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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended August 31, 2003

OR

For the transition period from                to                

AMERICAN GREETINGS CORPORATION

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

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

As of August 31, 2003, the date of this report, the number of shares outstanding of each of the issuer’s classes of common stock was:

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AMERICAN GREETINGS CORPORATION
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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AMERICAN GREETINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Thousands of dollars except share and per share amounts)

See notes to condensed consolidated financial statements (unaudited).

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AMERICAN GREETINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Thousands of dollars except share and per share amounts)

See notes to condensed consolidated financial statements (unaudited).

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AMERICAN GREETINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL POSITION

(Thousands of dollars)

See notes to condensed consolidated financial statements (unaudited).

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AMERICAN GREETINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Thousands of dollars)

See notes to condensed consolidated financial statements (unaudited).

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AMERICAN GREETINGS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Thousands of dollars except share and per share amounts)

Three and Six Months Ended August 31, 2003 and 2002

Note 1 - Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain amounts in the prior year financial statements have been reclassified to conform with the 2004 presentation.

The balance sheet at February 28, 2003 has been derived from the audited financial statements at that date but does not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in the Corporation’s annual report on Form 10-K for the year ended February 28, 2003.

The Corporation’s fiscal year ends on February 28 or 29. References to a particular year refer to the fiscal year ending in February of that year. For example, 2003 refers to the year ended February 28, 2003.

Note 2 - Seasonal Nature of Business

A significant portion of the Corporation’s business is seasonal in nature. Therefore, the results of operations for interim periods are not necessarily indicative of the results for the fiscal year taken as a whole.

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Note 3 - Recent Accounting Pronouncements

In April 2002, Statement of Financial Accounting Standards (SFAS) No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections”, was issued. SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. SFAS No. 145 requires that debt extinguishment must meet the criteria under APB Opinion No. 30 to be classified as an extraordinary item. This Statement also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The Corporation adopted this Statement effective March 1, 2003 (see Note 6).

In December 2002, SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” was issued. SFAS No. 148 amends the disclosure provisions of SFAS No. 123 and requires expanded and more prominent disclosure of the effects of an entity’s accounting policy in respect to stock-based employee compensation. The disclosure requirements in SFAS No. 148 are effective for financial statements for fiscal years ending after December 15, 2002 and for financial reports containing condensed consolidated financial statements for interim periods beginning after December 15, 2002. Beginning with its financial statements for the year ended February 28, 2003, the Corporation has adopted the disclosure provisions of SFAS No. 148 in its annual and interim reports (see Note 8).

In January 2003, Interpretation No. 46, “Consolidation of Variable Interest Entities” was issued. Interpretation No. 46 provides guidance for identifying a controlling interest in a Variable Interest Entity (“VIE”) established by means other than voting interests. Interpretation No. 46 also requires consolidation of a VIE by an enterprise that holds such a controlling interest. In October 2003, the Financial Accounting Standards Board deferred the effective date for all variable interests held by public companies in all entities that were acquired prior to February 1, 2003. The deferral will require the provisions of the Interpretation to be adopted at the end of the period ending after December 15, 2003. The Corporation does not expect this Interpretation to have a material effect on the financial statements of the Corporation.

In May 2003, SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, was issued. SFAS No. 150 establishes standards for how certain financial instruments with characteristics of both liabilities and equity are classified. This Statement requires that a financial instrument that is within its scope be classified as a liability (or as an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Corporation does not expect this Statement to have a material effect on the financial statements of the Corporation.

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Note 4 – Other (Income) – Net

During the three months ended May 31, 2002, “Other (income) – net” included $12,027 of income on the sale of a marketable security investment. The amount of the proceeds received from the sale of the marketable security investment of $16,964 is included in “Other – net” investing activities in the Statement of Cash Flows for the period.

Note 5 – Restructure Reserves

In 2002, the Corporation recorded a charge of $56,715 to restructure certain of the Corporation’s domestic and foreign manufacturing and distribution operations. The restructure charge included $29,053 for employee termination benefits, $2,054 for facility rationalization costs, $1,500 for lease exit costs, $17,727 for a change in the contractual relationship with a partner of the Corporation’s Internet unit and $6,381 of other related costs. In total, approximately 1,600 positions were eliminated, comprised of approximately 1,200 hourly and 400 salaried positions. All activities were substantially completed by February 28, 2002. The following table summarizes the remaining reserve associated with the 2002 restructure charge:

Included in “Accrued liabilities” at August 31, 2003 is $2,633 representing the portion of severance and other exit costs not yet expended. The payment of termination benefits will not be completed until 2006. Cash expenditures for the three months ended August 31, 2003 were $724.

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Note 6 – Debt

On June 29, 2001, the Corporation issued $175,000 of 7.00% convertible subordinated notes, due on July 15, 2006. The notes are convertible at the option of the holders into shares of the Corporation’s common stock at any time before the close of business on July 15, 2006, at a conversion rate of 71.9466 common shares per $1 principal amount of notes. The convertible notes outstanding could potentially result in the issuance of approximately 12,591,000 shares of the Class A Common Stock of the Corporation.

On August 9, 2001, the Corporation entered into a $350,000 senior secured credit facility that was amended to $320,000 on July 22, 2002. This revised facility consisted of three tranches: (1) a $75,000, 364-day revolving facility, of which there were no amounts outstanding at August 31, 2003; (2) a $120,000 revolving facility maturing January 15, 2006, of which $3,500 was outstanding at August 31, 2003; and (3) a $125,000 term loan maturing June 15, 2006. On August 5, 2003 the Corporation exercised its option on the 364-day revolving facility for an additional 364 days.

Under the terms of the facility, the Corporation paid the entire outstanding balance of $117,988 of the term loan on April 7, 2003. At that date, the Corporation recorded a charge of $4,639 for the write off of the related deferred financing costs and a premium associated with the early retirement of the loan.

As a result of the retirement and payment of the term loan and the $3,500 outstanding under the revolver, the amount available under the facility at August 31, 2003 was $191,500. The facility is secured by the domestic assets of the Corporation and a 66 2/3% interest in the common stock of its foreign subsidiaries. The facility contains various restrictive covenants. Some of these restrictions require that the Corporation meet specified periodic financial ratios, minimum net worth, maximum leverage, and earnings requirements. In April 2003, at the request of the Corporation, various restrictive covenants of the credit facility were amended. These amendments included the elimination of the minimum earnings before interest, taxes, depreciation and amortization covenant and the loosening of the interest coverage covenant. The credit facility also restricts the Corporation’s ability to incur additional indebtedness and to engage in acquisitions of other businesses and entities and to pay shareholder dividends. In August 2003, the Corporation amended several restrictive covenants of the credit facility. These amendments included a reduction in the frequency of financial reporting, a reduction in borrowing costs, and enhanced flexibility in its investments, acquisitions, and restricted payments. At August 31, 2003, the Corporation was in compliance with its debt covenants.

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On August 7, 2001, the Corporation entered into a three-year Accounts Receivable Securitization Financing that provides for up to $250,000 and is secured by certain trade accounts receivable. At the request of the Corporation, on August 6, 2002, the agreement was amended reducing the available financing from $250,000 to $200,000. Under the terms of the agreement, the Corporation transfers receivables to a wholly-owned consolidated subsidiary that in turn utilizes the receivables to secure borrowings through a credit facility with a financial institution. At August 31, 2003, there was $5,000 outstanding under this agreement.

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Note 7 – Earnings Per Share

The following tables set forth the computation of earnings per share and earnings per share – assuming dilution:

The effect of the convertible subordinated notes has been excluded for the six months ended August 31, 2003 because the effect would have been antidilutive.

The loss per share for the three months ended August 31, 2003 and 2002 was $(0.15) and $(0.24), respectively. The effect of the convertible subordinated notes and stock options has been excluded for the three months ended August 31, 2003 and 2002 because the effect would have been antidilutive.

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Note 8 – Stock-Based Compensation

The Corporation has elected to continue to follow Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations in accounting for its stock options granted to employees and directors. Because the exercise price of the Corporation’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Corporation has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”.

The following illustrates the pro forma effect on net income (loss) and earnings (loss) per share if the Corporation had applied the fair value recognition provisions of SFAS No. 123:

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Note 9 - Comprehensive Income (Loss)

The Corporation’s total comprehensive income (loss) is as follows:

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Note 10 - Business Segment Information

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The Corporation owns and operates over 600 card and gift retail stores in the United States and Canada through its Retail Operations segment. The stores are primarily located in malls and strip shopping centers. The stores sell products purchased from the Social Expression Products segment and products purchased from other vendors. This segment was previously included in the “Non-reportable segments”, and the prior year amounts have been reclassed to conform to the current year presentation.

Segment results are reported and evaluated at consistent exchange rates between years to eliminate the impact of foreign currency fluctuations. An exchange rate adjustment is included in the reconciliation of the segment results to the consolidated results; this adjustment represents the impact on the segment results of the difference between the exchange rates used for segment reporting and evaluation and the actual exchange rates for the periods presented.

Centrally-incurred and managed costs are not allocated to the operating segments. The unallocated items include interest expense on centrally-incurred debt and domestic profit-sharing expense. In addition, the costs associated with corporate operations including the senior management, corporate finance, legal and human resource functions, among other costs, are included in the unallocated items.

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Note 11 – Inventories

The valuation of inventory under the Last-In, First-Out (LIFO) method is made at the end of each fiscal year based on inventory levels and costs at that time. Accordingly, interim LIFO calculations, by necessity, are based on estimates of expected fiscal year-end inventory levels and costs and are subject to final fiscal year-end LIFO inventory calculations.

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Note 12 - Deferred Costs

In the normal course of its business, the Corporation enters into agreements with certain customers for the supply of greeting cards and related products. Under these agreements, the customer typically receives from the Corporation a combination of cash payments, credits, discounts, allowances and other incentive considerations to be earned by the customer as product is purchased from the Corporation over the effective time period of the agreement to meet a minimum purchase volume commitment. The Corporation periodically reviews the progress toward the commitment and adjusts the estimated amortization period accordingly to match the costs with the revenue associated with the agreement. In the event a contract is not completed, the Corporation has a claim for unearned advances under the agreement. The agreements may or may not specify the Corporation as the sole supplier of social expression products to the customer.

The Corporation classifies the total contractual amount of the incentive consideration committed to the customer but not yet earned as a deferred cost asset at the inception of an agreement, or any future amendments. Deferred costs estimated to be earned by the customer and charged to operations during the next twelve months are classified as “Prepaid expenses and other” in the Consolidated Statement of Financial Position, and the remaining amounts to be charged beyond the next twelve months are classified as “Other assets”.

A portion of the total consideration may be payable by the Corporation at the time the agreement is consummated. All future payment commitments are classified as liabilities at inception until paid. The payments that are expected to be made in the next twelve months are classified as “Other current liabilities” in the Consolidated Statement of Financial Position, and the remaining payment commitments beyond the next twelve months are classified as “Other liabilities”. The Corporation maintains adequate reserves for deferred costs related to supply agreements and does not expect that the non-completion of any particular contract would result in a material loss.

As of August 31, 2003, February 28, 2003 and August 31, 2002, deferred costs and future payment commitments are included in the following financial statement captions:

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Part 1, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business Developments

For the three months ended August 31, 2003, the Corporation had a net loss of $0.15 per share, which compares favorably with the $0.24 per share loss for the same period in the prior year. (Due to the seasonal nature of its business, the Corporation has historically had net losses in the three months ended August 31 each year.) The reduction in the loss for the period compared to prior year reflects the Corporation’s continued focus on reducing costs.

Results of Operations

Three months ended August 31, 2003
For the three months ended August 31, 2003, net sales were $403.5 million, a 1.7% increase from $396.9 million in the same period in the prior year. Overall increases in foreign currency exchange rates compared to the prior year drove the increase in reported net sales; excluding the effect on sales of the exchange rate increases, net sales were approximately flat for the three months ended August 31, 2003 compared to the same period in the prior year. During the three months, the Corporation began to integrate the first of approximately 1,400 additional stores of a major retail customer, which resulted in increased everyday card shipments. In addition, shipments of candles and party goods increased during the period compared to prior year. Those increases were offset by lower seasonal card shipments, including Christmas product shipments, as well as an increase in allowances provided to customers.

Total greeting card sales less returns were up approximately 2% for the three months ended August 31, 2003 from the same period in the prior year, as unit sales were up approximately 3% and average prices were down approximately 1% for the period.

Sales of everyday cards were up approximately 3% for the three months ended August 31, 2003 from the same period in the prior year, with unit sales up approximately 2% and average price up approximately 1%, reflecting the initial shipments to the additional stores of a major retail customer.

Sales less returns of seasonal cards were down approximately 5% for the three months ended August 31, 2003 from the same period in the prior year, with unit sales down approximately 2% and average prices down approximately 3%, reflecting in part the delay of some Christmas shipments into the third quarter.

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Material, labor and other production costs for the three months ended were $201.4 million, an increase of $7.8 million or 4.1% from $193.6 million for the same period in the prior year. As a percentage of net sales, these costs were 49.9% in the current period and 48.8% in the prior year period. The increase in the percentage of net sales reflects the shift in the sales mix toward non-card products, including candles and party goods, which have higher costs as a percentage of sales. Also contributing to the increase were higher royalty expenses attributable to licensed products.

Selling, distribution and marketing costs for the three months ended August 31, 2003 were $153.7 million, an increase of $5.6 million or 3.8% from $148.1 million in the prior year. As a percentage of net sales, these costs increased from 37.3% for the three months ended August 31, 2002 to 38.1% for the three months ended August 31, 2003. The shift in the sales mix toward non-card products also affected these costs due to the generally higher freight costs associated with the shipments of those products. These costs also include commission expenses related to increased income from the licensing of the Corporation’s “Care Bear” and “Strawberry Shortcake” characters.

Administrative and general expense decreased $8.6 million to $56.7 million for the three months ended August 31, 2003 compared to $65.2 million for the same period in the prior year. The decrease reflects lower bad debt expense, lower net costs of the corporate-owned life insurance program and lower employee costs.

Interest expense for the three months ended August 31, 2003 was $17.5 million, a $2.6 million decrease from $20.1 million for the same period in the prior year. This decrease was due to savings associated with the early payoff of the Term B loan in the first quarter of 2004.

Other (income) – net was $9.7 million of income for the three months ended August 31, 2003, up from $4.0 million of income for the same period in the prior year. This increase was due to increased character licensing royalty income and foreign currency exchange gains.

Six months ended August 31, 2003

For the six months ended August 31, 2003, net sales were $857.9 million, a 2.6% decrease from $881.1 million in the same period in the prior year. The decrease from the prior year for the six months reflects the customer account losses that impacted the first quarter of 2004 and an increase in allowances provided to customers, partially offset by increased candle and party goods sales and the favorable impact of higher foreign currency exchange rates.

For the six months ended August 31, 2003, greeting card sales less returns were down approximately 5% from the same period in the prior year. Unit sales were down approximately 4% for the six months from the same period in the prior year, and average prices were down approximately 1%.

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For the six months ended August 31, 2003 material, labor and other production costs were $386.4 million, an increase of $6.3 million or 1.7% from $380.1 million for the same period in the prior year. As a percentage of net sales, these costs were 45.0% in the current period compared to 43.1% in the prior period. The percentage increase for the six months ended August 31, 2003 compared to the same period in the prior year was due to a change in the components of the sales mix with a higher share of sales volume attributable to non-card products, including candles and party goods, which have higher costs as a percentage of sales than greeting cards. The planned investment in improving the Corporation’s supply chain, primarily in the first quarter, also contributed to the increase. These increases were partially offset by production efficiency improvements in the Corporation’s other operating units.

Selling, distribution, and marketing costs for the six months ended August 31, 2003 were $303.6 million, an increase of $5.3 million or 1.8% from $298.2 million in the prior year. As a percentage of net sales, these costs increased from 33.8% for the six months ended August 31, 2002 to 35.4% for the six months ended August 31, 2003. The percentage increases were due to costs associated with the planned investment in improving the Corporation’s supply chain, primarily in the first quarter, as well as higher marketing and licensing fees. These increases were partially offset by reduced merchandiser expenses in the Social Expression Product Segment and cost savings in the Corporation’s other operating segments.

Administrative and general expense decreased $10.9 million to $122.8 million for the six months ended August 31, 2003 compared to $133.7 million for the same period in the prior year. These decreases were due to lower bad debt expense, lower net costs associated with maintaining the corporate-owned life insurance program and lower employee costs.

Interest expense for the six months ended August 31, 2003 was $40.3 million compared to $39.8 million for the same period in the prior year. On April 7, 2003, the Corporation paid the entire $118 million outstanding amount of a $125 million term loan maturing June 15, 2006 and recorded a charge of $4.6 million for deferred financing costs and a premium associated with the early retirement of this loan.

Other (income) – net was $11.9 million of income for the six months ended August 31, 2003, down from $18.3 million of income for the same period in the prior year. Included in the six months for the prior year was a $12.0 million gain on the sale of a marketable security investment held by the Corporation’s United Kingdom subsidiary.

The effective tax rate for the six months ended August 31, 2003 was 39.7%, unchanged from the same period in the prior year.

Earnings per share and earnings per share assuming dilution for the six months ended August 31, 2002 were $0.44 and $0.41, respectively, compared to $0.15 in the current year. The dilutive effect of the Corporation’s subordinated notes have been excluded for the six months ended August 31, 2003 because the effect would have been antidilutive.

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Restructuring Activities

In 2002 the Corporation recorded a charge of $56.7 million to restructure certain of the Corporation’s domestic and foreign manufacturing and distribution operations. The restructure charge included $29.1 million for employee termination benefits, $2.0 million for facility rationalization costs, $1.5 million for lease exit costs, $17.7 million for a change in the contractual relationship with a partner of the Corporation’s Internet unit and $6.4 million of other related costs. In total, approximately 1,600 positions were eliminated, comprised of approximately 1,200 hourly and 400 salaried positions. All activities were substantially completed by February 28, 2002. The following table summarizes the remaining reserve associated with the 2002 restructure charge: