 2004. The overall increase reflects an approximately $73 million larger reduction of net deferred costs in 2005 compared to 2004.$57 million.

Accounts receivable, net of the effect of acquisitions and dispositions, provided a source of cash of $33.4$42.2 million in 2007, compared to $33.9 million in 2006 and $55.1 million in 2005. As a percentage of the prior twelve months’ net sales, net accounts receivable were 6.0% at February 28, 2007, compared to $55.7 million in 20057.4% at February 28, 2006. This source of cash is primarily attributable to our lower level of sales and $75.3 million in 2004.additional customers moving to the SBT business model. In general, customers on the SBT business model tend to have shorter payment terms than non-SBT customers. The decrease of $22.3 million in 2006 from the 2005 level is due to the impact of the SBT conversion of a large customer to scan-based trading in 2005. The decrease of $19.6 million in 2005 over 2004 relates to the strong collections during 2004, partially offset by the impact of converting a large customer to scan-based trading in 2005.

Inventories, net of the effect of acquisitions and dispositions, were a usesource of cash of $0.2$22.2 million in 2007 compared to $1.5 million in 2006 compared to sources of cash of $23.2and $23.3 million in 2005 and $42.0 million in 2004.2005. The increasedecrease in inventory in 2007 from 2006 was primarily due to decreased inventory levels in the North American Social Expression Products and Retail Operations segments. The reduced inventory in our Retail Operations segment is due to both fewer stores as well as reduced inventory levels in those stores. The change from 2005 to 2006 was primarily due to higher inventory levels in the Retail Operations segment and decreased inventory turns in the International Social Expression Products segment. The decreasesegment in inventory during 2005 was primarily related to lower inventory levels in the Retail Operations segment, due to fewer store locations and efforts to reduce average in-store inventory levels, and the display fixtures business primarily due to reduced levels of sales.2006.

Other current assets, net of the effect of acquisitions and dispositions, were a use of cash of $13.5$36.0 million in 2007 compared to $13.4 million in 2006 and $15.6$15.9 million in 2005, compared to a source2005. The increase of $11.0$22.6 million in 2004. The decrease of $2.1 million in 20062007 relates primarily to the increase in refundable income taxes. The 2005 decrease in cash flow is the resulta receivable of an increase in refundable taxes,approximately $31 million related to estimated tax payments made in that year.the termination of several long-term supply agreements.

Deferred costs—net generally represents payments under agreements with retailers net of the related amortization of those payments. During 2007, 2006 2005 and 2004,2005, amortization exceeded payments by $61.3$52.4 million, $107.3$56.6 million and $34.6$110.2 million, respectively. These results reflectIn 2007, deferred costs – net also includes the successreduction of our modifiedapproximately $76 million of deferred contract management strategies.costs associated with retailer consolidations. None of our major customer agreements are setscheduled to expire in fiscal 2007.2008.

Accounts payable and other liabilities, net of the effect of acquisitions and dispositions, were a source of cash of $0.1 million in 2007 compared to a use of cash of $33.2$33.4 million in 2006 and a source of cash of $28.6$29.3 million in 20052005. The change in accounts payable and other liabilities in 2007 was primarily due to a use of cash of $111.3 millionreduction in 2004.trade payables and profit-sharing partially offset by an increase in income taxes payable. The decrease in accounts payable and other liabilities in 2006 was primarily due to a reduction in severance accruals and income taxes payable. The increase in the liability balances in 2005 was primarily due to higher trade payables, severance accruals and higher profit-sharing and executive compensation liabilities. The decrease in 2004 was due to reduced trade payables, continued reduction of acquisition liabilities and lower severance, profit-sharing and executive compensation liabilities.

