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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
July 30, 1998
--------------------------
Date of Report
(Date of earliest event reported)
PCA INTERNATIONAL, INC.
-------------------------------
(Exact Name of Registrant as Specified in Charter)
North Carolina 0-8550 56-0888429
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(State or Other Jurisdiction (Commission (I.R.S. Employer
of Incorporation) File Number) Identification No.)
815 Matthews-Mint Hill Road
Matthews, North Carolina 28105
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(Address of Principal Executive Offices)
(Zip Code)
(704) 847-8011
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(Registrant's Telephone Number, Including Area Code)
Not Applicable
------------------------------------
(Former Name or Former Address,
if Changed since Last Report)
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Item 5. Other Events.
As previously reported, on April 20, 1998, the Registrant signed a
merger agreement (the "Merger Agreement") with Jupiter Acquisition Corp.
("Mergerco"), whereby Mergerco, a wholly-owned subsidiary of Jupiter Partners
II, L.P. ("Jupiter"), would be merged with and into the Registrant (the
"Merger"). In connection with the Merger, Jupiter is seeking to arrange
financing to be used to pay the consideration due pursuant to the Merger
Agreement, which financing will be the obligation of the Registrant upon
consummation of the Merger.
Jupiter, together with members of senior management of the Registrant,
has prepared disclosure materials (the "Disclosure Materials") in connection
with the Merger, excerpts of which are filed herewith as Exhibit 99.1. The
Board of Directors of the Registrant, on behalf of the Registrant, has not
reviewed the Disclosure Materials and disclaims any responsibility therefor.
The Registrant hereby incorporates by reference portions of the
Disclosure Materials attached hereto as Exhibit 99.1 and made a part hereof,
into this Item 5.
Item 7. Financial Statements and Exhibits
(c) Exhibits:
99.1 Selected portions of the Disclosure Materials
<PAGE> 3
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.
PCA INTERNATIONAL, INC.
By: /s/ John Grosso
-----------------------
John Grosso
President
Dated: July 30, 1998
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EXHIBIT INDEX
Exhibit
- - - - -----------
99.1 Selected portions of the Disclosure Materials
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PCA INTERNATIONAL, INC.
DISCLOSURE MATERIALS
THE FOLLOWING DISCLOSURE MATERIALS ARE FOR GENERAL INFORMATION PURPOSES ONLY,
AND IN NO EVENT SHALL THESE MATERIALS BE CONSTRUED AS AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY SECURITIES.
THE DATE OF THESE DISCLOSURE MATERIALS IS JULY 29, 1998.
<PAGE> 2
AVAILABLE INFORMATION
PCA is subject to the informational requirements of the Securities Exchange
Act of 1934 (the "Exchange Act"), and in accordance therewith files reports and
other information with the Commission. Such reports, proxy statements, and other
information concerning the Company can be inspected and copied at the public
reference facilities maintained by the Commission at Judiciary Plaza, 450 Fifth
Street, N.W., Room 1024, Washington, D.C. 20549, and at Regional Offices of the
Commission located at Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661 and at Seven World Trade Center, Suite 1300, New York,
New York 10048. Copies of such material can be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. The Commission maintains a site on the World Wide
Web that contains reports, proxy and information statements and other
information on registrants, such as the Company, who must file such material
with the Commission electronically. The Commission's internet address on the
World Wide Web is http://www.sec.gov. Certain of such reports, proxy materials
and other information may also be inspected at the offices of the National
Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, DC
20006.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
The information herein contains "forward-looking statements" as defined in
Section 27A of the Securities Act of 1933 (the "Securities Act") and Section 21E
of the Exchange Act that involve a number of risks and uncertainties. A number
of factors could cause actual results, performance, achievements of the Company,
or industry results to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements. These factors include, but are not limited to, the competitive
environment in the portrait photography industry in general and in the Company's
specific market areas; changes in prevailing interest rates and the availability
of and terms of financing to fund the anticipated growth of the Company's
business; inflation; changes in costs of goods and services; economic conditions
in general and in the Company's specific market areas; demographic changes;
changes in or failure to comply with federal, state and/or local governmental
regulations; liability and other claims asserted against the Company; changes in
operating strategy or development plans; the ability to attract and retain
qualified personnel; the significant indebtedness of the Company after the
Recapitalization (as defined herein) and the impact of increases in interest
rates on such indebtedness; labor disturbances; changes in the Company's capital
expenditure and studio expansion plans; termination of the Company's right to do
business in Kmart (as defined herein) or Wal-Mart (as defined herein) stores on
a permanent or traveling studio basis; decreases in the number of customers or
lower average sales amounts; and other factors referenced in "Risk Factors" and
elsewhere herein. In addition, such forward-looking statements are necessarily
dependent upon assumptions, estimates and dates that may be incorrect or
imprecise and involve known and unknown risks, uncertainties and other factors.
Accordingly, any forward-looking statements included herein do not purport to be
predictions of future events or circumstances and may not be realized.
Forward-looking statements can be identified by, among other things, the use of
forward-looking terminology such as "believes," "estimates," "will result,"
"will continue to," "plans," "projects," "outlook," "targets," "budgets,"
"expects," "may," "will," "should," "seeks," "pro forma," "anticipates,"
"intends" or the negative of any thereof, or other variations thereon or
comparable terminology, or by discussions of strategy or intentions. Given these
uncertainties, prospective investors are cautioned not to place undue reliance
on such forward-looking statements, projections and plans. Such forward-looking
statements speak solely as of the date hereof, and the Company disclaims any
obligation to update any such statements or to publicly announce the results of
any revisions to any of such statements to reflect future events or
developments.
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SUMMARY
The following summary is qualified in its entirety by and should be read in
conjunction with, the more detailed information and financial statements
(including the notes thereto) appearing elsewhere herein. Unless the context
indicates otherwise, the terms the "Company" and "PCA" mean, collectively, PCA
International, Inc. and its subsidiaries. Unless otherwise indicated, market and
industry data and other industry statistics are derived from The 1997
International Photo Imaging Industry Report by Photofinishing News, Inc. (the
"Photofinishing News 1997 Report"). The Company has not undertaken to verify
independently market and industry information.
THE COMPANY
PCA is the largest professional portrait photography company in the North
American discount department store sector based on revenue, number of customers,
and studio locations. The Company focuses on the pre-school segment of the $5.6
billion domestic professional portrait photography market, selling its products
and services through two premier distribution channels: Kmart Corporation
("Kmart") and Wal-Mart Stores, Inc. ("Wal-Mart"). PCA ranks among the top three
professional portrait photography companies in North America, with a market
share of over 20% of the $1.1 billion domestic pre-school portrait market
segment. As of May 3, 1998, the Company operated 2,034 portrait studios within
Kmart and Wal-Mart stores and supercenters in the United States, Canada, Mexico,
Puerto Rico and South America. PCA also operates an extensive traveling studio
business, providing portrait photography services in approximately 1,400
additional Wal-Mart retail locations as well as to church congregations and
other institutions. During fiscal 1997, PCA generated revenue and EBITDA of
$242.9 million and $38.3 million, respectively.
The Company's in-house technology and manufacturing group has designed,
developed and manufactured the industry's only proprietary integrated digital
imaging system. The Company's system automates and links the photography and
image selection process with the immediate sale of custom portrait packages and
integrates its studios with its portrait processing and production systems. This
proprietary system has three principal advantages over the vendor-supplied
systems of its competitors who use digital technology. First, PCA's proprietary
system was designed from its inception to integrate package selection, order
creation, film processing, editing, printing and order fulfillment as seamlessly
as possible, increasing efficiency and synergies among the various system
components. Second, the system design enables PCA to incorporate "off-the-shelf"
components (such as in-studio computers, video cameras and laser printers), all
of which can be purchased from more than one source, modified (if necessary) and
integrated into the system. The ability to purchase from more than one source
reduces the Company's capital expenditure requirements and resulting
depreciation because it allows the Company to "mix and match," using the
components that can be purchased most cost-effectively, rather than having to
purchase the components selected and priced by a vendor of digital imaging
systems. Third, the proprietary integrated digital system can be expanded,
modified and upgraded on a world-wide basis by PCA's own technology and
manufacturing group, allowing PCA to avoid depending on the availability or
willingness of an outside vendor to develop software upgrades or to perform
installations and modifications, thus maximizing flexibility and minimizing
system support costs and associated down-time.
The integrated digital imaging system also has two primary advantages over
non-digital portrait photography operations: increased average sales per
customer and lower production costs. Higher average sales per customer result
from the digital studios' superior portrait photography experience coupled with
a more effective, customer-friendly selling process. Lower production costs
result from printing only the poses and sizes that the customer orders, avoiding
the waste of labor and materials from printing large quantities of speculative
portraits in an attempt to predict the customer's purchase decision.
The Company strengthened its position in the discount department store
sector with the January 27, 1997 acquisition of American Studios, Inc. ("ASI"),
the primary operator of professional portrait photography studios in Wal-Mart
stores in the United States and Mexico. This acquisition increased by 2,300 the
number of Wal-Mart locations serviced by the Company through a combination of
permanent and traveling studios. During 1997, the Company redeployed its
industry-leading, but underutilized digital imaging assets from underperforming
locations to Wal-Mart locations acquired from ASI. As of July 31, 1997, the
Company had
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converted all domestic Wal-Mart permanent portrait studios to its integrated
digital imaging technology. In August 1997, with the acquisition from Wal-Mart
of 72 studios previously operated internally by Wal-Mart, PCA became Wal-Mart's
world-wide provider of professional portrait photography services.
COMPETITIVE STRENGTHS
The Company believes its competitive position is strengthened by the
following factors:
- Leading Market Position in Pre-School Portrait Segment. The Company,
with a market share of over 20%, is one of the largest participants in
the $1.1 billion pre-school portrait market segment of the $5.6 billion
domestic professional portrait photography market. Within the pre-school
segment, the Company, through a combination of permanent and traveling
studios, services approximately 3,400 domestic retail locations, which is
more than the total number of locations serviced by its three largest
competitors combined.
- Strong Relationships with Leading Discount Retailers. The Company has
built strong, long-term relationships with the two largest discount
department store chains in North America -- Wal-Mart and Kmart. The
Company's Kmart and Wal-Mart relationships span 32 and 15 years,
respectively. The Company currently services approximately 3,400 discount
retail locations in North America, with approximately 900 permanent
portrait studios in Kmart stores and approximately 1,100 permanent
portrait studios in Wal-Mart stores. The Company's permanent studios
account for approximately 95% of the permanent portrait studios in North
American discount department stores. The Company's remaining
approximately 1,400 U.S. Wal-Mart locations are serviced by traveling
studios, which average approximately six visits per store per year.
Between 1990 and 1997, Wal-Mart's and Kmart's combined revenues increased
at a compound annual growth rate ("CAGR") of 13%, compared to 10% for the
U.S. discount department store sector and 5% for the entire U.S. retail
sector over the same period, according to publicly available data.
Management's goal in building strong relationships with these leading
retailers is to position the Company to participate in their future
growth both domestically and internationally.
- Cost-Effective Production Process. The Company believes that it has one
of the lowest-cost portrait production systems in the industry. This
position is primarily the result of: (i) lower capital expenditures and
depreciation as a consequence of lower component and installation costs
associated with the Company's proprietary integrated digital imaging
system; (ii) the efficiency of the integrated system, which streamlines
and automates the production process, resulting in higher volume, higher
speed, lower labor costs, lower waste and fewer reprints; (iii)
flexibility and easier expansion and maintenance associated with its
proprietary integrated digital system as compared to competitors'
vendor-developed digital systems; and (iv) a marketing focus on selling
larger portrait collections based on more poses, lowering the average
production cost per unit.
- Proprietary Technology. PCA is the only company in the professional
portrait photography industry that has developed a proprietary integrated
digital imaging system (including photographic cameras, sales software
and production equipment) that integrates and automates the portrait
photography process from studio sitting through production and order
fulfillment. The principal advantages of the proprietary integrated
digital imaging system are: (i) seamless integration of critical
production processes, (ii) ability to use lower-cost, "off-the-shelf"
components and (iii) independence from outside vendors for system
support, expansion and upgrades. The technology and manufacturing group
continually evaluates the return on investment from implementing
technological advances in order to remain a leader in the commercially
viable application of emerging imaging technologies.
- Flexible Sales and Manufacturing System. PCA provides the customer with
the flexibility to create a "best value" portrait collection by choosing
specific poses, portrait sizes and quantities from a computer-assisted
sales program which displays digital images of the poses and price
information that is updated as a customer alters his or her selections.
This interactive order capability allows the customer to create a custom
portrait package while minimizing paperwork for the sales associate. In
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addition, the proprietary integrated digital system is extremely
flexible, allowing for easier upgrades to sales software and
PCA-developed production equipment without relying on outside software
vendors.
- Experienced Management Team. The Company's senior management team, with
over 90 years of combined experience in the professional portrait
photography industry, had the foresight to invest in PCA's proprietary
integrated digital imaging system which has positioned PCA as a leader in
the industry. Since arriving in 1987, John Grosso, PCA's President and
Chief Executive Officer, has successfully directed PCA's expansion in the
growing discount department store channel through the acquisition of ASI,
establishing the Company in its current position with Wal-Mart and Kmart,
the two largest retail chains in the growing discount retail sector. Eric
H. Jeltrup, Executive Vice President and Chief Technology Officer,
together with the technology and manufacturing group, were responsible
for developing PCA's proprietary integrated digital imaging system, which
was first used in Kmart, and spearheading the digital conversion at the
acquired Wal-Mart portrait studios.
BUSINESS STRATEGY
Management's business strategy is to capitalize on the Company's strengths
by implementing the following initiatives:
- Complete Integration of ASI. Following the acquisition of ASI, PCA
converted all of the approximately 600 Wal-Mart studios, which did not
utilize digital technology, to the PCA integrated digital imaging system.
PCA is continuing the training of Wal-Mart studio-level personnel on the
use of the PCA integrated digital system and effective sales techniques.
PCA's integrated digital system has aided the studio-level employee in
increasing average order size per customer. Since acquiring ASI on
January 27, 1997, PCA has increased average revenue per customer by over
$15 in the acquired Wal-Mart locations. This figure, however, still
trails the Company's Kmart location averages by approximately $5 per
customer, representing additional opportunities for improvement.
Management will continue to focus on improving per customer revenues in
both Wal-Mart and Kmart locations. Additionally, PCA is continuing with
an extensive studio renovation and refurbishment plan in its Wal-Mart
locations to improve studio layout and the customer studio reception
area.
- Maintain a Disciplined Studio Growth Initiative. The Company intends to
expand its permanent studio portfolio by (i) placing studios in higher
volume domestic Wal-Mart and Kmart locations (during the 1998 fiscal
year, PCA plans to open approximately 70 net new studios); (ii) targeting
locations served by existing high volume non-digital traveling studios
for transition to a permanent integrated digital studio format (PCA has
proposed approximately 270 Wal-Mart locations for this transition); (iii)
opening new studios as Wal-Mart expands internationally (during the 1998
fiscal year PCA plans to open 25 new international studios); and (iv)
expanding strategically into new distribution channels on an
opportunistic basis.
- Exploit Sales and Marketing Opportunities. The Company has implemented
several initiatives in order to improve in-store awareness at Kmart and
Wal-Mart studios and to generate repeat business, including: (i) using
the Company's proprietary customer database for occasion-related portrait
events and other promotions to generate repeat business; (ii) providing
more comfortable and child-friendly studios; (iii) launching
cross-promotional campaigns with companies such as McDonald's
Corporation, Walt Disney Co., Nabisco, Inc., SmithKline Beecham Consumer
Healthcare L.P. and Kimberly-Clark Corporation; and (iv) developing
in-store merchandising programs with child-oriented departments.
- Build Strategic Alliances and Enhance Customer Value. PCA is working
with major software vendors in an effort to provide customers with the
ability to manipulate the digital photographic images captured at a PCA
digital studio. With numerous professionally-designed templates to choose
from, this software would allow PCA customers to create customized screen
savers, calendars, family trees, holiday and birthday cards and other
computer-enhanced products.
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RECENT DEVELOPMENTS
In the fiscal year ended February 1, 1998, the Company eliminated certain
underperforming businesses to concentrate on its portrait studio operations. The
Company discontinued ASI's fashion photography services in Wal-Mart as well as
PCA's pilot pet portraiture program in PETsMART. PCA also closed 401
underperforming portrait studios in Kmart stores. The Company utilized the
assets from these discontinued services and closed locations, including digital
photography equipment, to upgrade former ASI Wal-Mart non-digital studios to
PCA's integrated digital system and to upgrade certain existing Kmart locations.
In the ordinary course of business, the Company continues to evaluate its asset
utilization on a store-by-store basis and may open new studios or close
underperforming studios.
In April 1998, Kmart notified the Company that it would close 75 studios in
which PCA is currently operating and would allow alternative portrait studio
operators to service such locations. While Kmart has stated to management that
it plans no further terminations in 1998, there can be no assurance that Kmart
will not close additional PCA studio locations in the future or that it will
retain PCA as its primary supplier of portrait photography services
indefinitely. Under the terms of the licensing agreement between Kmart and PCA,
PCA is required to exit these 75 studios within six months of notification, or
around November 1, 1998. Kmart will also pay PCA a termination fee of
approximately $500,000, representing PCA's unamortized investment in leasehold
improvements made in these specific 75 studios. These 75 studios generated
approximately $8.0 million in sales (approximately 8.2% of total sales in PCA's
Kmart studios) and approximately $1.7 million in income from operations before
interest and taxes in fiscal 1997. Any significant reduction in the number of
Kmart stores in which the Company operates, without replacement, could have a
material adverse effect on the Company. See "Risk Factors -- Risk of Loss of
Kmart and Wal-Mart Licenses" and "-- Kmart Development."
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THE TRANSACTIONS
THE RECAPITALIZATION
On April 20, 1998, Jupiter Acquisition Corp. ("JAC"), a wholly owned
subsidiary of Jupiter Partners II L.P. ("Jupiter"), entered into a definitive
merger agreement with PCA to acquire the common stock, par value $0.20 per share
(the "Common Stock"), of PCA (excluding certain shares to be retained by PCA
senior management) for $26.50 per share (the "Recapitalization"). The
transaction, which will be accounted for as a recapitalization, is valued at
approximately $275.0 million, including the refinancing of existing PCA debt.
The Recapitalization has been approved by the Board of Directors of PCA, will be
submitted to PCA's stockholders on August 17, 1998, and the closing of the
Recapitalization (the "Recapitalization Closing") is expected to be completed
shortly after the stockholders' meeting. After the Recapitalization, PCA will
continue to be run by its current management team led by John Grosso, President
and Chief Executive Officer of PCA. Immediately after the Recapitalization,
Jupiter will beneficially own between approximately 80.2% and 83.8% of the
outstanding equity of the Company, and the management team will beneficially own
approximately 8.9%. Subsequently, the Company intends to issue to management new
options to purchase Common Stock representing up to an additional 10.7% on a
fully-diluted basis. The new options will vest over time or upon the achievement
of certain performance targets. See "Security Ownership of Certain Beneficial
Owners and Management" and "Management -- New Management Stock Option Plan."
The Recapitalization will be financed with the proceeds of (i) a new $150.0
million bank facility (the "Bank Facility") of which approximately $125.0
million will be drawn at the Recapitalization Closing, (ii) Senior Subordinated
Notes (the "Notes") in an aggregate principal amount of $100.0 million, (iii)
$65.0 million in equity including between $50.5 million and $52.8 million in
cash contributed from Jupiter, approximately $5.0 million in rollover equity
from management and between $7.2 million and $9.5 million in rollover equity
("Rollover Equity") from other existing shareholders who retain their Common
Stock. Collectively, items (i), (ii) and (iii) are referred to herein as the
"Recapitalization Financing."
The following table outlines the sources and uses of funds in connection
with the Recapitalization as if it occurred on July 31, 1998:
<TABLE>
<CAPTION>
(DOLLARS IN MILLIONS)
---------------------
<S> <C>
SOURCES
Bank Facility(1)............................................ $125.0
Senior Subordinated Notes................................... 100.0
Equity Investment........................................... 65.0
------
Total Sources..................................... $290.0
======
USES
Purchase of Equity(2)....................................... $233.5
Repayment of Outstanding Debt............................... 41.4
Estimated Transaction Costs................................. 15.1
------
Total Uses........................................ $290.0
======
</TABLE>
- - - - ---------------
(1) Does not include any amounts relating to letters of credit.
(2) Includes: (i) Common Stock converted into the right to receive $26.50 in
cash; (ii) Rollover Equity; and (iii) payments made in cancellation of
outstanding PCA options and warrants.
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EQUITY SPONSOR
Following the Recapitalization, PCA will be controlled by Jupiter Partners
II L.P. ("Jupiter"). Jupiter is a private investment firm organized to invest in
management buyouts, industry consolidations and growth capital opportunities.
Jupiter's principals, John A. Sprague and Terry J. Blumer, are assisted by an
experienced staff of investment professionals.
Jupiter's predecessor fund ("Fund I") was formed in 1994 with over $350
million of capital available for investment. Fund I is approximately 85%
invested in seven portfolio companies. Companies which Jupiter seeks to purchase
typically have valuations between $100 million and $500 million, with Jupiter
providing equity from its own capital of between $30 million and $100 million
for each investment. Proceeds from the recently completed first closing of
Jupiter Partners II L.P., the firm's second fund, will be used to fund the
Recapitalization.
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SUMMARY UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL AND OPERATING DATA
The summary unaudited pro forma consolidated financial data of the Company
set forth below are based on historical consolidated financial statements of the
Company as adjusted to give effect to the Recapitalization, including the
Recapitalization Financing and the application of the proceeds thereof. The pro
forma statements of operating data and other data for the fiscal year ended
February 1, 1998, the quarter ended May 3, 1998 and the twelve months ended May
3, 1998 give effect to the Recapitalization, including the Recapitalization
Financing and the application of the proceeds thereof, as if they had occurred
as of February 3, 1997, February 2, 1998 and May 5, 1997, respectively. The pro
forma balance sheet data give effect to the Recapitalization, including the
Recapitalization Financing and the application of the proceeds thereof, as if
they had occurred on May 3, 1998. The pro forma adjustments are based upon
available information and upon certain assumptions that management believes are
reasonable under the circumstances. The pro forma financial data do not purport
to represent what the Company's actual results of operations or actual financial
position would have been if the Recapitalization, including the Recapitalization
Financing and the application of the proceeds thereof, had occurred on such
dates or to project what the Company's actual results of operations or actual
financial position would have been if the Recapitalization, including the
Recapitalization Financing and the application of the proceeds thereof, had
occurred on such dates or to project the Company's results of operations or
financial position for any future period or date. See "Pro Forma Condensed
Consolidated Financial Information."
<TABLE>
<CAPTION>
PRO FORMA
------------------------------------------------
FISCAL YEAR QUARTER TWELVE MONTHS
ENDED ENDED ENDED
FEBRUARY 1, 1998 MAY 3, 1998 MAY 3, 1998
---------------- ------------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
STATEMENT OF OPERATING DATA:
Sales(1)........................................ $242,899 $54,662 $ 238,869
Cost of sales(2)................................ 181,966(3) 41,577 178,542(3)
-------- ------- ---------
Gross profit.................................... 60,933 13,085 60,327
General and administrative expenses(4).......... 38,070 10,428(5) 37,866(5)
-------- ------- ---------
Income from operations before interest and
income taxes................................. $ 22,863 $ 2,657 $ 22,461
======== ======= =========
OTHER DATA:
EBITDA(6)....................................... $ 38,316 $ 6,405 $ 37,920
Adjusted EBITDA(7).............................. 39,469 7,023 39,691
Adjusted EBITDA margin.......................... 16.2% 12.8% 16.6%
Gross margin.................................... 25.1% 23.9% 25.3%
Capital expenditures............................ $ 12,086 $ 1,785 $ 10,508
Depreciation.................................... 13,543 3,241 13,498
Amortization.................................... 1,910 507 1,961
Cash interest expense(8)........................ 21,097 5,129 21,097
Ratio of adjusted EBITDA to cash interest
expense...................................... 1.9x 1.4x 1.9x
BALANCE SHEET DATA AT PERIOD END:
Working capital (deficit)....................... -- -- $ (14,550)
Total assets.................................... -- -- 152,682
Long-term debt.................................. -- -- 220,683
Stockholders' equity (deficit).................. -- -- (122,508)
</TABLE>
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NOTES TO SUMMARY UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL AND OPERATING DATA
(DOLLARS IN THOUSANDS)
(1) Sales for the fiscal year ended February 1, 1998 and for the twelve months
ended May 3, 1998 include sales from both continuing operations and
underperforming businesses which have been terminated (including
underperforming studios, PETsMART pilot operations and ASI fashion
photography operations). See "Business -- Recent Developments."
<TABLE>
<CAPTION>
FISCAL YEAR TWELVE MONTHS
ENDED ENDED
FEBRUARY 1, 1998 MAY 3, 1998
---------------- -------------
<S> <C> <C>
Sales attributable to continuing operations............ $233,914 $237,866
Sales attributable to underperforming businesses which
have been terminated................................. 8,985 1,003
-------- --------
Sales.................................................. $242,899 $238,869
======== ========
</TABLE>
(2) Includes advertising and promotional costs, costs of photographic sales and
store commissions and selling costs.
(3) Includes non-recurring expenses of $1,153 associated with the closure of
underperforming studios and redeployment of underutilized assets. See
"Business -- Recent Developments."
