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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q



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(Mark One)

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



For the quarterly period ended August 3, 2003



OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------



For the transition period from
 to



Commission file number 0-8550



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PCA International, Inc.

(Exact name of registrant as specified in its charter)



|North Carolina                                                 |  | 56-0888429                       
|-------------------------------------------------------------- |  | ---------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (IRS Employer Identification No.)



815 Matthews-Mint
Hill Road

Matthews, North Carolina 28105

(Address of principal executive offices)

(Zip Code)



(704) 588-4351

(Registrants telephone number, including area code)



---



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



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



As of September 17, 2003, there were 2,294,352 shares of the registrants common stock outstanding.



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##### Table of Contents

Table of Contents



|             |  |                                                                                                                                           |  | Page No.
|------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------- |  | --------
|Part I.      |  | Financial Information                                                                                                                     |  | 1       
|             |  |                                                                                                                                          
|Item 1.      |  | Financial Statements                                                                                                                      |  | 1       
|             |  |                                                                                                                                          
|             |  | Consolidated Balance Sheets as of August 3, 2003 (Unaudited) and February 2, 2003                                                         |  | 1       
|             |  |                                                                                                                                          
|             |  | Consolidated Statements of Operations Thirteen Weeks and Twenty-Six Weeks Ended August 3, 2003 (Unaudited) and August 4, 2002 (Unaudited) |  | 3       
|             |  |                                                                                                                                          
|             |  | Consolidated Statements of Cash Flows Twenty-Six Weeks Ended August 3, 2003 (Unaudited) and August 4, 2002 (Unaudited)                    |  | 4       
|             |  |                                                                                                                                          
|             |  | Notes to Consolidated Financial Statements (Unaudited)                                                                                    |  | 6       
|             |  |                                                                                                                                          
|Item 2.      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                                     |  | 16      
|             |  |                                                                                                                                          
|Item 3.      |  | Quantitative and Qualitative Disclosures About Market Risk                                                                                |  | 21      
|             |  |                                                                                                                                          
|Item 4.      |  | Controls and Procedures                                                                                                                   |  | 21      
|             |  |                                                                                                                                          
|Part II.     |  | Other Information                                                                                                                         |  | 21      
|             |  |                                                                                                                                          
|Item 6.      |  | Exhibits and Reports on Form 8-K                                                                                                          |  | 21      
|             |  |                                                                                                                                          
|             |  | Signatures                                                                                                                                |  | 22      
|             |  |                                                                                                                                          
|Exhibit 31.1 |  | Section 302 Certification of Principal Executive Officer                                                                                  |  | 23      
|             |  |                                                                                                                                          
|Exhibit 31.2 |  | Section 302 Certification of Principal Financial Officer                                                                                  |  | 24      



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##### Table of Contents

Part I. Financial Information



Item 1. Financial Statements



PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollar amounts in thousands)



|                                               |  | August 3,2003 |         | February 2,2003
|---------------------------------------------- |  | ------------- | ------- | ---------------
|                                               |  | (unaudited)   |         |                
|ASSETS                                         |  |               |         |                
|CURRENT ASSETS:                                |  |               |         |                
|Cash and cash equivalents                      |  | $             | 5,635   |                
|Accounts receivable                            |  |               | 2,454   |                
|Inventories                                    |  |               | 11,682  |                
|Deferred income taxes                          |  |               | 4,303   |                
|Prepaid expenses and other assets              |  |               | 3,741   |                
|                                               |  |               |         |                
|Total current assets                           |  |               | 27,815  |                
|PROPERTY AND EQUIPMENT:                        |  |               |         |                
|Land and improvements                          |  |               | 2,305   |                
|Buildings and improvements                     |  |               | 12,678  |                
|Photographic, sales and finishing equipment    |  |               | 130,574 |                
|Studio improvements                            |  |               | 21,214  |                
|Construction in progress                       |  |               | 4,193   |                
|                                               |  |               |         |                
|Total                                          |  |               | 170,964 |                
|Less accumulated depreciation and amortization |  |               | 106,671 |                
|                                               |  |               |         |                
|Property and equipment, net                    |  |               | 64,293  |                
|GOODWILL                                       |  |               | 51,609  |                
|DEFERRED FINANCING COSTS, NET                  |  |               | 9,301   |                
|DEFERRED INCOME TAXES, NONCURRENT              |  |               | 13,426  |                
|OTHER ASSETS                                   |  |               | 33      |                
|                                               |  |               |         |                
|TOTAL ASSETS                                   |  | $             | 166,477 |                
|                                               |  |               |         |                





See notes to consolidated financial statements.



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##### Table of Contents

PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (continued)

(dollar amounts in thousands)





|                                                                                                                                                 |  | August 3,2003 |          |   | February 2,2003 |  
|------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | -------- | - | --------------- | -
|                                                                                                                                                 |  | (unaudited)   |          |   |                 |  
|                                                                                                                                                 |  |              
|LIABILITIES AND SHAREHOLDERS DEFICIENCY                                                                                                         |  |               |          |   |                 |  
|CURRENT LIABILITIES:                                                                                                                             |  |               |          |   |                 |  
|Short-term borrowings                                                                                                                            |  | $             | 17,600   |   |                 | $
|Current portion of long-term debt                                                                                                                |  |               | 100      |   |                 |  
|Accounts payabletrade                                                                                                                           |  |               | 29,309   |   |                 |  
|Accrued insurance                                                                                                                                |  |               | 4,092    |   |                 |  
|Accrued income taxes                                                                                                                             |  |               | 452      |   |                 |  
|Accrued compensation                                                                                                                             |  |               | 5,336    |   |                 |  
|Accrued interest                                                                                                                                 |  |               | 492      |   |                 |  
|Other accrued liabilities                                                                                                                        |  |               | 12,781   |   |                 |  
|                                                                                                                                                 |  |               |          |   |                 |  
|Total current liabilities                                                                                                                        |  |               | 70,162   |   |                 |  
|LONG-TERM DEBT                                                                                                                                   |  |               | 221,288  |   |                 |  
|OTHER LIABILITIES                                                                                                                                |  |               | 3,960    |   |                 |  
|                                                                                                                                                 |  |               |          |   |                 |  
|TOTAL LIABILITIES                                                                                                                                |  |               | 295,410  |   |                 |  
|COMMITMENTS AND CONTINGENCIES                                                                                                                    |  |               |          |   |                 |  
|SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK, $10.00 par value (authorized200,000 shares; outstanding15,000
shares)                         |  |               | 33,183   |   |                 |  
|SHAREHOLDERS DEFICIENCY:                                                                                                                        |  |               |          |   |                 |  
|Common stock, $0.20 par value (authorized20,000,000 shares; issued and outstandingAugust 3, 20032,294,352
shares; February 2, 20032,293,152) |  |               | 459      |   |                 |  
|Warrants to purchase Series A redeemable convertible preferred stock (issued and outstanding287)                                                |  |               | 642      |   |                 |  
|Warrants to purchase common stock (issued and outstanding306,610)                                                                               |  |               | 2,947    |   |                 |  
|Additional paid-in capital                                                                                                                       |  |               | 2,870    |   |                 |  
|Deficit                                                                                                                                          |  |               | (169,058 | ) |                 |  
|Accumulated other comprehensive income (loss)                                                                                                    |  |               | 24       |   |                 |  
|                                                                                                                                                 |  |               |          |   |                 |  
|Total shareholders deficiency                                                                                                                   |  |               | (162,116 | ) |                 |  
|                                                                                                                                                 |  |               |          |   |                 |  
|TOTAL LIABILITIES AND SHAREHOLDERS DEFICIENCY                                                                                                   |  | $             | 166,477  |   |                 | $
|                                                                                                                                                 |  |               |          |   |                 |  





See notes to consolidated financial statements.



