UNITED STATES SECURITIES AND EXCHANGE COMMISSION

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)
x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended January 30, 2005
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
PORTRAIT CORPORATION OF AMERICA, INC.
(Exact name of registrant as specified in its charter)
Delaware		57-1208051
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
815 Matthews-Mint Hill Road, Matthews, NC		28105
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code: (704) 847-8011
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). ¨ Yes x No
The Company is privately held. There is no trading in the common equity and therefore an aggregate market value based on sales or bid and asked prices is not determinable.
The number of shares of $0.01 par value Common Stock outstanding as of July 28, 2005 was 2,294,352
Documents Incorporated by Reference: None

(Mark One)


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

For the fiscal year ended January 29, 2006


o		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

PORTRAIT CORPORATION OF AMERICA, INC.

~~FORM 10-K~~(Exact name of registrant as specified in its charter)

FISCAL YEAR ENDED JANUARY 30, 2005


Delaware (State or other jurisdiction of incorporation or organization)		57-1208051 (I.R.S. Employer Identification No.)

815 Matthews-Mint Hill Road, Matthews, NC (Address of principal executive offices)		28105 (Zip Code)

Registrant’s telephone number, including area code: (704) 847-8011
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes þ No o

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 o No þ

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.


Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

The Company is privately held. There is no trading in the common equity and therefore an aggregate market value based on sales or bid and asked prices is not determinable.

The number of shares of $0.01 par value Common Stock outstanding as of June 21, 2006 was 2,294,352

Documents Incorporated by Reference: None

PORTRAIT CORPORATION OF AMERICA, INC.
FORM 10-K
FISCAL YEAR ENDED JANUARY 29, 2006

TABLE OF CONTENTS

Item Number in Form 10-K		Page
Item Number in
	PART I
Form 10-K			Page
1.	Business	1
PART I
2.	Properties	24
1.		Business	1
3.	Legal Proceedings	25
1A.		Risk Factors	12
4.	Submission of Matters to a Vote of Security Holders	25
1B.		Unresolved Staff Comments	22
	PART II
2.		Properties	22
5.	Market for Registrant’s Common Equity and Related Stockholder Matters	26
3.		Legal Proceedings	22
6.	Selected Financial Data	26
4.		Submission of Matters to a Vote of Security Holders	22
7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30
PART II
7A.	Quantitative and Qualitative Disclosures About Market Risk	51
5.		Market for Registrant’s Common Equity and Related Stockholder Matters	23
8.	Financial Statements and Supplementary Data	53
6.		Selected Financial Data	23
9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	94
7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
9A.	Controls and Procedures	94
7A.		Quantitative and Qualitative Disclosures About Market Risk	44
9B.	Other Information	94
8.		Financial Statements and Supplementary Data	46
	PART III
9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	89
10.	Directors and Executive Officers of the Registrant	95
9A.		Controls and Procedures	90
11.	Executive Compensation	99
9B.		Other Information	91
12.	Security Ownership of Certain Beneficial Owners and Management	103
PART III
13.	Certain Relationships and Related Transactions	105
10.		Directors and Executive Officers of the Registrant	91
14.	Principal Accounting Fees and Services	105
11.		Executive Compensation	95
	PART IV
12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	99
15.	Exhibits, Financial Statement Schedules	107
13.		Certain Relationships and Related Transactions	102
(a)	1. Financial Statements	107
14.		Principal Accounting Fees and Services	102
	2. Financial Statement Schedules	107
PART IV
	3. Exhibits	107
15.		Exhibits and Financial Statement Schedules	104
Schedule II	Valuation and Qualifying Accounts	108
(a)		1. Financial Statements	104
Signatures		109
		2. Financial Statement Schedules	104
		3. Exhibits	104
Schedule II		Valuation and Qualifying Accounts	105
Signatures			106

PART I

ITEM 1. BUSINESS

Company Overview

We are one of the largest providers of professional portrait photography products and ~~services~~ services in North America based on revenue, number of customers and studio locations. We ~~believe~~For ~~that~~our wefiscal ~~are~~year ended ~~the~~January 29, ~~leader~~2006 in(“fiscal ~~the~~2005” ~~$1.2~~or ~~billion~~“fiscal ~~domestic~~year ~~pre-school portrait photography market~~2005”), ~~with~~we photographed over a6.7 million customers ~~20%~~and ~~share~~generated sales of ~~total sales~~$325.5 million. WeOf ~~are the sole~~our ~~operator~~total ofsales, ~~portrait~~96.8% ~~studios~~were inderived from our Wal-Mart ~~discount~~locations ~~stores~~worldwide and ~~supercenters in the U~~87.~~S.,~~2% ~~Canada,~~were ~~Mexico,~~derived ~~Germany~~from Wal-Mart and other locations in the U.KS., Unless ~~operating under~~ the ~~trade name~~context ~~Wal-Mart~~otherwise ~~Portrait~~requires, ~~Studios.~~as Asused ofherein, ~~January~~the ~~30,~~terms ~~2005~~“we”, ~~we operated 2~~“our”,~~401 permanent~~ ~~studios~~“us” ~~and~~(or ~~modular traveling portrait studios reaching approximately~~similar 1terms),~~000~~ ~~additional~~the ~~locations.~~“Company” ~~Wal-Mart~~or is“PCA” ~~the~~include ~~world’s~~Portrait ~~largest~~Corporation ~~retailer~~of inAmerica, ~~terms of sales~~Inc. ~~Consistent~~and ~~with~~its ~~Wal-Mart’s~~subsidiaries, except ~~every~~that ~~day~~when ~~low~~used ~~price~~with ~~strategy,~~reference weto ~~offer~~common ~~our customers~~stock ~~convenient,~~or ~~high~~other ~~quality~~securities ~~photography~~described ~~services~~herein atand ~~substantially~~in ~~lower price~~describing ~~points~~the ~~than~~positions ~~are~~held ~~offered~~ by ~~our~~management ~~principal~~of ~~industry~~the ~~competitors.~~Company, Wesuch ~~have established~~terms atinclude ~~least~~only ~~200 new portrait studios in Wal-Mart stores in each~~Portrait Corporation of ~~the past~~America, ~~three fiscal years~~Inc.

~~For our fiscal~~ Wal-Mart ~~year~~is ~~ended~~the ~~January~~world’s ~~30,~~largest ~~2005,~~retailer wein ~~photographed~~terms ~~over~~of 7sales. ~~million~~We ~~customers~~are the sole operator of portrait studios in Wal-Mart Stores and ~~generated~~ ~~sales~~Supercenters ofin ~~$323.6~~the ~~million~~U.S., OfCanada, ~~our~~Mexico, ~~total~~Germany ~~sales,~~and 95the U.9%K., ~~were~~operating ~~derived from our~~under the trade name Wal-Mart ~~locations~~Portrait Studios. As of January 29, 2006, we operated 2,492 permanent studios worldwide and ~~88.9%~~deployed ~~were~~modular ~~derived~~traveling ~~from~~portrait studios reaching approximately 1,000 additional locations. Consistent with Wal-Mart’s ~~and~~every day low price strategy, ~~other~~we offer our customers convenient, high quality photography services at substantially lower price ~~locations~~points than are offered by our principal competitors. In fiscal 2005, we opened 176 new studios in Wal-Mart ~~the~~stores Uand closed 85.S.

We have two reportable business segments, retail and institutional. The retail segment ~~serves~~ serves retail stores ~~and military bases~~ in the U.S., Canada, Mexico, Germany and the U.K. The institutional segment serves institutional markets such as church congregations. Of our total sales for ~~our~~ fiscal year ~~ended January 30,~~ 2005, 96 97.81%, or $~~313~~316.1 2 million, were realized in our retail segment. ~~See~~Of ~~Note~~the ~~12 of our~~retail ~~consolidated financial statements regarding further business~~ segment ~~financial~~ ~~information.~~sales, 99.17%, or $~~310~~315.3 2 million, ~~of our retail segment sales~~ were derived from our Wal-Mart locations worldwide,; 8887.52%, or $~~277~~283.1 7 million~~, were~~ ~~derived from Wal~~were fromWal-Mart and other locations in the U.S. and 1112.58%, or $3641.0 8 million, were ~~derived~~ from Wal-Mart and other locations outside the U.S. Certain other financial information regarding our business segments is included in Note 12 to the Consolidated Financial Statements included with this report and is incorporated by reference herein. As of ~~January~~ 30January 29, ~~2005~~2006, we operated ~~226~~2,129 studios in Wal-Mart U.S., 241 studios in Wal-Mart Canada, ~~and~~96 89 studios in Wal-Mart Mexico, and are testing 25 26 Wal-Mart locations in Germany and the U.K.

In addition, we operate two non-portrait photography related concepts in Wal-Mart stores in the U.S.: Hometown Threads®, ~~an owner~~ ~~and~~a franchisor of retail stores specializing in embroidery ~~services~~ services and the personalization of gifts, and Fun Factory, a retail store specializing in ~~making~~ making stuffed animals, selling accessories for these stuffed animals, and hosting birthday parties. AsWe also ofhave ~~the~~one ~~end~~store, ofCreation ~~fiscal 2004~~Station, wewhich ~~operated~~combines ~~one company-owned~~a portrait studio, Hometown Threads® and Fun Factory in ~~Wal-Mart~~ ~~and~~the ~~had~~same 42space. ~~franchised~~As ~~locations~~of the end of ~~which~~fiscal 322005, ~~were~~we inhad ~~Wal-Mart~~46 ~~stores.~~Hometown Threads franchised locations. We also operated ~~one~~12 Fun Factory ~~location~~locations. Under the trade name PCA International, we have ~~also~~a ~~serve other retail channels such as select military bases and~~ free-standing ~~specialty retail through our GoPortraits~~ all-digital portrait ~~studios~~ studio GoPortraits, and, ~~through~~we serve other retail channels using a modular traveling portrait platform,. We also serve the institutional ~~channels~~ channel, such as church congregations.

Despite the ~~decline~~modest increase in our year over year sales in fiscal ~~2004~~2005, ~~during~~over the past three fiscal years ~~overall~~, ~~we have increased~~ our net sales have increased at a compound annual growth rate (“CAGR”) of 43.42%, from $296.6 million to $~~323~~325.6 5 million. Asdriven aby ~~result of new~~ studio openings, ~~the total number of studios~~ in Wal-Mart ~~stores~~which ~~has experienced~~have grown at a CAGR of 10.65% over the same period. Our growth from new studio openings is largely a result of Wal-Mart’s own success in building its retail store base. ~~In April 2002, we executed a U.S. Master License Agreement with~~ Wal-Mart. The license agreement was amended on June 17, 2002 and subsequently on June 24, 2004. As part of this agreement, Wal-Mart committed to provide us a minimum of 150 new studios per year for four years and, thereafter, to use commercially reasonable efforts to provide 150 new studios per year. Since executing the Wal-Mart license agreement in April 2002, we have opened 497 new Wal-Mart studios in the U.S. through the end of fiscal 2004. Under the most recent amendment, 1,564 studio licenses or approximately 80% of the then existing studio licenses were extended to June 30, 2012, evidencing Wal-Mart’s commitment to our Company. Wal-Mart has agreed to use commercially reasonable efforts to include a Wal-Mart Portrait Studio operated by us in the blueprint of each new supercenter (except for new supercenters of 145,000 square feet) and store of 100,000 square feet or larger.

- 1 -

We believe ~~that~~ we ~~are able to~~ provide one of the industry’s lowest cost portrait services due primarily to our vertically integrated ~~and technologically advanced~~ operations. We use an integrated digital imaging system that allows ~~our~~ customers to view a digital ~~proof~~proofs of each pose ~~during the photography session~~ and to select ~~the~~ desired images before any printing occurs. Additionally, ~~This~~this proprietary system ~~also~~ automates and links the image selection process with the ~~immediate~~ sale of custom portrait packages and integrates ~~our~~the studios with our portrait processing and production system. This system, which includes two processing facilities and a distribution center in the Charlotte, North Carolina area, is fully scalable ~~as we grow with Wal-Mart~~. By integrating our portrait photography ~~and~~ and production processes, we ~~are~~can ~~able to~~ minimize processing costs, provide ~~prompt,~~ ~~automated~~superior customer service and grow with minimal incremental capital commitment ~~as we leverage our existing infrastructure~~. We offer portrait packages at prices consistent with Wal-Mart’s every day low price strategy. Furthermore, we do not charge sitting fees or handling charges, ~~while~~which we believe our competitors’ ~~packages~~ typically ~~require additional sitting fees or handling charges~~charge.

Our business model enjoys several competitive advantages over other specialty retailers. Unlike most specialty retailers,

- we are not required to undertake the effort and expense to identify and obtain real estate locations for our studios, but instead open substantially all of our new studios in prime Wal-Mart locations; - ~~we provide a customized service to Wal-Mart customers and therefore carry very few inventory items and use~~ our ~~inventory very quickly, thereby mitigating the effect of common inventory problems experienced by most specialty retailers, such as obsolescence and shrinkage; - our~~ new studios require ~~smaller~~lesser amounts of working capital and capital expenditures; and - our new studios generate immediate revenues because of their location in Wal-Mart stores without the extended new store opening ramp-up of a typical specialty retailer.

We have been in operation since 1967. ~~Until~~Our ~~January~~former ~~1997, our~~ business consisted principally of operating portrait studios in Kmart stores. AtIn ~~that time~~January 1997, we acquired American Studios, Inc., which was then the primary portrait photography provider to Wal-Mart stores in the U.S. and Mexico. AsIn the second quarter of 1997, as we expanded our Wal-Mart business, we began ~~in the second quarter of 1997~~ to close certain ~~of our~~ underperforming studios in Kmart stores. In response to these closings and our expansion in Wal-Mart, Kmart initiated closure of a number of our studios. In ~~August~~ August 1998, we ~~consummated~~completed a recapitalization ~~pursuant~~that toresulted ~~which~~in Jupiter Partners ~~became~~becoming ~~our~~the controlling stockholder ~~and~~of ~~thereafter hired a new senior~~the ~~management team~~Company. ~~Led by Barry J. Feld~~Additionally, ~~our Chairman, President and Chief Executive Officer, new~~ management ~~commenced~~received ~~wide-ranging initiatives to improve our cash flow and market share. After receiving~~ a commitment from Wal-Mart to accelerate our expansion in Wal-Mart stores,. weBased ~~made~~on Wal-Mart’s commitment to us, a strategic decision was made to ~~close~~ close all Kmart locations and redeploy those assets into Wal-Mart stores. ~~We completed~~ ~~this~~This process bywas completed by the end of fiscal 2000. ~~Despite~~Revenue ~~the decline in our year over year sales in fiscal 2004, revenue~~ from our Wal-Mart business has grown at a CAGR of 1211.71% from 1997 to ~~2004.~~2005 Asand athe ~~result~~number of new studio openings~~, we~~ ~~have~~in ~~experienced~~Wal-Mart stores has grown at a CAGR of 1110.65% ~~over~~ for the same period ~~in the total number of studios in Wal-Mart stores~~.

- 2 -

Portrait Corporation of America, Inc.’s predecessor was organized as a North Carolina corporation in 1967 and reincorporated by merger in Delaware on August 6, 2004. Our address is 815 Matthews-Mint Hill Road, Matthews, North Carolina 28105. Our corporate web site address is www.pcaintl.com. Information on our website is not part of this Annual Report on Form 10-K.

Industry

We compete in ~~the~~a ~~large and~~ highly fragmented $8.0 billion (according to Photofinishing News, Inc.) domestic professional portrait photography industry. The primary markets within ~~this~~the industry are pre-school children, school age children (including graduation portraits), adults, families/groups, weddings, passports, churches and ~~others,~~other ~~such~~markets aswhich include; cruise ships, conventions/events, ~~and~~ glamour and executive portraits. Our competitors ~~in the domestic professional portrait photography industry~~ include large studio chains operating in national retailers, other national free-standing portrait studio companies, national school and church photographers and a myriad of independent portrait photography providers. The majority of the industry is comprised of small, independent photography companies and individual photographers that use various independent processing labs.

~~Given~~2 the significant scale and capital investment required, the provision of portrait photography services in retail hosts is a business dominated by a few large national competitors. Other than PCA, there are only three companies that operate in retail hosts on a national basis. These are CPI Corporation, which operates in Sears; Lifetouch, which operates in JCPenney and Target; and Olan Mills, which operates in Kmart stores. We are the largest of these competitors by sales, the number of customers served in retail hosts and the number of studios.

~~A number of~~ The ~~companies~~provision inof ~~the professional~~ portrait photography ~~industry~~services ~~operate free-standing~~in ~~studios~~retail onhosts ais ~~national,~~dominated ~~regional~~by ora ~~local~~few ~~basis~~large national competitors. InCPI ~~addition to providing~~Corporation, ~~photography~~which ~~services~~operates in ~~retail~~Sears; ~~hosts~~Lifetouch, ~~both~~which ~~CPI~~operates ~~Corporation through~~in ~~its Sears~~JCPenney ~~Portrait~~and ~~Studios~~Target; ~~brand~~ and Olan Mills, ~~operate~~which ~~through~~operates ~~this~~in ~~format~~Kmart stores. ~~Independent~~ ~~studios~~We ~~and~~believe ~~portrait~~we ~~photographers~~ are the ~~most~~largest of ~~numerous~~these competitors in ~~the~~by ~~industry~~sales, ~~and generate~~ the ~~largest~~number ~~percentage~~ of ~~industry~~customers ~~sales.~~served ~~Few barriers~~in toretail ~~entry~~hosts ~~exist~~and ~~through~~the ~~this~~number ~~format. However, these competitors~~of ~~typically lack processing scale and geographic coverage~~studios.

A number of companies in the professional portrait photography industry operate free-standing studios on a national, regional or local basis. In addition to providing photography services in retail hosts, both CPI Corporation through its Sears Portrait Studios brand and Olan Mills operate through this format. Independent studios and portrait photographers are the most numerous competitors in the industry and generate the largest percentage of industry sales. Few barriers to entry exist in the industry through this format. However, independents typically lack processing scale and geographic coverage.

Companies within our industry compete on the basis of value, price, quality, access, service, package size and technology. Additionally, where portrait companies operate within retail hosts, the relative convenience of the hosts’ stores and consumer preferences for such retail hosts are also important competitive factors. We believe our products and services are very competitive in terms of all of these attributes.

We offer children, adult and family portraits both through permanent studios and traveling locations in retail hosts as well as through traveling locations in churches and other institutional channels. Currently, we participate in markets representing 68.0% of industry sales: school age, preschool, adult, family, passport and churches. Through our GoPortraits initiative, we have also recently entered and expect to expand our presence in the $800.0 million wedding market. The following presents sales information for the domestic professional portrait photography industry by market:

- 3 -

2004 Domestic Professional Portrait Photography Industry Sales: $8.0 Billion
School Age	32%
Pre-School	15%
Adult	10%
Weddings	10%
Family/Group	7%
Church	2%
Passport	2%
Other	22%
Source: 2004 Mass Portrait Review, by PhotoFinishing News, Inc.

From 1994 through 2004, according to Photofinishing News, Inc., the domestic professional portrait photography industry grew at a CAGR of 3.6%. We are one of the largest participants in the domestic preschool portrait photography market (children under six years old), which has been characterized historically by stable growth in line with a steady increase in domestic births. This steady growth is expected to continue since, according to the United States Census Bureau, births are projected to remain above 4.0 million annually in the U.S. Moreover, the population of grandparents, a common recipient of portrait photography, is growing as Americans live longer, which could result in the number of portrait sittings exceeding historical growth rates in the future.

Competitive Strengths

-	Leading Market Position. We believe we are the leader in the $1.2 billion domestic pre-school portrait photography market, with over a 20% share of total sales. In 2004, no other professional portrait provider served more customers in retail hosts or operated more permanent studio locations than our company. In fiscal 2003, we surpassed CPI Corporation as the leader in the professional portrait photography market by total sales. We have increased the number of customers we served domestically over the past three years from 5.9 million to 6.4 million. As of January 30, 2005, we operated 2,061 permanent portrait studios domestically.
-	Strong, Mutually Beneficial Relationship with Wal-Mart. By aligning our strategy with Wal-Mart’s emphasis on providing low-cost, high quality products, we have enjoyed a mutually beneficial, longterm relationship with Wal-Mart, the world’s largest retailer in terms of sales. Since 1998, we have been the sole operator of portrait photography studios in Wal-Mart stores in North America. The majority of our permanent Wal-Mart studios are located in prominent locations at the front of the discount store or supercenter, affording us easy access to Wal-Mart’s unrivaled customer foot traffic. In return, we provide Wal-Mart with strong profit per square foot and provide consumers with high quality photography at every day low prices. At January 30, 2005, Wal-Mart had 3,066 discount stores and supercenters in the U.S. as well as 1,587 stores internationally, and we operated in 2,061 Wal-Mart stores in the U.S. and 340 internationally. We have been able to significantly increase the number of permanent studios in Wal-Mart, having grown our number of permanent portrait studios in Wal-Mart stores in North America from 1,112 studios at the beginning of fiscal 1998 to 2,376 studios at the end of fiscal 2004, representing a CAGR of 11.5%. Sales from our Wal-Mart business totaled $310.3 million for the fiscal year ended January 30, 2005, which, despite the decline in our year over year sales in fiscal 2004, represents a CAGR of 12.8% from $150.6 million in fiscal 1998. As a result of this growth, we have been able to significantly expand brand awareness for Wal-Mart Portrait Studios. Wal-Mart has agreed to use commercially reasonable efforts to include a Wal-Mart Portrait Studio operated by us in the blueprint of each new supercenter (except for new supercenters of 145,000 square feet) and store of 100,000 square feet or larger.

-		Leading Market Position. In fiscal 2005, we believe no other professional portrait provider served more customers in retail hosts or operated more permanent studio locations than our Company. We served over 6.7 million customers domestically and as of January 29, 2006, we operated 2,129 permanent portrait studios domestically.

-		Strong, Mutually Beneficial Relationship with Wal-Mart. By aligning our strategy with Wal-Mart’s providing low-cost, high quality products, we have enjoyed a mutually beneficial, long-term relationship. Since 1998, we have been the sole operator of portrait photography studios in Wal-Mart stores in North America. The majority of our permanent Wal-Mart studios are located in prominent locations at the front of the store or Supercenter, affording us easy access to Wal-Mart’s unrivaled customer foot traffic. In return, we provide Wal-Mart with strong profit per square foot and provide consumers with high quality photography at every day low prices. At January 29, 2006, Wal-Mart had 3,189 stores and Supercenters in the U.S. as well as 1,847 stores internationally. We operate in 2,129 or 67% Wal-Mart stores in the U.S. and 363 internationally. We have been able to significantly increase the number of permanent studios in Wal-Mart, having grown in North America from 1,112 permanent studios at the beginning of fiscal 1998 to 2,466 studios at the end of fiscal 2005, representing a CAGR of 10.5%. Sales from our Wal-Mart business totaled $315.2 million for the fiscal year ended January 29, 2006, which represents a CAGR of 11.1% from $150.6 million in fiscal 1998. As a result of this growth, we have been able to significantly expand brand awareness for Wal-Mart Portrait Studios.

-		Low Cost Producer. We believe we have one of the lowest-cost portrait production systems in the industry. This cost advantage is due primarily to:

- 4 a modest capital expenditure requirement for each new studio; - low maintenance costs associated with our proprietary integrated imaging and portrait processing system;

-	Low Cost Producer. We offer our portrait packages at prices consistent with Wal-Mart’s every day low price strategy. We believe we have one of the lowest-cost portrait production systems in the industry. We believe that the cost advantage we enjoy today is due primarily to:
	-	our more modest capital expenditure requirements for each new studio;
	-	low depreciation and maintenance expenses associated with our proprietary integrated imaging and portrait processing system;
	-	our integrated digital imaging system, which allows our customers to view a digital proof of each pose during the photography session and to select only the desired images before any printing occurs;
	-	the efficiency and flexibility of our integrated portrait photography and production process system, which streamlines and automates the production process, resulting in higher volume, faster speeds, lower labor costs and less waste, and allows us to leverage our existing scalable infrastructure, which includes our two processing facilities and our distribution center in the Charlotte, North Carolina area; and
	-	a marketing focus on selling larger portrait collections based on more poses, which lowers the average production cost per unit as more units are produced per customer.
-	Focus on Innovation. We have a history of assessing advancements in technology and successfully implementing such advancements when we have determined that they are cost effective on a large-scale basis. We are one of the few companies in the domestic professional portrait photography industry to have developed a proprietary integrated system that allows customers to select their choice of portraits prior to actual production and that automatically links the image selection process to the sale and production of the portrait package. This technology is fully scalable; as we continue our rapid expansion plans, each new outlet or channel requires minimal incremental expenditures. We have developed a free-standing specialty retail concept called GoPortraits that features two all digital portrait photography studios in the Charlotte, North Carolina metropolitan area. In addition, we strive to maintain a strong focus on new product development. Recently, we expanded our portfolio of products to include all occasion greeting cards and large-format canvas portraits. Leveraging our digital imaging system, we have augmented our product offerings with digital portraits on CD or disk, the Portrait GalleryTM, available immediately after the portrait session with email capability. The Portrait Gallery is sold with PhotoParade, a companion software on CD that enables customers to create themed screensavers and print-at-home projects such as portrait stickers, gift tags and portrait magnets.
-	Experienced and Results-Oriented Management Team. Members of our senior management team have an average of over 14 years of experience in the specialty retail industry. They are invested in our business, beneficially owning approximately 11.2% of our common stock on a fully-diluted basis. Since joining PCA in 1999, Barry J. Feld, our Chairman, President and Chief Executive Officer, has directed our expansion by further strengthening our relationship with Wal-Mart.

- 5 our integrated digital imaging system, which allows customers to view digital proofs and select only the desired images before any printing occurs; - our efficient and flexible integrated portrait photography and production process system, which simplifies and automates the production process, resulting in higher volume, lower labor costs, less waste, and allows us to leverage our existing scalable infrastructure. - a marketing focus on selling larger portrait collections based on more poses, which lowers the average production cost per unit as more units are produced per customer.

Focus on Innovation. We strive to maintain a strong focus on new product development. Recently, we expanded our portfolio of products to include all occasion greeting cards, ornaments, puzzles and large-format canvas portraits. Leveraging our digital imaging system, we have augmented our product offerings with digital portraits on CD or disk, the Portrait GalleryTM, available immediately after the portrait session with e-mail capability. The Portrait Gallery is sold with PhotoParade, a companion software on CD, that enables customers to create themed screensavers and print-at-home projects such as portrait stickers, gift tags and portrait magnets.

Business Strategy

Our business strategy is to continue to capitalize on our strengths by implementing the following initiatives:

-	Increase Same Studio Sales. In order to address our recent weak same store sales trends, we have implemented a series of highly focused, tactical operating initiatives designed to restore our core U.S. Wal-Mart studio business back to prior positive same studio sales growth. Examples of these recent initiatives include:
	-	increased external recruiting of field operations management;
	-	instituting a new bonus program for our field associates;
	-	launching new marketing initiatives, including selected coordinated marketing efforts with Wal-Mart;
	-	re-implementing our successful “Portrait Smiles” customer continuity program which was previously eliminated in fiscal 2003;
	-	re-introducing a mid-tier price point in our package offers in order to promote customer trade ups; and
	-	increasing our opening price point.
	We believe these initiatives will result in improvements primarily in average transaction size per customer, as well as improved customer traffic as our current fiscal year progresses.
-	Continue to Participate in Wal-Mart’s Growth. Based upon our relationship with Wal-Mart, we believe that we have the strongest platform for expansion in the industry as Wal-Mart continues its rapid growth. We opened 200 permanent Wal-Mart studios in fiscal 2004 and are currently planning to open over 200 permanent Wal-Mart studios in fiscal 2005. We expect that this new studio growth, combined with the increasing brand awareness for Wal-Mart Portrait Studios, will result in increased market share for PCA.
-	Disciplined Extension of Our International Presence. We believe that international markets for professional portrait photography services represent an attractive growth opportunity for PCA. We intend to grow our international market share primarily through our relationship with Wal-Mart. As of January 30, 2005, we operated 226 studios in Wal-Mart Canada and 89 studios in Wal-Mart Mexico, and are testing 25 Wal-Mart locations in Germany and the U.K. See “Item 1. Business—Risk Factors—Risks Related to Our Business—Our international expansion may not be successful and may expose us to additional risks that could adversely affect our business.”
-	Disciplined Extension into Non-Portrait Photography Related Concepts. With our acquisition of certain assets and liabilities of Hometown Threads® in October 2004, we expanded our service offering in Wal-Mart stores beyond portrait photography to include embroidery services and personalization of gifts. Additionally, with the opening of our first Fun Factory location in Wal-Mart, we have the opportunity to expand our presence in Wal-Mart stores with this child-centered, value-priced concept.

Increase Same Studio Sales. In order to address our declining same store sales trends, we have implemented a series of highly focused, tactical operating initiatives designed to restore our core U.S. Wal-Mart studio business back to prior positive same studio sales growth. Examples of these initiatives include:

- 6 Reorganizing field operations management to put an emphasis on training and retaining studio personnel: to include - placing a renewed emphasis on photographer certification; - instituting a new bonus program for our field associates and a new PCA Partner program to recognize superior performance; - launching new marketing initiatives, including selected coordinated marketing efforts with Wal-Mart, increased customer direct mailing programs and participation in Wal-Mart advertising circular; - changing our studio hours to better serve our customers’ demand (this change was based on a detailed study of our sales by hour); - re-configuring backend packages, based on customer feedback, to increase their value and provide more order flexibility to our customers; and - increasing our average front end collection rates on custom ordered portraits which increase final collection rates.

Additionally, we are looking at our business more qualitatively including the use of focus groups, customer surveys, market testing, etc. to insure we understand our customers’ needs and address those needs. We believe these initiatives will result in improvements primarily in average transaction size

		per customer, as well as improved customer traffic as our current fiscal year progresses.

-		Continue to Participate in Wal-Mart’s Growth. Based upon our relationship with Wal-Mart, we believe we have the strongest platform for expansion in the industry as Wal-Mart continues its growth. However, such growth will be more focused than in prior years. Working closely with Wal-Mart, in fiscal 2005, we opened 176 permanent studios but closed 85.

-		Disciplined Extension of Our International Presence. We believe that international markets for professional portrait photography services represent an attractive growth opportunity for PCA primarily in Canada and Mexico. We intend to grow our international market share primarily through our relationship with Wal-Mart. As of January 29, 2006, we operated 241 studios in Wal-Mart Canada and 96 studios in Wal-Mart Mexico, and 26 Wal-Mart locations in Germany and the U.K. We continue to assess the viability of our European operations. See “Item 1. Business—Risk Factors—Risks Related to Our Business—Our international expansion may not be successful and may expose us to additional risks that could adversely affect our business.”

-		Disciplined Extension into Non-Portrait Photography Related Concepts. With the opening of 12 Fun Factory locations in Wal-Mart, we have the opportunity to expand our presence in Wal-Mart stores with this child-centered, value-priced concept.

-		Critically assessing our business channels and internal costs. Evaluating all business channels for strategic importance and profit contribution and ceasing to operate non-contributing channels and critically evaluating all our operations, support and administrative functions, for cost saving opportunities.

The Portrait Photography Experience

We provide our photography services in permanent studios in our retail hosts. We also service certain retail hosts and institutional customers through modular traveling locations.

Permanent Studios. The typical permanent studio occupies an average of 350 square feet and ~~consists~~ consists of a camera area, a portrait viewing and sales area, and a reception area with a point-of-sale system. Generally, the permanent studio is staffed by one to three associates who perform both the photography and sales functions. The majority of our professional portrait photography studios are open from 10:00 a.m. to 7 8:00 p.m., ~~seven~~six days a week and 12: 00 p.m. to 8:00 p.m. on Sunday .

Our permanent portrait studios are equipped with an integrated photography and sales ~~system~~ system and point-of-sale system. The photographic system integrates a professional film camera ~~and digital~~ with imaging capability. As the subject is photographed, each pose is captured on film and presented ~~digitally~~ on a a computer monitor for the customer to preview and approve before proceeding to the next pose. The ~~digital~~ photographic images are then sent electronically to a sales computer in an adjacent area, where a studio associate presents the ~~digital~~ portrait images and, ~~prompted~~utilizing by our software sales program, explains the portrait packages available. Guided by the studio associate, each customer customizes their order by choosing the poses, sizes and quantities desired. A portrait order receipt is printed with black and white thumbnails of the selected poses. The studio associate completes the transaction at ~~the~~ the point-of-sale system and the customer either pays in full or makes a deposit and returns in three weeks to pick up the finished portraits. Customers are not obligated to accept finished products.

Our principal products sold through our studio operations are portraits and ancillary products produced from the ~~photography~~photo images we create. Our portraits are printed on photographic paper or canvas and are available in a variety of sizes from wallet-size to wall portraits as large as 36 inches by 36 inches. Our ~~ancillary~~ ~~products include all-occasion greeting cards, large format canvas portraits, and portraits on disks. Portrait and~~ ancillary products ~~account~~ ~~for substantially all of our sales.~~

~~Modular~~5 Traveling Locations. Where we do not have permanent studios, we service Wal-Mart stores and supercenters with a modular traveling studio location. These modular traveling locations operate in designated Wal-Mart stores for a period of approximately five days every seven to twelve weeks. Several days prior to the scheduled arrival of one of our photographers at the host store, we advertise our traveling promotions by offering an assortment of color portraits at a special price. A modular traveling location in Wal-Mart occupies approximately 100 square feet and consists of a table, camera, lights, and portable backdrops. These modular traveling locations utilize a non-digital photographic and sales system, in which the photography session occurs separately from the sales process. Approximately three weeks after photographs are taken, a sales associate sets up a temporary sales area in the host store and for one to five days assists customers in selecting portraits for purchase. Given the non-digital nature of this system, customers in our modular traveling locations may purchase only portraits in the sizes and quantities produced; no ancillary products are available for purchase except Scrapbooklets©. Photographers and sales associates transport by personal vehicle all requisite camera, studio equipment and sales materials.

~~Our institutional~~include ~~business~~all-occasion isgreeting ~~conducted~~cards, ~~on a traveling basis and utilizes our integrated digital photography and sales system. We contract with institutions~~ornaments, ~~primarily~~ ~~church congregations~~puzzles, tolarge ~~photograph~~format ~~and~~canvas ~~sell~~portraits, ~~individual~~ and ~~family~~ portraits. Weon dodisks. ~~not~~Portrait ~~pay~~and ~~commissions~~ancillary toproducts ~~the~~account ~~host~~for ~~institutions,~~substantially ~~but we do provide a free photo directory to~~ all ~~members~~of ~~who~~our ~~agree to be photographed~~sales. ~~Approximately three weeks after the photography session, the finished portraits are sent to the host institution or directly to the consumer.~~

Modular Traveling Studios. In Wal-Marts where we do not have permanent studios, we use a 7 modular traveling studio. These modular traveling studios operate in designated Wal-Mart stores for a period of approximately five days every seven to twelve weeks. Several days prior to the scheduled arrival of one of our photographers at the host store, we advertise our traveling promotions at the location. These modular traveling studios utilize a photographic and sales system, in which the photography session occurs separately from the sales process. Approximately three weeks after photographs are taken, a sales associate sets up a temporary sales area in the host store and for one to five days assists customers in selecting portraits for purchase. Customers in our modular traveling locations may purchase only portraits in the sizes and quantities produced; no ancillary products are available for purchase except Scrapbooklets©.

Our institutional business is conducted on a traveling basis and utilizes our integrated photography and sales system. We contract with institutions, primarily church congregations, to photograph and sell individual and family portraits. We do not pay commissions to the host institutions, but we do provide a free photo directory to all members who agree to be photographed. Approximately three weeks after the photography session, the finished portraits are sent to the host institution or directly to the customer.

Distribution Channels

We have the following two primary distribution channels:

Retail:

- Wal-Mart Portrait Studios. We are currently the sole provider of portrait studios in Wal-Mart in all 50 states as well as Canada, Mexico, Germany and the U.K. As of January 3029, ~~2005~~2006, we had 2,~~401~~492 permanent studios in Wal-Mart stores in the U.S., Canada, Mexico, Germany and the U.K. ~~We continue to explore additional geographic diversification by monitoring our Wal-Mart Portrait Studios in Europe.~~ Our U.S. operations in Wal-Mart stores accounted for approximately 84.80%, 8584.8% and 8685.28% of consolidated sales in fiscal ~~2004~~2005, ~~2003~~2004 and ~~2002~~2003, respectively. Our international operations in Wal-Mart stores contributed 1112.18%, 911.51% and 89.15% of consolidated sales for fiscal ~~2004~~2005, ~~2003~~2004 and ~~2002~~2003, respectively. We operate our studios in Wal-Mart stores under license and lease agreements. - Other Retail. In fiscal ~~2000, we began portrait photography operations on select military bases. In fiscal~~ 2004, we began offering embroidery services and gift personalization in Wal-Mart stores through Hometown Threads® locations. ~~and~~We wefranchised ~~opened~~47 ~~our~~these ~~first~~locations as of January 29, 2006. Additionally, we had 12 Fun Factory locations, aour stuffed animal, child-centered, value-priced concept. - GoPortraits. WeIn ~~have~~2003, we developed a free-standing retail concept called GoPortraits that features ~~two~~an all-digital portrait photography ~~studios~~studio. We also provide services, including digital photographic retouching, and on-site production of film and digital images. ~~We currently have two concept studios located in the Charlotte, North Carolina metropolitan area.~~

Institutional:

- ~~Institutional.~~ Through our institutional channel, we target primarily church accounts. Our institutional operations accounted for less than 53% of overall sales for fiscal ~~2004~~2005, ~~2003~~2004 and ~~2002~~2003.

Technology, Manufacturing and Software Development

Our technology, manufacturing and software development groups design, develop and ~~implement~~ ~~advanced~~ implement systems and technologies to support our vertically integrated ~~operation~~ business process. From photographic and ~~digital~~ image capture ~~and~~to customizable order creation in our studios through manufacturing and product fulfillment, these groups continually explore the application of systems and technologies that allow us to reduce costs while ~~offering~~providing customers with high quality products at ~~low price~~ ~~points~~reasonable prices.

Leveraging our proprietary ~~digital~~ imaging system, we are one of the few companies in the ~~professional~~ professional portrait photography industry tothat ~~have~~has built a vertically integrated operation. ~~where~~Our ~~our~~ technology is fully scalable. As we continue ~~our~~to ~~rapid expansion~~grow ~~plans~~ and add new outlets or channels ~~to our infrastructure~~, new studios will be integrated seamlessly ~~with~~into our automated production processes with minimal incremental ~~expenditures~~costs.

- Our imaging system allows customers to view proofs during the photography session and select 8the desired images for purchase. Immediately after the photography session, using a computerized -sales system and guided by studio associates, customers can select specific poses, portrait sizes, and quantities for purchase. Consequently, we print only portraits ordered by customers in our permanent studios.

~~Our~~7 digital imaging system allows customers to view a digital proof of each pose during the photography session and to select the desired images from which to make a purchase decision. Immediately after the photography session, customers customize their portrait purchases using a computerized sales system, guided by studio associates, that enables customers to select specific poses, portrait sizes, and quantities for purchase. Customers return to the studio approximately three weeks later to pick up the finished portraits. As a result of our digital imaging system, we print only portraits ordered by customers in our permanent studios. Furthermore, the integration of our digital studio infrastructure with our production system allows us to minimize production and processing costs, and grow with a minimal incremental capital commitment as we leverage our existing production and processing infrastructure.

~~Leveraging our~~ By ~~digital~~leveraging our imaging system, we have ~~augmented~~enhanced our product offerings with ~~digital~~ portraits on CD or disk, the Portrait GalleryTM, available immediately after the portrait session with e-mail ~~email~~ capability. The Portrait GalleryTM is sold with PhotoParade®, a companion software that enables customers to create themed screensavers, ~~and~~ print-at-home projects such as portrait stickers /gift tags and portrait magnets. We believe ~~that~~ this is a unique product offering in the industry. We license this product under an exclusive arrangement with Callisto Corporation, the owner of the PhotoParade® trademark.

At January 30, 2005, we had 525 employees in our two manufacturing production operations. Our technology group, which consisted of 12 engineers and technicians, designs, develops, tests, and implements camera technologies, studio equipment such as lighting and background systems, and production and automation systems used in our film processing, portrait production labs, and digital fulfillment center. We continue to expand our digital fulfillment center with computer technology and printing equipment for production of e-commerce orders, large-format portrait production on canvas, and novelty products. At January 30, 2005, our information technology group consisted of 66 employees who design and develop studio and lab software and systems, manage systems architecture and quality, integrate technologies, support infrastructure and maintain both corporate and studio systems. Within this group we have a team dedicated to the advancement of our integrated studio systems by incorporating evolving digital imaging and camera technologies, and enhancing sales and point of sale systems and studio infrastructure. Our software group also provides system configuration for changes to our portrait offer and package contents driven by marketing campaigns.

Marketing and Sales

Our ~~marketing~~ group’s responsibilities include the creation and cost-effective production and placement of all in-store advertising, in-studio displays and general multi-media advertising. The marketing group performs all strategic marketing functions including, but not limited to, creative direction, campaign development, merchandising, cross-promotion development with well-known television and movie characters, media planning and analysis, studio sales support, and customer/market research. Our marketing group also manages the daily working relationships with external advertising agencies, ~~and~~ free-lance support and maintains our proprietary customer database. This database allows us to apply targeted advertising strategies.

We attract customers to our studios with a variety of advertising methods including in-store, point-of-sale merchandising, newspaper advertising, direct mail to prior and prospective customers, in-store cross-promotional efforts and internet marketing campaigns. We advertise under the name of our retail host. We seek to maintain an advertising presence throughout the year in all geographic markets where we operate permanent studios.

~~In addition~~ Additionally, we have expanded our Internet presence with our website, www.goportraits.com (a PCA-owned and operated website). ~~This website markets our studios and incorporates e-commerce.~~ In fiscal 2004, we expanded our e-commerce initiative to all U.S. studios. This service allows customers to order online additional portraits and other selected items. We continue to expand the number of products sold through this channel. Our company website, www.pcaintl.com, provides information about each of our portrait photography businesses including our free-standing specialty retail concept, GoPortraits, in the Charlotte, North ~~Carolina~~ Carolina metropolitan area.

- Training and development of our studio associates is critical to customer acquisition, 9retention and sales at the studio level. Studio associates participate in a certification program that develops their technical skills to insure consistent portrait quality and retail management skills to insure customer satisfaction. This program provides for studio associates to progress from Portrait Specialists to Portrait Artists to Master Photographer designation. Studio associates also learn the retail management and customer service skills to provide quality service and customer satisfaction. Studio associates are supported by a technical Help Desk and a customer support center with a toll-free customer service line. Production and headquarters personnel also participate in training specifically designed to enhance the customer’s total portrait experience.

~~Training and~~ We development of our studio associates are critical to customer acquisition and retention and building sales at the studio level. Studio associates participate in a certification program that develops their technical and retail management skills and ensures consistent portrait quality. This program permits studio associates to progress from Portrait Specialists to Portrait Artists and eventually leads to the Master Photographer designation. Studio associates learn the photographic, retail management and customer service skills to provide quality service and customer satisfaction. Studio associates are supported by a technical Help Desk and a customer support center with a toll-free customer service line. Production and headquarters personnel also ~~participate~~sponsor ~~in training specifically designed to enhance the customer’s total portrait experience. We also provide~~ an annual portrait competition among ~~our~~ studio associates ~~to encourage~~encouraging them to develop their photography skills and enhance their composition using creative ideas for new poses and props.

Raw Materials and Suppliers

~~AgfaPhoto USA~~ During ~~Corporation~~the isfourth ~~our~~quarter ~~principal supplier~~ of ~~photographic~~fiscal ~~film~~2005, ~~paper~~the ~~and processing~~Company ~~chemistry~~replaced ~~and~~Agfa, ~~has~~its ~~been~~long ~~our~~time supplier ~~for over 30 years. Our current~~of ~~relationship with AgfaPhoto USA Corporation is governed by a contract dated February 4~~paper, ~~2002.~~film ~~The~~and ~~contract has approximately a five-year term~~chemicals. ~~The~~Effective ~~parties agreed to negotiate~~ in ~~good~~December 2005, ~~faith to renew~~ the ~~contract~~Company ~~six~~entered ~~months~~into ~~prior to~~supply ~~the~~agreements ~~expiration~~with ~~date.~~Fuji ~~The terms of the contract require us to purchase substantially all of our requirements in North America~~ for ~~photographic film,~~ paper and ~~processing~~ ~~chemistry~~chemicals and inKodak ~~exchange~~for wefilm ~~receive certain discounts on purchases made~~supplies. ~~AgfaPhoto~~These ~~USA~~agreements ~~Corporation~~run ~~can~~until ~~terminate the sales contract if we breach~~June 30, ~~the~~2007 ~~contract in any way~~ and ~~fail~~provide tofor ~~cure~~minimum ~~such~~order ~~breach~~quantities ~~within 30 days after notice or if we are in violation of any of our financial covenants under any of our credit arrangements~~ which ~~are~~management ~~not~~believes ~~cured~~it orwill ~~amended within 90 days~~exceed. ~~AgfaPhoto~~ USA Corporation has the right to terminate upon shorter notice or immediately in the event of bankruptcy or insolvency relating to us or a violation of the trademark provisions of the sales contract.

~~During fiscal~~ Management ~~2004,~~believes ~~we were unable to meet the payment terms of AgfaPhoto USA Corporation. We have negotiated payment terms with AgfaPhoto USA Corporation~~ that ~~extend~~ the ~~payment~~company’s ~~date~~sources ~~for our outstanding payables (including interest which had been accrued at an annualized rate~~ of ~~6%)~~supply asare ofadequate ~~June 15, 2005 until June 15, 2006 and we have agreed~~ to ~~pay~~ensure ~~for~~a ~~products purchased from AgfaPhoto~~continuous ~~USA~~supply ~~Corporation~~of onraw ormaterials ~~after June 15, 2005 at or prior~~ to ~~their delivery. We are seeking to enter into a revised supply contract with AgfaPhoto USA Corporation within~~ the ~~next few months~~business. ~~However, there is no assurance that we will be~~ ~~able to do so.~~

~~Additionally,~~8 on May 27, 2005, AgfaPhoto USA Corporation’s German parent company, AgfaPhoto GmbH, filed a petition for insolvency. While we have been informed that AgfaPhoto USA Corporation has sufficient funding to continue its normal operations in the foreseeable future, if AgfaPhoto USA Corporation becomes unable to continue to provide us supplies under our current contract, we will need to obtain an alternative source of supplies.

~~Although management~~ We ~~believes~~build ~~that~~our ~~the~~own ~~available~~cameras ~~alternative~~and ~~sources~~believe ofthat ~~supplies are adequate and~~ we have ~~not~~an ~~found~~adequate itsupply ~~necessary to carry significant amounts~~ of ~~inventory~~ tocameras ~~ensure~~and ~~a continuous allotment of raw materials, there can be~~camera ~~no assurance~~components. weThe ~~would~~computers beand ~~able~~equipment toused ~~obtain~~by ~~such~~us ~~supplies~~in atour ~~the~~integrated ~~same~~imaging orsystem ~~similar~~consists of ~~terms to~~standard ~~those~~components wethat ~~have~~are ~~with~~readily ~~AgfaPhoto~~available ~~USA~~from ~~Corporation~~multiple suppliers.

We9 build our own cameras and believe that we have an adequate supply of cameras and camera components. The computer and digital equipment used by us in our integrated digital imaging system consists of standard components that are readily available from multiple suppliers.

- 10 -

Employees

At ~~January~~ 30January 29, ~~2005~~2006, we had 8,739 full-time and part-time employees. As of January 30 29, ~~2005~~2006, none of our employees were covered by a collective bargaining agreement. We believe that employee relations are satisfactory.

Governmental Regulations

We are subject to various federal and state laws and regulations, including the ~~Occupational~~ Occupational Safety and Health Act and federal and state environmental laws. We are not aware of any material violations ~~violation~~ of such laws and regulations. Continued compliance is not expected to have a material effect upon our competitive position, financial condition, or results of operations.

Licenses, Trademarks and Patents

Wal-Mart Licenses

United States. Within the U.S. our relationship with Wal-Mart Stores, Inc. is governed by a master license agreement dated April 4, 2002 with amendments on June 17, 2002 and June 24, 2004.

The terms of the master license agreement require us to pay a fee to Wal-Mart based upon our gross sales. The license allows us to use the trade name “Wal-Mart Portrait Studio” and to use Wal-Mart designated space within its stores. The license prohibits Wal-Mart from licensing a permanent, temporary or traveling portrait studio to any other person in the stores in which we operate but not in stores where we do not operate.

Wal-Mart can terminate the license with respect to a studio if we breach the agreement as it relates to such studio in any way and fail to cure such breach within fifteen days after notice. Certain events give Wal-Mart the right to terminate upon shorter notice or immediately. These events are (1) our failure to pay the license fee or deliver financial information within the time periods specified under the agreement, (2) certain events of bankruptcy or insolvency relating to us, (3) our causing liens on Wal-Mart’s property that are not discharged in the manner required under the agreement, (4) our vacating or injuring the licensed premises or (5) us or any of our employees, licensees, agents, officers, suppliers or contractors violating any law or committing any illegal act associated with the licensed premises.

Termination provisions also apply if we open certain competing businesses near Wal-Mart stores where we have existing studios or in the event of governmental property condemnations. These default provisions relate only to individual locations affected by the violation. Wal-Mart can terminate the agreement with respect to all locations if we are in default of the license with respect to one-third or more of our locations. Finally, Wal-Mart can temporarily suspend the agreement with respect to an individual location in the event of certain other events.

Pursuant to the Wal-Mart license amendment on June 24, 2004, studio licenses in effect on April 4, 2002 that existed on June 24, 2004 (1,564 studio licenses or approximately 80% of the then existing studio licenses) were extended to June 30, 2012, evidencing Wal-Mart’s commitment to our Company. Studios that began operations after the execution of the license on April 4, 2002, have a five-year term that commences upon their opening date and ends on June 30 of the fifth ~~year~~ year following the opening year. These studio licenses renew automatically for one additional period of five years unless either party gives notice of termination on or before 180 days prior to the end of the term. As of January 30 29, ~~2005~~2006, ~~in the U.S.,~~ we operated in 2,~~061~~129 Wal-Mart permanent studios and approximately 1,000 modular traveling locations in the U.S. Since the execution of the Wal-Mart license agreement on April 4, 2002, through January 30 29, ~~2005~~2006, we opened 497 portrait studios in Wal-Mart U.S. ~~Wal-Mart stores~~.

-10 ~~11 -~~

As of ~~January~~ 30January 29, ~~2005~~2006, the licenses with respect to our U.S. Wal-Mart studios expire as as follows: 123 studios in 2007, 169 studios in 2008, 176 studios in 2009, 29 studios in 2010 and 1,~~564~~632 studios in 2012.

Canada. ~~Within Canada,~~ ~~our~~Our relationship with Wal-Mart Canada, Corp. (formerly Wal-Mart Canada Inc.) is governed by aan amended and restated license agreement ~~dated~~made ~~February~~as 9of January 1, ~~1996~~2006. ~~This~~The general agreement has a five-year term and Wal-Mart Canada has an option to renew for ~~one~~two renewal ~~period~~ periods of two years. Studios that ~~began~~were ~~operations~~currently onin ~~and~~operation ~~after~~as ~~the execution~~ of the ~~license on February 9, 1996, have a five-year term that commences upon their opening~~ date ~~and~~ ~~can be renewed at the option~~ of ~~Wal-Mart~~this ~~Canada.~~agreement We are ~~currently in~~ ~~negotiations~~subject ~~with Wal-Mart Canada~~ to ~~renew~~a ~~the~~License ~~license~~Schedule ~~agreement~~which ~~and~~specifies ~~have agreed in~~expiration ~~principal~~dates tofor anthese ~~increase~~specific ~~in rent from 13% to 15% in approximately 50 stores. As of January 30, 2005, we operated in 226 Canadian Wal-Mart permanent~~ studios~~. To~~ ~~date,~~and all studios that have completed their initial five-year term have been renewed by Wal-Mart Canada for consecutive renewal periods of two years each. The terms of the license agreement are ~~similar to our U.S. license agreement.~~ ~~Termination rights are generally similar to those under the U~~controlling.S. ~~license agreement~~Based ~~except~~on ~~that~~this ~~Wal-Mart~~License ~~also~~Schedule Canadian ~~has the right to terminate with respect~~Studio ~~to an~~licenses ~~individual~~expire ~~studio~~as iffollows; we55 ~~sell substantially all of the assets of our Canadian~~in ~~subsidiary~~2006, or90 ~~fail~~in to2007, ~~own~~34 ~~majority voting control~~ in ~~such~~2008, ~~subsidiary or operate a competing business within a~~ 25~~-mile~~ ~~radius~~in ~~of a Wal-Mart store. Wal-Mart can terminate the agreement with respect to all locations~~2009, ~~subject~~22 toin ~~180~~2010 ~~days notice,~~and if15 ~~one-third~~in or2011. ~~more~~Management ofbelieves the ~~licensed~~2006 licenses ~~stores~~will ~~are~~be ~~susceptible~~renewed ~~to termination,~~for ortwo ~~have~~year ~~been terminated~~terms, ~~under~~but ~~the~~such ~~agreement~~renewals orare ifnot ~~5% or more of our Wal-Mart Canada studios generate annual gross sales of less than $90,000 each~~assured.

~~The licenses~~ Mexico. Within Mexico, our relationship with ~~respect~~Nueva toWal-Mart ~~our~~De ~~Canadian~~Mexico, S.A. de R.L. de C.V. (“Nueva Wal-Mart ~~studios~~De ~~expire~~Mexico”) is governed by an agreement dated as ~~follows:~~of June 1, 2002. The agreement 79runs for an undefined period of time but either we or Nueva Wal-Mart De Mexico may terminate this ~~studios~~agreement inat ~~2005~~any time upon 30 days written notice after May 31, 782003. ~~studios~~Under this agreement, Nueva Wal-Mart De Mexico is compensated based upon our total net sales in all Wal-Mart stores in Mexico. As of January 29, 2006, 25we ~~studios~~operated in ~~2007,~~96 16Nueva Wal-Mart De Mexico permanent studios. inThe ~~2008,~~licenses 20 for these studios inare ~~2009~~terminable ~~and~~at ~~eight~~will inby ~~2010~~either party following a studio’s first year of operation.

~~Mexico~~ Germany. Within ~~Mexico~~ Germany, our relationship with ~~Nueva~~ Wal-Mart DeGermany ~~Mexico,~~GmbH ~~S.A.~~& ~~de R~~Co.L. deKG ~~C.V.~~ (“~~Nueva~~ Wal-Mart ~~De Mexico~~ Germany”) is governed by anlease ~~agreement~~agreements ~~dated~~with asa oftwo ~~June~~year 1,term beginning at the commencement of ~~2002~~operations for aneach ~~undefined~~studio. ~~period~~The first lease is dated as of ~~time~~August 28, 2002. ~~Either~~The weleases orexpire ~~Nueva~~after two ~~Wal-Mart~~years, Debut ~~Mexico~~will automatically renew for successive periods of six months each if not terminated ~~may~~ by either party. Either party can terminate this agreement at the end of any ~~time~~term upon 30three months ~~days~~notice. ~~written~~This ~~notice~~agreement ~~after~~allows ~~May 31, 2003~~us to use Wal-Mart designated space within its stores. Under this agreement, ~~Nueva~~ Wal-Mart DeGermany ~~Mexico~~ is compensated based upon our total net sales in all Wal-Mart stores in ~~Mexico~~Germany. As of January 30 29, ~~2005~~2006, we operated in 8921 ~~Nueva~~ Wal-Mart DeGermany ~~Mexico~~ permanent studios. ~~The licenses for~~ ~~these studios are terminable at will by either party following a studio’s first year of operation.~~

~~Germany~~ United Kingdom. Within ~~Germany~~ the U.K., our relationship with ~~Wal-Mart~~ASDA ~~Germany~~Stores ~~GmbH~~Limited ~~& CO. KG~~ (“Wal-Mart ~~Germany~~ U.K.”) is governed by ~~lease~~separate ~~agreements~~leases ~~with a two year term beginning at the commencement of operations~~ for each studio. ~~The~~with the first ~~lease~~one is dated as of ~~August~~ 28February 5, ~~2002~~2003. One ~~The~~lease ~~leases~~expires ~~expire~~ after ~~two~~ 10 years, ~~but~~and ~~will~~all ~~automatically renew for~~other ~~successive~~leases ~~periods~~expire ofafter ~~six~~five ~~months~~years. ~~each~~Under ifthese agreements, ~~not~~Wal-Mart ~~terminated by either party~~U. ~~Either~~K. ~~party~~is ~~can~~compensated ~~terminate~~based ~~this~~upon ~~agreement~~our attotal ~~the~~net ~~end~~sales ofin ~~any~~all ~~term~~Wal-Mart ~~upon~~stores ~~three~~in ~~months~~the ~~notice~~U.K. ~~This~~As ~~agreement~~of ~~allows~~January 29, us2006, towe ~~use~~operated in 5 Wal-Mart ~~designated~~U.K. ~~space within its~~permanent ~~stores~~studios. ~~Under~~Commencing ~~this~~in 2005 ~~agreement~~and for each year thereafter, Wal-Mart ~~Germany~~U.K. ismay ~~compensated~~terminate ~~based~~any ~~upon our total~~license ~~net~~agreement ~~sales~~if init ~~all~~sends ~~Wal-Mart~~us a ~~stores~~termination innotice ~~Germany.~~by AsJanuary 31 of ~~January~~such 30year, ~~2005, we operated~~with intermination 20effective ~~Wal-Mart~~on ~~Germany~~April 30 ~~permanent~~of ~~studios~~such year.

~~United Kingdom. Within the~~ Hometown UThreads®.K. As of January 29, ~~our~~2006, ~~relationship~~we ~~with~~leased ~~ASDA~~40 ~~Stores~~locations ~~Limited~~from (“Wal-Mart ~~U.K.”) is~~ ~~governed~~pursuant byto separate leases, ~~for~~the ~~each~~first ~~studio~~of ~~with~~which ~~the~~was ~~first~~entered ~~one~~into ~~dated~~on asSeptember 19, of2000. Hometown ~~February~~Threads® 5,franchisees ~~2003.~~sublease ~~One~~all ~~lease~~of ~~expires~~these ~~after~~locations. 10The ~~years~~leases ~~and~~are ~~all~~for ~~other~~a ~~leases~~term ~~expire after~~of five years. ~~Under~~each ~~these~~with ~~agreements,~~the ~~Wal-Mart~~option ~~U.K.~~to isrenew ~~compensated~~for ~~based upon~~an ~~our~~additional ~~total~~five ~~net~~years ~~sales~~provided inwe ~~all~~give Wal-Mart ~~stores~~at inleast 180 days ~~the~~notice ~~U.K.~~we Aswant ofto ~~January 30, 2005,~~renew. weWe ~~operated~~pay inrent ~~five~~directly to Wal-Mart ~~U.K.~~and ~~permanent~~deduct ~~studios.~~it ~~Commencing~~from inthe ~~2005 and~~franchisee’s ~~for~~revenue. ~~each~~In ~~year~~the ~~thereafter,~~event ~~Wal-Mart~~a ~~U.K.~~franchisee ~~may~~does ~~terminate~~not ~~any~~pay ~~license~~the ~~agreement~~rent, we are liable to Wal-Mart iffor itany ~~sends~~unpaid usrent. aIn ~~termination~~addition, ~~notice~~we byhave ~~January~~7 31other offranchisees ~~such~~in ~~year,~~locations ~~with~~other ~~termination~~than Wal-Mart ~~effective~~who onhave ~~April~~their 30own oflease ~~such year.~~arrangements

Fun Factory In fiscal 2005, we opened 11 Fun Factories Stores in Wal-Mart with 6 being opened in the U.S. and 5 being opened in Canada. This brought to 12 the total number of these -stores we operate. One of these stores is the Creation Station test concept. The stores in the U.S. are on a five year lease term with a base rent plus a commission override. In fiscal 2005, no stores exceeded this threshold. In Canada, the lease is for five years at a flat rate with a commission override if applicable (i.e. the greater of base rent or the commission based on sales).

~~Hometown~~11 Threads®. As of January 30, 2005, we leased 33 locations from Wal-Mart pursuant to separate leases, the first of which was entered into on September 19, 2000. Hometown Threads® franchisees sublease 32 of these locations and we operate one location as a company-owned store. The leases are for a term of five years each with the option to renew for an additional five years provided we give Wal-Mart at least 180 days notice we want to renew. Our sublessees, the 32 franchisees, pay rent directly to Wal-Mart, but, in the event a franchisee does not pay the rent, we are liable to Wal-Mart for any such unpaid rent.

Other Licenses and Concessions

Meijer. As ~~of January~~In ~~30,~~fiscal ~~2005~~2004, we operated in 24 Meijer permanent studios. ~~Our~~We ~~relationship with~~ceased ~~Meijer,~~all ~~Inc.~~operations ~~was governed by two master~~ in~~-store license agreements~~ ~~dated June 25, 2001. These agreements gave us the ability to operate a portrait studio in select~~ Meijer stores. ~~The~~as ~~term~~ of ~~the license for each studio began on the earlier of the projected start date for each Meijer location and the date we commenced operations in such location~~April 4, ~~and ended on the last day of the third license year~~2005. ~~A license year was defined as the 12-month period from August~~ ~~1 to July 31.~~

~~The terms of~~ Navy/Marines. ~~our~~We ~~master~~operated ~~in-store license agreements with Meijer required us to pay, on~~ a ~~monthly~~ ~~basis~~portrait ~~with~~studio ~~respect~~at toCamp ~~each location~~LeJeune, aNorth ~~base~~Carolina ~~license fee~~ and a separate ~~supplemental~~one-hour ~~license~~film ~~fee~~processing ~~based upon our gross receipts in our Meijer permanent studios~~facility. ~~The~~These ~~license~~ agreements ~~permitted~~expired usin tofiscal ~~use~~2005 ~~our designated space within Meijer’s locations solely for the purpose of operating a portrait studio~~ and ~~selling~~ ~~select~~were ~~portrait~~not ~~related~~renewed ~~products~~by us.

~~Notice of termination~~ We ~~under~~operated ~~our~~a ~~master~~studio ~~in-store~~within ~~license~~the ~~agreements~~Navy ~~was~~Exchange, ~~given~~Pearl byHarbor, us Hawaii, pursuant to an agreement ~~Meijer~~that expired on ~~January 3~~October 24, 2005 ~~and~~which we ~~ceased~~did ~~all~~not ~~operations in Meijer stores as of April 4, 2005~~renew.

~~Navy~~ Army/~~Marines~~Air Force. We ~~operated~~ ahad ~~portrait studio at Camp LeJeune, North Carolina pursuant to~~ an agreement ~~that~~with ~~expired~~the onArmy ~~April~~& ~~30,~~Air ~~2005.~~Force WeExchange ~~paid~~Service a(“AAFES”) ~~fee to Camp LeJeune based~~that ~~upon~~governed ~~our~~9 ~~total~~studios ~~gross sales~~ in ~~this~~AAFES ~~studio~~exchanges. ~~The~~This ~~items~~agreement ~~sold~~expired asJuly 31, ~~well~~2005 asand ~~the prices charged~~was bynot ~~us were subject to the approval of the Camp LeJeune general manager~~renewed.

~~Also~~ Callisto (PhotoParade®). Under our arrangement with Callisto Corporation, we agree to pay to inCallisto a royalty based on gross retail sales derived from the sale of each Portrait GalleryTM disk. We have agreed to sell the ~~Camp~~Portrait ~~LeJeune~~GalleryTM ~~location~~CD weor ~~operated,~~disk only ~~under~~as a ~~separate~~bundled ~~agreement~~product ~~that~~with ~~expired in~~Callisto’s ~~May~~PhotoParade® ~~2005~~screen saver CD. Furthermore, Callisto has agreed to pay PCA a ~~one-hour~~royalty ~~processing~~based ~~facility~~on ~~for~~internet sales generated from customers’ ~~film~~who ~~and~~link ~~pictures~~to Callisto’s web site from the PhotoParade® CD sold in our studios.

~~In addition,~~ Other. weWe ~~operate~~own aother ~~studio within the Navy Exchange~~patents, ~~Pearl~~trademarks ~~Harbor,~~and ~~Hawaii, pursuant~~licenses ~~to an agreement~~ that ~~commenced~~we ~~October~~do ~~25,~~not ~~2002~~believe and expires on October 24, 2005. We pay a fee to Hawaii District Navy Exchange based upon our total gross sales in this studio. The items sold as well as the prices charged by us are ~~subject~~material to ~~the approval of the Technical Representative for the Hawaii~~ ~~District~~our ~~Navy Exchange~~business.

~~Army/Air Force. We~~ITEM have an agreement with the Army & Air Force Exchange Service (“AAFES”) that governs our sale of professional photography services in select AAFES exchanges in the United States1A. ~~This~~RISK ~~agreement expires July 31, 2005. As of January~~FACTORS ~~30, 2005, we operated nine studios in AAFES exchanges.~~

~~The terms of~~ We ~~the~~wish ~~contract~~to ~~require~~caution usreaders tothat ~~pay~~in aaddition ~~fee~~ to ~~AAFES~~the ~~based~~important ~~upon~~factors ~~our~~described ~~total~~elsewhere ~~gross~~in ~~sales~~this atAnnual ~~AAFES~~Report ~~exchanges.~~on ~~This~~Form ~~contract~~10-K, ~~allows~~the usfollowing toimportant ~~operate~~factors, ~~our~~among ~~portrait~~others, sometimes have ~~studios~~affected, ~~during~~or ~~similar~~in ~~hours~~the offuture ~~operation~~could asaffect, ~~the~~our ~~AAFES~~actual ~~exchanges~~results ~~governed~~or financial condition, and could cause ~~by this~~our ~~contract~~actual consolidated results or financial condition during fiscal 2006, and beyond, to ~~use~~differ materially ~~designated~~from ~~space~~those ~~within~~experienced ~~such~~in ~~exchanges~~prior periods or expressed in any forward-looking statements made by us or on our behalf.

This contract may be terminated in whole or in part by AAFES or us for any reason upon 90 days written notice and immediately upon written notice in the event of (1) our failure to pay license fees under the agreement, (2) certain events of bankruptcy or insolvency relating to us, or (3) our failure to perform our obligations under the agreement. In addition, this contract will automatically terminate, with respect to an AAFES exchange, upon the dispatch of written notice to us that such AAFES exchange is inactivated or the Army or Air Force base at which such exchange is located has been inactivated.

- 13 -

Callisto (PhotoParade®). Under our arrangement with Callisto Corporation, we agree to pay to Callisto a royalty based on gross retail sales derived from the sale of each Portrait GalleryTM disk. We have agreed to sell the Portrait GalleryTM CD or disk only as a bundled product with Callisto’s PhotoParade®screen saver CD. Furthermore, Callisto has agreed to pay PCA a royalty based on internet sales generated from customers who link to Callisto’s web site from the PhotoParade® CD sold in our studios.

Other. We own other patents, trademarks and licenses we do not believe are material to our business.

RISK FACTORS

We wish to caution readers that in addition to the important factors described elsewhere in this Annual Report on Form 10-K, the following important factors, among others, sometimes have affected, or in the future could affect, our actual results and could cause our actual consolidated results during fiscal 2005, and beyond, to differ materially from those expressed in any forward-looking statements made by us or on our behalf.

Risks Related to Our Business

We are materially dependent upon Wal-Mart.

Approximately 96.8% of our sales for fiscal ~~2004~~2005 were derived from sales in Wal-Mart stores. ~~Therefore,~~We we are materially dependent upon our relationship with Wal-Mart, the continued goodwill of Wal-Mart and the integrity of the Wal-Mart brand name in the retail marketplace. Any deterioration in our Wal-Mart relationship would have a material adverse effect on us.

~~Because we~~ Furthermore, ~~represent~~because ~~only~~of athe ~~small~~demands ~~fraction~~placed ofon us to open studios in new Wal-Mart’s ~~sales~~Stores, ~~any~~we have ~~deterioration~~not ofbeen able to diversify our ~~relationship~~ ~~with~~business. ~~Wal-Mart~~In ~~would~~addition, ~~have~~our acompetitive ~~far~~posture ~~greater~~could ~~effect~~be weakened onwith usnegative ~~than~~changes on in Wal-Mart’s competitive posture.

~~Furthermore, because~~ We ofcontinued ~~the~~to ~~demands~~experience ona usdownturn ~~from~~in our ~~current~~results ~~business model~~ of ~~opening~~operations ~~studios~~ in ~~all~~fiscal ~~new Wal-Mart supercenters and stores of 100,000 square feet or larger, we have not been able to diversify our business~~2005. ~~This~~We ~~could~~had ~~adversely affect~~a usnet ~~in the event our Wal-Mart business declines. In addition~~loss, ~~our~~deficiency ~~competitive~~of ~~posture could~~earnings beto ~~weakened~~fixed ~~with~~charges and negative ~~changes~~net ~~in Wal-Mart’s competitive posture~~worth.