(4) Includes amortization of intangibles.
(5) Includes non-recurring expenses of $618 associated with the
Recapitalization.
(6) EBITDA represents earnings before interest expense, income taxes,
depreciation and amortization. EBITDA is included because it is one measure
used by certain investors to determine a company's ability to service its
indebtedness. EBITDA is unaffected by the debt and equity structure of the
Company. EBITDA does not represent cash flow from operations as defined by
generally accepted accounting principles ("GAAP"), is not necessarily
indicative of cash available to fund all cash flow needs and should not be
considered an alternative to net income under GAAP for purposes of
evaluating the Company's results of operations. EBITDA is not necessarily
comparable with similarly-titled measures for other companies.
(7) Adjusted EBITDA represents EBITDA plus adjustments for nonrecurring expenses
as follows:
<TABLE>
<CAPTION>
FISCAL YEAR QUARTER TWELVE MONTHS
ENDED ENDED ENDED
FEBRUARY 1, 1998 MAY 3, 1998 MAY 3, 1998
---------------- ----------- -------------
<S> <C> <C> <C>
EBITDA........................................ $38,316 $6,405 $37,920
Non-recurring expenses associated with the
closure of underperforming studios and the
redeployment of underutilized assets........ 1,153 -- 1,153
Non-recurring expenses associated with the
Recapitalization............................ -- 618 618
------- ------ -------
Adjusted EBITDA............................... $39,469 $7,023 $39,691
======= ====== =======
</TABLE>
See "Business -- Recent Developments."
(8) Excludes amortization of debt issuance costs.
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SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
This summary historical consolidated financial and operating data for and
as of each of the fiscal years in the five-year period ended February 1, 1998
set forth below under the captions "Statement of Operating Data," "Other Data"
and "Balance Sheet Data" have been derived from the Audited Consolidated
Financial Statements of the Company. The summary historical consolidated
financial and operating data set forth below for the quarters ended May 4, 1997
and May 3, 1998 have been derived from the Unaudited Consolidated Financial
Statements of the Company and, in each case, include, in the opinion of
management, all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of the results for the unaudited interim
periods. Results of operations for the quarter ended May 3, 1998 are not
necessarily indicative of the results that may be expected for the entire year.
The information presented below is qualified in its entirety by, and should be
read in conjunction with "Capitalization," "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the Consolidated Financial
Statements and the notes thereto included elsewhere herein.
<TABLE>
<CAPTION>
FOR THE QUARTER
FOR THE FISCAL YEAR ENDED APPROXIMATELY JANUARY 31, ENDED
---------------------------------------------------- -------------------
MAY 4, MAY 3,
1994 1995 1996 1997 1998 1997 1998
-------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATING DATA:
Sales............................. $149,150 $144,881 $144,715 $156,099 $242,899 $ 58,692 $ 54,662
Cost of sales(1).................. 120,353 114,092 107,611 119,107 181,966 45,001 41,577
-------- -------- -------- -------- -------- -------- --------
Gross profit...................... 28,797 30,789 37,104 36,992 60,933 13,691 13,085
General and administrative
expenses(2)..................... 20,594 22,936 23,782 31,676 38,070 10,632 10,428
-------- -------- -------- -------- -------- -------- --------
Income from operations before
interest and income taxes....... 8,203 7,853 13,322 5,316 22,863 3,059 2,657
Interest expense (income), net.... (5) 406 459 179 6,571 1,620 1,220
-------- -------- -------- -------- -------- -------- --------
Income from operations before
income taxes.................... 8,208 7,447 12,863 5,137 16,292 1,439 1,437
Income tax provision.............. 3,296 3,074 5,246 2,143 7,557 796 659
-------- -------- -------- -------- -------- -------- --------
Income from continuing
operations...................... 4,912 4,373 7,617 2,994 8,735 643 778
Loss (income) associated with
discontinued operations......... 2,200 (412) -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Net income........................ $ 2,712 $ 4,785 $ 7,617 $ 2,994 $ 8,735 $ 643 $ 778
======== ======== ======== ======== ======== ======== ========
OTHER DATA:
EBITDA(3)(4)...................... $ 13,362 $ 14,989 $ 21,812 $ 14,814 $ 38,316 $ 6,801 $ 6,405
EBITDA margin(4).................. 9.0% 10.3% 15.1% 9.5% 15.8% 11.6% 11.7%
Gross margin...................... 19.3% 21.3% 25.6% 23.7% 25.1% 23.3% 23.9%
Capital expenditures.............. $ 21,875 $ 14,698 $ 6,309 $ 13,424 $ 12,086 $ 3,363 $ 1,785
Depreciation...................... 5,159 7,136 8,490 9,498 13,543 3,286 3,241
Amortization...................... -- -- -- -- 1,910 456 507
BALANCE SHEET DATA AT PERIOD END:
Cash and cash equivalents......... $ 5,119 $ 312 $ 3,915 $ 1,536 $ 12,290 $ 3,735 $ 11,073
Working capital (deficit)......... (4,321) (6,697) (3,878) (18,472) (20,334) (20,200) (19,668)
Total assets...................... 56,751 59,557 59,884 146,661 153,301 151,308 146,916
Long-term debt.................... -- -- -- 58,680 42,064 63,228 41,105
Stockholders' equity.............. 30,296 33,032 31,235 33,641 44,689 35,161 45,712
OTHER OPERATING DATA:
Year-end number of permanent
studios:
Domestic........................ 1,323 1,397 1,411 2,204 1,953 2,196 1,908
International................... 94 111 108 84 122 95 126
Other........................... -- -- 14 114 -- 114 --
</TABLE>
10
<PAGE> 12
NOTES TO SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
(DOLLARS IN THOUSANDS)
(1) Includes advertising and promotional costs, costs of photographic sales and
store commissions and selling costs. Cost of sales for the fiscal year ended
February 1, 1998 includes non-recurring expenses of $1,153 associated with
the closure of underperforming studios and redeployment of underutilized
assets. See "Business -- Recent Developments."
(2) Includes amortization of intangibles. General and administrative expenses
for the quarter ended May 3, 1998 include non-recurring expenses of $618
associated with the Recapitalization. General and administrative expenses
for the fiscal year ended February 2, 1997 include non-recurring expenses of
$6,000 associated with the closure of underperforming studios and
redeployment of underutilized assets. See "Business -- Recent Developments."
(3) EBITDA represents earnings before interest expense, income taxes,
depreciation and amortization. EBITDA is included because it is one measure
used by certain investors to determine a company's ability to service its
indebtedness. EBITDA is unaffected by the debt and equity structure of the
company. EBITDA does not represent cash flow from operations as defined by
GAAP, is not necessarily indicative of cash available to fund all cash flow
needs and should not be considered an alternative to net income under GAAP
for purposes of evaluating the Company's results of operations. EBITDA is
not necessarily comparable with similarly-titled measures for other
companies.
(4) EBITDA and EBITDA margin for the fiscal years ended February 2, 1997 and
February 1, 1998 and the three months ended May 3, 1998 reflect certain
non-recurring expenses:
<TABLE>
<CAPTION>
FISCAL YEAR FISCAL YEAR THREE MONTHS
ENDED ENDED ENDED
FEBRUARY 2, 1997 FEBRUARY 1, 1998 MAY 3, 1998
---------------- ---------------- ------------
<S> <C> <C> <C>
EBITDA...................................... $14,814 $38,316 $6,405
Non-recurring expenses associated with the
closure of underperforming studios and the
redeployment of underutilized assets...... 6,000 1,153 --
Non-recurring expenses associated with the
Recapitalization.......................... -- -- 618
------- ------- ------
Adjusted EBITDA............................. $20,814 $39,469 $7,023
======= ======= ======
Adjusted EBITDA margin...................... 13.3% 16.2% 12.8%
</TABLE>
11
<PAGE> 13
RISK FACTORS
Certain statements herein constitute forward-looking statements. See
"Cautionary Statement Concerning Forward-Looking Statements."
LEVERAGE
After the Recapitalization, the Company will be highly leveraged. On May 3,
1998, after giving pro forma effect to the Recapitalization and the
Recapitalization Financing, the Company would have had total consolidated
indebtedness of approximately $229.3 million (of which $100.0 million would have
consisted of the Notes and the balance would have consisted of the Bank
Facility, including $4.3 million in letters of credit drawn thereunder) and
stockholders' deficit of approximately $122.5 million. Also, after giving pro
forma effect to such transactions, the Company's earnings would have been
insufficient to cover its fixed charges by approximately $2.7 million for the
three months ended May 3, 1998. The Company and its subsidiaries will be
permitted to incur substantial additional indebtedness in the future. In
addition, as of May 3, 1998, on a pro forma adjusted basis giving effect to the
Recapitalization and the Recapitalization Transactions, approximately $20.7
million would have been available for additional borrowing under the Bank
Facility. "See Selected Combined Financial and Operating Data."
The Company's ability to make scheduled payments of principal of, or to pay
the interest or Liquidated Damages (if any) on, or to refinance, its
indebtedness (including the Notes), or to fund planned capital expenditures,
research and development expenses and other obligations will depend on its
future performance, which, to a certain extent, is subject to general economic,
financial, competitive, legislative, regulatory and other factors that are
beyond its control. The Company may need to refinance all or a portion of the
principal of the Notes on or prior to maturity. There can be no assurance that
the Company's business will generate sufficient cash flow from operations, that
anticipated revenue growth and operating improvements will be realized or that
future borrowings will be available under the Bank Facility or otherwise in an
amount sufficient to enable the Company to service its indebtedness, including
the Notes, or to fund its other liquidity needs. In addition, there can be no
assurance that the Company will be able to effect any such refinancing on
commercially reasonable terms or at all. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
The degree to which the Company will be leveraged following the
Recapitalization could have important consequences to holders of the Notes,
including, but not limited to: (i) making it more difficult for the Company to
satisfy its obligations with respect to the Notes, (ii) increasing the Company's
vulnerability to general adverse economic and industry conditions, (iii)
limiting the Company's ability to obtain additional financing to fund future
working capital, capital expenditures, research and development and other
general corporate requirements, (iv) requiring the dedication of a substantial
portion of the Company's cash flow from operations to the payment of principal
of, and interest on, its indebtedness, thereby reducing the availability of such
cash flow to fund working capital, capital expenditures, research and
development or other general corporate requirements, (v) limiting the Company's
flexibility in planning for, or reacting to, changes in its business and the
industry and (vi) placing the Company at a competitive disadvantage vis-a-vis
less leveraged competitors. In addition, the Indenture governing the Notes (the
"Indenture") and the Bank Facility will contain financial and other restrictive
covenants that will limit the ability of the Company to, among other things,
borrow additional funds. Failure by the Company to comply with such covenants
could result in an event of default which, if not cured or waived, could have a
material adverse effect on the Company. In addition, the degree to which the
Company is leveraged could prevent it from repurchasing all of the Notes
tendered to it upon the occurrence of a Change of Control. See "-- Possible
Inability to Fund a Change of Control Offer" and "Description of Bank Facility."
RISK OF LOSS OF KMART AND WAL-MART LICENSES
Approximately 96% of the Company's revenues for the fiscal year ended
February 1, 1998 were derived from sales at permanent and traveling studios
located at Kmart and Wal-Mart stores. Such studios are operated under agreements
with Kmart and Wal-Mart, respectively, that permit the Company to operate its
12
<PAGE> 14
studios in exchange for a commission payable by the Company based on a
percentage of sales from the studio in each store. The U.S. license agreement
with Kmart expires May 9, 2001 and may be terminated by either party at any time
before May 9, 2001 upon 180 days' notice. The Company's U.S. license agreement
with Wal-Mart may be terminated by either party at any time without notice. The
Company's license agreement with Wal-Mart for its Canadian stores expires on a
store-by-store basis five years after a store opens and may be terminated by
either party, on a store-by-store basis, if certain minimum sales results are
not achieved. The loss of the license to do business in the U.S. Kmart stores,
U.S. Wal-Mart stores or international Wal-Mart stores, the reduction or
cancellation of a significant number of traveling studios or the closing of a
significant number of Kmart or Wal-Mart stores, without replacement, could have
a material adverse effect on the Company.
In April 1998, Kmart notified the Company that it would close 75 studios in
which PCA is currently operating and would allow alternative portrait studio
operators to service such locations. While Kmart has stated to management that
it plans no further terminations in 1998, there can be no assurance that Kmart
will not close additional PCA studio locations in the future or that it will
retain PCA as its primary supplier of portrait photography services
indefinitely. Under the terms of the licensing agreement between Kmart and PCA,
PCA is required to exit these 75 studios within six months of notification, or
around November 1, 1998. Kmart will also pay to PCA a termination fee of
approximately $500,000 representing PCA's unamortized investment in leasehold
improvements made in these specific 75 studios. These 75 studios generated
approximately $8.0 million in sales (approximately 8.2% of total sales in PCA
Kmart studios) and approximately $1.7 million in income from operations before
interest and taxes in fiscal 1997. Any significant reduction in the number of
Kmart stores in which the Company operates, without replacement, could have a
material adverse effect on the Company.
DEPENDENCE ON KEY PERSONNEL
The Company's continued success depends, to a large extent, upon the
efforts and abilities of key managerial employees, particularly the Company's
senior management. See "Management and Board of Directors of the Company." While
the Company has employment contracts with several members of senior management,
including John Grosso, Bruce A. Fisher, Eric H. Jeltrup and J. Robert Wren, Jr.,
such contracts cannot assure the continued employment of such officers.
Competition for qualified management personnel in the industry is intense. The
loss of the services of certain of these key employees or the failure to retain
qualified employees when needed could have a material adverse effect on the
Company.
SAME-STUDIO SALES PRESSURES
Same-studio sales in the Company's Kmart studios have decreased by 15.1%
between fiscal 1996 and fiscal 1997 and by 20.0% between the first quarter of
fiscal 1997 and the first quarter of fiscal 1998. These decreases in Kmart
same-studio sales have been offset by increases in same-studio sales in certain
of PCA's other studios, resulting in a decrease of 1.0% in overall Company
same-studio sales between fiscal 1996 and fiscal 1997 and an increase of 3.9%
between the first quarter of fiscal 1997 and the first quarter of fiscal 1998.
Declines in sales for certain of the Company's studios may continue in the
future and are expected to continue at least into the second quarter of fiscal
1998. In addition, since the Company's retail hosts compete against each other
in certain geographic markets, increases in sales from the opening of a new
studio by the Company may be offset by decreases in same-studio sales for other
PCA studios in the same geographic market. Significant future decreases in
overall same-studio sales could have a material adverse effect on the Company.
MANAGEMENT AND FUNDING OF GROWTH
Any future growth of the Company will require the Company to manage its
expanding domestic and international operations and to adapt its operational and
financial systems to respond to changes in its business environment, while
maintaining a competitive cost structure. The expansion of the Company's
business has placed and will continue to place significant demands on the
Company and its management to improve the Company's operational, financial and
management systems, to develop further the management skills of the Company's
managers and supervisors, and to continue to retain, train, motivate and
effectively manage the Company's employees. The failure of the Company to manage
any future growth effectively could have a material adverse effect on the
Company.
13
<PAGE> 15
Additionally, the Company's ability to maintain and increase its revenue
base and to respond to shifts in customer demand and changes in industry trends
will be partially dependent on its ability to generate sufficient cash flow or
obtain sufficient capital for the purpose of, among other things, financing
capital expenditures, infrastructure growth and acquisitions. There can be no
assurances that the Company will be able to generate sufficient cash flow or
that financing will be available on acceptable terms (or permitted to be
incurred under the terms of the Bank Facility and any future indebtedness) to
fund the Company's future growth.
SEASONALITY
Because of the retail nature of its services and its focus on discount
stores, the Company's business is very seasonal. The Christmas season accounts
for a high percentage of the Company's sales and earnings, and the Company's
fourth fiscal quarter (late October through late January) typically produces a
large percentage of annual sales and annual earnings. The fourth quarters of the
fiscal years ended February 1, 1998, February 2, 1997, and January 28, 1996,
accounted for approximately 31.2%, 33.2% and 32.2%, respectively, of sales, and
89.4%, 32.8% and 64.2%, respectively, of earnings for those years. Fiscal 1997
fourth quarter earnings as a percentage of total earnings were negatively
impacted due to significant costs incurred for restructuring the Company's
digital studio operations, which led to operating losses in the first half of
the year. The 1996 fourth quarter earnings would have accounted for 69.5% of
annual earnings before giving effect to a $3.6 million after-tax charge for
studio closure costs. The Company can be adversely affected by inclement
weather, especially during the important fiscal fourth quarter, and by general
downturns in consumer Christmas spending.
COMPETITION
The professional portrait photography industry, including both permanent
and traveling studios, is highly competitive. The companies in the industry
compete on the basis of price, service, package size, technology and convenience
via the retail distribution channel. The major professional portrait studio
companies, including CPI Corporation ("CPI"), Lifetouch, Inc. ("Lifetouch") and
Olan Mills, Inc. ("Olan Mills"), operate permanent studios in retail chains and
independent locations. To compete successfully, the Company must continue to
remain competitive in areas of price, service, package size, technology and
convenience.
Furthermore, consumer products, particularly those that are value-priced,
are subject to significant price competition. There can be no assurance that the
Company will not be forced to engage in price-cutting initiatives to respond to
competitive and consumer pressures. The failure of the Company's sales volumes
to grow sufficiently to improve overall revenues and income as a result of a
competitive price reduction could have a material adverse effect on the Company.
See "Business -- Competition."
CONTROL BY JUPITER
Following the Recapitalization, between approximately 80.2% and 83.8% of
the outstanding shares of Common Stock will be held by Jupiter. As a result of
its stock ownership, Jupiter will control the Company and have the power to
elect all of its directors, appoint new management and approve any action
requiring the approval of the holders of Common Stock, including adopting
amendments to the Company's Restated Articles of Incorporation, as amended, and
approving mergers or sales of all or substantially all of the Company's assets.
The directors elected by Jupiter will have the authority to effect decisions
affecting the capital structure of the Company, including the issuance of
additional capital stock, the implementation of stock repurchase programs and
the declaration of dividends.
RESTRICTIVE DEBT COVENANTS
The Bank Facility and the Indenture impose significant operating and
financial restrictions on the Company and the subsidiaries of the Company. The
Bank Facility and the Indenture significantly limit or prohibit, among other
things, the ability of the Company and its subsidiaries to incur additional
indebtedness, incur liens, pay dividends or make certain other restricted
payments or investments, consummate certain asset sales, enter into certain
transactions with affiliates, merge or consolidate with any other person or
sell, assign, transfer, lease, convey or otherwise dispose of all or
substantially all of the assets of the Company. The Bank Facility also requires
the Company to maintain fixed charge coverage, interest coverage and leverage
ratios. The ability of the Company to comply with these and other provisions of
the Bank Facility and the Indenture
14
<PAGE> 16
may be affected by events beyond the Company's control. These restrictions could
limit the ability of the Company to respond to market conditions or meet
extraordinary capital needs or otherwise restrict corporate activities. There
can be no assurance that such restrictions will not materially adversely affect
the ability of the Company to finance its future operations or capital needs.
See "Description of Bank Facility."
POSSIBLE INABILITY TO FUND A CHANGE OF CONTROL OFFER
Upon a Change of Control (as defined in the Indenture), the Company will be
required to offer to repurchase all outstanding Notes at 101% of the principal
amount thereof plus accrued and unpaid interest and Liquidated Damages, if any,
to the date of repurchase. Any Change of Control under the Indenture would
constitute a default under the Bank Facility. Therefore, upon the occurrence of
a Change of Control, the lenders under the Bank Facility would have the right to
accelerate the Company's obligations under the Bank Facility and be entitled to
receive payment of all outstanding obligations under the Bank Facility. See
"Description of Bank Facility." If a Change of Control occurs and waivers under
the Bank Facility are not obtained, it is unlikely that the Company would have
sufficient funds, without a significant infusion of new capital, available to
repurchase the Notes pursuant to the covenant governing Changes of Control in
the Indenture. Notwithstanding these provisions, the Company could enter into
certain transactions, including certain recapitalizations, that would not
constitute a Change of Control but would increase the amount of debt outstanding
at such time.
15
<PAGE> 17
THE TRANSACTIONS
THE RECAPITALIZATION
On April 20, 1998, JAC, a wholly owned subsidiary of Jupiter, entered into
a definitive merger agreement with PCA to acquire Common Stock (excluding
certain shares to be retained by PCA senior management) for $26.50 per share.
The transaction, which will be accounted for as a recapitalization, is valued at
approximately $275.0 million, including the refinancing of existing PCA debt.
The Recapitalization has been approved by the Board of Directors of PCA, will be
submitted to PCA's stockholders on August 17, 1998, and the Recapitalization
Closing is expected to be completed shortly after the stockholders meeting.
After the Recapitalization, PCA will continue to be run by its current
management team led by John Grosso, President and Chief Executive Officer of
PCA. Immediately after the Recapitalization, Jupiter will beneficially own
between approximately 80.2% and 83.8% of the outstanding equity of the Company,
and the management team will beneficially own approximately 8.9%. Subsequently,
the Company intends to issue to management new options to purchase Common Stock
representing up to an additional 10.7% on a fully-diluted basis. The new options
will vest over time or upon the achievement of certain performance targets. See
"Security Ownership of Certain Beneficial Owners and Management" and
"Management -- New Management Stock Option Plan."
The Recapitalization will be financed with the proceeds of (i) a new $150.0
million bank facility of which approximately $125.0 million will be drawn at the
Recapitalization Closing, (ii) the Notes, (iii) $65.0 million in equity
including between $50.5 million and $52.8 million in cash contributed from
Jupiter, approximately $5.0 million in rollover equity from management and
between $7.2 million and $9.5 million in Rollover Equity from other existing
shareholders who retain their Common Stock.
The following table outlines the sources and uses of funds in connection
with the Recapitalization as if it occurred on July 31, 1998.
<TABLE>
<CAPTION>
(DOLLARS IN MILLIONS)
---------------------
<S> <C>
SOURCES
Bank Facility(1)............................................ $125.0
Senior Subordinated Notes................................... 100.0
Equity Investment........................................... 65.0
------
Total Sources..................................... $290.0
======
USES
Purchase of Equity(2)....................................... $233.5
Repayment of Outstanding Debt............................... 41.4
Estimated Transaction Costs................................. 15.1
------
Total Uses........................................ $290.0
======
</TABLE>
- - - - ---------------
(1) Does not include any amounts relating to letters of credit.
(2) Includes: (i) Common Stock converted into the right to receive $26.50 in
cash; (ii) Rollover Equity; and (iii) payments made in cancellation of
outstanding PCA options and warrants.
16
<PAGE> 18
BANK FACILITY
At the Recapitalization Closing, the Company will enter into the Bank
Facility with the several lenders named therein and NationsBank, N.A. as agent
for such lenders. The Bank Facility will consist of (i) a $45.0 million term
loan facility (the "Tranche A Term Loan Facility"), (ii) an $80.0 million term
loan facility (the "Tranche B Term Loan Facility") and (iii) a $25.0 million
revolving credit facility (the "Revolving Credit Facility"). At the
Recapitalization Closing, the Company expects to borrow $45.0 million under the
Tranche A Term Loan Facility, $80.0 million under the Tranche B Term Loan
Facility. As of May 3, 1998, on a pro forma adjusted basis after giving effect
to the Recapitalization and the Recapitalization Financing, approximately $20.7
million would have been available for additional borrowing under the Bank
Facility, the Company having drawn $4.3 million in letters of credit. See
"Description of Bank Facility."
EQUITY SPONSOR
Following the Recapitalization, PCA will be controlled by Jupiter. Jupiter
is a private investment firm organized to invest in management buyouts, industry
consolidations and growth capital opportunities. Jupiter's principals, John A.
Sprague and Terry J. Blumer, are assisted by an experienced staff of investment
professionals.
Jupiter's predecessor fund ("Fund I") was formed in 1994 with over $350
million of capital available for investment. Fund I is approximately 85%
invested in seven portfolio companies. Companies which Jupiter seeks to purchase
typically have valuations between $100 million and $500 million, with Jupiter
providing equity from its own capital of between $30 million and $100 million
for each investment. Proceeds from the recently completed first closing of
Jupiter Partners II L.P., the firm's second fund, will be used to fund the
Recapitalization.
17
<PAGE> 19
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION
The following unaudited pro forma consolidated financial information (the
"Pro Forma Financial Information") of the Company is based on historical audited
consolidated financial statements of the Company and gives effect to the
Recapitalization and the Recapitalization Financing. The pro forma statements of
operations for the year ended February 1, 1998 give effect to the
Recapitalization and the Recapitalization Financing as if it had occurred at
February 3, 1997, for the quarter ended May 3, 1998 as if they had occurred at
February 2, 1998 and the twelve months ended May 3, 1998 as if they had occurred
on May 5, 1997. The pro forma balance sheet gives effect to the Recapitalization
and the Recapitalization Financing as if they had occurred on May 3, 1998. The
pro forma adjustments are based upon available information and upon certain
assumptions that management believes are reasonable under the circumstances. The
Pro Forma Financial Information and accompanying notes should be read in
conjunction with the historical consolidated financial statements of the
Company, including the notes thereto, which are incorporated by reference, and
other financial information pertaining to the Company. The Pro Forma Financial
Information does not purport to represent what the Company's actual results of
operations or actual financial position would have been if the Recapitalization
and the Recapitalization Financing in fact occurred on such dates or to project
the Company's results of operations or financial position for any future period
or date.
