10-Q 1 e10-q.txt ALBECCA INC. 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended May 28, 2000. 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: 333-67975 ALBECCA INC. (Exact name of registrant as specified in its charter) GEORGIA 39-1389732 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3900 Steve Reynolds Boulevard, Norcross, Georgia 30093 (Address of principal executive offices) (Zip Code) (770) 279-5210 (Registrant's telephone number, including area code) Indicate by checkmark 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 [ ] 1 2 ALBECCA INC. INDEX TO FORM 10-Q

2 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ALBECCA INC. CONSOLIDATED BALANCE SHEETS (in thousands)

The accompanying notes are an integral part of these consolidated balance sheets. 3 4 ALBECCA INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands) (unaudited)

The accompanying notes are an integral part of these consolidated financial statements. 4 5 ALBECCA INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)

The accompanying notes are an integral part of these consolidated financial statements. 5 6 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Note 1. INTERIM FINANCIAL STATEMENT PRESENTATION The unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, the unaudited interim consolidated financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair presentation have been included. On a quarterly basis, the Company's results may vary. The results of operations for any interim period are not necessarily indicative of the results of operations to be expected for a full year. For further information, refer to the consolidated financial statements and accompanying footnotes included in the Company's Form 10-K for the fiscal year ended August 29, 1999, as filed with the Securities and Exchange Commission. Note 2. USE OF ESTIMATES The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Note 3. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Albecca Inc. ("Albecca", the "Company") and its subsidiaries. All significant intercompany transactions have been eliminated. Minority interest represents minority shareholders' interest in majority-owned subsidiaries. Note 4. INCOME TAXES Albecca is an S corporation and several of its subsidiaries are classified as either partnerships or single member entities. Each is treated as a pass-through entity under the Internal Revenue Code. They are not subject to federal and certain state income taxes. As a result, the related taxable income is included in the tax returns of the shareholders and members of the respective companies. The Company makes distributions to shareholders to pay their income tax obligations as a result of the Company's status as an S corporation. The provision for income taxes included in the accompanying consolidated financial statements primarily relates to certain state and foreign income taxes. Note 5. ACQUISITION During March 2000, the Company acquired the outstanding 23% interest in its Italian subsidiary for approximately $2.4 million in cash. Note 6. INFREQUENT ITEMS WRITE-DOWN OF GOODWILL In October 1997, the Company acquired Robert F. deCastro, Inc. ("deCastro") a distributor of products in the pre-framed art and the custom framing markets. Since the acquisition, the demand in the markets for the deCastro product line has dramatically decreased or ceased. As a result, in the second quarter of fiscal 2000, management determined to redirect its effort from pre-framed art and to focus its energies and resources, both financial and managerial, on the custom picture framing market. The Company determined that the estimated future undiscounted cash flows of the deCastro product line were below the carrying value of the associated long-lived assets, primarily consisting of goodwill. Accordingly, during the second quarter of fiscal 2000, the Company adjusted the carrying value of deCastro's unamortized goodwill to its estimated fair value of approximately $.2 million, resulting in a non-cash impairment charge of approximately $5.0 million. The estimated fair value of goodwill was based on anticipated future cash flows discounted at a rate commensurate with the risk involved. DISPOSITION OF MERSCH ENTITIES In the second quarter of fiscal 2000, Albecca made a decision to sell its investment in its Mersch entities, a manufacturer and supplier of readymade frames to large European discount stores, located in Germany and France. This decision was based on management's continued initiative to focus its energies and resources, both financial and managerial, on the European custom picture framing market. In January 2000, Albecca sold its investment in its Mersch entities for cash of $16.3 million and retained certain long-term assets of $3.0 million, for total gross consideration of $19.3 million. In addition, the Company retained certain liabilities of $12.5 million (which were primarily paid at closing). 6 7 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) The loss on the disposition of the Mersch entities, recorded during the second quarter of fiscal 2000, was approximately $1.4 million. During the third quarter of fiscal 2000, the Company determined that the realizable value of one of the Mersch buildings, a long-term asset retained in the sale, was less than previously estimated. Therefore, the Company has recorded an additional loss on the disposition of the Mersch entities of $.5 million, which represents the write-down of this asset to estimated realizable value from future sale. This increases the total loss on the disposition of the Mersch entities to $1.9 million. The sale agreements required the Mersch entities to maintain a minimum level of working capital through the closing date as supported by a closing balance sheet audit, which has not yet been agreed to by the respective parties. In the opinion of management, the disposition of the Mersch entities will not have a material impact on the future operations or financial position of the Company. The Mersch entities' five month sales and operating income for fiscal 2000 were approximately $10.0 million and $.1 million, respectively. RESTRUCTURING CHARGES UNITED KINGDOM - NORTHAMPTON During the third quarter of fiscal 2000, the Company initiated a restructuring plan related to the closure of one of its facilities in the United Kingdom and recorded a charge to operations of approximately $909,000. Management made the decision to close this operation following a series of under-performing quarters, at which time management determined that the Company's resources, both financial and managerial, could be more effectively invested in operations with a greater potential return. This charge included severance costs for 37 team members approximating $222,000, a $270,000 write-down of property, plant and equipment to its estimated realizable value, $233,000 of lease termination costs and $184,000 of other exit costs including post-closure maintenance and administrative costs. The $233,000 of lease termination costs represent the Company's estimated future obligations under the existing lease commitments of the closed facility, net of estimated recoverable costs through subleasing. Management anticipates the restructuring plan will be completed prior to the second quarter of fiscal 2001. PREVIOUSLY REPORTED RESTRUCTURING PLANS SWEDEN As of May 28, 2000, the Company's closure of its duplicate facilities in Sweden was complete. None of the 25 team members originally identified for termination remained at the facility. The facility was sold in August 1999 and physical possession was transferred during the second quarter of fiscal 2000. NEW ZEALAND As of May 28, 2000, the Company, through its Australian operations, continued to sell existing assets and collect existing accounts receivable related to its closed New Zealand distribution operations. None of the 9 team members originally identified for termination remained at the facility at May 28, 2000. The Company estimates that the remaining closure activities will be materially complete by the end of fiscal 2000. GREECE As of May 28, 2000, one of the original 14 team members related to the Company's closed distribution operations in Greece remained to sell existing assets and collect existing accounts receivable. The Company estimates that the team member will continue to provide services through the second quarter of fiscal 2001. 7 8 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) UNITED STATES As of May 28, 2000, the Company's closure of its duplicate facilities in the United States was complete. None of the 17 team members originally identified for termination remained at the facility. The unused balance of $29,000 of the remaining restructuring provision was reversed and reflected as a component of the current restructuring charges incurred during the third quarter of fiscal 2000. UNITED KINGDOM - PLASTIC MOULDING MANUFACTURING OPERATIONS As of May 28, 2000, none of the original 59 team members remained with respect to the closure of the Company's plastic moulding manufacturing operations in the United Kingdom and all material events associated with the restructuring plan had been completed. The unused balance of $25,000 of the remaining restructuring provision was reversed and reflected as a component of the current restructuring charges incurred during the third quarter of fiscal 2000. For more descriptive information of the above mentioned restructuring plans, please see the Company's Form 10-K for the fiscal year ended August 29, 1999, as filed with the Securities and Exchange Commission. SUMMARY OF RESTRUCTURING PLANS. As of May 28, 2000, as it relates to the Company's fiscal 1998, 1999 and 2000 restructuring plans, approximately $791,000 of restructuring charges remained in accrued liabilities representing approximately $246,000 of severance and other termination costs and approximately $545,000 of lease termination and other related exit costs. A summary of the previously reported restructuring plans and activity and restructuring plans adopted during the third quarter of fiscal 2000 consist of the following estimated accrued future cash/non-cash requirements:

8 9 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited)

9 10 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited)

Note 7. EXTRAORDINARY GAIN In September and November 1999, and February 2000, the Company retired a portion of its senior subordinated notes with a combined face value of $23.8 million. The debt retirements resulted in extraordinary gains approximating $4.5 million, net of state income taxes of approximately $.2 million. 10 11 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) Note 8. INVENTORIES Inventories consist of the following (in thousands):

Note 9. STOCK OPTION PLAN In 1998, the Company adopted the Albecca Inc. 1998 Stock Option Plan. In March 1999, the Company awarded 378,000 non-qualified options to acquire shares of common stock at $6.46 per share to certain members of management under the Stock Option Plan. No compensation expense was recognized relating to these grants, as the exercise price was equal to the fair market value as determined by management's estimation at the time of grant. The options granted vest on November 1, 2003. In May 2000, the Company elected to reduce the exercise price of the options issued under the 1998 Stock Option Plan from $6.46 per share to $5.80 per share. Due to the repricing, the Company will record an aggregate compensation charge of approximately $1.6 million, which will be amortized over the remaining life of the options, or 41 months. The Company has recorded a compensation charge during the third quarter of $.05 million related to this change. Note 10. RECLASSIFICATIONS Certain prior period amounts have been reclassified to conform to the current period presentation. Note 11. COMPREHENSIVE INCOME Comprehensive income for the Company is as follows (in thousands):

Note 12. COMMITMENTS AND CONTINGENCIES CONSTRUCTION OF MANUFACTURING FACILITY Albecca has entered into a commitment to build a new manufacturing facility in Ashland, Wisconsin, consisting of land and a building, for a net capitalizable cost of approximately $4.3 million. As of May 28, 2000, the Company had expended approximately $4.1 million for this project. Completion of construction is expected by the end of fiscal 2000. LITIGATION In the third quarter of fiscal 2000, Albecca either settled or reached substantive agreement on certain outstanding litigation. As a result of the settlement of this litigation during the third quarter of fiscal 2000, the Company reversed $3.9 million of previously provided reserves recorded during fiscal 1998 and prior periods. These amounts were reflected as a reduction of operating expenses in the Company's third quarter. The Company is involved in certain other litigation arising in the ordinary course of business. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the Company's financial position or results of operations. 11 12 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) Note 13. ACCRUED LIABILITIES AND OTHER LONG-TERM LIABILITIES DEFERRED COMPENSATION During May 2000, the Company amended certain bonus arrangements with its Chief Executive Officer and majority shareholder whereby payment of certain amounts, earned in fiscal years 1999 and 1998, aggregating $1.8 million would be deferred and paid after fiscal year 2001. As such, the liability for these deferred amounts have been classified as long-term liabilities in the accompanying balance sheets. During the third quarter of fiscal 2000, the Company finalized certain employee bonuses related to fiscal 1999. Accordingly, the Company decreased its estimate of accrued bonuses to the amount actually paid. As a result, the Company reversed previously provided reserves recorded during fiscal 1999 of $.5 million. These amounts were reflected as a reduction of operating expenses in the Company's third quarter of fiscal 2000. EMPLOYER BENEFIT PLAN In January 2000, the Company replaced its self-funded medical employer benefit plan with a similar plan that was fully insured by third party insurers. In May 2000, the Company settled open obligations under the terminated plan in a favorable manner. As a result, during the third quarter $.7 million was reversed relating to previously provided reserves recorded in prior periods. These amounts were reflected as a reduction of operating expenses in the Company's third quarter of fiscal 2000. Note 14. SUBSEQUENT EVENTS DISPOSITION OF BRIO Subsequent to the end of the third quarter of fiscal 2000, the Company sold it's Brio operations, a manufacturer and supplier of readymade frames and framing supplies to large "Do-It-Yourself" stores in Europe. This decision was based on management's decision to focus its energies and resources, both financial and managerial, on the European custom picture framing market. The transaction was concluded on May 31, 2000, for cash of $14.0 million. The gain on the disposition of Brio was approximately $1.8 million. The sales agreement required Brio to maintain a minimum level of working capital through the closing date as supported by a closing balance sheet audit, which has not yet been completed. As such, the preliminary estimated gain is subject to adjustment pending the final results of the audit. Brio's nine-month sales and operating income for fiscal 2000 were approximately $16.1 million and $.9 million, respectively. In the opinion of management, the disposition of Brio will not have a material impact on the future operations or financial position of the Company. INDUSTRIAL REVENUE BOND PLACEMENT In June 2000, the Company completed an Industrial Revenue Bond placement through an economic incentive program by the City of Ashland, Wisconsin, relating to the development of the Company's new manufacturing plant and purchase of associated equipment. The placement was for $4.6 million, net of debt issuance costs of $.09 million, of variable interest rate notes with a weekly adjusting rate, which at closing was 4.37%. Amortization of the bonds consists of interest only payments for the first five years and a subsequent amortization period of fifteen years with varying annual principal payments ranging from $.2 million to $.4 million. The bonds are secured by a letter of credit that is collateralized by the new manufacturing plant and a majority of the related new and existing furniture, machinery and equipment. RETIREMENT OF SENIOR SUBORDINATED NOTES Subsequent to the end of the third quarter of fiscal 2000, the Company retired a portion of its senior subordinated notes with a combined face value of $5.0 million. The debt retirement will result in an extraordinary gain of approximately $.6 million, net of state income taxes of approximately $.02 million. Note 15. GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS These condensed consolidating financial statements reflect Albecca Inc. and Subsidiary Guarantors, which consist of all of the Company's wholly-owned restricted subsidiaries other than the foreign subsidiaries, as defined under the Indenture dated August 11, 1998. These nonguarantor foreign subsidiaries are herein referred to as "Subsidiary Nonguarantors." The subsidiary guarantee of each Subsidiary Guarantor will be subordinated to the prior payment in full of all senior debt of such Subsidiary Guarantor. Separate financial statements of the Subsidiary Guarantors are not presented because the Subsidiary Guarantees are joint and several and full and unconditional and the Company believes the condensed consolidating financial statements presented are more meaningful in understanding the financial position of the Subsidiary Guarantors and the separate financial statements are deemed not material to investors. 12 13 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) CONDENSED CONSOLIDATING BALANCE SHEETS (in thousands)