Investing Activities

Cash used inprovided by investing activities was $61.2$177.5 million during 2006,2007, compared to $196.4cash used of $50.0 million in 20052006 and $32.1$181.3 million in 2004.2005. The source of cash in the current year usageis primarily related to sales of short-term investments exceeding purchases. Short-term investments decreased $208.7 million during the year. In addition, $12.6 million was received related to discontinued operations, $6.2 million was received from the sale of the candle product lines and $4.8 million was received from the sale of fixed assets. These sources of cash were partially offset by a use of cash of $13.1 million for the acquisition of the online greeting card business and the final payment for Collage.

Capital expenditures totaled $41.7 million, $46.1 million and $47.2 million in 2007, 2006 and 2005, respectively. We currently expect 2008 capital expenditures to increase approximately $15 million over the 2007 level.

Cash flows from investing activities in 2006 also included an outflow of $15.3 million related to the acquisition of Collage and the buyout of the remaining portion of the minority interest of AG Interactive. Inflows in the current year includedInteractive and an inflow of $11.4 million for the proceeds from the sale of fixed assets.

Capital expenditures totaled $46.2 million, $47.2 million and $31.5 million in 2006, 2005 and 2004, respectively. We expect 2007 capital expenditures to increase approximately $15 million to $20 million over the 2006 level.

Cash inflowsflows from investing activities in 2005 included a net cash outflow of $208.7 million related to purchases of short-term investments, an outflow of $25.2 million for business acquisitions and inflows of $77.0 million offor the proceeds from the sale of Magnivision, $19.1 million offor the proceeds from the sale of an equity investment and $5.8 million for proceeds from the sale of fixed assets.

Cash inflows in 2004 included the wind-down of our corporate-owned life insurance program, which generated cash inflows of $6.8 million.

Financing Activities

Financing activities used $249.5$518.5 million of cash in 2006. This2007 compared to $249.5 million in 2006 and $208.6 million in 2005. The current year amount relates primarily to our debt activities in the period. We retired $277.3 million of our 6.10% senior unsecured notes and issued $200.0 million of 7.375% senior unsecured notes. We repaid $159.1 million of our 7.00% convertible subordinated notes. We paid $8.5 million of debt issuance costs during the current period for our new credit facility, the 7.375% senior unsecured notes and the exchange offer on our 7.00% convertible subordinated notes. These amounts were deferred and will be amortized over the respective periods of the instruments. Our Class A common share repurchase programs also contributed to the cash used for financing activities in the current year. These repurchases were made through 10b5-1 programs,

which are intended to be in compliance with the Securities and Exchange Commission’s Rule 10b-18. During 2007, $257.5 million was paid to repurchase 11.1 million shares under the repurchase programs. We paid $0.3 million to repurchase Class B common shares during 2007, in accordance with our Amended Articles of Incorporation.

Our receipt of the exercise price on stock options provided $6.8 million, $27.1 million and $40.1 million in 2007, 2006 and 2005, respectively. The significant stock option exercises in 2005 were due to a tranche of options nearing their expiration dates. In accordance with SFAS 123R, tax benefits associated with share-based payments are classified as financing activities in the Consolidated Statement of Cash Flows, rather than as operating cash flows as required under previous accounting guidance. Prior year amounts, which totaled approximately $5 million in 2006 and $8 million in 2005, were not reclassified.

We paid dividends totaling $18.4 million, $21.2 million and $8.3 million in 2007, 2006 and 2005, respectively.

In 2006, cash used for financing activities related primarily to our two programs to repurchase Class A common shares. On April 5, 2005, we announced our intention to repurchase up to $200 million of our Class A common shares through a 10b5-1 program. This program was completed in January 2006. In February 2006, we announced our intention to repurchase an additional $200 million of our Class A common shares. In total under both programs, we paid $243.1 million to repurchase 10.3 million Class A common shares during the year. In addition, we paid $1.5 million to repurchase Class B common shares primarily related to options that were exercised, which shares were repurchased by us in accordance with our Amended Articles of Incorporation. We also received $27.1paid $10.8 million uponto repurchase the exerciseremaining portion of stock options during the year. During 2006, we paid dividends totaling $21.2 million.our 11.75% senior subordinated notes.