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PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(dollar amounts in
thousands)



|                             |  | For the ThirteenWeeks Ended |        |   | For the Twenty-SixWeeks Ended |  
|---------------------------- |  | --------------------------- | ------ | - | ----------------------------- | -
|                             |  | August 3,2003               |        |   | August 4,2002                 |  
|SALES                        |  | $                           | 71,309 |   |                               | $
|COST OF SALES                |  |                             | 55,284 |   |                               |  
|                             |  |                             |        |   |                               |  
|GROSS PROFIT                 |  |                             | 16,025 |   |                               |  
|GENERAL AND ADMINISTRATIVE   |  |                             | 10,846 |   |                               |  
|AMORTIZATION OF INTANGIBLES  |  |                             |       |   |                               |  
|                             |  |                             |        |   |                               |  
|INCOME FROM OPERATIONS       |  |                             | 5,179  |   |                               |  
|INTEREST INCOME              |  |                             | 3      |   |                               |  
|INTEREST EXPENSE             |  |                             | (7,659 | ) |                               |  
|OTHER INCOME (EXPENSE)       |  |                             |       |   |                               |  
|EARLY EXTINGUISHMENT OF DEBT |  |                             |       |   |                               |  
|                             |  |                             |        |   |                               |  
|LOSS BEFORE INCOME TAXES     |  |                             | (2,477 | ) |                               |  
|INCOME TAX BENEFIT           |  |                             | 1,094  |   |                               |  
|                             |  |                             |        |   |                               |  
|NET LOSS                     |  | $                           | (1,383 | ) |                               | $
|                             |  |                             |        |   |                               |  



See notes to
consolidated financial statements.



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PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(dollar amounts in
thousands)

|                                                                                          |  | For the Twenty-six WeeksEnded |        
|----------------------------------------------------------------------------------------- |  | ----------------------------- | -------
|                                                                                          |  | August 3, 2003                |        
|OPERATING ACTIVITIES:                                                                     |  |                               |        
|Net loss                                                                                  |  | $                             | (3,058 
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                               |        
|Depreciation and amortization                                                             |  |                               | 5,607  
|Amortization of deferred financing cost                                                   |  |                               | 804    
|Interest expense-effective interest method                                                |  |                               |       
|Change in fair value of derivative instruments                                            |  |                               |       
|Early extinguishment of debt                                                              |  |                               |       
|Amortization of debt discounts                                                            |  |                               | 307    
|Provision for deferred income taxes                                                       |  |                               | (2,399 
|Loss on disposal of property and equipment                                                |  |                               | 150    
|Changes in assets and liabilities which provided (used) cash:                             |  |                               |        
|Accounts receivable                                                                       |  |                               | (731   
|Inventories                                                                               |  |                               | (1,140 
|Prepaid expenses and other assets                                                         |  |                               | (770   
|Other noncurrent assets                                                                   |  |                               | 6      
|Accounts payable - trade                                                                  |  |                               | 2,682  
|Accrued expenses                                                                          |  |                               | 685    
|Accrued interest                                                                          |  |                               | (8,913 
|Other current and non-current accrued liabilities                                         |  |                               | 3,097  
|                                                                                          |  |                               |        
|NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES                                       |  |                               | (3,673 
|                                                                                          |  |                               |        
|INVESTING ACTIVITIES:                                                                     |  |                               |        
|Purchase of property and equipment                                                        |  |                               | (11,744
|Proceeds from sales of property and equipment                                             |  |                               | 7      
|                                                                                          |  |                               |        
|NET CASH USED IN INVESTING ACTIVITIES                                                     |  |                               | (11,737
|                                                                                          |  |                               |        



See notes to
consolidated financial statements.



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PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)

(dollar amounts in
thousands)



|                                                                                     |  | For the Twenty-six WeeksEnded |        
|------------------------------------------------------------------------------------ |  | ----------------------------- | -------
|                                                                                     |  | August 3, 2003                |        
|FINANCING ACTIVITIES:                                                                |  |                               |        
|Increase in borrowings under senior secured credit facility                          |  |                               | 47,900 
|Repayment of senior secured credit facility and capital lease obligations            |  |                               | (29,145
|Repayment of senior subordinated term loans                                          |  |                               |       
|Deferred financing cost                                                              |  |                               | (82    
|Proceeds from issuance of senior notes                                               |  |                               |       
|Proceeds from issuance of PCA International, Inc. senior subordinated discount notes |  |                               |       
|Proceeds from issuance of PCA LLC senior subordinated term loans                     |  |                               |       
|Issuance of common stock                                                             |  |                               | 10     
|                                                                                     |  |                               |        
|NET CASH PROVIDED BY FINANCING ACTIVITIES                                            |  |                               | 18,683 
|                                                                                     |  |                               |        
|EFFECT OF EXCHANGE RATE CHANGES ON CASH                                              |  |                               | (160   
|                                                                                     |  |                               |        
|INCREASE IN CASH AND CASH EQUIVALENTS                                                |  |                               | 3,113  
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                     |  |                               | 2,522  
|                                                                                     |  |                               |        
|CASH AND CASH EQUIVALENTS AT END OF PERIOD                                           |  | $                             | 5,635  
|                                                                                     |  |                               |        
|NONCASH INVESTING AND FINANCING ACTIVITIES:                                          |  |                               |        
|Issuance of warrants                                                                 |  | $                             |       
|                                                                                     |  |                               |        
|Cancellation of warrants                                                             |  | $                             |       
|                                                                                     |  |                               |        
|Paid-in-kind interest capitalized                                                    |  | $                             | 2,679  
|                                                                                     |  |                               |        



See notes to
consolidated financial statements.



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PCA INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(dollar amounts in
thousands, except where noted)



1. BASIS OF PRESENTATION



The accompanying unaudited Consolidated Financial Statements of PCA International, Inc.
and its subsidiaries (the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. The financial statements do not include all information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the accompanying consolidated financial
statements contain all adjustments (including normal recurring accruals) necessary for a fair presentation of the Companys financial information. Operating results for the thirteen week and twenty-six week periods ended August 3, 2003 and
August 4, 2002 are not necessarily indicative of the results for the fiscal years ending February 1, 2004 and February 2, 2003, respectively. These financial statements should be read in conjunction with the Consolidated Financial Statements
included in the Companys Annual Report on Form 10-K for the fiscal year ended February 2, 2003.



Certain financial statement items have been reclassified to conform to the current periods format.



2. STOCK OPTION PLAN



The Company accounts 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 relating to stock options granted to employees is recorded on the date of grant only if the current fair value of the underlying stock exceeds the exercise price (see Note 9 to the Consolidated
Financial Statements (Item 8.) in the Annual Report on Form 10-K for the fiscal year ended February 2, 2003.)



As required by Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based CompensationTransition and Disclosurean amendment of FASB Statement No. 123, the
Company provides pro forma net income disclosures for employee stock option grants as if the fair-value-based method as defined in SFAS No. 123 had been applied. The Companys net income as reported and the pro forma amounts are indicated
below:



|                                              |  | For the Thirteen Weeks Ended |        |   | For the Twenty-Six Weeks Ended |  
|--------------------------------------------- |  | ---------------------------- | ------ | - | ------------------------------ | -
|                                              |  | August 3,2003                |        |   | August 4,2002                  |  
|Net loss attributable to common shareholders: |  |                              |        |   |                                |  
|As reported                                   |  | $                            | (1,383 | ) |                                | $
|                                              |  |                              |        |   |                                |  
|Proforma                                      |  | $                            | (1,393 | ) |                                | $
|                                              |  |                              |        |   |                                |  



3. IMPACT OF NEWLY ISSUED
ACCOUNTING STANDARDS



In April 2003, the Financial Accounting Standards
Board (FASB) issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133. The adoption of SFAS No. 149 did not affect the Companys financial position and results of operations.



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In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. SFAS No. 150 establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires an issuer to classify preferred stock as a
liability at fair value when it becomes manditorily redeemable. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after
June 15, 2003. The adoption of SFAS No. 150 did not affect the Companys financial position and results of operations.



4. SEASONALITY



Sales of portrait photography and ancillary portrait photography products are highly seasonal, with the holiday season accounting for a high percentage of sales as well as operating income. The fourth quarter
(generally, late October/early November through late January/early February) typically produces a large percentage of annual sales and operating income. First quarter and second quarter results may be affected by the timing of the Easter holiday.



5. COMPREHENSIVE LOSS



Total comprehensive loss for the thirteen weeks and twenty-six weeks ended August 3, 2003
and August 4, 2002 was comprised of the following:



|                                                      |  | For the ThirteenWeeks Ended |        |   | For the Twenty-SixWeeks Ended |  
|----------------------------------------------------- |  | --------------------------- | ------ | - | ----------------------------- | -
|                                                      |  | August 3,2003               |        |   | August 4,2002                 |  
|Net loss                                              |  | $                           | (1,383 | ) |                               | $
|Foreign currency translation adjustment, net of taxes |  |                             | 20     |   |                               |  
|                                                      |  |                             |        |   |                               |  
|Total comprehensive loss                              |  | $                           | (1,363 | ) |                               | $
|                                                      |  |                             |        |   |                               |  



6. DERIVATIVE: SERIES A REDEEMABLE
CONVERTIBLE PREFERRED STOCK



In connection with a 1999 recapitalization,
the Company issued an aggregate amount of $15.0 million of Series A Redeemable Convertible Preferred Stock (Series A) for cash proceeds of $14.9 million. On December 9, 2002, a special meeting of the shareholders of the Company was held
and the shareholders approved modifications to the liquidation and redemption provisions of the Series A. Upon the filing of the restated articles of incorporation of the Company on December 20, 2002, the liquidation and redemption provisions of the
Series A were modified. The Series A may now be redeemed at the option of the holders of the Series A, rather than being mandatorily redeemable on April 30, 2011. Also, the redemption price of the Series A and the amount payable upon certain
extraordinary events is now $1,000 per share plus all declared and unpaid dividends, rather than the greater of $1,000 per share or the fair market value of the common stock into which the Series A is convertible plus all declared and unpaid
dividends. As a result of the change in these provisions, the Company has determined that the embedded derivative in the Series A no longer meets the requirements for bifurcation and separate accounting under the provisions of SFAS No. 133.



Upon the adoption of SFAS No. 133 in fiscal 2001, the Series A met the
definition of a hybrid instrument. This hybrid instrument was comprised of a debt instrument (mandatorily redeemable preferred stock), as the host contract, and an embedded derivative consisting of the conversion option, which derives its value, in
part, based on changes in the fair value of the Companys common stock. The embedded derivative instrument was not clearly and closely related to the underlying debt instrument because the economic characteristics and risks associated with this
derivative are based on equity prices. Therefore, in accordance with SFAS No. 133, the Company separated the embedded derivative instrument from the host contract based on their relative fair values and classified the embedded derivative as a
component of other liabilities in the consolidated balance sheets until December 20, 2002. Changes in the fair value of the derivative were classified as a component of other expenses in the consolidated statement of operations. For the thirteen
weeks and twenty-six weeks ended August 4, 2002, the mark-to-market change in the fair value resulted in other income of $5,000 and other expense of $2.1 million, respectively.





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The Company had an independent valuation performed regarding the fair value of the embedded derivative prior to the
change in the redemption and liquidation provisions on December 20, 2002. The fair value of the embedded derivative was determined to be $27.3 million on December 20, 2002. Given the change in the liquidation and redemption provisions of the Series
A and, thus, the elimination of the need to bifurcate and separately account for the embedded derivative, the $27.3 million was reclassified into the Series A on the balance sheet. The revised carrying amount of the Series A on December 20, 2002 of
$35.4 million is being accreted to the $15.0 million par value over the life of the Series A using the effective interest method. As of August 3, 2003 and February 2, 2003, the Series A carrying amount was $33.2 million and $34.9 million,
respectively.



7. OTHER ACCRUED LIABILITIES



Other accrued liabilities were comprised of the following:



|                                |  | August 3, 2003 |        | February 2,2003
|------------------------------- |  | -------------- | ------ | ---------------
|Accrued taxes other than income |  | $              | 2,708  |                
|Other accrued expenses          |  |                | 3,954  |                
|Customer deposits               |  |                | 6,119  |                
|                                |  |                |        |                
|                                |  | $              | 12,781 |                
|                                |  |                |        |                



8. OTHER LIABILITIES



Other liabilities were comprised of the following:



|                                                       |  | August 3, 2003 |       | February 2,2003
|------------------------------------------------------ |  | -------------- | ----- | ---------------
|Accrued interest                                       |  | $              | 596   |                
|Long-term portion of retiree benefit obligation        |  |                | 1,060 |                
|Long-term portion of workers compensation obligations |  |                | 2,304 |                
|                                                       |  |                |       |                
|                                                       |  | $              | 3,960 |                
|                                                       |  |                |       |                



9. GOODWILL AND INTANGIBLE ASSETS



As of August 3, 2003 and February 2, 2003, the Company had no intangible
assets subject to amortization. The following table sets forth the information for intangible assets not subject to amortization:



|                               |  | August 3,2003 |        | February 2,2003
|------------------------------ |  | ------------- | ------ | ---------------
|Unamortized intangible assets: |  |               |        |                
|Goodwill                       |  | $             | 51,609 |                
|                               |  |               |        |                



|                               |  | For the Thirteen Weeks Ended |   | For the Twenty-Six Weeks Ended
|------------------------------ |  | ---------------------------- | - | ------------------------------
|                               |  | August 3, 2003               |   | August 4, 2002                
|Aggregate amortization expense |  | $                            |  |                               
|                               |  |                              |   |                               





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10. BUSINESS SEGMENT AND GEOGRAPHIC DATA



The Company has two reportable segments, Retail Portraiture and Institutional Portraiture. The Retail Portraiture segment serves permanent
and traveling studios in retail stores and military bases in the United States, Canada, Mexico, Germany and the United Kingdom. The Institutional Portraiture segment serves institutional markets such as church congregations and schools.



The Company evaluates performance based on sales and Adjusted EBITDA (a non-GAAP financial
measure). Adjusted EBITDA is also a significant financial covenant under the terms of the Companys senior secured credit facility (see Note 2 to the Consolidated Financial Statements (Item 8.) in the Annual Report on Form 10-K for the fiscal
year ended February 2, 2003) upon which the Companys performance is evaluated. The Company defines Adjusted EBITDA as income (loss) before cumulative effect of accounting change plus the mark-to-market adjustment expense for the embedded
derivative in the Series A (other expense), early extinguishment of debt, interest, taxes, depreciation and amortization. Although the Company may maintain information at the segment level, certain indicators such as assets and capital expenditures
are not evaluated at the segment level. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in the Annual Report on Form 10-K for the fiscal year ended February 2,
2003.



Adjusted EBITDA is presented herein because the Company believes it to
be relevant and useful information to investors because it is used by management to evaluate the operating performance of the business and compare the Companys operating performance with that of its competitors. Management also uses Adjusted
EBITDA for planning purposes, including the preparation of annual operating budgets, to determine appropriate levels of operating and capital investments and as one of the target elements in the Companys compensation incentive programs.
Adjusted EBITDA excludes certain items, including the mark-to-market change in the fair value of the Series A and the loss on early extinguishment of debt, which management believes are not indicative of the Companys core operating results and
are not expected to have a financial impact in the foreseeable future. The Company therefore utilizes Adjusted EBITDA as a useful alternative to net income as an indicator of operating performance. However, Adjusted EBITDA is not a measure of
financial performance under GAAP and Adjusted EBITDA should be considered in addition to, but not as a substitute for, other measures of financial performance reported in accordance with GAAP, such as net income. While management believes that some
of the items excluded from Adjusted EBITDA are not indicative of the Companys core operating results, these items do impact the Companys statement of operations, and management, therefore, utilizes Adjusted EBITDA as an operating
performance measure in conjunction with GAAP measures such as net income and gross margin.



The following table reconciles net loss to Adjusted EBITDA:



|                                            |  | RetailPortraiture |        |   | Institutional Portraiture |   |      | Consolidated | 
|------------------------------------------- |  | ----------------- | ------ | - | ------------------------- | - | ---- | ------------ | 
|For the thirteen weeks ended August 3, 2003 |  |                   |        |   |                           |   |      |              | 
|Net loss                                    |  | $                 | (1,099 | ) |                           | $ | (284 | )            | 
|Reconciling items:                          |  |                   |        |   |                           |   |      |              | 
|Depreciation and amortization               |  |                   | 2,838  |   |                           |   | 43   |              | 
|Income tax benefit                          |  |                   | (1,059 | ) |                           |   | (35  | )            | 
|Interest income                             |  |                   | (3     | ) |                           |   |     |              | 
|Interest expense                            |  |                   | 7,345  |   |                           |   | 314  |              | 
|                                            |  |                   |        |   |                           |   |      |              | 
|Adjusted EBITDA                             |  | $                 | 8,022  |   |                           | $ | 38   |              | 
|                                            |  |                   |        |   |                           |   |      |              | 
|For the thirteen weeks ended August 4, 2002 |  |                   |        |   |                           |   |      |              | 
|Net loss                                    |  | $                 | (7,935 | ) |                           | $ | (935 | )            | 
|Reconciling items:                          |  |                   |        |   |                           |   |      |              | 
|Depreciation and amortization               |  |                   | 2,415  |   |                           |   | 42   |              | 
|Interest income                             |  |                   | (3     | ) |                           |   |     |              | 
|Interest expense                            |  |                   | 6,738  |   |                           |   | 322  |              | 
|Other income                                |  |                   | (5     | ) |                           |   |     |              | 
|Early extinguishment of debt                |  |                   | 4,424  |   |                           |   | 145  |              | 
|                                            |  |                   |        |   |                           |   |      |              | 
|Adjusted EBITDA                             |  | $                 | 5,634  |   |                           | $ | (426 | )            | 
|                                            |  |                   |        |   |                           |   |      |              | 



9



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##### Table of Contents

|                                              |  | RetailPortraiture  |         |   | Institutional Portraiture |   |        | Consolidated | 
|--------------------------------------------- |  | ------------------ | ------- | - | ------------------------- | - | ------ | ------------ | 
|For the twenty-six weeks ended August 3, 2003 |  |                    |         |   |                           |   |        |              | 
|Net loss                                      |  | $                  | (2,383  | ) |                           | $ | (675   | )            | 
|Reconciling items:                            |  |                    |         |   |                           |   |        |              | 
|Depreciation and amortization                 |  |                    | 5,512   |   |                           |   | 95     |              | 
|Income tax benefit                            |  |                    | (2,323  | ) |                           |   | (76    | )            | 
|Interest income                               |  |                    | (5      | ) |                           |   |       |              | 
|Interest expense                              |  |                    | 14,739  |   |                           |   | 594    |              | 
|                                              |  |                    |         |   |                           |   |        |              | 
|Adjusted EBITDA                               |  | $                  | 15,540  |   |                           | $ | (62    | )            | 
|                                              |  |                    |         |   |                           |   |        |              | 
|For the twenty-six weeks ended August 4, 2002 |  |                    |         |   |                           |   |        |              | 
|Net loss                                      |  | $                  | (9,204  | ) |                           | $ | (1,486 | )            | 
|Reconciling items:                            |  |                    |         |   |                           |   |        |              | 
|Depreciation and amortization                 |  |                    | 4,691   |   |                           |   | 82     |              | 
|Interest income                               |  |                    | (5      | ) |                           |   |       |              | 
|Interest expense                              |  |                    | 13,169  |   |                           |   | 645    |              | 
|Other expense                                 |  |                    | 1,943   |   |                           |   | 118    |              | 
|Early extinguishment of debt                  |  |                    | 4,424   |   |                           |   | 145    |              | 
|                                              |  |                    |         |   |                           |   |        |              | 
|Adjusted EBITDA                               |  | $                  | 15,018  |   |                           | $ | (496   | )            | 
|                                              |  |                    |         |   |                           |   |        |              | 
|                                              |  |                    |        
|Business Segment Data                         |  | Retail Portraiture |         |   | Institutional Portraiture |   |        | Consolidated | 
|For the thirteen weeks ended August 3, 2003   |  |                    |         |   |                           |   |        |              | 
|Sales                                         |  | $                  | 68,351  |   |                           | $ | 2,958  |              | 
|Adjusted EBITDA                               |  | $                  | 8,022   |   |                           | $ | 38     |              | 
|                                              |  |                    |        
|For the thirteen weeks ended August 4, 2002   |  |                    |         |   |                           |   |        |              | 
|Sales                                         |  | $                  | 58,728  |   |                           | $ | 3,051  |              | 
|Adjusted EBITDA                               |  | $                  | 5,634   |   |                           | $ | (426   | )            | 
|                                              |  |                    |        
|For the twenty-six weeks ended August 3, 2003 |  |                    |         |   |                           |   |        |              | 
|Sales                                         |  | $                  | 136,899 |   |                           | $ | 5,966  |              | 
|Adjusted EBITDA                               |  | $                  | 15,540  |   |                           | $ | (62    | )            | 
|                                              |  |                    |        
|For the twenty-six weeks ended August 4, 2002 |  |                    |         |   |                           |   |        |              | 
|Sales                                         |  | $                  | 123,277 |   |                           | $ | 6,424  |              | 
|Adjusted EBITDA                               |  | $                  | 15,018  |   |                           | $ | (496   | )            | 



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|Geographic Data as of and for the Thirteen Weeks andTwenty-Six Weeks Ended: |  | United States |         | Canada |   | Mexico |  | Other Foreign |       | Consolidated
|--------------------------------------------------------------------------- |  | ------------- | ------- | ------ | - | ------ |  | ------------- | ----- | ------------
|August 3, 2003                                                              |  |               |         |        |   |        |  |               |       |             
|Sales for the Thirteen Weeks Ended                                          |  | $             | 64,878  |        | $ | 4,201  |  | $             | 2,088 |             
|Sales for the Twenty-Six Weeks Ended                                        |  |               | 130,977 |        |   | 7,613  |  |               | 4,043 |             
|Long-lived assets                                                           |  |               | 105,452 |        |   | 5,863  |  |               | 3,181 |             
|                                                                            |  |               |         |        |  
|August 4, 2002                                                              |  |               |         |        |   |        |  |               |       |             
|Sales for the Thirteen Weeks Ended                                          |  | $             | 56,688  |        | $ | 3,427  |  | $             | 1,664 |             
|Sales for the Twenty-Six Weeks Ended                                        |  |               | 119,886 |        |   | 6,627  |  |               | 3,188 |             
|Long-lived assets                                                           |  |               | 97,842  |        |   | 4,913  |  |               | 2,760 |             



11



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##### Table of Contents

11. GUARANTOR AND NON-GUARANTOR FINANCIAL STATEMENTS



On June 27, 2002, PCA LLC (the Issuer) and PCA Finance Corp. (the
Co-issuer) issued an aggregate amount of $165 million of 11.875% senior notes due 2009 (the Senior Notes) at an offering price of 98.218%. Payment of the Senior Notes is unconditionally guaranteed, jointly and severally, by
the Company and all of the Issuers domestic subsidiaries (other than the Co-issuer).



The Company has determined that separate and complete financial statements of the guarantor entities would not be material to users of the financial statements; therefore, the following information sets forth
condensed consolidated financial statements of the guarantor and non-guarantor companies (see Note 2 to the Consolidated Financial Statements (Item 8.) in the Annual Report on Form 10-K for the fiscal year ended February 2, 2003.)



PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET

August 3, 2003

(Unaudited)



|                                                |  | Parent/Guarantor |          |   | Issuer andGuarantorSubsidiaryEntities |   |          | Non-guarantorEntities |  |   | Eliminations |   | Total |  
|----------------------------------------------- |  | ---------------- | -------- | - | ------------------------------------- | - | -------- | --------------------- |  | - | ------------ | - | ----- | -
|Assets:                                         |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Cash and cash equivalents                       |  | $                |         |   |                                       | $ | 5,433    |                       |  | $ | 202          |   |       | $
|Accounts receivable                             |  |                  |         |   |                                       |   | 2,209    |                       |  |   | 245          |   |       |  
|Inventories                                     |  |                  |         |   |                                       |   | 11,638   |                       |  |   | 44           |   |       |  
|Deferred income taxes                           |  |                  |         |   |                                       |   | 4,303    |                       |  |   |             |   |       |  
|Prepaid expenses and other assets               |  |                  |         |   |                                       |   | 3,147    |                       |  |   | 594          |   |       |  
|                                                |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Total current assets                            |  |                  |         |   |                                       |   | 26,730   |                       |  |   | 1,085        |   |       |  
|Investments and intercompany receivables        |  |                  | (94,821  | ) |                                       |   | (45,876  | )                     |  |   | (5,806       | ) |       |  
|Property and equipment, net                     |  |                  |         |   |                                       |   | 59,693   |                       |  |   | 4,600        |   |       |  
|Goodwill, intangible and other assets, net      |  |                  |         |   |                                       |   | 51,622   |                       |  |   | 20           |   |       |  
|Deferred financing costs, net                   |  |                  |         |   |                                       |   | 9,301    |                       |  |   |             |   |       |  
|Deferred income taxes, noncurrent               |  |                  |         |   |                                       |   | 13,426   |                       |  |   |             |   |       |  
|                                                |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Total assets                                    |  | $                | (94,821  | ) |                                       | $ | 114,896  |                       |  | $ | (101         | ) |       | $
|                                                |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Liabilities and shareholders deficiency:       |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Short-term borrowings                           |  | $                |         |   |                                       | $ | 17,600   |                       |  | $ |             |   |       | $
|Current portion of long-term debt               |  |                  |         |   |                                       |   | 100      |                       |  |   |             |   |       |  
|Accounts payable - trade                        |  |                  |         |   |                                       |   | 29,095   |                       |  |   | 214          |   |       |  
|Accrued insurance                               |  |                  |         |   |                                       |   | 4,092    |                       |  |   |             |   |       |  
|Accrued income taxes                            |  |                  |         |   |                                       |   | 452      |                       |  |   |             |   |       |  
|Accrued compensation                            |  |                  |         |   |                                       |   | 5,314    |                       |  |   | 22           |   |       |  
|Accrued interest                                |  |                  |         |   |                                       |   | 492      |                       |  |   |             |   |       |  
|Other accrued liabilities                       |  |                  |         |   |                                       |   | 12,714   |                       |  |   | 67           |   |       |  
|                                                |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Total current liabilities                       |  |                  |         |   |                                       |   | 69,859   |                       |  |   | 303          |   |       |  
|Long-term debt, less current portion            |  |                  | 34,112   |   |                                       |   | 187,176  |                       |  |   |             |   |       |  
|Other liabilities                               |  |                  |         |   |                                       |   | 3,960    |                       |  |   |             |   |       |  
|Series A redeemable convertible preferred stock |  |                  | 33,183   |   |                                       |   |         |                       |  |   |             |   |       |  
|Total shareholders deficiency                  |  |                  | (162,116 | ) |                                       |   | (146,099 | )                     |  |   | (404         | ) |       |  
|                                                |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Total liabilities and shareholders deficiency  |  | $                | (94,821  | ) |                                       | $ | 114,896  |                       |  | $ | (101         | ) |       | $
|                                                |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  



12



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PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING BALANCE SHEET

February 2, 2003

(Unaudited)



|                                                        |  | Parent/Guarantor |          |   | Issuer andGuarantorSubsidiaryEntities |   |          | Non-guarantorEntities |  |   | Eliminations |   | Total |  
|------------------------------------------------------- |  | ---------------- | -------- | - | ------------------------------------- | - | -------- | --------------------- |  | - | ------------ | - | ----- | -
|Assets:                                                 |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Cash and cash equivalents                               |  | $                |         |   |                                       | $ | 2,312    |                       |  | $ | 210          |   |       | $
|Accounts receivable                                     |  |                  |         |   |                                       |   | 1,472    |                       |  |   | 251          |   |       |  
|Inventories                                             |  |                  |         |   |                                       |   | 10,493   |                       |  |   | 49           |   |       |  
|Deferred income taxes                                   |  |                  |         |   |                                       |   | 4,303    |                       |  |   |             |   |       |  
|Prepaid expenses and other assets                       |  |                  |         |   |                                       |   | 2,356    |                       |  |   | 615          |   |       |  
|                                                        |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Total current assets                                    |  |                  |         |   |                                       |   | 20,936   |                       |  |   | 1,125        |   |       |  
|Investments and intercompany receivables                |  |                  | (94,970  | ) |                                       |   | (46,735  | )                     |  |   | (3,619       | ) |       |  
|Property and equipment, net                             |  |                  |         |   |                                       |   | 54,044   |                       |  |   | 3,718        |   |       |  
|Goodwill, intangible and other assets, net              |  |                  |         |   |                                       |   | 51,570   |                       |  |   | 26           |   |       |  
|Deferred financing costs, net                           |  |                  |         |   |                                       |   | 10,023   |                       |  |   |             |   |       |  
|Deferred income taxes, noncurrent                       |  |                  |         |   |                                       |   | 11,027   |                       |  |   |             |   |       |  
|                                                        |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Total assets                                            |  | $                | (94,970  | ) |                                       | $ | 100,865  |                       |  | $ | 1,250        |   |       | $
|                                                        |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Liabilities and shareholders equity (deficiency):      |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Current portion of long-term debt                       |  | $                |         |   |                                       | $ | 94       |                       |  | $ |             |   |       | $
|Accounts payable - trade                                |  |                  |         |   |                                       |   | 26,467   |                       |  |   | 160          |   |       |  
|Accrued insurance                                       |  |                  |         |   |                                       |   | 3,960    |                       |  |   |             |   |       |  
|Accrued income taxes                                    |  |                  |         |   |                                       |   | 495      |                       |  |   |             |   |       |  
|Accrued compensation                                    |  |                  |         |   |                                       |   | 4,697    |                       |  |   | 43           |   |       |  
|Accrued interest                                        |  |                  |         |   |                                       |   | 12,084   |                       |  |   |             |   |       |  
|Other accrued liabilities                               |  |                  |         |   |                                       |   | 9,776    |                       |  |   | 77           |   |       |  
|                                                        |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Total current liabilities                               |  |                  |         |   |                                       |   | 57,573   |                       |  |   | 280          |   |       |  
|Long-term debt, less current portion                    |  |                  | 31,358   |   |                                       |   | 185,795  |                       |  |   |             |   |       |  
|Other liabilities                                       |  |                  |         |   |                                       |   | 3,791    |                       |  |   |             |   |       |  
|Series A redeemable convertible preferred stock         |  |                  | 34,924   |   |                                       |   |         |                       |  |   |             |   |       |  
|Total shareholders equity (deficiency)                 |  |                  | (161,252 | ) |                                       |   | (146,294 | )                     |  |   | 970          |   |       |  
|                                                        |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  
|Total liabilities and shareholders equity (deficiency) |  | $                | (94,970  | ) |                                       | $ | 100,865  |                       |  | $ | 1,250        |   |       | $
|                                                        |  |                  |          |   |                                       |   |          |                       |  |   |              |   |       |  



13



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PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

For the Thirteen Weeks Ended
August 3, 2003

(Unaudited)



|                                                              |  | Parent/Guarantor |        |   | Issuer andGuarantorSubsidiaryEntities |   |        | Non-guarantorEntities |  |   | Eliminations |   | Total |  
|------------------------------------------------------------- |  | ---------------- | ------ | - | ------------------------------------- | - | ------ | --------------------- |  | - | ------------ | - | ----- | -
|Sales                                                         |  | $                |       |   |                                       | $ | 69,079 |                       |  | $ | 2,230        |   |       | $
|Cost of sales                                                 |  |                  |       |   |                                       |   | 53,022 |                       |  |   | 2,262        |   |       |  
|                                                              |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  
|Gross profit                                                  |  |                  |       |   |                                       |   | 16,057 |                       |  |   | (32          | ) |       |  
|General and administrative                                    |  |                  |       |   |                                       |   | 10,534 |                       |  |   | 312          |   |       |  
|                                                              |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  
|Income (loss) from operations                                 |  |                  |       |   |                                       |   | 5,523  |                       |  |   | (344         | ) |       |  
|Interest income                                               |  |                  |       |   |                                       |   | 2      |                       |  |   | 1            |   |       |  
|Interest expense                                              |  |                  | (1,408 | ) |                                       |   | (6,251 | )                     |  |   |             |   |       |  
|Investment income (loss) in equity of wholly-owned subsidiary |  |                  | 25     |   |                                       |   | (343   | )                     |  |   |             |   |       |  
|                                                              |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  
|Loss before income taxes                                      |  |                  | (1,383 | ) |                                       |   | (1,069 | )                     |  |   | (343         | ) |       |  
|Income tax benefit                                            |  |                  |       |   |                                       |   | 1,094  |                       |  |   |             |   |       |  
|                                                              |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  
|Net income (loss)                                             |  | $                | (1,383 | ) |                                       | $ | 25     |                       |  | $ | (343         | ) |       | $
|                                                              |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  



PCA INTERNATIONAL,
INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

For the Thirteen Weeks Ended August 4, 2002

(Unaudited)



|                                                     |  | Parent/Guarantor |        |   | Issuer andGuarantorSubsidiaryEntities |   |        | Non-guarantorEntities |  |   | Eliminations |   | Total |  
|---------------------------------------------------- |  | ---------------- | ------ | - | ------------------------------------- | - | ------ | --------------------- |  | - | ------------ | - | ----- | -
|Sales                                                |  | $                |       |   |                                       | $ | 60,115 |                       |  | $ | 1,664        |   |       | $
|Cost of sales                                        |  |                  |       |   |                                       |   | 47,332 |                       |  |   | 1,433        |   |       |  
|                                                     |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  
|Gross profit                                         |  |                  |       |   |                                       |   | 12,783 |                       |  |   | 231          |   |       |  
|General and administrative                           |  |                  |       |   |                                       |   | 9,838  |                       |  |   | 377          |   |       |  
|Amortization of intangibles                          |  |                  |       |   |                                       |   | 48     |                       |  |   |             |   |       |  
|                                                     |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  
|Income (loss) from operations                        |  |                  |       |   |                                       |   | 2,897  |                       |  |   | (146         | ) |       |  
|Interest income                                      |  |                  |       |   |                                       |   | 3      |                       |  |   |             |   |       |  
|Interest expense                                     |  |                  | (535   | ) |                                       |   | (6,524 | )                     |  |   | (1           | ) |       |  
|Other income                                         |  |                  | 5      |   |                                       |   |       |                       |  |   |             |   |       |  
|Early extinguishment of debt                         |  |                  |       |   |                                       |   | (4,569 | )                     |  |   |             |   |       |  
|Investment loss in equity of wholly-owned subsidiary |  |                  | (8,340 | ) |                                       |   | (147   | )                     |  |   |             |   |       |  
|                                                     |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  
|Net loss                                             |  | $                | (8,870 | ) |                                       | $ | (8,340 | )                     |  | $ | (147         | ) |       | $
|                                                     |  |                  |        |   |                                       |   |        |                       |  |   |              |   |       |  





14



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PCA INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

For the Twenty-Six Weeks
Ended August 3, 2003

(Unaudited)



|                                                     |  | Parent/Guarantor |        |   | Issuer andGuarantorSubsidiaryEntities |   |         | Non-guarantorEntities |  |   | Eliminations |   | Total |  
|---------------------------------------------------- |  | ---------------- | ------ | - | ------------------------------------- | - | ------- | --------------------- |  | - | ------------ | - | ----- | -
|Sales                                                |  | $                |       |   |                                       | $ | 138,590 |                       |  | $ | 4,275        |   |       | $
|Cost of sales                                        |  |                  |       |   |                                       |   | 106,226 |                       |  |   | 4,420        |   |       |  
|                                                     |  |                  |        |   |                                       |   |         |                       |  |   |              |   |       |  
|Gross profit                                         |  |                  |       |   |                                       |   | 32,364  |                       |  |   | (145         | ) |       |  
|General and administrative                           |  |                  |       |   |                                       |   | 21,939  |                       |  |   | 409          |   |       |  
|                                                     |  |                  |        |   |                                       |   |         |                       |  |   |              |   |       |  
|Income (loss) from operations                        |  |                  |       |   |                                       |   | 10,425  |                       |  |   | (554         | ) |       |  
|Interest income                                      |  |                  |       |   |                                       |   | 4       |                       |  |   | 1            |   |       |  
|Interest expense                                     |  |                  | (2,800 | ) |                                       |   | (12,533 | )                     |  |   |             |   |       |  
|Investment loss in equity of wholly-owned subsidiary |  |                  | (258   | ) |                                       |   | (553    | )                     |  |   |             |   |       |  
|                                                     |  |                  |        |   |                                       |   |         |                       |  |   |              |   |       |  
|Loss before income taxes                             |  |                  | (3,058 | ) |                                       |   | (2,657  | )                     |  |   | (553         | ) |       |  
|Income tax benefit                                   |  |                  |       |   |                                       |   | 2,399   |                       |  |   |             |   |       |  
|                                                     |  |                  |        |   |                                       |   |         |                       |  |   |              |   |       |  
|Net loss                                             |  | $                | (3,058 | ) |                                       | $ | (258    | )                     |  | $ | (553         | ) |       | $
|                                                     |  |                  |        |   |                                       |   |         |                       |  |   |              |   |       |  



PCA INTERNATIONAL,
INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

For the Twenty-Six Weeks Ended August 4, 2002

(Unaudited)



|                                                     |  | Parent/Guarantor |         |   | Issuer andGuarantorSubsidiaryEntities |   |         | Non-guarantorEntities |  |   | Eliminations |   | Total |  
|---------------------------------------------------- |  | ---------------- | ------- | - | ------------------------------------- | - | ------- | --------------------- |  | - | ------------ | - | ----- | -
|Sales                                                |  | $                |        |   |                                       | $ | 126,513 |                       |  | $ | 3,188        |   |       | $
|Cost of sales                                        |  |                  |        |   |                                       |   | 96,877  |                       |  |   | 2,825        |   |       |  
|                                                     |  |                  |         |   |                                       |   |         |                       |  |   |              |   |       |  
|Gross profit                                         |  |                  |        |   |                                       |   | 29,636  |                       |  |   | 363          |   |       |  
|General and administrative                           |  |                  |        |   |                                       |   | 19,486  |                       |  |   | 668          |   |       |  
|Amortization of intangibles                          |  |                  |        |   |                                       |   | 96      |                       |  |   |             |   |       |  
|                                                     |  |                  |         |   |                                       |   |         |                       |  |   |              |   |       |  
|Income (loss) from operations                        |  |                  |        |   |                                       |   | 10,054  |                       |  |   | (305         | ) |       |  
|Interest income                                      |  |                  |        |   |                                       |   | 5       |                       |  |   |             |   |       |  
|Interest expense                                     |  |                  | (535    | ) |                                       |   | (13,277 | )                     |  |   | (2           | ) |       |  
|Other expense                                        |  |                  | (2,061  | ) |                                       |   |        |                       |  |   |             |   |       |  
|Early extinguishment of debt                         |  |                  |        |   |                                       |   | (4,569  | )                     |  |   |             |   |       |  
|Investment loss in equity of wholly-owned subsidiary |  |                  | (8,094  | ) |                                       |   | (307    | )                     |  |   |             |   |       |  
|                                                     |  |                  |         |   |                                       |   |         |                       |  |   |              |   |       |  
|Net loss                                             |  | $                | (10,690 | ) |                                       | $ | (8,094  | )                     |  | $ | (307         | ) |       | $
|                                                     |  |                  |         |   |                                       |   |         |                       |  |   |              |   |       |  



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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



Results of Operations



Thirteen Weeks Ended August 3, 2003 Compared With Thirteen Weeks Ended August 4, 2002.



Sales for the thirteen weeks ended August 3, 2003 (Q2 2003)
increased 15.4% to $71.3 million from $61.8 million for the thirteen weeks ended August 4, 2002 (Q2 2002). The sales increase in Q2 2003 was attributable to the growth of our Wal-Mart business, increasing 16.3% to $67.7 million from
$58.2 million in Q2 2002. The increase was the result of sales from newly opened studios of $5.7 million and same-studio sales growth of 8.9%, or $4.5 million. In total, we ended Q2 2003 with 2,092 permanent studios, representing an increase of 219
studios as compared to the end of Q2 2002.



Gross profit
increased 23.1% to $16.0 million in Q2 2003 from $13.0 million in Q2 2002. Gross profit as a percentage of sales increased to 22.5% in Q2 2003 from 21.1% in Q2 2002. The improvement in gross profit margin was principally due to the increased volume
related to the timing of the delivery of portraits for the Easter holiday. Because of our policy to recognize sales and related cost of sales only upon the delivery of portraits to customers and Easter occurring late in the thirteen week period
ended May 4, 2003 (Q1 2003), a substantial portion of Easter week portrait sales and cost of sales was recognized in Q2 2003. In fiscal 2002, portrait delivery for the peak Easter volume was substantially completed in the thirteen week
period ended May 5, 2002 (Q1 2002).



General and
administrative expenses increased 6.2% in Q2 2003 to $10.8 million from $10.2 million in Q2 2002. General and administrative expenses as a percentage of sales were 15.2% and 16.5% for Q2 2003 and Q2 2002, respectively. This increase of $0.6 million
is a result of an increase in workers compensation, life and health insurance, professional services and payroll cost of living adjustments for field, manufacturing and corporate personnel.



Operating income increased 88.3% in Q2 2003 to $5.2 million from $2.8 million
in Q2 2002. Operating income as a percentage of sales increased to 7.3% in Q2 2003 from 4.5% in Q2 2002. These changes reflect the net effect of changes in gross profit and general and administrative expenses as described above.



Net interest expense increased 8.5% in Q2 2003 to $7.7 million from $7.1
million in Q2 2002 as a result of increased borrowings under our credit facility to help finance the expansion of our business (e.g., capital expenditures for new permanent studios) and the increase in the weighted averaged interest rate of our
debt.



Other income was $0 in Q2 2003 as compared to $5,000 in
Q2 2002. Other income in Q2 2002 represented the mark-to-market adjustment for the derivative in our Series A Redeemable Convertible Preferred Stock (Series A), which met the criteria of an embedded derivative under SFAS 133,
Accounting for Derivative Instruments and Hedging Activities (as amended), which we adopted in fiscal 2001. The embedded derivative value was computed based on several factors including the underlying value of our common stock at the time of
computation. On December 9, 2002, our shareholders approved modifications to the terms of our Series A and the modifications became effective upon the filing of restated articles of incorporation on December 20, 2002. We determined, based on these
modified terms, the embedded derivative no longer meets the requirements for bifurcation and separate accounting. Therefore, no mark-to-market adjustment was made in Q2 2003. (See Note 6 Derivative: Series A Redeemable Convertible Preferred
Stock in the Notes to Consolidated Financial Statements located in Item 1. Financial Statements of Part I. Financial Information.)



In Q2 2002, we retired $218.4 million of senior and senior subordinated debt resulting in a charge for early extinguishment of debt of $4.6 million
relating to the write-off of deferred financing costs ($10.2 million) less the write-off of accrued interest on retired increasing rate debt ($5.6 million).



Income tax benefit for Q2 2003 was $1.1 million. Prior to fiscal 2002, a valuation allowance was provided against deferred tax assets because, based on
the weight of available evidence (operating performance, debt structure, forecasted earnings, etc.) at that time, it was not likely such assets would ultimately be realized. In fiscal 2002, we determined, based on the weight of available evidence,
it is now more likely than not that such assets will ultimately be realized, with the exception of assets generated by operations in Argentina discontinued in fiscal 2000. Therefore, the valuation allowance on deferred tax assets was reduced to
$77,000 in fiscal 2002. Because we anticipate taxable income for fiscal 2003, we recognized an income tax benefit in Q2 2003 based on our anticipated effective income tax rate for fiscal 2003.



Net loss decreased to $1.4 million in Q2 2003 from $8.9 million in Q2 2002.
The decrease in net loss is a result of the net effect of changes in operating income, net interest expense, other income, early extinguishment of debt and income tax benefit as described above.



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Twenty-Six Weeks Ended August 3, 2003 Compared With Twenty-Six Weeks Ended August 4, 2002.



Sales for the twenty-six
weeks ended August 3, 2003 (first half of 2003) increased 10.1% to $142.9 million from $129.7 million for the twenty-six weeks ended August 4, 2002 (first half of 2002). The sales increase in the first half of 2003 was
attributable to the growth of our Wal-Mart business, increasing 11.0% to $135.7 million from $122.3 million in the first half of 2002. The increase in the first half of 2003 was the result of sales from newly opened permanent studios of $11.5
million and same studio sales growth of 2.8%, or $3.0 million. In total, we ended the first half of 2003 with 2,092 permanent studios, representing an increase of 219 studios as compared to the end of the first half of 2002.



Gross profit increased 7.4% to $32.2 million in the first half of 2003 from
$30.0 million in the first half of 2002. Gross profit as a percentage of sales decreased to 22.6% in the first half of 2003 from 23.1% in the first half of 2002. The decline in gross margin was principally due to a change in product mix reflecting
favorable customer acceptance of our expanded digital and canvas product offerings, which carry a lower margin.



General and administrative expenses increased 10.9% in the first half of 2003 to $22.3 million from $20.2 million in the first half of 2002. General and
administrative expenses as a percentage of sales were 15.6% and 15.5% for the first half of 2003 and the first half of 2002, respectively. This increase of $2.2 million is a result of an increase in workers compensation, life and health
insurance, professional services, and payroll cost of living adjustments for field, manufacturing and corporate personnel.



Operating income increased 1.3% in the first half of 2003 to $9.9 million from $9.7 million in the first half of 2002. Operating income as a percentage of
sales decreased to 6.9% in the first half of 2003 from 7.5% in the first half of 2002. These changes reflect the net effect of changes in gross profit and general and administrative expenses as described above.



Net interest expense increased 11.0% in the first half of 2003 to $15.3
million from $13.8 million in the first half of 2002 as a result of increased borrowings under our credit facility to help finance the expansion of our business and the increase in the weighted averaged interest rate of our debt.



Other expense was $0 in the first half of 2003 as compared to $2.1 million in
the first half of 2002. Other expense in the first half of 2002 represented the mark-to-market adjustment for the derivative in our Series A, which met the criteria of an embedded derivative under SFAS 133, Accounting for Derivative Instruments
and Hedging Activities (as amended), which we adopted in fiscal 2001. The embedded derivative value was computed based on several factors including the underlying value of our common stock at the time of computation. On December 9, 2002, our
shareholders approved modifications to the terms of our Series A and it became effective upon the filing of restated articles of incorporation on December 20, 2002. We determined, based on these modified terms, the embedded derivative no longer
meets the requirements for bifurcation and separate accounting. Therefore, no mark-to-market adjustment was made in the first half of 2003.



In the first half of 2002, we retired $218.4 million of senior and senior subordinated debt resulting in a charge for early extinguishment of debt of $4.6
million relating to the write-off of deferred financing costs ($10.2 million) less the write-off of accrued interest on retired increasing rate debt ($5.6 million).



Income tax benefit for the first half of 2003 was $2.4 million. Prior to fiscal 2002, a valuation allowance was provided
against deferred tax assets because, based on the weight of available evidence (operating performance, debt structure, forecasted earnings, etc.) at that time, it was not likely such assets would ultimately be realized. In fiscal 2002, we
determined, based on the weight of available evidence, it is now more likely than not that such assets will ultimately be realized, with the exception of assets generated by operations in Argentina discontinued in fiscal 2000. Therefore, the
valuation allowance on deferred tax assets was reduced to $77,000 in fiscal 2002. Because we anticipate taxable income for fiscal 2003, we recognized an income tax benefit in the first half of 2003 based on our anticipated effective income tax rate
for fiscal 2003.



Net loss decreased to $3.1 million in the
first half of 2003 from $10.7 million in the first half of 2002. The decrease in net loss is a result of the net effect of changes in operating income, net interest expense, other income, early extinguishment of debt and income tax benefit as
described above.



Liquidity and Capital Resources



Liquidity. Our principal sources of liquidity are cash flow from
operations and borrowings under our senior secured credit facility. Our principal uses of cash are capital expenditures and seasonal working capital. During the first half of 2003, we used $11.7 million in cash on capital expenditures as compared to
$7.9 million during the first half of 2002. Our working capital deficit remained relatively constant at $42.3 million at the end of Q2 2003 as compared to $40.9 million at the end of Q2 2002.



Due to the seasonality of our operations, cash is generally consumed during
the first three fiscal quarters and generated during the remaining fourth fiscal quarter. During the Christmas season, which falls in our fiscal fourth quarter, families emphasize the need for portraits as gifts and/or inclusions in holiday cards,
making it our busiest quarter of the fiscal year.



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On June 27, 2002, we issued an aggregate amount of $165 million 11.875%
senior notes due 2009 through our wholly owned subsidiaries, PCA LLC and PCA Finance Corp. Payment of the senior notes is unconditionally guaranteed, jointly and severally, by PCA International, Inc. and certain of PCA LLCs domestic
subsidiaries. PCA LLC also entered into a senior secured credit facility on June 27, 2002, which allows it to borrow up to $50.0 million of which $25.0 million may be standby and commercial letters of credit. As of August 3, 2003, $32.6 million was
outstanding in revolving loans in addition to $14.5 million in letters of credit. As of August 3, 2003, we had additional credit availability of $2.9 million. As of August 3, 2003, the weighted average interest rate on our senior secured credit
facility was 4.71%. The senior secured credit facility is guaranteed by PCA International, Inc. and certain of PCA LLCs domestic subsidiaries. Also on June 27, 2002, PCA LLC issued $10.0 million of 13.75% senior subordinated notes due June 27,
2010. These notes are subordinated to the senior secured credit facility and the 11.875% senior notes and are guaranteed by PCA International, Inc. and certain of PCA LLCs domestic subsidiaries. These notes bear interest payable in cash
semiannually, in arrears, at a rate of 13.75% per year. Also on June 27, 2002, PCA International, Inc. issued $30.0 million of 16.50% senior subordinated discount notes due June 27, 2010. These notes are subordinated to PCA International,
Inc.s guarantee of the senior secured credit facility and the 11.875% senior notes. These notes bear interest at a rate of 16.5% per year. Through June 27, 2007, interest will be added to the outstanding principal amount semiannually, in
arrears. After June 27, 2007, interest will be payable in cash semiannually in arrears at the rate of 16.5%. Each of these individual debt instruments contain covenants with which we were in compliance as of August 3, 2003.



Capital Expenditures. Capital expenditures were $11.7 million in the
first half of 2003 as compared to $7.9 million in the first half of 2002. Capital expenditures were principally for equipment and studio improvements in new permanent studios, as well as for expenditures for the upgrade of certain equipment in
existing permanent studios. Capital expenditures were financed from borrowings under our senior secured credit facility. The most significant capital expenditures contemplated over the next five years will be for new studio openings.



Net Cash Provided by (Used in) Operating Activities. Net cash used in
operating activities was $3.7 million in the first half of 2003 as compared to net cash provided by operating activities of $10.4 million in the first half of 2002. The decrease in cash provided by operating activities of $14.0 million between the
first half of 2003 and the first half of 2002 was primarily due to the $13.9 million decrease in net cash provided by changes in operating assets and liabilities, the most significant changes being the timing of our accrued interest payments (our
senior notes interest payment was made on August 1, 2003); the effect of changes in accounts payable, inventories and other accrued liabilities of $1.9 million, $1.8 million and $0.9 million, respectively; and the $7.6 million decrease in net loss
offset primarily by $4.6 million from the early extinguishment of debt in 2002, $2.4 million from the income tax benefit in 2003, and $2.1 million from the change in the value of the embedded derivative in our Series A in 2002.



Net Cash Used in Investing Activities. Net cash used in investing
activities increased to $11.7 million in the first half of 2003 from $7.9 million in the first half of 2002. The reason for this increase is the capital expenditure requirements related to the acceleration of our expansion in the Wal-Mart host
environment.



Net Cash Provided by Financing Activities.
Net cash provided by financing activities was $18.7 million in the first half of 2003 as compared to $39,000 in the first half of 2002. Financing activities in the first half of 2003 primarily related to the ordinary borrowings and repayments under
our senior secured credit facility.



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Preferred Stock. Prior to December 2002, we determined our Series A met the definition of a hybrid
instrument. This hybrid instrument was comprised of a debt instrument (mandatorily redeemable preferred stock) as the host contract and an embedded derivative consisting of a conversion option, which derived its value, in part, based on the changes
in the fair value of our common stock. Therefore, we separated the embedded derivative, valued it, and classified it as a component of Other Liabilities in our balance sheet. We valued the embedded derivative using the Black-Scholes
option pricing model with an assumption of fair value of our underlying common stock. To value our common stock, we used the income approach, which considers expected returns on investment, which are discounted or capitalized at an appropriate rate
of return to reflect investor risks and hazards. A discounted net cash flow analysis was utilized which provides an indication of value based upon the present value of anticipated future cash flows, discounted at an appropriate present worth factor
reflecting the risk inherent in the investment. In addition, we applied a discount because there is not a readily available market for our common stock. The value of our common stock we calculated, therefore, could be different if we applied a
different discount with regard to the marketability of our common stock as well as if we applied a different discount rate in our discounted net cash flow analysis. Consequently, the value of the embedded derivative could have changed based on
differences in assumptions used in valuing our common stock.



In December 2002, our shareholders approved modifications to the liquidation and redemption provisions of the Series A. The redemption of the Series A is now at the option of the holders of the Series A, rather than being mandatorily
redeemable on April 30, 2011. Also, the redemption price of the Series A and the amount payable upon certain extraordinary events is now $1,000 per share plus all declared and unpaid dividends, rather than the greater of $1,000 per share of the fair
market value of the common stock into which the Series A is convertible plus all declared and unpaid dividends. As a result of the change in these provisions, we have determined the embedded derivative in the Series A no longer meets the
requirements for bifurcation and separate accounting. Therefore, in the first half of 2002 we recognized other expense of $2.1 million for the mark-to-market adjustment related to the fair value of the embedded derivative, while we recognized no
expense in the first half of 2003.



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Recent Developments



We opened 43 studios in the thirteen weeks ended August 3, 2003, which was comprised of 35 studios in the U.S., 3 in Mexico, 4 in Germany, and 1 in the
U.K. We opened 91 studios in the twenty-six weeks ended August 3, 2003, which was comprised of 78 studios in the U.S., 5 in Mexico, 6 in Germany, and 2 in the U.K. Costs of opening these studios were charged to operations as incurred.



Forward-Looking Statements



Certain statements in this Quarterly Report on Form 10-Q, including
statements under Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations and Item 3. Quantitative and Qualitative Disclosures About Market Risk, that are not historical facts,
including information concerning possible or assumed future results of operations of PCA International, Inc. and its subsidiaries and those statements preceded by, followed by, or that include the words may, believes,
expects, anticipates, or the negation thereof, or similar expressions, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements which address
operating performance, events or developments that are expected or anticipated to occur in the future, including statements relating to revenue growth, earnings growth or statements expressing general optimism about future operating results, are
forward-looking statements within the meaning of the Reform Act.



These forward-looking statements are based on our current expectations, speak only as of the date of this Quarterly Report on Form 10-Q and are susceptible to a number of risks, uncertainties and other factors. Our actual results,
performance and achievements may differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. For those statements, we claim the protection of the safe-harbor for forward-looking
statements contained in the Reform Act.



Factors that may cause
actual results to differ from expected results include, among others



| |  |  | Risks associated with substantial indebtedness, leverage, debt service and liquidity;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | Risks associated with our relationship with Wal-Mart, our principal business relationship;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | Performance of our new stores and their future operating results;
| | - |  | -----------------------------------------------------------------



| |  |  | Risks of competition from, including, but not limited to, companies currently operating in other photography markets;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | Risks associated with the domestic professional portrait photography industry; and
| | - |  | ----------------------------------------------------------------------------------



| |  |  | Other risks and uncertainties affecting PCA International, Inc. and its subsidiaries referred to in this Form 10-Q (see especially Item 2. Managements Discussion and
Analysis of Financial Condition and Results of Operations and Item 3. Quantitative and Qualitative Disclosures About Market Risk) and in our other current and periodic filings with the Securities and Exchange Commission, all of
which are difficult or impossible to predict accurately and many of which are beyond our control.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



All future written and verbal forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary
statements contained or referred to in this section. We undertake no obligation, and specifically decline any obligation, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or
otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Quarterly Report on Form 10-Q might not occur.





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Item 3. Quantitative and Qualitative Disclosures About Market Risk



Our exposure to market risks from changes in interest rates relates primarily to the effects that changes in interest rates have on floating rate debt. To lower or limit overall borrowing costs, from time to time, we
may enter into interest rate hedging agreements to modify the interest characteristics of portions of our outstanding debt. As of August 3, 2003, we have not entered into any interest rate hedging agreements. In addition, a 1.0% change in the
interest rate on our senior secured credit facility would have a $0.3 million annualized effect on our financial position and results of operations based on the outstanding balance on our senior secured credit facility as of August 3, 2003.



We conduct business in foreign currencies in Canada, Mexico, Germany and the
United Kingdom. A 10% change in the value of all foreign currencies would not have a material effect on our financial position, liquidity or results of operations.



Item 4. Controls and Procedures



The
Companys Chief Executive Officer and Chief Financial Officer (its principal executive officer and principal financial officer, respectively) have concluded, based on their evaluation that the Companys disclosure controls and procedures
(as defined in the Securities and Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) were effective as of the end of the period covered by this report to ensure that information required to be disclosed by the Company in the reports filed or
submitted by it under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and include controls and procedures designed to ensure that
information required to be disclosed by the Company in such reports is accumulated and communicated to the Companys management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.



There were no significant changes in the
Companys internal controls or in other factors that could significantly affect these controls subsequent to the date of such evaluation.



It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the
system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there is only reasonable assurance
that our controls will succeed in achieving their stated goals under all potential future conditions.



Part II. Other Information



Item 5. Other
Information



The Company is not required to file reports with the
Securities and Exchange Commission pursuant to Section 13(a) or 15d of the Securities Exchange Act of 1934, as amended, but is filing this Quarterly Report on Form 10-Q on a voluntary basis. Accordingly, it is not an issuer as defined in
Section 2(a)(7) of the Sarbanes-Oxley Act of 2002.



Item 6. Exhibits and Reports on Form 8-K



(a)
Exhibits:



|31.1 |  | Section 302 Certification of Principal Executive Officer
|---- |  | --------------------------------------------------------



|31.2 |  | Section 302 Certification of Principal Financial Officer
|---- |  | --------------------------------------------------------



(b) Reports on Form 8-K:



No reports were filed during the period covered by this report.



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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.(Registrant)By:

/s/ Barry J. FeldBarry J. FeldPresident, Chief Executive Officer, and Chairman of the BoardBy:

/s/ Don NorsworthyDon NorsworthyExecutive Vice President,Chief Financial Officer and TreasurerDated:

September 17, 2003




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