~~We experienced~~ In afiscal ~~significant~~2005, ~~downturn~~our inconsolidated ~~our~~sales ~~results~~increased ofover ~~operations~~the prior year by $1.9 million, $325.5 million versus $323.6 million in fiscal 2004 ~~were~~ ~~unable~~primarily due to ~~comply~~increased ~~with~~Wal-Mart ~~certain~~studio ~~financial~~sales. However, ~~covenants~~we insaw our ~~prior~~income ~~senior secured~~from ~~credit~~operations ~~facility~~decrease from $17.5 million Wein ~~had~~fiscal a2004 ~~net~~to ~~loss~~$5.3 million ~~and~~in afiscal ~~deficiency~~2005 ofdriven ~~earnings~~by ~~to fixed charges~~the decrease in ~~fiscal~~same ~~2004,~~store sales and weless ~~have~~customer atraffic ~~negative net~~spread ~~worth~~over more studios than fiscal 2004. Net loss was

In12 fiscal 2004, for the first time since fiscal 2000, our year over year consolidated sales decreased. Consolidated sales decreased from $324.8 million in fiscal 2003 to $323.6 million in fiscal 2004. Primarily as a result of these decreases in sales, we saw our income from operations decrease from $34.2 million in fiscal 2003 to $17.5 million in fiscal 2004. Net loss was $29.7 million in fiscal 2004 as compared to net income of $1.3 million in fiscal 2003. We experienced a 7.0% decline in year over year same studio sales in our Wal-Mart permanent studio operations in fiscal 2004, compared to an increase of 1.5% in fiscal 2003.

~~As of October~~$34.4 million ~~31,~~in ~~2004,~~fiscal ~~the~~2005 ~~end~~compared ofto ~~our~~net ~~fiscal~~loss ~~third~~of ~~quarter,~~$29.7 million wein ~~were~~fiscal ~~not~~2004 in(Note: ~~compliance~~The ~~with~~net ~~certain~~loss ~~financial covenants contained~~ in ~~our~~fiscal ~~prior~~2004 ~~senior~~was ~~secured credit facility agreement~~$15.0 million ~~Although~~before onthe ~~July~~impact ~~15,~~of ~~2005, we refinanced our prior senior secured credit facility with~~ a ~~new~~valuation ~~senior~~allowance ~~secured~~on ~~revolving credit facility~~deferred ~~and a~~taxes ~~new~~made ~~letters~~in offiscal ~~credit~~2004. ~~facility,~~See ~~there~~Note is8 ~~no assurance we will be able~~ to ~~remain~~ inThe ~~compliance~~Consolidated ~~with~~Financial ~~the~~Statements ~~conditions~~contained ~~to borrowing under our new senior~~herein ~~secured~~for ~~revolving~~further ~~credit facility or our new letters of credit facility~~information).

- Although we are implementing measures to improve our performance, external factors such as 14increases in gasoline prices and rising interest rates may continue to adversely impact our -success. Therefore, we may be unable to improve our operating results and accordingly, can provide no assurance we will be able to remain in compliance with the covenants in our various debt agreements.

~~Although~~ In fiscal 2005, we ~~are~~had ~~implementing~~a ~~measures~~net toloss ~~improve~~of $34.4 million and our ~~performance~~fixed ~~and~~charges ~~believe~~exceeded ~~that~~earnings by ~~the decline~~$34.4 million. inWe ~~results~~cannot ofgive ~~operations~~assurance ~~was~~that ~~caused~~we inwill ~~part~~return byto ~~external~~profitability ~~factors~~or ~~beyond our~~report ~~control,~~earnings ~~such~~in excess asof afixed ~~reduction~~charges in ~~disposable~~any ~~income~~future ~~due~~period. toFuture ~~increases~~net inlosses and/or deficiencies of earnings to ~~gasoline~~fixed ~~prices~~charges ~~and~~may ~~rising~~prevent ~~interest~~us ~~rates~~from pursuing our growth and ~~other~~diversification ~~economic~~strategies ~~pressures~~and ~~affecting~~could ~~U.S.~~cause ~~customers,~~us weto ~~may~~ be unable to ~~improve~~meet our ~~results~~debt ofobligations, ~~operations~~capital ~~and~~expenditure requirements or working ~~there can~~capital beneeds. noAdditionally, ~~assurance~~as weof ~~will~~January 29, be2006, ~~able~~our tototal ~~remain~~assets were less than our total liabilities by $204.8 million, resulting in ~~compliance~~a ~~with~~negative ~~the~~net ~~covenants~~worth. If we are unable to fund our operations in the future, we may not be able to liquidate our ~~various~~assets ~~debt~~to ~~agreements~~pay our liabilities.

~~We had~~ Substantial ~~a net~~doubt ~~loss~~has ofbeen ~~$29.7~~raised ~~million~~about ~~and~~the ~~our~~ability ~~fixed charges exceeded earnings by $15.0 million in fiscal 2004. There can be no assurance that we will report net income or earnings in excess~~ of ~~fixed~~the ~~charges~~Company ~~in any future period. Future net losses and/or deficiencies of earnings~~ to ~~fixed~~continue charges may prevent us from pursuing our strategies for growth and could cause us to be unable to meet our debt obligations, capital expenditure requirements or working capital needs. Although we obtained financing in July 2005, our net loss in fiscal 2004 and potential future losses may impact our ability to obtain adequate financing on satisfactory terms or at all. In addition, as ~~of January 30, 2005, our total assets were less than our total liabilities, resulting in~~ a ~~negative~~going ~~net worth~~concern. ~~We may not be able to liquidate our assets to pay our liabilities if we are unable to fund our operations in the future.~~

~~Substantial~~ Our independent registered public accounting firm, Eisner LLP, issued their report dated May ~~doubt~~26, ~~was~~2006 ~~raised~~which expressed a substantial doubt about ~~PCA~~the ~~LLC~~Company’s ability to continue as a going concern. As discussed in Note 2 to the financial statements, ~~our~~the ~~wholly-owned~~Company ~~operating~~at ~~subsidiary~~January 29, 2006 had a working capital deficiency and a capital deficiency, and has incurred a substantial net loss for the year ended January 29, 2006. The Company anticipates that such conditions will continue in 2006. In addition, as discussed in Note 2, the Company is in default of certain obligations which were due on June 15, 2006 and does not have sufficient liquidity to meet these obligations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

~~Our independent~~ See ~~registered~~further ~~public~~discussion ~~accounting~~in ~~firm,~~connection ~~Deloitte~~with &their ~~Touche~~audit ~~LLP,~~of ~~issued a~~the ~~report~~Company’s ~~dated~~consolidated ~~June~~financial statements ~~24,~~for ~~2005~~the ~~which~~fiscal ~~expressed~~year anended ~~unqualified~~January 29, ~~opinion~~2006 ~~and~~in ~~included an~~“Item 7. ~~explanatory paragraph expressing substantial doubt about our operating subsidiary~~Management’s Discussion and Analysis ~~its~~of ~~subsidiaries’~~Financial ~~ability~~Condition toand ~~continue~~Results asof aOperations—Liquidity ~~going~~and ~~concern in~~Capital ~~connection~~Resources—Liquidity” ~~with~~and ~~their~~in ~~audit~~Note 2 ofto ~~PCA~~the ~~LLC’s consolidated financial statements for~~Consolidated ~~the~~Financial ~~fiscal~~Statements ~~year~~included ~~ended~~in ~~January~~this ~~30, 2005~~report.

We Failure anticipate, based on our currently proposed plans and assumptions, that the additional liquidity we have obtained from the issuance of senior secured notes together with our new senior secured revolving credit facility and our new letters of credit facility and our obtaining waivers of existing defaults under our debt agreements, all of which occurred subsequent to ~~the~~pay ~~report~~interest ~~issued in connection~~on ~~with PCA LLC’s consolidated financial statements for the fiscal year~~Notes ended January 30, 2005, will be sufficient to satisfy our cash requirements in fiscal 2005. See further discussion in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Liquidity.”

~~We were~~ On ~~unable~~June 15, to2006, ~~timely~~the ~~file~~Company ~~our~~did ~~Annual~~not ~~Report~~make onan ~~Form~~interest ~~10-K~~payment ~~for~~in ~~fiscal~~the ~~2004 and our~~amount ~~Quarterly~~of ~~Report~~$687,500 due on ~~Form~~its 10133/4% Senior Subordinated Notes Due 2010 (the “Notes”). The 30-Qday grace period for ~~the~~payment of ~~thirteen~~such ~~weeks~~interest ~~ended~~expired ~~May~~on 1June 14, ~~2005 because~~2006. As a result, an event of default occurred with respect to the ~~ineffectiveness~~Notes, ofwhich ~~our~~default ~~internal~~also ~~controls~~causes ~~over~~a ~~financial~~cross-default ~~reporting~~under the Company’s credit agreement with its senior lender. The Company is currently in discussions with the holders of ~~our~~the ~~Mexican~~Notes ~~subsidiary.~~and Ifits senior welender ~~fail~~regarding obtaining a forbearance or similar agreement with respect to ~~improve~~this ~~and~~interest payment. ~~maintain~~In the ~~effectiveness of~~event ~~our~~that ~~internal~~an ~~control~~agreement ~~over~~is ~~financial~~not ~~reporting~~reached with the holders of ~~our~~the ~~Mexican~~Notes ~~subsidiary,~~and the ~~we may~~Company’s ~~not~~senior belender, ~~able~~such holders or senior lender will have the right to ~~accurately~~submit ~~and~~a ~~timely~~notice ~~file~~to the ~~our~~Company ~~periodic~~declaring ~~reports~~all principal and ~~our~~interest and other amounts due in respect of the Notes ~~financial~~immediately ~~condition~~due and ~~results~~payable. ofWhile ~~operations~~the ~~may~~Company beis ~~materially~~hopeful ~~adversely~~that such discussions will be resolved ~~affected~~favorably, no assurances can be given that any such agreement will be reached.

~~During fiscal~~ If ~~2004,~~ we ~~became~~fail ~~aware of a tax claim for amounts due~~ to ~~SAT,~~favorably ~~the~~resolve ~~Mexican~~ tax ~~authority,~~disputes from our Mexican subsidiary. The amounts alleged due to SAT consisted of $1.4 million for the fiscal years 1997 and 1998 and approximately $0.1 million for January through June of 2000. As a result of our delinquency in paying these amounts, fines, penalties and interest of $4.5 million were added by SAT to the outstanding claim. We conducted a preliminary investigation of this matter and subsequently engaged law firms in Mexico and the U.S. to assist in negotiating a settlement with ~~SAT~~various ~~and~~taxing anauthorities ~~independent accounting firm (other than~~ our independent registered public accounting firm) to perform forensic accounting work. We recorded a $1.5 million charge in the third quarter of fiscal 2004 reflecting management’s best estimate of the ultimate settlement of this claim. As a result of our investigation, we dismissed several employees who we suspect may have been engaged in fraudulent activities and hired new employees to replace those employees. As a result of our internal investigation, we discovered errors in the financial ~~statements provided to us each period~~ ~~beginning~~condition in 1997 through the third quarter of fiscal 2004 by our Mexico accounting department. As a result, we concluded that certain adjustments were required to restate our historical financial statements. Such adjustments have been reflected as a restatement in our accompanying annual financial statements as of and ~~for~~results ~~the years ended February 1, 2004 and February 2, 2003. The uncertainty~~ of ~~the~~operations impact of these activities on our financial reporting and other disclosures is one reason we did not file our annual report on Form 10-K for the 2004 fiscal year and our quarterly report on Form 10-Q for the first quarter of fiscal 2005 on a timely basis. Although we are acting to rectify these deficiencies and continuing to evaluate and improve our internal controls over financial reporting, we may be ~~unsuccessful~~materially ~~and~~adversely ~~other deficiencies in our internal controls over financial reporting could arise in the future~~affected. If we are unable to assert that our internal controls are effective in any future period, we may again be unable to accurately and timely file a periodic report. Failure to file a periodic report, if uncured within a specified time period, would result in an event of default under the terms of our indebtedness.

- During the fourth quarter of fiscal 2005, the Company settled a tax claim against its Mexican 15subsidiary for $1.9 million. During fiscal 2005, Revenue Canada asserted a claim against our -Canadian subsidiary relating to transfer pricing for goods and services rendered by our U.S. parent company. The claim relates to fiscal years 2000 through 2004, we are currently challenging this claim and have retained Canadian legal counsel and PriceWaterhouseCoopers to assist us in this process.

We were unable to timely file our Annual Report on Form 10-K for fiscal 2005 and our Quarterly Reports on Form 10-Q for the thirteen weeks ended May 1, 2005 and the thirty-nine weeks ended October 30, 2005. We may not be able to accurately and timely file our periodic reports and our financial condition and results of operations may be materially adversely affected as a result.

Our Quarterly Report on Form 10-Q for the thirteen weeks ended May 1, 2005 was delayed due to the uncertainty associated with the financial statements of our Mexican operations. Our Quarterly Report on Form 10-Q for the thirty-nine weeks ended October 30, 2005 was delayed due to the turnover in the Company’s financial staff. Additionally, we failed to timely file Forms 8-K relating to: the hiring of David Alexander as Chairman and CEO; a personal services agreement with a principal of Jupiter Partners our majority shareholder; and our new 5 year agreement with Wal-Mart Canada. These failures to timely file reports with the U.S. Securities and Exchange Commission (“SEC”) violate the covenants contained in the indenture agreements for the Company’s Senior Notes and Senior Secured Notes. We had a period of sixty (60) days following notice from either the Trustee of our 11.875% senior notes due 2009 (the “Senior Notes”), or our 14% senior secured notes due 2009 (the “Senior Secured Notes”), or the holders of 25% of the principal amount of the Senior Notes to cure the defaults. Notice was received with respect to the filing of the Company’s Form 10-Q for the period ended October 30, 2005. Such defaults relating to the filing of the Company’s Form 10-Qs and Form 8-K filings discussed above were cured.

This Annual Report on Form 10-K for our fiscal year ended January 29, 2006 was delayed due to a turnover in the Company’s financial staff. We have received a 60 day notice relating to this timely filing default, discussed above. Additionally, we were in default of covenants contained in our Senior Notes and Senior Secured Notes requiring the delivery of our audited financial statements within 90 days after the end of the fiscal year, without an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern. On June 20, 2006, the Company entered into the Third Amendment to Credit Agreement, Waiver, Consent and Forbearance Agreement with its Senior Lender. This agreement provides, among other things, that the Senior Lender waives certain requirements to deliver audited financial statements or that such statements will not contain “going concern” language. The Senior Lender has also agreed to forebear any action with regard to certain defaults under its credit agreements for a specified length of time.

We may face similar default issues as a result of our recent failure to timely file our Quarterly Report on Form 10-Q for the quarter ended April 30, 2006. See Note 18 — Subsequent Events — Failure to File 10-Q for the Period Ended April 30, 2006 in the Consolidated Financial Statements included in this report. See also “Failure to pay interest on Notes” discussed above and the ending of the standstill agreement with AgfaPhoto USA discussed below under “Our failure to maintain good relations with our major suppliers...”.

Our business practices and operations need to be acceptable to Wal-Mart.

Because of the importance of our Wal-Mart relationship ~~to us~~, our business practices and ~~procedures~~ procedures must at all times be acceptable to Wal-Mart. Consequently, in the future, we may make changes to our business practices and procedures, including ~~with~~ ~~regards to~~ advertising, ~~and~~ promotions, pricing, product offerings, studio facilities, technology, management and employment practices in response to Wal-Mart’s requests that would not be in our best interests and could materially and adversely affect our sales, costs, margins, business development or other aspects of our business. In addition, under our license agreements Wal-Mart has substantial contractual rights, which it can exercise in a manner that can have a material adverse effect on us.

Among other things, pursuant to our license agreements we must:

- relocate any studio location in a Wal-Mart store at Wal-Mart'’s request, - obtain Wal-Mart's prior written approval of all advertising, - maintain specified levels of worker's compensation and liability insurance, - operate the studios every day that the Wal-Mart store is open for specified hours, - indemnify Wal-Mart from any claim by an employee, vendor or portrait studio customer relating to studio operation or for accident or injury anywhere in the Wal-Mart store, - observe all Wal-Mart policies relating to customer service, and - observe all Wal-Mart policies relating to the activities of our employees in the Wal-Mart store,;

	-		obtain Wal-Mart’s prior written approval of all advertising;

	-		maintain specified levels of worker’s compensation and liability insurance;

	-		operate the studios for specified hours every day that the Wal-Mart store is open;

	-		indemnify Wal-Mart from any claim by an employee, vendor or portrait studio customer relating to studio operation or for accident or injury anywhere in the Wal-Mart store;

	-		observe all Wal-Mart policies relating to customer service; and

	-		observe all Wal-Mart policies relating to the activities of our employees in the Wal-Mart store;

and we are not permitted to

- make improvements to our Wal-Mart studios without Wal-Mart'’s prior written consent,; - conduct any “fire,” “50% off” or similar sales,; - issue a press release using the Wal-Mart name without Wal-Mart’s consent,; and - advertise on radio or television without Wal-Mart’s consent.

- 16 -

Wal-Mart may terminate, breach, otherwise limit or increase our expenses under our license or lease agreements.

Our Wal-Mart permanent studios in the U.S. and Canada are operated pursuant to ~~license~~ license agreements while our permanent studios in Mexico, Germany and the U.K. are operated pursuant to lease agreements. These license and lease agreements can be terminated or suspended by Wal-Mart for various reasons, some of which are beyond our control. As of January 30, 2005, our license and lease agreements with various Wal-Mart entities have the following expiration dates: (1) for our 1,564 U.S. Wal-Mart studios that were open when the U.S. Wal-Mart agreement was entered into, April 2012; for each of our 497 Wal-Mart studios opened subsequent to April 4, 2002, June 30 of the fifth year following the opening of that studio, in each case if no renewal option is exercised; (2) for each of our 226 Canadian Wal-Mart studios, various expiration dates, ranging from fiscal 2004 to 2010, depending upon the date the relevant studio commenced operations; (3) for each of our 89 Mexican Wal-Mart studios, terminable at will by either party following a studio’s first year of operation; (4) for each of our 20 German Wal-Mart studios, two years from its opening date with automatic renewals for successive periods of six months each if not terminated by either party (either party can terminate at the end of any term upon three months notice); and (5) for our five U.K. Wal-Mart studios, 2008 for two studios, 2009 for two studios and 2013 for one studio. These agreements are more fully ~~described~~ described in “Item 1., Business—Licenses, Trademarks and Patents—Wal-Mart Licenses.”

Wal-Mart is under no obligation to renew existing locations. Wal-Mart may also increase ~~the~~ the expenses we are required to pay under our license or lease agreements upon renewal of the agreements. In addition, license fees under our Wal-Mart licenses may increase periodically if certain sales or other conditions are met. We do not have the right to close any poorly performing locations prior to the expiration of the term of the license or lease for such locations. Although our license and lease agreements prohibit Wal-Mart from licensing or leasing permanent portrait studios to any other person in the stores in which we operate, they do not make us the exclusive provider for all Wal-Mart stores. In addition, our license and lease agreements do not prohibit Wal-Mart from selling many of the tangible goods we sell, or from developing film, in other departments within its stores. Furthermore, there is always the risk that Wal-Mart might breach one or more of our license or lease agreements. The loss or breach of a substantial number of the licenses or leases from Wal-Mart could have a material adverse effect on us. An adverse change in any other aspects of our business relationship with Wal-Mart, the reduction of the number of ~~studios~~ studios operated pursuant to such arrangements, a decision by Wal-Mart to license or lease studios to other persons or changes in Wal-Mart’s expansion plans could have a material adverse effect on us. See “Item 1. , Business—Licenses, Trademarks and Patents—Wal-Mart Licenses.”

An economic downturn, a reduction in consumer spending or decreased customer traffic in our host stores could materially adversely affect our business.

Portrait photography services may be affected by negative trends in the general economy. ~~Any~~ ~~reduction in consumer confidence or disposable income in general may~~The ~~affect companies in this specialty retail service industry. In addition, the~~ portrait studios in Wal-Mart stores rely largely on customer traffic generated by the host stores. The host stores, ~~as part of the retail industry,~~ may be affected by a downturn in the economy ~~and~~caused aby ~~decrease~~increasing infuel ~~discretionary~~costs ~~income of potential~~and ~~customers.~~rising ~~For~~interest ~~example,~~rates wewhich ~~previously~~decrease ~~provided portrait photography services in Kmart host stores. During~~ the ~~term~~discretionary income of ~~our~~potential ~~relationship with Kmart, Kmart’s business was not growing, and this negatively impacted our own performance~~customers. There is no assurance that Wal-Mart or any other host stores in which we may operate will not ~~suffer~~experience ~~similar financial difficulties. A~~ a reduction in host store traffic which could adversely affect us.

In addition, we have substantial fixed costs ~~due~~associated towith our three facilities in the Charlotte, North Carolina area. These fixed costs make us vulnerable into ~~the event of~~ an economic downturn ~~or other inability to generate sufficient cash flow~~.

- 17 -

We may not be able to finance the rapid growth we may experience.

In April 2002, we executed a U.S. Master License Agreement with Wal-Mart. As part of this agreement, Wal-Mart committed to provide us a minimum of 150 new studios per year for four years and, thereafter, to use commercially reasonable efforts to provide 150 new studios per year. Further, Wal-Mart has agreed to use commercially reasonable efforts to include a Wal-Mart Portrait Studio operated by us in the blueprint of each new ~~supercenter~~Supercenter (except for new ~~supercenters~~ Supercenters of 145,000 square feet) and store of 100,000 square feet or larger. We anticipate opening a studio in all new Wal-Mart stores where our studios are incorporated into the blueprint. This will require us to make substantial capital expenditures. To ~~accomplish~~open ~~this~~new studios, ~~as well as to~~ maintain and ~~increase~~grow our sales base, ~~and to~~ respond to shifts in customer demand and changes in industry trends, as well as finance capital expenditures, infrastructure growth and acquisitions, we will need to generate sufficient cash flow orand obtain sufficient capital ~~for purposes of, among other things, financing capital expenditures, infrastructure growth and acquisitions~~. ~~There~~We iscan give no assurance that we will be able to generate sufficient cash flow to fund these activities or that financing onwill be available to us on acceptable terms and will be ~~available and~~ permitted to be incurred under the terms of our current and any future indebtedness ~~to fund our future growth~~. Our failure to generate sufficient cash flow or obtain sufficient financing to fund our future growth could materially adversely affect us. The rapid growth of portrait studios within Wal-Mart could limit our ability to fund growth outside of Wal-Mart.

~~During fiscal~~ Our ~~2004,~~failure ~~we were unable~~ to ~~meet~~maintain ~~the~~good ~~payment~~relations ~~terms~~with of our ~~key~~major ~~supplier~~ suppliers of photographic film, paper and processing chemistry. ~~Additionally,~~could ~~the~~materially ~~German parent~~adversely ~~company~~affect of our key supplier recently filed a petition for insolvency. If our key supplier becomes unable to continue to provide us supplies under our current contract, we will need to obtain an alternative source of ~~supplies. If we~~supply ~~enter into an agreement to obtain such supplies at less desirable terms, we may be required to raise additional equity~~ and~~/or~~ ~~debt financing and~~ our ~~financial~~ ~~condition and results of operations could be materially adversely~~financial ~~affected~~condition.

~~During fiscal~~ Effective ~~2004~~January 1, we2006, ~~were unable to meet~~ the ~~payment~~Company ~~terms~~agreed ofto ~~AgfaPhoto~~purchase ~~USA Corporation,~~100% ~~our key supplier~~ of ~~photographic~~its ~~film,~~North ~~paper, and processing~~American ~~chemistry.~~requirements Wefor ~~have~~color ~~negotiated~~negative ~~payment~~film ~~terms~~from ~~with~~Kodak ~~AgfaPhoto~~during ~~USA Corporation that extend~~ the ~~payment~~period ~~date~~beginning ~~for~~January 1, ~~our~~2006 ~~outstanding~~and ending ~~payables~~June 30, ~~(including~~2007, ~~interest which had~~except ~~been~~that ~~accrued~~the atCompany anmay ~~annualized~~purchase ~~rate~~up ofto 61%) as of ~~June~~its ~~15,~~North ~~2005 until June~~American ~~15, 2006~~requirements ~~and we have agreed to pay~~ for ~~products~~film ~~purchased~~ from ~~AgfaPhoto~~other ~~USA Corporation~~vendors onfor ortesting ~~after~~and ~~June~~evaluation. 15Effective December 8, 2005, the atCompany orhas ~~prior~~agreed to ~~their~~purchase ~~delivery.~~100% Weof ~~are seeking~~its toNorth ~~enter~~American ~~into~~requirements afor ~~revised~~photographic ~~supply~~paper and ~~contract~~chemicals ~~with~~from ~~AgfaPhoto~~Fuji ~~USA~~during ~~Corporation within~~ the ~~next~~period ~~few~~beginning ~~months. However~~January 1, ~~there~~2006 isand noending ~~assurance~~June 30, ~~that~~2007. ~~we will be~~Both ~~able to~~agreements dohave ~~so.~~payment ~~Our~~terms ~~obligations~~of tocash-in-advance ~~AgfaPhoto~~and ~~USA~~have ~~Corporation~~provisions ~~are~~requiring ~~secured~~annual ~~by a lien~~minimum ~~on the products which we~~ purchase ~~from them~~quantities.

~~Additionally, on~~ Prior ~~May~~to ~~27,~~the ~~2005~~agreements with Kodak and Fuji, AgfaPhoto USA Corporation’s ~~German~~was ~~parent~~our ~~company, AgfaPhoto~~principal ~~GmbH~~supplier of photographic film, ~~filed~~paper aand ~~petition~~processing chemistry and had been our supplier for ~~insolvency~~over 30 years. ~~While~~During fiscal 2004, we ~~have~~were ~~been~~unable ~~informed~~to ~~that~~ meet the payment terms of AgfaPhoto USA Corporation. The ~~has~~Company’s ~~sufficient~~total ~~funding~~indebtedness to ~~continue~~AgfaPhoto ~~its~~is ~~normal~~approximately $22.8 million. Approximately $2.1 ~~operations~~million is on open account and is currently due and payable. Approximately $20.7 million is subject to a letter agreement dated June 15, 2005 in ~~the~~which ~~foreseeable~~AgfaPhoto ~~future~~agreed, ifunder certain conditions, to defer any collection action until June 15, 2006. Further, AgfaPhoto ~~USA~~has ~~Corporation~~agreed ~~becomes~~to ~~unable~~subordination terms with respect to ~~continue~~other debt of the Company that effectively limits AgfaPhoto’s ability to ~~provide~~collect usany ~~supplies~~of ~~under~~the ~~our~~$22.8 million ~~current~~as ~~contract~~a secured creditor. On June 15, we2006 the Company’s ~~will~~standstill agreement with AgfaPhoto USA ended. In that agreement, AgfaPhoto USA agreed that it ~~need~~would not take any action to ~~obtain~~collect ancertain ~~alternative~~amounts ~~source~~owed ofby ~~supplies.~~us for photographic paper, film and chemicals

~~Although~~16 management believes that the available alternative sources of supplies are adequate, there can be no assurance we would be able to obtain such supplies at the same or similar terms to those we have with AgfaPhoto USA Corporation. If we enter into an agreement to obtain such supplies at less desirable terms, we may be required to raise additional equity and/or debt financing and our financial condition and results of operations could be materially adversely affected. There is no assurance we will be able to obtain new sources of funds on favorable terms or otherwise.

-purchased from AgfaPhoto USA . The Company has asked AgfaPhoto USA to extend this agreement to 18September 30, 2006. While AgfaPhoto USA has stated that it would request such an extension from -the bankruptcy trustee of its parent company in Germany, there can be no assurance that such an extension will be given. Also, to date, AgfaPhoto USA has been working with the Company to resolve amounts owed to them, but there can be no assurance that AgfaPhoto USA will not institute legal action to collect such amounts.

If we fail to maintain adequate relations with Fuji and Kodak, we may be unable to obtain supplies at comparable terms. In such an event, our ability to secure additional suppliers and acceptable credit terms, or to obtain additional equity and/or debt financing would likely be limited in light of our recent operating performance and financial condition. In such an event, our financial condition and results of operations would be materially adversely affected. We can give no assurance we would be able to obtain new sources of funds on favorable terms or otherwise.

Our inability to raise prices could limit our growth.

Because of competitive pressures, we are unlikely to be able to increase profitability on a sustained basis by raising our prices. Rather, our ability to increase profitability over the longer term will depend on our ability to open new studios, to increase ~~our~~ customer ~~volumes~~traffic in ~~our~~ existing studios and to manage expanding operations effectively.

If we lose our key personnel, our business may be adversely affected.

Our continued success depends upon, toour aability ~~large~~to ~~extent,~~attract ~~the efforts~~ and ~~abilities of our~~retain key ~~employees, particularly Barry J~~personnel. ~~Feld~~During fiscal 2005, ~~our~~Our President, Chief Executive Officer and Chairman ofresigned as well as the ~~Board.~~Chief Financial MrOfficer. ~~Feld’s~~The ~~departure~~Company ~~would~~has ~~result~~since inhired a ~~loss of~~new ~~leadership~~President and aChief ~~strong~~Executive ~~contact~~Officer ~~person with Wal-Mart~~R. ~~We cannot assure~~ ~~you~~David ~~of the~~Alexander. ~~continued~~Additionally, ~~employment~~in offiscal ~~Mr.~~2006, ~~Feld~~the orCompany’s ~~any~~Senior ~~other~~Vice ~~members~~President, ofInterim ~~management.~~Chief ~~Competition~~Financial ~~for~~Officer ~~qualified~~and ~~management~~Controller; ~~personnel~~Vice isPresident, ~~intense.~~Tax; ~~Mr.~~Vice ~~Feld’s~~President, ~~employment~~Manufacturing Controller; ~~agreement~~and isVice ~~terminable~~President atFinancial ~~will~~Controller byresigned ~~either~~from ~~party~~their ~~and,~~positions ~~while~~with hethe ~~would~~Company. ~~forfeit~~The Chief ~~certain~~Financial ~~stock~~Officer ~~option~~role ~~benefits~~is ifbeing heperformed ~~chose~~by toBob ~~compete~~Wren, ~~with~~Executive ~~us,~~Vice hePresident isand ~~not~~General Counsel ~~prohibited~~of ~~from~~the ~~doing so~~Company. The ~~loss~~Controller, ofTax ~~the~~and ~~services~~Financial ofController ~~our~~functions ~~key~~have ~~employees~~been or filled and the ~~failure~~Manufacturing toController’s ~~retain~~responsibilities ~~qualified~~have ~~employees~~been ~~when~~spread ~~needed~~among ~~could~~other ~~materially adversely affect us~~employees.

Our business may be adversely affected if we cannot manage the growth of our operations or generate sufficient cash flow or obtain sufficient capital to fund future growth.

It is essential to our relationship with Wal-Mart that we open new studios in all stores in which Wal-Mart wants us to do so. ~~Our~~It ~~resources are not as great as Wal-Mart’s, however, and it~~ could be difficult or impossible for us to keep pace ~~with~~ with Wal-Mart’s rapid expansion plans. Our future growth will require us to manage our expanding domestic and international operations and to adapt our operational, manufacturing, financial and management systems to ~~respond~~support ~~to changes~~those inefforts ~~our business environment~~ while ~~maintaining~~controlling ~~a competitive cost structure~~costs. ~~The~~Our ~~expansion of our~~ business ~~will~~expansion will continue to place significant demands on us to ~~improve~~further develop our ~~operational,~~field ~~manufacturing,~~managers ~~financial~~ and ~~management~~ ~~systems~~supervisors, ~~to develop further the management skills of our managers~~ and ~~supervisors,~~ ~~and to~~ continue to retain, train, motivate and effectively manage our employees. Our failure to manage ~~any future~~ growth effectively and to adequately expand these systems in response to such growth could ~~materially~~ materially adversely affect us by limiting our ability to ~~continue~~maintain toor expand ~~or to continue~~ our current level of service to customers in our existing studios.

~~Additionally,~~17 our ability to maintain and increase our revenue base and to respond to shifts in customer demand and changes in industry trends will be partially dependent on our ability to generate sufficient cash flow or obtain sufficient capital for the purpose of, among other things, financing capital expenditures, infrastructure growth and acquisitions. There can be no assurances that we will be able to generate sufficient cash flow or that financing will be available on acceptable terms, or permitted to be incurred under the terms of our new senior secured revolving credit facility, our new letters of credit facility or our other existing indebtedness or any future indebtedness, to fund our future growth. Our failure to generate sufficient cash flow or obtain sufficient financing to fund our future growth could materially adversely affect us.

We can give no assurances that we will be able to generate sufficient cash flow or obtain funding from external sources to support our future growth. Our failure to generate sufficient cash flow or obtain sufficient funding to support our future growth could materially adversely affect us.

Our expansion into geographic areas we already serve could adversely affect our business.

We have experienced reduced sales at existing studios when we have opened new studios in ~~close~~ close proximity to existing studios. Success of our growth strategy will ~~somewhat~~ depend somewhat on our ability to minimize this effect. In addition, our license agreement with Wal-Mart prohibits us from opening a new non-Wal-Mart studio within a certain distance of any store where we operate a Wal-Mart portrait studio. This prohibition could negatively impact our non-Wal-Mart expansion plans.

- 19 -

Our fourth quarter sales and income are disproportionately high and we are vulnerable to downturns in consumer holiday spending that can adversely affect our business.

Our business is highly seasonal. The holiday season accounts for a high percentage of our sales and operating income, and our fourth fiscal quarter, typically late October/early November through late January/early February, generally produces a large percentage of annual sales and operating income. The fourth quarters in fiscal ~~2004~~2005 and ~~2003~~2004 have accounted for approximately 33% of our annual sales ~~and~~ ~~approximately 101%~~ and ~~67%,~~all ~~respectively,~~ of our annual operating income. Our operations can be adversely affected by inclement weather or other factors that reduce consumer holiday spending in our host stores, especially during the important fiscal fourth quarter.

If our competitors initiate price-cutting or changes in package configurations or introduce new technology, we may experience lower sales or higher costs.

The professional portrait photography industry is highly competitive. ~~Certain of~~Evolving our competitors and potential competitors are more established, benefit from greater name recognition and have significantly greater capital and resources than we do. Moreover, evolving technology and business relationships may make it easier and ~~cheaper~~less expensive for our ~~competitors~~competition ~~and potential competitors~~ to develop ~~products~~ products or services similar to ours or to sell competing products or services in our markets.

The companies in our industry compete on the basis of value, price, quality, access, service, package size, technology and convenience of retail distribution ~~channel~~. The major professional portrait studio companies, including CPI Corporation and Olan Mills, operate permanent studios in retail chains and independent locations. To compete successfully, we must continue to remain ~~competitive~~ competitive in areas of value, price, quality, access, service, package size, technology and convenience of distribution and we must do so on terms and at prices compatible with the Wal-Mart philosophy.

The evolution of digital portrait technology has introduced additional competition ~~from~~ from companies, ~~such as Picture People,~~ which operate independent locations specializing in such portrait technology. ~~Although~~We ~~we have not experienced~~can ~~a significant~~give ~~decline in the discount retail distribution channel due to such technology or companies, there is~~ no assurance such technology, or companies specializing in such technology, will not take significant business from us, resulting in either lower sales or higher cost of operation for us.

Furthermore, consumer products, particularly those that are value-priced, are subject to significant price competition. ~~There~~We iscan give no assurance that we will not be forced to engage in price-cutting initiatives to respond to competitive and consumer pressures. The failure of our sales volumes to grow sufficiently to improve overall sales and income as a result of a competitive price reduction could materially adversely affect us.

Our international expansion may not be successful and may expose us to additional risks that could adversely affect our business.

~~International~~18 operations in Canada, Mexico, Germany and the U.K. accounted for approximately 11% of sales during fiscal 2004. We expect international sales to increase in the future as we continue to grow in Canada and Mexico and, potentially, as we expand operations in Europe (we currently only operate European studios in Germany and the U.K.). To the extent our international operations increase, we will become more vulnerable to risks involving the geographic distance of operations, differences in language or culture, changes in business regulations, taxation and currency fluctuations and political instability. Further, there is no proven market for portrait photography services in retail studio locations in Europe. Therefore, our in-store studio model may not perform well in Europe.

- International operations in Canada and Mexico accounted for approximately 12.2% of sales 20during fiscal 2005. Germany and the U.K accounted for .6%. We expect international sales to increase in the future as we continue to grow in Canada and Mexico and potentially, as we expand operations in Europe (we currently only operate European studios in Germany and the U.K.). To the extent our international operations increase, we will become more vulnerable to risks involving the geographic distance of operations, differences in language or culture, changes in business regulations, taxation and currency fluctuations and political instability. Further, there is no proven market for portrait photography services in retail studio locations in Europe. Therefore, our in-store studio model may not perform well in Europe.

We may not be able to keep pace with the evolution of technology and develop and invest in new technologies as required to compete effectively.

The evolution of digital portrait technology, computer technology, manufacturing ~~technology~~ technology and information technology may make it difficult for us to continue using our current technologies and ~~require~~remain uscompetitive. We must continue to invest in new technologies. There can be no assurance we can generate sufficient capital from operations or outside ~~financing~~funding sources to invest in such evolving technologies. To the extent we do invest in such technology, there is no assurance our investment will lead to increased sales or profits. In addition, our ability to develop digital technology, e-commerce capabilities and other new information and distribution technologies may affect our position in the marketplace. As digital photography and processing systems ~~evolve~~improve and the costs associated with such systems ~~continue~~ ~~to decline~~declines, it may impair our ability to compete in the ~~marketplace~~ marketplace as we may no longer be able to produce our products at ~~low~~competitive ~~costs~~prices.

A significant increase in piracy of our photographs could materially adversely affect our business, financial condition or results of operations.

We rely on copyright laws to protect our proprietary rights in our portrait photographs. However, our ability to prevent piracy and enforce our proprietary rights in our photographs is limited. We are aware that unauthorized copying of photographs occurs within our industry. A significant increase in the frequency of unauthorized copying of our photographs could materially adversely affect our business, financial condition and results of operations by reducing revenues from photograph sales.

Any disruption in our manufacturing process could have a material adverse impact on our business.

We are dependent upon the efficient operation of our portrait processing facilities to maintain our portrait quality, and timeliness of delivery ~~and low cost operation~~. These facilities are located in a single metropolitan area, Charlotte, North Carolina, and serve primarily all of our operations worldwide. Any disruption of our processing systems for any reason could adversely impact us.

Risks Related to Our Indebtedness

Our substantial indebtedness could materially adversely affect our business and prevent us from fulfilling our debt obligations.

We have outstanding a substantial amount of debt. As of ~~July 15~~January 29, ~~2005~~2006, this debt ~~consisted~~ consisted of:

- $50.0 million of 14% senior secured notes due 2009,; - $1820.0 million of letters of credit ~~issued~~due ~~under~~2009; ~~our new $20.0 million letters of credit facility,~~ - $~~165.0 million of senior notes, - $~~10.0 million of senior ~~subordinated~~secured ~~notes,~~revolving -credit ~~$30.0~~facility million of senior subordinated discount notes and $14.6 million of additional principal outstanding from capitalized interest on such notes, and - $20.7 million of interest bearing extended vendor payables due ~~in June 2006 if we are unable to renegotiate the supply contract.~~2009;

We19 will need to refinance our $50.0 million senior secured notes, our new $10.0 million senior secured revolving credit facility, our new $20.0 million letters of credit facility and our $165.0 million of senior notes by 2009, and our $30.0 million of senior subordinated discount notes and our $10.0 million of senior subordinated notes by 2010. We do not expect to generate sufficient cash flow from future operations to repay our indebtedness and will need to refinance to do so. There is no assurance we will be able to obtain new sources of credit on favorable terms or otherwise. If we are unable to refinance our debt when due, we could be deemed in default by our lenders, which could lead to foreclosure on our assets and perhaps insolvency.

- 21 $165.0 million of 11.875 % senior notes due 2009; - $10.0 million of 13.75% senior subordinated notes due 2010; - $30.0 million of 16.5% senior subordinated discount notes and $22.3 million of additional principal outstanding from capitalized interest on such notes due 2010; and - $22.8 million of extended vendor payables due June 2006, unless we are able to negotiate a further extension of this obligation.

We do not expect to generate sufficient cash flow from future operations to repay our ~~incurred~~indebtedness ~~approximately~~or ~~$32~~to meet current debt obligations.5 ~~million~~We inwill ~~net~~need ~~interest~~to ~~expense~~restructure inand/or ~~fiscal~~refinance ~~2004,~~our ~~which~~debt ~~represented~~to ~~approximately~~do ~~186%~~so. ofWe ~~our~~can ~~operating~~give ~~income~~no ~~for~~assurance ~~the~~we ~~year. As~~will ~~of January~~be ~~30,~~able ~~2005,~~to ~~approximately~~restructure ~~11.7%~~or ofrefinance our debt ~~bears~~on favorable ~~interest~~terms ator ~~floating~~otherwise. ~~rates~~ Our ability to continue operations is largely dependent on continued forbearance from our creditors and ifour ~~interest~~ability ~~rates~~to ~~rise,~~compromise or otherwise restructure our debt ~~service~~obligations ~~obligation~~to ~~will~~levels ~~rise~~that ascan be ~~well,~~supported by our existing cash flows from operations. If we are ~~except~~unable to do so, the ~~extent~~Company wecould ~~are~~be ~~able~~forced to ~~enter~~seek ~~into~~bankruptcy protection ~~hedging~~or ~~contracts~~could be forced to sell assets on ~~favorable~~ unfavorable terms toin exchange ~~mitigate~~for ~~our~~proceeds ~~exposure~~that towould ~~interest~~likely ~~rate~~be ~~movements~~insufficient to satisfy our obligations. (See ~~“Item~~ ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations— “Liquidity and Capital Resources” ~~and “Item 7A~~). ~~Quantitative and~~ ~~Qualitative Disclosures About Market Risk” for more detail about our debt.~~

~~Our substantial~~ We ~~amount~~incurred ofapproximately ~~debt,~~$38.8 million asin ~~well~~net asinterest ~~the~~expense ~~guarantees~~in offiscal ~~our~~2005. ~~guarantors~~As ~~and~~of ~~the security~~January 29, ~~interests~~2006, inapproximately 10.5% of our ~~assets~~debt bears interest at floating rates and ~~the~~if ~~assets~~interest rates ofrise, our ~~guarantors~~debt service obligation will rise as well. See “Item 7., ~~could~~Management’s Discussion ~~adversely~~and ~~impact~~Analysis ~~our~~of ~~business~~Financial Condition and usResults byof Operations—Liquidity and Capital Resources” and “Item 7A., ~~including~~Quantitative ~~but~~and ~~not~~Qualitative ~~limited~~Disclosures About Market Risk” for more detail about our ~~to:~~debt.

- increasing our vulnerability to adverse economic and industry conditions; - limiting our ability to obtain additional financing; - requiring a substantial portion of our cash flow from operations to be used for interest payments on our debt and annual revolver pay downs required by our new senior secured revolving credit facility, thereby reducing our ability to use our cash flow to fund our studio expansion program and capital expenditures; - limiting our flexibility in planning for, or reacting to, changes in our business and industry; and - placing us at a disadvantage compared to competitors with less debt or greater resources.

The agreements governing our debt impose restrictions on our business.

The agreements governing our ~~new~~various ~~senior secured revolving~~ credit ~~facility,~~facilities ~~our new letters of credit facility, our senior secured notes, our senior notes, our senior subordinated notes and our senior subordinated discount notes~~ contain a number of covenants imposing significant restrictions on our business. These restrictions may affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. These covenants place restrictions on our ability to, among other things:

- incur more debt; - ~~pay dividends, redeem or repurchase our stock or~~ make ~~other distributions; - make~~ acquisitions or investments; - ~~enter into transactions with affiliates; -~~ merge or consolidate with others; - dispose of assets or use asset sale proceeds; - create liens on our assets; and - pledge capital stock of any subsidiary that is held by PCA LLC, PCA Finance Corp. or any of their domestic subsidiaries.

- The breach of any of these covenants or restrictions could result in a default under the 22agreements governing our debt. Such a default would permit some of our lenders to declare all -amounts borrowed from them to be due and payable, together with accrued and unpaid interest, and the commitments of the senior lenders to make further extensions of credit under our new senior secured revolving credit facility and issue additional letters of credit under our new letters of credit facility could be terminated. If we are unable to repay debt to our senior lenders, these lenders could proceed against the collateral securing that debt.

Our new senior secured revolving credit facility and our new letters of credit facility each also require us to meet a number of financial ratios and tests on a regular basis. We describe certain of these requirements in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Our ability to comply with these agreements may be affected by events beyond our control, including, but not limited to, prevailing economic, financial and industry conditions. The breach of any of these covenants or restrictions, as well as any failure to make a payment of interest or principal when due, could result in a default under the agreements governing our debt. Such a default would permit some of our lenders to declare all amounts borrowed from them to be due and payable, together with accrued and unpaid interest, and the commitments of the senior lenders to make further extensions of credit under our new senior secured revolving credit facility and issue additional letters of credit under our new letters of credit facility could be terminated. If we are unable to repay debt to our senior lenders, these lenders could proceed against the collateral securing that debt.

Forward Looking Statements

~~This~~20 Annual Report on Form 10-K includes “forward-looking statements,” as defined by federal securities laws, with respect to our financial condition, results of operations and business and our expectations or beliefs concerning future events. Words such as, but not limited to, “believes,”“expects,”“anticipates,”“estimates,”“intends,”“plans,”“targets,”“likely,”“would,”“could,” and similar expressions identify forward-looking statements.

~~All forward-looking~~ This ~~statements~~Annual ~~involve~~Report ~~risks~~on ~~and~~Form ~~uncertainties.~~10-K ~~Many~~includes ~~risks~~“forward-looking ~~and uncertainties~~statements,” ~~are~~as ~~inherent~~defined inby ~~the professional portrait photography industry.~~federal ~~Others~~securities ~~are~~laws, ~~more~~with ~~specific~~respect to our ~~operations.~~financial ~~The~~condition, ~~occurrence~~results of ~~the~~operations ~~events described,~~ and ~~the~~business ~~achievement~~and our ofexpectations ~~the~~or ~~expected~~beliefs ~~results,~~concerning ~~depend~~future onevents. ~~many~~Words ~~events~~such as, ~~some~~ orbut ~~all~~not oflimited ~~which~~to, “believes,” ~~are~~“expects,” ~~not~~“anticipates,” ~~predictable~~“estimates,” or“intends,” ~~within~~“plans,” ~~our~~“targets,” ~~control.~~“likely,” “would,” ~~Actual~~“could,” ~~results may~~and ~~differ~~similar ~~materially~~expressions ~~from~~identify ~~expected~~forward-looking ~~results~~statements.

All forward-looking statements involve risks and uncertainties. Many risks and uncertainties are inherent in the professional portrait photography industry, and others are more specific to our operations. The occurrence of the events described, and the achievement of the expected results, depend on many factors, some or all of which are not predictable or within our control. Actual results may differ materially from expected results.

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

- risks associated with substantial indebtedness, leverage, debt service, liquidity and ~~liquidity~~the ability to obtain other sources of financing and/or restructure our debt; - risks associated with management’s ability to successfully design and implement a plan to improve results of operations; - risks associated with digital photographic technology; - risks associated with our ability to extend payment terms with our vendors; - risks associated with operating in countries outside the U.S.; - risks associated with our relationship with Wal-Mart, our principal business relationship; - performance of our new or existing studios and their future operating results; - risks of competition from companies including, but not limited to, those currently operating in other photography markets; - risks associated with the domestic professional portrait photography industry; and

-21 ~~23 -~~

- other risks and uncertainties affecting Portrait Corporation of America, Inc. and its subsidiaries referred to in this Form 10-K (see “Part I, Item 11A., ~~Business—~~Risk Factors” and “Part II, Item 7., Management’s Discussion and Analysis of Financial Condition and Results of Operations”) 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~~Form 10-K. 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 outcomes indicated or implied by forward-looking events discussed in this Annual Report on Form 10-K might not occur.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable

ITEM 2. PROPERTIES

~~Over the last~~ We ~~several~~own ~~years,~~three ~~we have made a substantial investment in our portrait photography manufacturing~~ facilities inand ~~order~~lease ~~to become, what management believes to be,~~ one offacility ~~the industry’s lowest cost producers. We own three facilities~~ in the Charlotte, North Carolina area. The primary facility serves as our corporate headquarters, main production facility and warehouse and is is approximately 167,000 square feet. AAnother 60,000 square foot facility which houses a second film production and portrait processing facility, our technology group, our customer support center and administrative and sales offices. WeAdjacent ~~also~~to ~~have~~ this facility we operate a 31,400 square foot distribution center.

We Additionally, we have a lease that ~~commenced~~began in June 2003 and ends April 30, 2008, on a 39,800 square foot warehouse and distribution facility in Charlotte, North Carolina. On ~~May~~ May 1, 2005 we added 20,112 square feet to this lease, bringing our total space in this facility to 59,912 square feet.

The facilities described above are utilized by both our retail and institutional reporting segments.

We own or lease the equipment, furniture and fixtures in our permanent retail studios and stores as well as our traveling and institutional equipment. Our production facilities are subject to a lien under our new senior secured revolving credit facility and our new letters of credit facility. There are no other major encumbrances with regard to our manufacturing equipment or facilities.

We operate in Wal-Mart under license agreements in the U.S. and Canada and under ~~lease~~ lease agreements in Mexico, Germany and the U.K. as discussed in “Item 1. , Business—Licenses, Trademarks and Patents.” Our license and lease agreements provide that we are entitled to remove our equipment at the end of the license term. The license and lease agreements do not provide for a security interest in our equipment.

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ITEM 3. LEGAL PROCEEDINGS

We are currently party to various litigations and other legal proceedings that have arisen in the normal course of business. We do not believe the outcome of any of these matters will have a material adverse effect on our financial condition or results of operations.

During fiscal 2004, we became aware of a tax claim due to SAT, the Mexican tax authority, from our Mexican subsidiary. The amounts alleged due to SAT consisted of $1.4 million for the fiscal years 1997 and 1998 and approximately $0.1 million for January through June of 2000. As a result of our delinquency in paying these amounts, fines, penalties and interest of $4.5 million were added by SAT to the outstanding claim. We conducted a preliminary investigation of this matter and subsequently engaged law firms in Mexico and the U.S. to assist in negotiating a settlement with SAT and an independent accounting firm (other than our independent registered public accounting firm) to perform forensic accounting work. We recorded a $1.5 million charge in the third quarter of fiscal 2004 reflecting management’s best estimate of the ultimate settlement of this claim.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None noted.

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PART II


ITEM 5.		MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Portrait Corporation of America, Inc.’s common stock is not traded on a stock exchange. or other established public trading market. As of ~~July 28~~June 21, ~~2005~~2006, there were 2,294,352 outstanding shares of Portrait Corporation of America, Inc.’s common stock held of record by less than 100 holders.

We did not pay any dividends in fiscal ~~2004~~2005 or ~~2003~~2004. Our debt arrangements ~~generally~~ prohibit or restrict the payment of dividends.

ITEM 6. SELECTED FINANCIAL DATA

The selected historical consolidated financial data for ~~and as of each of~~ the fiscal years in the five-year period ended January 30 29, ~~2005~~2006 set forth below under the captions “Statement of Operations Data,” “Cash Flow Data,” and “Balance Sheet Data” have been derived from PCA’s consolidated financial statements. The information presented below should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes ~~of Portrait Corporation of America, Inc. and its subsidiaries~~ included elsewhere in this Annual Report on Form 10-K. Our fiscal year ends on the Sunday closest to ~~January~~ January 31, resulting in fiscal years of either 52 or 53 weeks. For example, ~~our~~ fiscal ~~2004~~2005 ended on January 30 29, ~~2005~~2006 and contained 52 weeks.

	For the Fiscal Year
	2004			2003 (13)			2002 (13)			2001 (1) (13)			2000 (13)
	2005				2004 (13)				2003 (13)				2002 (13)			2001 (1)(13)
	(in thousands)
Statement of Operations Data:
Sales (2)	$	~~323~~325,~~553~~516		$	~~324,814~~$	323,553	$	~~296,616~~	$	$324,814	~~258,403~~		$	~~227~~296,~~470~~616		$	258,403
Costs of sales		~~258~~268,~~396~~747			~~245,028~~	258,396		~~219,551~~		245,028	~~192,362~~			~~171~~219,~~875~~551			192,362
Gross profit		6556,~~157~~769			~~79,786~~	65,157		~~77,065~~		79,786	~~66,041~~			5577,~~595~~065			66,041
General and administrative expenses (3)		4751,~~669~~471			~~45,610~~	47,669		~~41,300~~		45,610	~~37,652~~			3441,~~546~~300			37,652
Amortization of intangibles		~~----~~—			~~----~~	—		~~192~~		—	~~1,971~~			~~1,974~~192			1,971
Income from operations		175,~~488~~298			~~34,176~~	17,488		~~35,573~~		34,176	~~26,418~~			1935,~~075~~573			26,418
Interest expense, net		3238,~~459~~760			~~30,706~~	32,459		~~28,610~~		30,706	~~29,681~~			2928,~~107~~610			29,681
Other expense (4)		~~----~~—			~~----~~	—		~~2,776~~		—	~~15,026~~			~~----~~2,776			15,026
Early extinguishment of debt (5)		~~----~~980			~~----~~	—		~~4,569~~		—	~~----~~			~~----~~4,569			—
Income tax provision (benefit) (6)		~~14,769~~—			~~2,148~~	14,769		~~(14,817~~	)	2,148	43			(~~448~~14,817	)		43
Income (loss) before cumulative effect of accounting change		(2934,~~740~~442	)		~~1,322~~	(29,740	)	~~14,435~~		1,322	~~(18,332~~	)		(914,~~584~~435	)		(18,332	)
Cumulative effect of accounting change (7)		~~----~~—			~~----~~	—		~~----~~		—	~~(1,728~~	)		~~(5,990~~—	)		(1,728	)
Net income (loss)	$	(2934,~~740~~442	)	$	~~1,322~~$	(29,740	$)	~~14,435~~	$	$1,322	~~(20,060~~	)	$	~~(15~~14,~~574~~435	)	$	(20,060	)

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	For the Fiscal Year
	2004			2003 (13)			2002 (13)			2001 (1) (13)			2000 (13)
	2005				2004 (13)				2003 (13)				2002 (13)			2001 (1)(13)
	(in thousands)
Cash Flow Data:
Purchases of property and equipment	$	2112,~~382~~934		$	~~21,080~~$	21,382	$	~~17,046~~	$	$21,080	~~12,924~~		$	1117,~~316~~046		$	12,924
Depreciation and amortization		1214,~~818~~101			~~11,408~~	12,818		~~10,168~~		11,408	~~9,114~~			910,~~477~~168			9,114
Net cash provided by operating activities		24,248			17,994			30,901			12,522			5,702
Net cash provided by (used in) operating activities		(10,549	)			24,248				17,994				30,901			12,522
Net cash used in investing activities		(2212,~~522~~930	)		~~(21,066~~	)(22,522	)	~~(17,046~~	)	(21,066	~~(12,924~~)	)		(917,~~076~~046	)		(12,924	)
Net cash provided by (used in) financing activities		816,~~713~~223			~~6,031~~	8,713		~~(14,598~~	)	6,031	~~(963~~	)		(~~298~~14,598	)		(963	)
Other Financial Data:
Ratio of earnings to fixed charges (8)		~~---~~—			~~1.1~~	—		~~---~~		1.1	~~---~~			~~---~~—			—
Same studio sales percentage increase (decrease) (9)		(74.0	)%		~~1.5~~	%(7.0	)%	~~5.2~~	%	1.5	~~3.2~~%	%		65.42	%		3.2	%

	At End of Fiscal Year
	2004			2003 (13)			2002 (13)			2001 (13)			2000 (13)
	2005				2004 (13)				2003 (13)				2002 (13)			2001 (1)(13)
Balance Sheet Data: (in thousands)
Cash and cash equivalents	$	157,~~178~~973		$	~~4,820~~$	15,178	$	~~2,515~~	$	$4,820	~~2,870~~		$	42,~~822~~515		$	2,870
Working capital (deficit) (10)		(39318,~~393~~702	)		~~(39,592~~	)(39,393	)	~~(36,253~~	)	(39,592	~~(50,322~~)	)		(3736,~~613~~253	)		(50,322	)
Total assets		~~166~~161,~~792~~310			~~163,665~~	166,792		~~150,981~~		163,665	~~129,294~~			~~125~~150,~~886~~981			129,294
Total consolidated debt		~~245~~274,~~862~~955			~~229,937~~	245,862		~~217,247~~		229,937	~~217,961~~			~~214~~217,~~975~~247			217,961
Series A preferred stock		15,000			~~15,000~~	15,000		~~15,000~~		15,000	~~7,688~~			1415,~~914~~000			7,688
Consolidated shareholders’ deficiency		(~~171~~204,~~041~~820	)		~~(141,144~~	)(171,041	)	~~(142,793~~	)	(141,144	~~(179,177~~)	)		(~~160~~142,~~872~~793	)		(179,177	)
Studio/Store Data:
Number of permanent studios and stores:
Wal-Mart:
U.S. (11)		2,~~063~~136			~~1,900~~	2,063		~~1,707~~		1,900	~~1,537~~			1,~~381~~707			1,537
Canada, Mexico, Germany and U.K.		340			301			256			210			171
Canada, Mexico, Germany and U.K. (11)		368				340				301				256			210
Other (12)		131			39	13		38		39	30			1038			30
Total		2,~~416~~505			~~2,240~~	2,416		~~2,001~~		2,240	~~1,777~~			12,~~562~~001			1,777

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	For the Fiscal Year
	2004			2003			2002			2001		2000
	2005				2004				2003			2002		2001
Studio/Store Opening Data:
Number of new permanent studios and stores opened:
Wal-Mart:
U.S. (11)		~~163~~157			~~193~~	163		~~170~~		193	~~156~~		~~127~~170		156
Canada, Mexico, Germany and U.K.		39			45			46			39		14
Canada, Mexico, Germany and U.K. (11)		30				39				45			46		39
Other (12)		(26	)		1			8			20		10
Wal-Mart and Other (12)		(98	)			(26	)			1			8		20
Total		~~176~~89			~~239~~	176		~~224~~		239	~~215~~		~~151~~224		215

_______________

Notes



(1)		fiscal year 2001 consisted of 53 weeks. (All other years presented consisted of 52 weeks.)

(2)		The following table sets forth our sales by channel:

	For the Fiscal Year
	2004		2003			2002			2001		2000
	2005			2004				2003			2002		2001
	(in thousands)
Wal-Mart	$	~~310~~315,~~253~~165	$	~~309,398~~$	310,253	$	~~279,692~~	$	$309,398	~~247,404~~	$	~~215~~279,~~557~~692	$	247,404
Kmart		---		---			---			---		4,758
Other		10,351			13,300				15,416			16,924		10,999
Other		13,300		15,416			16,924			10,999		7,155
Total	$	325,516		$	323,553			$	324,814		$	296,616	$	258,403
Total	$	323,553	$	324,814		$	296,616		$	258,403	$	227,470

(3)	The amounts for fiscal 2000 and fiscal 2001 include $3.2 million and $0.8 million, respectively, of expenses incurred to close our studios in Kmart stores, including severance, net of reimbursements received from Kmart for unamortized leasehold improvements in our closed studios.	The amount for fiscal 2001 includes $0.8 million of expenses incurred to close our studios in Kmart stores, including severance, net of reimbursements received from Kmart for unamortized leasehold improvements.
(4)	Other expense in fiscal 2001 and 2002 represented the cumulative mark-to-market adjustment for the relevant fiscal year for the embedded derivative in our Series A redeemable convertible preferred stock in accordance with Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”), “Accounting for Derivative Instruments and Hedging Activities,” as amended (see Note (7) below), which we adopted in fiscal 2001. In 1999, we issued to Jupiter Partners 15,000 shares of our Series A redeemable convertible preferred stock for net cash proceeds of $14.9 million. Prior to December 20, 2002, our Series A redeemable convertible preferred stock was convertible at any time and redeemable in cash on April 30, 2011 at the greater of (a) $1,000 per share or (b) the fair value of our common stock into which it is convertible, plus declared and unpaid dividends. On December 9, 2002, a special meeting of the shareholders of PCA was held and the shareholders approved modifications to the provisions of our Series A redeemable convertible preferred stock. Upon the filing of restated articles of incorporation on December 20, 2002, we modified the liquidation and redemption provisions of our Series A redeemable convertible preferred stock. As a result of these changes, we have determined the embedded derivative in our Series A redeemable convertible preferred stock no longer meets the requirements of bifurcation and separate accounting under the provisions of SFAS No. 133. See Notes (4) and (10) of our consolidated financial statements.	Other expense in fiscal 2001 and 2002 represented the cumulative mark-to-market adjustment for the relevant fiscal year for the embedded derivative in our Series A redeemable convertible preferred stock in accordance with Statement of Financial Accounting Standards No. 133 (“SFAS No. 133”), “Accounting for Derivative Instruments and Hedging Activities,” as amended (see Note (7) below), which we adopted in fiscal 2001. On December 9, 2002, a special meeting of the shareholders of PCA was held and the shareholders approved modifications to the provisions of our Series A redeemable convertible preferred stock. Upon the filing of restated articles of incorporation on December 20, 2002, we modified the liquidation and redemption provisions of our Series A redeemable convertible preferred stock. As a result of these changes, we have determined the embedded derivative in our Series A redeemable convertible preferred stock no longer meets the requirements of bifurcation and separate accounting under the provisions of SFAS No. 133. See Notes (4) and (11) of our consolidated financial statements.

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(5)	On June 27, 2002, PCA LLC and PCA Finance Corp., our wholly-owned subsidiaries, issued $165.0 million in senior notes due 2009. Also on June 27, 2002, PCA LLC entered into our prior senior secured credit facility, PCA LLC issued $10.0 million of senior subordinated notes, and we issued $30.0 million of senior subordinated discount notes. The net proceeds from the issuance of the senior notes, together with borrowings under our prior senior secured credit facility and the proceeds from the sale of the senior subordinated notes and the senior subordinated discount notes, were used to repay our other previously outstanding senior secured credit facility, our previously outstanding senior subordinated term loans, and related interest and fees. As a result of these extinguishments, we realized a loss on the early extinguishment of debt in fiscal 2002 of $4.6 million. This loss was comprised of $10.2 million for the write-off of deferred financing costs less $5.6 million for the write-off of accrued effective interest on retired increasing rate debt.	On July 15, 2005, PCA LLC and PCA Finance Corp., our wholly-owned subsidiaries, issued $50 million of senior secured notes due 2009. The proceeds from the notes were used to fully repay PCA LLC’s prior senior secured credit facility of $32.5 million. As a result, the Company recognized a charge of $.98 million for early extinguishment of debt equal to the unamortized deferred financing costs and administrative fees on this debt. On June 27, 2002, PCA LLC and PCA Finance Corp. issued $165.0 million in senior notes due 2009. Also on June 27, 2002, PCA LLC entered into our prior senior secured credit facility, PCA LLC issued $10.0 million of senior subordinated notes, and we issued $30.0 million of senior subordinated discount notes. The net proceeds from the issuance of the senior notes, together with borrowings under our prior senior secured credit facility and the proceeds from the sale of the senior subordinated notes and the senior subordinated discount notes, were used to repay our other previously outstanding senior secured credit facility, our previously outstanding senior subordinated term loans, and related interest and fees. As a result of these extinguishments, we realized a loss on the early extinguishment of debt in fiscal 2002 of $4.6 million. This loss was comprised of $10.2 million for the write-off of deferred financing costs less $5.6 million for the write-off of accrued effective interest on retired increasing rate debt.
(6)	For fiscal 2004, 2001 and 2000, a valuation allowance was provided against deferred tax assets since we concluded it was more likely than not that such deferred tax assets would not ultimately be realized. For fiscal 2002, we concluded it was more likely than not that we would be able to utilize substantially all of the existing deferred tax assets. Therefore, substantially all of the valuation allowance in fiscal 2001 was reversed in fiscal 2002. This change in the valuation allowance generated a tax benefit and additional net income of $18.6 million in fiscal 2002 which was subsequently reversed as a charge in fiscal 2004. See Note (7) of our consolidated financial statements.	For fiscal 2004 and 2001, a valuation allowance was provided against deferred tax assets since we concluded it was more likely than not that such deferred tax assets would not ultimately be realized. For fiscal 2002, we concluded it was more likely than not that we would be able to utilize substantially all of the existing deferred tax assets. Therefore, substantially all of the valuation allowance in fiscal 2001 was reversed in fiscal 2002. This change in the valuation allowance generated a tax benefit and additional net income of $18.6 million in fiscal 2002 which were subsequently reversed as a charge in fiscal 2004. See Note (8) of our consolidated financial statements.
(7)	Effective for fiscal 2001, we adopted SFAS No. 133. Our Series A preferred stock contained an embedded derivative under SFAS No. 133 which required bifurcation and separate accounting. As a result, PCA recorded a cumulative effect of accounting change under SFAS No. 133 of $(1.7) million for fiscal 2001. In addition, we recorded $(15.0) million in fiscal 2001 of other expense as we marked the embedded derivative to market in accordance with SFAS No. 133. See Note (4) above. Effective for fiscal 2000, we changed our policy for recognizing revenues relating to photographic sales to be consistent with the Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements.” Revenues from photographic sales are recognized when the photographs are delivered to customers. Costs relating to portraits processed, or in process, are deferred when incurred and expensed when the photographs are delivered and the related photographic sales revenue is recognized. As a result of this change in accounting policy, we recorded a cumulative effect of accounting change of $(6.0) million in fiscal 2000. Prior to the change, sales were recognized when portraits were purchased at the time of photography and all costs incurred or to be incurred related to portraits processed or to be processed but not delivered were accrued and expensed.	Effective for fiscal 2001, we adopted SFAS No. 133. Our Series A preferred stock contained an embedded derivative under SFAS No. 133 which required bifurcation and separate accounting. As a result, PCA recorded a cumulative effect of accounting change under SFAS No. 133 of $(1.7) million for fiscal 2001. In addition, we recorded $(15.0) million in fiscal 2001 of other expense as we marked the embedded derivative to market in accordance with SFAS No. 133. See Note (4) above.
(8)	For purposes of computing the ratio of earnings to fixed charges, earnings consist of income from continuing operations before income taxes plus fixed charges. Fixed charges consist of net interest expense and amortization of deferred financing costs. For fiscal 2003, earnings were sufficient to cover fixed charges by $3.5 million. However, for fiscal 2004, 2002, 2001, and 2000, earnings were insufficient to cover fixed charges by $15.0 million, $0.4 million, $18.3 million, and $10.0 million, respectively.	For purposes of computing the ratio of earnings to fixed charges, earnings consist of income from continuing operations before income taxes plus fixed charges. Fixed charges consist of net interest expense and amortization of deferred financing costs. For fiscal 2003, earnings were sufficient to cover fixed charges by $3.5 million. However, for fiscal 2005, 2004, 2002, and 2001, earnings were insufficient to cover fixed charges by $34.4 million, $15.0 million, $0.4 million, and $18.3 million, respectively.
(9)	We consider a studio to be in our same studio sales calculation once it has been open for fifty-two weeks (i.e., in its fifty-third week). Same studio sales represent only Wal-Mart studios, both domestically and internationally. As noted in Note (7) above, we adopted SAB No. 101 in fiscal 2000.	We consider a studio to be in our same studio sales calculation once it has been open for fifty-two weeks (i.e., in its fifty-third week). Same studio sales represent only Wal-Mart studios, both domestically and internationally.
(10)	~~Current assets minus current liabilities.~~	Current assets minus current liabilities.

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(11)	~~Includes the acquisition of one Hometown Threads® company-owned store and the opening of one Fun Factory store.~~	Includes 7 Fun Factory Stores in the U.S. and 5 in Canada of which 6 were opened in the U.S. in fiscal 2005 and 5 in Canada.
(12)	~~Includes the closings of 24 permanent studios in Meijer locations and 2 permanent studios in military locations.~~	In fiscal 2005, 85 permanent studios in Wal-Mart were closed including 83 in the U.S., and 1 each in Canada and Europe. Additionally, 11 Military and 1 Go Portraits studios were closed. We also sold 1 Hometown Threads store.
(13)	~~The selected financial data has been restated to give effect to the matters discussed in Note 16 to the consolidated financial statements.~~	The selected financial data has been restated to give effect to the matters discussed in Note 17 to the consolidated financial statements.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the consolidated financial condition and results of operations of Portrait Corporation of America, Inc. and subsidiaries should be read in conjunction with the historical financial statements and the related notes and other information included elsewhere in this Annual Report on Form 10-K for the fiscal year ended January 30 29, ~~2005~~2006. See “Item 8. ~~Financial~~ Financial Statements and Supplementary Data.” The following discussion gives effect to the restatement discussed in Note 1617 to the consolidated financial statements.

The following discussion contains forward-looking statements that involve risks and uncertainties. Actual events or results could differ materially from those anticipated events or results due to various factors, including, but not limited to, the risks set forth in “Item 1 1A. ~~Business—~~, Risk Factors” in this Annual Report on Form 10-K. In particular, see “Item 1. Business—Risks Factors—Risks Related to Our Business—We experienced a significant downturn in our results of operations in fiscal 2004, and in fiscal 2004 we were unable to comply with certain financial covenants in our prior senior secured credit facility. We had a net loss and a deficiency of earnings to fixed charges in fiscal 2004, and we have a negative net worth,” and “—We were unable to timely file our Annual Report on Form 10-K for fiscal 2004 and our Quarterly Report on Form 10-Q for the thirteen weeks ended May 1, 2005 because of the ineffectiveness of our internal controls over financial reporting of our Mexican subsidiary. ~~If we fail to improve and maintain the effectiveness~~ of our internal control over financial reporting of our Mexican subsidiary, we may not be able to accurately and timely file our periodic reports and our financial condition and results of operations may be materially adversely affected.”

Description of the Company

We are a leading professional photography business primarily serving the needs of the Wal-Mart customer. ~~As of January 30, 2005, we operated 2,401 permanent studios~~ and ~~modular traveling portrait studios reaching approximately 1,000 additional locations, and we~~ are currently the sole operator of portrait studios in Wal-Mart stores. ~~Wal-Mart is the world’s largest retailer.~~ Consistent ~~with~~ with Wal-Mart’s every day low price strategy, we offer our customers convenient, high ~~quality~~ quality photography services at substantially lower price points than are offered by our principal industry competitors. As of January 30 29, ~~2005~~2006, we operated 2,~~061~~492 permanent studios and modular traveling studios reaching approximately 1,000 additional locations. Of these permanent studios, 2,129 are in Wal-Mart stores in the U.S. ~~As of January 30~~, ~~2005,~~241 weare ~~operated 226 studios~~ in Wal-Mart Canada, ~~and~~96 89are ~~studios~~ in Wal-Mart Mexico, and 26 are in ~~testing 25~~ Wal-Mart locations in Germany and the U.K. In addition, we operate two non-portrait photography related concepts in Wal-Mart stores in the U.S.: Hometown Threads®, ~~an owner~~ ~~and~~a franchisor of retail stores specializing in embroidery services and the personalization of gifts, and Fun Factory, a retail store specializing in making stuffed animals, selling accessories for these stuffed animals, and hosting birthday parties. As of the end of fiscal ~~2004~~2005, we ~~operated~~had ~~one company-owned~~47 franchised Hometown Threads® ~~and~~ ~~had 42~~locations, ~~franchised~~40 ~~locations~~of which were in Wal-Mart stores. We also operated ~~one~~ 12 Fun Factory ~~location~~locations. Under the trade name PCA International, we ~~also~~operated ~~serve~~one ~~other~~GoPortraits ~~retail channels on military~~all ~~bases~~digital ~~(including~~portrait ~~Fort~~studio ~~Bragg,~~ and ~~Pearl~~an ~~Harbor) and, through a modular traveling portrait platform,~~ institutional ~~channels,~~channel ~~such~~servicing asprimarily church congregations.

-27 ~~30 -~~

Selected Performance Metrics

The following table presents financial and operating data used by our management to assess performance and direct strategic initiatives to improve our performance.

	Fiscal Year (1)
	2004			2003			2002
	2005				2004				2003
	(dollar amounts in millions)
Financial and Operating Data:
Sales	$	~~323~~325.65		$	~~324.8~~$	323.6	$	~~296.6~~	$	324.8
Gross profit		6556.28			~~79.8~~	65.2		~~77.1~~		79.8
Income from operations		~~17.~~5.3			~~34.2~~	17.5		~~35.6~~		34.2
Income (loss) before taxes		(1534.04	)		~~3.5~~	(15.0	)	~~(0.4~~	)	3.5
Net income (loss) (2)		(2934.74	)		~~1.3~~	(29.7	)	~~14.4~~		1.3
Permanent studios/stores at end of year		2,~~416~~505			~~2,240~~	2,416		~~2,001~~		2,240
Change in permanent studios/stores (3)		~~176~~89			~~239~~	176		~~224~~		239
Customers served (in millions)		76.37			~~7.3~~	7.3		~~6.7~~		7.3
Change over Prior Year:
Sales		(0.46	)%		~~9.5~~	%(0.4	)%	~~14.8~~	%	9.5	%
Gross profit		(1812.39	)%		~~3.5~~	%(18.3	)%	~~16.7~~	%	3.5	%
Income from operations		(4869.87	)%		~~(3.9~~	)%(48.8	)%	~~34.7~~	%	(3.9	)%
Income (loss) before taxes		(~~531~~130.40	)%		~~1,008.4~~	%(531.4	)%	~~97.9~~	%	1,008.4	%
Net income (loss) (2)		(~~2,349~~15.68	)%		~~(90.8~~	)%(2,349.6	)%	~~172.0~~	%	(90.8	)%
Permanent studios/stores		73.97	%		~~11.9~~	%7.9	%	~~12.6~~	%	11.9	%
New permanent studios/stores (3)		(2649.4	)%		~~6.7~~	%(26.4	)%	~~4.2~~	%	6.7	%
Customers served		0(8.42	)%		~~9.2~~	%0.4	%	~~12.8~~	%	9.2	%
Same studio sales percentage increase (decrease) (4)		(74.0	)%		~~1.5~~	%(7.0	)%	~~5.2~~	%	1.5	%

_______________


(1)		Our fiscal years 2005, 2004, and 2003 ended on January 29, 2006, January 30, 2005, and February 1, 2004, respectively. Each fiscal year presented consisted of 52 weeks.

(2)		For fiscal 2005 and 2004, a valuation allowance was provided against deferred tax assets since we concluded it was more likely than not that such deferred tax assets would not ultimately be realized. See Note (8) of our consolidated financial statements.

(3)		In fiscal 2005, we opened 176 new permanent studios and 11 Fun Factory store in Wal-Mart stores worldwide. However, we closed 85 Wal-Mart permanent studios, 11 Military and 1 Go Portrait studios and sold 1 Hometown Threads store.

(4)		We consider a studio to be in our same studio sales calculation once it has been open for fifty-two weeks (i.e., in its fifty-third week). Same studio sales represent Wal-Mart studios, both domestically and internationally, as such calculation is not significant for our non-Wal-Mart business.

(1)	Our fiscal years 2004, 2003, and 2002 ended on January 30, 2005, February 1, 2004 and February 2, 2003, respectively. Each fiscal year presented consisted of 52 weeks.
(2)	For fiscal 2004, a valuation allowance was provided against deferred tax assets since we concluded it was more likely than not that such deferred tax assets would not ultimately be realized. See Note (7) of our consolidated financial statements.

(3)	In fiscal 2004, we opened 200 new permanent studios and 1 Fun Factory store and acquired 1 Hometown Threads® company-owned store in Wal-Mart stores worldwide. However, we closed 24 permanent studios in Meijer stores and 2 permanent studios in military locations during fiscal 2004.
(4)	We consider a studio to be in our same studio sales calculation once it has been open for fifty-two weeks (i.e., in its fifty-third week). Same studio sales represent Wal-Mart studios, both domestically and internationally, as such calculation is not significant for our non-Wal-Mart-based business.

- 31 -

Executive Summary

Financial Results

Our ~~Company~~ ~~experienced many challenges in fiscal 2004. For the first time since fiscal 2000, our~~ year over year consolidated sales ~~decreased,~~increased from $~~324~~323.8 6 million in fiscal ~~2003~~2004 to $~~323~~325.6 5 million in fiscal ~~2004~~2005. ~~Our~~Customer’s ~~weak~~average ~~performance in fiscal~~revenue ~~2004~~per istransaction ~~primarily~~increased ~~attributable~~which tooffset lower customer traffic and ~~lower average order size per customer, both of which resulted in~~ declining same studio performance. Our year over year same studio sales in our Wal-Mart permanent studios declined 74.0% in fiscal ~~2004~~2005, compared to a decrease of 7.0% in fiscal 2004 and an increase of 1.5% in fiscal 2003. ~~and~~At 5the same time, we were successful in increasing the average transaction size per customer by 9.29% in fiscal ~~2002.~~2005 versus fiscal 2004.

~~Beginning~~ Our costs of goods; which includes inmanufacturing ~~the~~costs, ~~summer~~film, ofportrait ~~2004~~freight, materials distribution, and ~~continuing~~other ~~throughout~~products, improved over fiscal 2004, ~~macro-economic~~by $.7 million or 1.3% but these benefits were ~~factors~~offset ~~such~~by asincreased ~~escalating~~year ~~gasoline~~over ~~prices~~year selling and ~~rising~~general ~~interest~~and ~~rates~~administrative ~~began~~expenses of $11.1 million ~~to have~~and a$3.8 million ~~noticeable~~respectively. ~~negative~~As ~~impact~~a onresult, ~~the~~operating ~~amount~~income ofdecreased ~~disposable~~in ~~income~~fiscal of2005 versus ~~Wal-Mart’s~~fiscal ~~target~~2004 ~~customer~~by ~~base,~~$12.2 million. ~~which~~Management ~~led~~has adopted plans to aimprove ~~reduction~~same instore sales and customer traffic through the studios and ~~average~~is ~~order~~evaluating ~~size~~costs in ~~our~~all ~~studios~~support areas.

~~To a lesser~~Management’s ~~extent, our fiscal 2004 results were also negatively impacted by a~~Plan change in the pricing of our photo packages. We lowered our opening price point in our first fiscal quarter in select markets, which subsequently resulted in higher traffic in promotion stores in the first two fiscal quarters but lower average order size throughout fiscal 2004.

~~Primarily as~~ To aaddress ~~result~~the ofnegative ~~weaker~~ same studio sales ~~attributable~~in toour ~~both macro~~Wal-~~economic factors~~Mart ~~and~~permanent ~~pricing~~studios, ~~decisions~~maintain increased ~~specific~~customer toorder ~~our Company~~size, weincrease ~~saw~~customer ~~our~~traffic, ~~income from operations~~and ~~decrease~~reduce ~~from~~operating ~~$34.2~~costs ~~million~~management inhas implemented ~~fiscal~~several ~~2003~~initiatives. toExamples ~~$17.5~~of ~~million~~these inare: ~~fiscal 2004.~~

~~In order~~ – reorganizing field operations management to ~~proactively~~put ~~address~~an ~~the~~emphasis ~~negative~~on ~~same~~training and retaining studio ~~sales~~personnel; in– ~~our~~placing ~~Wal-Mart~~a ~~permanent studios,~~renewed ~~our~~emphasis ~~management~~on ~~team~~photographer ~~has~~certification; ~~implemented~~– ~~several~~instituting ~~initiatives~~a ~~since~~new ~~the beginning~~bonus ofprogram ~~fiscal~~for ~~2005~~our ~~designed~~field associates and a new PCA Partner program to ~~increase~~recognize ~~same~~superior ~~studio~~performance; ~~sales.~~– ~~These~~ launching new marketing initiatives, ~~are~~including ~~focused~~selected oncoordinated ~~increasing~~marketing ~~average~~efforts ~~transaction~~with ~~size~~Wal-Mart, ~~per~~increased customer ~~as well~~ asdirect ~~customer~~mailing ~~traffic.~~programs ~~Examples~~and ofparticipation ~~these~~in ~~initiatives~~a ~~include~~Wal-Mart ~~increased external~~advertising ~~recruiting~~circular; of– ~~field~~changing ~~operations~~our ~~management,~~studio ~~instituting~~hours to better serve our customers’ demand (this change was based on a ~~new~~detailed ~~bonus program~~study ~~for~~of our ~~field~~sales ~~associates,~~by ~~launching~~hour); ~~new~~– ~~marketing initiatives,~~ re-~~implementing~~configuring ~~the~~backend ~~successful~~packages, ~~“Portrait Smiles”~~based on customer ~~continuity~~feedback, ~~program~~to ~~which~~increase ~~was~~their ~~previously~~value ~~eliminated~~and inprovide ~~fiscal 2003,~~more ~~re-introducing~~order aflexibility ~~mid-tier~~to ~~price~~our ~~point~~customers; in– increasing our ~~package~~average ~~offers~~front toend ~~improve the customer~~collection ~~experience~~rates ~~and~~on tocustom ~~encourage~~ordered ~~customer~~portraits ~~trade~~which ~~ups,~~increase ~~and~~final ~~increasing~~collection rates; – looking at our ~~opening~~ ~~price~~business ~~point.~~more ~~While~~qualitatively using focus groups, customer surveys, market testing, among other tools to insure we ~~believe~~understand ~~that~~our ~~these~~customers’ ~~initiatives~~needs ~~will~~and ~~result in higher~~address ~~customer~~those ~~traffic~~needs; – more controlled and ~~increases~~focused ingrowth ~~average~~with ~~order~~Wal-Mart ~~size~~— working closely with Wal-Mart in fiscal 2005, ~~there~~we ~~can~~opened ~~be no assurance~~176 ~~this~~permanent ~~will~~studios ~~actually~~but ~~occur.~~closed 85.

~~Amendment~~29 ~~to Prior Senior Secured Credit Facility~~

~~As of October~~– ~~31,~~disciplined ~~2004,~~expansion ~~the~~internationally ~~end~~— ofwe ~~our~~believe ~~fiscal~~Canada ~~third~~and ~~quarter,~~Mexico weprovide ~~were~~an ~~not~~attractive inplatform ~~compliance with~~for ~~certain~~international ~~financial~~growth ~~covenants~~and ~~contained~~we inare assessing the viability of our ~~prior~~European ~~senior~~operations; ~~secured~~– ~~credit facility~~disciplined ~~agreement.~~expansion Weinto ~~subsequently~~non-portrait ~~amended~~photography ~~this~~related ~~agreement~~concepts — with ~~our~~the ~~lenders on December~~opening ~~14,~~of ~~2004~~12 Fun Factory locations in Wal-Mart, ~~and~~we ~~obtained~~have ~~waivers~~the ofopportunity ~~these~~to ~~covenants~~expand ~~from~~our ~~October~~presence ~~31, 2004 through~~in ~~January~~Wal-Mart 31stores with this child-centered, ~~2005.~~value-priced Onconcept; ~~February~~– 4,critically ~~2005~~evaluating all our operations, wesupport and ~~our~~administrative ~~lenders~~functions, ~~executed another~~for ~~amendment~~cost ~~effective~~saving asopportunities; ofand ~~January~~– ~~31,~~evaluating ~~2005~~all ~~that~~business ~~reset~~channels ~~certain~~for ~~financial covenants~~strategic ~~through~~importance ~~January~~and ~~29,~~profit ~~2006.~~contribution and ceasing to operate non-contributing channels.

~~Issues Regarding~~ Our Key ~~Supplier~~Suppliers

~~During fiscal~~ Effective ~~2004~~January 1, we2006, ~~were~~the ~~unable~~Company agreed to ~~meet~~purchase ~~the~~100% ~~payment terms~~ of ~~AgfaPhoto~~its ~~USA~~North American ~~Corporation,~~requirements ~~our~~for ~~key~~color ~~supplier~~negative ~~of photographic~~ film, ~~paper,~~from ~~and~~Kodak ~~processing chemistry.~~during Wethe ~~have~~period ~~negotiated~~beginning ~~payment~~January 1, ~~terms~~2006 ~~with~~and ending ~~AgfaPhoto~~June 30, ~~USA~~2007, ~~Corporation~~ except that ~~extend~~ the ~~payment~~Company ~~date~~may ~~for~~purchase ~~our~~up ~~outstanding~~to ~~payables~~1% ~~(including~~of ~~interest which had~~its ~~been~~North ~~accrued~~American requirements atfor anfilm ~~annualized~~from ~~rate~~other ofvendors ~~6%)~~for astesting ofand ~~June~~evaluation. 15Effective December 8, 2005 ~~until June 15~~, ~~2006~~the ~~and~~Company wehas ~~have~~ agreed to ~~pay~~purchase ~~for~~100% ~~products~~of ~~purchased~~its ~~from~~North ~~AgfaPhoto~~American ~~USA Corporation~~requirements onfor orphotographic ~~after~~paper and ~~June~~chemicals ~~15,~~from ~~2005~~Fuji atduring orthe ~~prior~~period tobeginning ~~their~~January 1, ~~delivery.~~2006 Weand ~~are seeking~~ending toJune 30, ~~enter~~2007. ~~into a revised supply contract with AgfaPhoto USA Corporation~~Both ~~within~~agreements ~~the~~have ~~next~~payment ~~few~~terms ~~months.~~of ~~However,~~cash-in-advance ~~there~~and ishave noprovisions ~~assurance~~requiring ~~that~~annual ~~we will be~~minimum ~~able to~~purchase ~~do so~~quantities.

-Going 32Concern Paragraph in Auditors Report -

~~Additionally~~ Our independent registered public accounting firm, on ~~May~~Eisner, 27LLP, ~~2005~~issued their report dated May 26, ~~AgfaPhoto~~2006, ~~USA~~in ~~Corporation~~connection with their audit of the Company’s ~~German~~consolidated ~~parent~~financial ~~company,~~statements ~~AgfaPhoto~~for the ~~GmbH,~~fiscal ~~filed~~year aended ~~petition~~January 29, ~~for~~2006 ~~insolvency.~~which ~~While~~expressed wean ~~have~~unqualified ~~been~~opinion ~~informed~~and ~~that~~included an ~~AgfaPhoto~~explanatory ~~USA~~paragraph ~~Corporation~~expressing ~~has~~substantial ~~sufficient~~doubt ~~funding~~about the Company’s ability to continue ~~its~~as ~~normal operations~~a going concern. As discussed in Note 2 to the ~~foreseeable~~financial ~~future~~statements, ifthe ~~AgfaPhoto~~Company ~~USA~~at January 29, ~~Corporation~~2006 ~~becomes~~had a working capital deficiency and a capital ~~unable~~deficiency, toand ~~continue~~has toincurred ~~provide~~a ~~supplies~~substantial tonet usloss ~~under~~for ~~our~~the ~~current~~year ended ~~contract~~January 29, 2006. The Company anticipates that such weconditions will continue in 2006. In addition, as discussed in ~~need~~Note 2, tothe ~~obtain~~Company anis ~~alternative~~in ~~source~~default of ~~supplies.~~certain Ifobligations wewhich were ~~enter~~due ~~into~~on anJune 15, ~~agreement~~2006 and does not have sufficient liquidity ~~with~~to anmeet ~~alternative~~these ~~supplier~~obligations. atThese ~~less~~factors ~~desirable~~raise ~~terms~~substantial ~~than~~doubt about the ~~terms~~Company’s ofability ~~our~~to continue as a going concern. ~~agreement~~Management’s ~~with~~plans ~~AgfaPhoto~~in ~~USA~~regard ~~Corporation,~~to wethese ~~may~~matters are also described in Note 2. The financial statements do not include any adjustments that might be ~~required~~necessary toif ~~raise~~the ~~additional~~Company is unable to ~~equity~~continue ~~and/or~~as ~~debt~~a ~~financing.~~going concern.

~~Going~~ Consequently, we are in default of our covenants under our Senior Notes and Senior Secured ~~Concern~~Notes. We have received waivers of this covenant and with ~~Respect~~the filing of this report on Form 10-K, we have cured this default. However, see discussion below under “Reclassification of Long Term Debt to ~~Operating~~Current ~~Subsidiary~~Liabilities”, and further discussion in “—Liquidity and Capital Resources—Liquidity” located herein.

~~Our independent~~Late ~~registered~~Filing ~~public~~of ~~accounting firm~~Form 10-K, ~~Deloitte~~Form 10-Q ~~& Touche LLP, issued a report dated June 24, 2005 which expressed an unqualified opinion~~ and ~~included~~Form 8-K an explanatory paragraph expressing substantial doubt about our operating subsidiary’s and its subsidiaries’ ability to continue as a going concern in connection with their audit of PCA LLC’s consolidated financial statements for the fiscal year ended January 30, 2005.

~~We anticipate,~~ Our ~~based~~Quarterly Report on ~~our~~Form ~~currently~~10-Q ~~proposed~~for ~~plans~~the ~~and~~thirteen ~~assumptions,~~weeks ~~that~~ended ~~the additional~~May 1, ~~liquidity~~2005 wewas ~~have~~delayed ~~obtained~~due ~~from~~ to the ~~issuance~~uncertainty ofassociated ~~senior secured notes together~~ with ~~our~~the ~~new~~financial ~~senior~~statements ~~secured~~of ~~revolving~~our ~~credit~~Mexican ~~facility~~subsidiary ~~and~~Our ~~our new~~Quarterly ~~letters~~Report ofon ~~credit~~Form ~~facility~~10-Q ~~and~~for ~~our~~the ~~obtaining~~thirty-nine ~~waivers~~weeks ofended ~~existing defaults~~October 30, ~~under our~~2005 ~~debt~~was ~~agreements,~~delayed ~~all~~due ofto ~~which~~turnover ~~occurred~~in ~~subsequent to~~ the ~~report~~Company’s ~~issued in connection~~financial ~~with~~staff. ~~PCA~~This ~~LLC’s~~Annual ~~consolidated~~Report on ~~financial~~Form ~~statements~~10-K for ~~the~~our fiscal year ended January 30 29, ~~2005,~~2006 ~~will~~was bedelayed ~~sufficient~~due to ~~satisfy~~a ~~our~~turnover ~~cash requirements~~ in ~~fiscal~~ ~~2005. See further discussion in “—Liquidity and Capital~~the ~~Resources—Liquidity”~~Company’s ~~located~~financial ~~herein~~staff. Additionally, we

~~Suspected~~30 ~~Fraudulent Activities by Former Employees at Our Mexican Subsidiary~~

~~During fiscal~~failed ~~2004,~~to wetimely ~~became~~file ~~aware~~Forms 8-K relating to: the hiring of aDavid ~~tax~~Alexander ~~claim~~as ~~for~~Chairman ~~amounts~~and ~~due~~CEO; toa ~~SAT,~~personal ~~the~~services ~~Mexican tax~~agreement ~~authority~~with John Klein, ~~from~~one of our ~~Mexican~~directors ~~subsidiary.~~and ~~The~~a ~~amounts~~principal ~~alleged~~of ~~due~~Jupiter toPartners, ~~SAT~~our majority ~~consisted~~shareholder; ofand ~~$1.4~~our ~~million~~new ~~for~~5 year ~~the~~agreement ~~fiscal~~with ~~years~~Wal-Mart ~~1997~~Canada. ~~and~~These ~~1998~~failures ~~and~~to ~~approximately~~timely file ~~$0.1~~reports ~~million~~with ~~for~~the ~~January~~U.S. ~~through~~Securities ~~June~~and ofExchange ~~2000.~~Commission As(“SEC”) aviolate ~~result~~the ofcovenants ~~our~~contained ~~delinquency~~ in ~~paying~~the ~~these~~indenture ~~amounts,~~agreements ~~fines,~~for ~~penalties~~the ~~and~~Company’s ~~interest~~Senior ofNotes ~~$4.5~~and ~~million~~Senior ~~were added by~~Secured ~~SAT to the outstanding claim~~Notes. We ~~conducted~~had a ~~preliminary investigation~~period of ~~this~~ ~~matter~~sixty ~~and~~(60) days ~~subsequently~~following ~~engaged~~notice ~~law~~from ~~firms~~either inthe ~~Mexico~~Trustee ~~and~~of the ~~U.S.~~Senior ~~to assist in~~Notes ~~negotiating~~or athe ~~settlement~~Senior Secured ~~with~~Notes ~~SAT~~or ~~and~~the anholders ~~independent~~of ~~accounting~~25% ~~firm~~of ~~(other than~~the ~~our~~principal ~~independent~~amount ~~registered~~of ~~public~~the ~~accounting~~Senior ~~firm)~~Notes to ~~perform~~cure ~~forensic~~the ~~accounting work~~defaults. WeNotice ~~recorded~~was areceived ~~$1.5~~with ~~million~~respect ~~charge~~to inthe filing of the ~~third~~Company’s ~~quarter~~Form of10-Q for the period ~~fiscal~~ended ~~2004~~October 30, ~~reflecting~~2005. ~~management’s~~Such ~~best~~defaults ~~estimate~~relating to the filing of the ~~ultimate~~Company’s ~~settlement~~Form of10-Qs and Form ~~this~~8-K ~~claim~~filings discussed above were cured.

As This Annual Report on Form 10-K for our fiscal year ended January 29, 2006 was delayed due to a turnover in the Company’s financial staff. We have received a 60 day notice relating to ~~result~~this oftimely ~~our~~filing ~~investigation~~default, wediscussed ~~dismissed~~above. ~~several~~Additionally, ~~employees~~we ~~who~~were wein ~~suspect may have~~default ~~been~~of ~~engaged~~covenants contained in ~~fraudulent~~our ~~activities~~Senior Notes and ~~hired~~Senior ~~new~~Secured ~~employees~~Notes torequiring ~~replace~~the delivery of our audited ~~those~~financial ~~employees.~~statements ~~The~~within ~~uncertainty~~90 days ofafter the ~~impact~~end of ~~these~~the ~~activities~~fiscal onyear, ~~our~~without an explanatory ~~financial~~paragraph ~~reporting~~expressing ~~and~~substantial ~~other~~doubt ~~disclosures~~about isthe ~~one~~Company’s ~~reason~~ability weto ~~did~~continue ~~not~~as ~~file~~a ~~our~~going ~~Annual~~concern. ~~Report~~On onJune 16, ~~Form~~2006, ~~10-K~~the ~~for~~Company entered into the ~~2004~~Third ~~fiscal~~Amendment ~~year~~to Credit Agreement, Waiver, Consent and ~~our~~Forbearance ~~quarterly~~Agreement ~~report~~with its Senior Lender. This agreement ~~on Form~~provides, ~~10-Q~~among ~~for~~other things, that the ~~first~~Senior ~~quarter~~Lender ofwaives ~~fiscal~~certain ~~2005~~requirements onto ~~time.~~deliver audited ~~See~~financial statements or that such statements will not contain “~~—Late~~going ~~Filing~~concern” language. ofThe Senior Lender has also agreed to forebear any action with regard to certain ~~Form~~defaults ~~10-K~~under ~~and~~its ~~Form~~credit ~~10-Q”~~agreements ~~herein~~for a specified length of time.

With the filing of this Annual Report on Form 10-K for the fiscal year ended January 29, 2006, 33we will cure the defaults to file timely reports with the SEC under the indenture agreement for the -Senior Notes and the Senior Secured Notes.

As Reclassification ~~a result~~ of ~~our~~Long ~~internal~~Term ~~investigation,~~Debt ~~we discovered errors in the financial statements provided~~ to usCurrent ~~each~~Liabilities As ~~period~~of ~~beginning in 1997~~January ~~through~~29, 2006 the Company ~~third quarter~~had ofapproximately ~~fiscal~~$274.9 million ~~2004~~aggregate byprincipal ~~our~~amount ~~Mexico~~of ~~accounting~~indebtedness ~~department~~outstanding. As ~~a result,~~noted ~~we concluded~~above, ~~that~~the ~~certain~~Company ~~adjustments~~was ~~were~~not ~~required~~in tocompliance ~~restate~~with ~~our~~the ~~historical financial~~terms ~~statements.~~of ~~Such~~certain ~~adjustments~~covenants ~~have~~under ~~been~~various ~~reflected as a restatement~~loan ~~in our~~agreements. ~~annual~~The ~~financial~~Company ~~statements~~has ~~filed~~received ~~herein~~temporary aswaivers offrom ~~and~~its ~~for~~debt ~~the years ended February 1~~holders, ~~2004~~but ~~and~~there ~~February~~can 2,be ~~2003.~~no assurance Wethat ~~are~~the ~~also~~Company ~~implementing~~will acomply ~~process through~~with ~~which~~these wecovenants ~~will~~or ~~review and validate~~ the ~~controls~~noteholders ~~and~~will ~~procedures~~extend inthe ~~place, including~~waivers ~~but~~for ~~not~~an ~~limited~~additional toperiod. ~~approval~~As ofa ~~expenses~~result, ~~treasury~~substantially ~~management~~all ~~policies for~~the ~~cash~~debt ~~handling,~~has ~~and~~been ~~review~~classified ofas ~~bank reconciliations and tax filings. This~~a ~~process~~current ~~will be performed by U~~liability.~~S.-based personnel in conjunction with our~~ ~~Mexican operations senior management team.~~

~~Late~~ Our ability to continue operations is largely dependent on continued ~~Filing~~forbearance from our creditors and our ability to compromise or otherwise restructure our debt obligations to levels that can be supported by our existing cash flows from operations. If we are unable to do so, the Company could be forced to seek bankruptcy protection or could be forced to sell assets on unfavorable terms in exchange for proceeds that would likely be insufficient to satisfy our obligations. (See ITEM 7. Management’s Discussion and Analysis of ~~Form~~Financial ~~10-K~~Condition and ~~Form~~Results ~~10-Q~~of Operations — “Liquidity and Capital Resources”).

~~On May~~Financing 3,Transactions 2005, we filed a Form 8-K regarding the issuance of a press release disclosing we had filed Form 12b-25, Notification of Late Filing, in conjunction with our Annual Report on Form 10-K, which was due on May 2, 2005 for the fiscal year ended January 30, 2005. On June 16, 2005, we filed a Form 8-K regarding the issuance of a press release disclosing we had filed Form 12b-25, Notification of Late Filing, in conjunction with our Quarterly Report on Form 10-Q, which was due on June 15, 2005 for the fiscal quarter ended May 1, 2005. We were unable to timely file our 10-K for fiscal 2004 and our 10-Q for the first quarter of fiscal 2005 because we were engaged in an investigation of the suspected fraudulent activities of the former employees of our Mexican subsidiary described above. As previously discussed, we have restated our consolidated financial statements as a result of the impact of these activities. In addition, we chose to delay the filings while we continued discussions to obtain financing necessary to provide the amount of liquidity which we will require for operating purposes during fiscal 2005. We intend to file our 10-Q for the first quarter of fiscal 2005 subsequent to the filing of this Annual Report on Form 10-K. We believe the recent offering of senior secured notes, our new senior secured revolving credit facility, our new letters of credit facility and our obtaining waivers of existing defaults under our debt agreements are adequate to provide the liquidity which we believe we will require for operating purposes during fiscal 2005.

~~Classification~~ On July 15, 2005, we issued $50.0 million aggregate principal amount of senior secured notes due 2009 and simultaneously entered into a new four-year $10.0 million senior secured revolving credit facility and a new four-year $20.0 million letters of ~~Long~~credit ~~Term~~facility. ~~Indebtedness~~The new letters of credit facility and the new senior secured revolving credit facility are contained in our new credit agreement. We used $32.5 million of the net proceeds of the senior secured notes offering to fully repay our prior senior secured credit facility, $9.8 million was used to satisfy our interest payment due on August 1, 2005 relating to our obligations under our Senior Notes, $3.9 million was used to pay fees and expenses related to the issuance of our Senior Secured Notes and the remaining $3.8 million was used for working capital. As of June 12, 2006 we have no availability under our revolver and $5.7 million on our letters of credit.

~~Portrait~~31 Corporation of America, Inc. and its wholly-owned subsidiary, PCA LLC, were in default of covenants contained in our senior subordinated notes, senior subordinated discount notes and prior senior secured credit facility requiring the delivery of our audited financial statements, without an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern, within 90 days after the end of each fiscal year. We received waivers of these defaults from the holders of the senior subordinated notes and the senior subordinated discount notes. The lenders under our prior senior secured credit facility agreed to forebear from exercising remedies in respect of such default until July 15, 2005 provided there were no other defaults within such forbearance period that would cause such forbearance period to end sooner than July 15, 2005.

Portrait Corporation of America, Inc. and PCA LLC were also in default of the covenant contained in the senior subordinated notes, senior subordinated discount notes and senior notes that requires us to timely comply with all filing requirements of the SEC. We did not timely file our Annual Report on Form 10-K for the fiscal year ended January 30, 2005. We received waivers of these defaults from the holders of the senior subordinated notes and the senior subordinated discount notes. We would have had a period of 60 days following notice from either the trustee of the senior notes or the holders of 25% of the principal amount of the senior notes to cure this default. No such notice was received.

- 34 -

Each of the senior notes, the senior subordinated discount notes and the senior subordinated notes contain, and the prior senior secured credit facility contained, cross-default provisions triggered, among other things, in the event the agent, trustee, or holders, as applicable, exercise their rights to accelerate the due date of principal and interest under any one of such notes or credit facility.

As a result of the defaults under the respective agreements, PCA LLC classified the entire outstanding balances under the prior senior secured credit facility, senior notes and the senior subordinated notes as current liabilities on its consolidated balance sheet as of January 30, 2005 that was included in Portrait Corporation of America, Inc.’s current report on Form 8-K filed on June 27, 2005. As of January 30, 2005, the total amount of such indebtedness that was classified as current liabilities in PCA LLC’s consolidated balance sheet was $201.9 million. The defaults under our various debt instruments were resolved as a result of our repayment in full of amounts outstanding under our prior senior secured credit facility on July 15, 2005, our receipt of waivers from the holders of the senior subordinated notes and the senior subordinated discount notes and our filing of this Annual Report on Form 10-K, and such indebtedness was not required to be classified as current liabilities in the consolidated financial statements of Portrait Corporation of America, Inc. included in this Annual Report on Form 10-K. See “—Recent Financing Transactions” below.

Amendments to the Senior Subordinated Notes and the Senior Subordinated Discount Notes

In connection with the aforementioned waivers, we executed amendments to our senior subordinated notes and senior subordinated discount notes with the holders thereof. The amendments provided for the following:

(i) an extension of the date by which we must deliver our audited consolidated financial statements for the fiscal year ended January 30, 2005 to the holders of the senior subordinated discount notes without a report which expresses an unqualified opinion that includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern, (of which the failure to deliver would also result in an event of default under the senior subordinated notes);

(ii) additional limitations on the amount of senior indebtedness PCA LLC and its subsidiaries may incur under the senior subordinated notes and the senior subordinated discount notes; and

(iii) a prohibition on our ability to incur indebtedness or provide guarantees that (a) are not subordinated in right of payment to the senior subordinated notes or the guarantees provided by the guarantors under the senior subordinated notes, other than indebtedness incurred pursuant to the senior secured notes and the new senior secured revolving credit facility, or any refinancing thereof or (b) rank pari passu with the senior subordinated notes, other than indebtedness incurred pursuant to the new letters of credit facility or any refinancing thereof.

Recent Financing Transactions

On July 15, 2005, we issued $50.0 million aggregate principal amount of senior secured notes due 2009 and simultaneously entered into a new four-year $10.0 million senior secured revolving credit facility and a new four-year $20.0 million letters of credit facility. The new letters of credit facility and the new senior secured revolving credit facility are contained in our new credit agreement. We used $32.5 million of the net proceeds of the senior secured notes offering to fully repay our prior senior secured credit facility, $9.8 million was placed in escrow to satisfy our interest payment due on August 1, 2005 relating to our obligations under our senior notes, $3.9 million was used to pay fees and expenses related to the issuance of our senior secured notes and the remaining $3.8 million will be used for working capital. We anticipate, based on our currently proposed plans and assumptions, that the net proceeds from the issuance of our senior secured notes together with the additional liquidity provided under our new senior secured revolving credit facility and our new letters of credit facility and our obtaining waivers of existing defaults under our debt agreements will be sufficient to satisfy our cash requirements in fiscal 2005.

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Non-Portrait Photography-Related Specialty Retail Concepts

During fiscal ~~2004~~2005, ~~for the first time~~ we ~~began~~operated ~~operating~~ non-portrait photography related specialty retail concepts in U.S. and Canadian Wal-Mart stores. InWe ~~October~~are ~~2004, we acquired~~ the ~~assets~~franchisor ~~and certain liabilities~~ of Hometown Threads®, ~~an operator~~ ~~and~~a ~~franchisor of~~ retail store ~~stores~~ specializing in embroidery services and the personalization of gifts. AtAs ~~the~~of ~~end~~January 29, 2006, we franchised 47 locations of Hometown Threads. In fiscal ~~2004~~2005, we ~~operated~~opened ~~one~~11 Fun Factory ~~company~~Stores in Wal-~~owned~~Mart, ~~store~~6 ~~and~~in ~~had~~the 42U.S. ~~franchised~~and ~~locations~~5 in Canada. InThis ~~October~~was ~~2004,~~in addition to the one store we opened ~~our~~in ~~first~~2004. Fun Factory, is a retail store specializing in making stuffed animals, selling clothing accessories for these stuffed animals, and hosting birthday parties. WeOne ~~opened~~of ~~our~~these ~~second~~stores ~~Fun~~is the Creation Station test concept, which incorporates a portrait studio, Hometown Threads and Fun Factory in ~~March~~one ~~2005~~location.

Sales and Expenses

Our sales are derived from the sale of portrait photography and ancillary portrait ~~photography~~ photography products. In fiscal ~~2004~~2005, 9596.98% of our total sales were generated in Wal-Mart portrait studios. All such sales are recognized at the time of delivery to the customers. We collect approximately 60 65% of a customer’s order at the time of photography and the remaining balance is due at the time of delivery. Our policy is to collect, at a minimum, the full price of our advertised special, 50% of the price of the customer’s custom portrait order, 100% of the price of canvas and 16x20 portraits and 100% of the price of all other ancillary items purchased. Because of the retail nature of our services, our business is highly seasonal. The holiday season accounts for a high percentage of our sales and operating income, and our fourth quarter (typically late October/early ~~November~~ November through late January/early February) generally produces a large percentage of annual sales and operating income. The fourth quarter in fiscal ~~2004~~2005 and ~~2003~~ 2004 accounted for approximately 34% and 33% of our annual sales and approximately ~~101~~256% and 67 101%, ~~respectively,~~ of our annual operating income, respectively. We believe such seasonal trends will continue for the foreseeable future. Our operations can be adversely affected by inclement weather, especially during the important fourth quarter.

Costs of sales include manufacturing costs (including depreciation) related to the production of portraits including photographic film, paper, processing chemistry and direct labor; salaries, benefits and related overhead (including depreciation) for photography services and sales; fees paid to our host environments; and other miscellaneous selling expenses. General and administrative expenses include salaries, benefits (including life and health and workers’ compensation expense) and related overhead (including depreciation) associated with corporate and field management functions and support services.

-32 ~~36 -~~

Statement of Operations -– By Percentage of Sales

The following table presents certain consolidated statement of operations information stated as a percentage of total sales. Certain columns may not add due to rounding.

	Fiscal Year
	2004			2003			2002
	2005				2004				2003
Sales		100.0	%		~~100.0~~	%100.0	%	~~100.0~~	%	100.0	%
Cost of sales		7982.95			~~75.4~~	79.9		~~74.0~~		75.4
Gross profit		2017.15			~~24.6~~	20.1		~~26.0~~		24.6
General and administrative		1415.78			~~14.0~~	14.7		~~13.9~~		14.0
Amortization of intangibles		---			---			0.1
Income from operations		1.7				5.4				10.5
Income from operations		5.4			10.5			12.0
Interest expense, net		(11.9	)			(10.0	)			(9.5	)
Interest expense, net		(10.0	)		(9.5	)		(9.6	)
Early extinguishment of debt		(.3	)%			—				—
Other expense		---			---			(0.9	)
Income (loss) before income taxes		(10.6	)%			(4.6	)			1.1
Early extinguishment of debt		---			---			(1.5	)
Income tax (provision) benefit		—				(4.6	)			(0.7	)
Income (loss) before income taxes		(4.6	)		1.1			(0.1	)
Net income (loss)		(10.6	)%			(9.2	)%			0.4	%
Income tax (provision) benefit		(4.6	)		(0.7	)		5.0
Net income (loss)		(9.2)%			0.4	%		4.9	%

-33 ~~37 -~~

Results of Operations

2005 Fiscal Year Compared With 2004 Fiscal Year.

Sales for fiscal 2005 increased 0.6%, or $1.9 million, to $325.5 million from $323.6 million in fiscal 2004. The increase in total sales was a result of the following:


	Amount
Attributable to	(in millions)
4.0% decrease in same studio sales in Wal-Mart permanent portrait studios	$	(11.6	)
Wal-Mart permanent portrait studios not yet included in the same studio sales base		19.6
Decrease in sales in our Wal-Mart traveling locations due to fewer locations visited		(4.6	)

Total increase attributable to our Wal-Mart portrait photography business		3.4
Decrease in other retail businesses		(0.4	)
Decrease in sales in institutional segment as a result of a decrease in photography sessions in churches		(1.1	)

Total increase in sales	$	1.9

Gross profit for fiscal 2005 decreased by $8.4 million to $56.8 million from $65.2 million in fiscal 2004. Gross profit as a percentage of sales was 17.5% in fiscal 2005 versus 20.1% in fiscal 2004. The decline in gross profit as a percentage of sales was principally attributable to the following:


Attributable to	%
Decline in same studio sales, more studios and less customer traffic resulted in an increase in retail photography labor, license fees, commissions, general studio costs, manufacturing and other product costs as a percentage of sales.		(3.1	)%
Decrease in marketing & travel spending		0.7
Increase in depreciation expense due to studio expansion and supplies freight		(0.6	)
Other		0.4

Total decrease in gross profit percentage		(2.6	)%

Increased labor costs, license fees, commissions and general studio costs are a direct function of increased studio openings. As we open new studios, our costs increase but our revenue per studio has been decreasing. Consequently, our operating costs increase. We can give no assurance that as Wal-Mart expands, our customer base will expand proportionately. In fiscal 2005, we reduced our costs associated with marketing and travel.

General and administrative expenses for fiscal 2005 increased 8.0%, or $3.8 million, to $51.5 million from $47.7 million in fiscal 2004. General and administrative expenses as a percentage of sales were 15.8% and 14.7% for fiscal 2005 and 2004, respectively. The increase in total general and administrative expenses was a result of the following:


	Amount
Attributable to	(in millions)
Increase in labor costs due to increase in studio openings and changes in customer service.	$	3.4
Decrease in legal, professional, meetings and seminars primarily as a result of cancellation of the Company’s annual sales meeting.		(0.8	)
Increase in travel, business development and recruiting expenses.		1.0
Other		0.2

Total increase in general and administrative expenses	$	3.8

Income from operations for fiscal 2005 decreased 69.7% to $5.3 million from $17.5 million in fiscal 2004. Income from operations as a percentage of sales decreased to 1.6% in fiscal 2005 from 5.4% in fiscal 2004. This decrease reflects the net effect of changes in gross profit and general and administrative expenses as described above.

Interest expense for fiscal 2005 increased 19.5%, or $6.3 million, to $38.8 million from $32.5 million in fiscal 2004 as a result of the following:


	Amount
Attributable to	(in millions)
Increase from senior subordinated discount notes issued in June 2002	$	1.2
Increase from supplier provided financing		0.7
Increase from new senior secured notes issued July 2005		3.9
Increase in LC fees and underwriting fees		.8
Other		(0.3	)

Total increase in interest expense	$	6.3

The weighted average interest rate on our outstanding debt was 12.8% in fiscal 2005 as compared to 12.0% in fiscal 2004.

In fiscal 2005, 2004 and prior to fiscal 2002, a valuation allowance was provided against deferred tax assets because we determined it was more likely than not that such assets would not ultimately be realized. At the end of fiscal 2005, we had federal net operating loss carry-forwards of approximately $57 million expiring in various amounts from 2010 through 2026. Additionally, we had minimum tax credit carry-forwards with indefinite expiration of approximately $1 million.

Net loss was $34.4 million in fiscal 2005 compared to net loss of $29.7 million in fiscal 2004. The change in net loss is a result of the net effect of changes in operating income and interest expense described above.

2004 Fiscal Year Compared With 2003 Fiscal Year.

~~Sales~~35 ~~for fiscal 2004 decreased 0.4%, or $1.3 million, to $323.6 million from $324.8 million in fiscal 2003. The decrease in total sales was a result of the following:~~

Attributable to	Amount (in millions)
7.0% decrease in same studio sales in Wal-Mart permanent portrait studios	$	(20.2	)
Wal-Mart permanent portrait studios not yet included in the same studio sales base		24.9
Decrease in sales in our Wal-Mart traveling locations due to fewer locations visited		(4.3	)
Total increase attributable to our Wal-Mart portrait photography business		0.4
Increase in other retail businesses		0.3
Decrease in sales in institutional segment as a result of a decrease in photography sessions in churches		(2.0	)
Total decrease in sales	$	(1.3	)

Sales for fiscal 2004 decreased 0.4%, or $1.2 million, to $323.6 million from $324.8 million in fiscal 2003. The decrease in total sales was a result of the following:

Gross profit for fiscal 2004 decreased 18.3 to $65.2 million from $79.8 million in fiscal 2003. Gross profit as a percentage of sales was 20.1% and 24.6% in fiscal 2004 and fiscal 2003, respectively. The decline in gross profit as a percentage of sales was principally attributable to the following:


	Amount
Attributable to	(in millions)
7.0% decrease in same studio sales in Wal-Mart permanent portrait studios	$	(20.2	)
Wal-Mart permanent portrait studios not yet included in the same studio sales base		24.9
Decrease in sales in our Wal-Mart traveling locations due to fewer locations visited		(4.3	)

Total increase attributable to our Wal-Mart portrait photography business		0.4
Increase in other retail businesses		0.4
Decrease in sales in institutional segment as a result of a decrease in photography sessions in churches		(2.0	)

Total decrease in sales	$	(1.2	)

Gross profit for fiscal 2004 decreased 18.3% to $65.2 million from $79.8 million in fiscal 2003. Gross profit as a percentage of sales was 20.1% and 24.6% in fiscal 2004 and fiscal 2003, respectively. The decline in gross profit as a percentage of sales was principally attributable to the following:


Attributable to	%
Increase in retail photography labor, general studio supplies, freight costs for portraits and supplies and distribution costs as a percentage of sales due to decrease in same studio sales		(3.2	)%
Increase in life and health insurance costs for retail employees		(0.3	)
Change in our product mix		(0.7	)
Increase in depreciation expense due to studio expansion		(0.4	)
Other		0.1

Total decrease in gross profit percentage		(4.5	)%

~~Given the rising costs related to providing healthcare, we expect to see a continuation of life and health insurance costs increasing as a percentage of sales.~~ The decrease in our gross profit percentage attributable to the change in product mix is a result of favorable customer acceptance of our expanded digital and canvas product offerings, which have lower profit margins than traditional printed portraits. ~~If customer acceptance of these new product offerings~~ ~~continues to increase at a greater percentage rate than traditional printed portraits, we would expect this product mix to negatively impact our gross profit percentage.~~

-36 ~~38 -~~

General and administrative expenses for fiscal 2004 increased 4.5%, or $2.1 million, to $47.7 million from $45.6 million in fiscal 2003. General and administrative expenses as a percentage of sales were 14.7% and 14.0% for fiscal 2004 and 2003, respectively. The increase in total general and administrative expenses was a result of the following:

Attributable to	Amount (in millions)
	Amount
Attributable to	(in millions)
Increase in professional services primarily related to our Sarbanes-Oxley effort, legal services and audit fees	$	2.3
Decrease in workers’ compensation expense and general casualty insurance expense primarily due to elevated charges experienced in fiscal 2003		(1.8	)
Reduction in expense related to termination of benefit plan for certain retired employees		(1.1	)
Increase in foreign currency transaction gain		(0.3	)
Management’s estimate of settlement of outstanding tax claims due to Mexican tax authority from our Mexican subsidiary as the result of suspected fraudulent activities conducted by Mexican employees		1.5
Other increases related to Mexican subsidiary		0.7
Loss on disposal of property, plant and equipment		0.6
Other		0.2
Total increase in general and administrative expenses	$	2.1

Income from operations for fiscal 2004 decreased 48.8% to $17.5 million from $34.2 million in fiscal 2003. Income from operations as a percentage of sales decreased to 5.4% in fiscal 2004 from 10.5% in fiscal 2003. This decrease reflects the net effect of changes in gross profit and general and administrative expenses as described above.

Interest expense for fiscal 2004 increased 5.7%, or $1.8 million, to $32.5 million from $30.7 million in fiscal 2003 as a result of the following:

Attributable to	Amount (in millions)
	Amount
Attributable to	(in millions)
Increase from senior subordinated discount notes issued in June 2002	$	1.0
Increase from supplier provided financing		0.3
Increase from prior senior secured credit facility entered into June 2002		0.5
Total increase in interest expense	$	1.8

The weighted average interest rate on our outstanding debt was 12.0% in fiscal 2004 as compared to 11.8% in fiscal 2003.

Our income tax provision was $14.8 million in fiscal 2004 compared to $2.1 million in fiscal 2003. In fiscal 2004 and prior to fiscal 2002, a valuation allowance was provided against deferred tax assets because we determined it was more likely than not that such assets would not ultimately be realized. In fiscal 2002, we determined it was more likely than not that substantially all of such assets would be realized. At the end of fiscal 2004, we had federal net operating loss carry-forwards ~~carryforwards~~ of approximately $33 million expiring in various amounts from 2010 through 2025. Additionally, we had minimum tax credit ~~carryforwards~~ carry-forwards with indefinite expiration of approximately $1 million.

-37 ~~39 -~~

Net loss was $29.7 million in fiscal 2004 compared to net income of $1.3 million in fiscal 2003. The change in net income (loss) is a result of the net effect of changes in operating income, interest expense, and income taxes described above.

2003 Fiscal Year Compared With 2002 Fiscal Year.

Sales for fiscal 2003 increased 9.5%, or $28.2 million, to $324.8 million from $296.6 million in fiscal 2002. The increase in total sales was a result of the following:

Attributable to	Amount (in millions)
1.5% increase in same studio sales in Wal-Mart permanent portrait studios	$	3.8
Wal-Mart permanent portrait studios not yet included in the same studio sales base		28.2
Decrease in sales in our Wal-Mart traveling locations due to fewer locations visited		(2.3	)
Total increase attributable to our Wal-Mart business		29.7
Increase in other retail businesses		0.3
Decrease in sales in institutional portraiture as a result of a decrease in photography sessions in churches and schools		(1.8	)
Total increase in sales	$	28.2

Gross profit for fiscal 2003 increased 3.5% to $79.8 million from $77.1 million in fiscal 2002. Gross profit as a percentage of sales was 24.6% and 26.0% in fiscal 2003 and fiscal 2002, respectively. The decline in gross profit as a percentage of sales was principally attributable to the following:

Attributable to	%
Increase in workers’ compensation expense pertaining to retail employees		(0.1	)%
Increase in life and health insurance costs for retail employees		(0.4	)
Change in our product mix		(0.3	)
Increase in depreciation expense due to studio expansion		(0.2	)
Lower of cost or market write-down of inventory pertaining to low-priced portrait packages		(0.1	)
Other		(0.3	)
Total decrease in gross profit percentage		(1.4	)%

Given the rising costs related to providing healthcare, we expect to see a continuation of life and health insurance costs increasing as a percentage of sales. The decrease in our gross profit percentage attributable to the change in product mix is a result of favorable customer acceptance of our expanded digital and canvas product offerings, which have lower profit margins than traditional printed portraits. If customer acceptance of these new product offerings continues to increase at a greater percentage rate than traditional printed portraits, we would expect this product mix to negatively impact our gross profit percentage.

- 40 -

General and administrative expenses for fiscal 2003 increased 10.4%, or $4.3 million, to $45.6 million from $41.3 million in fiscal 2002. General and administrative expenses as a percentage of sales were 14.0% and 13.9% for fiscal 2003 and 2002, respectively. The increase in total general and administrative expenses was a result of the following:

Attributable to	Amount (in millions)
Increase in expenses related to 1995 to 2000 plan years administered by insolvent workers’ compensation/general casualty carrier	$	1.7
Increase in expenses related to 2000 to 2003 plan years administered by second insolvent workers’ compensation/general casualty carrier		0.8
Increase in expenses related 2003 plan year administered by workers’ compensation/general casualty carrier who discontinued operations in North America		0.3
Total expenses related to insolvent and discontinued workers’ compensation/general casualty carriers		2.8
Increase in other general liability insurance expense		0.4
Loss on disposals of property and equipment		0.5
Increase in payroll cost		1.6
Stock option compensation expense as a result of adopting SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”		0.1
Other decreases related to Mexico subsidiary		(0.7	)
Other decreases in general and administrative expenses		(0.4	)
Total increase in general and administrative expenses	$	4.3

During fiscal 2003 we received notification from two insolvent workers compensation carriers, who administered large deductible plans for us, one from 1995 to 2000 and the other from 2000 to 2003, that they had updated their reserve analyses of open claims. The carrier who administered plan years from 1995 to 2000 updated their reserve analyses for the first time in over two years. Additionally, we received notification from a third carrier that they were discontinuing their operations in North America. Effective December 16, 2003, a fourth workers’ compensation carrier is administering our workers’ compensation program. We do not expect to realize additional charges for prior plan years; however, the insolvent carriers may continue to update their reserve databases which may cause us to experience further charges or gains.

Income from operations for fiscal 2003 decreased 3.9% to $34.2 million from $35.6 million in fiscal 2002. Income from operations as a percentage of sales decreased to 10.5% in fiscal 2003 from 12.0% in fiscal 2002. This decrease reflects the net effect of changes in gross profit and general and administrative expenses as described above.

- 41 -

Interest expense for fiscal 2003 increased 7.3%, or $2.1 million, to $30.7 million from $28.6 million in fiscal 2002 as a result of the following:

Attributable to	Amount (in millions)
Increase from senior notes issued in June 2002	$	8.0
Increase from senior subordinated discount notes issued in June 2002		2.8
Increase from prior senior secured credit facility entered into June 2002		0.3
Decrease from senior term loans retired in June 2002		(2.5	)
Decrease from senior subordinated debt retired in June 2002		(6.5	)
Total increase in interest expense	$	2.1

The weighted average interest rate on our outstanding debt was 11.8% in fiscal 2003 as compared to 11.9% in fiscal 2002.

Other expense was $0 in fiscal 2003 as compared to $2.8 million in fiscal 2002. Other expense represents the mark-to-market adjustment for the embedded derivative in our Series A redeemable convertible preferred stock, which met the criteria for bifurcation and separate accounting under SFAS No. 133, 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 a point in time. In December 2002, our shareholders approved modifications to the terms of our Series A redeemable convertible preferred stock, and we have determined, based on these modified terms, the embedded derivative no longer meets the requirements for bifurcation and separate accounting. Therefore, we do not anticipate future mark-to-market adjustments related to this derivative.

In June 2002, we retired $218.4 million of senior and senior subordinated debt resulting in a loss on 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).

Our income tax provision was $2.1 million in fiscal 2003 compared to a $14.8 million income tax benefit in fiscal 2002. Prior to fiscal 2002, a valuation allowance was provided against deferred tax assets because we determined it was more likely than not that such assets would not ultimately be realized. In fiscal 2002, we determined it was more likely than not that substantially all of such assets would be realized.

Net income decreased to $1.3 million in fiscal 2003 from $14.4 million in fiscal 2002. The decrease in net income is a result of the net effect of changes in operating income, net interest expense, other expense, early extinguishment of debt and income taxes described above.

Liquidity and Capital Resources

Liquidity. ~~Our principal~~We ~~sources~~have ofexperienced ~~liquidity~~a ~~are~~significant ~~cash~~decline ~~flow~~in ~~from~~results of operations and ~~borrowings under~~the ~~our~~corresponding ~~new $10.0 million senior secured revolving credit facility and~~cash ~~supported~~flows byin ~~our~~fiscal ~~new $20~~2005.0 ~~million~~Our ~~letters~~ongoing ofnegative ~~credit~~results ~~facility. Our principal uses~~ of ~~cash are interest payments on our debt~~operations, ~~capital expenditures and seasonal working capital. During fiscal 2004, we used $21.4 million in~~ cash ~~on purchases~~ ofneeds ~~property and equipment compared~~ to ~~$21.1~~satisfy ~~million used during fiscal 2003. During fiscal 2004, we also used $1.1 million on~~ the ~~acquisition of~~ ~~certain~~outstanding ~~assets~~payment ~~and liabilities of Hometown Threads®. Our working capital deficit increased~~ to ~~$39.4~~AgfaPhoto ~~million~~USA as of ~~January 30, 2005 from~~ $3920.6 7 million asdue ~~of February 1, 2004. As of July~~ June 15, ~~2005~~2006, wedescribed ~~had~~below, noand ~~borrowings~~other ~~under~~debt ~~our~~obligations ~~new~~(including ~~senior~~long-term ~~secured~~debt ~~revolving~~obligations ~~credit~~and ~~facility.~~trade Aspayables), ofraise ~~July~~substantial ~~15, 2005,~~doubt ~~there~~about ~~was~~our ~~$10.0~~ability ~~million~~to ~~borrowing~~continue ~~availability~~as ~~under~~a ~~our~~going ~~new senior secured revolving credit facility~~concern.

- Our principal sources of liquidity are cash from operations, borrowings under our $10.0 42million senior secured revolving credit facility and supported by our $20.0 million letters of -credit facility. Our principal uses of cash are interest payments on our debt, capital expenditures and seasonal working capital. During fiscal 2005, we used $12.9 million in cash on purchases of property and equipment compared to $21.4 million used during fiscal 2004. Our working capital deficit increased to $318.7 million as of January 29, 2006 from $39.4 million as of January 30, 2005. In addition, we had past due trade accounts payable, other than those owed to AgfaPhoto USA, of $6.8 million and $7.8 million as of January 29, 2006 and January 30, 2005, respectively. These trade accounts payable averaged approximately 28 days and 30 days past due as of January 29, 2006 and January 30, 2005, respectively. As of June 12, 2006 we have no availability under our revolver and $5.7 million on our letters of credit.

As The Company’s total indebtedness to AgfaPhoto is approximately $22.8 million. Approximately of$2.1 million is on open account and is currently due and payable. Approximately $20.7 million is ~~October~~subject 31to a letter agreement dated June 15, ~~2004~~2005 in which AgfaPhoto agreed, ~~the~~under ~~end~~certain conditions, ofto ~~our~~defer ~~fiscal~~any ~~third~~collection ~~quarter~~action until June 15, we2006. ~~were~~Further, ~~not~~AgfaPhoto inhas ~~compliance~~agreed to subordination terms with ~~certain~~respect ~~financial~~to ~~covenants~~other ~~contained~~debt inof the ~~agreement~~Company ~~for~~that ~~our~~effectively ~~prior~~limits AgfaPhoto’s ~~senior secured~~ability ~~credit~~to ~~facility~~collect any of the $22.8 million Weas ~~subsequently~~a ~~amended~~secured ~~this~~creditor. On June 15, 2006 the Company’s standstill agreement with ~~our lenders on~~AgfaPhoto ~~December~~USA 14ended. In that agreement, ~~2004~~AgfaPhoto USA agreed that it would not take any action to collect certain amounts owed by us for photographic paper, film and chemicals ~~obtained~~purchased ~~waivers~~from ofAgfaPhoto ~~these~~USA ~~covenants~~. ~~from~~The ~~October~~Company has asked AgfaPhoto USA to extend this 31agreement to September 30, 2006. While AgfaPhoto USA has stated that it would request such an ~~2004~~extension ~~through~~from ~~January~~the 31bankruptcy trustee of its parent company in Germany, ~~2005.~~there Oncan ~~February~~be 4no assurance that such an extension will be given. Also, ~~2005~~to date, weAgfaPhoto ~~and~~USA ~~our~~has ~~lenders~~been ~~executed~~working with the ~~another~~Company ~~amendment~~to ~~effective~~negotiate asa ofsettlement ~~January~~for 31amounts owed to them, ~~2005~~but there can be no assurance that ~~reset~~AgfaPhoto ~~certain~~USA ~~financial~~will not ~~covenants~~institute ~~through~~legal ~~January~~action ~~29,~~to ~~2006~~collect such amounts.

~~During fiscal~~ On ~~2004~~June 15, we2006, ~~were~~the ~~also~~Company ~~unable~~did tonot ~~meet~~make ~~the~~an interest payment ~~terms~~in the amount of ~~AgfaPhoto~~$687,500 ~~USA~~due ~~Corporation,~~on ~~our~~its ~~key~~133/4% ~~supplier~~Senior ofSubordinated ~~photographic~~Notes ~~film,~~Due ~~paper,~~2010 ~~and~~(the ~~processing chemistry~~“Notes”). WeThe ~~have~~30-day ~~negotiated~~grace period for payment of ~~terms~~such ~~with~~interest ~~AgfaPhoto~~expired ~~USA~~on ~~Corporation~~June 14, 2006. As a result, an event of default occurred with respect ~~that extend~~to the ~~payment~~Notes, ~~date~~which ~~for~~default ~~our~~also ~~outstanding~~causes ~~payables~~a ~~(including~~cross-default ~~interest~~under the Company’s credit agreement with ~~which had~~its ~~been~~senior ~~accrued~~lender. atThe anCompany ~~annualized~~is ~~rate~~currently ofin ~~6%)~~discussions aswith ofthe ~~June~~holders ~~15,~~of ~~2005~~the ~~until~~Notes ~~June~~and its ~~15, 2006~~senior ~~and~~lender weregarding ~~have~~obtaining ~~agreed~~a toforbearance ~~pay~~or ~~for~~similar ~~products~~agreement ~~purchased~~with ~~from~~respect ~~AgfaPhoto~~to ~~USA~~this interest ~~Corporation~~payment. onIn orthe ~~after~~event ~~June~~that 15an agreement is not reached with the holders of the Notes and the Company’s senior lender, ~~2005~~such atholders or ~~prior~~senior lender will have the right to ~~their~~submit ~~delivery.~~a Wenotice ~~are~~to ~~seeking~~the toCompany ~~enter~~declaring ~~into~~all aprincipal ~~revised~~and ~~supply~~interest ~~contract~~and ~~with~~other ~~AgfaPhoto~~amounts ~~USA~~due ~~Corporation within~~in respect of the ~~next~~Notes immediately ~~few~~due ~~months~~and payable. ~~However,~~While ~~there~~the Company is nohopeful ~~assurance~~ that wesuch discussions will be resolved ~~able to~~favorably, dono ~~so.~~assurances can be given that any such agreement will be reached.

~~Additionally, on~~ The ~~May 27, 2005, AgfaPhoto USA Corporation~~Company’s ~~German~~ability ~~parent~~to ~~company,~~meet ~~AgfaPhoto GmbH,~~its ~~filed~~contractual aobligation ~~petition~~to ~~for insolvency. While we have been informed that~~ AgfaPhoto ~~USA Corporation has sufficient funding to continue its normal operations~~ in the ~~foreseeable~~ future, ifas ~~AgfaPhoto USA Corporation becomes~~well ~~unable~~as toits ~~continue~~other todebt, ~~provide~~interest ~~supplies~~and totrade uspayables ~~under our current contract~~obligations, we ~~will need~~is todependent ~~obtain~~upon anits ~~alternative~~ability ~~source of supplies. If we enter into an agreement~~to ~~with~~achieve anthe ~~alternative~~following ~~supplier~~objectives, ator ~~less~~some ~~desirable~~combination ~~terms~~thereof: ~~than~~(a) improve ~~the~~operating ~~terms of our~~performance ~~agreement~~based ~~with~~on ~~AgfaPhoto~~the ~~USA~~initiatives ~~Corporation,~~discussed ~~we may be required to raise additional~~previously ~~equity and/or debt financing.~~

On38 July 15, 2005, we issued $50.0 million aggregate principal amount of senior secured notes due 2009 and simultaneously entered into a new four-year $10.0 million senior secured revolving credit facility and a new four-year $20.0 million letters of credit facility. The new letters of credit facility and the new senior secured revolving credit facility are contained in our new credit agreement. We used $32.5 million of the net proceeds of our senior secured notes offering to fully repay our prior senior secured credit facility, $9.8 million was placed in escrow to satisfy our interest payment due on August 1, 2005 relating to our obligations under our senior notes, $3.9 million was used to pay fees and expenses related to the issuance of our senior secured notes, and the remaining $3.8 million will be used for working capital. We anticipate, based on our currently proposed plans and assumptions, that the net proceeds from the issuance of our senior secured notes together with the additional liquidity provided under our new senior secured revolving credit facility and our new letters of credit facility and our obtaining waivers of existing defaults under our debt agreements will be sufficient to satisfy our cash requirements in fiscal 2005.

~~Our funding~~under ~~needs~~“ ~~for~~Executive ~~fiscal~~Summary ~~2005~~— ~~depend~~Management’s ~~on many factors~~Plan”, ~~including~~(b) amend ~~our~~its ~~ability to successfully~~deferred ~~implement~~payment ~~measures~~agreement towith ~~improve~~AgfaPhoto ~~our~~on ~~performance.~~terms Infavorable ~~order~~ to ~~proactively~~ ~~address~~ the ~~negative same studio sales in our Wal-Mart permanent studios~~Company, ~~our~~(c) seek ~~management~~additional ~~team~~funds ~~has~~from implemented several initiatives since the beginning of fiscal 2005 designed to increase same studio sales. These initiatives are focused on increasing average transaction size per customer as well as customer traffic. Examples of these initiatives include increased external ~~recruiting~~sources ~~of field operations management, instituting a new bonus~~or ~~program~~restructure ~~for~~its ~~our~~existing ~~field~~debt ~~associates~~obligations, ~~launching~~and/or ~~new marketing initiatives~~(d) continue, ~~re-implementing~~ ~~the~~where ~~successful “Portrait Smiles” customer continuity program which was previously eliminated in fiscal 2003~~possible, ~~re-introducing~~to aextend ~~mid-tier~~vendor ~~price point~~payables inbeyond ~~our~~usual ~~package~~payment ~~offers~~terms. toWhile ~~improve~~management believes the ~~customer~~Company’s ~~experience~~operating ~~and to encourage~~performance ~~customer~~will ~~trade ups~~improve, ~~and~~there ~~increasing~~can ~~our~~be ~~opening price point. Nonetheless, there is~~ no assurance ~~these~~that ~~measures~~the Company will be successful ~~and~~in weimplementing ~~may~~any ~~require additional~~of ~~capital~~these ~~to meet our operating needs~~initiatives.

- Our 43initiatives to improve results from operations and reduce expenses -will be critical to our ability to generate sufficient cash to support our operations for the twelve months beyond January 29, 2006.

~~Our~~ The ~~estimates~~adverse ofbusiness ~~our~~conditions ~~fiscal~~the ~~2005~~Company ~~funding~~has ~~needs~~experienced, ~~assume~~coupled awith various ~~continuation~~defaults ofunder our ~~studio openings~~debt ~~in Wal-Mart~~obligations, ~~further~~the ~~evaluation~~expiration on June 15, 2006 of ~~other~~Agfa’s ~~specialty~~agreement ~~retail~~to ~~concepts~~forbear from taking action to ~~in Wal-Mart~~collect ~~retail~~amounts ~~locations~~owing ~~and~~from the ~~return~~Company, ofas ~~positive~~well ~~same~~as ~~store~~the ~~sales~~practical limitations on our further access to capital in light of these factors and our current financial condition, potentially threaten our ~~business~~viability as a going concern. WeOur ~~will~~ability to continue tooperations ~~monitor~~is largely ~~our~~dependent ~~sales,~~on ~~financial~~continued ~~results~~forbearance ~~and~~from our ~~liquidity~~ ~~position~~creditors and, ifour ability ~~necessary,~~to ~~will~~compromise ~~execute~~or ~~further~~otherwise ~~actions~~restructure toour ~~mitigate~~debt obligations ~~our~~to ~~concerns~~levels ~~with~~that ~~regard~~can tobe supported by our ~~liquidity~~existing ~~position~~cash ~~including~~flows from operations. If we are unable to do so, ~~but~~the ~~not~~Company ~~limited~~could be forced to seek bankruptcy protection or could be forced to, ~~further~~sell ~~reductions~~assets on unfavorable terms in ~~general~~exchange ~~and~~for ~~administrative~~proceeds ~~expenses~~that ~~and~~would ~~capital~~likely be ~~expenditures~~insufficient to satisfy our obligations.

In The ~~the event~~Company ~~that~~is ~~our~~undertaking ~~business~~several ~~plans~~measures ~~change~~to oraddress ~~the~~these ~~assumptions~~issues. ~~used~~With respect to ~~predict~~operations, ~~our~~management has implemented the initiatives ~~funding~~described ~~needs~~under ~~change~~“Management’s orPlan” ~~prove~~above. ~~inaccurate~~With respect to its debt obligations, weas ~~may~~disclosed bein ~~required~~more todetail ~~seek~~in ~~additional~~the ~~financing.~~Company’s Incurrent ~~particular,~~report ~~during~~on ~~fiscal~~Form 8-K filed June 21, 2006 (the we“June ~~will~~21 beForm ~~required~~8-K”), tothe ~~pay~~Company ~~$20.7~~has executed an ~~million~~additional ofamendment, ~~interest~~waiver, ~~bearing~~consent ~~extended~~and ~~vendor~~forbearance ~~payables~~agreement with the lenders under its senior credit facility that, ~~which~~under ~~obligation~~the ~~has~~terms ~~not~~provided therein, provide forbearance with respect to (1) any ~~been~~cross-defaults ~~included~~arising infrom ~~our~~the ~~funding~~Company’s ~~need~~failure ~~estimates~~to timely deliver audited financial statements for fiscal 2005., We(2) ~~have~~the ~~no current~~failure ~~arrangements~~of ~~with~~such ~~respect~~financial statements to ~~sources~~be free of ~~additional~~any ~~financing~~“going concern” ~~and~~qualification, ~~our~~(3) the Company’s failure as of June 15, 2006 to ~~improve~~ ~~our~~make ~~results~~an interest payment of ~~operations~~$687,500 ~~will~~due ~~likely~~on ~~make~~the Notes itwithin ~~more~~the ~~difficult~~applicable ~~and expensive~~30-day grace period for usmaking tosuch payment, ~~raise~~and ~~additional~~(4) ~~capital~~the ~~that~~expiration ~~may~~on beJune ~~necessary~~15, 2006 of Agfa’s agreement to ~~continue~~forbear from exercising its rights and remedies to ~~our~~collect ~~operations~~amounts owing from the Company. ~~The~~As ~~covenants~~further described above and in ~~our~~the ~~new~~June ~~senior~~21, ~~secured~~2006 ~~revolving~~Form ~~credit~~8-K, the Company is in discussions with ~~facility~~both Agfa and ~~instruments~~the ~~governing~~holders ~~our~~of ~~other~~the ~~debt,~~Notes ~~including~~regarding extensions or additional accommodations regarding these respective obligations. The senior lenders’ agreement to forbear lasts until the ~~indenture~~earlier of ~~governing~~July 31, 2006 or any such earlier time as Agfa or the ~~senior~~holders ~~secured~~of ~~notes~~the Notes cease their forbearance, ~~limit~~demand ~~our~~forbearance ~~ability~~on terms unacceptable to ~~incur~~the ~~more~~agent for the senior lenders, or another default ~~debt~~or event of default occurs under the senior credit obligations.