13 14 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) CONDENSED CONSOLIDATING BALANCE SHEETS (in thousands)

14 15 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (in thousands)

15 16 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (in thousands)

16 17 ALBECCA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (unaudited) CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS (in thousands)

17 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with Albecca's unaudited consolidated financial statements and the related notes thereto. In this "Management's Discussion and Analysis of Financial Condition and Results of Operations," all references to the Company's international operations ("International") include all of Albecca's operations outside of the U.S. The following table sets forth certain consolidated statements of operations data as a percentage of net sales for the periods indicated:

NET SALES For the third quarter ended May 28, 2000, net sales were $87.9 million compared to $96.2 million for the third quarter ended May 30, 1999. For the nine months ended May 28, 2000, net sales were $282.2 million compared to $297.5 million for the nine months ended May 30, 1999. The decrease in net sales for the three and nine months ended May 28, 2000 were primarily the result of the sale of the South African operations completed at the end of fiscal 1999 and the disposition of the Mersch entities completed during January of fiscal 2000, along with unfavorable changes in foreign currency rates, partially offset by an increase in sales to independent custom framing retailers. U.S. net sales increased 10.5% and 9.8% for the three and nine months ended May 28, 2000 from the comparable periods in 1999, primarily the result of an increase in sales to independent custom framing retailers. International net sales decreased 28.7% and 20.1% for the three and nine months ended May 28, 2000 from the comparable periods in 1999 primarily due to the sale of the South African operations completed at the end of fiscal 1999 and the disposition of the Mersch entities completed during January of fiscal 2000 and the unfavorable changes in the foreign currency exchange rates for the French franc, the Deutsche mark and the Dutch guilder. COST OF SALES Cost of sales were $47.6 million and $157.3 million for the three and nine months ended May 28, 2000, compared to $55.8 million and $170.3 million for the three and nine months ended May 30, 1999. In the U.S., gross profit increased to 48.4% and 46.5% for the three and nine months ended May 28, 2000, compared to 44.9% and 45.3% for the comparable periods in 1999. The increase was primarily the result of an improvement in the product mix sold and steps taken last year by management to address its non-performing U.S. acquisition-related inventory. International gross profit margin increased to 41.5% and 41.1% for the three and nine months ended May 28, 2000, compared to 39.0% and 40.3% for the comparable periods in 1999. This increase was primarily the result of a decrease in net sales of lower-margin products associated with the recently sold South African operations, as well as an increase of value added sales in Japan. 18 19 OPERATING EXPENSES Operating expenses were $24.6 million and $88.3 million for the three and nine months ended May 28, 2000, compared to $33.9 million and $105.8 million for the three and nine months ended May 30, 1999. In the U.S., operating expenses as a percentage of net sales decreased to 21.2% and 26.8% for the three and nine months ended May 28, 2000, compared to 33.4% and 34.2% for the comparable periods in 1999. The decrease was primarily attributable to the reduction of duplicative acquisition-related expenses and gains in efficiencies at the acquisition locations, along with the reversals of previously provided reserves as more fully described in Notes 12 and 13 to the consolidated financial statements. International operating expenses as a percentage of net sales increased to 38.9% and 37.4% for the three and nine months ended May 28, 2000, compared to 37.2% and 36.9% for the comparable periods in 1999. This increase was primarily due to the decrease in net sales associated with the recently sold South African operations and the Mersch entities, along with the recording of charges associated with the closure of the United Kingdom - Northampton location. Had the reversals of the previously provided reserves referred to above and more fully described in Notes 12 and 13 to the consolidated financial statements not taken place, operating expenses as a percentage of net sales would have been 30.6% and 29.9% in the U.S. and 33.7% and 33.0% for the total Company for the three and nine months ended May 28, 2000, respectively. RESTRUCTURING CHARGES During the third quarter and the nine months ended May 28, 2000, the Company recorded a restructuring charge related to the closure of one of its United Kingdom