Factory Card & Party Outlet Corp - Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended August 4, 2007

Commission File Number: 21859

FACTORY CARD & PARTY OUTLET CORP.

(Exact name of registrant as specified in its charter)

DELAWARE

36-3652087

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

2727 Diehl Road,

Naperville, IL 60563-2371

(Address of principal executive offices, zip code)

Registrant's telephone number, including area code: (630) 579-2000

Factory Card Outlet Corp.

(Former Name)

Indicate by check mark whether this 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in rule 12b-2 of the Exchange Act (Check One).

Large accelerated filer ¨ , accelerated filer ¨ , non-accelerated filer x .

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12(b)-2 of the Exchange Act): Yes ¨ No x .

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

The number of shares of the Registrant's Common Stock outstanding as of August 31, 2007 was 3,383,117.

Factory Card & Party Outlet Corp.

Form 10-Q

For the Quarter Ended August 4, 2007

Index


			Page
	Cautionary Statement Regarding Forward-Looking Statements		2

Part I	Financial Information

Item 1	Financial Statements:

	Condensed Consolidated Balance Sheets (Unaudited) as of August 4, 2007 and February 3, 2007		3

	Condensed Consolidated Statements of Operations (Unaudited) for the three and six months ended August 4, 2007 and July 29, 2006		4

	Condensed Consolidated Statements of Cash Flows (Unaudited) for the six months ended August 4, 2007 and July 29, 2006		5

	Notes to Condensed Consolidated Financial Statements - (Unaudited)		6-13

Item 2	Management’s Discussion and Analysis of Financial Condition And Results of Operations		14-20

Item 3	Quantitative and Qualitative Disclosures About Market Risk		21

Item 4	Controls and Procedures		21

Part II	Other Information
	Item 1.	Legal Proceedings	22
	Item 1A.	Risk Factors	22
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22
	Item 3.	Defaults Upon Senior Securities	22
	Item 4.	Submission of Matters to a Vote of Security Holders	23
	Item 5.	Other Information	23
	Item 6.	Exhibits	24-28
	Signatures		29

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

References throughout this document to the Company include Factory Card & Party Outlet Corp. and its wholly-owned subsidiary Factory Card Outlet of America, Ltd. In this document the words “we,” “our,” “ours” and “us” refer only to Factory Card & Party Outlet Corp. and its wholly-owned subsidiary and not to any other person.

The Company’s website – www.factorycard.com – provides access, free of charge, to the Company’s Securities and Exchange Commission reports, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports. On our website, please see “Corporate Information” for a link to our Securities and Exchange Commission reports.

Statements made in this Form 10-Q, and in our other public filings and releases, which are not historical facts, contain “forward-looking” statements (as defined in the Private Securities Litigation Reform Act of 1995) that involve risks and uncertainties and are subject to change at any time. The forward-looking statements are made a number of times throughout the document and may be identified by forward-looking terminology as “estimate,” “project,” “expect,” “believe,” “may,” “will,” “intend” or similar statements or variations of such terms.

The forward-looking statements involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond our control. You are cautioned that these statements are good only at the time made and are not guarantees of future performance and that actual results and trends in the future may differ materially. Unless otherwise required by applicable securities laws, the Company assumes no obligation to update its forward-looking statements to reflect subsequent events or circumstances.

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

•

ability to meet sales plans;

•

weather and economic conditions;

•

results of our exploration of strategic alternatives;

•

dependence on key personnel;

•

competition and industry consolidation;

•

ability to maintain compliance with bank covenants

•

ability to anticipate merchandise trends and consumer demand;

•

ability to maintain relationships with suppliers;

•

successful implementation of information systems;

•

successful handling of merchandise logistics;

•

inventory shrinkage;

•

ability to meet future capital needs;

•

seasonality of business;

•

disruption with our imported product;

•

vendor performance;

•

political unrest;

•

consumer confidence and consumer spending;

•

availability of retail store space on reasonable lease terms;

•

adverse developments with respect to litigation;

•

changes in accounting policies and practices;

•

governmental regulations; and

•

other factors both referenced and not referenced in this Form 10-Q.

PART I - FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

FACTORY CARD & PARTY OUTLET CORP.

AND SUBSIDIARY

Condensed Consolidated Balance Sheets

(Unaudited)

(Dollar amounts in thousands)


	August 4, 2007		February 3, 2007
ASSETS
Current assets:
Cash	$	493	$	446
Merchandise inventories, net		46,097		45,130
Prepaid rent		2,628		2,994
Prepaid expenses and other assets		1,410		1,511
Deferred tax asset, net		5,491		5,491

Total current assets		56,119		55,572

Fixed assets, net		9,422		9,400
Intangible assets, net		131		—
Other assets		123		131
Deferred tax asset, net		4,739		5,929

Total assets	$	70,534	$	71,032


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Line of credit	$	7,742	$	8,731
Accounts payable		16,788		16,908
Accrued expenses:
Payroll and other compensation		4,814		6,430
Insurance		1,427		1,205
Taxes		789		1,064
Other		3,054		2,896
Capital lease obligations		—		1

Total current liabilities		34,614		37,235

Deferred rent liabilities		2,068		1,913

Total liabilities		36,682		39,148

Stockholders’ equity		33,852		31,884

Total liabilities and stockholders’ equity	$	70,534	$	71,032

See accompanying notes to condensed consolidated financial statements.

FACTORY CARD & PARTY OUTLET CORP.

AND SUBSIDIARY

Condensed Consolidated Statements of Operations

(Unaudited)

(Dollar amounts in thousands, except share and per share data)


	Three months ended August 4, 2007		Three months ended July 29, 2006		Six months ended August 4, 2007		Six months ended July 29, 2006
Net sales	$	62,821	$	66,343	$	120,005	$	123,315
Cost of sales		37,871		40,725		74,437		77,423

Gross profit		24,950		25,618		45,568		45,892
Selling, general and administrative expenses		20,040		21,467		40,827		40,457
Depreciation expense		773		798		1,532		1,579
Interest expense		130		165		333		465

Income before income taxes		4,007		3,188		2,876		3,391
Income taxes		1,661		1,248		1,190		1,339

Net income	$	2,346	$	1,940	$	1,686	$	2,052


Earnings per share:
Net income per share – basic	$	0.71	$	0.60	$	0.51	$	0.65

Weighted average shares outstanding – basic		3,318,898		3,230,436		3,304,600		3,178,761

Net income per share – diluted	$	0.65	$	0.57	$	0.47	$	0.61

Weighted average shares outstanding – diluted		3,613,292		3,427,688		3,579,139		3,380,358

See accompanying notes to condensed consolidated financial statements.

FACTORY CARD & PARTY OUTLET CORP.

AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Dollar amounts in thousands)


	For the six months ended August 4, 2007			For the six months ended July 29, 2006
Cash flows from operating activities:
Net income	$	1,686		$	2,052
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation and amortization expense		1,532			1,579
Deferred taxes		1,190			1,339
Stock compensation		98			293
Loss on disposal of fixed assets		10			9
Amortization of deferred financing costs		8			9
Impairment charge on fixed assets		132			88
Changes in assets and liabilities:
Merchandise inventories, net		(967	)		3,448
Prepaid expenses and other assets		467			273
Accounts payable		(120	)		3,607
Accrued expenses		(1,511	)		586
Deferred rent obligations		155			(69	)

Net cash flows provided by operating activities		2,680			13,214

Net cash flows used in investing activities – purchase of fixed and intangible assets		(1,827	)		(1,245	)

Cash flows from financing activities:
Borrowings – line of credit		125,259			117,027
Repayments – line of credit		(126,248	)		(129,590	)
Payment of capital lease obligations		(1	)		(7	)
Cash received from exercise of stock options and warrants		184			601

Net cash flows used in financing activities		(806	)		(11,969	)

Net increase in cash		47			—
Cash at beginning of period		446			196

Cash at end of period	$	493		$	196


Supplemental cash flow information:
Interest paid	$	400		$	550
Alternative minimum taxes paid		102			—

See accompanying notes to condensed consolidated financial statements.