In 2005, weCash used $208.6 million for financing activities includingin 2005 included $216.4 million related to the repurchase of a portion of our 11.75% senior subordinated notes in the first quarter. In addition, stock activity provided and used a significant amount of cash during the year. There was a high amount of employee option exercises due to a tranche of options nearing their expiration date. Our receipt of the exercise price on these options provided approximately $40 million during the year. In addition, wenotes. We repurchased shares, primarily Class B common shares related to options that were exercised, at a cost of approximately $24$24.1 million. During 2005, we paid dividends totaling $8.3 million.

In 2004, cash used by financing activities was $192.0 million related primarily to the early retirement of our term loan in the first quarter and the repurchase of some of our 11.75% senior subordinated notes in the third quarter. Our receipt of the exercise price upon the exercise of stock options generated cash of approximately $18 million during 2004.

Credit Sources

Substantial credit sources are available to us. In total, we had available sources of approximately $400$600 million at February 28, 2006.2007. This included our $200$450 million senior secured revolving credit facility and our $200$150 million accounts receivable securitization financing.facility. There were no balances outstanding balances under either of these arrangements at February 28, 2006. Effective April 4, 2006,2007. While there were no balances outstanding under either facility, we do have, in the available sources increased to $800 million.aggregate, $27.9 million outstanding under letters of credit, which reduces total unused credit sources.

On April 4, 2006, we entered into a new $650 million credit agreement, dated April 4, 2006. The new credit agreement includes a $350 million revolving credit facility and a secured $300$100 million delay draw term loan. In connection with the execution of this new agreement, our amended and restated credit agreement dated May 11, 2004 was terminated. The obligations under the new credit agreement are guaranteed by our material domestic subsidiaries and are secured by substantially all of the personal property of American Greetings Corporation and each of our material domestic subsidiaries, including a pledge of all of the capital stock in substantially all of our domestic subsidiaries and 65% of the capital stock of our first tier foreign subsidiaries. The revolving loanscredit facility will mature on April 4, 2011, and theany outstanding term loans will mature on April 4, 2013. Each term loan will amortize in equal quarterly installments equal to 0.25% of the amount of such term loan, beginning on April 4, 2007,2008, with the balance payable on April 4, 2013.

Term loans under the new credit agreement will bear interest at a rate per annum based on either the London Inter-Bank Offer Rate (“LIBOR”) plus 150 basis points or based on the alternate base rate (“ABR”), as defined in the credit agreement, plus 25 basis points. Revolving loans denominated in U.S. dollars under the credit agreement will bear interest at a rate per annum based on the then applicable LIBORLondon Inter-Bank Offer Rate (“LIBOR”) or ABRthe alternate base rate (“ABR”), as defined in the credit agreement, in each case, plus margins adjusted according to our leverage ratio. Term loans will bear interest at a rate per annum based on either LIBOR plus 150 basis points or based on the ABR, as defined in the credit agreement, plus 25 basis points. We pay an annual commitment fee of 75 basis points on the undrawn portion of the term loan. The commitment fee on the revolving facility fluctuates based on our leverage ratio.

The credit agreement contains certain restrictive covenants that are customary for similar credit arrangements, including covenants relating to limitations on liens, dispositions, issuance of debt, investments, payment of dividends, repurchases of capital stock, acquisitions and transactions with affiliates. There are also financial performance covenants that require us to maintain a maximum leverage ratio and a minimum interest

coverage ratio. The credit agreement also requires us to make certain mandatory prepayments of outstanding indebtedness using the net cash proceeds received from certain dispositions, events of loss and additional indebtedness that we may incur from time to time.