operations, explained more fully in Note 6 of the notes to the accompanying consolidated financial statements. In addition, the Company off-set the remaining $.03 million unused balance associated with the closure of its duplicate facilities in the United States and the $.02 million unused balance associated with the closure of the UK plastic moulding manufacturing operations with the current restructuring charges incurred in the quarter. The restructuring charges for the quarter were $.9 million. Restructuring charges of $1.2 million and $1.5 million were recorded for the three and nine months ended May 30, 1999. WRITE-DOWN OF GOODWILL In October 1997, the Company acquired Robert F. deCastro, Inc. ("deCastro") a distributor of products in the pre-framed art and the custom framing markets. Since the acquisition, the demand in the markets for the deCastro product line has dramatically decreased or ceased. As a result, in the second quarter of fiscal 2000, management determined to redirect its effort from pre-framed art and to focus its energies and resources, both financial and managerial, on the custom picture framing market. The Company determined that the estimated future undiscounted cash flows of the deCastro product line were below the carrying value of the associated long-lived assets, primarily consisting of goodwill. Accordingly, during the second quarter of fiscal 2000, the Company adjusted the carrying value of deCastro's unamortized goodwill to its estimated fair value of approximately $.2 million, resulting in a non-cash impairment charge of approximately $5.0 million. The estimated fair value of goodwill was based on anticipated future cash flows discounted at a rate commensurate with the risk involved. DISPOSITION OF MERSCH ENTITIES In the second quarter of fiscal 2000, Albecca made a decision to sell its investment in its Mersch entities, a manufacturer and supplier of readymade frames to large European discount stores, located in Germany and France. This decision was based on management's continued initiative to focus its energies and resources, both financial and managerial, on the European custom picture framing market. In January 2000, Albecca sold its investment in its Mersch entities for cash of $16.3 million and retained certain long-term assets of $3.0 million, for total gross consideration of $19.3 million. In addition, the Company retained certain liabilities of $12.5 million (which were primarily paid at closing). The loss on the disposition of the Mersch entities, recorded during the second quarter of fiscal 2000, was approximately $1.4 million. During the third quarter of fiscal 2000, the Company determined that the realizable value of one of the Mersch buildings, a long-term asset retained in the sale, was less than previously estimated. Therefore, the Company has recorded an additional loss on the disposition of the Mersch entities of $.5 million, which represents the write-down of this asset to estimated realizable value from future sale. This increases the total loss on the disposition of the Mersch entities to $1.9 million. The sale agreements required the Mersch entities to maintain a minimum level of working capital through the closing date as supported by a closing balance sheet audit, which has not yet been agreed to by the respective parties. In the opinion of management, the disposition of the Mersch entities will not have a material impact on the future operations or financial position of the Company. The Mersch entities' five month sales and operating income for fiscal 2000 were approximately $10.0 million and $.1 million, respectively. 19 20 INTEREST INCOME Interest income was $1.3 million and $3.1 million for the three and nine months ended May 28, 2000, compared to $.6 million and $1.6 million for the three and nine months ended May 30, 1999. The increase resulted primarily from the interest income associated with the Company's investment in its senior subordinated notes. INTEREST EXPENSE Interest expense was $6.0 million and $18.4 million for the three and nine months ended May 28, 2000, compared to $6.2 million and $19.9 million for the three and nine months ended May 30, 1999. The decrease in interest expense is primarily due to a decrease in long-term debt associated with the sale of the South African operations and the Mersch entities and the Company's continued focus to reduce its debt. EXTRAORDINARY GAIN ON EXTINGUISHMENT OF DEBT Consistent with its stated objective of using a portion of its cash to lower its debt, including its senior subordinated debt, for the nine months ended May 28, 2000, the Company retired $23.8 million of its senior subordinated notes. The debt retirements resulted in extraordinary gains totaling $4.5 million, net of state income taxes of $.2 million. NET INCOME For the reasons set forth above, net income was $9.2 and $16.4 million for the three and nine months ended May 28, 2000, compared to $.0 million and $.5 million for the three and nine months ended May 30, 1999. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of funds have been, and are expected to continue to be, cash flow from operations and its on-hand cash and cash equivalents. The Company's principal need for funds historically has been to finance its working capital (principally inventory and accounts receivable), capital expenditures, acquisitions and debt reduction. Consistent with its stated objective, the Company will continue to use its cash, whether generated from operations, third-party financing, or otherwise, to lower its debt, including its senior subordinated debt. As of May 28, 2000, the Company had cash and cash equivalents of $25.0 million compared to $35.1 million as of August 29, 1999. Net cash provided by operating activities was $36.0 million for the nine months ended May 28, 2000, compared to $10.7 million for the nine months ended May 30, 1999. The increase is primarily attributable to the increase in net income for the nine months ended May 28, 2000 and a reduction in the Company's inventories during the period. Net cash provided by investing activities increased to $8.7 million for the nine months ended May 28, 2000, compared to net cash used of $7.1 million for the nine months ended May 30, 1999. The increase was primarily due to the disposition of the Company's Mersch entities and a reduction in the Company's acquisition activities, partially offset by an increase in capital expenditures. During the nine months ended May 28, 2000, the Company invested $7.8 million for capital expenditures, primarily associated with the construction of the Company's new manufacturing plant located in Ashland, Wisconsin. The land and building cost of the manufacturing facility is expected to be approximately $4.3 million. As of May 28, 2000, approximately $4.1 million had been expended on the project. Completion is expected by the end of fiscal 2000. The Company also purchased the outstanding 23% interest in its Italian subsidiary for approximately $2.4 million. During the nine months ended May 28, 2000, cash used in financing activities increased to $56.3 million compared to $16.2 million for the nine months ended May 30, 1999, primarily due to the Company retiring a portion of its senior subordinated debt with a face value of $23.8 million and debt reduction of $11.9 million associated with the disposition of the Mersch entities. As of May 28, 2000, Albecca had outstanding indebtedness of approximately $187.1 million, consisting of $164.9 million in principal amount of the August 1998 senior subordinated debt and $22.2 million of other indebtedness. As of August 29, 1999, Albecca had outstanding indebtedness of approximately $239.8 million, consisting of $188.8 million in principal amount of the notes and $51.0 million of other indebtedness. The Company enters into forward exchange contracts to hedge purchases and payables denominated in foreign currencies for periods consistent with its identified exposures. Gains and losses related to qualifying hedges of these exposures are deferred and recognized in operating income when the underlying hedged transaction occurs. Albecca's ability to make scheduled payments of the principal of, or to pay the interest or liquidated damages, if any, on, or to refinance its indebtedness, including the August 1998 senior subordinated debt, or to fund planned capital or other expenditures, will depend on its future financial or operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, many of which are beyond its control. Based upon the current levels of operations, management believes that cash flow from operations and available cash and cash equivalents will provide adequate funds for the Company's foreseeable working capital needs, capital expenditures, scheduled 20 21 payments of principal and interest on its indebtedness, including the senior subordinated debt, and acquisitions. There is no certainty that Albecca's business will generate sufficient cash flow from operations or that future borrowings will be available in an amount sufficient to enable Albecca to service its indebtedness, including the senior subordinated debt, or to make anticipated capital and other expenditures. YEAR 2000 UPDATE The efficient operation of the Company's business is dependent in part on its computer software programs and operating systems. These programs and systems are used in several key areas of the Company's business, including order entry, purchasing, inventory management, pricing, sales, shipping, and financial reporting, as well as in various administrative functions. Albecca has an ongoing program to assess the impact of Year 2000 compliance on its information technology systems and its non-information technology systems and has formulated plans to address business disruption associated with potential date processing problems. Through its assessments, Albecca has identified potential Year 2000 issues in its IT systems, both hardware and software, and in its non-IT systems. Albecca continues to address these deficiencies through upgrades, replacements, specific enhancements and other corrective measures. In connection with its non-IT systems, which are building security, heating, ventilation and air conditioning, and other equipment with date sensitive operating controls, Albecca has completed its testing. Albecca has incurred expenses of $1.1 million in conjunction with the Year 2000 compliance project. The majority of these expenditures were expensed during fiscal 1999. Albecca believes that the most reasonable likely worst case Year 2000 scenario would be a failure by a significant third party in supplying Albecca products and services it needs to conduct its day-to-day operations. This risk is not limited to its vendors but also includes, without limitation, utilities or other general service providers or government entities. Albecca is focusing its remedial efforts on those factors which it can reasonably be expected to have influence upon. The extent of lost revenue as a result of such scenarios cannot be estimated at this time. As of the filing date of this Form 10-Q, the Company has not experienced any significant Year 2000 issues arising from its systems or those of its material vendors and suppliers. To the extent that there might be any ongoing Year 2000 issues that might arise at a later date, the Company has contingency plans in place to address such issues. The Company continues to maintain close contact with third parties with whom it has material relationships, such as vendors, suppliers and financial institutions, with respect to such third parties' Year 2000 compliance and any ongoing Year 2000 issues that might arise at a later date. In light of the Company's efforts, the Year 2000 issue has had no material adverse effect to date on the operations or results of operations of the Company, and is not expected to have a material impact on the Company's financial statements. However, there can be no assurance that the Company or any third parties will not have ongoing Year 2000 issues that may have a material adverse effect on the Company's business, operating results and financial condition in the future. FORWARD LOOKING STATEMENTS When used in this Form 10-Q and in future filings by the Company with the Securities and Exchange Commission and in its press releases, and in other written or oral statements made by the Company's representatives, the words and phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimates," "projects," "believes," "plans," "anticipates," "intends," "may," or similar expressions, are intended to identify "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward looking statements include, without limitation, the Company's expectations regarding sales, earnings, or other future financial performance and liquidity, and general statements about future operations and operating results. Although the Company believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results will not differ materially from its expectations. Factors that could cause actual results to differ from expectations include, without limitation, (i) the timing and expense associated with, and effects of, cost-reduction and integration initiatives being implemented by the Company; (ii) general competitive factors and the overall financial condition of the custom framing industry, the retail industry and the general economy; (iii) change in retailer or consumer acceptance of the Company's products; (iv) consolidations and restructurings in the retail industry causing a decrease in the number of stores that sell the Company's products; (v) social, political, and economic risks to the Company's foreign operations and customers; (vi) changes in the laws, regulations, and policies, including changes in accounting standards, that affect, or will affect, the Company in the United States and internationally; (vii) shipment delays, depletion of inventory, service problems; (viii) changes in product mix to ones which are less profitable; and (ix) the ability of the Company and third parties, including customers or suppliers, to adequately address Year 2000 issues. The Company assumes no responsibility to update forward-looking statements made herein or elsewhere. 21 22 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits:

b. Reports on Form 8-K: None 22 23 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 hereunto duly authorized. ALBECCA INC. (registrant) Date: July 12, 2000 /s/ Craig A. Ponzio ------------- --------------------------------------- Craig A. Ponzio, Chairman of the Board, President, Chief Executive Officer (Principal Executive Officer) Date: July 12, 2000 /s/ R. Bradley Goodson ------------- --------------------------------------- R. Bradley Goodson, Vice President Finance, Chief Financial Officer (Principal Financial Officer) 23

ALBECCA INC 10-Q