As a result of the Recapitalization, the Company will incur a net loss in
the quarter in which the Recapitalization occurs. Because this loss will result
directly from the non-recurring charges incurred in connection with the
Recapitalization, the Company does not expect this loss to materially impact its
ongoing operations or liquidity.
The pro forma adjustments were applied to the respective historical
consolidated financial statements of the Company to reflect and account for the
Recapitalization as a recapitalization; accordingly, the historical basis of the
Company's assets and liabilities has not been impacted thereby.
18
<PAGE> 20
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
STATEMENT OF INCOME AND OTHER DATA
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FEBRUARY 1, 1998(1)
----------------------------------------
PRO FORMA
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE NUMBERS)
<S> <C> <C> <C>
INCOME DATA:
Sales................................................. $242,899 $242,899
Cost of sales(2)(3)................................... 181,966 181,966
-------- --------
Gross profit.......................................... 60,933 60,933
General and administrative expenses(4)................ 38,070 38,070
-------- --------
Income from operations before interest and income
taxes.............................................. 22,863 22,863
Interest expense, net................................. 6,571 $ 15,639(5) 22,210
-------- -------- --------
Income (loss) from operations before income taxes..... 16,292 (15,639) 653
Income tax provision.................................. 7,557 6,256(6) 1,301
-------- -------- --------
Net Income (loss).................................. $ 8,735 $ (9,383) $ (648)
======== ======== ========
OTHER DATA:
Gross margin.......................................... 25.1% 25.1%
Ratio of earnings to fixed charges(7)................. 3.5x 1.0x
Weighted average number of shares
Basic.............................................. 7,779 2,387
Diluted............................................ 8,195 2,426
Basic and diluted earnings (loss) per share
Basic.............................................. $ 1.12 $ (0.27)
Diluted............................................ $ 1.07 $ (0.27)
</TABLE>
See Notes to Unaudited Pro Forma Condensed Consolidated Statements of Income and
Other Data
19
<PAGE> 21
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
STATEMENT OF INCOME AND OTHER DATA
<TABLE>
<CAPTION>
QUARTER ENDED MAY 3, 1998 (1)
--------------------------------------
PRO FORMA
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE NUMBERS)
<S> <C> <C> <C>
INCOME DATA:
Sales.................................................... $54,662 $54,662
Cost of sales (2)........................................ 41,577 41,577
------- -------
Gross profit............................................. 13,085 13,085
General and administrative expenses (4)(8)............... 10,428 10,428
------- -------
Income from operations before interest and income
taxes................................................. 2,657 2,657
Interest expense, net.................................... 1,220 $ 4,188(5) 5,408
------- ------- -------
Income (loss) from operations before income taxes........ 1,437 (4,188) (2,751)
Income tax provision (benefit)........................... 659 1,675(6) (1,016)
------- ------- -------
Net income (loss)..................................... $ 778 $(2,513) $(1,735)
======= ======= =======
OTHER DATA:
Gross margin............................................. 23.9% 23.9%
Ratio of earnings to fixed charges (7)(9)................ 2.2x --
Weighted average number of shares
Basic................................................. 7,932 2,387
Diluted............................................... 8,373 2,426
Basic and diluted earnings (loss) per share
Basic................................................. $ 0.10 $ (0.73)
Diluted............................................... $ 0.09 $ (0.73)
</TABLE>
See Notes to Unaudited Pro Forma Condensed Consolidated Statements of Income and
Other Data
20
<PAGE> 22
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
STATEMENT OF INCOME AND OTHER DATA
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED MAY 3, 1998(1)
-------------------------------------
PRO FORMA
HISTORICAL ADJUSTMENTS PRO FORMA
---------- ----------- ---------
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE NUMBERS)
<S> <C> <C> <C>
INCOME DATA:
Sales..................................................... $238,869 $238,869
Cost of sales(2)(3) 178,542 178,542
-------- --------
Gross profit.............................................. 60,327 60,327
General and administrative expenses(4)(8)................. 37,866 37,866
-------- --------
Income from operations before interest and income taxes... 22,461 22,461
Interest expense, net..................................... 6,171 $ 16,039(5) 22,210
-------- -------- --------
Income from operations before income taxes................ 16,290 (16,039) 251
Income tax provision...................................... 7,420 6,416(6) 1,004
-------- -------- --------
Net Income (loss)...................................... $ 8,870 $ (9,623) $ (753)
======== ======== ========
OTHER DATA:
Gross margin.............................................. 25.3% 25.3%
Ratio of earnings to fixed charges(7)..................... 3.6x 1.0x
Weighted average number of shares
Basic.................................................. 7,932 2,387
Diluted................................................ 8,373 2,426
Basic and diluted earnings (loss) per share
Basic.................................................. $ 1.12 $ (0.32)
Diluted................................................ $ 1.06 $ (0.32)
</TABLE>
See Notes to Unaudited Pro Forma Condensed Consolidated Statements of Income and
Other Data
21
<PAGE> 23
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED STATEMENTS OF INCOME AND OTHER DATA
(DOLLARS IN THOUSANDS)
(1) It is estimated that the Company will incur non-recurring charges of
approximately $26,199 in the quarter in which the Recapitalization and the
Recapitalization Financing is consummated. These non-recurring charges
consist of a cash payment upon cancellation of stock options of
approximately $19,660, a non-cash charge of $1,750 for rollover of options,
certain change in control cash payments of approximately $1,000, other cash
fees of $1,860 and an estimated $1,929 non-cash write-off of unamortized
financing expenses related to its existing credit facilities. Because these
expenses are non-recurring, they have been excluded from the unaudited pro
forma consolidated statements of income.
(2) Includes advertising and promotional costs, costs of photographic sales and
store commissions and selling costs.
(3) Includes non-recurring expenses of $1,153 associated with the closure of
underperforming studios and redeployment of underutilized assets. See
"Business -- Recent Developments."
(4) Includes amortization of intangibles.
(5) Reflects the following adjustments to net interest expense:
<TABLE>
<CAPTION>
FISCAL YEAR QUARTER TWELVE MONTHS
ENDED ENDED ENDED
FEBRUARY 1, 1998 MAY 3, 1998 MAY 3, 1998
---------------- ----------- -------------
<S> <C> <C> <C>
NEW LONG-TERM DEBT INSTRUMENTS:
New revolving credit facility................ $ 706 $ 53 $ 706
New term loans............................... 9,821 2,426 9,821
Senior Subordinated Notes.................... 10,250 2,563 10,250
New commitment fees.......................... 80 28 80
Other interest and bank charges.............. 1,353 338 1,353
------- ------ -------
Total new interest expense..................... 22,210 5,408 22,210
Less net interest expense relating to the
existing credit facility..................... 6,571 1,220 6,171
------- ------ -------
TOTAL PRO FORMA ADJUSTMENT..................... $15,639 $4,188 $16,039
======= ====== =======
</TABLE>
(6) The adjustments reflect the tax effect of the pro forma adjustments at a 40%
effective tax rate.
(7) For purposes of computing this ratio, earnings consist of income from
operations before income taxes plus fixed charges. Fixed charges consist of
net interest expense and amortization of deferred financing costs.
(8) Includes non-recurring expenses of $618 associated with the
Recapitalization.
(9) On a pro forma basis, earnings would not be sufficient to cover fixed
charges by $2,751 for the quarter ended May 3, 1998.
22
<PAGE> 24
UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF MAY 3, 1998
--------------------------------------------------------
PRO FORMA
HISTORICAL PRO FORMA ADJUSTMENTS ---------
---------- ------------------------------------------
DEBITS CREDITS
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........... $ 11,073 $277,800(1)(2) $286,817(3) $ 2,056
Accounts receivable (net -- less
allowance of $1,488)............. 7,518 7,518
Inventories......................... 8,069 8,069
Deferred income taxes............... 4,788 8,544(4) 13,332
Prepaid expenses.................... 1,247 1,247
-------- -------- -------- ---------
Total current assets.................. 32,695 286,344 286,817 32,222
Property, net....................... 53,325 53,325
Intangible assets................... 59,241 59,241
Other assets........................ 1,655 7,840(5) 1,601(6) 7,894
-------- -------- -------- ---------
Total assets.......................... $146,916 $294,184 $288,418 $ 152,682
======== ======== ======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
Current liabilities:
Current portion of long-term debt... $ 8,750 $ 8,750(7) $ 4,500(1) $ 4,500
Accounts payable-trade.............. 23,798 23,798
Accrued insurance................... 3,824 3,824
Accrued income tax.................. 1,342 1,342(4) 0
Accrued compensation................ 4,792 4,792
Other accrued liabilities........... 9,858 9,858
-------- -------- -------- ---------
Total current liabilities............. 52,364 10,092 4,500 46,772
Long-term debt........................ 41,105 40,922(7)(8) 220,500(1) 220,683
Deferred income taxes................. 107 107
Other liabilities..................... 7,628 7,628
-------- -------- -------- ---------
Total liabilities..................... 101,204 51,014 225,000 275,190
Stockholders' equity (deficit)........ 45,712 1,929(6)(8) 52,800(2) (122,508)
200,169(9)
20,010(10)
1,538(11) 9,886(4)
7,260(12)
-------- -------- -------- ---------
Total liabilities and stockholders'
equity (deficit).................... $146,916 $281,920 $287,686 $ 152,682
======== ======== ======== =========
</TABLE>
See Notes to Unaudited Pro Forma Condensed Consolidated Balance Sheet
23
<PAGE> 25
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) Represents funds received from the issuance of new long-term indebtedness
totaling $225,000.
(2) Represents funds received from the issuance of 1,992,453 shares of Common
Stock to JAC at $26.50 per share, totalling $52,800.
(3) Pro forma credits to cash and cash equivalents include:
(i) An adjustment of $50,000 representing the repayment of the Company's
existing long-term debt instruments (including an original issue
discount of $328);
(ii) An adjustment of $200,169 representing the repurchase of 7,553,539
shares of Common Stock at $26.50 per share;
(iii) An adjustment of $20,010 for cash payments for cancellation of
1,381,600 stock options, including an estimate of payroll tax
liabilities. The rollover of options for 122,900 shares will be
expensed. The option value is determined by the difference between
$26.50 and the average exercise price of $12.27;
(iv) An adjustment of $1,538 for the exercise of 150,000 warrants with
an average exercise price of $16.25 and the repurchase of the
resulting 150,000 shares of Common Stock at $26.50 per share; and
(v) An adjustment of $15,100 for financing costs, professional fees
and other expenses incurred in connection with the
Recapitalization, including $7,840 for deferred financing costs
that will be amortized over the life of the related debt
instruments.
(4) The adjustments reflect the tax effect of the pro forma adjustments at a
40% effective tax rate.
(5) Represents financing costs that will be amortized over the life of the
related debt instruments.
(6) Represents the write-off of unamortized deferred financing costs relating
to the repayment of the Company's existing long-term debt instruments of
$1,601.
(7) Represents repayment of debt outstanding under the Company's existing
long-term debt instruments.
(8) Includes the original issue discount on the Company's existing long-term
debt instruments of $328.
(9) Represents the repurchase of 7,553,539 shares of Common Stock at $26.50 per
share.
(10) Represents cash payments for cancellation of 1,381,600 stock options,
including an estimate of payroll tax liabilities. The rollover of options
for 122,900 shares of Common Stock will be expensed. The option value is
determined by the difference between $26.50 and the average exercise price
of $12.27.
(11) Represents the exercise of 150,000 warrants with an average exercise price
of $16.25 and the repurchase of the resulting 150,000 shares of Common
Stock at $26.50 per share.
(12) Represents financing costs, professional fees and other expenses incurred
in connection with the Recapitalization that will not be amortized.
24
<PAGE> 26
SELECTED HISTORICAL CONSOLIDATED
FINANCIAL AND OPERATING DATA
The selected historical consolidated financial and operating data for and
as of each of the fiscal years in the five-year period ended February 1, 1998
set forth below under the captions "Statement of Operating Data," "Other Data"
and "Balance Sheet Data" have been derived from the audited Consolidated
Financial Statements of the Company. The selected historical financial
consolidated data set forth below for the quarters ended May 4, 1997 and May 3,
1998 have been derived from the unaudited Consolidated Financial Statements of
the Company. The information presented below is qualified in its entirety by,
and should be read in conjunction with "Capitalization," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements and the notes thereto included elsewhere
herein.
<TABLE>
<CAPTION>
FOR THE FISCAL YEAR ENDED APPROXIMATELY JANUARY 31, FOR THE QUARTER ENDED
-------------------------------------------------------- ----------------------
MAY 4, MAY 3,
1994 1995 1996 1997 1998 1997 1998
-------- -------- -------- -------- -------- --------- ---------
(DOLLARS IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATING DATA:
Sales............................. $149,150 $144,881 $144,715 $156,099 $242,899 $ 58,692 $ 54,662
Cost of sales(1).................. 120,353 114,092 107,611 119,107 181,966 45,001 41,577
-------- -------- -------- -------- -------- -------- --------
Gross profit...................... 28,797 30,789 37,104 36,992 60,933 13,691 13,085
General and administrative
expenses(2)..................... 20,594 22,936 23,782 31,676 38,070 10,632 10,428
-------- -------- -------- -------- -------- -------- --------
Income from operations before
interest and income taxes....... 8,203 7,853 13,322 5,316 22,863 3,059 2,657
Interest expense (income), net.... (5) 406 459 179 6,571 1,620 1,220
-------- -------- -------- -------- -------- -------- --------
Income from operations before
income taxes.................... 8,208 7,447 12,863 5,137 16,292 1,439 1,437
Income tax provision.............. 3,296 3,074 5,246 2,143 7,557 796 659
-------- -------- -------- -------- -------- -------- --------
Income from continuing
operations...................... 4,912 4,373 7,617 2,994 8,735 643 778
Loss (income) associated with
discontinued operations......... 2,200 (412) -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Net income........................ $ 2,712 $ 4,785 $ 7,617 $ 2,994 $ 8,735 $ 643 $ 778
======== ======== ======== ======== ======== ======== ========
Ratio of earnings to fixed
charges(3)...................... --(4) 19.3x 29.0x 29.7x 3.5x 1.9x 2.2x
OTHER DATA:
EBITDA(5)(6)...................... $ 13,362 $ 14,989 $ 21,812 $ 14,814 $ 38,316 $ 6,801 $ 6,405
EBITDA margin(6).................. 9.0% 10.3% 15.1% 9.5% 15.8% 11.6% 11.7%
Gross margin...................... 19.3% 21.3% 25.6% 23.7% 25.1% 23.3% 23.9%
Capital expenditures.............. $ 21,875 $ 14,698 $ 6,309 $ 13,424 $ 12,086 $ 3,363 $ 1,785
Depreciation...................... 5,159 7,136 8,490 9,498 13,543 3,286 3,241
Amortization...................... -- -- -- -- 1,910 456 507
BALANCE SHEET DATA AT PERIOD END:
Cash and cash equivalents......... $ 5,119 $ 312 $ 3,915 $ 1,536 $ 12,290 $ 3,735 $ 11,073
Working capital (deficit)......... (4,321) (6,697) (3,878) (18,472) (20,334) (20,200) (19,668)
Total assets...................... 56,751 59,557 59,884 146,661 153,301 151,308 146,916
Long-term debt.................... -- -- -- 58,680 42,064 63,228 41,105
Stockholders' equity.............. 30,296 33,032 31,235 33,641 44,689 35,161 45,712
OTHER OPERATING DATA:
Year-end number of permanent
studios
Domestic........................ 1,323 1,397 1,411 2,204 1,953 2,196 1,908
International................... 94 111 108 84 122 95 126
Other........................... -- -- 14 114 -- 114 --
</TABLE>
25
<PAGE> 27
NOTES TO SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA
(DOLLARS IN THOUSANDS)
(1) Includes advertising and promotional costs, costs of photographic sales and
store commissions and selling costs. Cost of sales February 1, 1998 includes
non-recurring expenses of $1,153 associated with the closure of
underperforming studios and redeployment of underutilized assets. See
"Business -- Recent Developments."
(2) Includes amortization of intangibles. General and administrative expenses
for the quarter ended May 3, 1998 include non-recurring expenses of $618
associated with the Recapitalization. General and administrative expenses
for the fiscal year ended February 2, 1997 include non-recurring expenses of
$6,000 associated with the closure of underperforming studios and
redeployment of underutilized assets. See "Business -- Recent Developments."
(3) For purposes of computing this ratio, earnings consist of income from
operations before income taxes plus fixed charges. Fixed charges consist of
net interest expense and amortization of deferred financing costs.
(4) For the fiscal year 1994, fixed charges were less than zero because of net
interest income of $5.
(5) EBITDA represents earnings before interest expense, income taxes,
depreciation and amortization. EBITDA is included because it is one measure
used by certain investors to determine a company's ability to service its
indebtedness. EBITDA is unaffected by the debt and equity structure of the
company. EBITDA does not represent cash flow from operations as defined by
GAAP, is not necessarily indicative of cash available to fund all cash flow
needs and should not be considered an alternative to net income under GAAP
for purposes of evaluating the Company's results of operations. EBITDA is
not necessarily comparable with similarly-titled measures for other
companies.
(6) EBITDA and EBITDA margin for the fiscal years ended February 2, 1997 and
February 1, 1998 and the three months ended May 3, 1998 reflect certain
non-recurring expenses:
<TABLE>
<CAPTION>
FISCAL YEAR FISCAL YEAR THREE MONTHS
ENDED ENDED ENDED
FEBRUARY 2, 1997 FEBRUARY 1, 1998 MAY 3, 1998
---------------- ---------------- ------------
<S> <C> <C> <C>
EBITDA.................................................... $14,814 $38,316 $6,405
Non-recurring expenses associated with the closure of
underperforming studios and the redeployment of
underutilized assets.................................... 6,000 1,153 --
Non-recurring expenses associated with the
Recapitalization........................................ -- -- 618
------- ------- ------
Adjusted EBITDA........................................... $20,814 $39,469 $7,023
======= ======= ======
Adjusted EBITDA margin.................................... 13.3% 16.2% 12.8%
</TABLE>
26
<PAGE> 28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the more
detailed information and the historical financial statements and pro forma
financial data included elsewhere herein. As used in this discussion and in
"Business," the terms "fiscal 1997," "fiscal year 1997" and "1997" refer to the
fiscal year ended February 1, 1998, the terms "fiscal 1996," "fiscal year 1996"
and "1996" refer to the fiscal year ended February 2, 1997, and the terms
"fiscal 1995," "fiscal year 1995" and "1995" refer to the fiscal year ended
January 28, 1996.
OVERVIEW
PCA is engaged, through its subsidiaries, in the sale and processing of
professional color portraits of children, adults, and families. The Company
operates 2,075 retail portrait studios in the United States, Canada, Mexico,
Puerto Rico, and South America. The Company also operates an extensive traveling
studio business, providing portrait photography services in approximately 1,400
additional retail locations and to church congregations and other institutions.
Portrait sales at discount stores accounted for 96.2% of sales in fiscal 1997.
As of February 1, 1998, the Company operated 1,953 permanent portrait studios in
the United States and 122 internationally.
On January 27, 1997, the Company acquired 94.9% of the outstanding common
stock of ASI, portrait provider to Wal-Mart in the United States and Mexico.
This acquisition expanded the number of Wal-Mart stores PCA serves to over
2,300, including 832 permanent studios in U.S. Wal-Mart stores previously served
by ASI and 18 permanent studios in other countries. At the end of fiscal 1996,
the Company operated 2,288 portrait studios in discount stores, which included
the 850 permanent studios acquired from ASI and 42 studios acquired through
other transactions. PCA's studio counts at the end of fiscal 1996 reflect the
combined companies for fiscal 1996, while financial results do not include the
results of ASI.
Following the January 1997 acquisition of ASI, the Company completed
several strategic initiatives intended to strengthen the Company's competitive
position and improve the profitability of its portrait studio operations, as
follows:
- Integration and consolidation of corporate administrative functions and
field operations yielding 1997 cost savings in excess of $6.0 million.
- Discontinuation of ASI's fashion photography and PCA's pilot pet
portraiture businesses and the closure of 401 portrait studios which were
not meeting the Company's profit objectives. Closed and discontinued
businesses represented $9.0 million of 1997 sales and $44.0 million of
pro forma Company sales in fiscal 1996.
- Redeployment of underutilized digital studio assets from these closed and
discontinued operations to certain Wal-Mart studios acquired from ASI. Of
the 850 Wal-Mart portrait studios acquired from ASI, the Company
converted approximately 600 non-digital studios to its proprietary
integrated digital system and upgraded approximately 250 ASI digital
studios.
- Expansion of the Company's customer base by opening 188 new studios
domestically and internationally.
- As a result of the conversion and upgrade of domestic Wal-Mart studios
and continued studio expansion during fiscal 1997, the Company increased
by 44% the number of digital portrait studios it operated in Wal-Marts
and Kmarts.
HISTORICAL BUSINESS REVIEW
In fiscal 1996, portrait studio sales in discount stores were 91.6% of
total sales. During the year, the Company diversified its retail partnerships
and expanded its distribution principally through the acquisition of Wal-Mart
portraiture businesses in Canada and the United States. In April 1996, the
Company acquired two Canadian Wal-Mart portraiture businesses, Portrait Works,
Inc. and Portrait Experience of Canada, Ltd.
27
<PAGE> 29
PCA's Canadian subsidiary entered into a long-term license agreement with
Wal-Mart's Canadian subsidiary to operate permanent studios in Wal-Mart's
Canadian stores.
In fiscal 1995, PCA operated 1,508 portrait studios principally in Kmart
stores in the United States, Canada and Mexico. Portrait studio sales in
discount stores accounted for 94.8% of 1995 total sales. The Company opened 164
permanent Kmart studios in 1995 and closed 73 studios, resulting in a net
addition of 91 studios.
Beginning with the fourth quarter of the fiscal year ended January 30, 1994
and continuing through fiscal 1996, the portrait services industry experienced
extremely competitive pricing and promotional conditions. The Company expects
competitive pricing conditions will be less aggressive than in the past and
continues to place emphasis on the quality and value-pricing of its portrait
products and services, and the enhanced portrait experience made possible
through its proprietary integrated digital imaging system.
Because of the retail nature of its services and its locations in discount
stores, the Company's business is very seasonal. The Christmas season accounts
for a high percentage of the Company's sales and earnings, and the Company's
fourth fiscal quarter (late October through late January) typically produces a
large percentage of annual sales and annual earnings. The fourth fiscal quarters
of 1997, 1996, and 1995 accounted for approximately 31.2%, 33.2%, and 32.2%,
respectively, of sales, and 89.4%, 32.8%, and 64.2%, respectively, of earnings
for those years. Fiscal 1997 fourth quarter earnings as a percentage of total
earnings were out of proportion compared to prior years due to significant costs
incurred for restructuring the Company's digital studio operations, which led to
operating losses in the first half of the year. The 1996 fourth quarter earnings
would have accounted for 69.5% of annual earnings before giving effect to a $3.6
million after-tax charge for studio closure costs. The Company's operations can
be adversely affected by inclement weather, especially during the important
fiscal fourth quarter.
OPERATIONS
First Quarter 1998 Compared with First Quarter 1997. Consolidated sales
for the first quarter 1998 were $54.7 million, a decrease of 6.9% compared to
sales of $58.7 million reported in the comparable fiscal 1997 quarter. The $4.0
million sales decline in the 1998 first quarter was due to discontinued and
closed operations in fiscal 1997. During the first half of fiscal 1997, the
Company discontinued its subsidiary's fashion photography business and PCA's
pilot pet portrait operations, and closed 401 underperforming discount store
portrait studios. These operations represented sales of approximately $8.0
million and a loss before corporate overhead of $0.3 million in the fiscal 1997
first quarter. Excluding sales from these discontinued or closed operations in
the fiscal 1997 first quarter, sales for PCA's 1998 first quarter increased $4.0
million or 7.8%, due principally to improved sales averages in Wal-Mart studios
which benefitted from the conversion to PCA's digital imaging technology.
Portrait studio sales through discount retailers represented $52.9 million or
96.7% of total sales for the fiscal 1998 first quarter. At May 3, 1998, the
Company operated 2,034 portrait studios in discount stores. During the quarter,
the Company opened 12 portrait studios and closed 53 studios, resulting in a net
reduction of 41 studios from the year-end studio count of 2,075.
Total costs and expenses as a percentage of sales increased to 95.1% in the
1998 first quarter from 94.8% in the first quarter of fiscal 1997. The 1998
quarter includes costs and expenses of $0.6 million or 1.1% of sales related to
the execution of the Recapitalization agreement with Jupiter. Advertising and
promotional expenses as a percentage of sales decreased to 6.2% for the fiscal
1998 first quarter from 7.4% in the fiscal 1997 first quarter, reflecting a less
promotional environment in the discount retail segment. Cost of photographic
sales decreased to 35.4% of sales from 37.1% of sales in the year-ago quarter
principally due to cost savings resulting from the completion of the ASI
integration and the conversion of 600 ASI studios in Wal-Mart to PCA's
integrated digital technology system which lowered production costs per
customer. Store commissions and selling expense as a percentage of sales
increased to 34.4% in the 1998 first quarter versus 32.2% in the 1997 first
quarter principally due to increased labor expense required to operate more
traveling studio promotions and staffing requirements for additional seven-day
studios. General and administrative expenses increased as a percentage of sales
to 18.1% compared to 17.3% of sales in the fiscal 1997 quarter due to the
incurrence of $0.6 million of Recapitalization costs.