Also, on April 4, 2006, we reduced theWe are also party to an amended and restated receivables purchase agreement with available financing of up to $150 million. The agreement expires on October 23, 2009. Under the amended and restated receivables purchase agreement, American Greetings and certain of its subsidiaries sell accounts receivable to AGC Funding Corporation (“AGC Funding”), a wholly-owned, consolidated subsidiary of American Greetings, which in turn sells undivided interests in eligible accounts receivable to third party financial institutions as part of a process that provides funding similar to a revolving credit facility. Funding under ourthe facility may be used for working capital, general corporate purposes and the issuance of letters of credit.

The interest rate under the accounts receivable securitization financingfacility is based on (i) commercial paper interest rates, (ii) LIBOR rates plus an applicable margin or (iii) a rate that is the higher of the prime rate as announced by the applicable purchaser financial institution or the federal funds rate plus 0.50%. AGC Funding pays an annual commitment fee of 28 basis points on the unfunded portion of the accounts receivable securitization facility, together with customary administrative fees on outstanding letters of credit that have been issued and on outstanding amounts funded under the facility.

The amended and restated receivables purchase agreement fromcontains representations, warranties, covenants and indemnities customary for facilities of this type, including the obligation of American Greetings to maintain the same consolidated leverage ratio as it is required to maintain under its secured credit facility.

On May 24, 2006, we issued $200 million to $150 million.of 7.375% senior unsecured notes, due on June 1, 2016. The proceeds from this issuance were used for the repurchase of our 6.10% senior notes that were tendered in our tender offer and consent solicitation that was completed on May 25, 2006.

On April 6,May 25, 2006, we commenced a cash tender offer, subject to several conditions, for allrepurchased $277.3 million of our $300 million of outstanding6.10% senior notes. In conjunction with the tender offer for the 6.10% senior notes, due on August 1, 2028 and a consent solicitation to amend the related note indenture. The consent solicitation seeks consents from holders ofindenture governing the 6.10% senior notes was amended to eliminate certain restrictive covenants and events of default fromdefault. The remaining 6.10% senior notes may be put back to the note indenture. We are undertaking this initiative to increase our financial flexibility. The commencement date of this offer was April 6, 2006, andCorporation on August 1, 2008, at the expected expiration date is May 24, 2006. As of April 19, 2006, we had received sufficient consents to amend the indenture governing the notes.

Also, on April 6, 2006, we commenced an exchange offer for our existing 7.00% convertible subordinated notes for a new series of convertible notes with substantially the same terms except that the new convertible notes will permit us to settle the conversionoption of the new notes in cash and stock, whereas the old notes were convertible into stock only. Assuming allholders, at 100% of the notes are exchanged,principal amount provided the net effect on the financial statements will be to use approximately $175 million of cash to settle, inholders exercise this option between July 2006, a portion of the total conversion value.

Within the next two months, we anticipate issuing $200 million of senior unsecured notes with a ten-year final maturity. If completed, proceeds from this issuance are expected to be used to finance the tender for the 6.10% notes as well as for general corporate purposes.1, 2008 and August 1, 2008.

Our future operating cash flow and borrowing availability under existingour credit facilitiesagreement and our accounts receivable securitization financing programfacility are expected to meet currently anticipated funding requirements. The seasonal nature of the business results in peak working capital requirements that may be financed through short-term borrowings.

In executing our card growth strategy, we expect to use approximately $75 million of cash during the next fiscal year. The actual timing of the expenditure will depend on the schedules of our retail partners. Additionally, one of our largest customers recently announced that it has entered into an agreement to sell its entire company. Our future earnings and cash flows may be impacted due to possible changes in sales volume, sales terms, contract terms and the potential for refunding of contract obligations.

In ana continued effort to return value to our shareholders, we announced on February 1, 2006, aApril 17, 2007, an additional program to repurchase up to $200$100 million of our Class A common shares. These repurchases will be made through a 10b5-1 program in open market or privately negotiated transactions in compliance with the Securities and Exchange Commission’s Rule 10b-18, subject to market conditions, applicable legal requirements and other factors. There is no set expiration date for this program.

Contractual Obligations

The following table presents our contractual obligations and commitments to make future payments as of February 28, 2006:2007: