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 Companys 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
Companys policy is to record revenue net of related sales, use or value added taxes net basis.
While the Companys
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).
6
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 Companys 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.
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|
|
|
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
7
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 Companys 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 Companys 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 Companys 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.
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.
8
Borrowings under the facility are limited by a percentage of inventory levels. At August 4, 2007,
the weighted average interest rate on the Companys borrowings was 7.96%. Borrowings under the Loan Agreement are secured by substantially all of the Companys 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 Companys 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 Companys 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.
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 Companys 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.
9
Stock Option Plans
Stock option activity for the six months ended August 4, 2007 is as follows:
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|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
|
|
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|
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The fair value of each non-qualified stock option was estimated on the date of grant using the
Black-Scholes option pricing model.
|
|
|
|
|
|
|
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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 Companys 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:
10
|
|
|
|
|
|
|
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 Companys 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 managements
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.
11
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.
In accordance with SFAS No. 128
Earnings per Share, earnings per sharebasic was computed by dividing net income by the weighted average number of common shares outstanding during the period. Earnings per sharediluted 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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
Stock options and warrants with exercise prices below the applicable market price of the Companys
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.
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.
Certain items in the 2006 financial
statements have been reclassified to conform to the 2007 presentation.
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 Outlets 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.
13