This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited 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 description 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

We achieved significantly higher earnings for the second quarter ended August 28, 2009 compared to the prior year period. This improvement was the result of the strategic acquisitions and dispositions over the past nine months, the realization of cost savings from initiatives implemented during the prior year, an improved balance of card unit shipments compared to card unit net sales that reduced supply chain, scrap and distribution costs, and a benefit from certain corporate-owned life insurance ("COLI") programs.

As previously disclosed, during the past nine months we acquired Recycled Paper Greetings ("RPG") and the wholesale business division of Schurman Fine Papers ("Schurman") that supplies Papyrus brand greeting cards to specialty, mass, grocery and drug store channels. In addition, we divested of our Retail Operations segment, which at the time of the transaction operated 341 specialty card and gift stores in the United States and Canada. For the current quarter, the impact of this change in business mix resulted in a net decrease in revenue of approximately $4 million compared to the prior year period, while driving an improvement in earnings of approximately $8 million. We expect this change in business mix to continue to drive earnings as we begin to integrate the supply chain, manufacturing, distribution and administrative functions of these acquisitions into our existing structure during the next few quarters. Based on our preliminary estimates, we expect to use approximately $20 million of cash to implement the integration plan over the next eighteen months.

For the quarter, consolidated revenues were lower compared to the prior year period, approximately half of which is due to unfavorable foreign currency translation. Adding to this decrease was lower sales of non-card products, primarily gift packaging products, in our North American Social Expression Products segment, reduced royalty revenue from our Strawberry Shortcake and Care Bears properties and continued lower advertising revenues in our AG Interactive segment, slightly offset by improved revenues in our International Social Expression Products segment.

In our International Social Expression Products segment, improved sales of gifting products along with savings realized from cost reduction activities and the anticipated recovery of customer accounts previously considered uncollectible drove earnings improvement compared to the prior year second quarter. Despite the favorable second quarter results in this segment, we expect that the general economic conditions in the United Kingdom ("U.K.") will continue to put downward pressure on our international revenues and earnings during the remainder of the fiscal year.

Our AG Interactive segment continues to experience lower revenues compared to the prior year due primarily to lower advertising revenues. Earnings in this segment were up compared to the prior year quarter, with cost savings initiatives and lower intangible asset amortization more than offsetting the impact of lower revenues.

The current quarter included a benefit of approximately $7 million related to our COLI programs due to higher than average death benefit income reported by our third party administrators.

As previously disclosed in our Annual Report on Form 10-K for the fiscal year ended February 28, 2009, we have entered into an agreement to sell our Strawberry Shortcake and Care Bears properties. See Part II, Item 1, "Legal Proceedings," for further information.

Results of Operations

Three months ended August 28, 2009 and August 29, 2008

Net income was $23.1 million, or $0.59 per share, in the second quarter compared to net income of $2.3 million, or $0.05 per share, in the prior year second quarter (all per-share amounts assume dilution).

Our results for the three months ended August 28, 2009 and August 29, 2008 are summarized below:

                                                                % Total                        % Total
(Dollars in thousands)                            2009          Revenue          2008          Revenue
Net sales                                       $ 348,639          97.8 %      $ 372,942          96.7 %
Other revenue                                       7,711           2.2 %         12,893           3.3 %

Total revenue                                     356,350         100.0 %        385,835         100.0 %

Material, labor and other production costs        153,248          43.0 %        170,112          44.1 %
Selling, distribution and marketing expenses      117,531          33.0 %        154,387          40.0 %
Administrative and general expenses                48,483          13.6 %         57,162          14.8 %
Other operating income - net                       (1,397 )        (0.4 )%          (111 )        (0.0 )%


Operating income                                   38,485          10.8 %          4,285           1.1 %

Interest expense                                    6,671           1.9 %          5,434           1.4 %
Interest income                                      (989 )        (0.3 )%          (898 )        (0.2 )%
Other non-operating income - net                   (1,291 )        (0.4 )%        (2,617 )        (0.7 )%


Income before income tax expense                   34,094           9.6 %          2,366           0.6 %
Income tax expense                                 10,972           3.1 %             69           0.0 %


Net income                                      $  23,122           6.5 %      $   2,297           0.6 %

For the three months ended August 28, 2009, consolidated net sales were $348.6 million, down from $372.9 million in the prior year second quarter. This 6.5%, or approximately $24 million, decrease was primarily the result of unfavorable foreign currency translation and lower sales in our Retail Operations segment of approximately $14 million and $35 million, respectively. These decreases were partially offset by an increase of approximately $24 million in our North American Social Expression Products segment. Increased net sales in our International Social Expression Products segment of approximately $3 million due to improved sales of gifting products were substantially offset by a decrease in our AG Interactive segment of approximately $2 million as a result of continued lower advertising revenues.

Net sales in our North American Social Expression Products segment increased approximately $24 million. The majority of the increase is attributable to RPG and Papyrus sales of approximately $30 million, both of which were acquired in the last nine months. These increases from RPG and Papyrus were partially offset by lower sales of our gift-packaging product lines of approximately $7 million.

The sale of our retail stores in April 2009 accounted for approximately $35 million of the reduction in net sales quarter-over-quarter. There were no sales in our Retail Operations segment during the three months ended August 28, 2009.

Other revenue, primarily royalty revenue from our Strawberry Shortcake and Care Bears properties, decreased $5.2 million from $12.9 million during the three months ended August 29, 2008 to $7.7 million for the three months ended August 28, 2009.

Wholesale Unit and Pricing Analysis for Greeting Cards

Unit and pricing comparatives (on a sales less returns basis) for the three
months ended August 28, 2009 and August 29, 2008 are summarized below:



                                                        Increase (Decrease) From the Prior Year
                                        Everyday Cards          Seasonal Cards           Total Greeting Cards
                                        2009        2008       2009        2008          2009             2008
Unit volume                               6.7 %     (0.2 )%     13.2 %      29.7 %          7.7 %            4.0 %
Selling prices                            1.3 %     (0.1 )%     (1.3 )%    (13.7 )%         0.9 %           (2.4 )%
Overall increase / (decrease)             8.1 %     (0.2 )%     11.7 %      12.0 %          8.7 %            1.5 %

During the second quarter, combined everyday and seasonal greeting card sales less returns improved 8.7% compared to the prior year quarter, including 7.7% unit growth and 0.9% improvement in selling prices. These increases were driven by the RPG and Papyrus acquisitions. Net of the impact of these acquisitions, combined everyday and seasonal greeting card sales less returns were flat, with a 1% decrease in unit volume offset by a 1% improvement in selling prices.

Everyday card sales less returns for the three months ended August 28, 2009 were up 8.1% compared to the prior year quarter, with unit volume and selling prices improving 6.7% and 1.3%, respectively. Net of the impact of the Papyrus and RPG acquisitions, overall everyday card sales less returns declined 0.9%, with a decrease in unit volume of 2.1% partially offset by an increase in selling prices of 1.2%. Decreases in unit volume were driven primarily by our North American Social Expression Products segment. Selling price improvement was a result of the continued growth in higher priced technology cards, which more than offset the continued shift to a higher mix of the value line cards.

Seasonal card sales less returns improved 11.7% during the second quarter including 13.2% unit growth partially offset by a 1.3% decline in selling prices. Net of the impact of the Papyrus and RPG acquisitions, overall sales less returns improved 4.4%, with a 5.4% increase in unit volume more than offsetting a decrease in selling prices of 1.0%. The increase in unit volume was driven primarily by the timing of shipments associated with our Graduation program in the current quarter compared to the prior year quarter.

Expense Overview

During the current quarter, we experienced decreased costs as a result of exiting our retail stores, the realization of cost reduction actions taken in the fourth quarter of 2009 as well as favorable foreign currency translation impacts.

Material, labor and other production costs ("MLOPC") for the three months ended August 28, 2009 were $153.2 million, approximately $17 million less than the prior year three months. As a percentage of total revenue, these costs were 43.0% in the current period compared to 44.1% for the three months ended August 29, 2008. The decrease is due to favorable spending of approximately $9 million, volume variances of approximately $3 million due to the lower sales in the period and foreign currency translation impacts of approximately $5 million. Decreased spending was a result of reduced scrap levels.

Selling, distribution and marketing ("SDM") expenses for the three months ended August 28, 2009 were $117.5 million, decreasing approximately $37 million from $154.4 million during the prior year three months. The decrease is due to lower spending of approximately $30 million and favorable foreign currency translation of approximately $7 million. The elimination of the operating costs of our retail stores due to the disposition of those stores during the first quarter of 2010 accounted for approximately $26 million of the $30 million decrease as the prior year second quarter included approximately $26 million of store related expenses. The remaining $4 million of lower spending is attributable to reduced expenses in our licensing business in line with the lower royalty revenue. Decreases in supply chain costs, specifically freight and distribution costs, due to a reduction in units shipped were substantially offset by ongoing SDM expenses from our recent acquisitions.

Administrative and general expenses were $48.5 million for the three months ended August 28, 2009, a decrease from $57.2 million for the three months ended August 29, 2008. The decrease of $8.7 million is primarily related to a benefit of approximately $7 million associated with our COLI programs and favorable foreign currency translation of approximately $2 million.

Other operating income - net was $1.4 million for the three months ended August 28, 2009 compared to $0.1 million for the prior year second quarter. The current year period included a $0.6 million gain on the sale of our calendar product lines.

Interest expense for the three months ended August 28, 2009 was $6.7 million, up from $5.4 million for the prior year quarter. The increase of $1.3 million is primarily attributable to interest on the new 7.375% notes and the $100 million term loan facility that were issued and drawn down, respectively, during the fourth quarter of 2009.

Other non-operating income - net was $1.3 million in the current year second quarter compared to $2.6 million for the three months ended August 29, 2008. The $1.3 million decrease is due primarily to decreased foreign exchange gains partially offset by reduced losses on the disposal of fixed assets in the current period compared to the prior year second quarter.

The effective tax rate was 32.2% and 2.9% for the three months ended August 28, 2009 and August 29, 2008, respectively. The lower than statutory effective tax rate in the current quarter is due primarily to the COLI benefit discussed above, which is non-taxable. The low rate in the prior year quarter is due to the recognition of a tax benefit from a return to provision adjustment. The impact of this benefit was magnified by the seasonally low level of income in the period.

Results of Operations

Six months ended August 28, 2009 and August 29, 2008

Net income was $33.1 million, or $0.84 per share, in the six months ended August 28, 2009 compared to net income of $15.6 million, or $0.32 per share, in the prior year six months.

Our results for the six months ended August 28, 2009 and August 29, 2008 are summarized below:

                                                                % Total                        % Total
(Dollars in thousands)                            2009          Revenue          2008          Revenue
Net sales                                       $ 757,916          98.5 %      $ 798,405          98.1 %
Other revenue                                      11,356           1.5 %         15,730           1.9 %

Total revenue                                     769,272         100.0 %        814,135         100.0 %

Material, labor and other production costs        320,417          41.7 %        363,454          44.6 %
Selling, distribution and marketing expenses      249,748          32.5 %        305,262          37.5 %
Administrative and general expenses               111,634          14.5 %        119,723          14.7 %
Other operating expense (income) - net             26,376           3.4 %           (838 )        (0.1 )%


Operating income                                   61,097           7.9 %         26,534           3.3 %

Interest expense                                   13,658           1.8 %         10,339           1.3 %
Interest income                                    (1,265 )        (0.2 )%        (1,888 )        (0.2 )%
Other non-operating income - net                   (2,333 )        (0.3 )%        (3,518 )        (0.4 )%


Income before income tax expense                   51,037           6.6 %         21,601           2.6 %
Income tax expense                                 17,954           2.3 %          5,971           0.7 %


Net income                                      $  33,083           4.3 %      $  15,630           1.9 %

For the six months ended August 28, 2009, consolidated net sales were $757.9 million, down from $798.4 million in the prior year six months. This 5.1%, or approximately $40 million, decrease was primarily the result of decreased net sales in our Retail Operations

segment of approximately $61 million and an unfavorable foreign currency translation impact of approximately $38 million. These decreases were partially offset by higher net sales in our North American Social Expression Products segment of approximately $58 million. Increased net sales in our fixtures business of approximately $4 million were substantially offset by a decrease in our AG Interactive segment of approximately $3 million as a result of continued declining advertising revenues.

Approximately all of the $58 million increase in net sales in our North American Social Expression Products segment is attributable to our recent acquisitions of RPG and Papyrus. Increased card sales in our legacy business were substantially offset by lower sales in our gift packaging and party goods product lines.

Net sales of our Retail Operations segment decreased approximately $61 million due to the sale of this business in April 2009. Included in the six months ended August 28, 2009 is approximately $12 million of net sales compared to approximately $73 million in the prior year six months.

Other revenue, primarily royalty revenue from our Strawberry Shortcake and Care Bears properties, decreased $4.3 million from $15.7 million during the six months ended August 29, 2008 to $11.4 million for the six months ended August 28, 2009.

Wholesale Unit and Pricing Analysis for Greeting Cards

Unit and pricing comparatives (on a sales less returns basis) for the six months
ended August 28, 2009 and August 29, 2008 are summarized below:



                                                        Increase (Decrease) From the Prior Year
                                        Everyday Cards          Seasonal Cards           Total Greeting Cards
                                        2009        2008        2009        2008         2009             2008
Unit volume                               5.1 %      5.3 %        3.9 %     12.3 %          4.7 %            7.2 %
Selling prices                            2.1 %     (2.6 )%       1.9 %     (7.9 )%         2.1 %           (4.0 )%
Overall increase / (decrease)             7.3 %      2.6 %        5.9 %      3.4 %          6.9 %            2.8 %

During the six months ended August 28, 2009, combined everyday and seasonal greeting card sales less returns improved 6.9%, compared to the prior year six months, with increases coming from both everyday and seasonal cards. Overall unit volume and selling prices improved 4.7% and 2.1%, respectively. Net of the impact of the Papyrus and RPG acquisitions, overall greeting card sales less returns declined 0.5% as a result of a decrease in unit volume of 2.5% which more than offset a selling price improvement of 2.0%.

Everyday card sales less returns were up 7.3%, compared to the prior year six months, including increases in both unit volume and selling prices of 5.1% and 2.1%, respectively. Net of the impact of the Papyrus and RPG acquisitions, overall greeting card sales less returns decreased 0.8%, with a decline in unit volume of 2.8% more than offsetting a 2.0% improvement in selling prices. Increased selling prices were driven primarily by our North American Social Expression Products segment where higher priced technology cards are continuing to improve prices despite the mix shift towards the value line cards.

Seasonal card sales less returns increased 5.9%, with improvements in unit volume of 3.9% and selling prices of 1.9%, compared to the prior year six months. Net of the impact of the Papyrus and RPG acquisitions, overall sales less returns for seasonal greeting cards were essentially flat. Improvements of 2.0% in selling prices were offset by a decline in unit volume of 1.8%. The decrease in unit volume was driven primarily by the Mother's Day program.

Expense Overview

During the current year, we experienced decreased costs as a result of exiting our retail stores, the realization of cost reduction actions taken in the fourth quarter of 2009 as well as favorable foreign currency translation impacts. Additionally, costs were lower in the current period compared to the prior year six months as the prior period included costs associated with the rollout of the new Canadian line of cards.

MLOPC for the six months ended August 28, 2009 were $320.4 million, a decrease from $363.5 million for the comparable period in the prior year. As a percentage of total revenue, these costs were 41.7% in the current period compared to 44.6% for the six months ended August 29, 2008. The decrease of approximately $43 million is due to favorable spending and product mix of approximately $22 million and $4 million, respectively. Favorable volume variances due to the decreased sales volume in the current year and foreign currency translation impacts decreased MLOPC approximately $1 million and $16 million, respectively. The decreased spending is primarily attributable to lower scrap costs as well as lower costs associated with the conversion to our new Canadian line of cards, which unfavorably impacted prior year results. The favorable product mix is primarily due to a shift to higher margin card products versus non-card products.

SDM expenses for the six months ended August 28, 2009 were $249.7 million, decreasing from $305.3 million for the comparable period in the prior year. The decrease of approximately $56 million is due to lower spending of approximately $39 million and favorable foreign currency translation of approximately $17 million. The elimination of the operating costs of our retail stores due to the disposition of those stores during the first quarter of 2010 accounted for approximately all of the $39 million decrease as the prior year six months included approximately $40 million of store related expenses. Lower spending on supply chain costs, specifically freight and distribution costs, due to a decrease in units shipped, as well as reduced expenses in our licensing business were substantially offset by ongoing SDM expenses from our recent acquisitions.

Administrative and general expenses were $111.6 million for the six months ended August 28, 2009, a decrease from $119.7 million for the six months ended August 29, 2008. The decrease of $8.1 million is primarily related to the COLI benefit of approximately $7 million discussed above and favorable foreign currency translation of approximately $4 million partially offset by higher domestic profit-sharing plan expense of approximately $4 million due to the increased income in the current year period.

Other operating expense (income) - net was expense of $26.4 million for the six months ended August 28, 2009 compared to income of $0.8 million in the prior period. The current six months includes a preliminary loss of $28.3 million on the sale of our retail stores to Schurman partially offset by a gain of $0.6 million on the sale of our calendar product lines.

Interest expense for the six months ended August 28, 2009 was $13.7 million, up from $10.3 million in the prior year period. The increase of $3.4 million is attributable to interest on the new 7.375% notes and the $100 million term loan facility that were issued and drawn down, respectively, during the fourth quarter of 2009.

Other non-operating income - net was $2.3 million in the current year six months compared to $3.5 million for the six months ended August 29, 2008. The $1.2 million decrease in income is due primarily to less foreign exchange gains partially offset by reduced losses on the disposal of fixed assets in the current period compared to the prior year six months.

Segment Information

Our operations are organized and managed according to a number of factors, including product categories, geographic locations and channels of distribution. Our North American Social Expression Products and our International Social Expression Products segments primarily design, manufacture and sell greeting cards and other related products through various channels of distribution, with mass retailers as the primary channel. As permitted under Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information," certain operating divisions have been aggregated into both the North American Social Expression Products and International Social Expression Products segments. The aggregated operating divisions have similar

economic characteristics, products, production processes, types of customers and distribution methods. AG Interactive distributes social expression products, including electronic greetings, personalized printable greeting cards and a broad range of graphics and digital services and products, through a variety of electronic channels, including Web sites, Internet portals, instant messaging services and electronic mobile devices. AG Interactive also offers online photo sharing space and a platform to provide consumers the ability to use their own photos to create unique, high quality physical products, including greeting cards, calendars, photo albums and photo books.

We review segment results using consistent exchange rates between periods to eliminate the impact of foreign currency fluctuations.

North American Social Expression Products Segment



                                  Three Months Ended                                     Six Months Ended
(Dollars in thousands)    August 28, 2009     August 29, 2008    % Change       August 28, 2009     August 29, 2008    % Change
Total revenue            $         266,934   $         243,036        9.8 %    $         585,714   $         527,907       11.0 %
Segment earnings                    42,679              22,275       91.6 %              117,045              64,281       82.1 %

Total revenue of our North American Social Expression Products segment, excluding the impact of foreign exchange and intersegment items, increased $23.9 million and $57.8 million for the three and six months ended August 28, 2009, respectively, compared to the prior year periods. The majority of the revenue improvement in both the three and six month periods is attributable to the RPG and Papyrus acquisitions. The current year three and six months include revenue of approximately $30 million and $59 million, respectively, from the acquisitions. These increases were partially offset by decreases in our gift packaging product lines, which more than offset improved net sales of our everyday and seasonal greeting cards in our core greeting card business.

Segment earnings, excluding the impact of foreign exchange and intersegment items, increased $20.4 million and $52.8 million in the current year three and . . .