FACTORY CARD & PARTY OUTLET CORP.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(Unaudited)

(Dollar amounts in thousands, except share and per share data)

(1)	Business and Basis of Presentation

As of August 4, 2007, Factory Card & Party Outlet Corp. and its subsidiary, Factory Card Outlet of America Ltd., operated 185 company-owned retail stores in 20 states, offering a wide selection of party supplies, greeting cards, gift wrap, balloons, everyday and seasonal merchandise and other special occasion merchandise.

The condensed consolidated unaudited financial statements include the accounts of Factory Card & Party Outlet Corp. and its wholly owned subsidiary, Factory Card Outlet of America Ltd. These financial statements have been prepared by management without audit and should be read in conjunction with the consolidated financial statements and notes for the fiscal year ended February 3, 2007 included in the Company’s Annual Report on Form 10-K. The operating results for the interim periods are not necessarily indicative of the results for the year. All intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, the accompanying condensed consolidated financial statements reflect all normal recurring adjustments necessary for a fair presentation of the interim financial statements.

Management Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period and related disclosures. Actual results could differ from those estimates.

(2)	Significant Accounting Policies

Revenue Recognition

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

Per Emerging Issues Task Force (“EITF”) Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (i.e., Gross versus Net Presentation)” (“EITF No. 06-3”), the Company’s policy is to record revenue net of related sales, use or value added taxes – net basis.

While the Company’s product offerings can be differentiated among the various categories (i.e. cards, candy, gift wrap, etc.), the Company deems the products to be similar in nature and therefore does not present the categories as “segments” as per the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 131 “Disclosures about Segments of an Enterprise and Related Information,” (“SFAS No. 131”).

Merchandise Inventories

Merchandise inventories are stated at the lower of average cost or estimated net realizable value utilizing the retail method. The Company has entered into agreements with certain vendors and at August 4, 2007 the Company’s purchase commitments are $3.5 million.

At August 4, 2007 and February 3, 2007, the Company had reserves of $1,579 and $1,383, respectively, for certain merchandise, which is to be discontinued from the ongoing inventory assortment, as well as inventory with excess quantities on hand, and certain seasonal inventory remaining from past holidays.

Long-Lived Assets

Fixed asset additions are recorded at cost. Depreciation is computed on a straight-line basis over three to ten years for fixtures and equipment and over the shorter of the useful life or the initial term of the lease for leasehold improvements. Depreciation related to capital leases is also included in depreciation.

The Company capitalizes software in accordance with Statement of Position (“SOP”) 98-1 “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”). Capitalized software is made up of purchased software and the respective licenses, including the many components of JDA, administrative systems and eCommerce software. The software is depreciated over three years.

During the first quarter of fiscal 2007, the Company capitalized a non-compete agreement with a competitor. This agreement has a 10 year term, but will be amortized straight-line over 9.0 years, concurrent with the remaining lease term of our store located within the geographic scope of the non-compete agreement. It is recorded as the intangible asset on the accompanying condensed consolidated balance sheet. The gross carrying amount is $135 and the aggregate amortization for the three months and six months ended August 4, 2007 was $4 and $4, respectively.


Estimated future amortization expense:
For the year ended February 2, 2008	$	7
For the year ended January 31, 2009		15
For the year ended January 30, 2010		15
For the year ended January 29, 2011		15
For the year ended January 28, 2012		15
Thereafter		64

Total Amortization		131

The Company evaluates long-lived assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”). Long-lived assets are evaluated for recoverability in accordance with SFAS No. 144 whenever events or changes in circumstances indicate that an asset may have been impaired. In evaluating an asset for recoverability, the Company estimates the future cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair market value of the asset is recognized. The fair market value of assets is determined primarily by market prices of similar assets at the stores.

The Company evaluated its long-lived assets in the current fiscal quarter. Based on current and projected performance, the Company has recorded a fixed asset impairment of $132 for the three months

ended August 4, 2007. It is the only impairment recorded in fiscal 2007. During the three months ended July 29, 2006, the Company recorded an impairment of $88 which was the only impairment recorded in fiscal 2006. The Company believes the carrying value of the assets is appropriate.

Cooperative Advertising, Markdown Reimbursement and Placement Fees

The Company receives vendor allowances principally as a result of meeting defined purchase levels or promoting vendors’ products. Those received as a result of purchase levels are accrued as a reduction of merchandise purchase price and result in a reduction of cost of sales as the merchandise is sold. Those received for promoting vendors’ products are offset against specific advertising expense relating to the promotion and result in a reduction of selling, general and administrative expenses. Markdown allowances reduce cost of goods sold in the period the related markdown is taken. Placement allowances are offset against specific, incremental expenses incurred in getting the product ready for sale. The Company’s accounting policies relating to cash received from vendors are consistent with the conclusions reached by Emerging Issues Task Force (“EITF”) 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” which was issued in September 2002. Total consideration received from vendors was $1,583 and $1,164 for the three months ended August 4, 2007 and July 29, 2006, respectively. For the six months ended August 4, 2007 and July 29, 2006 total consideration received from vendors was $2,856 and $2,822, respectively. Advertising cooperative payments were $222 and $143 for the three months ended August 4, 2007 and July 29, 2006, respectively. For the six months ended August 4, 2007 and July, 29, 2006, advertising cooperative payments were $324 and $240, respectively.

Income Taxes

The Company files a consolidated federal income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial reporting and tax basis of assets and liabilities and are determined using tax rates and laws that are expected to be in effect when the differences are expected to reverse. The Company assesses its deferred tax assets and establishes valuation allowances when it is determined that deferred tax assets are not likely to be realized. There are no valuation allowances on the Company’s deferred tax assets as of August 4, 2007 or February 3, 2007. The Company paid alternative minimum tax of $0 during the three months ended August 4, 2007 and $102 during the six months ended August 4, 2007 due to its estimate of fiscal 2006 taxable income.

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”) on February 3, 2007. At the adoption date and as of August 4, 2007, the Company had no material unrecognized tax benefits and no adjustment to liabilities, retained earnings, loss from continuing operations, or net loss were required. The adoption of FIN 48 had no effect on the Company’s basic and diluted earnings per share. The Company files tax returns in all appropriate jurisdictions, which include a federal tax return and all required state jurisdictions. Open tax years for all jurisdictions are 2003 to 2005, which statutes expire in 2007 to 2009, respectively.

The Company recognizes interest and penalties related to uncertain tax positions as income tax expense as incurred. No expense for interest and penalties was recognized for the six months ended August 4, 2007.

(3)	Line of Credit

The Company is party to a secured financing facility, dated April 8, 2002, with Wells Fargo Retail Finance, LLC (as amended, the “Loan Agreement”). At August 4, 2007, the Loan Agreement, which is a line of credit, provided $35,000 (including $10,000 for letters of credit) to fund working capital needs and for general corporate purposes. The maturity date on the Loan Agreement is October 31, 2008.

Borrowings under the facility are limited by a percentage of inventory levels. At August 4, 2007, the weighted average interest rate on the Company’s borrowings was 7.96%. Borrowings under the Loan Agreement are secured by substantially all of the Company’s assets. Certain restrictive covenants apply, including achievement of specified operating results and limitations on the incurrence of additional liens and indebtedness, capital expenditures, asset sales and payment of dividends.

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

(4)	Lease Commitments

The Company conducts all of its activities using leased premises. Stores and office leases generally provide that real estate taxes, insurance, common area maintenance, and operating expenses are the Company’s obligations. Certain store leases provide for contingent rentals based on sales in excess of specified minimums. Contingent rental expense was $20 and $17 for the three months ended at August 4, 2007 and July 29, 2006, respectively, and was $36 and $43 for the six months ended August 4, 2007 and July 29, 2006, respectively. Rent expense, excluding real estate taxes, insurance, common area maintenance, charged to operations under operating leases for the three months ended August 4, 2007 and July 29, 2006 was $7,023, and $7,384, respectively, and was $14,435 and $14,653 for the six months ended August 4, 2007 and July 29, 2006, respectively.

(5)	Stock Based Compensation

Compensation expense is recognized only for share-based payments expected to vest. The shares granted in fiscal 2006 and fiscal 2007 had a vesting period of three years and a contractual life of 10 years. All non-performance based share awards issued by the Company have graded vesting schedules of three to four years. The Company recognizes stock based compensation expense on a straight-line basis for awards with graded vesting.

Stock Option Plans

Stock option activity for the six months ended August 4, 2007 is as follows:


Stock Option Award Summary:	Number of Stock Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Intrinsic Value
Outstanding – February 4, 2007	690,674		$	6.43
Granted	40,000			11.52
Exercised	(25,523	)		5.42
Forfeited	(1,300	)		6.85

Outstanding – May 5, 2007	703,851			6.75

Granted	—			—
Exercised	(2,400	)		5.94
Forfeited	(9,650	)		11.07

Outstanding – August 4, 2007	691,801			6.70	5.8	$	1,229

Exercisable – August 4, 2007	634,863			6.35	5.4	$	1,229

Available for grant – August 4, 2007	152,753

The fair value of each non-qualified stock option was estimated on the date of grant using the Black-Scholes option pricing model.


Stock-Based Compensation Valuation Assumptions:	Fiscal 2007 Grants			Fiscal 2006 Grants
Risk-free interest rate		4.69	%		4.56%–4.99	%
Expected dividend yield		0	%		0	%
Expected price volatility		47	%		50	%
Expected life of non-qualified stock options (years)		6.0			6.0
Weighted average grant date fair value	$	5.93		$	4.07

The Company recognized stock based compensation expense of $35 and $79 for the three months ended August 4, 2007 and July 29, 2006, respectively and $53 and $173 for the six months ended August 4, 2007 and July 29, 2006, respectively. This expense is included in selling, general and administrative expenses.

Total unrecognized compensation cost for stock options as of August 4, 2007 was $276. The aggregate intrinsic value of options outstanding at August 4, 2007 is $1,229 and the aggregate intrinsic value of exercisable options is $1,229. Proceeds received from the exercise of options for the three months ended August 4, 2007 and July 29, 2006 was $14 and $220, respectively. Proceeds received for the six months ended August 4, 2007 and July 29, 2006 was $153 and $430, respectively. The total intrinsic value of options exercised through August 4, 2007 was $154. Based on the Company’s election of the “with and without” approach, the realized tax benefit from stock options for both the six months ended August 4, 2007 and the six months ended July 29, 2006 was $0.

In April 2002, the Company authorized an aggregate of 10,000,000 shares of new Common Stock, par value $0.01 per share. A total of 3,382,917 common shares were outstanding at August 4, 2007.

Nonvested Stock

A summary of the nonvested stock activity during the six months ended August 4, 2007 is summarized in the table below:


Nonvested Awards Summary:	Shares		Weighted Average Grant-Date Fair Value
Outstanding at February 3, 2007	11,500		$	7.92
Granted to employees	9,200			9.28
Vested, converted	(3,169	)		7.64
Terminated or resigned	—			—

Outstanding – May 5, 2007	17,531			8.68

Granted to employees	—			—
Vested, converted	(3,333	)		8.30
Terminated or resigned	—			—

Total outstanding, August 4, 2007	14,198		$	8.77

Total nonvested pre-tax stock compensation expense for the three and six months ended August 4, 2007 was $17 and $45 and for the three and six months ended July 29, 2006 was $14 and $41, respectively. Total unrecognized compensation cost at August 4, 2007 for the Company’s nonvested stock is $109, which will be recognized over the weighted average period of the next 1.6 years.

In February 2007, the Board of Directors approved a nonvested share award under the 2003 Equity Incentive Plan to certain employees of the Company. A total of 5,700 shares were awarded which vest ratably over 3 years. Expense recognized for this plan for the three months and the six months ended August 4, 2007 was $4 and $8, respectively

In March 2007, the Board of Directors approved a nonvested share award under the 2003 Equity Incentive Plan to certain employees of the Company. A total of 1,000 shares were awarded which vest ratably over 3 years. Expense recognized for this plan for the three months and six months ended August 4, 2007 was $1 and $1, respectively.

In April 2007, the Board of Directors approved a nonvested share award under the 2003 Equity Incentive Plan to an officer of the Company. A total of 2,500 shares were awarded which vests ratably over 3 years. Expense recognized for this plan for the three months and the six months ended August 4, 2007 was $2 and $2, respectively.

Nonvested Performance-based Stock

On January 31, 2006, the Board of Directors approved a nonvested performance-based share award under the 2003 Equity Incentive Plan to the officer group of the Company. A total of 60,000 shares were awarded with a grant date fair value of $7.99. The performance condition for full or partial vesting will be satisfied if and only to the extent the Company achieves a predetermined return on invested capital for a rolling 12-consecutive-month period beginning after January 28, 2006 and ending on or before February 9, 2009. During the first three quarters of fiscal 2006, the ratable portion of the expense (straight-line over the performance term) was included in the results of operations, however based on management’s fourth quarter fiscal 2006 assessment of progress the return on invested capital goal, the cumulative expense was reversed, making the full year fiscal 2006 pre-tax expense for this award $0.

Pretax expense recognized for this award for the six months ended August 4, 2007 and July 29, 2006 was $0 and $80, respectively. Based on the guidance set forth in SFAS 123(R), the Company has excluded these performance-based shares from the dilutive earnings per share calculations. Total unrecognized compensation cost of nonvested performance-based stock at August 4, 2007 was $376, which will not be recognized over the next 1.5 years, unless the aforementioned performance conditions become available. Based on the present evaluation, the company cannot conclude that the targets as originally contemplated will be achieved.

A summary of the nonvested performance-based stock activity during the six months ended August 4, 2007 is summarized in the table below:


Nonvested Performance-Based Award Summary:	Shares		Weighted Average Grant-Date Fair Value
Outstanding at February 3, 2007	58,500		$	7.99
Granted to employees	500			8.41
Vested, converted	—			—
Terminated or resigned	(12,000	)		7.99

Outstanding at May 5, 2007	47,000			7.99

Granted to employees	—			—
Vested, converted	—			—
Terminated or resigned	—			—

Total outstanding, August 4, 2007	47,000		$	7.99

Warrants

In April 2002, the Company issued four series of new Warrants, Series A through D, granting such holders the right to purchase an aggregate of 306,934 additional shares of the new Common Stock. The Warrants were issued to non-employees upon emergence from bankruptcy. The Series A Warrants expired on April 9, 2006. The Series B Warrants are exercisable at any time prior to April 9, 2008 at a price of $8.00 per share. The Series C Warrants are exercisable any time prior to April 9, 2010 at a price of $8.00 per share. The Series D Warrants are exercisable any time prior to April 9, 2010 at a price of $17.00 per share. At August 4, 2007, Warrants to purchase an aggregate of 204,164 shares common stock were outstanding. Cash proceeds received from the exercise of warrants for the three months ended August 4, 2007 and July 29, 2006 was $31 and $0, respectively. Proceeds received from the exercise of warrants for the six months ended August 4, 2007 and July 29, 2006 was $31 and $172, respectively.