28
<PAGE> 30
Net interest expense for the quarter ended May 3, 1998 was $1.2 million, or
2.3% of sales, as compared to $1.6 million, or 2.8% of sales, in the fiscal 1997
first quarter. The net interest expense on borrowings decreased as a result of a
lower level of debt. See "Liquidity and Capital Resources."
The income tax provision for the first quarter of 1998 was $0.7 million.
This resulted in an effective tax rate for the 1998 quarter of 45.9% compared to
55.3% in the first quarter of 1997. The decrease in effective tax rate for the
1998 period is attributable to using the projected effective annual tax rate as
compared to using the first quarter actual calculated rate in the same period in
the prior year.
Net income for the first quarter of fiscal 1998 increased 21.0% to $0.8
million or 1.4% of sales as compared to $0.6 million or 1.1% of sales in the
same quarter of the prior year. Diluted earnings per share for the 1998 first
quarter were $0.09 as compared to $0.08 diluted earnings per share in the fiscal
1997 quarter. Net income for the 1998 first quarter includes $0.4 million
tax-effected expense, or $0.04 per diluted share, for previously mentioned
expenses related to the execution of the Recapitalization agreement with
Jupiter.
1997 Fiscal Year Compared with 1996 Fiscal Year. Sales for fiscal year
1997 increased 55.6% to $242.9 million, compared to $156.1 million in fiscal
year 1996. Fiscal 1997 was a 52-week year versus 53 weeks in fiscal 1996. The
sales increase of $86.8 million in fiscal 1997 was attributable to the Company's
acquisition of ASI's Wal-Mart distribution channel, net of discontinued
businesses, and to a lesser degree, studio expansion and increased customer
purchase averages realized in each of the Company's retail channels. PCA's
financial results for fiscal 1996 do not include the operating results of ASI
while studio counts reflect the combined companies at the end of fiscal 1996.
Total operating costs and expenses as a percentage of sales declined 2.2
percentage points to 90.6% in fiscal 1997 compared to 92.8% in fiscal 1996,
before the 1996 fourth quarter pretax charge of $6.0 million to reflect the
closing of 401 underperforming portrait studios. Advertising and promotional
costs as a percentage of sales were 6.9% in 1997, versus 10.4% in 1996,
reflecting a less promotional environment in the discount retail segment. Costs
of photographic sales increased to 35.3% of sales in 1997, compared to 33.7% of
sales in 1996, principally due to higher labor costs to operate ASI's
non-digital studios for half the year and traveling studios for the full year.
Store commission and selling costs increased to 32.8% of sales in 1997, compared
to 32.3% the prior year. Increased labor expenses related to staffing
requirements to operate more seven-day studios in discount stores was a primary
factor for the rise in direct selling cost. General and administrative expenses
declined 1.5% to 14.9% of sales in fiscal 1997 compared to 16.4% (before the
$6.0 million 1996 fourth quarter pretax charge) of sales in fiscal 1996. This
decline is principally the result of cost savings from the consolidation of
field and corporate general and administrative functions.
Income from operations increased to $22.9 million or 9.4% of sales in
fiscal 1997 versus $11.3 million or 7.2% of sales in fiscal 1996 (stated before
the 1996 studio closure charge). This 102.0% increase in 1997 reflects one full
year of operations of ASI, as well as the elimination of underperforming
operations and improved performance of the Company's portrait studio operations.
Fiscal 1997 operating costs include $1.9 million for amortization of intangible
assets relating to the acquisition of ASI.
Pretax income increased to $16.3 million or 6.7% of sales in fiscal 1997
compared to $5.1 million or 3.3% of sales in the prior year. Fiscal 1996 pretax
income includes a $6.0 million charge for studio closure costs noted above.
Fiscal 1997 net interest expense was $6.6 million compared to $0.2 million in
1996, reflecting an increase in indebtedness related to the acquisition of ASI.
Income tax provision for 1997 was $7.6 million as compared to $2.1 million
in 1996. The fiscal 1997 tax provision as a percentage of pretax income was
46.4% versus 41.7% in 1996. The increase in the effective tax rate in 1997 was
due to amortization of intangibles related to the ASI acquisition, which are not
deductible for tax purposes. Net income in 1997 was $8.7 million or 3.6% of
sales compared to $3.0 million or 1.9% of sales in 1996. Fiscal 1997 earnings
per share on a diluted basis were $1.07 compared to $0.38 in fiscal 1996. Fiscal
1996 results include the previously mentioned studio closure charge, which
reduced net income by $3.6 million after tax or $0.46 per diluted share.
1996 Fiscal Year Compared with 1995 Fiscal Year. Sales for fiscal year
1996 increased 7.9% to $156.1 million, compared to $144.7 million in fiscal year
1995. The sales increase of $11.4 million in fiscal 1996 was
29
<PAGE> 31
attributable to the Company's diversification strategy (expansion of Wal-Mart
stores and the pilot pet portraiture program), which led to an increase in the
number of customers served. Fiscal 1996 was a 53-week year versus 52 weeks in
fiscal 1995. On a comparable 52-week basis, sales increased 6.5%.
In 1996, PCA diversified its retail partnerships; consequently, sales
through the retail distribution channel increased to reflect this strategy.
Sales through U.S. Kmart portrait studios were $135.1 million, or 86.5% of total
sales; and Wal-Mart portrait studio sales, both international and domestic, were
$6.6 million, or 4.2% of sales. PCA's Institutional Division and pet portrait
pilot program provided an aggregate of $13.3 million, or 8.5% of sales. In 1995,
U.S. Kmart studios provided sales of $130.6 million, or 90.2% of sales; and
PCA's pilot pet portrait and Institutional sales provided sales of $7.5 million,
or 5.2% of sales.
Total operating costs and expenses increased 10.2%, before the fourth
quarter charge of $6.0 million to close underperforming portrait studios, and
accounted for 92.8% of sales compared to 90.8% of sales in 1995. Advertising and
promotional costs as a percentage of sales were 10.4%, versus 10.2% in 1995.
Cost of photographic sales increased $4.9 million, or 10.3%, to 33.7% of sales
in 1996, compared to 32.9% of sales in 1995, due principally to the increase in
customers photographed. Store commission and selling costs increased to 32.3% of
sales, compared to 31.2% the prior year. Labor costs associated with the pilot
pet portrait program and staffing requirements to operate more seven-day studios
in discount store permanent studios caused the increase in direct selling cost.
General and administrative expense levels before the fourth quarter charge
were 16.4% of sales for 1996, similar to prior year's level. The Company
recorded a pretax charge of $6.0 million for the closing of 401 portrait studios
which were not meeting the Company's profitability objectives. This charge
includes the write-off of leasehold improvements and other fixed assets in these
stores, separation pay, cost to restore the studios to the same condition they
were in prior to the Company installing the portrait studio, and customer
refunds.
Income from operations, before the charge to close 401 portrait studios,
declined to 7.2% of sales from 9.2% of sales in 1995, a direct result of the
investment spending initiatives to pursue the Company's diversification
objectives. The costs associated with the pilot pet portrait expansion, the
Wal-Mart expansion, and overall costs to support the diversification activities
were the principal reasons for the operating margin decline.
Pretax income declined 60.1% to $5.1 million, compared to $12.9 million in
1995. This pretax figure includes the $6.0 million charge for studio closure
costs noted above. Net interest expense declined 60.9% due to repayment of
borrowings to fund the Company's repurchase of over $7.7 million of stock in
1995. Income tax provision for 1996 was $2.1 million as compared to $5.2 million
in 1995. The tax provision as a percentage of income was 41.7% versus 40.8% in
1995. The increase in effective tax rate was generally attributable to losses in
the pet portraiture pilot operation which did not generate state tax benefits.
Net income in 1996 was $3.0 million, or $0.38 per diluted share, including the
previously mentioned charge, which reduced per share earnings by $0.46, compared
to $7.6 million, or $0.96 per diluted share in 1995.
LIQUIDITY AND CAPITAL RESOURCES
Prior to the Recapitalization, the Company's principal sources of working
capital were cashflow from operations and borrowing under its revolving line of
credit. Generally, due to the seasonality of the Company's operations, cash is
consumed during the first fiscal quarter and generated during the remaining
fiscal quarters. Cash flow from operating activities was $29.5 million during
the 1997 fiscal year and $1.3 million for the quarter ended May 3, 1998. At
February 1, 1998, the Company had $12.3 million in cash and cash equivalents,
$4.3 million in letters of credit and $20.7 million available under its
revolving credit facility. At May 3, 1998, the Company had $11.1 million in cash
and cash equivalents and no short-term borrowings. Effective May 21, 1998, the
Company reduced the maximum balance of its revolving line of credit to $15.0
million from $25.0 million.
EBITDA was $38.3 million in fiscal 1997, up from $14.8 million in fiscal
1996. Excess cash flow enabled the Company to reduce long-term borrowings and
pay dividends. EBITDA for the quarter ended May 3, 1998
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was $7.0 million (before deducting costs associated with the Recapitalization)
up from $6.8 million the quarter ended May 4, 1997.
During fiscal 1997, the Company had property additions of $12.1 million,
principally for materials and equipment for the addition of new permanent
studios in Wal-Mart and Kmart, the upgrading of certain processing equipment in
the Company's two laboratory and processing facilities, and new computing
equipment in the corporate office. During the 1998 first quarter, the Company
had property additions of $1.8 million principally for materials and equipment
for the new permanent studios in the U.S. and Canada. For the fiscal year 1998,
the Company expects to spend approximately $11.0 million in capital
expenditures, including the opening of new permanent portrait studios, the
refurbishment of existing studios and the purchase of laboratory equipment.
At February 1, 1998 shareholders' equity was $44.7 million, an increase of
$11.0 million. For the 1997 fiscal year, net income added $8.7 million to
shareholders' equity, and dividends paid totaled $1.6 million. During fiscal
1997, exercised stock options contributed $4.2 million to shareholders' equity.
At May 3, 1998, shareholders' equity was $45.7 million. Net income for the 1998
first quarter added $0.8 million to shareholders' equity and dividends paid in
the quarter amounted to $0.6 million. Options exercised in the first quarter of
fiscal 1998 contributed $0.7 million to shareholders' equity.
The Recapitalization will have a substantial impact on the Company's
current capital structure. The recapitalized Company will be significantly more
highly leveraged and, accordingly, the Recapitalization will result in
substantial changes to the Company's debt-to-equity ratio and its related debt
service requirements.
The Company will also incur various non-recurring cash costs currently
estimated to be $35.1 million (as well as a non-recurring non-cash charge
currently estimated to be $1.9 million) in connection with the proposed
Recapitalization, and the exact timing, nature and amount of these costs are
subject to change. It is currently estimated that the Company will incur
non-recurring charges of approximately $26.2 million in the quarter in which the
Recapitalization is consummated. These non-recurring charges consist of a cash
payment upon cancellation of stock options of approximately $19.6 million, a
non-cash charge of $1.8 million for rollover of options, certain change in
control cash payments of approximately $1.0 million, other cash fees of $1.9
million and an estimated $1.9 million non-cash write-off of unamortized
financing expenses related to its existing credit facilities. The $19.6 million
stock option cancellation expense assumes that approximately 1,381,600 options
are canceled and approximately 122,900 options are rolled over by current option
holders. The unaudited pro forma consolidated balance sheet at May 3, 1998
reflects the above costs, net of a $9.9 million tax benefit. Because these
expenses are non-recurring, they have been excluded from the unaudited pro forma
consolidated statement of income for the year-ended February 2, 1998. In
addition, financing-related expenses of approximately $7.8 million will be
capitalized and amortized over the expected life of the Company's indebtedness.
It is estimated that the Company will incur additional non-recurring costs of
$4.4 million in the quarter in which the Recapitalization is consummated related
to the formation of JAC and other corporate matters. As a result of the
foregoing, the Company will incur a net loss in the quarter in which the
Recapitalization is recorded. Because this loss will result directly from the
non-recurring charges incurred in connection with the Recapitalization, the
Company does not expect this loss to materially impact its ongoing operations or
liquidity. See "Pro Forma Condensed Consolidated Financial Information."
Following the Recapitalization, the Company's principal sources of
liquidity will be cash flow from operations and borrowings under the Revolving
Credit Facility. The Company's principal uses of cash will be debt service
requirements, capital expenditures, research and development and working
capital. In connection with future acquisitions, the Company may require
additional funding which may be provided in the form of additional debt, equity
financing or a combination thereof. No future acquisitions are under discussion
at this time.
Concurrently with the consummation of the Recapitalization, the Company is
expected to borrow all $125.0 million under the Tranche A and Tranche B Term
Loan Facilities. As of May 3, 1998, on a pro forma adjusted basis giving effect
to the Recapitalization and the Recapitalization Transactions, approximately
$20.7 million would have been available for additional borrowing under the Bank
Facility, the Company having drawn $4.3 million in letters of credit. In
addition, the Company expects to incur $100.0 million of debt
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represented by the Notes. Each financing is subject to customary conditions,
including the negotiation, execution and delivery of definitive documentation
with respect to such financing.
Borrowings under the Bank Facility will bear interest at a rate per annum
equal to a margin over, at the Company's option, LIBOR or a Base Rate. The
Revolving Credit Facility will mature five years after the closing date. The
Tranche A Term Loan Facility and the Tranche B Term Loan Facility will be
amortized over five and seven years, respectively. The Bank Facility will be
secured by substantially all of the assets of the Company and its direct and
indirect domestic subsidiaries, subject to certain limitations with respect to
foreign subsidiaries, and contains customary covenants and events of default,
including substantial restrictions on the Company's ability to declare dividends
or distributions. In addition, the Bank Facility will be guaranteed by such
subsidiaries. The Bank Facility will be subject to mandatory prepayment with the
proceeds of certain asset sales, certain equity issuances and certain funded
debt issuances for borrowed money, and with a portion of the Company's Excess
Cash Flow (as defined in the Bank Facility). See "Description of Bank Facility."
The proceeds of the Notes, the Bank Facility and the equity contribution by
Jupiter and management will be used to finance the payment of the cash portion
of the Recapitalization consideration, to refinance the outstanding indebtedness
of the Company, to pay fees and expenses incurred in connection with the
Recapitalization and to provide for working capital and general corporate
purposes of the Company.
The Company's ability to make scheduled payments of principal of, or to pay
the interest or Liquidated Damages, if any, on, or to refinance, its
indebtedness (including the Notes), or to fund planned capital expenditures and
research and development expense will depend on its future performance, which,
to a certain extent, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond its control. Based
upon the current level of operations, management believes that cash flow from
operations and available cash, together with available borrowings under the Bank
Facility, will be adequate to meet the Company's future liquidity needs for at
least the next several years. The Company may, however, need to refinance all or
a portion of the principal of the Notes on or prior to maturity. There can be no
assurance that the Company's business will generate sufficient cash flow from
operations or that future borrowings will be available under the Bank Facility
in an amount sufficient to enable the Company to service its indebtedness,
including the Notes, or to fund its other liquidity needs. In addition, there
can be no assurance that the Company will be able to effect any such refinancing
on commercially reasonable terms or at all. See "Risk Factors -- Leverage."
YEAR 2000 ISSUES
During 1997, the Company upgraded its mainframe computer hardware to a
version that is designed to be year 2000 compliant and vendor-supported into the
new millennium. The Company has initiated plans to correct programming code in
existing computer software applications as the year 2000 approaches. The Company
will utilize both internal and external resources to reprogram Company-developed
applications, install up-to-date releases of purchased systems, and test all
systems for year 2000 compliance. The Company continues to evaluate its various
systems to determine the most cost-effective corrective action which could
include replacement of certain systems. The Company currently believes that
reprogramming will be completed by the first quarter of 1999. The cost to
correct year 2000 program code is expected to be $0.8 to $1.2 million and will
be expensed over the next two years.
INFLATION
Over the past few years, inflation has not had a significant impact on the
Company's financial condition or results of operations.
COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
Reporting Comprehensive Income. SFAS No. 130 requires the reporting of
comprehensive income in financial statements by all entities that provide a full
set of financial statements. The Statement is effective for fiscal years
beginning after
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December 15, 1997. Management of the Company does not expect that the adoption
of SFAS No. 130 will have a material impact on the Company's financial position
or results of operation.
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information. SFAS No.
131 requires disclosures of and provides accounting guidance for reporting
information about operating segments in annual financial statements. The
Statement is effective for fiscal years beginning after December 15, 1997. The
Company has not yet determined how the Statement will affect its reporting of
financial information.
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BUSINESS
OVERVIEW
PCA is the largest professional portrait photography company in the North
American discount department store sector based on revenue, number of customers,
and studio locations. The Company focuses on the pre-school segment of the $5.6
billion domestic professional portrait photography market, selling its products
and services through two premier distribution channels: Kmart and Wal-Mart. PCA
ranks among the top three professional portrait photography companies in North
America, with a market share of over 20% of the $1.1 billion domestic pre-school
portrait market segment. As of May 3, 1998, the Company operated 2,034 portrait
studios within Kmart and Wal-Mart stores and supercenters in the United States,
Canada, Mexico, Puerto Rico and South America. PCA also operates an extensive
traveling studio business, providing portrait photography services in
approximately 1,400 additional Wal-Mart retail locations as well as to church
congregations and other institutions. During fiscal 1997, PCA generated revenue
and EBITDA of $242.9 million and $38.3 million, respectively.
The Company's in-house technology and manufacturing group has designed,
developed and manufactured the industry's only proprietary integrated digital
imaging system. The Company's system automates and links the photography and
image selection process with the immediate sale of custom portrait packages and
integrates its studios with its portrait processing and production systems. This
proprietary system has three principal advantages over the vendor-supplied
systems of its competitors who use digital technology. First, PCA's proprietary
system was designed from its inception to integrate package selection, order
creation, film processing, editing, printing and order fulfillment as seamlessly
as possible, increasing efficiency and synergies among the various system
components. Second, the system design enables PCA to incorporate "off-the-shelf"
components (such as in-studio computers, video cameras and laser printers), all
of which can be purchased from more than one source, modified (if necessary) and
integrated into the system. The ability to purchase from more than one source
reduces the Company's capital expenditure requirements and resulting
depreciation because it allows the Company to "mix and match," using the
components that can be purchased most cost-effectively, rather than having to
purchase the components selected and priced by a vendor of digital imaging
systems. Third, the proprietary integrated digital system can be expanded,
modified and upgraded on a world-wide basis by PCA's own technology and
manufacturing group, allowing PCA to avoid depending on the availability or
willingness of an outside vendor to develop software upgrades or to perform
installations and modifications, thus maximizing flexibility and minimizing
system support costs and associated down-time.
The integrated digital imaging system also has two primary advantages over
non-digital portrait photography operations: increased average sales per
customer and lower production costs. Higher average sales per customer result
from the digital studios' superior portrait photography experience coupled with
a more effective, customer-friendly selling process. Lower production costs
result from printing only the poses and sizes that the customer orders, avoiding
the waste of labor and materials from printing large quantities of speculative
portraits in an attempt to predict the customer's purchase decision.
The Company strengthened its position in the discount department store
sector with the January 27, 1997 acquisition of ASI, the primary operator of
professional portrait photography studios in Wal-Mart stores in the United
States and Mexico. This acquisition increased by 2,300 the number of Wal-Mart
locations serviced by the Company through a combination of permanent and
traveling studios. During 1997, the Company redeployed its industry-leading, but
underutilized digital imaging assets from underperforming locations to Wal-Mart
locations acquired from ASI. As of July 31, 1997, the Company had converted all
domestic Wal-Mart permanent portrait studios to its integrated digital imaging
technology. In August 1997, with the acquisition from Wal-Mart of 72 studios
previously operated internally by Wal-Mart, PCA became Wal-Mart's world-wide
provider of professional portrait photography services.
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COMPETITIVE STRENGTHS
The Company believes its competitive position is strengthened by the
following factors:
- - - - - Leading Market Position in Pre-School Portrait Segment. The Company, with a
market share of over 20%, is one of the largest participants in the $1.1
billion pre-school portrait market segment of the $5.6 billion domestic
professional portrait photography market. Within the pre-school segment, the
Company, through a combination of permanent and traveling studios, services
approximately 3,400 domestic retail locations, which is more than the total
number of locations serviced by its three largest competitors combined.
- - - - - Strong Relationships with Leading Discount Retailers. The Company has built
strong, long-term relationships with the two largest discount department store
chains in North America -- Wal-Mart and Kmart. The Company's Kmart and
Wal-Mart relationships span 32 and 15 years, respectively. The Company
currently services approximately 3,400 discount retail locations in North
America, with approximately 900 permanent portrait studios in Kmart stores and
approximately 1,100 permanent portrait studios in Wal-Mart stores. The
Company's permanent studios account for approximately 95% of the permanent
portrait studios in North American discount department stores. The Company's
remaining approximately 1,400 U.S. Wal-Mart locations are serviced by
traveling studios, which average approximately six visits per store per year.
According to Wal-Mart's and Kmart's annual reports and the Department of
Commerce, between 1990 and 1997, Wal-Mart's and Kmart's combined revenues
increased at a CAGR of 13%, compared to 10% for the U.S. discount department
store sector and 5% for the entire U.S. retail sector over the same period.
Management's goal in building strong relationships with these leading
retailers is to position the Company to participate in their future growth
both domestically and internationally.
- - - - - Cost-Effective Production Process. The Company believes that it has one of
the lowest-cost portrait production systems in the industry. This position is
primarily the result of: (i) lower capital expenditures and depreciation as a
consequence of lower component and installation costs associated with the
Company's proprietary integrated digital imaging system; (ii) the efficiency
of the integrated system, which streamlines and automates the production
process, resulting in higher volume, higher speed, lower labor costs, lower
waste and fewer reprints; (iii) flexibility and easier expansion and
maintenance associated with its proprietary integrated digital system as
compared to competitors' vendor-developed digital systems; and (iv) a
marketing focus on selling larger portrait collections based on more poses,
lowering the average production cost per unit.
- - - - - Proprietary Technology. PCA is the only company in the professional portrait
photography industry that has developed a proprietary integrated digital
imaging system (including photographic cameras, sales software and production
equipment) that integrates and automates the portrait photography process from
studio sitting through production and order fulfillment. The principal
advantages of the proprietary integrated digital imaging system are: (i)
seamless integration of critical production processes, (ii) ability to use
lower-cost, "off-the-shelf" components and (iii) independence from outside
vendors for system support, expansion and upgrades. The technology and
manufacturing group continually evaluates the return on investment from
implementing technological advances in order to remain a leader in the
commercially viable application of emerging imaging technologies.
- - - - - Flexible Sales and Manufacturing System. PCA provides the customer with the
flexibility to create a "best value" portrait collection by choosing specific
poses, portrait sizes and quantities from a computer-assisted sales program
which displays digital images of the poses and price information that is
updated as a customer alters his or her selections. This interactive order
capability allows the customer to create a custom portrait package while
minimizing paperwork for the sales associate. In addition, the proprietary
integrated digital system is extremely flexible, allowing for easier upgrades
to sales software and PCA-developed production equipment without relying on
outside software vendors.
- - - - - Experienced Management Team. The Company's senior management team, with over
90 years of combined experience in the professional portrait photography
industry, had the foresight to invest in PCA's proprietary integrated digital
imaging system which has positioned PCA as a leader in the industry. Since
arriving in 1987, John Grosso, PCA's President and Chief Executive Officer,
has successfully directed
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PCA's expansion in the growing discount department store channel through the
acquisition of ASI, establishing the Company in its current position with
Wal-Mart and Kmart, the two largest retail chains in the growing discount
retail sector. Eric H. Jeltrup, Executive Vice President and Chief Technology
Officer, together with the technology and manufacturing group, were
responsible for developing PCA's proprietary integrated digital imaging
system, which was first used in Kmart, and spearheading the digital conversion
at the acquired Wal-Mart portrait studios.
BUSINESS STRATEGY
Management's business strategy is to capitalize on the Company's strengths
by implementing the following initiatives:
- Complete Integration of ASI. Following the acquisition of ASI, PCA
converted all of the approximately 600 Wal-Mart studios, which did not
utilize digital technology, to the PCA integrated digital imaging system.
PCA is continuing the training of Wal-Mart studio-level personnel on the
use of the PCA integrated digital system and effective sales techniques.
PCA's integrated digital system has aided the studio-level employee in
increasing average order size per customer. Since acquiring ASI on
January 27, 1997, PCA has increased average revenue per customer by over
$15 in the acquired Wal-Mart locations. This figure, however, still
trails the Company's Kmart location averages by approximately $5 per
customer, representing additional opportunities for improvement.
Management will continue to focus on improving per customer revenues in
both Wal-Mart and Kmart locations. Additionally, PCA is continuing with
an extensive studio renovation and refurbishment plan in its Wal-Mart
locations to improve studio layout and the customer studio reception
area.
- Maintain a Disciplined Studio Growth Initiative. The Company intends to
expand its permanent studio portfolio by (i) placing studios in higher
volume domestic Wal-Mart and Kmart locations (during the 1998 fiscal
year, PCA plans to open approximately 70 net new studios); (ii) targeting
locations served by existing high volume non-digital traveling studios
for transition to a permanent integrated digital studio format (PCA has
proposed approximately 270 Wal-Mart locations for this transition); (iii)
opening new studios as Wal-Mart expands internationally (during the 1998
fiscal year PCA plans to open 25 new international studios); and (iv)
expanding strategically into new distribution channels on an
opportunistic basis.
- Exploit Sales and Marketing Opportunities. The Company has implemented
several initiatives in order to improve in-store awareness at Kmart and
Wal-Mart studios and to generate repeat business, including: (i) using
the Company's proprietary customer database for occasion-related portrait
events and other promotions to generate repeat business; (ii) providing
more comfortable and child-friendly studios; (iii) launching
cross-promotional campaigns with companies such as McDonald's
Corporation, Walt Disney Co., Nabisco, Inc., SmithKline Beecham Consumer
Healthcare L.P. and Kimberly Clark Corporation; and (iv) developing
in-store merchandising programs with child-oriented departments.
- Build Strategic Alliances and Enhance Customer Value. PCA is working
with major software vendors in an effort to provide customers with the
ability to manipulate the digital photographic images captured at a PCA
digital studio. With numerous professionally-designed templates to choose
from, this software would allow PCA customers to create customized screen
savers, calendars, family trees, holiday and birthday cards and other
computer-enhanced products.
TECHNOLOGY
Management has found that its integrated digital imaging system has been an
invaluable competitive advantage in each channel it has entered. In order to
appreciate the strengths of PCA's integrated digital imaging operations, it is
important to distinguish PCA's operations from non-digital portrait photography
operations.
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Non-digital Portrait Photography Operations. Traditionally, customers were
attracted to permanent and traveling studios through advance advertising of a
specially-priced promotional offer of an assortment of color portraits. In
addition to such specially-priced offers, additional assortments of color
portraits were made available at regular prices. Most of the profits were
generated from the sale of these regularly-priced portraits. During the portrait
session, the photographer took several exposures of the subject varying the pose
and background. Upon completion of the photography session, customers paid
appropriate sitting fees and returned three weeks later to view, for the first
time, finished portraits. Following a photography session, film was sent to a
portrait processing facility where it was developed, edited and processed.
During the editing process, company personnel viewed all frames from a
customer's session and selected the sizes and quantities of portraits to be
processed for each pose. This "speculation" production method involved printing
a large quantity of finished portraits in advance of the customer making a
purchase decision. The portrait packages, consisting of the specially-priced
promotional offer and additional assortments determined by company personnel,
were returned to the host store for viewing and purchase by the customers; any
portraits not purchased were discarded as waste. The customer did not have the
luxury of ordering additional portraits of their favorite poses therefore
limiting the company's average sale potential to the amount of product produced.
Since fully implementing its integrated digital imaging system in 1994, this
"speculation" process no longer exists in PCA's domestic permanent studios.
PCA's Integrated Digital Imaging System. The integrated digital imaging
system, installed in all of PCA's domestic permanent studios, has resulted in
two primary advantages over non-digital portrait photography operations:
increased average sales per customer and lower production costs. Higher average
sales per customer are due to the digital studios offering a superior portrait
photography experience coupled with a more effective, customer-friendly selling
process. During the digital portrait photography session, customers preview and
approve each photographic image on a color monitor thereby "buying into" the
quality of each pose and expression. Following photography and during the same
session, only selected and approved poses are transmitted to a digital sales
system with proprietary software designed to step customers through the sales
process. The integrated digital sales system enables customers to view all poses
and customize a portrait collection. Customers choose the exact poses to be
produced in the specific portrait sizes and quantities desired which has led to
higher customer satisfaction and higher sales averages. Furthermore, the
integrated digital sales system has strengthened the Company's field
organization by guiding a consistent sales approach.
Beginning in the second half of 1994, PCA began to realize production cost
savings (paper, chemicals, etc.) because portraits were printed based on
specific customer orders, rather than on speculation, thus eliminating the cost
associated with unsold portraits. After PCA's acquisition of ASI on January 27,
1997, PCA began the process of integrating ASI's operations, converting
approximately 600 of ASI's permanent non-digital studios to PCA's integrated
digital system and making modifications to approximately 250 of ASI's permanent
digital studios and processing center (which, unlike PCA's digital studios and
processing center, did not use an integrated system). By July 1997, all of the
former domestic ASI permanent locations had been upgraded to PCA's integrated
digital imaging technology. Management believes that the conversion of ASI's
studios has been largely responsible for the $15 increase in revenue per
customer at the former ASI locations since January 27, 1997. The conversion of
ASI's permanent locations is now complete, but the Company is also proposing to
convert approximately 270 additional Wal-Mart locations that are currently
served by traveling studios (which use non-digital technology) to permanent
integrated digital studios.
PCA's Integrated Digital System Compared to Competitors' Digital
Systems. The Company's in-house technology and manufacturing group has
designed, developed and manufactured the industry's only proprietary integrated
digital imaging system. The Company's system automates and links the photography
and image selection process with the immediate sale of custom portrait packages
and integrates its studios with its portrait processing and production systems.
This proprietary system has three principal advantages over the vendor-supplied
systems of its competitors who use digital technology. First, PCA's proprietary
system was designed from its inception to integrate package selection, order
creation, film processing, editing, printing and order fulfillment as seamlessly
as possible, increasing efficiency and synergies among the various system
components. Second, the system design enables PCA to incorporate "off-the-shelf"
components (such as in-studio computers, video cameras and laser printers), all
of which can be purchased from more than one
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source, modified (if necessary) and integrated into the system. The ability to
purchase from more than one source reduces the Company's capital expenditure
requirements and resulting depreciation because it allows the Company to "mix
and match," using the components that can be purchased most cost-effectively,
rather than having to purchase the components selected and priced by a vendor of
digital imaging systems. Third, the proprietary integrated digital system can be
expanded, modified and upgraded on a world-wide basis by PCA's own technology
and manufacturing group, allowing PCA to avoid depending on the availability or
willingness of an outside vendor to develop software upgrades or to perform
installations and modifications, thus maximizing flexibility and minimizing
system support costs and associated down-time.
THE STUDIO EXPERIENCE
Overview. In the digital studio, a computerized video camera, mounted on
the stationary portrait camera, captures images of the live subject being
photographed for review on a color monitor. When a photograph is taken, the
image is frozen on the screen. Should a pose be unsatisfactory to the customer
(as is often the case with pre-school children) the photograph is re-taken.
Beyond the pose for the advertised portrait collection, up to six additional
poses are taken for the optional portrait collection. When the photography
session ends, the sales presentation begins. The digital photographic images are
sent to another computer in an adjacent room. There, the
photographer/salesperson presents the photographic images on the sales computer
screen and, prompted by a sales program designed by PCA's research and
development staff, explains the portrait packages available. The customer
chooses the poses, the sizes and quantities, as the package price is
re-calculated and appears on the screen when each choice is made. The receipt is
a laser print-out of the order, with the poses displayed. The customer either
pays in full or makes a deposit and returns in two to three weeks to pick up the
finished portraits. This is in sharp contrast to the non-digital system, under
which the customer returns two to three weeks later to see the portraits for the
first time with only limited selections of product to purchase.
Permanent Studios. The typical permanent studio occupies 250 square feet
and consists of a camera room, a portrait viewing and sales area, and a
reception area with point-of-sale computer. Generally, the permanent studio is
staffed by one to three employees who perform both the photography and sales
functions. Except for extended hours during certain holiday seasons, the
majority of PCA's portrait studios are open from 10:00 a.m. to 7:00 p.m. either
five or seven days a week.
Traveling Studios. Non-digital traveling studios operate in designated
Wal-Mart stores at regularly scheduled intervals throughout the year. A
traveling studio is operated for a period of approximately five days every seven
to ten weeks in a host Wal-Mart store designated for traveling studio
operations. The Company begins a traveling studio promotion by advertising a
promotional offer of an assortment of color portraits at a special price several
days prior to the scheduled arrival of the photographer at a host store. The
traveling studio occupies approximately 100 square feet and consists of a table,
camera, lights, and portable backdrops. Approximately three weeks after the
photographs are taken, a sales associate sets up a temporary sales area in the
host store and for one to five days assists the customers in selecting portraits
for purchase. In traveling studios servicing Wal-Mart locations, customer volume
per day is typically higher while purchase averages are generally lower than in
permanent studios because of the non-digital technology used in traveling
studios. During fiscal year 1997, PCA's Wal-Mart traveling studios serviced an
average of 161 locations per week (a "promotion").
PCA photographs a greater number of customers per location at permanent
studios than through traveling studios since permanent studios are operated five
to seven days per week, 52 weeks per year, while traveling studios typically
service a store for only five days for a limited number of weeks per year.
Additionally, since traveling studios do not employ the Company's integrated
digital technology, the average customer purchase in a permanent studio is
significantly higher than the average purchase in a traveling studio.
38
<PAGE> 40
MARKET OVERVIEW
The Company operates within the professional portrait photography industry,
specializing in pre-school children's portraits offered through permanent and
traveling studios and adult and family portraits provided through traveling
studios in churches and other institutions.
According to the Photofinishing News 1997 Report, as of the end of 1996,
the domestic professional portrait photography market was estimated to be $5.6
billion, and the domestic pre-school segment represented 20% ($1.1 billion) of
this market. The primary segments within the professional portrait photography
market are newborn infants, pre-school children, school age children, adults,
passport, and groups of all sorts including family, church and business.
The following chart summarizes, as of the end of 1996, the major segments
(greater than 5%) that comprised the $5.6 billion domestic professional portrait
photography market:
DOMESTIC PROFESSIONAL PORTRAIT PHOTOGRAPHY MARKET
(DOLLARS IN MILLIONS)
['PIE CHART']
- - - - ---------------
Source: Photofinishing News 1997 Report
PCA is one of the largest participants in the pre-school market segment
(children under six years old). According to the National Center for Health
Statistics, births are projected to remain above 3.9 million annually until the
year 2000 (the end of the projected period) supporting a stable market over the
next several years. Moreover, the population of grandparents, the most common
recipients of photos, is growing as Americans live longer.
DISTRIBUTION CHANNELS
Recent Trends & Opportunities. Management believes that the following
recent trends and opportunities within the Company's distribution channels are
important factors in its future prospects:
- Discount Retail Host Growth. PCA benefits from the high growth rates of
its retail hosts, Wal-Mart and Kmart, versus the host stores of its
competitors. According to Wal-Mart and Kmart's annual reports and the
Department of Commerce, between 1990 and 1997, Wal-Mart and Kmart's
combined revenues increased at a CAGR of 13%, exceeding the CAGRs of 10%
for the U.S. discount retail sector and 5% for the entire U.S. retail
sector over the same period.
- Host Retailer Penetration. While permanent studio revenues in the
discount retail channel (which PCA dominates through its hosts, Kmart and
Wal-Mart) have grown rapidly since 1990, management believes that the
Company is underpenetrated relative to its competitors. Because the
discount retail channel is the largest and fastest-growing in the retail
industry, PCA management views the
39
<PAGE> 41
Company's relatively low penetration as a substantial growth opportunity.
To this end, PCA management has implemented a growth strategy to continue
increasing its penetration in two ways: (i) grow same-studio sales by
continuing to increase the average revenues per customer through
increased employee sales training and in-store advertising; and (ii)
continue to penetrate Wal-Mart locations (the proportion of locations
served by a PCA permanent studio) by opening additional permanent studios
in existing domestic stores currently served by PCA traveling studios and
in both domestic and international newly-built stores.
U.S. Discount Retail Channel Operations -- Wal-Mart and Kmart. The Company
operates portrait studios in discount stores in all 50 states, principally
servicing the pre-school portrait market. PCA's portrait studio operations
contributed 92.0% of the Company's sales in fiscal year 1997, 87.2% in 1996, and
90.2% in 1995. At the end of fiscal 1997, the Company operated 1,953 permanent
portrait studios in the United States. The Company seeks to maintain an
advertising presence throughout the year in all geographic markets where the
Company operates permanent studios by advertising under the name of its retail
partners. Customers are attracted to the studio through a variety of advertising
methods including in-store point-of-sale merchandising, television and newspaper
advertising, and direct mail to current and prospective customers.
In fiscal 1997, PCA became the nationwide portrait studio operator for
Wal-Mart, building on a 15-year partnership established by ASI. As of May 3,
1998, the Company operated approximately 1,000 permanent studios in U.S.
Wal-Mart stores and supercenters. The Company also services approximately 1,400
Wal-Mart stores in the United States approximately six times a year with
non-digital traveling studios. The Company currently plans to open approximately
70 net new permanent studios domestically in 1998. The Company assumed ASI's
license agreement with Wal-Mart when it acquired ASI on January 27, 1997. The
license agreement with Wal-Mart may be terminated by either party at any time.
Between January 26, 1997 and the end of the 1997 fiscal year, the Company
acquired ASI (adding 832 U.S. permanent studios in Wal-Mart stores), opened 150
new U.S. permanent studios and closed 401 underperforming permanent studios,
resulting in a net increase of 581 U.S. permanent studios. (As described more
fully in "Management's Discussion and Analysis of Financial Conditions and
Results of Operations," PCA's fiscal 1996 financial results do not reflect the
operating results of ASI; however, studio counts at the end of 1996 do reflect
the combined companies.) The Company also discontinued ASI's fashion photography
services in Wal-Mart as well as PCA's pilot pet portraiture program in PETsMART.
The Company utilized the assets from the discontinued services, including
digital photography equipment, to upgrade former ASI Wal-Mart non-digital
studios to PCA's integrated digital system and to upgrade certain existing Kmart
locations.
The Company has maintained a continuous business relationship with Kmart
since 1967. The Company is party to a license agreement with Kmart that allows
the Company to operate its permanent studios in U.S. Kmart stores under the
Kmart name in exchange for a commission from the Company based on a percentage
of sales from the permanent studio in each store. The license agreement expires
May 9, 2001, and may be terminated by either party at any time before May 9,
2001 upon 180-days' notice.
In the fiscal year ended February 1, 1998, the Company eliminated certain
underperforming businesses to concentrate on its portrait studio operations. The
Company discontinued ASI's fashion photography services in Wal-Mart as well as
PCA's pilot pet portraiture program in PETsMART. PCA also closed 401
underperforming portrait studios in Kmart stores. The Company utilized the
assets from these discontinued services and closed locations, including digital
photography equipment, to upgrade former ASI Wal-Mart non-digital studios to
PCA's integrated digital system and to upgrade certain existing Kmart locations.
In the ordinary course of business, the Company continues to evaluate its asset
utilization on a store-by-store basis and may open new studios or close
underperforming studios.
In April 1998, Kmart notified the Company that it would close 75 studios in
which PCA is currently operating and would allow alternative portrait studio
operators to service such locations. While Kmart has stated to management that
it plans no further terminations in 1998, there can be no assurance that Kmart
will not close additional PCA studio locations in the future or that it will
retain PCA as its primary supplier of portrait photography services
indefinitely. Under the terms of the licensing agreement between Kmart and
40
<PAGE> 42
PCA, PCA is required to exit these 75 studios within six months of notification,
or around November 1, 1998. Kmart will also pay PCA a termination fee of
approximately $500,000, representing PCA's unamortized investment in leasehold
improvements made in these specific 75 studios. These 75 studios generated
approximately $8.0 million in sales (approximately 8.2% of total sales in PCA
Kmart studios) and approximately $1.7 million in income from operations before
interest and taxes in fiscal 1997.
The loss of the license to do business in U.S. Kmart stores or U.S.
Wal-Mart stores, or the closing of a significant number of U.S. Kmart studios or
U.S. Wal-Mart studios, without replacement, could have a material adverse effect
on the Company. See "Risk Factors -- Risk of Loss of Kmart and Wal-Mart
Licenses."
U.S. Institutional Portrait Operations. The Company's institutional
operations accounted for 3.1%, 4.7%, and 4.6% of sales in fiscal years 1997,
1996, and 1995, respectively. The Company contracts with institutions, primarily
church congregations, to photograph and sell individual and family group
portraits of congregation members. The Company does not pay commissions to the
hosting institutions, but provides a free photo directory to all members who
agree to be photographed. Approximately three weeks after the photography
session, the finished portraits are sent to the church or directly to the
consumer. During fiscal 1997, the Company operated approximately 31 portable
camera units on average each week for institutional promotions. The Company does
not expect the number of portable units in service to change significantly
during 1998.
International Portrait Operations. At the end of fiscal year 1997, the
Company operated 122 portrait studios internationally in Wal-Mart stores, with
94 permanent studios in Canada, 26 in Mexico and two in Argentina. The Company's
international studios contributed 4.3%, 4.4%, and 4.5% of sales for fiscal 1997,
1996, and 1995, respectively. International expansion added 38 new studios in
1997. Fiscal 1998 studio expansion plans include up to 25 new studios
internationally.
On February 9, 1996, the Company's Canadian subsidiary entered into a
license agreement with Wal-Mart Canada, Inc. to operate portrait studios in
Wal-Mart's stores in Canada. The license agreement expires on a store-by-store
basis five years after a store opens and may be terminated by either party, on a
store-by-store basis, if certain minimum sales results are not achieved.
Over the last fiscal year, Wal-Mart has committed significant resources to
acquiring and building discount stores outside the United States, including
Cifra, S.A. a 400-store Mexican retail chain and Wertkauf, a 21-store German
retailer.
COMPETITION
The professional portrait photography industry, including both permanent
and traveling studios, is highly competitive and fragmented. The companies in
the industry compete on the basis of price, service, package size and
technology. In addition, for companies (such as the Company, CPI and Lifetouch)
located within retail hosts, the relative convenience of each company's retail
host and consumer preferences for such retail hosts are important competitive
factors. The major professional portrait studio companies, including CPI,
Lifetouch and Olan Mills, operate permanent studios in retail chains and
stand-alone locations. There are three primary channels in which companies
compete: discount department stores, department stores, and stand-alone
locations. The Company dominates the discount department store channel, with
studios in both Wal-Mart and Kmart. PCA competes directly with the department
store segment for customer sittings including CPI at Sears and Lifetouch at JC
Penney. The independent channel (i.e., Olan Mills) targets the higher end of the
market, including families. In addition, there are many unaffiliated
competitors.
41
<PAGE> 43
The following table summarizes the major industry players and their
respective distribution channels:
<TABLE>
<CAPTION>
PERM. SALES(2)
COMPANY CHANNEL SITTINGS(1) STUDIOS(2) ($ MM)
- - - - ------- ---------------- ----------- ---------- --------
<S> <C> <C> <C> <C>
PCA(3)................................. Kmart/Wal-Mart 4.6 million 2,075 $234
CPI.................................... Sears 5.4 million 1,026 $304
Lifetouch(4)........................... JC Penney/Target 2.9 million 560 $150
Olan Mills(5).......................... Independent 7.0 million 1,005 $380
</TABLE>
- - - - ---------------
Sources: PCA, latest available CPI Annual Report and the Photofinishing News
1997 Report.
(1) PCA data as of fiscal year end 1997. All other data as of year end 1996.
(2) PCA and CPI data as of fiscal year end 1997. All other data as of year
end 1996.
(3) Includes Kmart and Wal-Mart Portrait Studios.
(4) Excludes National School Studio, Senior Portrait and Yearbook divisions.
(5) Does not include school division or UK operations.
SALES AND MARKETING
PCA's marketing team consists of 13 marketing professionals. The group's
responsibilities include the creation and cost effective production and
placement of all in-store advertising, in-studio displays and general
multi-media advertising. Strategic marketing, cross-promotion development and
communication with host store management is conducted by two senior marketing
directors, one dedicated to each of the Kmart and Wal-Mart channels. Daily
working relationships with external advertising agencies and free-lance support
are managed by two production coordinators that also have an exclusive host
store focus. The other members of the group provide a broad support base for
both Wal-Mart and Kmart distribution channels, including media planning and
analysis, studio sales support and customer/market research. The group also
manages the proprietary customer database that allows the Company to apply
targeted advertising strategies.
Customers are attracted to the studios through a variety of advertising
methods including in-store, point-of-sale merchandising, television and
newspaper advertising, direct mail to prior and prospective customers and
in-store cross-promotional efforts. The Company seeks to maintain an advertising
presence throughout the year in all geographic markets where it operates
permanent studios. Additionally, as a Wal-Mart and Kmart licensee, the Company
is able to place its media advertising under the Wal-Mart and Kmart name at
rates that are lower than those it could independently obtain.
Studio managers participate in a certification program that develops their
technical skills and ensures consistent portrait quality. This program permits
studio managers to progress from Portrait Specialist to Portrait Artist, finally
earning the Master Photographer designation. The studio managers are given the
skills, knowledge, and authority to respond to any customer concern with an
immediate solution, including support by a toll-free customer service line.
Production and headquarters personnel also participate in training specifically
designed to enhance the customer's total portrait experience.
RESEARCH AND DEVELOPMENT
Led by Eric H. Jeltrup, the technology and development group consists of 22
employees that design and develop equipment and processes that are employed in
PCA's processing lab and field studios. The group is divided into three basic
areas: electronic engineering, mechanical engineering, and computer
systems/software. The group designs and develops equipment used in the
integrated automated production facility. Additionally, the group provides
programming support for a network of process control and data management
computers. Mechanical and electronic engineers also develop cameras, lighting
and other systems for field photographers.
The Company's software engineers designed the Company's proprietary digital
sales and point-of-sale systems. They provide system support for ongoing changes
in portrait-offer configurations and marketing promotions and advance the
Company's systems on a continual basis by enhancing system features and
incorporating evolving computer technologies.
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<PAGE> 44
In 1997, the Company initiated a two-year research grant with the Cornell
University Program of Computer Graphics. This relationship is directed by PCA
Board member Donald P. Greenberg, Ph.D., the Gould Schurman Professor of
Computer Graphics at Cornell University. See "Management." The focus of the
grant is to investigate evolving digital photography and computer technologies
for commercial application and viability in the portrait studio industry. With
the convergence of digital photographic imaging and advanced communications
technologies, PCA continues to develop additional capabilities and innovative
technology applications.
MANUFACTURING AND FACILITIES
Over the last several years, PCA has made a substantial investment in its
portrait photography manufacturing facilities in order to become what management
believes to be one of the industry's lowest cost producers. The Company owns
three facilities in the Charlotte, North Carolina, area. The primary facility
serves as the Company's corporate headquarters, production facility, and
warehouse and is approximately 166,000 square feet. The two other facilities
were acquired through the ASI acquisition and include a 60,000 square foot
processing and administrative facility and a 31,400 square foot distribution
center.
The PCA production facility handles approximately 85% of the Company's
permanent studio film development (70% of total film development). The former
ASI production facility is used for processing film from traveling studios and
the remaining permanent studios. During the Christmas selling season, the
busiest time during the year for the Company, PCA's manufacturing facilities
operate at approximately 85% of capacity. Management believes its current
manufacturing capacity is sufficient for the business going forward.
RAW MATERIALS AND SUPPLIERS
The Agfa Division of Bayer Corporation is PCA's primary supplier of
photographic film, paper, and processing chemicals. PCA renewed its supply
contract with Agfa in August 1997 after receiving bids from other suppliers. PCA
has not had significant difficulty obtaining its paper, film and portrait
processing chemical supplies, and management considers the available alternative
sources of such supplies to be adequate. Additionally, PCA has not found it
necessary to carry significant amounts of inventory to ensure itself of a
continuous allotment of raw materials.
PCA builds its own cameras and has an adequate supply of cameras and camera
components. The computer and video equipment used by PCA in its integrated
digital imaging system consists of standard components that are readily
available from multiple suppliers.
MARKET COVERAGE
The Company has operations throughout the United States, with no single
market representing more than 2.7% of sales and the Company's top 10 markets
representing less than 21% of sales. A market is typically represented as a
Designated Market Area (as defined by Nielsen Media Research, a division of the
Dun & Bradstreet Corp., to be a rigidly defined geographical area used by
Nielson to identify television stations that best reach an area and attract the
most viewers).
SEASONALITY
Because of the retail nature of its services and its locations in discount
stores, the Company's business is very seasonal. The Christmas season accounts
for a high percentage of the Company's sales and earnings, and the Company's
fourth fiscal quarter (late October through late January) typically produces a
large percentage of annual sales and annual earnings. The fourth fiscal quarters
of 1997, 1996, and 1995, accounted for approximately 31.2%, 33.2%, and 32.2%,
respectively, of sales, and 89.4%, 32.8%, and 64.2%, respectively, of earnings
for those years. Fiscal 1997 fourth quarter earnings as a percentage of total
earnings were out of proportion compared to prior years due to significant costs
incurred for restructuring the Company's digital studio operations, which led to
operating losses in the first half of the year. The 1996 fourth quarter earnings
would have accounted for 69.5% of annual earnings before giving effect to the
$3.6 million after-tax charge for studio closure costs.
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<PAGE> 45
GOVERNMENTAL REGULATIONS
The Company is subject to various federal and state laws and regulations,
including the Occupational Safety and Health Act and federal and state
environmental laws. The Company is not aware of any material violation of such
laws and regulations. Continued compliance is not expected to have a material
effect upon capital expenditures, earnings, or the competitive position of the
Company.
EMPLOYEES
At February 1, 1998, the Company had approximately 5,735 full-time and
part-time employees, none of which are now or ever have been represented by
labor unions. The Company believes employee relations are good.
INTELLECTUAL PROPERTY
The Company owns certain other patents, trademarks, and licenses that it
does not believe are material to its business.
LEGAL PROCEEDINGS
On April 22, 1998, the Company and the members of its Board of Directors
were sued by Harbor Finance Partners, a shareholder of the Company, to enjoin
the Recapitalization, or in the alternative, for damages. The lawsuit was filed
in the Superior Court of Mecklenburg County, North Carolina. Harbor Finance
Partners has alleged that the Company and its Directors breached their fiduciary
duty to the shareholders in connection with the Recapitalization. The Company
and the Directors have denied these allegations and have stated that they will
defend the lawsuit vigorously. On May 26, 1998, the Company and the Directors
moved to dismiss the lawsuit on the basis that Harbor Finance Partners had
failed to state a claim for which relief can be granted. As of the date hereof,
the Court had not set a hearing date for that motion to dismiss.
The Company is party to various litigations which have arisen in the normal
course of business. The Company does not believe that the outcome of any of the
matters in which it is currently involved will have a material adverse effect on
its financial condition or results of operations.
44
<PAGE> 46
MANAGEMENT AND BOARD OF DIRECTORS
OF THE COMPANY
MANAGEMENT
The Company's senior management team has over 90 years of combined
experience in the professional portrait photography industry.
<TABLE>
<CAPTION>
NAME AGE POSITIONS AND OFFICES
---- --- ---------------------
<S> <C> <C>
John Grosso.......................... 51 President, Chief Executive Officer, and
Director
Eric H. Jeltrup...................... 53 Executive Vice President and Chief Technical
Officer
J. Robert Wren, Jr................... 51 Executive Vice President and General Counsel
Bruce A. Fisher...................... 48 Senior Vice President and Chief Financial
Officer and Secretary
R. Michael Spencer................... 50 Senior Vice President and Treasurer
</TABLE>
Mr. Grosso joined PCA in 1987 as President and Chief Executive Officer.
Prior to joining PCA, Mr. Grosso was President and Chief Executive Officer of
Nimslo International, Ltd., a company that provided professional portrait
services to Sears in the Northeast United States. Mr. Grosso was Vice President
of Worldwide Marketing for that company prior to becoming its President and CEO.
Prior to working for Nimslo Corporation, Mr. Grosso worked for 10 years at
Polaroid Corporation, and during his last 3 years at Polaroid was director of
marketing for North American amateur photographic products. He is a 1969
graduate of George Washington University.
Mr. Jeltrup is responsible for developing the Company's integrated digital
imaging technology. He has been with the Company in various positions ranging
from research and development to production and distribution since 1976. From
1972 to 1976, he managed several engineering projects for Sperry Microwave, a
division of Sperry Rand, relating to airborne Doppler radar. From 1967 to 1972,
Mr. Jeltrup held various positions in radar and telephone systems engineering
while at General Precision, a division of Singer Kearfott. He received a
Bachelor of Electrical Engineering from Rensselaer Polytechnic Institute in 1967
and a Masters of Electrical Engineering from the University of South Florida in
1975.
Mr. Wren joined PCA in January 1997 with PCA's acquisition of ASI as
Executive Vice President and General Counsel. Prior to that, and since 1995, Mr.
Wren served as Director and Chief Executive Officer of ASI. From 1993 to 1995,
Mr. Wren served as Director, Executive Vice President and General Counsel of
ASI. From 1980 to 1992, Mr. Wren worked as a partner and associate at various
law firms focusing on corporate law, mergers and acquisitions, tax and real
estate. From 1974 to 1979, Mr. Wren was an associate, partner and Director of
Tax with Cherry, Bekaert and Holland, a regional firm of certified public
accountants. Mr. Wren is a 1969 graduate of Wake Forest University. He received
his J.D., with honors, in 1972 from George Washington University Law School, and
a Masters in Business Administration in 1973 from the University of
Pennsylvania, Wharton Graduate School of Business.
Mr. Fisher has been with the Company in various positions in accounting and
finance since 1977. He was promoted to Chief Financial Officer and Secretary in
1994. From 1973 to 1977, Mr. Fisher worked as a financial analyst with Korf
Industries and Midrex Corporation. In 1973, he graduated from the University of
Toledo with a degree in finance.
Mr. Spencer has been with PCA in various positions in accounting and
finance since 1973. He was promoted to Senior Vice President and Treasurer in
1994. Mr. Spencer worked with Haskins & Sells (currently Deloitte & Touche) in
Greensboro, NC, from 1970 to 1973 as a senior assistant accountant. He received
his Accounting degree from Wake Forest University in 1970 and his CPA license in
1972 from the State of North Carolina.
45
<PAGE> 47
BOARD OF DIRECTORS
The following table sets forth information with respect to each person who
is expected to serve as a Director of the Company following the
Recapitalization.
<TABLE>
<CAPTION>
NAME AGE AFFILIATION
- - - - ---- --- -----------
<S> <C> <C>
Thomas A. Berglund.......................................... 38 Jupiter
Terry J. Blumer............................................. 39 Jupiter
Donald P. Greenberg, Ph.D................................... 64 Cornell University
John Grosso................................................. 51 PCA
Bridgette P. Heller......................................... 36 Kraft Foods
John F. Klein............................................... 35 Jupiter
Joseph H. Reich............................................. 63 Centennial Associates
Eric F. Scheuermann......................................... 32 Jupiter
John A. Sprague............................................. 45 Jupiter
</TABLE>
Thomas A. Berglund is a Principal of Jupiter and has been associated with
the firm since 1994. Prior to that time he served for three years with the Invus
Group, a privately funded buy-out group.
Terry J. Blumer co-founded Jupiter Partners L.P. in 1994. Prior to that
time he was associated with Goldman, Sachs & Co. for over eight years, most
recently as an Executive Director.
Donald P. Greenberg, Ph.D. has been a member of the faculty of Cornell
University since 1968 and Director, Program of Computer Graphics, Cornell
University, since 1973. He is the Founding Director of the National Science and
Technology Center for Computer Graphics and Scientific Visualization. He has
served as a director of Data Broadcasting Corporation since 1995 and Chyron
Corporation since 1996. He has been a director of the Company since 1996.
John Grosso has been President, Chief Executive Officer and a director of
the Company since 1987.
Bridgette P. Heller has been General Manager GEVALIA Kaffe, a division of
Kraft Foods, since 1996. She has held various positions with Kraft Foods since
1986. She has been a director of the Company since March 4, 1998.
John F. Klein is a Principal of Jupiter and has been associated with the
firm since 1995. Prior to that time he served for three years as a consultant
with Bain & Company, a management consulting firm.
Joseph H. Reich has been the Managing Partner of Centennial Associates,
L.P. an investment firm, since April 1989. He has been a director of the Company
since 1987.
Eric F. Scheuermann is an Associate of Jupiter and joined the firm in
March, 1998. Prior to joining Jupiter, he served for three years with McKinsey &
Company, a management consulting firm, and as an associate with Latham &
Watkins, a law firm.
John A. Sprague co-founded Jupiter Partners L.P. in 1994. Prior to that
time he was associated with Forstmann Little & Co. for eleven years, most
recently as a partner. He is a director of Heartland Wireless Communications,
Inc. and Harmon Industries, Inc.
46
<PAGE> 48
EXECUTIVE COMPENSATION
The following sets forth certain compensation information with regard to
the Company's chief executive officer and each of the next four most highly
compensated executive officers (together with the chief executive officer, the
"Named Executive Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------
AWARDS
ANNUAL COMPENSATION ------------
---------------------------- SECURITIES ALL OTHER
FISCAL SALARY BONUS UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) OPTIONS(#) ($)(1)
--------------------------- ------ ------- ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
John Grosso.......................... 1997 254,100 38,115 0 6,560
President 1996 248,325 120,000 50,000 2,193
Chief Executive Officer 1995 228,881 68,664 0 7,566
J. Robert Wren, Jr. ................. 1997 250,000 31,250(2) 0 6,560
Executive Vice President 1996 0 0(3) 0(3) 0
General Counsel 1995 0 0 0 0
Eric H. Jeltrup...................... 1997 210,271 26,284 0 6,560
Executive Vice President 1996 194,987 41,248 0 2,193
Chief Technical Officer 1995 186,500 55,950 25,000 7,566
Bruce A. Fisher...................... 1997 155,250 15,525 0 6,413
Senior Vice President 1996 153,938 43,090 0 2,193
Chief Financial Officer 1995 148,750 44,625 0 7,532
R. Michael Spencer................... 1997 144,900 14,490 0 5,985
Senior Vice President 1996 143,675 31,551 0 2,110
Treasurer 1995 138,638 27,728 0 7,021
</TABLE>
- - - - ---------------
(1) Company's portion of Profit Sharing Plan contribution.
(2) The Company paid Mr. Wren $539,000 to terminate an employment and noncompete
agreement between Mr. Wren and ASI and $168,750 to purchase Mr. Wren's ASI
stock options.
(3) $75,000 was paid to Mr. Wren for services rendered to ASI and he received a
grant of options to purchase 150,000 shares of Common Stock.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
NUMBER OF PERCENT OF EXERCISE OR STOCK PRICE
SECURITIES TOTAL OPTIONS BASE APPRECIATION FOR
UNDERLYING GRANTED IN SHARE OPTION TERM(2)
OPTIONS GRANTED FISCAL PRICE EXPIRATION ---------------------
NAME (#) YEAR(1) ($/SHARE) DATE 5% 10%
---- --------------- ------------- ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
John Grosso.............. 50,000 72.5% 16.25 3/5/02 $203,125 $406,250
J. Robert Wren, Jr. ..... 0 -- -- -- -- --
Eric H. Jeltrup.......... 0 -- -- -- -- --
Bruce A. Fisher.......... 0 -- -- -- -- --
R. Michael Spencer....... 0 -- -- -- -- --
</TABLE>
- - - - ---------------
(1) The options vested on April 9, 1998.
(2) These values are hypothetical; there is no assurance that the Common Stock
will achieve these rates of appreciation.
47
<PAGE> 49
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth certain information with respect to options
exercised in fiscal 1997 by the Named Executive Officers and remaining options
held at the end of fiscal 1997:
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF SECURITIES UNEXERCISED
UNDERLYING IN-THE-MONEY
SHARES UNEXERCISED OPTIONS OPTIONS HELD AT
ACQUIRED VALUE HELD AT FISCAL YEAR END FISCAL YEAR END
ON EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
NAME (#) ($) (#) ($)
---- ----------- -------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
John Grosso...................... 0 0 144,500/65,000 1,851,625/488,750
J. Robert Wren, Jr. ............. 0 0 50,000/100,000 256,500/513,000
Eric H. Jeltrup.................. 0 0 80,000/25,000 1,349,500/294,250
Bruce A. Fisher.................. 10,000 88,750 23,000/7,000 262,250/87,750
R. Michael Spencer............... 15,000 310,925 27,000/3,000 263,250/36,750
</TABLE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During fiscal 1997, Mr. Fisher participated in deliberations of the Board
of Directors regarding the general merits of the Company's management stock
option plan. During fiscal 1997, no other executive officers of the Company
participated in the deliberations of the Board of Directors regarding executive
compensation.
EMPLOYMENT AND SEVERANCE ARRANGEMENTS
Mr. Grosso entered into an employment agreement with the Company in June
1997. The employment agreement provides for a base salary of $254,100 initially,
an increase to $304,000 as of June 9, 1998 and periodic reviews by, and
adjustments in the discretion of, the Board of Directors. The employment
agreement also allows Mr. Grosso to participate in any management bonus program
and earn up to 60% of his base salary for the year pursuant to such programs.
The employment agreement is terminable with or without cause by the Company and
at will by Mr. Grosso following a change in control (as defined therein).
Severance benefits payable to Mr. Grosso in the event the Company terminates his
employment without cause or in the event of his death or disability consist of a
cash payment of 48 times his average monthly compensation received during the
preceding five-year period and the immediate vesting of all options previously
granted to Mr. Grosso. The amount Mr. Grosso is to receive in the event he
terminates his employment following a change of control of the Company consists
of a cash payment equal to 35.99 times his average monthly compensation received
during the preceding five-year period and the immediate vesting of all options
previously granted to Mr. Grosso. Mr. Grosso has agreed not to compete with the
Company for a period of two years after termination of his employment for any
reason. Mr. Grosso has indicated that he will terminate his employment agreement
as of the date of the Recapitalization Closing and the Company will pay him
approximately $951,000 pursuant to the terms of the agreement. Mr. Grosso will
enter into a new employment agreement with the Company at the Recapitalization
Closing with terms substantially identical to those of his current employment
agreement except that it will not include a "change of control" provision and
will provide for an increase in annual salary from $304,000 to $350,000 as well
as participation in the New Option Plan (as defined herein), with maximum
aggregate awards thereunder of 2.5% of the outstanding shares of Common Stock
calculated as of the date of the Recapitalization Closing. See "-- New
Management Stock Option Plan."
Mr. Jeltrup entered into an employment agreement with the Company in June
1997. The employment agreement provides for a base salary of $220,000 initially
and periodic reviews by, and adjustments in the discretion of, the Board of
Directors. The employment agreement also allows Mr. Jeltrup to participate in
any management bonus program and earn up to 50% of his base salary for the year
pursuant to such programs. The employment agreement is terminable with or
without cause by the Company. Severance benefits payable to Mr. Jeltrup in the
event the Company terminates his employment without cause or in the event of his
death or
48
<PAGE> 50
disability consist of a cash payment of 36 times his average monthly
compensation received during the preceding five-year period and the immediate
vesting of all options previously granted to Mr. Jeltrup. Mr. Jeltrup has agreed
not to compete with the Company for a period of two years after termination of
his employment for any reason. Mr. Jeltrup will enter into an amendment to this
employment agreement with the Company as of the date of the Recapitalization
Closing providing for a base annual salary increase from $220,000 to $250,000
and participation in the New Option Plan, with maximum aggregate awards
thereunder of 1.0% of the outstanding shares of Common Stock calculated as of
the date of the Recapitalization Closing. See "-- New Management Stock Option
Plan."
Mr. Fisher entered into an employment agreement with the Company in June
1997. The employment agreement provides for a base salary of $155,250 initially
and periodic reviews by, and adjustments in the discretion of, the Board of
Directors. The employment agreement also allows Mr. Fisher to participate in any
management bonus program and earn up to 40% of his base salary for the year
pursuant to such programs. The employment agreement is terminable with or
without cause by the Company. Severance benefits payable to Mr. Fisher in the
event the Company terminates his employment without cause or in the event of his
death or disability consist of a cash payment of 36 times his average monthly
compensation received during the preceding five-year period and the immediate
vesting of all options previously granted to Mr. Fisher. Mr. Fisher has agreed
not to compete with the Company for a period of two years after termination of
his employment for any reason. Mr. Fisher will enter into an amendment to this
employment agreement as of the date of the Recapitalization Closing providing
for a base annual salary increase from $155,250 to $200,000 and participation in
the New Option Plan, with maximum aggregate awards thereunder of 0.6% of the
outstanding shares of Common Stock calculated as of the date of the
Recapitalization Closing. See "-- New Management Stock Option Plan."
Mr. Wren entered into an employment agreement with the Company effective as
of January 28, 1997 for a non-renewable term of three years. The employment
agreement provides for a base salary of $250,000. Severance payable to Mr. Wren
in the event the Company terminates his employment without cause equals (i) 100%
of his base salary for the balance of the term (if his employment is terminated
during the first twelve months of the term), or (ii) 200% of his base salary (if
his employment is terminated after the first twelve months of the term). In the
event the Company does not offer employment to Mr. Wren at the end of the term
or thereafter upon the same or better terms, Mr. Wren will be paid a lump-sum
severance benefit equal to 100% of his base salary. Mr. Wren may terminate his
employment with the Company at any time after the first twelve months of the
term, in which case the severance payable to Mr. Wren will equal (i) 200% of his
base salary payable in equal monthly installments (if he terminates during the
second twelve months of the term), (ii) 100% of his base salary payable in equal
monthly installments (if he terminates during the third twelve months) or (iii)
100% of his base salary payable in equal monthly installments (if he terminates
at any time after the three-year period). In the event of a termination for
cause, Mr. Wren will have no further rights to compensation and vested stock
option grants or other benefits except for those benefits existing under the
Consolidated Omnibus Budget Reconciliation Act. Mr. Wren has agreed not to
compete with the Company during the term and for a period of two years
thereafter.
NEW MANAGEMENT STOCK OPTION PLAN
After the Recapitalization Closing, the Company intends to adopt the PCA
International, Inc. Stock Option Plan (the "New Option Plan"). The purpose of
the New Option Plan is to provide for certain officers, directors and key
personnel of the Company and certain of its affiliates an equity-based incentive
to maintain and to enhance the performance and profitability of the Company.
The New Option Plan authorizes the grant to participants of options to
purchase shares of Common Stock equal to an aggregate of 12.5% of the
outstanding Common Stock calculated as of the date of the Recapitalization
Closing, subject to adjustment to avoid dilution or enlargement of intended
benefits in the event of changes in capitalization of the Company.
Subject to the provisions of the New Option Plan, the option committee (the
"Committee") appointed by the Board of Directors, or any person or persons
designated by the Committee, will have sole and complete
49
<PAGE> 51
authority to determine the participants to whom options will be granted, the
number of shares to be covered by each option, the exercise price therefor and
the conditions and limitations applicable to the exercise thereof. As provided
in each stock option agreement and in the New Option Plan, options become
exercisable either over time ("Time Options") or after the Company achieves the
Minimum EBITDA Target (as defined in the New Option Plan) ("Performance
Options"). Except to the extent otherwise provided in the applicable stock
option agreement, each Time Option will become exercisable with respect to 20%
of the shares of Common Stock subject thereto on each of the first, second,
third and fourth anniversaries of the date of grant if the grantee is still
employed by the Company on each relevant date, and each Time Option will become
100% exercisable on the fifth anniversary of the date of grant if the grantee is
still employed by the Company at such date. The extent to which Performance
Options granted under this Plan will become exercisable will be conditioned upon
the attainment of the Minimum EBITDA Target in the relevant calculation period
and will increase as EBITDA exceeds such Minimum EBITDA Target (up to a
predetermined maximum). A Performance Option may be exercised only with respect
to the applicable portion of the number of shares covered by such Performance
Option and, upon exercise, will expire and be canceled with respect to any
shares in excess thereof.
As of the date of a Change of Control (as defined in the New Option Plan),
any unexercisable portion of any option granted under the New Option Plan will
be deemed exercisable immediately prior to such Change of Control, and any
previously unexercisable portion of any option not exercised prior to such
Change of Control will be canceled.
COMPENSATION OF DIRECTORS
During fiscal 1997, non-employee directors received an annual retainer of
$12,000, and the Chairman received an annual retainer of $52,000. Directors
serving on a committee received an additional $1,000, and committee chairs
received an additional $1,500 for such service. Directors were permitted to
receive options to purchase Common Stock at an exercise price equal to the
then-current market price of the Common Stock, in lieu of cash compensation. All
reasonable expenses incurred by the Directors in connection with their service
on the Board of Directors were reimbursed. After the Recapitalization Closing,
Directors appointed by Jupiter will not receive any compensation but will
receive reimbursement for expenses.
50
<PAGE> 52
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The following table sets forth, as of the date hereof, certain information
regarding the beneficial ownership of the Common Stock (i) by each person who
will own more than 5% of the outstanding shares of Common Stock, (ii) by each of
the Named Executive Officers and Directors and (iii) by all such Directors and
Named Executive Officers as a group, in each case, estimated on a pro forma
basis, giving effect to the Transactions:
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF
NAME AND ADDRESS(1) BENEFICIAL PERCENT
OF BENEFICIAL OWNER(S) OWNERSHIP(2)(3) OF CLASS(4)
- - - - ---------------------- -------------------- -----------
<S> <C> <C>
Jupiter............................................. 1,905,660 to 1,992,452 80.2% to 83.8%
Terry J. Blumer..................................... 1,905,660 to 1,992,452(5) 80.2% to 83.8%
Thomas A. Berglund.................................. -- --
Donald P. Greenberg, Ph.D........................... (6) (6)
John Grosso......................................... 80,475(7) 3.4%
Bridgette P. Heller................................. -- --
John F. Klein....................................... -- --
Joseph H. Reich..................................... (8) (8)
Eric F. Scheuermann................................. -- --
John A. Sprague..................................... 1,905,660 to 1,992,452(5) 80.2% to 83.8%
Bruce A. Fisher..................................... 14,151(9) *
Eric H. Jeltrup..................................... 38,681(10) 1.6%
R. Michael Spencer.................................. 6,614(11) *
J. Robert Wren...................................... 7,027(12) *
All Executive Officers and Directors as a group..... (13) (13)
</TABLE>
- - - - ---------------
* Less than 1% of the outstanding shares of Common Stock.
(1) The address for Jupiter and Messrs. Berglund, Blumer, Klein, Scheuermann and
Sprague is 30 Rockefeller Plaza, Suite 4525, New York, New York 10112. The
address for Messrs. Grosso, Fisher, Jeltrup, Spencer and Wren is 815
Matthews-Mint Hill Road, Matthews, NC 28105. The address for Dr. Greenberg
is 109 Highgate Place, Ithaca, NY 14850. The address for Ms. Heller is 555
South Broadway TBI-3, Tarrytown, NY 10591. The address for Mr. Reich is 900
Third Avenue, Suite 1801, New York, NY 10022.
(2) Pursuant to Rule 13d-3 under the Exchange Act, beneficial ownership of a
security consists of sole or shared voting power (including power to vote or
direct the vote) and/or sole or shared investment power (including the power
to dispose or direct the disposition) with respect to the security through
any contract, arrangement, understanding, relationship or otherwise. All
shares of Common Stock subject to options that are currently exercisable or
exercisable within 60 days after the date hereof are deemed to be
beneficially owned by the holders thereof. For the purpose of calculating
each holder's percentage of the class, no shares subject to such options are
deemed to be outstanding other than shares subject to options held by such
holder.
(3) Post-Recapitalization holdings for each of the Named Executive Officers are
estimated, based on the assumptions that: (i) the Named Executive Officers
will roll over, in the aggregate, approximately $3,625,000 of equity
interests in the Company, consisting of a combination of shares of Common
Stock and options to purchase Common Stock; (ii) on the date of the
Recapitalization Closing, the Named Executive Officers will roll over
options to purchase Common Stock which will have an exercise price of $8.00;
and (iii) members of management other than the Named Executive Officers will
roll over, in the aggregate, approximately $1,375,000 of equity interests in
the Company, consisting entirely of options to purchase 74,324 shares of
Common Stock. All such estimated amounts are subject to change at the
Recapitalization Closing.
(4) Assumes that 2,377,456 shares of Common Stock will remain outstanding
after the Recapitalization.
51
<PAGE> 53
(5) Represents Common Stock owned by Jupiter. Messrs. Blumer and Sprague
exercise investment and voting power over the shares owned by Jupiter.
Each of Messrs. Blumer and Sprague disclaim beneficial ownership of all
Common Stock owned by Jupiter, except to the extent of their respective
ownership interests in Jupiter.
(6) Dr. Greenberg held, as of March 31, 1998, 300 shares of Common Stock. The
amount to be rolled-over by Dr. Greenberg will be determined at the
Recapitalization Closing.
(7) Assumes that Mr. Grosso will roll over a total of approximately $2,000,000
of equity interests in the Company, consisting of 63,900 shares of Common
Stock and options to purchase 16,575 shares of Common Stock.
(8) Mr. Reich held, as of March 31, 1998, 2,527,107 shares of Common Stock.
The amount to be rolled-over by Mr. Reich will be determined at the
Recapitalization Closing.
(9) Assumes that Mr. Fisher will roll over 14,151 shares of Common Stock and
will not roll over any options.
(10) Assumes that Mr. Jeltrup will roll over a total of approximately $950,000
of equity interests in the Company, consisting of 29,300 shares of Common
Stock and options to purchase 9,381 shares of Common Stock.
(11) Assumes that Mr. Spencer will roll over a total of approximately $150,000
of equity interests in the Company, consisting of 3,454 shares of Common
Stock and options to purchase 3,160 shares of Common Stock.
(12) Assumes that Mr. Wren will roll over a total of approximately $150,000 of
equity interests in the Company, consisting of 2,500 shares of Common
Stock and options to purchase 4,527 shares of Common Stock.
(13) To be determined at the Recapitalization Closing.
52
<PAGE> 54
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The spouse of Mr. Wren (an officer of PCA) is a partner in the law firm of
Kilpatrick Stockton LLP of Charlotte, North Carolina. The Company has engaged
Kilpatrick Stockton LLP on various legal matters during the year.
The Company has awarded a grant to the Cornell University Program of
Computer Graphics to support digital photographic research principally related
to retail portrait studio business. Dr. Greenberg (a Director of PCA) is the
director of the Computer Graphics Department at Cornell University.
The Company has employment, severance and stock option arrangements with
certain members of its senior management. See "Management -- Employment and
Severance Arrangements" and "-- New Management Stock Option Plan." In connection
with the Recapitalization Closing, management will roll over options to purchase
shares of Common Stock at $8.00 per share, the number of the options rolled-over
to be based on the value of options held prior to the Recapitalization Closing.
The Merger Agreement provides that the Company will pay Jupiter Partners
LLC a transaction fee of approximately $2.76 million upon consummation of the
Recapitalization. The fee equals one percent of the transaction size and is
Jupiter Partners LLC's principal form of compensation for arranging the
Recapitalization Financing.