(6)	Earnings Per Share

In accordance with SFAS No. 128 “Earnings per Share,” earnings per share–basic was computed by dividing net income by the weighted average number of common shares outstanding during the period. Earnings per share–diluted assumes, in addition to the above, the effect of potentially dilutive securities. The dilutive impact of stock options and warrants is calculated using the treasury method.

The reconciliation of earnings per share - basic to earnings per share - diluted for the three and six months ended August 4, 2007 and July 29, 2006 are as follows (in thousands, except per share amounts):


	For the three months ended August 4, 2007		For the three months ended July 29, 2006		For the six months ended August 4, 2007		For the six months ended July 29, 2006
Net income	$	2,346	$	1,940	$	1,686	$	2,052
Earnings per share – basic	$	0.71	$	0.60	$	0.51	$	0.65
Earnings per share – diluted	$	0.65	$	0.57	$	0.47	$	0.61
Weighted average shares outstanding – basic		3,318,898		3,230,436		3,304,600		3,178,761
Dilutive effect of stock options, warrants and restricted stock		294,394		197,252		274,539		201,597

Weighted average shares outstanding - diluted		3,613,292		3,427,688		3,579,139		3,380,358

Stock options and warrants with exercise prices below the applicable market price of the Company’s common stock are included in potentially dilutive common shares outstanding when the Company reports net income for a reporting period. However, if the Company incurs a net loss for a reporting period, the inclusion of any such shares would result in a decrease in loss per share, and therefore all stock options, warrants and restricted stock units are ignored when calculating diluted loss per share.

Options and warrants to purchase 241,850 common shares at prices ranging from $11.08 to $22.40 per share were not considered in the calculation of diluted earnings per share for the three months ended August 4, 2007, because the strike price was greater than the average price per share during the period.

Options and warrants to purchase 242,250 common shares at prices ranging from $10.53 to $22.40 per share were not considered in the calculation of diluted earnings per share for the six months ended August 4, 2007 because the strike price was greater than the average market price per share during the period.

Options and warrants to purchase 403,802 common shares at prices ranging from $8.30 to $22.40 per share were not considered in the calculation of diluted earnings per share for the three months ended July 29, 2006 because the strike price was greater than the average market price per share during the period.

Options and warrants to purchase 398,802 common shares at a price ranging from $8.00 to $22.40 per share were not considered in the calculation of diluted earnings per share for the six months ended July 29, 2006 because the strike price was greater than the average market price per share during the period.

(7)	Legal Proceedings

The Company is or may be subject to certain legal proceedings and claims from time to time that are incidental to the ordinary course of business. The Company will record a liability when it has been determined that it is probable that the Company will be obligated to pay and the amount can be reasonably estimated, and the Company will disclose the related facts in the footnotes to the financial statements, if material. If the Company determines that an obligation is reasonably possible it will, if material, disclose the nature of the loss contingency and the estimated range of possible loss, or include a statement that no estimate of loss can be made.

The Company is from time to time named in charges filed with the Equal Employment Opportunity Commission (“EEOC”) and other federal and state governmental entities governing employees and the workplace. In one of those matters, the EEOC issued a determination on February 28, 2006 that there is reasonable cause to believe that certain employees were subject to verbal harassment in violation of applicable laws. A determination that the Company is not in compliance with the rules and regulations of these governmental entities could result in the award of damages and/or equitable remedies. Based on its best estimate of probable loss, a $325 reserve is recorded in accrued expenses as of August 4, 2007.

As of the date of this Quarterly Report on Form 10-Q, the Company is not aware of any other material existing or threatening litigation to which we are or may be a party.

(8)	Reclassifications

Certain items in the 2006 financial statements have been reclassified to conform to the 2007 presentation.

(9)	Subsequent Event

On September 17, 2007, a subsidiary of AAH Holdings Corporation (AAH) and Factory Card & Party Outlet Corp. signed a definitive merger agreement pursuant to which AAH will acquire Factory Card & Party Outlet in an all-cash transaction valued at approximately $72 million, including payments with respect to outstanding stock options and warrants and the assumption of debt and net of cash acquired. The transaction has been approved by the Board of Directors of both companies.

Under the terms of the merger agreement, a subsidiary of AAH will commence a tender offer for all outstanding shares of Factory Card & Party Outlet Corp. stock at a price of $16.50 per share in cash within ten business days. Shares not purchased pursuant to the tender offer, other than dissenting shares, will be acquired in a subsequent merger at a price of $16.50 per share in cash, without interest, as soon as practicable after completion of the tender offer.

Completion of the tender offer is subject to certain conditions, including the acquisition by the AAH subsidiary of a majority of Factory Card & Party Outlet’s common shares on a fully-diluted basis and other customary conditions. The tender offer is not subject to a financing contingency. The Board of Directors of Factory Card & Party Outlet Corp. has recommended that its stockholders accept the offer.

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollar amounts in thousands)

Overview

Factory Card & Party Outlet stores provide our customers with value solutions for all their party and social occasion needs in a one-stop, festive environment. As a leader in the market place, our stores, which average approximately 11,500 square feet, carry merchandise in the party solution, greeting card, gift wrap, balloon, seasonal event and special occasion merchandise arenas. Based on the published number of stores of our competitors as compiled by various business publications and other publicly available information, we believe we are one of the largest chains of company-owned stores in the party supply, greeting card and special occasion industry.

Our fiscal years end on the 52 or 53 weeks, as applicable, ending the Saturday nearest to January 31 ^st . Fiscal 2007 is the 52-week period February 4, 2007 through February 2, 2008. Fiscal 2006 is the 53-week period January 29, 2006 to February 3, 2007. The following table summarizes store opening and closing activity during the first half of fiscal 2007.


	For the six months ending
	August 4, 2007		July 29, 2006
Beginning of period	187		188
Openings	—		6
Closings	(2	)	(2	)

End of period	185		192

Greeting Card Agreement

On February 5, 2005, we entered into a definitive agreement with the Premier Greetings division of Paramount Cards Inc. to be our primary supplier of everyday and seasonal greeting cards. In late July 2006, Paramount decided to close its operations and a receiver was appointed for Paramount’s assets. On August 29, 2006, the Ontario Superior Court of Justice in Bankruptcy and Insolvency approved the sale by Paramount of substantially all of its assets and property to Hallmark Cards Incorporated. During the third quarter of fiscal 2006, we negotiated with Hallmark to procure greeting cards at favorable costs. These purchases have positively impacted our greeting card margins during the first half of fiscal 2007. We anticipate the sell-through of this product will continue to positively impact our greeting card gross margin rate for the remainder of the fiscal year and into fiscal 2008. We are currently in discussions with several greeting card vendors with respect to a formal long-term supply agreement.

Party Supply Agreement

On January 26, 2006, we entered into a definitive agreement with Amscan Holdings, Inc. to be our exclusive supplier of solid color paper tableware products. In conjunction with the agreement, Amscan ships all sourced merchandise to our centralized distribution center. The agreement also provides that the ownership of merchandise will not transfer over until the goods are shipped out of our distribution center.

Critical Accounting Policies and Estimates

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

Revenue Recognition

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

Per Emerging Issues Task Force (“EITF”) Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (i.e., Gross versus Net Presentation)” (“EITF No. 06-3”), our policy is to record revenue net of related sales, use or value added taxes – net basis.

While our product offerings can be differentiated among the various categories (i.e. cards, candy, gift wrap, etc.), we deem the products to be similar in nature and therefore does not present the categories as “segments” as per the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 131 “Disclosures about Segments of an Enterprise and Related Information,” (“SFAS No. 131”).

Merchandise Inventories

We state merchandise inventories at the lower of average cost or estimated net realizable value utilizing the retail method. We perform periodic evaluations of the net realizable value of merchandise, including merchandise which is to be discontinued from our ongoing inventory assortment as well as inventory with excess quantities on hand and certain seasonal inventory remaining from past holidays. Based upon these evaluations, a provision for the excess of inventory cost over the net realizable value is recorded as a reduction to the net inventory balance. At August 4, 2007 and February 3, 2007, we had reserves of $1,579 and $1,383, respectively.

Cooperative Advertising, Markdown Reimbursement and Placement Fees

We receive vendor allowances principally as a result of meeting defined purchase levels or promoting vendor’s products. Those received as a result of purchase levels are accrued as a reduction of merchandise purchase price and resulting in a reduction of cost of sales as the merchandise is sold. Those received for promoting vendors’ products are offset against specific advertising expense relating to the promotion and result in a reduction of selling, general and administrative expenses. Markdown allowances reduce cost of goods sold in the period the related markdown is taken. Placement allowances are offset against specific, incremental expenses incurred in getting the product ready for sale. Our accounting policies relating to cash received from vendors are consistent with the conclusions reached by EITF 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” which was issued in September 2002. Total consideration received from vendors was $1,583 and $1,164 for the three months ended August 4, 2007 and July 29, 2006, respectively. For the six months ended August 4, 2007 and July 29, 2006 total consideration received from vendors was $2,856 and $2,822, respectively. Advertising cooperative payments were $222 and $143 for the three months ended August 4, 2007 and July 29, 2006, respectively. For the six months ended August 4, 2007 and July 29, 2006, advertising cooperative payments were $324 and $240, respectively.

Long-Lived Assets

We capitalize software in accordance with Statement of Position (“SOP”) 98-1 “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”). Capitalized software is made up of purchased software and the respective licenses, including the many components of JDA, administrative systems and eCommerce software. The software is depreciated over three years.

During the first quarter of fiscal 2007, we acquired a non-compete agreement from a competitor. This agreement has a 10 year term, but will be amortized straight-line over 9.0 years concurrent with the lease term of our store located with the geographic scope of the non-compete agreement. The non-compete agreement is recorded as an intangible asset on the accompanying condensed consolidated balance sheet. The gross carrying amount is $135 and the aggregate amortization for the three and six months ended August 4, 2007 was $4 and $4, respectively.


Estimated future amortization expense:
For the year ended February 2, 2008	$	7
For the year ended January 31, 2009		15
For the year ended January 30, 2010		15
For the year ended January 29, 2011		15
For the year ended January 28, 2012		15
Thereafter		64

Total Amortization		131

We evaluate long-lived assets in accordance with SFAS No. 144: “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”). Long-lived assets are evaluated for recoverability in accordance with SFAS No. 144 whenever events or changes in circumstances indicate that an asset may have been impaired. In evaluating an asset for recoverability, we estimate the future cash flows expected to result from the use of the asset and eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair market value of the asset is recognized. The fair market value of assets is determined primarily by market prices of similar assets at the stores.

We have evaluated our long-lived assets in the current fiscal year. Based on current and projected performance we have recorded a fixed asset impairment of $132 for the three months ended August 4, 2007. It is the only impairment recorded in fiscal 2007. During the three months ended July 29, 2006, we recorded an impairment of $88 which was the only impairment recorded in fiscal 2006. We believe the carrying value of the assets is appropriate.

Results of Operations

The following table sets forth, for the periods indicated selected statements of operations data expressed as a percentage of net sales and the number of stores open at the end of each period. The following table is included solely for use in comparative analysis of results of operations and to complement management’s discussion and analysis.


	Three months ended August 4, 2007		Three months ended July 29, 2006		Six months ended August 4, 2007		Six months ended July 29, 2006
Sales	100.0	%	100.0	%	100.0	%	100.0	%
Cost of sales	60.3		61.4		62.0		62.8

Gross profit	39.7		38.6		38.0		37.2
Selling, general and administrative expenses	31.9		32.4		34.0		32.8
Depreciation expense	1.2		1.2		1.3		1.3
Interest expense	0.2		0.2		0.3		0.4

Income before income taxes	6.4		4.8		2.4		2.7
Income taxes	2.7		1.9		1.0		1.1

Net income	3.7	%	2.9	%	1.4	%	1.6	%

Number of stores open at end of period	185		192		185		192

Three Months Ended August 4, 2007 and July 29, 2006

Net Sales. Net sales decreased $3,522 or 5.3% to $62,821 for the three months ended August 4, 2007 (“second quarter of fiscal 2007”) from $66,343 for the three months ended July 29, 2006 (“second quarter of fiscal 2006”). While comparable store sales were flat for the quarter at 0.0%, the decrease in sales can be primarily attributed to store count since on both a total and weighted average basis, we operated seven fewer stores during the second quarter of fiscal 2007 compared to the second quarter of fiscal 2006. During the second quarter of 2007, sales on a comparable store basis trended positive in our seasonal, party, balloon and candy categories, while we experienced declines in the card, gift wrap and gift categories. Comparable store sales are defined as sales from those stores open for at least one full year.

Gross Profit . Cost of sales includes merchandise, distribution and store occupancy costs. Gross profit decreased $668 or 2.6%, to $24,950 for the second quarter of fiscal 2007 from $25,618 for the second quarter of fiscal 2006. As a percent of sales, gross profit was 39.7% for the second quarter of fiscal 2007 compared to 38.6% for the second quarter of fiscal 2006. The 110 basis point improvement can be attributed to better merchandise margins resulting from favorable mark-up on merchandise available for sale. Distribution costs of the second quarter fiscal 2007 were essentially flat when compared to the second quarter of fiscal 2006, which reflected increased shipments on a per store basis consistent with our strategy to reduce merchandise receipts directly from our vendors. Store occupancy costs decreased $261 or 3.0% for the second fiscal quarter of 2007 based on fewer stores being operated than in the second quarter of fiscal 2006.

Selling, General and Administrative Expenses . Selling, general and administrative expenses include store payroll, advertising and other store operating and corporate administrative expenses. Selling, general and administrative expenses decreased $1,427 or 6.7% to $20,040 for the second quarter of fiscal 2007 from $21,467 for the second quarter of fiscal 2006. Major contributors to the decrease are the following:

•

Store related expenses, decreased $522 or 3.9%. Store payroll decreased both as a function of store count as well as due to our continued efforts in managing store expenses. Additionally, we realized savings in our general store expenses as we scrutinized spending on our repairs and maintenance and store supplies. These savings were somewhat offset as we remodeled four stores in the second quarter of fiscal 2007 and none in the second quarter of fiscal 2006.

•

Net advertising expense decreased approximately $425 or 15.5% due primarily to the shift in our advertising spend for the Mother’s Day holiday falling into our first fiscal quarter of 2007, compared to these costs hitting in the second quarter of fiscal 2006. We continue to utilize our customer database and rely more on direct mail advertisements than circulars to maintain and attract new customers.

•

Other corporate expenses decreased approximately $480 or 8.9%. The decrease in the second quarter of fiscal 2007 is primarily the result of reduced payroll-related costs, including reduced stock compensation expenses, as well as a $75 reduction in our estimated settlement of a pending legal matter.

As a percentage of net sales selling, general and administrative expenses were 31.9% in the second quarter of fiscal 2007 compared to 32.4% in the second quarter of fiscal 2006.

Depreciation expense . Depreciation expense was $773 in the second quarter of fiscal 2007 compared to $798 in the second quarter of fiscal 2006. The decrease can be attributed to the decreased store count and the aging of our store-based assets.

Interest Expense . Interest expense was $130 in the second quarter of fiscal 2007 compared to $165 in the second quarter of fiscal 2006. The decrease resulted from significantly lower average borrowing levels, which were somewhat offset by higher interest rates.

Income Taxes. Income tax expense was $1,661 in the second quarter of fiscal 2007 compared to income tax expense of $1,248 in the second quarter of fiscal 2006. The increase is a function of higher income in the second quarter of fiscal 2007 compared to second quarter of fiscal 2006. Until the benefits of our net operating loss carry forwards are fully utilized, we do not expect to pay federal income taxes, with the exception of alternative minimum taxes.

Six months Ended August 4, 2007 and July 29, 2006

Net Sales. Net sales decreased $3,310 or 2.7% to $120,005 for the six months ended August 4, 2007 (“first half of fiscal 2007”) from $123,315 for the six months ended July 29, 2006 (“first half of fiscal 2006”). The decrease can be attributed to a decrease in store count combined with a decrease in comparable store sales of 0.5%. During the first half of fiscal 2007 on a weighted average basis we operated 186 stores compared to 190 during the first half of fiscal 2006. We experienced comparable store sales improvement in our party, seasonal, balloon and candy categories, but had declines in our card, gift wrap and gifts categories. Comparable store sales are defined as sales from those stores open for at least one full year.

Gross Profit . Cost of sales includes merchandise, distribution and store occupancy costs. Gross profit decreased $324 or 0.7%, to $45,568 for the first half of fiscal 2007 from $45,892 for the first half of fiscal 2006. As a percent of sales, gross profit was 38.0% in the first half of fiscal 2007 compared to 37.2% in the first half of fiscal 2006. This 80 basis point improvement can be attributed to better merchandise margins resulting from favorable mark-up on merchandise available for sale. For the first half of fiscal 2007, freight and distribution costs increased $426 due both to an increase in per store shipments from our distribution center and the rising fuel costs. Occupancy costs were flat for the first half of fiscal 2007 when compared to the first half of fiscal 2006. This was a function of reduced store count offset by rent escalations in our remaining store base.

Selling, General and Administrative Expenses . Selling, general and administrative expenses include store payroll, advertising and other store operating and corporate administrative expenses. Selling, general and administrative expenses increased $370 or 0.9% to $40,827 for the first half of fiscal 2007 from $40,457 for the first half of fiscal 2006. Major contributors to the increase are the following:

•

Store related expenses, decreased $281 or 1.1%. Decreased store count and continued monitoring led to a 2.8% decrease in store payroll during the first half of fiscal 2007 compared to the first half of fiscal 2006. Additionally, we experienced some savings as we have not opened any new stores during the first half of fiscal 2007, though we did remodel ten stores compared to the five new stores opened and zero remodeled during the first half of fiscal 2006. These savings were somewhat offset as general store expenses increased due primarily to banking charges, as more customers buy on credit, and costs to rollout our Wide Area Network.

•

Net advertising expense increased approximately $417 or 9.2% due primarily to the increased costs of our direct mail program as we distribute a greater number of mailings using this method versus prior years when we relied more heavily on circulars. Additionally during the first half of fiscal 2007, eCommerce marketing costs have increased as we continue to build our factorycard.com offering and strive to communicate our program via the internet.

•

Other corporate expenses increased approximately $234 or 2.2% mostly due to the first quarter 2007 senior management reorganization costs, as well as an increase of consulting and professional fees expenses incurred during the first half of fiscal 2007. These items were somewhat offset by savings attributed to decreased payroll-related expenses.

As a percentage of net sales selling, general and administrative expenses were 34.0% in the first half of fiscal 2007 compared to 32.8% in the first half of fiscal 2006.

Depreciation expense . Depreciation expense was $1,532 in the first half of fiscal 2007 compared to $1,579 in the first half of fiscal 2006. The decrease can be attributed to the decreased store count and the aging of our store-based assets.

Interest Expense . Interest expense was $333 in the first of fiscal 2007 compared to $465 in the first half of fiscal 2006. The decrease resulted from significantly lower average borrowing levels, which were somewhat offset by higher interest rates.

Income Taxes. Income tax expense was $1,190 in the first half of fiscal 2007 compared to income tax expense of

$1,339 in the first half of fiscal 2006. The decrease is a function of lower income in the second half of fiscal 2007. Until the benefits of our net operating loss carry forwards are fully utilized, we do not expect to pay federal income taxes, with the exception of alternative minimum taxes.

Liquidity and Capital Resources

Our uses of capital for fiscal 2007 are expected to include working capital for operating expenses and satisfaction of current liabilities, expenditures related to maintaining and refurbishing existing stores, and interest payments on outstanding borrowings. Historically, these cash requirements have been met through cash flow from operations and borrowings from our credit facility.

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


	Fiscal 2007			Fiscal 2006
	Six months ended August 4, 2007			Six months ended July 29, 2006
Cash flows provided by operating activities	$	2,680		$	13,214

Cash flows used in investing activities	$	(1,827	)	$	(1,245	)

Cash flows used in financing activities	$	(806	)	$	(11,969	)

At August 4, 2007, our working capital was $21,505 compared to $15,310 at July 29, 2006. Net cash provided by operating activities for the six months ended August 4, 2007 was $2,680 compared to $13,214 of net cash provided by operating activities for the six months ended July 29, 2006. The decrease in cash flows from operating activities for the six months ended August 4, 2007 is attributed to the purchasing of inventory, and payments made against our accounts payable and accrued expenses, as well as the lower level of income earned in the first half of fiscal 2007 as compared to fiscal 2006.

Net cash used in investing activities for the six months ended August 4, 2007 and the six months ended July 29, 2006 was $1,827 and $1,245, respectively. During the first six months of fiscal 2007, net cash used in investing activities included $656 for existing stores, $630 for leasehold improvements and computer and warehouse equipment at our corporate headquarters, $406 for store remodeling, and $135 relating to a non-compete agreement executed during the first quarter of fiscal 2007. By comparison, during the first half of fiscal 2006 we utilized $689 on new store openings, $366 on equipment for the warehouse and distribution center, and $190 on existing stores and computer equipment.

Net cash used in financing activities for the six months ended August 4, 2007 was $806 compared to $11,969 during the six months ended July 29, 2006. Fluctuations are attributable mostly to the level of borrowings and repayments. Additionally, we received cash from the exercise of stock options and warrants of $184 in the first half of fiscal 2007 compared to $601 in the first half of fiscal 2006.

We are party to a secured financing facility, dated April 8, 2002, with Wells Fargo Retail Finance, LLC (as amended, the “Loan Agreement”). The Loan Agreement, which is a line of credit expiring on October 31, 2008, currently provides up to $35,000, (including $10,000 for letters of credit) to fund working capital needs and for general corporate purposes. The maturity date on the Loan Agreement is October 31, 2008. Borrowings under the facility are limited by a percentage of inventory levels, and are secured by substantially all of our assets.

As of August 4, 2007, we had $7,742 in borrowings outstanding under the Loan Agreement and had utilized approximately $3,716 to issue letters of credit. As of September 6, 2007, we had $9,013 in borrowings outstanding under the Loan Agreement, utilized approximately $3,248 to issue letters of credit and had $14,400 available for future cash borrowings.

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

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

Contractual Obligations

We conduct all of our activities using leased premises. Store and office leases generally provide that real estate taxes, insurance, common area maintenance, and operating expenses are our obligations. Certain store leases also provide for contingent rentals based on sales in excess of specified minimums.

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


Contractual Obligations	Payments due by Period (dollar amounts in millions)
Contractual Obligations	Total		Less Than One Year		1-3 Years		3-5 Years		More than 5 Years
Debt & Capital Leases (*) (including current portion)	$	7.7	$	7.7	$	—	$	—	$	—
Operating Leases(**)		143.4		28.6		46.9		32.3		35.6
Inventory Purchase Commitments (including open purchase orders)		16.1		13.5		2.6		—		—

Total	$	167.2	$	49.8	$	49.5	$	32.3	$	35.6

(*)	Interest payments are excluded from total.

(**)

Payments to the landlord covering taxes, maintenance, other common area maintenance items and contingent rental amounts for stores are excluded from total. Amounts expensed for these items during the three months ended August 4, 2007 and July 29, 2006 was $2.2 million and $2.2 million, respectively. The amounts expensed for the six months ended August 4, 2007 and July 29, 2006 totaled $4.4 million and $4.4 million, respectively

Off-Balance Sheet Arrangements

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

Seasonality

Our business is highly seasonal, with operating results varying from quarter to quarter. We historically have experienced higher sales during the second and fourth fiscal quarters due to increased demand by customers for our products attributable to special occasions and holiday seasons during these periods. Our fiscal 2007 quarters are defined as follows: first fiscal quarter is February 4, 2007 to May 5, 2007, second fiscal quarter is May 6, 2007 to August 4, 2007, third fiscal quarter is August 5, 2007 to November 3, 2007 and fourth fiscal quarter is November 4, 2007 to February 2, 2008. Our fiscal year ends on the 52 or 53 weeks, as applicable, ending the Saturday nearest to January 31 ^st . Fiscal 2007 is a 52-week period while fiscal 2006 was a 53-week period.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to market risks from changes in interest rates. As of August 4, 2007, the interest rate on the Company’s revolving credit facilities, which represents a significant portion of the Company’s outstanding debt, is variable based upon the prime and LIBOR rates. We believe our interest rate risk is minimal as a hypothetical 1.0% increase to the average interest rate under the credit facilities applied to the average outstanding balance during the six months ended August 4, 2007 and the six months ended July 29, 2006 would not have had a material impact on our financial position or results of operations.

ITEM 4.

CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As of September 12, 2006 and as required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

During the quarter ended August 4, 2007, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

We are or may be subject to certain legal proceedings and claims from time to time that are incidental to the ordinary course of business. We will record a liability when it has been determined that it is probable that the Company will be obligated to pay and the amount can be reasonably estimated, and we will disclose the related facts in the footnotes to the financial statements, if material. If we determine that an obligation is reasonably possible it will, if material, disclose the nature of the loss contingency and the estimated range of possible loss, or include a statement that no estimate of loss can be made.

We are from time to time named in charges filed with the Equal Employment Opportunity Commission (“EEOC”) and other federal and state governmental entities governing employees and the workplace. In one of those matters, the EEOC issued a determination on February 28, 2006 that there is reasonable cause to believe that certain employees were subject to verbal harassment in violation of applicable laws. A determination that we are not in compliance with the rules and regulations of these governmental entities could result in the award of damages and/or equitable remedies. Although the outcome cannot be predicted with certainty, a $325 reserve remains as part of accrued expenses as of August 4, 2007.

As of the date of this Quarterly Report on Form 10-Q, we are not aware of any other material existing or threatening litigation to which we are or may be a party.

Item 1A.

Risk Factors

Except as set forth below, we have not identified any material changes from risk factors as previously disclosed in Form 10-K filed on April 20, 2007. As discussed in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, we are currently in discussions with Hallmark and other vendors with respect to the supply of greeting cards. Although we are managing our greeting card program through our distribution center utilizing inventory currently in our supply chain, our failure to secure sourcing of greeting cards on terms acceptable to us could adversely affect our ability to compete and our financial performance.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Submission of Matters to a Vote of Security Holders

On July 18, 2007, we held our Annual Meeting of Stockholders. There were a total of 3,379,895 votes entitled to be cast as the meeting. Of this total, 2,223,087, or approximately 65.8% of the total number of voters eligible to be cast were represented either in person or by proxy. At the meeting, the stockholders elected the Board of Directors. Set forth below are (i) the names of the persons elected to serve on our Board of Directors until the 2008 Annual Meeting of Stockholders or until their successors are duly elected and qualified and (ii) the results of the voting for the nominees:


Directors	Votes For Number	% of Total		Withheld Number	% of Total
Mone Anathan	2,112,019	62.5	%	111,068	3.3	%
Ben Evans	1,912,045	56.6	%	311,042	9.2	%
Richard E. George	1,912,061	56.6	%	311,026	9.2	%
Peter M. Holmes	1,912,061	56.6	%	311,026	9.2	%
Martin G. Mand	1,912,045	56.6	%	311,042	9.2	%
Patrick O’Brien	1,912,061	56.6	%	311,026	9.2	%
Gary W. Rada	1,655,098	49.0	%	567,989	16.8	%
Robert S. Sandler	1,912,045	56.6	%	311,042	9.2	%

The stockholders also ratified the appointment of McGladrey & Pullen LLP as the independent auditors for the current fiscal year ending February 2, 2008.


	Votes For Number	% of Total		Votes Against Total	% of Total		Votes Abstained Total	% of Total
Ratification of appointment of McGladrey & Pullen as our independent auditor.	2,201,487	65.1	%	16,162	0.5	%	5,438	0.2	%

Item 5.

Other Information

Subsequent Event

On September 17, 2007, a subsidiary of AAH Holdings Corporation and Factory Card & Party Outlet Corp. signed a definitive merger agreement pursuant to which AAH will acquire Factory Card & Party Outlet in an all-cash transaction valued at approximately $72 million, including payments with respect to outstanding stock options and warrants and the assumption of debt and net of cash acquired. The transaction has been approved by the Board of Directors of both companies.

Item 6.

Exhibits


2.1(1)		Debtor’s Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code, dated February 5, 2002.

3.1(2)		Amended and Restated Certificate of Incorporation of Factory Card & Party Outlet Corp.

3.2(4)		Amended Bylaws of Factory Card & Party Outlet Corp.

3.3(7)		Amendment to and Restated Certificate of Incorporation of Factory Card & Party Outlet Corp, dated July 17, 2003.

3.4(7)		Amendment to and Restated Certificate of Incorporation of Factory Card & Party Outlet Corp, dated April 6, 2004.

3.5(12)		Amended and Restated Certificate of Incorporation of Factory Card & Party Outlet Corp, dated February 6, 2006.

3.6(15)		Amended and Restated Certificate of Incorporation of Factory Card & Party Outlet Corp, dated May 2, 2006.

3.7(16)		Amended and Restated Certificate of Incorporation of Factory Card & Party Outlet Corp, dated June 9, 2006.

3.6(17)		Material modification to the rights of the stockholders of Factory Card & Party Outlet Corp, dated June 28, 2006.

4.1(2)		Warrant Agreement, dated April 9, 2002, between Factory Card & Party Outlet Corp. and Wells Fargo Bank Minnesota, N.A.

4.2(2)		Form of New Management Warrant, dated April 9, 2002.

4.3(2)		Schedule of New Management Warrants (pursuant to Instruction 2 of Item 601).

4.4(2)		Trade Conversion Note of Factory Card & Party Outlet Corp. and Factory Card Outlet of America Ltd., dated April 9, 2002, for the benefit of CSS Industries, Inc.

4.5(2)		Schedule of Trade Conversion Notes (pursuant to Instruction 2 of Item 601).