53
<PAGE> 55
DESCRIPTION OF BANK FACILITY
On April 20, 1998, Jupiter received a commitment letter from NationsBank to
provide the Bank Facility which is expected to be syndicated by NationsBanc
Montgomery Securities LLC. The Bank Facility will consist of (i) a $25.0 million
revolving credit facility which will include a $5.0 million sublimit for the
issuance of standby and commercial letters of credit (the "Revolving Credit
Facility"), (ii) a $45.0 million term loan facility (the "Tranche A Term Loan
Facility") and (iii) an $80.0 million term loan facility (the "Tranche B Term
Loan Facility").
The Revolving Credit Facility and Tranche A Term Loan Facility will bear
interest at a rate per annum equal to, at the Company's option, either (i) the
London interbank-offered rate, adjusted for reserves ("LIBOR"), plus 225 basis
points, or (ii) the "Alternate Base Rate" (which is defined as the higher of (a)
the NationsBank prime rate and (b) the Federal Funds rate plus 1/2%) plus 125
basis points. The Tranche B Term Loan Facility will bear interest at a rate
equal to, at the Company's option, either (i) LIBOR plus 275 basis points, or
(ii) the Alternate Base Rate plus 175 basis points; provided, that each of the
Revolving Credit Facility, the Tranche A Term Loan and the Tranche B Term Loan
shall be subject to performance pricing adjustments downward based on the
Company's Funded Debt to EBITDA ratio commencing twelve months after the
consummation of the Recapitalization.
The Bank Facility will be repayable according to a fixed amortization
schedule and require prepayment in an amount equal to (a) 100% of the net cash
proceeds of all asset sales by the Company or any subsidiary of the Company
(including stock of subsidiaries), subject to de minimis baskets and
reinvestment provisions to be agreed upon; (b) 50% of Excess Cash Flow pursuant
to an annual cash sweep arrangement; (c) 100% of the net cash proceeds from the
issuance of any debt by the Company or any subsidiary (excluding certain
permitted debt); and (d) 50% of the net cash proceeds from the issuance of
equity by the Company or any subsidiary (excluding proceeds from the issuance of
any equity to certain affiliates).
The Tranche A Term Loan Facility will mature five years after the Closing
and the Tranche B Term Loan Facility will mature seven years after the Closing.
Commitments under the Revolving Credit Facility will terminate five years after
the Closing.
NationsBank, as agent on behalf of the lenders (the "Agent"), will receive
a first priority perfected security interest in all of the capital stock of each
of the direct and indirect domestic subsidiaries of the Company and 65% of the
capital stock of each direct foreign subsidiary of the Company or any of its
domestic subsidiaries, which capital stock shall not be subject to any other
lien or encumbrance. The Agent will also receive a first priority perfected
security interest in substantially all other assets and properties of the
Company and its subsidiaries (including, without limitation, accounts
receivable, inventory, real property, machinery, equipment, contracts,
trademarks, copyrights, patents, license agreements, and general intangibles).
The Bank Facility will contain usual and customary covenants for similar
financing transactions, including, without limitation, covenants on: (i)
delivery of financial statements and other reports; (ii) delivery of compliance
certificates; (iii) notices of default, material litigation and material
governmental and environmental proceedings; (iv) compliance with laws; (v)
payment of taxes; (vi) maintenance of insurance; (vii) limitation on liens;
(viii) limitations on mergers, consolidations and sales of assets; (ix)
limitations on Incurrence of debt; (x) limitations on dividends and stock
redemptions and the redemption and/or prepayment of other debt; (xi) limitations
on investments and acquisitions; (xii) ERISA; (xiii) limitation on transactions
with affiliates; and (xiv) limitation on capital expenditures.
Pursuant to the terms of the Bank Facility, the Company will be in default
upon certain events (such default events that are usual and customary for
financing transactions of this type), including but not limited to the
following: (i) nonpayment of principal, interest, fees or other amounts; (ii)
violation of covenants; (iii) inaccuracy of representations and warranties; (iv)
cross-default to other material agreements and indebtedness; (v) bankruptcy or
insolvency; (vi) material judgments; (vii) ERISA; (viii) actual or asserted
invalidity of any loan documents or security interests; or (ix) Change in
Control (such term, as well as other capitalized terms in this section which are
not otherwise defined, will be defined in the documentation for the Bank
Facility).
54
<PAGE> 56
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The consolidated financial statements of the Company at May 3, 1998 and May
4, 1997, and for each of the three years in the period ended February 1, 1998,
included herein, have been audited by KPMG Peat Marwick LLP, independent
certified public accountants, as stated in their report appearing herein.
55
<PAGE> 57
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE NO.
FINANCIAL STATEMENTS: --------
<S> <C>
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets at February 1, 1998 and February
2, 1997................................................... F-3 - F-4
Consolidated Statements of Income for Fiscal Years Ended
February 1, 1998; February 2, 1997; and January 28,
1996...................................................... F-5
Consolidated Statements of Changes in Shareholders' Equity
for Fiscal Years Ended February 1, 1998; February 2, 1997;
and January 28, 1996...................................... F-6
Consolidated Statements of Cash Flows for Fiscal Years Ended
February 1, 1998; February 2, 1997; and January 28,
1996...................................................... F-7
Notes to Consolidated Financial Statements.................. F-8 - F-19
Consolidated Balance Sheets -- Unaudited May 3, 1998 and
Audited February 1, 1998.................................. F-20
Unaudited Consolidated Statements of Income for the Three
Months Ended May 3, 1998 and May 4, 1997.................. F-21
Unaudited Consolidated Statements of Changes in
Shareholders' Equity for the Three Months Ended May 3,
1998...................................................... F-22
Unaudited Consolidated Statements of Cash Flows for the
Three Months Ended May 3, 1998 and May 4, 1997............ F-23
Condensed Notes to Consolidated Financial Statements........ F-24
</TABLE>
F-1
<PAGE> 58
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
PCA International, Inc.:
We have audited the consolidated financial statements of PCA International,
Inc. and subsidiaries as of February 1, 1998 and February 2, 1997 and for each
of the years in the three-year period ended February 1, 1998, as listed in the
accompanying index. In connection with our audits of the consolidated financial
statements, we also have audited the financial statement schedule as listed in
the accompanying index. These consolidated financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PCA
International, Inc. and subsidiaries as of February 1, 1998 and February 2,
1997, and the results of their operations and their cash flows for each of the
years in the three-year period ended February 1, 1998, in conformity with
generally accepted accounting principles. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
/s/ KPMG PEAT MARWICK LLP
--------------------------------------
KPMG PEAT MARWICK LLP
Charlotte, North Carolina
March 13, 1998
F-2
<PAGE> 59
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
FEBRUARY 1, FEBRUARY 2,
1998 1997
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................. $ 12,289,761 $ 1,536,234
Accounts receivable (net of allowance for doubtful
accounts of $1,315,666 and $867,961):
Due from licensor stores and customers................. 6,740,560 6,702,335
Other, including employee advances..................... 763,925 602,349
Inventories............................................... 10,078,719 9,814,682
Deferred income taxes..................................... 5,827,324 6,853,985
Prepaid expenses.......................................... 1,043,708 1,490,918
------------ ------------
TOTAL CURRENT ASSETS.............................. 36,743,997 27,000,503
PROPERTY:
Land and improvements..................................... 2,305,293 2,443,939
Building and improvements................................. 12,148,732 12,883,962
Photographic and sales equipment.......................... 57,713,911 61,902,588
Photographic finishing equipment.......................... 15,599,525 18,660,080
Furniture and equipment................................... 13,872,058 14,188,792
Transportation equipment.................................. 292,593 477,073
Leasehold improvements.................................... 16,050,719 17,935,712
Construction in progress.................................. 1,429,621 1,120,788
------------ ------------
Total............................................. 119,412,452 129,612,934
Less: Accumulated depreciation and amortization........... 64,488,965 71,348,374
------------ ------------
PROPERTY, NET............................................. 54,923,487 58,264,560
------------ ------------
INTANGIBLE ASSETS........................................... 59,733,731 60,256,854
OTHER ASSETS................................................ 1,899,611 1,139,305
------------ ------------
TOTAL ASSETS...................................... $153,300,826 $146,661,222
============ ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 60
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
FEBRUARY 1, FEBRUARY 2,
1998 1997
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion long-term debt............................ $ 8,750,000 $ --
Accounts payable-trade.................................... 25,915,285 19,799,067
Accrued insurance......................................... 4,085,191 2,705,199
Accrued income taxes...................................... 1,188,859 1,643,816
Accrued compensation...................................... 6,474,414 5,924,407
Other accrued liabilities................................. 10,664,577 15,399,563
------------ ------------
TOTAL CURRENT LIABILITIES......................... 57,078,326 45,472,052
LONG-TERM DEBT............................................ 42,063,857 58,679,770
DEFERRED INCOME TAXES..................................... 1,738,255 --
OTHER LIABILITIES......................................... 7,730,964 8,868,660
COMMITMENTS AND CONTINGENCIES:
SHAREHOLDERS' EQUITY:
Preferred stock, $10.00 par value (authorized -- 2,000,000
shares; outstanding -- none)........................... -- --
Common stock, $0.20 par value (authorized -- 20,000,000
shares; outstanding -- 7,901,579 and 7,607,129
shares)................................................ 1,580,316 1,521,426
Additional paid-in capital................................ 9,995,238 5,838,131
Retained earnings......................................... 33,423,465 26,334,992
Cumulative foreign currency translation adjustments....... (309,595) (53,809)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY........................ 44,689,424 33,640,740
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY.......................................... $153,300,826 $146,661,222
============ ============
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 61
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
--------------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
SALES............................................ $242,899,027 $156,099,050 $144,714,535
COSTS AND EXPENSES:
Advertising and promotional costs.............. 16,661,542 16,163,273 14,784,803
Costs of photographic sales.................... 85,707,294 52,558,425 47,635,178
Store commissions and selling costs............ 79,597,084 50,384,753 45,190,783
General and administrative expenses............ 36,160,218 31,676,471 23,781,509
Amortization of intangibles.................... 1,909,772 -- --
------------ ------------ ------------
Total Costs and Expenses............... 220,035,910 150,782,922 131,392,273
INCOME FROM OPERATIONS BEFORE
INTEREST AND INCOME TAXES...................... 22,863,117 5,316,128 13,322,262
Interest expense, net.......................... 6,570,945 179,221 458,923
------------ ------------ ------------
INCOME FROM OPERATIONS BEFORE
INCOME TAXES................................... 16,292,172 5,136,907 12,863,339
INCOME TAX PROVISION............................. 7,557,320 2,143,053 5,246,170
------------ ------------ ------------
NET INCOME....................................... $ 8,734,852 $ 2,993,854 $ 7,617,169
============ ============ ============
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES:
Basic.......................................... 7,779,176 7,522,188 7,632,297
============ ============ ============
Diluted........................................ 8,195,108 7,835,613 7,894,656
============ ============ ============
BASIC AND FULLY DILUTED EARNINGS
PER COMMON SHARE:
Basic.......................................... $ 1.12 $ 0.40 $ 1.00
============ ============ ============
Diluted........................................ $ 1.07 $ 0.38 $ 0.96
============ ============ ============
CASH DIVIDENDS PER COMMON SHARE.................. $ 0.21 $ 0.21 $ 0.28
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 62
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED FEBRUARY 1, 1998, FEBRUARY 2, 1997 AND JANUARY 28,
1996
<TABLE>
<CAPTION>
CUMULATIVE
FOREIGN
COMMON STOCK ADDITIONAL CURRENCY
---------------------- PAID-IN RETAINED TRANSLATION UNEARNED
SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENTS COMPENSATION
--------- ---------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 29, 1995: ....... 8,160,171 $1,632,035 $12,204,069 $19,444,035 $(215,087) $(32,597)
Net income...................... 7,617,169
Exercise of stock options....... 66,200 13,240 415,533
Dividends....................... (2,142,495)
Acquisition of Company stock.... (744,300) (148,860) (7,565,092)
Compensatory stock options...... 23,665
Canceled compensatory stock
options...................... (8,932) 8,932
Foreign currency translation
adjustment................... (11,006)
--------- ---------- ----------- ----------- --------- --------
BALANCE, JANUARY 28, 1996: ....... 7,482,071 1,496,415 5,045,578 24,918,709 (226,093) --
Net income...................... 2,993,854
Exercise of stock options....... 434,300 86,860 4,372,329
Dividends....................... (1,577,571)
Acquisition of Company stock.... (309,242) (61,849) (4,128,776)
Issuance of warrants to purchase
common stock................. 549,000
Foreign currency translation
adjustment................... 172,284
--------- ---------- ----------- ----------- --------- --------
BALANCE, FEBRUARY 2, 1997: ....... 7,607,129 1,521,426 5,838,131 26,334,992 (53,809) --
Net income...................... 8,734,852
Exercise of stock options....... 294,450 58,890 4,157,107
Dividends....................... (1,646,379)
Foreign currency translation
adjustment................... (255,786)
--------- ---------- ----------- ----------- --------- --------
BALANCE, FEBRUARY 1, 1998: ....... 7,901,579 $1,580,316 $ 9,995,238 $33,423,465 $(309,595) $ --
========= ========== =========== =========== ========= ========
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE> 63
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
--------------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income............................................... $ 8,734,852 $ 2,993,854 $ 7,617,169
Adjustments to reconcile net income to net cash provided
from operating activities:
Depreciation and amortization.......................... 15,453,159 9,498,315 8,489,754
Increase (decrease) in allowance for doubtful
accounts............................................. 449,734 (167,303) 165,140
Provision for deferred income taxes.................... 2,764,916 (1,421,999) 1,264,649
Loss on disposal of property........................... 1,539,689 3,287,772 776,592
Compensatory stock option expense...................... -- -- 23,665
(Increase) decrease in other liabilities............... (1,147,285) (375,932) 177,572
Increase in other noncurrent assets.................... (760,306) (156) (15,659)
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable............. (660,510) 1,254,260 (530,433)
(Increase) decrease in inventories..................... (268,838) (4,489,573) 755,065
Decrease (increase) in prepaid expenses................ 454,106 (178,505) 122,987
Increase (decrease) in accounts payable................ 6,124,980 2,596,851 (2,246,715)
(Decrease) increase in accrued expenses................ (3,150,299) 4,679,050 3,686,168
------------ ------------ ------------
NET CASH PROVIDED FROM OPERATING ACTIVITIES............ 29,534,198 17,676,634 20,285,954
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchase of property..................................... (12,086,194) (13,423,544) (6,309,168)
Proceeds from sales of fixed assets...................... 16,100 10,151 47,311
Purchase of Canadian assets.............................. -- (1,201,213) --
Purchase of American Studios, Inc........................ (1,410,741) (52,689,671) --
------------ ------------ ------------
NET CASH USED IN INVESTING ACTIVITIES.................. (13,480,835) (67,304,277) (6,261,857)
------------ ------------ ------------
FINANCING ACTIVITIES:
(Decrease) increase in borrowings........................ (7,865,913) 48,334,816 (974,215)
Exercise of stock options................................ 4,215,997 4,459,189 428,773
Acquisition of Company stock............................. -- (4,190,625) (7,713,952)
Cash dividends........................................... (1,646,379) (1,577,571) (2,142,495)
------------ ------------ ------------
NET CASH (USED IN) PROVIDED FROM FINANCING
ACTIVITIES........................................... (5,296,295) 47,025,809 (10,401,889)
------------ ------------ ------------
Effect of exchange rate changes on cash................ (3,541) 223,555 (19,454)
------------ ------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........... 10,753,527 (2,378,279) 3,602,754
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD........... 1,536,234 3,914,513 311,759
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD................. $ 12,289,761 $ 1,536,234 $ 3,914,513
============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash Flow Data:
Interest paid.......................................... $ 7,749,779 $ 173,644 $ 364,041
============ ============ ============
Income taxes paid...................................... $ 2,751,652 $ 3,160,160 $ 3,059,180
============ ============ ============
Schedule of Noncash Financing Activities:
Stock options canceled and unearned compensation
credited............................................. $ -- $ -- $ 8,932
============ ============ ============
Warrants issued to purchase common stock............... $ -- $ 549,000 $ --
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE> 64
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE FISCAL YEARS ENDED FEBRUARY 1, 1998,
FEBRUARY 2, 1997 AND JANUARY 28, 1996
1. SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation and Concentrations of Credit Risk:
The consolidated financial statements include the accounts of PCA
International, Inc. and its subsidiaries (the "Company"), all of which are
wholly owned. All material intercompany balances and transactions have been
eliminated in consolidation. The Company's operations in Kmart stores accounted
for approximately 40.0%, 87.2%, and 94.8% of consolidated sales during the
fiscal years ended February 1, 1998, February 2, 1997 and January 28, 1996,
respectively. The license agreement with Kmart Corporation was revised and
renewed on May 10, 1996. The license is for the period through May 9, 2001 and
may be terminated by either party upon 180-days' notice. Operations in Wal-Mart
stores accounted for approximately 56.2% of consolidated sales in the fiscal
year ended February 1, 1998, and less than 5% of total sales in fiscal years
ending in 1997 and 1996. The Company operates its U.S. studios in Wal-Mart
stores under the terms of the license agreement between Wal-Mart and American
Studios, Inc. (see note 2). Wal-Mart may amend or terminate this agreement at
any time at its sole discretion. The loss of the license to do business in Kmart
or Wal-Mart stores would have a materially adverse effect on the Company.
Kmart's or Wal-Mart's closing of a significant number of discount stores could
have a material impact on the Company's revenues and could result in a write-off
of leasehold improvements and furniture and equipment in the affected locations.
No estimate can be made of the impact to earnings if Kmart or Wal-Mart should
close a significant number of locations.
Fiscal Year:
The Company's fiscal year ends on the Sunday nearest the end of January.
The fiscal year ended February 2, 1997 was a 53-week year. The fiscal years
ended January 28, 1996 and February 1, 1998 were 52-week years. The Company's
fiscal year that will end January 31, 1999 will be 52 weeks.
Foreign Currency Transactions:
Gains and losses on foreign currency transactions are included in the
determination of net income for the period. The amount of such gain and (loss)
was ($78,748), $10,940 and $19,474 for the fiscal years ended February 1, 1998,
February 2, 1997 and January 28, 1996, respectively.
Cash and Cash Equivalents:
The Company considers all highly liquid investments with an original
maturity of three months or less when purchased to be cash equivalents.
Inventories:
Inventories are valued at the lower of cost or market, cost being
determined on the first-in, first-out basis.
Property and Depreciation:
Property is recorded at cost. Maintenance and repairs are charged to
expense as incurred, and property additions, renewals, and improvements are
capitalized. When property is retired or otherwise disposed of, the related
costs and accumulated depreciation are removed from the respective accounts and
any gain or loss is
F-8
<PAGE> 65
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
credited or charged to income. A summary of the estimated useful lives used in
computing depreciation and amortization, principally on the straight-line
method, is as follows:
<TABLE>
<S> <C>
Land improvements........................... 10 to 30 years
Building and improvements................... 10 to 55 years
Leasehold improvements...................... 3 to 10 years
Photographic and sales equipment............ 3 to 13 years
Photographic finishing equipment............ 3 to 15 years
Furniture and equipment..................... 3 to 10 years
Transportation equipment.................... 3 years
</TABLE>
Intangible Assets:
Substantially all intangible assets are amortized over 35 years by the
straight-line method. The recoverability of intangible assets is evaluated by
the Company on the basis of undiscounted expected future cash flows from the
acquired operations before interest for the remaining amortization period. If
impairment exists, the carrying amount of the intangible assets is reduced based
on the greater of fair value or estimated shortfall of cash flows.
Impairment of Long-lived Assets:
The Company periodically evaluates its long-lived assets for financial
impairment to determine if the carrying amount of such assets may not be fully
recoverable. The Company evaluates the recoverability of long-lived assets not
held for sale by measuring the carrying amount of the assets against the
estimated undiscounted future cash flows associated with them. If such an
evaluation indicates that the future undiscounted cash flows of certain
long-lived assets are not sufficient to recover the carrying value of such
assets, the assets are then adjusted to their fair values.
Photographic Sales and Deferred Costs:
Digital photographic sales are recorded when portraits are purchased at the
time of photography. Substantially all of the Company's sales are digital.
Traditional photographic sales are recorded when portraits are delivered to
studios and sold to customers. Costs relating to portraits processed, or in
process, but not recorded as sales prior to the fiscal year-end, are deferred.
Substantially all portraits are subsequently delivered and offered for sale to
the customer within three weeks.
Income Taxes:
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
F-9
<PAGE> 66
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Postretirement Benefits:
The Company sponsors a postretirement health care plan for retirees and
certain current employees. The Company measures the cost of its obligations
based on actuarial assumptions. The cost of this program is not funded.
Fair Value of Financial Instruments:
The Company is required to disclose in its consolidated financial
statements the fair value of all financial instruments, including assets and
liabilities both on- and off-balance sheet, for which it is practicable to
estimate such fair value. Fair value methods, assumptions, and estimates for the
Company are as follows:
- Cash and cash equivalents, accounts receivable, prepaid expenses,
short-term borrowings, accounts payable-trade, and accrued
expenses -- the carrying amount approximates fair value because of the
short maturity of these instruments.
- Non-current liabilities -- the carrying amount approximates fair value
because such liabilities consist primarily of actuarially determined
postretirement liabilities using current market rate assumptions and
long-term debt at market rates currently offered.
Costs and Expenses:
Advertising and promotional costs consist of the direct mail, television
broadcasting, and print media costs, and the payroll and related taxes, benefits
and other costs for employees in the adult/family market who directly promote
and acquire customers, as well as the cost of church directories.
Costs of photographic sales are all the direct and indirect portrait
production costs: salaries, commissions, payroll taxes, related benefits and
traveling costs for all photography personnel, as well as the recruiting and
training costs of these employees. The costs of film, accessories, photography
equipment depreciation and maintenance, supplies, and distribution are also
included in this category.
Store commissions and selling costs include the commissions paid to each
chain based on a percentage of net sales, salaries, commissions, payroll taxes,
related benefits and travel costs for all sales personnel, and recruiting and
training, sales supplies, sales equipment depreciation, and related distribution
costs.
Research and Development:
The Company spent $1,311,000, $1,321,000 and $1,033,000 on research and
development activities during the fiscal years ended February 1, 1998, February
2, 1997 and January 28, 1996, respectively. Such costs are charged to costs of
photographic sales as incurred.
Stock Option Plan:
Prior to January 28, 1996, the Company accounted for its stock option plan
in accordance with the provisions of Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees, and related interpretations.
As such, compensation expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. On
January 29, 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, which permits
entities to recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows
entities to continue to apply the provisions of APB Opinion No. 25 and provide
pro forma net income and pro forma earnings per share disclosures for employee
stock option grants made in 1995 and future years as if the fair-value-based
method defined in SFAS No. 123 had been applied. The Company has elected to
continue to apply provisions for APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
F-10
<PAGE> 67
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Earnings per Share:
During fiscal 1997, the Company adopted the provisions of SFAS No. 128,
Earnings per Share. SFAS No. 128 specifies the computation, presentation, and
disclosure requirements for earnings per share (EPS). Basic EPS is computed by
dividing income available to common stockholders by the weighted-average number
of common shares outstanding during the period. Diluted EPS reflects the
dilution that would occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the Company. All prior period
EPS data presented have been restated to conform with the Statement's
provisions.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management 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 revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
Reclassifications:
Certain reclassifications have been made to the fiscal year 1996 amounts to
conform to the fiscal 1997 presentation.
2. ACQUISITION:
On January 27, 1997, PCA acquired 94.9% of the outstanding common stock of
American Studios, Inc. ("ASI") for $2.50 a share, or $50,833,770. In addition,
the Company incurred transaction costs of $1,855,901, resulting in an aggregate
purchase price of $52,689,671. ASI was based in Charlotte, North Carolina, and
was engaged in the sale of photographic color portraits of children, adults, and
families. The acquisition was accounted for by the purchase method at February
2, 1997. Since the acquisition was accounted for at February 2, 1997, the
results of operations of ASI were not included in PCA's consolidated financial
statements for the fiscal year ended February 2, 1997. The excess of the
purchase price over the fair value of the net identifiable assets acquired at
February 2, 1997 of $59,134,104 has been recorded as an intangible asset and is
being amortized on a straight-line basis over 35 years.
During the fiscal year ended February 1, 1998, PCA acquired an additional
4.8% of the outstanding common stock of ASI for $2.50 a share, or $2,601,968.
Intangible asset adjustments resulted in an addition to intangible assets of
$1,410,741.
The following unaudited pro forma financial information presents the
combined results of operations of the Company and ASI as if the acquisition had
occurred as of the beginning of fiscal 1996 and 1995, after giving effect to
certain adjustments, including amortization of intangible assets, additional
depreciation expense, increased interest expense on debt related to the
acquisition, acquisition-related costs, and related income tax effects. The pro
forma financial information does not necessarily reflect the results of
operations that would have occurred had the Company and ASI constituted a single
entity during such periods.
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
----------------------------
FEBRUARY 2, JANUARY 28,
1997 1996
------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Sales........................................... $263,974,050 $246,614,535
============ ============
Net loss........................................ $ (855,898) $ (1,168,645)
============ ============
Basic loss per share............................ $ (0.11) $ (0.15)
============ ============
</TABLE>
F-11
<PAGE> 68
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During fiscal 1996, the Company also purchased certain assets of two
Canadian companies for $1.2 million. The effect of this acquisition is not
material to the results of operations of the Company. Such acquisitions were
accounted for by the purchase method.
3. DEBT:
The Company signed a new credit agreement with NationsBank of North
Carolina, N.A. ("NationsBank") on February 28, 1997, for $90 million, which
includes a $65 million senior term loan and a $25 million revolving credit
facility. The senior term loan and the revolving credit facility bear interest
at a rate equal to LIBOR plus an applicable margin or an Alternate Base Rate
plus an applicable margin. The credit agreement was amended on September 15,
1997. The amendment reduced the applicable margin up to 0.75% from the range of
0.75% to 2.5% in the original loan agreement. The applicable margin is based on
a ratio of debt to EBITDA. Aggregate annual maturities for each of the five
fiscal years subsequent to February 2, 1997 are as follows: $0 in 1997, $10
million in 1998, $15 million in 1999, $20 million in 2000, and $20 million in
2001. The Company prepaid $10 million of the term loan on May 29, 1997, and $4
million on January 29, 1998, reducing the amount payable in 1998 to $8.5 million
and in 2001 to $10 million.
On February 2, 1997, the Company had available a $75.8 million senior
tender facility that included a $25 million revolving credit facility. The
senior tender facility matured on February 28, 1997, upon the closing of the
merger between the Company's wholly-owned subsidiary, ASI Acquisition
Corporation, and American Studios, Inc.
Borrowings under the agreements are secured by tangible property other than
property located in portrait studios. Minimum levels of adjusted earnings,
tangible net worth, an interest coverage ratio, and a fixed charge ratio must be
maintained in addition to other financial covenants. The Company has been in
compliance with all financial covenants throughout the life of the credit
agreement. The amount of debt is reduced by 150,000 stock warrants issued to
NationsBank to purchase common stock of the Company. The warrants expire January
27, 2002. The amount available under the revolving credit facility is reduced by
outstanding letters of credit. As of February 1, 1998 and February 2, 1997, the
Company had letters of credit of $4,300,000 and $3,560,750, respectively, for
its Workers' Compensation insurance.
The components of net interest expense (income) were:
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
-----------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Interest Income.............................. $ (218,622) $ (225,748) $ (123,865)
Interest Expense........................... 6,789,567 404,969 582,788
---------- ----------- -----------
Net........................................ $6,570,945 $ 179,221 $ 458,923
========== =========== ===========
</TABLE>
F-12
<PAGE> 69
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAXES:
PCA International, Inc. and its domestic subsidiaries file a consolidated
federal income tax return. The components of income tax expense are as follows:
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
-----------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
CURRENT:
Federal..................................... $2,491,486 $ 2,824,740 $2,888,851
State....................................... 714,587 957,859 1,082,736
---------- ----------- ----------
3,206,073 3,782,599 3,971,587
---------- ----------- ----------
DEFERRED:
Federal..................................... 3,690,903 (1,270,094) 1,178,154
State....................................... 660,344 (369,452) 96,429
---------- ----------- ----------
4,351,247 (1,639,546) 1,274,583
---------- ----------- ----------
Total Provision............................... $7,557,320 $ 2,143,053 $5,246,170
========== =========== ==========
</TABLE>
A reconciliation of the amount computed by applying the statutory federal
income tax rate to income from operations to the consolidated income tax
provision follows:
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
-----------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Tax expense at statutory federal rates......... $5,539,338 $1,746,548 $4,402,166
Tax effect of expenses not deductible.......... 218,392 71,011 65,338
State income taxes, net of federal income tax
benefit...................................... 907,454 388,349 766,458
Tax effect related to foreign subsidiary....... 73,078 14,200 13,203
Amortization of goodwill....................... 620,107 -- --
Other.......................................... 198,951 (77,055) (995)
---------- ---------- ----------
Total Provision................................ $7,557,320 $2,143,053 $5,246,170
========== ========== ==========
</TABLE>
F-13
<PAGE> 70
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at February 1,
1998 and February 2, 1997 are presented below:
<TABLE>
<CAPTION>
FEBRUARY 1, FEBRUARY 2,
1998 1997
----------- -----------
<S> <C> <C>
DEFERRED TAX ASSETS:
CURRENT:
Accounts receivable, principally due to allowance for
doubtful accounts.................................... $ 517,963 $ 346,360
Inventory, principally due to obsolescence reserve...... 235,856 600,155
Life and health, principally due to adoption of SFAS No.
106.................................................. 339,210 153,696
Stock options, principally due to compensation
element.............................................. 118,379 139,806
Workers' compensation................................... 2,811,175 2,414,430
Reserves, principally due to accrual for financial
reporting purposes................................... 878,659 942,945
Studio closure costs, principally due to accrual for
financial reporting purposes......................... 93,426 2,396,400
----------- -----------
Gross current deferred tax assets....................... 4,994,668 6,993,792
NONCURRENT:
Alternative minimum tax and other tax credits........... 832,654 875,538
Net operating loss carryforward......................... 2,546,988 2,770,246
Life and health, principally due to adoption of SFAS No.
106.................................................. 1,009,407 1,154,131
Intangibles............................................. 1,888,075 498,892
----------- -----------
Gross noncurrent deferred tax assets.................... 6,277,124 5,298,807
----------- -----------
Gross deferred tax assets............................... 11,271,792 12,292,599
----------- -----------
DEFERRED TAX LIABILITIES:
NONCURRENT:
Plant and equipment, principally due to differences in
depreciation......................................... (7,182,724) (5,296,956)
----------- -----------
NET DEFERRED TAX ASSETS................................... $ 4,089,068 $ 6,995,643
=========== ===========
</TABLE>
In assessing the ability to realize deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible.
Management considers the scheduled reversal of deferred tax liabilities,
projected future taxable income, and tax planning strategies in making this
assessment. Based upon the level of historical taxable income and projections
for future taxable income over the periods in which the deferred tax assets are
deductible, management believes it is more likely than not the Company will
realize the benefits of these deductible differences that were available at
February 1, 1998.
At February 1, 1998, the Company has federal net operating loss
carryforwards of approximately $6,062,000 expiring in various amounts beginning
2010; however, net operating loss carryforwards may be subject to restriction
under Section 382 and the separate return limitation year rules of the Internal
Revenue Code due to the acquisition of ASI. Additionally, the Company has
minimum tax credit carryforwards with indefinite expiration of approximately
$786,000.
F-14
<PAGE> 71
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. OTHER ACCRUED LIABILITIES:
<TABLE>
<CAPTION>
FEBRUARY 1, FEBRUARY 2,
1998 1997
----------- -----------
<S> <C> <C>
Costs accrued to complete church directories.............. $ 1,043,437 $ 992,786
Accrued taxes other than income........................... 1,175,602 2,377,105
Accrued expenses.......................................... 8,248,176 8,686,672
Costs to close approximately 400 underperforming
studios................................................. 197,362 3,343,000
----------- -----------
Total........................................... $10,664,577 $15,399,563
=========== ===========
</TABLE>
6. EMPLOYEE BENEFITS:
The Company has a profit sharing plan with annual contributions by the
Company as directed by the Board of Directors for all employees who meet certain
eligibility requirements. For fiscal 1997, the contribution was equal to 10% of
consolidated income before income taxes and profit sharing less expenses
associated with the plan. Company contributions, net of forfeitures, are as
follows:
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
-----------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Contributions.................................. $1,653,000 $ 421,000 $1,429,000
Forfeitures.................................... (146,000) (212,000) (172,000)
---------- --------- ----------
Net Contribution............................... $1,507,000 $ 209,000 $1,275,000
========== ========= ==========
</TABLE>
The Company provides health and life insurance benefits to those persons
already retired on February 1, 1992 and to those employees who were 55 years of
age with 5 years of service on February 1, 1992. The plan provides for annual
benefits of $2,000 (single) or $4,000 (married) toward the purchase of
supplemental health care coverage. An eligible employee who retires after
February 1, 1992 can receive benefits after attaining the age of 65.
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7% at February 1, 1998, February 2, 1997
and January 28, 1996. There were no assumptions for trends since the Company's
obligation was limited to the dollar amounts previously stated.
The Company's net periodic cost of this program, not included in the
accumulated obligation, including service cost and interest-related cost for the
most recent three years is:
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
-----------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Service Cost................................... $ -- $ -- $ --
Interest Related Cost.......................... 140,000 140,000 154,000
---------- --------- ----------
Net Periodic Cost.............................. $ 140,000 $ 140,000 $ 154,000
========== ========= ==========
</TABLE>
On February 1, 1998, the accrued cost was $2.5 million, of which $250,000
was classified as current liabilities.
F-15
<PAGE> 72
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMITMENTS AND CONTINGENCIES:
The Company is obligated under operating leases with initial or remaining
noncancelable terms in excess of one year which provide, in some instances, for
the payment of taxes, insurance, and maintenance. The future minimum rental
payments are not material.
Certain of the Company's operating lease agreements have renewal options.
Rental expense for all operating leases was $296,567, $237,923 and $249,444 for
the fiscal years ended February 1, 1998, February 2, 1997 and January 28, 1996,
respectively.
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a materially adverse effect on the
Company's consolidated financial position, results of operations, or liquidity.
8. STOCK OPTIONS:
The 1996 Omnibus Long-Term Compensation Plan (the "1996 Plan") provides for
the issuance of up to 811,550 shares of the Company's common stock (the same
number that had been available for issuance under the Company's 1990
Non-Qualified Stock Option Plan [the "1990 Plan"] and the 1992 Non-Qualified
Stock Option Plan [the "1992 Plan"]). The 1996 Plan replaced and superseded the
1990 Plan and the 1992 Plan, except with respect to options and shares of common
stock issued and outstanding under those plans which will continue to be
governed by the terms of such plans. The 1996 Plan is designed to give the Board
of Directors flexibility to adapt the long-term incentive compensation of key
employees to changing business conditions through a variety of long-term
incentive awards. Under the 1996 Plan, the Compensation Committee may approve
the grant of employee Stock Options, Stock Appreciation Rights (SARs),
Performance Restricted Stock Awards, Performance Awards, and performance units
("Awards") to senior level employees of the Company. In addition, the 1996 Plan
provides for the grant of stock options to nonemployee directors upon their
election to the Board and allows nonemployee directors to elect to take their
compensation as directors in the form of options. The exercise price for stock
options and stock Awards may not be less than the fair market value of the
common stock on the date of grant with terms up to 10 years. As of February 1,
1998 and February 2, 1997, options for 271,250 shares and 342,850 shares were
available for future grant under the 1996 Plan, and 287,300 shares and 200,000
shares were exercisable, respectively.
The 1990 Plan provides for the grant of non-qualified stock options to key
employees and nonemployee directors. As of February 1, 1998, February 2, 1997
and January 28, 1996, options for 498,400, 588,450 and 403,350 shares,
respectively, were exercisable.
The 1992 Plan provides for the grant of non-qualified stock options to key
employees and nonemployee directors of the Company. As of February 1, 1998,
February 2, 1997 and January 28, 1996, options for 303,800, 297,900 and 0
shares, respectively, were exercisable.
The Company applies APB Opinion No. 25 in accounting for its stock option
plans and, accordingly, no compensation cost has been recognized for its stock
options in the financial statements. Had the Company
F-16
<PAGE> 73
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
determined compensation cost based on the fair value at the grant date for its
stock options under SFAS No. 123, the Company's net income would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
-----------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income............................... As reported $8,734,852 $2,993,854 $7,617,169
========== ========== ==========
Pro forma $8,365,608 $2,374,079 $7,556,540
========== ========== ==========
Basic earnings per share................. As reported $ 1.12 $ 0.40 $ 1.00
========== ========== ==========
Pro forma $ 1.08 $ 0.32 $ 0.99
========== ========== ==========
Diluted earnings per share............... As reported $ 1.07 $ 0.38 $ 0.96
========== ========== ==========
Pro forma $ 1.02 $ 0.30 $ 0.96
========== ========== ==========
</TABLE>
The following table sets forth information regarding the 1990, 1992, and
1996 Plans with respect to the exercise, cancellation, expiration, and grant of
options during the previous three fiscal years:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVERAGE
SHARES OPTION PRICE
--------- ------------
<S> <C> <C>
Options outstanding January 29, 1995........................ 1,880,550 $ 9.49
Exercised................................................. (66,200) $ 4.49
Canceled.................................................. (109,700) $10.70
Granted................................................... 199,800 $11.25
---------
Options outstanding January 28, 1996........................ 1,904,450 $ 9.76
Exercised................................................. (434,300) $ 7.79
Canceled.................................................. (15,800) $10.10
Expired................................................... (87,000) $16.22
Granted................................................... 468,700 $17.10
---------
Options outstanding February 2, 1997........................ 1,836,050 $11.80
Exercised................................................. (294,450) $10.86
Canceled.................................................. (72,200) $12.71
Granted................................................... 71,600 $16.87
---------
Options outstanding February 1, 1998........................ 1,541,000 $12.17
=========
</TABLE>
At February 1, 1998, the range of exercise prices, the weighted average
exercise price, and the weighted average contractual remaining life of options
outstanding are as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- -----------------------------
NUMBER WGT. AVG. REMAINING WGT. AVG. NUMBER WGT. AVG.
RANGE OF EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- - - - ------------------------ ----------- ------------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C>
$ 1.67 to $ 4.92......... 172,400 2.1 years $ 1.68 172,400 $ 1.68
$ 9.25 to $12.88......... 685,500 4.0 years $10.46 478,000 $10.51
$14.12 to $18.50......... 683,100 5.8 years $16.53 439,100 $16.31
--------- ---------
$ 1.67 to $18.50......... 1,541,000 5.4 years $12.17 1,089,500 $11.45
========= =========
</TABLE>
F-17
<PAGE> 74
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Options outstanding with exercise price above market price:
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
-----------------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Number................................ -- 470,200 1,257,700
============= ============= =============
Price range........................... -- $16.25-$17.12 $10.00-$17.00
============= ============= =============
</TABLE>
9. COMMON STOCK:
On March 20, 1996, the Company's Board of Directors increased the number of
shares authorized for repurchase by 744,300, bringing the total number of shares
authorized for repurchase to 1,000,000. During fiscal 1996, the Company
purchased, in various transactions, 309,242 shares. The credit agreement dated
February 28, 1997 restricts the Company from repurchasing any shares of the
Company's stock.
10. EARNINGS PER SHARE:
The following table sets forth a reconciliation of the numerators and
denominators of the basic and diluted EPS computations for the previous three
fiscal years:
<TABLE>
<CAPTION>
FOR THE FISCAL YEARS ENDED
-----------------------------------------
FEBRUARY 1, FEBRUARY 2, JANUARY 28,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
BASIC EARNINGS PER COMMON SHARE:
EARNINGS APPLICABLE TO COMMON STOCK:
Net income................................ $8,734,852 $2,993,854 $7,617,169
========== ========== ==========
Weighted average number of common
shares.................................. 7,779,176 7,522,188 7,632,297
========== ========== ==========
Basic earnings per common share........... $ 1.12 $ 0.40 $ 1.00
========== ========== ==========
DILUTED EARNINGS PER COMMON SHARE:
EARNINGS APPLICABLE TO COMMON STOCK:
Net Income................................ $8,734,852 $2,993,854 $7,617,169
========== ========== ==========
COMPUTATION OF DILUTED COMMON SHARES:
Weighted average number of common shares
outstanding............................... 7,779,176 7,522,188 7,632,297
Dilutive effect of stock options............. 398,784 313,425 262,359
Dilutive effects of warrants................. 17,148 -- --
---------- ---------- ----------
Weighted average number of common shares of
outstanding as adjusted................... 8,195,108 7,835,613 7,894,656
========== ========== ==========
DILUTED EARNINGS PER COMMON SHARE:
Net income................................... $ 1.07 $ 0.38 $ 0.96
========== ========== ==========
</TABLE>
F-18
<PAGE> 75
PCA INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. UNAUDITED QUARTERLY FINANCIAL DATA:
<TABLE>
<CAPTION>
FOR THE FISCAL YEAR ENDED FEBRUARY 1, 1998
--------------------------------------------------------
FEBRUARY 1, NOVEMBER 2, AUGUST 3, MAY 4,
1998 1997 1997 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales......................... $75,834,923 $61,235,465 $47,136,830 $58,691,809
Gross Profit*................. $25,569,922 $14,295,372 $ 7,376,925 $13,690,889
Net Income (Loss)............. $ 7,811,302 $ 1,919,844 $(1,639,620) $ 643,326
Basic Earnings Per Common
Share....................... $ 0.99 $ 0.24 $ (0.21) $ 0.08
Diluted Earnings Per Common
Share....................... $ 0.94 $ 0.23 $ (0.20) $ 0.08
</TABLE>
<TABLE>
<CAPTION>
FOR THE FISCAL YEAR ENDED FEBRUARY 2, 1997
--------------------------------------------------------
FEBRUARY 2, OCTOBER 27, JULY 28, APRIL 28,
1997 1996 1996 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales......................... $51,801,203 $37,093,025 $31,116,836 $36,087,986
Gross Profit*................. $15,250,619 $ 7,165,823 $ 5,773,728 $ 8,802,429
Net Income.................... $ 981,667 $ 641,112 $ 232,297 $ 1,138,778
Basic Earnings Per Common
Share....................... $ 0.13 $ 0.08 $ 0.03 $ 0.15
Diluted Earnings Per Common
Share....................... $ 0.12 $ 0.08 $ 0.03 $ 0.15
</TABLE>
- - - - ---------------
*Sales less advertising and promotional costs, costs of photographic sales, and
store commissions and selling costs.
F-19
<PAGE> 76
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MAY 3, FEBRUARY 1,
1998 1998
------------ ------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 11,073,455 $ 12,289,761
Accounts receivable (net of allowance for doubtful
accounts of $1,488,299 and $1,315,666):
Due from licensor stores and customers.................. 7,079,533 6,740,560
Other, including employee advances...................... 438,133 763,925
Inventories............................................... 8,069,236 10,078,719
Deferred income taxes..................................... 4,788,074 5,827,324
Prepaid expenses.......................................... 1,247,313 1,043,708
------------ ------------
Total Current Assets............................... 32,695,744 36,743,997
------------ ------------
PROPERTY:
Land and improvements..................................... 2,305,293 2,305,293
Building and improvements................................. 12,160,430 12,148,732
Photographic and sales equipment.......................... 57,685,314 57,713,911
Photographic finishing equipment.......................... 15,607,775 15,599,525
Furniture and equipment................................... 13,923,558 13,872,058
Transportation equipment.................................. 294,920 292,593
Leasehold improvements.................................... 16,022,441 16,050,719
Construction in progress.................................. 2,296,667 1,429,621
------------ ------------
Total Property..................................... 120,296,398 119,412,452
Less: Accumulated depreciation and amortization........... 66,971,841 64,488,965
------------ ------------
Property, net...................................... 53,324,557 54,923,487
------------ ------------
Intangible Assets........................................... 59,240,646 59,733,731
Other Assets................................................ 1,655,283 1,899,611
------------ ------------
Total Assets....................................... $146,916,230 $153,300,826
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt......................... $ 8,750,000 $ 8,750,000
Accounts payable -- trade................................. 23,797,823 25,915,285
Accrued insurance......................................... 3,823,960 4,085,191
Accrued income taxes...................................... 1,341,524 1,188,859
Accrued compensation...................................... 4,791,914 6,474,414
Other accrued liabilities................................. 9,858,281 10,664,577
------------ ------------
Total Current Liabilities.......................... 52,363,502 57,078,326
------------ ------------
Long-term debt.............................................. 41,104,831 42,063,857
------------ ------------
Deferred Income Taxes....................................... 107,019 1,738,255
------------ ------------
Other Liabilities........................................... 7,628,444 7,730,964
------------ ------------
SHAREHOLDERS' EQUITY:
Preferred stock, $10.000 par value
(authorized -- 2,000,000 shares; outstanding -- none)... -- --
Common Stock, $0.20 par value (authorized -- 20,000,000
shares; issued -- 7,947,879 shares and 7,901,579
shares)................................................. 1,589,576 1,580,316
Additional paid-in capital................................ 10,707,615 9,995,238
Retained earnings......................................... 33,646,734 33,423,465
Cumulative foreign currency translation adjustments....... (231,491) (309,595)
------------ ------------
Total Shareholders' Equity......................... 45,712,434 44,689,424
------------ ------------
Total Liabilities and Shareholders' Equity......... $146,916,230 $153,300,826
============ ============
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
F-20
<PAGE> 77
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------
MAY 3, MAY 4,
1998 1997
----------- -----------
<S> <C> <C>
SALES....................................................... $54,661,925 $58,691,809
----------- -----------
COSTS AND EXPENSES:
Advertising and promotional costs......................... 3,392,749 4,313,900
Costs of photographic sales............................... 19,361,353 21,794,658
Store commissions and selling costs....................... 18,822,775 18,892,362
General and administrative expenses....................... 9,921,037 10,176,412
Amortization of intangibles............................... 507,418 455,738
----------- -----------
Total costs and expenses.......................... 52,005,332 55,633,070
----------- -----------
INCOME FROM OPERATIONS...................................... 2,656,593 3,058,739
Interest expense, net..................................... 1,219,709 1,619,383
----------- -----------
INCOME BEFORE INCOME TAXES.................................. 1,436,884 1,439,356
INCOME TAX PROVISION........................................ 658,811 796,030
----------- -----------
NET INCOME.................................................. $ 778,073 $ 643,326
=========== ===========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES:
Basic..................................................... 7,931,757 7,631,209
=========== ===========
Diluted................................................... 8,373,084 7,932,863
=========== ===========
BASIC AND FULLY DILUTED EARNINGS PER
COMMON SHARE:
Basic..................................................... $ 0.10 $ 0.08
=========== ===========
Diluted................................................... $ 0.09 $ 0.08
=========== ===========
CASH DIVIDENDS PER COMMON SHARE............................. $ 0.07 $ --
=========== ===========
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
F-21
<PAGE> 78
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MAY 3, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
CUMULATIVE
FOREIGN
COMMON STOCK ADDITIONAL CURRENCY
---------------------- PAID-IN COMPREHENSIVE RETAINED TRANSLATION
SHARES AMOUNT CAPITAL INCOME EARNINGS ADJUSTMENT
--------- ---------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, FEBRUARY 1, 1998..... 7,901,579 $1,580,316 $ 9,995,238 $33,423,465 $(309,595)
Comprehensive Income
Net income.................. $778,073 778,073
Foreign currency translation
adjustment............... 46,081 78,104
--------
Total comprehensive
income................... $824,154
Exercise of stock options..... 46,300 9,260 712,377
Dividends..................... (554,804)
--------- ---------- ----------- ----------- ---------
BALANCE MAY 3, 1998:.......... 7,947,879 $1,589,576 $10,707,615 $33,646,734 $(231,491)
========= ========== =========== =========== =========
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
F-22
<PAGE> 79
PCA INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------
MAY 3, MAY 4,
1998 1997
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income................................................ $ 778,073 $ 643,326
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization.......................... 3,748,314 3,741,882
Increase (decrease) in allowance for doubtful
accounts.............................................. 172,312 (25,679)
Provision for deferred income taxes.................... (591,986) (15,743)
Loss on disposal of property........................... 166,233 4,283
Decrease in other liabilities.......................... (112,109) (275,131)
Decrease (increase) in other noncurrent assets......... 244,328 (1,499,779)
Changes in operating assets and liabilities
Increase in accounts receivable...................... (182,710) (902,267)
Decrease in inventories.............................. 2,010,683 1,700,347
(Increase) decrease in prepaid expenses.............. (193,772) 360,276
Decrease in accounts payable......................... (2,118,292) (3,412,559)
Decrease in accrued expenses......................... (2,603,743) (992,566)
----------- -----------
NET CASH PROVIDED FROM (USED IN) OPERATING ACTIVITIES....... 1,317,331 (673,610)
----------- -----------
INVESTING ACTIVITIES:
Purchase of property...................................... (1,785,076) (3,363,219)
Purchase of American Studios, Inc......................... -- (2,516,646)
Proceeds from sale of fixed assets........................ 17,568 1,200
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES..................... (1,767,508) (5,878,665)
----------- -----------
FINANCING ACTIVITIES:
(Decrease) increase in borrowings......................... (959,026) 7,798,680
Exercise of stock options................................. 721,637 963,121
Cash dividends............................................ (554,804) --
----------- -----------
NET CASH (USED IN) PROVIDED FROM FINANCING ACTIVITIES....... (792,193) 8,761,801
----------- -----------
Effect of exchange rate changes on cash................... 26,064 (11,106)
----------- -----------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............ (1,216,306) 2,198,420
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 12,289,761 1,536,234
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $11,073,455 $ 3,734,654
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash Flow Data:
Interest paid.......................................... $ 901,935 $ 3,736,171
=========== ===========
Income taxes paid...................................... $ 986,472 $ 1,219,348
=========== ===========
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
F-23
<PAGE> 80
PCA INTERNATIONAL INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE QUARTERS ENDED MAY 3, 1998 AND MAY 4, 1997
With respect to the significant accounting policies of PCA International,
Inc., and its subsidiaries ("PCA" or the "Company"), which are wholly owned,
reference is made to note 1 of the financial statements in the Company's Form
10-K filed for the fiscal year ended February 1, 1998. The interim financial
statements reflect all adjustments (consisting of normal recurring accruals)
which are, in the opinion of management, necessary for a fair statement of the
results for the interim periods presented.
F-24