4.6(2)		Trade Conversion Agreement, dated as of April 9, 2002, among Factory Card & Party Outlet Corp., Factory Card Outlet of America, Ltd., Amscan, Inc., Creative Expressions Group, Inc., Images and Editions Limited, Unique Industries, Inc., CSS Industries, Inc., P.S. Greetings, Inc., and Maryland Plastics, Inc.

10.1(2)		Loan and Security Agreement dated as of April 9, 2002, among Factory Card Outlet of America, Ltd., as borrower, the lenders thereto as Wells Fargo Retail Finance, LLC, as arranger, collateral agent and administrative agent.

10.2(7)		First Amendment dated April 9, 2004, to the Loan and Security Agreement, among Factory Card Outlet of America, Ltd., as borrower, the lenders thereto as Well Fargo Retail Finance, LLC, as arranger, collateral agent and administrative agent.


10.3(2)		Security Agreement, dated April 9, 2002, among Factory Card & Party Outlet Corp. and Factory Card Outlet of America, Ltd., in favor of William Kaye, as Collateral Trustee.

10.4(2)		Factory Card & Party Outlet Corp. 2002 Stock Incentive Plan.

10.5(2)		Trade Vendor Supply Agreement, dated April 9, 2002, between Factory Card & Party Outlet Corp., Factory Card Outlet of America, Ltd. and Maryland Plastics.

10.6(2)		Schedule of Trade Vendor Supply Agreements (pursuant to Instruction 2 of Item 601).

10.7(2)*		Employment Agreement, dated as of April 9, 2002, between Factory Card Outlet of America, Ltd. and James D. Constantine.

10.8(5)*		Employment Agreement, dated as of December 23, 2004, between Factory Card Outlet of America, Ltd. and Timothy F. Gower.

10.9(5)*		Employment Agreement, dated as of December 23, 2004, between Factory Card Outlet of America, Ltd. and Gary W. Rada.

10.10(3)*		Factory Card & Party Outlet Corp. 2002 Non-Employee Directors Stock Option Plan.

10.11(3)*		First Amendment to the Factory Card & Party Outlet Corp. 2002 Stock Incentive Plan.

10.12(3)*		Second Amendment to the Factory Card & Party Outlet Corp. 2002 Stock Option Plan.

10.13(4)*		Factory Card & Party Outlet Corp. 2003 Equity Incentive Plan.

10.14(11)		Factory Card & Party Outlet Corp. Form of Stock Option Agreement – 2002 Stock Option Plan.

10.15(6)**		Primary Supply and Consignment Agreement dated February 5, 2005 between Factory Card Outlet of America, Ltd and Paramount Cards, Inc.

10.16(11)*		Factory Card & Party Outlet Corp., Form of Stock Option Agreement – 2002 Non-Employee Directors Stock Option Plan.

10.17(11)*		Factory Card & Party Outlet Corp., Form of Stock Option Agreement - Equity Incentive Plan.

10.18(11)*		Factory Card & Party Outlet Corp., Form of Restricted Stock Agreement - Equity Incentive Plan.

10.19(11)*		Factory Card & Party Outlet Corp., Summary of Incentive Bonus Agreements.

10.20(11)*		Factory Card & Party Outlet Corp., Summary of Non-employee Director Compensation.


10.21(11)*		Factory Card & Party Outlet Corp., Summary of Arrangements with Certain Executives.

10.22(8)		Second Amendment dated October 7, 2005, to the Loan and Security Agreement, among Factory Card Outlet of America, Ltd., as borrower, the lenders thereto as Well Fargo Retail Finance, LLC, as arranger, collateral agent and administrative agent.

10.23(9)*		Waiver and Release of James D. Constantine, CFO, dated as of December 2, 2005.

10.24(10)*		Amended Employment Agreement, dated as of December 9, 2005, between Factory Card Outlet of America, Ltd. and Timothy F. Gower.

10.25(10)*		Amended Employment Agreement, dated as of December 9, 2005, between Factory Card Outlet of America, Ltd. and Gary W. Rada.

10.26(10)*		Employment Agreement, dated as of December 9, 2005, between Factory Card Outlet of America, Ltd. and Jarett A. Misch.

10.27(10)*		Amended and Restated Executive Severance Plan, dated as of December 9, 2005.

10.28(11)*		Factory Card & Party Outlet, 2006 Management Incentive Plan.

10.29(12)		Primary Supply and Consignment Agreement dated January 26, 2006 between Factory Card & Party Outlet Corp. and Amscan Holdings, Inc.

10.30(14)		Agreement by and among Cramer Rosenthal McGlynn, LLC, a Delaware limited liability company (“CRM LLC”) and Cramer Rosenthal McGlynn, Inc., a New York corporation (“CRM Inc.” and together with CRM LLC, “CRM”), on the one hand, and Factory Card & Party Outlet Corp. on the other dated April 18, 2006.

10.31(15)		Industrial Building Lease dated October 28, 1996 between CenterPoint Realty Services Corporation and Factory Card Outlet of America Ltd.

10.32(15)		Lease Amendment dated as of January 31, 1998 by and between CenterPoint Realty Services Corporation and Factory Card Outlet of America Ltd.

10.33(15)		Second Lease Amendment dated as of November 30, 2006 by and between CJF1 LLC and Factory Card Outlet of America Ltd.

10.34(16)		Separation Agreement of Jarett A. Misch, Vice President / Controller / Chief Accounting Officer, dated as of February 16, 2007.

10.35(19)		Employment Agreement dated as of December 24, 2004, and Amendment to Employment Agreement dated as of December 9, 2005 between Factory Card Outlet of America, Ltd. and Michael Perri.

16.1(17)		Letter on change in certifying accountant, dated as of October 23, 2006.

21		Subsidiaries of the Company.


31.1		Chief Executive Officer Certification under Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Chief Financial Officer Certification under Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Chief Executive Officer Certification of Periodic Report under Section 906 of Sarbanes-Oxley Act of 2002.

32.2		Chief Financial Officer Certification of Periodic Report under Section 906 of Sarbanes-Oxley Act of 2002.

Notes

*	Management contracts or compensatory plans or arrangements.

**	The Company has submitted, to the Securities and Exchange Commission (the “Commission”), a request for confidential treatment for portions of this document. The redacted material has been filed separately with the Commission.

(1)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on March 25, 2002.

(2)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on April 23, 2002.

(3)	Incorporated by reference to the Company’s Quarterly Report on Form 10-Q as filed on June 18, 2002.

(4)	Incorporated by reference to the Company’s Annual Report on Form 10-K as filed on May 2, 2003.

(5)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on December 23, 2004.

(6)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on February 7, 2005.

(7)	Incorporated by reference to the Company’s Current Report on Form 10-K as filed on April 21, 2004.

(8)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on October 17, 2005.

(9)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on December 2, 2005.

(10)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on December 9, 2005.

(11)	Incorporated by reference to the Company’s Quarterly Report on Form 10-Q as filed on June 14, 2005.

(12)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on April 19, 2006.

(13)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on June 28, 2006.

(14)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on April 20, 2006.

(15)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on December 7, 2006.

(16)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on February 20, 2007.

(17)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on October 26, 2006.

(18)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on February 16, 2007.

(19)	Incorporated by reference to the Company’s Current Report on Form 8-K as filed on April 30, 2007.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	FACTORY CARD & PARTY OUTLET CORP.

Dated: September 17, 2007	By:	/s/ Gary W. Rada
		Gary W. Rada
		President and Chief Executive Officer

Dated: September 17, 2007	By:	/s/ Timothy J. Benson
		Timothy J. Benson
		Vice President, Treasurer and Chief Financial Officer [Principal Accounting Officer]