~~Our~~ In ~~ability~~addition, toas ~~borrow~~described ~~under~~in ~~our~~the ~~new~~June ~~senior~~21, ~~secured~~2006 ~~revolving~~Form ~~credit~~8-K, ~~facility and~~the ~~to use~~Company ~~our new letters of credit facility depends on our ability to meet the~~is ~~lenders’~~engaged ~~borrowing~~in ~~conditions~~discussions atregarding ~~the~~a ~~relevant~~potential ~~times.~~financial ~~The new senior secured~~restructuring ~~revolving~~with ~~credit~~representatives ~~facility~~of ~~provides~~certain ~~for~~holders ~~limitations on borrowings based on 125%~~ of ~~PCA~~its ~~LLC’s~~Senior ~~consolidated~~Notes, ~~trailing~~and ~~twelve months earnings before interest,~~both ~~taxes,~~the ~~depreciation~~Company and ~~amortization~~(at ~~as defined in~~ the ~~agreement~~Company’s ~~(“EBITDA”~~expense)~~, less~~ ~~any~~representatives ~~letters~~of holders of ~~credit~~the ~~outstanding~~Senior ~~under~~Notes ~~the~~have ~~new~~engaged ~~letters~~financial ofadvisers ~~credit~~and ~~facility.~~legal ~~Revolving~~counsel ~~loans~~to ~~under~~assist ~~the~~them ~~new~~in ~~senior~~evaluating ~~secured~~the ~~revolving~~Company’s ~~credit facility, at~~financial ~~our~~alternatives. ~~option, bear interest payable on a monthly basis at either:~~

- Although the Company believes and is hopeful that such a ~~rate~~restructuring can be ~~equal~~achieved toon terms that will reduce the ~~prime~~Company’s ~~rate~~debt ~~announced~~load byto more ~~Wells~~manageable ~~Fargo~~levels ~~Foothill,~~and ~~Inc.~~permit ~~from~~it ~~time~~ to ~~time~~ ~~plus~~continue operations, such a restructuring ~~margin~~will torequire bethe ~~determined~~consent, ~~within~~concurrence and cooperation of a ~~range~~substantial ~~between~~majority ~~1.75%~~in interest of the Company’s creditors and 3Jupiter Partners, its majority shareholder.~~00%~~ In addition, the ~~(which~~achievement isof ~~fixed~~such ata ~~5.00%~~restructuring ~~until~~will ~~July~~require 30continued forbearance by those of the Company’s lenders who do, ~~2006)~~or may acquire, ~~based~~rights onto ~~our~~accelerate ~~consolidated~~their credit obligations as the result ~~trailing~~of ~~twelve~~any ~~months~~existing ~~EBITDA;~~or future uncured or unwaived defaults.

- For athese ~~rate~~reasons, among others, our independent registered public ~~equal~~accounting tofirm ~~LIBOR~~has, ~~(the~~in ~~London~~their ~~Interbank~~report ~~Offered~~dated ~~Rate)~~May ~~plus~~26, 2006 on our Consolidated Financial Statements for and as of January 29, 2006 expressed a ~~margin~~substantial todoubt beabout the Company’s ability to ~~determined~~continue ~~within~~as a ~~range~~going ~~between~~concern, ~~3.75%~~ and ~~5.00%~~in ~~(which~~addition, issubstantially ~~fixed~~all atof our 5debt has been reclassified as a current liability.~~00%~~ See “ ~~until~~—Executive Summary — Going Concern with Respect to ~~July~~Operating ~~30,~~Subsidiary” ~~2006),~~and ~~based~~“ on— ~~our~~Reclassification ~~consolidated~~of ~~trailing~~Long Term ~~twelve~~Debt ~~months~~to Current Liabilities.” ~~EBITDA;~~

provided that at no time will any portion of indebtedness owing under the new senior secured revolving credit facility bear interest at a per annum rate of less than 6.00%. The new senior secured revolving credit facility contains customary negative covenants that limit or restrict, among other things, subject to certain exceptions, the incurrence of indebtedness, the creation of liens, mergers, consolidations, transactions with affiliates, amendments to material agreements, investments, dividends and asset sales by PCA LLC and its subsidiaries. PCA LLC is subject to customary financial covenants under the terms of the new senior secured revolving credit facility, including a fixed charge coverage ratio requirement. The new senior secured revolving credit facility includes customary affirmative covenants, reporting requirements and events of default.

In connection with issuances of letters of credit under the new letters of credit facility, PCA LLC is required to pay a letter of credit fee equal to an amount to be determined based on our consolidated trailing twelve months EBITDA within a range between 3.75% and 5.00% (which is fixed at 5.00% until July 30, 2006) per annum times the undrawn amount of all outstanding letters of credit. The new letters of credit facility contains customary negative covenants that limit or restrict, among other things, subject to certain exceptions, the incurrence of indebtedness, the creation of liens, mergers, consolidations, transactions with affiliates, amendments to material agreements, investments, dividends and asset sales by PCA LLC and its subsidiaries. PCA LLC is subject to customary financial covenants under the terms of the new letters of credit facility, including a fixed charge coverage ratio requirement. The new letters of credit facility includes customary affirmative covenants, reporting requirements and events of default.

- 44 -

PCA LLC and certain of its domestic subsidiaries are borrowers under the new senior secured revolving credit facility and new letters of credit facility. The new senior secured revolving credit facility and new letters of credit facility are guaranteed by Portrait Corporation of America, Inc. and all domestic subsidiaries of PCA LLC that are not borrowers. Our obligations under the new senior secured revolving credit facility and new letters of credit facility are collateralized by a first-priority security interest in all of our now owned or hereafter acquired property and assets, subject to certain exceptions, on a ratable basis between the two facilities. The lenders under the new senior secured revolving credit facility and new letters of credit facility have full cash dominion over our deposit accounts to which our customers remit payment.

The senior secured notes bear interest at an annual rate of 14% and mature on June 1, 2009. The senior secured notes are guaranteed on a senior secured basis by Portrait Corporation of America, Inc. and all domestic subsidiaries of PCA LLC. The senior secured notes and the guarantees thereof are secured by a security interest in substantially all of the guarantors’ existing and future personal property assets (other than certain excluded assets), which security interest is contractually subordinated to the security interest on the collateral securing the new senior secured revolving credit facility and new letters of credit facility. PCA LLC and PCA Finance Corp. may redeem the senior secured notes, in whole or in part, prior to December 1, 2006 at a make-whole premium and after December 1, 2006 at specified offering prices. The senior secured notes contain covenants and other restrictions that restrict our ability to engage in certain activities.

On June 27, 2002, Portrait Corporation of America, Inc. issued $30.0 million of senior subordinated discount notes. The senior subordinated discount notes are subordinated to the guarantee of our new senior secured revolving credit facility, our new letters of credit facility, our senior secured notes and our senior notes by Portrait Corporation of America, Inc. The senior subordinated discount notes bear interest at a rate of 16.5% per year. Through June 27, 2007, interest will be added to the outstanding principal amount of the senior subordinated discount notes semiannually, in arrears. As of January 30, 2005, $14.6 million had been added to the outstanding principal amount. After June 27, 2007, interest will be payable in cash semiannually in arrears at the rate of 16.5%. We must repay in full all amounts outstanding under the senior subordinated discount notes by June 27, 2010. We may repay amounts outstanding in whole or in part at specified premiums at any time. The senior subordinated discount notes contain covenants and other restrictions that restrict our ability to engage in certain activities.

On June 27, 2002, PCA LLC issued $10.0 million of senior subordinated notes. The senior subordinated notes are subordinated to our new senior secured revolving credit facility, our new letters of credit facility, our senior secured notes and our senior notes and are guaranteed by Portrait Corporation of America, Inc. and all of PCA LLC’s domestic subsidiaries. The senior subordinated notes bear interest payable in cash semiannually, in arrears, at a rate of 13.75% per year. We must repay in full all amounts outstanding under the senior subordinated notes by June 27, 2010. We may repay amounts outstanding in whole or in part at specified premiums at any time. The senior subordinated notes contain covenants and other restrictions that restrict our ability to engage in certain activities.

On June 27, 2002, PCA LLC and PCA Finance Corp. issued $165 million of senior notes. The senior notes are unsecured, bear interest at an annual rate of 11.875% and mature on August 1, 2009. PCA LLC and PCA Finance Corp. may redeem the senior notes at their option at any time at the greater of 101% of the principal amount of the notes or a make-whole premium, plus accrued and unpaid interest to the redemption date. The senior notes contain covenants and other restrictions that restrict our ability to engage in certain activities.

We will need to refinance our $50.0 million senior secured notes by 2009, our new senior secured revolving credit facility by 2009, our new letters of credit facility by 2009, our $165.0 million of senior notes by 2009, and our $30.0 million of senior subordinated discount notes and our $10.0 million of senior subordinated notes by 2010. We do not expect to generate sufficient cash flow from future operations to repay these obligations and will need to obtain additional financing to do so.

- 45 -

We entered into our prior senior secured credit facility on June 27, 2002, which allowed PCA LLC to borrow up to $50.0 million of which $25.0 million was allowed to be letters of credit. Outstanding revolving loans under this credit facility bore interest at a rate equal to LIBOR plus 3.5% or, at PCA LLC’s option, an alternate base rate (which was the higher of (i) the Bank of America, N.A. prime rate and (ii) the Federal Funds rate plus 0.50%) plus 2.5%. PCA LLC was able to prepay loans and reduce the amounts available to PCA LLC at any time by giving prior notice without premium or penalty. PCA LLC was required to prepay loans with 100% of the net cash proceeds of all asset sales by us and our subsidiaries (subject to certain restrictions), 100% of the net cash proceeds from the issuance of debt (subject to certain restrictions), and 100% of the net cash proceeds from the issuance of equity by us and/or any of our subsidiaries, provided that such net cash proceeds were permitted to be applied to prepay up to 35% of the outstanding senior notes. In addition, PCA LLC was subject to mandatory prepayment obligations so that from December 15, 2002 through January 15, 2003 the aggregate principal amount of loans outstanding would not exceed $20.0 million, from December 15, 2003 through January 15, 2004 the aggregate principal amount of loans outstanding would not exceed $15.0 million, and from December 15 through January 15 of each year thereafter the aggregate principal amount of loans outstanding would not exceed $10.0 million. On February 4, 2005, the lenders under PCA LLC’s prior senior secured credit facility and PCA LLC executed an additional amendment to the prior senior secured credit facility agreement, effective as of January 31, 2005. Pursuant to this amendment, all defaults under the agreement caused by our failure to meet certain financial covenants with respect to the period ended October 31, 2004 were waived and certain terms of the agreement were permanently amended, effective January 31, 2005, including certain financial covenants, the interest rate setting mechanism, the mandatory prepayment requirements and other provisions. The mandatory prepayment provisions were modified such that the aggregate principal amount of loans outstanding were not to exceed $15.0 million from December 15, 2005 to January 15, 2006 and from December 15, 2006 to January 15, 2007.

Seasonality. Due to the seasonality of our operations, cash is generally consumed during the first three quarters and generated during the fourth quarter. During the Christmas season, which falls in our 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.

Purchases of Property and Equipment. Purchases of property and equipment were $2112.4 9 million in fiscal ~~2004~~2005, $21.1 4 million in fiscal ~~2003~~2004, and $1721.0 1 million in fiscal ~~2002~~2003. Purchases of ~~property~~ property and equipment were principally for equipment and leasehold improvements in new ~~permanent~~ permanent studios, as well as for expenditures for the upgrade of certain processing equipment in our two laboratory and processing facilities, and new computing equipment in our corporate office. Purchases of property and equipment in ~~fiscal 2004, 2003, and 2002~~ were financed from operations in addition to borrowings under our credit facilities. The most significant purchases of property and equipment contemplated over the next five years will be for new studio openings. We expect to incur approximately $15 8 million in purchases of property and equipment in fiscal ~~2005~~2006 and anticipate these purchases will be ~~funded~~ funded by operating cash flow and borrowings under our senior secured revolving credit facility, ~~net~~if ~~proceeds~~needed. ~~from~~Our ~~the~~ability ~~issuance~~to offund ~~our~~these ~~senior~~capital ~~secured~~expenditures ~~notes~~will ~~and~~be ~~borrowings~~dependent ~~under~~on a successful turnaround of our ~~new~~ ~~senior~~business ~~secured~~and/or ~~revolving~~our ~~credit~~ability ~~facility,~~to ifrestructure ~~needed~~our debt.

-39 ~~46 -~~

Net Cash ~~Provided by/~~Used in/Provided by Operating Activities. Net cash used in operating activities was $10.5 million, in fiscal 2005 while net cash was provided by operating activities ~~was~~of $24.2 million, and $18.0 million, ~~and $30.9 million~~ in fiscal 2004, ~~2003,~~ and ~~2002~~2003, respectively. The ~~increase~~ decrease in cash provided by operating activities of $~~6.3~~ 34.8 million in fiscal ~~2004~~2005 was due to the following:

Changes Attributable to	Amount (in millions)
	Amount
Net loss	$	(31.1	)
Changes Attributable to	(in millions)
Trade accounts payable		15.4
Net loss	$	(4.7	)
Deferred income taxes		11.6
Trade accounts payable		(18.0	)
Other current accrued liabilities		3.6
Deferred income taxes		(13.4	)
Other noncurrent accrued liabilities		(2.7	)
Other current accrued liabilities		(2.2	)
Inventories		2.5
Other non-current accrued liabilities		1.1
Accrued interest		2.1
Inventories		(1.7	)
Prepaid expenses and other assets		1.5
Accrued interest		1.3
Depreciation and amortization		1.4
Prepaid expenses and other assets		(1.6	)
Loss on disposal		0.6
Depreciation and amortization		1.7
Paid-in-kind interest		1.0
Early extinguishment of debt		1.0
Accounts receivable		0.6
Paid-in-kind interest		1.1
Other		(0.26	)
Total increase in cash provided by operating activities	$	6.3
Total decrease in cash provided by operating activities	$	(34.8	)

The ~~decrease~~ increase in cash provided by operating activities of $126.9 3 million in fiscal ~~2003~~ 2004 was due to the following:

Changes Attributable to	Amount (in millions)
	Amount
Net income	$	(13.1	)
Changes Attributable to	(in millions)
Trade accounts payable		(5.3	)
Net loss	$	(31.1	)
Accrued interest		(9.7	)
Trade accounts payable		15.4
Other current accrued liabilities		0.2
Deferred income taxes		11.6
Other noncurrent accrued liabilities		2.6
Other current accrued liabilities		3.6
Inventories		0.5
Other non-current accrued liabilities		(2.7	)
Prepaid expenses and other assets		(1.5	)
Inventories		2.5
Depreciation and amortization		1.2
Accrued interest		2.1
Paid-in-kind interest		1.4
Prepaid expenses and other assets		1.5
Change in fair value of derivative instruments		(2.8	)
Depreciation and amortization		1.4
Early extinguishment of debt		(4.6	)
Loss on disposal		0.6
Provision for deferred income taxes		17.2
Paid-in-kind interest		1.0
Loss on disposal of property and equipment		0.7
Accounts receivable		0.6
Amortization of deferred financing costs		(0.5	)
Other		(0.2	)
Interest expense—effective interest method		0.5
Total increase in cash provided by operating activities	$	6.3
Amortization of debt discounts		0.2
Other		0.1
Total decrease in cash provided by operating activities	$	12.9

Net Cash Used in Investing Activities. Net cash used in investing activities was $2212.5 9 million in fiscal ~~2004~~2005, $2122.1 5 million in fiscal ~~2003~~2004, and $1721.0 1 million in fiscal ~~2002~~2003. Net cash used in investing activities ~~increased~~decreased $19.5 6 million in fiscal ~~2004~~2005 ~~and~~compared ~~$4.0~~to ~~million in~~ fiscal ~~2003~~2004. The primary reason for ~~these~~this ~~increases~~decrease was the ~~acceleration of~~reduced ~~our expansion~~number inof ~~the~~ Wal-Mart ~~host~~permanent ~~environment.~~studio Inopenings ~~addition,~~ in ~~fiscal 2004 we~~ ~~completed~~2005 ~~the~~versus ~~acquisition of certain assets and liabilities of Hometown Threads®~~2004.

- Net Cash Provided by/Used in Financing Activities. Net cash provided by financing activities 47was $16.2 million in fiscal 2005 and $8.7 million in fiscal 2004. Net cash provided by financing -activities was $6.0 million in

~~Net~~40 Cash Provided by/Used in Financing Activities. Net cash provided by financing activities was $8.7 million in fiscal 2004 and $6.0 million in 2003. Net cash used in financing activities was $14.6 million in fiscal 2002. The increase in net cash provided in fiscal 2004 and 2003 was primarily the result of borrowings under our prior senior secured credit facility. The increase in net cash used in fiscal 2002 was primarily the result of our debt restructuring in June 2002.

~~Interest Rate~~fiscal ~~Exposure~~2003. ~~Our exposure~~The toincrease ~~market~~in ~~risks~~net ~~from~~cash ~~changes~~provided in ~~interest~~fiscal ~~rates~~2005 ~~relates primarily~~was toprimarily the ~~effects~~ ~~that~~result ~~changes~~of inborrowings ~~interest~~under ~~rates have on floating rate debt. A 100~~our ~~basis point~~new ~~change~~senior insecured ~~the~~notes ~~interest~~and ~~rate~~revolving ~~on our prior senior secured~~ credit facility ~~would~~. ~~have~~Our anet ~~$0.3~~cash ~~million~~provided ~~effect~~increase onin fiscal ~~income~~2004 ~~before~~and ~~taxes~~2003 ~~based~~was onprimarily the ~~average outstanding~~result ~~balance~~of onborrowings under our prior senior secured credit ~~facility for fiscal~~ ~~2004~~facility.

Interest Rate Exposure. 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. In addition, a 100 basis point change in the interest rate on our average outstanding $10 million revolving line of credit and $20 million letters of credit would have had an impact on our (loss) before taxes for fiscal 2005 of less than $300 thousand.

Contractual Obligations and Commercial Commitments

The table below summarizes the material contractual cash obligations and other commercial commitments of Portrait Corporation of America, Inc. and its subsidiaries as of ~~January~~ 30January 29, ~~2005~~2006. In addition to the commitments reflected in the table below, we have several other commitments that are not quantifiable at present. We have a ~~contract~~contracts with ~~AgfaPhoto~~Fuji ~~USA~~and ~~Corporation~~Kodak ~~that requires us~~ to purchase ~~substantially~~ substantially all of our photographic film, paper and processing chemistry. The contracts specify minimum ~~from AgfaPhoto~~purchase ~~USA~~quantities ~~Corporation,~~of ~~but~~product ~~does~~which ~~not~~management ~~specify~~believes awill ~~minimum~~be ~~purchase~~exceeded ~~amount.~~through normal business usage. We also have license and lease agreements with each of our retail hosts, which require us to pay them a percentage of our sales on a monthly basis. In addition, we participate in large deductible workers’ compensation and general insurance plans and we have established reserves for claims under these plans that have been reported but not paid and have been incurred but not reported. As of January 30 29, ~~2005~~2006, $4.1 2 million represented the estimated long-term portion of ~~the~~ the reserves for these claims. These reserves have been excluded from the table below, as we are uncertain as to the timing of when cash payments may be required.

-41 ~~48 -~~

The table below ~~excludes~~includes ~~all~~debt ~~amounts~~reclassified ~~classified~~ as current liabilities in our Consolidated Balance Sheet as of January 30 29, ~~2005~~2006, ~~other~~and ~~than~~its ~~current~~repayment ~~maturities~~by period of“as ~~long-term debt.~~if” reclassification had not occurred

	Repayment by Period
	Total		Less than 1 year (fiscal 2005)			2-3 years (fiscal 2006 &2007)			4-5 years (fiscal 2008 &2009		More than 5 years (beyond fiscal 2009)
													More
	(in millions)
				Less than				2-3 years			4-5 years		Than 5
Long-term debt obligations:
				1 year				(fiscal			(fiscal		years
Lines of credit (prior senior secured credit facility)	$	29.0	$	14.0		$	15.0		$	---	$	---
				(fiscal				2007 &			2009 &		(beyond
Commitment and letters of credit fees (prior senior secured credit facility)		1.8		0.8			1.0			---		---
	Total			2006)				2008)			2010		fiscal 2010
Senior notes due 2009		165.0		---			---			165.0		---
	(in millions)
Interest payments on senior notes due 2009		98.0		19.6			49.0			29.4		---
Short-term debt obligations:
Senior subordinated notes		10.0		---			---			---		10.0
Senior secured notes due 2009	$	50.0		$	0.0			$	0.0		$	50.0	$	0.00
Interest payments on senior subordinated notes		7.6		1.4			2.8			2.8		0.6
Interest payments on senior secured notes due 2009.		23.9			7.0				14.0			2.9		0.0
Senior subordinated discount notes (original principal amount)		30.0		---			---			---		30.0
Senior notes due 2009		165.0			—				—			165.0		0.0
Paid-in-kind interest capitalized on senior subordinated discount notes		36.3		---			---			---		36.3
Interest payments on senior notes due 2009		78.4			19.6				39.2			19.6		—
Interest payments on senior subordinated discount notes		32.8		---			5.5			21.8		5.5
Senior subordinated notes		10.0							—			10.0
Total long-term debt obligations		410.5		35.8			73.3			219.0		82.4
Interest payments on senior subordinated notes		6.3			1.4				2.8			2.1		—
Purchase obligations:
Senior subordinated discount notes (original principal amount)		30.0							—			30.0
Installment purchase agreement		0.2		0.2			---			---		---
Paid-in-kind interest capitalized on senior subordinated discount notes		36.3							—			36.3
Other obligations:
Total short-term debt obligations		399.9			28.0				56.0			315.9		0.0
Operating lease obligations		3.2		1.4			1.3			0.4		0.1
Other obligations:
Sub-lease guarantee obligations		2.0		0.6			1.0			0.4		---
Operating lease obligations		1.5			0.9				0.6			0.0		0.0
Severance agreements with former employees		0.1		0.1			---			---		---
Sub-lease guarantee obligations		2.1			0.6				1.1			0.4		0.0
Series A preferred stock		15.0		~~---~~	—		~~---~~		—	~~---~~		~~15.0~~—		15.0
Total other obligations		20.3		2.1			2.3			0.8		15.1
Minimum film, paper and chemical purchases		15.2			12.1				3.1			—		—
Total contractual cash obligations	$	431.0	$	38.1		$	75.6		$	219.8	$	97.5
Total other obligations		33.8			13.6				4.8			.4		15.0
Total contractual cash obligations	$	433.7		$	41.6			$	60.8		$	316.3		15.0

Off Balance Sheet Arrangements

We have no off balance sheet arrangements other than the operating leases described in Note 9 10 of the consolidated financial statements ~~attached~~included ~~herein~~in this report.

- 49 -

Critical Accounting Policies

In preparing the financial statements in accordance with accounting principles ~~generally~~ generally accepted in the United States (“GAAP”), we must often make estimates and assumptions that affect the reported amounts of assets, liabilities, sales, expenses, and related disclosures at the date of the financial statements and during the reporting period. Some of those judgments can be subjective and complex, and consequently actual results could differ from those estimates and ~~those~~ those estimates can change from period to period. For any given individual estimate or assumption made by us, there may ~~also~~ be other estimates or assumptions that are reasonable; however, we believe that given current facts and circumstances, it is unlikely that applying any such other reasonable judgment would cause a material effect on our consolidated results of operations, financial position, or liquidity for the periods presented here.

Our most critical accounting policies include revenue recognition and deferred costs, workers’ compensation, general insurance liability amounts, recoverability of deferred tax assets, goodwill impairment testing, depreciation of property and equipment and long lived asset impairments.

Revenue Recognition and Deferred Costs. We record photographic sales when portraits and/or other merchandise are delivered to our customers. We collect approximately 6065% of a customer’s portrait order at the time of photography and treat this payment as a deposit (recorded in current liabilities on our balance sheet). Our policy is to collect, at a minimum, the full price of the advertised special, 50% of the price of the customer’s custom portrait order, 100% of the price of canvas and 16x20 portraits and 100% of the price of all other ancillary items purchased. At the time portraits are delivered to the customer, sales are recorded and the outstanding balance on the customer’s order is collected,. ~~unless~~If the customer does not accept the photographs, ~~which results in~~ a refund ~~to the customer~~is issued. Costs relating to portraits processed, or in process, are deferred as incurred and ~~expensed~~ expensed when the related photographic sales are recognized.

Workers’ Compensation and General Insurance. We participate in large deductible workers’ compensation and general insurance plans. We have established reserves for workers’ compensation and general insurance claims that have been reported but not paid and claims that have been incurred but not reported. These reserves are developed using actuarial principles and assumptions which consider a number of factors, including ; historical claim payment patterns, ~~and~~ changes in case reserves, the assumed rate of increase in healthcare costs and property damage repairs, ultimate ~~court~~ court awards and the discount rate. The amount of these reserves could differ from our ~~ultimate~~ ultimate liability related to these claims due to changes in ~~our~~these ~~accident reporting, claims payment and settlement practices or claims reserve practices, as well as differences between assumed and future cost increases and discount rates~~factors. ~~See discussion in “—Results of Operations” above.~~

Income Tax. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to operating loss and tax credit ~~carryforwards~~carry-forwards as well as differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax ~~bases~~basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance ~~will~~is becurrently provided against deferred tax assets ifbecause we ~~determine~~determined in fiscal 2004 it is more likely than not such assets will not ultimately be realized. ~~During~~Income ~~fiscal~~taxes ~~2002,~~are we determined itin ~~was~~part ~~more~~by ~~likely~~using ~~than~~calculated ~~not~~best ~~such~~estimates ~~assets~~of ~~would~~temporary ~~ultimately~~and bepermanent ~~realized.~~differences using Asboth acurrent ~~result,~~and ~~the~~historic ~~valuation allowance~~information, ~~was~~effective ~~reduced~~tax ~~to $77~~rates,~~000~~ ~~in fiscal 2002 from $18.7 million in fiscal~~and ~~2001.~~future ~~During~~events ~~fiscal~~which ~~2004,~~may ~~however,~~affect wevaluation ~~determined~~allowances itand ~~was~~future ~~more likely than~~income ~~not such~~tax ~~assets~~liabilities, ~~would~~based ~~not~~on ~~ultimately~~prior becompany ~~realized.~~experience ~~In addition we evaluate the~~and ~~need for~~representations ~~income~~of ~~tax~~third ~~liabilities~~parties ~~under~~and ~~the~~company ~~guidance espoused in SFAS No~~management. 5, ~~“Accounting for Contingencies.”~~

- 50 -

Goodwill. In accordance with SFAS No. 142, goodwill and indefinite lived intangible assets are no longer amortized. We test for impairment at least annually, or more frequently when events or circumstances indicate that impairment might have occurred. In evaluating goodwill for impairment, we compare the fair value of our retail reporting unit, where all of the goodwill is recorded, to the carrying value of this reporting unit. This represents the first step of the impairment test. If the fair value of the reporting unit is less than the carrying value of the reporting unit, we are then required to proceed to the second step of the impairment test. The second step compares the implied fair value of reporting unit goodwill with the carrying value of the goodwill. If the carrying value of the reporting unit goodwill exceeds the implied fair value of that goodwill, we recognize an impairment in an amount equal to that excess.

Fair value is derived utilizing the income approach, which considers expected returns on an investment and are discounted or capitalized at an appropriate rate of return to reflect investor risks and hazards. A discounted net cash flow analysis is utilized which provides an indication of value based upon the present value of anticipated future cash flows, discounted at an appropriate factor reflecting the risk inherent in the investment. We utilize an independent third party to determine the fair value of our retail reporting unit.

At43 January 31, 2005 (the date of our latest impairment test), the fair value of the retail reporting unit exceeded the carrying value of that reporting unit’s equity (step one of the impairment test). As a result, we were not required to conduct the second step of the impairment test described above, and we recognized no impairment of the carrying value of our goodwill on our balance sheet at January 30, 2005.

At January 29, 2006 (the date of our latest impairment test), the fair value of the retail reporting unit exceeded the carrying value of that reporting unit’s equity and we recognized no impairment of the carrying value of our goodwill on our balance sheet at January 29, 2006.

Depreciation of Property and Equipment. We use the straight-line method to depreciate property and equipment over the estimated useful lives of these assets. A summary of estimated useful lives is as follows:


Land improvements			10 to 30 years
Buildings and improvements			10 to 55 years
Photographic, sales and finishing equipment			3 to 13 years
Studio improvements			3 to 10 years

In the event the estimated useful lives of these assets are materially different from their actual useful lives, the fair value of property and equipment could be materially different than the carrying value of these assets.

Long-Lived Asset Impairments. We evaluate the carrying value of long-lived assets, excluding goodwill, when circumstances indicate the carrying value of those assets may not be fully recoverable. We evaluate the recoverability of long-lived assets held for use by comparing the net carrying value of an asset group to the estimated undiscounted future cash flows (excluding interest) during the remaining life of the asset group. For long-lived assets, an impairment exists when the carrying value exceeds the sum of estimates of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the asset is impaired, the asset’s carrying value is adjusted to its estimated fair value. As these assumptions and estimates may change over time, it may or may not be necessary for us to record impairment charges.

Inflation

Over the past few years, inflation has not had a significant impact on our financial condition or results of operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have not entered into financial instruments in fiscal ~~2004~~2005, ~~2003~~2004 and ~~2002~~2003 for trading purposes and, therefore, have not experienced market risks from such instruments.

Our exposure to market risks from changes in interest rates relates primarily to the ~~effects~~ 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 January 30 29, ~~2005~~2006, we had not entered into any interest rate hedging agreements. In addition, a 100 basis point change in the ~~interest~~ interest rate on our ~~prior~~average ~~senior~~outstanding ~~secured~~$10 million revolving line of credit ~~facility~~and $20 million letters of credit would have had an impact on ~~income~~our (loss) before taxes for fiscal ~~2004,~~2005 ~~2003 and 2002 based on the average outstanding balance on our prior senior secured credit facility in each fiscal year~~ of ~~$0.3~~less ~~million,~~than $~~0.3 million and $0.2 million,~~300 ~~respectively~~thousand.

- Given our presence in Canada, Mexico, Germany and the U.K., we have exposure to market risks 51from changes in foreign currency exchange rates. In fiscal 2005, 2004 and 2003, we realized -foreign currency gains (losses) in our statements of operations of $(0.3) million, $0.7 million and $0.5 million, respectively. A 10% change in foreign currency exchange rates would have had the following impact on net income (loss) in fiscal 2005, 2004 and 2003.

~~Given~~44 our presence in Canada, Mexico, Germany and the U.K., we have exposure to market risks from changes in foreign currency exchange rates. In fiscal 2004, 2003 and 2002, we realized foreign currency gains (losses) in our statements of operations of $0.7 million, $0.5 million and $(0.4) million, respectively. A 10% change in foreign currency exchange rates would have had the following impact on net income (loss) in fiscal 2004, 2003 and 2002.

	Fiscal 2004						Fiscal 2003					Fiscal 2002
	Fiscal 2005								Fiscal 2004							Fiscal 2003
	(in thousands)
	+10%			-10%			+10%			-10%		+10%			-10%
		+10	%			-10	%			+10	%		-10	%			+10	%		-10	%
Canada	$	(~~287~~26	)	$	~~372~~$	26	$	~~(492~~	)$	$(287	~~617~~)	$	~~(385~~372	)	$	~~471~~$	(492	)	$	617
Mexico	$	~~(177~~43	)	$	~~212~~$	(43	$)	~~(291~~	)$	$(177	~~363~~)	$	~~(166~~212	)	$	~~212~~$	(291	)	$	363
Germany	$	(~~275~~44	)	$	~~329~~$	44	$	~~(178~~	)$	$(275	~~209~~)	$	~~(64~~329	)	$	78$	(178	)	$	209
U.K.	$	(326	)	$	39$	6	$	~~(25~~	)$	$(32	26)	$	~~(13~~39	)	$	16$	(25	)	$	26

NOTE: A 10% positive change in a foreign currency exchange rate represents an increase in the amount of foreign currency equaling one U.S. dollar. For example, if the exchange rate for Canadian dollars is 1.25 Canadian dollars for each U.S. dollar, a 10% increase, for purposes of the above illustration, in the Canadian dollar exchange rate would yield 1.375 Canadian dollars for each U.S. dollar. Conversely, a 10% decrease would yield 1.125 Canadian dollars for each U.S. dollar.

-45 ~~52 -~~

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


Reports of Independent Registered Public Accounting Firms			47

Consolidated Balance Sheets as of January 29, 2006 and January 30, 2005			48

Consolidated Statements of Operations for the fiscal year ended January 29, 2006, January 30, 2005 and February 1, 2004 (Restated).			50

Consolidated Statements of Shareholders’ Deficiency and Comprehensive Income (Loss) for the fiscal year ended January 29, 2006, January 30, 2005 and February 1, 2004 (Restated).			51

Consolidated Statements of Cash Flows for the fiscal year ended January 29, 2006, January 30, 2005 and February 1, 2004 (Restated).			52

Notes to Consolidated Financial Statements			54

Report of Independent Registered Public Accounting Firm	54
Consolidated Balance Sheets as of January 30, 2005 and February 1, 2004 (Restated)	55
Consolidated Statements of Operations for the fiscal year ended January 30, 2005, February 1, 2004 (Restated), and February 2, 2003 (Restated)	57
Consolidated Statements of Shareholders’ Deficiency and Comprehensive Income (Loss) for the fiscal year ended January 30, 2005, February 1, 2004 (Restated), and February 2, 2003 (Restated)	58
Consolidated Statements of Cash Flows for the fiscal year ended January 30, 2005, February 1, 2004 (Restated), and February 2, 2003 (Restated)	59
Notes to Consolidated Financial Statements	61

- 53 -

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Portrait Corporation of America, Inc.

We have audited the accompanying consolidated balance sheet of Portrait Corporation of America, Inc.: and subsidiaries (the “Company”) as of January 29, 2006 and the related consolidated statements of operations, stockholders’ deficiency and comprehensive income and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.

We ~~have audited~~ ~~the~~conducted ~~accompanying~~our ~~consolidated~~audit ~~balance~~in ~~sheets~~accordance ofwith ~~Portrait~~the ~~Corporation~~ standards of ~~America,~~ ~~Inc.,~~the ~~and~~Public ~~subsidiaries~~Company Accounting Oversight Board (~~the~~United ~~“Company”~~States). asThose ofstandards ~~January~~require ~~30,~~that ~~2005~~we plan and perform the audit to obtain ~~February~~reasonable 1,assurance ~~2004,~~about ~~and~~whether the ~~related~~financial ~~consolidated~~ statements are free of ~~operations,~~material misstatement. We ~~shareholders’~~were ~~deficiency~~not ~~and~~engaged ~~comprehensive~~to ~~income~~perform ~~(loss)~~an ~~and~~audit ~~cash~~of ~~flows~~the ~~for~~Company’s ~~each~~internal control over financial reporting. ofOur ~~the~~audit ~~three~~included ~~years~~consideration inof ~~the~~internal ~~period~~control ~~ended~~over ~~January~~financial ~~30,~~reporting ~~2005.~~as ~~Our~~a ~~audits~~basis ~~also~~for ~~included~~designing ~~the~~audit ~~financial~~procedures ~~statement~~that ~~schedule~~are ~~listed~~appropriate in the ~~Table~~circumstances, ofbut ~~Contents at Item~~not ~~15.~~for ~~These~~the ~~financial~~purpose ~~statements~~of expressing ~~and~~an ~~financial~~opinion ~~statement~~on ~~schedule are~~ the ~~responsibility~~ effectiveness of the Company’s ~~management.~~internal ~~Our~~control ~~responsibility~~over isfinancial reporting. toAccordingly, we express an no such opinion. An audit includes examining, on ~~these~~a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement ~~schedule~~presentation. ~~based~~We believe that our audit provides a reasonable basis on for our ~~audits~~opinion.

~~We conducted~~In our ~~audits~~opinion, ~~in accordance with~~ the ~~standards~~financial ofstatements ~~the~~referred ~~Public~~to ~~Company Accounting~~above ~~Oversight~~present ~~Board~~fairly, ~~(United~~in ~~States).~~all ~~Those standards require that~~material werespects, ~~plan and perform~~ the ~~audit~~consolidated ~~to obtain reasonable assurance about whether the~~ financial ~~statements~~ ~~are~~position ~~free~~ of ~~material~~the ~~misstatement. The~~ Company isand ~~not~~its ~~required to have,~~subsidiaries ~~nor~~as ~~were we engaged to perform, an audit~~ of ~~its internal control over~~January 29, ~~financial~~2006, ~~reporting.~~and ~~Our~~the ~~audits~~consolidated ~~included~~results ~~consideration~~ of ~~internal~~their ~~control over financial~~operations ~~reporting~~and astheir aconsolidated ~~basis~~cash flows for ~~designing audit procedures that are~~the ~~appropriate~~year inended ~~the~~January 29, ~~circumstances~~2006, ~~but~~in ~~not~~conformity ~~for~~with ~~the~~accounting ~~purpose~~principles ofgenerally ~~expressing~~accepted ~~an opinion~~in on the United ~~effectiveness~~States of ~~the Company's internal control over financial reporting~~America. ~~Accordingly~~Also, wein ~~express~~our ~~no such~~ opinion~~. An audit also includes examining~~, onthe arelated ~~test~~financial ~~basis~~statement schedule, ~~evidence~~when considered ~~supporting~~in ~~the~~relation ~~amounts~~to ~~and disclosures in~~ the financial statements, ~~assessing~~taken ~~the~~as ~~accounting~~a ~~principles~~whole, ~~used~~presents ~~and significant~~fairly, ~~estimates~~in ~~made~~all material ~~by management~~respects, ~~as well as evaluating~~ the ~~overall financial~~information ~~statement~~set ~~presentation.~~forth ~~We believe that our audits provide a reasonable basis for our opinion~~therein.

~~In our opinion,~~The ~~such~~accompanying consolidated financial statements ~~present~~have ~~fairly,~~been inprepared ~~all~~assuming ~~material respects,~~that the ~~financial~~Company will ~~position~~continue ofas ~~the~~a ~~Company~~going atconcern. ~~January~~As ~~30,~~discussed ~~2005~~in ~~and~~Note ~~February 1~~2 to the financial statements, ~~2004~~the Company at January 29, ~~and~~2006 ~~the~~had ~~results~~a ofworking ~~its~~capital ~~operations~~deficiency and ~~its~~a ~~cash~~capital ~~flows~~deficiency, ~~for~~and ~~each~~has ofincurred a ~~the three~~substantial ~~years~~net inloss for the ~~period~~year ended January 30 29, ~~2005,~~2006. inThe ~~conformity~~Company ~~with~~anticipates ~~accounting~~that such ~~principles~~conditions ~~generally~~will ~~accepted~~continue in ~~the~~2006. ~~United~~In ~~States~~addition, ofas ~~America.~~discussed ~~Also~~in Note 2, the Company is in ~~our~~default ~~opinion,~~of ~~such~~certain ~~financial~~obligations ~~statement~~which ~~schedule~~were due on June 15, ~~when~~2006 ~~considered~~and indoes ~~relation~~not have sufficient liquidity to ~~the basic~~meet ~~consolidated~~these ~~financial~~obligations. ~~statements~~These ~~taken~~factors raise substantial doubt about the Company’s ability to continue as a ~~whole,~~going ~~presents~~concern. ~~fairly~~ Management’s plans in ~~all~~regard to these matters are also described in ~~material~~Note ~~respects~~2. The financial statements do not include any adjustments that might be necessary if the Company ~~information~~is ~~set~~unable ~~forth~~to ~~therein~~continue as a going concern.

~~As discussed~~/s/ inEisner ~~Note 16 to the consolidated financial statements, the accompanying financial statements for the fiscal years ended February 2, 2003 and February 1, 2004 have been restated.~~LLP

~~As discussed~~New ~~in Note 17 to the consolidated financial statements~~York, onNew ~~July 15,~~York ~~2005~~May 26, ~~the~~ ~~Company issued $50 million of 14% Senior Secured Notes due 2009.~~2006

~~As discussed~~With inrespect ~~Note 1~~ to ~~the~~Note ~~consolidated financial statements, the Company~~2 ~~adopted the fair value expense recognition provisions of Statement of Financial Accounting Standards No. 123~~June 15, ~~“Accounting for Stock-Based Compensation,” on February 3, 2003.~~2006

~~/s/~~47-1 ~~Deloitte & Touche LLP~~

Deloitte & Touche LLP 1100 Carillon Building 227 West Trade Street Charlotte, NC 28202 ~~North~~USA Tel: ~~Carolina~~+1 704 887 1500 Fax: +1 704 887 1561 www.deloitte.com

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have audited the accompanying consolidated balance sheets of Portrait Corporation of America, Inc., and subsidiaries (the “Company”) as of January 30, 2005, and the related consolidated statements of operations, shareholders’ deficiency and comprehensive income (loss) and cash flows for each of the two years in the period ended January 30, 2005. Our audits also included the financial statement schedule listed in the Table of Contents at Item 15. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at January 30, 2005, and the results of its operations and its cash flows for each of the two years in the period ended January 30, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.

As discussed in Note 17 to the consolidated financial statements, the accompanying financial statements for the fiscal year ended February 1, 2004 have been restated.

Deloitte & Touche LLP

July 28, 2005

47-2 ~~54 -~~

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (dollar amounts in thousands)

CONSOLIDATED BALANCE SHEETS


	January 29,			January 30,
	2006			2005
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	7,973		$	15,178
Accounts receivable		2,668			2,781
Inventories		12,344			11,439
Deferred income taxes					108
Prepaid expenses and other assets		4,364			3,303

Total current assets		27,349			32,809
PROPERTY AND EQUIPMENT:
Land and improvements		2,306			2,306
Buildings and improvements		13,893			13,684
Photographic, sales and finishing equipment		164,068			152,315
Studio improvements		28,095			26,530
Construction in progress		598			3,048

Total		208,960			197,883
Accumulated depreciation and amortization		(136,951	)		(123,974	)

Property and equipment, net		72,009			73,909
GOODWILL		53,046			52,989
OTHER INTANGIBLE ASSETS		135			135
DEFERRED FINANCING COSTS, NET		8,605			6,823
OTHER ASSETS		166			127

TOTAL ASSETS	$	161,310		$	166,792

(dollar amounts in thousands)

	January 30, 2005			February 1, 2004 (as restated; see Note 16)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	15,178		$	4,820
Accounts receivable		2,781			2,593
Inventories		11,439			12,236
Deferred income taxes		108			1,605
Prepaid expenses and other assets		3,303			3,626
Total current assets		32,809			24,880
PROPERTY AND EQUIPMENT:
Land and improvements		2,306			2,306
Buildings and improvements		13,684			13,117
Photographic, sales and finishing equipment		152,315			138,679
Studio improvements		26,530			23,566
Construction in progress		3,048			1,085
Total		197,883			178,753
Accumulated depreciation and amortization		(123,974	)		(111,931	)
Property and equipment, net		73,909			66,822
GOODWILL		52,989			51,643
OTHER INTANGIBLE ASSETS		135			---
DEFERRED FINANCING COSTS, NET		6,823			8,466
DEFERRED INCOME TAXES, NONCURRENT		---			11,835
OTHER ASSETS		127			19
TOTAL ASSETS	$	166,792		$	163,665

See notes to consolidated financial statements.

-48 ~~55 -~~

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (continued) (dollar amounts in thousands)

CONSOLIDATED BALANCE SHEETS (continued)


	January 29,			January 30,
	2006			2005
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
CURRENT LIABILITIES:
Short-term borrowings	$	21		$	—
Current portion of long-term debt		274,934			182
Accounts payable—trade		30,658			36,179
Accrued insurance		5,193			4,141
Accrued income taxes		1,930			2,022
Accrued compensation		5,257			4,834
Accrued interest		11,893			10,377
Other accrued liabilities		16,165			14,467

Total current liabilities		346,051			72,202
LONG-TERM DEBT					245,680
DEFERRED INCOME TAXES					108
OTHER LIABILITIES		5,079			4,843

TOTAL LIABILITIES		351,130			322,833
COMMITMENTS AND CONTINGENCIES
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK, $0.01 par value at January 29, 2006 and January 30, 2005 (authorized—200,000 shares; outstanding—15,000 shares)		15,000			15,000
SHAREHOLDERS’ DEFICIENCY:
Common stock, $0.01 par value at January 29, 2006 and at January 30, 2005 (authorized—20,000,000 shares; issued and outstanding at January 29, 2006 and January 30, 2005 —2,294,352 shares)		23			23
Warrants to purchase Series A redeemable convertible preferred stock (issued and outstanding—287)		642			642
Warrants to purchase common stock (issued and outstanding—306,610)		2,947			2,947
Additional paid-in capital		24,104			24,104
Deferred compensation		(182	)		(256	)
Accumulated deficit		(232,675	)		(198,233	)
Accumulated other comprehensive income/(loss)		321			(268	)

Total shareholders’ deficiency		(204,820	)		(171,041	)

TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIENCY	$	161,310		$	166,792

(dollar amounts in thousands)

	January 30, 2005			February 1, 2004 (as restated; see Note 16)
LIABILITIES AND SHAREHOLDERS’ DEFICIENCY
CURRENT LIABILITIES:
Short-term borrowings	$	---		$	10,000
Current portion of long-term debt		182			279
Accounts payable—trade		36,179			23,667
Accrued insurance		4,141			4,043
Accrued income taxes		2,022			858
Accrued compensation		4,834			5,309
Accrued interest		10,377			10,197
Other accrued liabilities		14,467			10,119
Total current liabilities		72,202			64,472
LONG-TERM DEBT		245,680			219,658
DEFERRED INCOME TAXES		108			---
OTHER LIABILITIES		4,843			5,679
TOTAL LIABILITIES		322,833			289,809
COMMITMENTS AND CONTINGENCIES
SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK, $0.01 par value at January 30, 2005 and $10.00 par value at February 1, 2004 (authorized—200,000 shares; outstanding—15,000 shares)		15,000			15,000
SHAREHOLDERS’ DEFICIENCY:
Common stock, $0.01 par value at January 30, 2005 and $0.20 par value at February 1, 2004 (authorized—20,000,000 shares; issued and outstanding at January 31, 2005 and February 1, 2004—2,294,352 shares)		23			459
Warrants to purchase Series A redeemable convertible preferred stock (issued and outstanding—287)		642			642
Warrants to purchase common stock (issued and outstanding—306,610)		2,947			2,947
Additional paid-in capital		24,104			23,668
Deferred compensation		(256	)		(333	)
Accumulated deficit		(198,233	)		(168,493	)
Accumulated other comprehensive loss		(268	)		(34	)
Total shareholders’ deficiency		(171,041	)		(141,144	)
TOTAL LIABILITIES AND SHAREHOLDERS’ DEFICIENCY	$	166,792		$	163,665

See notes to consolidated financial statements.

-49 ~~56 -~~

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (dollar amounts in thousands)

CONSOLIDATED STATEMENTS OF OPERATIONS


	Fiscal Year Ended
							February 1,
							2004
	January 29,			January 30,			(as restated;
	2006			2005			see Note 17)
SALES	$	325,516		$	323,553		$	324,814
COST OF SALES		268,747			258,396			245,028

GROSS PROFIT		56,769			65,157			79,786
GENERAL AND ADMINISTRATIVE		51,471			47,669			45,610


INCOME FROM OPERATIONS		5,298			17,488			34,176
INTEREST INCOME		25			8			10
INTEREST EXPENSE		(38,785	)		(32,467	)		(30,716	)

EARLY EXTINGUISHMENT OF DEBT		(980	)		—			—

(LOSS) INCOME BEFORE INCOME TAXES		(34,442	)		(14,971	)		3,470
INCOME TAX (PROVISION)		—			(14,769	)		(2,148	)

NET (LOSS) INCOME	$	(34,442	)	$	(29,740	)	$	1,322

(dollar amounts in thousands)

	For the Fiscal Year Ended
	January 30, 2005			February 1, 2004 (as restated; see Note 16)			February 2, 2003 (as restated; see Note 16)
SALES	$	323,553		$	324,814		$	296,616
COST OF SALES		258,396			245,028			219,551
GROSS PROFIT		65,157			79,786			77,065
GENERAL AND ADMINISTRATIVE		47,669			45,610			41,300
AMORTIZATION OF INTANGIBLES		---			---			192
INCOME FROM OPERATIONS		17,488			34,176			35,573
INTEREST INCOME		8			10			14
INTEREST EXPENSE		(32,467	)		(30,716	)		(28,624	)
OTHER EXPENSE		---			---			(2,776	)
EARLY EXTINGUISHMENT OF DEBT		---			---			(4,569	)
INCOME (LOSS) BEFORE INCOME TAXES		(14,971	)		3,470			(382	)
INCOME TAX BENEFIT (PROVISION)		(14,769	)		(2,148	)		14,817
NET INCOME (LOSS)	$	(29,740	)	$	1,322		$	14,435

See notes to consolidated financial statements.

-50 ~~57 -~~

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIENCY AND COMPREHENSIVE INCOME (LOSS) (dollar amounts in thousands)

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIENCY AND COMPREHENSIVE INCOME (LOSS)


																									Accumul-
																									ated
						Warrants to Purchase																			Other
						Series A Redeemable																Compre-			Compre-			Total
						Convertible Preferred				Warrants to Purchase				Additional		Deferred			Accumul-			hensive			hensive			Share-
	Common Stock					Stock				Common Stock				Paid-In		Comp-			ated			Income			Income			holders’
	Shares		Amount			Shares		Amount		Shares		Amount		Capital		ensation			Deficit			(Loss)			(Loss)			Deficiency
BALANCE, FEBRUARY 2, 2003 (as restated; see Note 17)		2,293,152	$	458			287	$	642		306,610	$	2,947	$	23,273		—		$	(169,815	)				$	(298	)	$	(142,793	)
Comprehensive income:
Net income (as restated; see Note 17)																				1,322		$	1,322						1,322
Foreign currency translation adjustment, net of tax (as restated; see Note 17)																							264			264			264
Total comprehensive income (as restated; see Note 17)																						$	1,586
Amortization of deferred compensation															386	$	(333	)											53
Issuance of common stock		1,200		1											9														10

BALANCE, FEBRUARY 1, 2004 (as restated; see Note 17)		2,294,352		459			287		642		306,610		2,947		23,668		(333	)		(168,493	)					(34	)		(141,144	)
Comprehensive loss:
Net loss																				(29,740	)	$	(29,740	)					(29,740	)
Foreign currency translation adjustment, net of tax																							(234	)		(234	)		(234	)
Total comprehensive loss																						$	(29,974	)
Amortization of deferred compensation																	77												77
Effect of merger and reincorporation				(436	)										436

BALANCE, JANUARY 30, 2005		2,294,352		23			287		642		306,610		2,947		24,104		(256	)		(198,233	)					(268	)		(171,041	)
Comprehensive loss:
Net loss																				(34,442	)	$	(34,442	)					(34,442	)
Foreign currency translation adjustment, net of tax																							589			589			589
Total comprehensive loss																						$	(33,853	)
Amortization of deferred compensation																	74												74


BALANCE, JANUARY 29, 2006		2,294,352	$	23			287	$	642		306,610	$	2,947	$	24,104	$	(182	)	$	(232,675	)				$	321		$	(204,820	)

(dollar amounts in thousands)

	Common Stock					Warrants to Purchase Series A Redeemable Convertible Preferred Stock				Warrants to Purchase Common Stock						Additional Paid-In Capital		Deferred Comp- ensation			Accumul-ated Deficit			Compre- hensive Income (Loss)			Accumul- ated Other Compre- hensive Income (Loss)			Total Share- holders’ Deficiency
	Shares		Amount			Shares		Amount		Shares			Amount
BALANCE, FEBRUARY 3, 2002 (as previously reported)		2,293,152	$	458			---	$	---		508,300		$	4,843		$	---	$	---		$	(182,173	)				$	(518	)	$	(177,390	)
Restatement adjustment (see Note 16)																						(1,645	)					(142	)		(1,787	)
BALANCE, FEBRUARY 3, 2002 (as restated; see Note 16)		2,293,152		458			---		---		508,300			4,843			---		---			(183,818	)					(660	)		(179,177	)
Comprehensive income:
Net income (as restated; see Note 16)																						14,435		$	14,435						14,435
Foreign currency translation adjustment, net of tax (as restated; see Note 16)																									362			362			362
Total comprehensive income (as restated; see Note 16)																								$	14,797
Accretion of Series A redeemable convertible preferred stock																						(432	)								(432	)
Reclassification of embedded derivative																	20,412														20,412
Issuance of warrants							287		642		52,460			965																	1,607
Cancellation of warrants											(254,150	)		(2,861	)		2,861														---
BALANCE, FEBRUARY 2, 2003 (as restated; see Note 16)		2,293,152		458			287		642		306,610			2,947			23,273		---			(169,815	)					(298	)		(142,793	)
Comprehensive income:
Net income (as restated; see Note 16)																						1,322		$	1,322						1,322
Foreign currency translation adjustment, net of tax (as restated; see Note 16)																									264			264			264
Total comprehensive income (as restated; see Note 16)																								$	1,586
Stock option compensation																	386		(333	)											53
Issuance of common stock		1,200		1													9														10
BALANCE, FEBRUARY 1, 2004 (as restated; see Note 16)		2,294,352		459			287		642		306,610			2,947			23,668		(333	)		(168,493	)					(34	)		(141,144	)
Comprehensive loss:
Net loss																						(29,740	)	$	(29,740	)					(29,740	)
Foreign currency translation adjustment, net of tax																									(234	)		(234	)		(234	)
Total comprehensive loss																								$	(29,974	)
Stock option compensation																			77												77
Effect of merger and reincorporation				(436	)												436
BALANCE, JANUARY 30, 2005		2,294,352	$	23			287	$	642		306,610		$	2,947		$	24,104	$	(256	)	$	(198,233	)				$	(268	)	$	(171,041	)

See notes to consolidated financial statements.

-51 ~~58 -~~

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (dollar amounts in thousands)

CONSOLIDATED STATEMENTS OF CASH FLOWS


	Fiscal Year Ended
							February 1,
							2004
	January 29,			January 30,			(as restated;
	2006			2005			see Note 17)
OPERATING ACTIVITIES:
Net income (loss)	$	(34,442	)	$	(29,740	)	$	1,322
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation and amortization		14,101			12,818			11,408
Amortization of deferred financing costs		2,073			1,643			1,642
Paid-in-kind interest		7,661			6,538			5,579
Early extinguishment of debt		980			—			—
Amortization of debt discounts		614			614			614
Amortization of deferred compensation		74			77			53
Provision for deferred income taxes		—			13,440			1,890
Loss on disposal of property and equipment		1,210			1,356			781
Changes in assets and liabilities which provided (used) cash:
Accounts receivable		113			(163	)		(733	)
Inventories		(905	)		797			(1,694	)
Prepaid expenses and other assets		(1,301	)		324			(1,210	)
Other non-current assets		(39	)		7			(3	)
Accounts payable—trade		(5,521	)		12,512			(2,901	)
Accrued expenses		1,383			787			959
Accrued interest		1,516			180			(1,887	)
Other current accrued liabilities		1,698			3,894			286
Other non-current accrued liabilities		236			(836	)		1,888

NET CASH (USED IN)/PROVIDED BY OPERATING ACTIVITIES		(10,549	)		24,248			17,994

INVESTING ACTIVITIES:
Purchases of property and equipment		(12,934	)		(21,382	)		(21,080	)
Purchase of Hometown Threads^®		—			(1,140	)		—
Proceeds from disposal of property and equipment		4			—			14

NET CASH USED IN INVESTING ACTIVITIES		(12,930	)		(22,522	)		(21,066	)

(dollar amounts in thousands)

	For the Fiscal Year Ended
	January 30, 2005			February 1, 2004 (as restated; see Note 16)			February 2, 2003 (as restated; see Note 16)
OPERATING ACTIVITIES:
Net income (loss)	$	(29,740	)	$	1,322		$	14,435
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		12,818			11,408			10,168
Amortization of deferred financing costs		1,643			1,642			2,114
Interest expense—effective interest method		---			---			(509	)
Paid-in-kind interest		6,538			5,579			4,135
Change in fair value of derivative instruments		---			---			2,776
Early extinguishment of debt		---			---			4,569
Amortization of debt discounts		614			614			374
Stock compensation expense		77			53			---
Provision for deferred income taxes		13,440			1,890			(15,330	)
Loss on disposal of property and equipment		1,356			781			46
Changes in assets and liabilities which provided (used) cash:
Accounts receivable		(163	)		(733	)		(560	)
Inventories		797			(1,694	)		(2,225	)
Prepaid expenses and other assets		324			(1,210	)		296
Other noncurrent assets		7			(3	)		(6	)
Accounts payable—trade		12,512			(2,901	)		2,416
Accrued expenses		787			959			956
Accrued interest		180			(1,887	)		7,848
Other current accrued liabilities		3,894			286			92
Other noncurrent accrued liabilities		(836	)		1,888			(694	)
NET CASH PROVIDED BY OPERATING ACTIVITIES		24,248			17,994			30,901
INVESTING ACTIVITIES:
Purchases of property and equipment		(21,382	)		(21,080	)		(17,046	)
Purchase of Hometown Threads®		(1,140	)		---			---
Proceeds from sales of property and equipment		---			14			---
NET CASH USED IN INVESTING ACTIVITIES		(22,522	)		(21,066	)		(17,046	)

See notes to consolidated financial statements.

-52 ~~59 -~~

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(dollar amounts in thousands)
	For the Fiscal Year Ended
	January 30, 2005			February 1, 2004 (as restated; see Note 16)			February 2, 2003 (as restated; see Note 16)
FINANCING ACTIVITIES:
Proceeds from issuance of senior notes		---			---			162,060
Proceeds from issuance of senior subordinated discount notes		---			---			30,000
Proceeds from issuance of senior subordinated notes		---			---			10,000
Increase in borrowings under senior secured credit facility		78,800			93,000			79,700
Repayment of senior secured credit facility and capital lease obligations		(69,859	)		(86,894	)		(74,983	)
Repayment of senior subordinated term loans		---			---			(210,393	)
Repayment of installment purchase agreement		(228	)		---			---
Deferred financing cost		---			(85	)		(10,982	)
Issuance of common stock		---			10			---
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		8,713			6,031			(14,598	)

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(dollar amounts in thousands)

EFFECT OF EXCHANGE RATE CHANGES ON CASH		(81	)		(654	)		388
	Fiscal Year Ended
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		10,358			2,305			(355	)
									February 1,
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		4,820			2,515			2,870
									2004
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	15,178		$	4,820		$	2,515
	January 29,				January 30,				(as restated;
SUPPLEMENTAL CASH FLOW INFORMATION:
	2006				2005				see Note 17)
Interest paid	$	23,435		$	24,658		$	14,106
FINANCING ACTIVITIES:
Income taxes paid	$	293		$	116		$	23
Proceeds from issuance of senior notes		50,000				—				—
NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES:
Increase in borrowings under senior secured credit facility		53,600				78,800				93,000
Service contract acquired under installment purchase agreement	$	---		$	60		$	---
Repayment of senior secured credit facility and capital lease obligations		(82,619	)			(69,859	)			(86,894	)
Property and equipment acquired under installment purchase agreement	$	---		$	331		$	---
Repayment of installment purchase agreement		(163	)			(228	)			—
Property and equipment acquired under capital lease	$	60		$	---		$	---
Deferred financing cost		(4,595	)			—				(85	)
Issuance of warrants	$	---		$	---		$	1,607
Issuance of common stock		—				—				10
Cancellation of warrants	$	---		$	---		$	(2,861	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		16,223				8,713				6,031
Paid-in-kind interest capitalized	$	6,538		$	5,579		$	4,135
EFFECT OF EXCHANGE RATE CHANGES ON CASH		51				(81	)			(654	)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(7,205	)			10,358				2,305
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR		15,178				4,820				2,515
CASH AND CASH EQUIVALENTS AT END OF YEAR		7,973			$	15,178			$	4,820
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	27,025			$	23,435			$	24,658
Income taxes paid	$	286			$	293			$	116
NONCASH OPERATING, INVESTING AND FINANCING ACTIVITIES:
Service contract acquired under installment purchase agreement	$	—			$	—			$	60
Property and equipment acquired under installment purchase agreement	$	—			$	—			$	331
Property and equipment acquired under capital lease	$	—			$	60			$	—
Paid-in-kind interest capitalized	$	7,661			$	6,538			$	5,579

See notes to consolidated financial statements.

-53 ~~60 -~~

PORTRAIT CORPORATION OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollar amounts in thousands, except share data, per share data and where noted)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollar amounts in thousands, except share data, per share data and where noted)

1. Description of Business and Summary of Significant Accounting Policies

Description of Business—Portrait Corporation of America, Inc. and its subsidiaries (the “Company”) are engaged in the sale and processing of professional color portraits of children, ~~adults~~ adults and families. The Company is a voluntary registrant with the U.S. Securities and ~~Exchange~~ Exchange Commission. The Company operates portrait studios within Wal-Mart stores and ~~supercenters~~Supercenters in the United States (“U.S.”), Canada, Mexico, Germany and the United Kingdom (“U.K.”). The Company also operates a modular traveling business providing portrait photography services in additional retail ~~locations~~ locations and to church congregations and other institutions.

Principles of Consolidation—The consolidated financial statements include the accounts of Portrait Corporation of America, Inc. and its subsidiaries (see list of subsidiaries on Exibit 21.1). All significant ~~intercompany~~inter-company balances and transactions have been eliminated in consolidation.

Fiscal Year—The Company’s fiscal year ends on the Sunday nearest the end of January. The ~~fiscal~~ fiscal years ~~2004~~2005, ~~2003~~2004 and ~~2002~~2003 ended January 30 29, ~~2005~~2006, ~~February 1~~January 30, ~~2004~~2005 and February 2 1, ~~2003, respectively~~2004. The Company’s fiscal quarters are generally thirteen-week periods. In 53-week years, the fourth quarter has fourteen weeks.

Concentrations:

Source of Revenue—Approximately 96 97%, 9596%, and 9495% of sales for the fiscal years ~~ended January 30,~~ 2005, ~~February 1,~~ 2004 and ~~February 2,~~ 2003, respectively, were derived from sales at permanent and traveling portrait studios located in Wal-Mart stores. These studios are operated under agreements with Wal-Mart in the U.S., Canada, Mexico, Germany, and the U.K. that commit the Company to a percentage-of-sales commission payable to Wal-Mart. The agreements can be terminated or suspended by Wal-Mart for various reasons, some of which are beyond the Company’s control.

Source of Supply—The Company purchases substantially all of its photographic film, paper, and processing chemistry from ~~one~~two ~~supplier~~suppliers. ~~Although~~Agreements ~~there~~with ~~are a limited number of manufacturers of~~ these ~~products, management believes other~~ suppliers ~~could provide~~were ~~similar~~reached ~~products. During fiscal 2004, the Company was not~~ in ~~compliance~~January ~~with~~2006 ~~its~~and ~~contractual~~expire ~~agreement~~in ~~with the supplier~~July 2007. ~~The~~Although ~~Company~~there ~~agreed~~are toa ~~pay the supplier~~limited ~~interest~~number ~~at an annual rate~~ of 6%manufacturers ~~on past due payables. As~~ of ~~January~~these 30products, ~~2005,~~management ~~the~~believes ~~amount~~other ofsuppliers ~~past~~could ~~due~~provide ~~payables~~similar ~~to the supplier was approximately $15 million~~products. As(See ~~discussed in~~ Note: ~~2, the Company entered into an agreement with~~10) the supplier on June 15, 2005 to defer payment of all amounts outstanding as of that date, $20.7 million, for a period of 12 months, provided the Company does not breach its agreement with the supplier in any other way, and pays for its paper, film and chemistry needs on a cash-on-delivery basis.

~~On May 27,~~ Use ~~2005~~of ~~the~~Estimates—The ~~supplier’s~~preparation ~~German~~of ~~parent~~financial ~~company~~statements ~~declared~~in itconformity ~~was~~with ~~insolvent.~~accounting principles Ingenerally accepted in the United States of America requires management to make estimates ~~event~~and ~~this~~assumptions ~~insolvency~~that ~~affects~~affect the ~~supplier’s~~reported ~~ability~~amounts toof ~~provide~~assets ~~photographic~~and liabilities at the date of the ~~paper,~~financial ~~film~~statements and ~~processing~~the ~~chemistry,~~reported ~~management~~amounts ~~believes~~of sales and expenses during the ~~Company~~reporting ~~can~~period. ~~obtain necessary~~Significant ~~resources~~estimates ~~from~~include, ~~alternate~~but ~~suppliers.~~are ~~Nevertheless~~not limited to, ~~there~~deferral isof ~~no assurance~~costs ~~the~~related ~~Company~~to ~~can~~undelivered portraits, ~~obtain~~worker’s ~~these~~compensation ~~resources~~and ongeneral ~~the~~property ~~same~~and orcasualty ~~similar~~liability ~~terms~~insurance reserves, ~~which~~useful ~~could~~lives ~~have~~of aproperty ~~material~~and ~~adverse~~equipment, ~~effect~~potential onand ~~the~~asserted ~~Company’s~~tax ~~liquidity,~~claims ~~financial~~and the valuation ~~condition~~allowance ~~and~~for deferred tax assets. Actual results ofcould ~~operations~~differ from those estimates.

- Foreign Currency Transactions—Assets and liabilities of foreign operations are translated into 61U.S. dollars at the exchange rate in effect on the balance sheet date, while income and expense -accounts are translated at the average rates in effect during each fiscal period. Gains and losses on foreign currency transactions are included in the determination of net income (loss) for the period and are included in general and administrative expenses. The Company recognized a foreign currency transaction loss of $0.3 million in fiscal 2005 and gains of $0.7 million and $0.5 million in fiscal 2004 and 2003, respectively.

~~Use~~54 of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. Significant estimates include, but are not limited to, deferral of costs related to undelivered portraits, worker’s compensation and general property and casualty liability insurance reserves, useful lives of property and equipment, potential and asserted tax claims and the valuation allowance for deferred tax assets, if necessary. Actual results could differ from those estimates.

Foreign Currency Transactions—Assets and liabilities of foreign operations are translated into U.S. dollars at the exchange rate in effect on the balance sheet date, while income and expense accounts are translated at the average rates in effect during each fiscal period. Gains and losses on foreign currency transactions are included in the determination of net income (loss) for the period and are included in general and administrative expenses. The Company recognized foreign currency transaction gains of $0.7 million and $0.5 million in fiscal 2004 and 2003, respectively, and recognized a foreign currency transaction loss of $0.4 million in fiscal 2002.

Cash and Cash Equivalents—The Company considers all highly liquid investments with an original maturity of three months or less at date of purchase to be cash equivalents.

Accounts Receivable—There was no allowance for doubtful accounts at January 29, 2006 and January 30, 2005 ~~and February 1, 2004~~ as substantially all accounts receivable relate to amounts to be remitted by credit card processing companies and management has a high level of assurance ~~of the~~ ~~collectibility of~~ these amounts will be collected.

Inventories—Inventories include photographic film, paper, processing chemistry, photographic ~~and~~ and sales supplies, add-on merchandise, and work-in-progress on undelivered portraits which are valued at the lower of cost or market, cost being determined on ~~the first-in,~~ ~~first-out~~an average cost basis.

Property and Equipment—Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. A summary of estimated useful lives is as follows:


Land improvements			10 to 30 years
Buildings and improvements			10 to 55 years
Photographic, sales and finishing equipment			3 to 15 years
Studio improvements			3 to 10 years

Construction-in-progress represents short-term capital projects such as camera, background, and lighting system construction. Depreciation of these assets begins at the time the projects are completed and placed into service.

Maintenance and repairs are charged to expense as incurred. When properties are disposed, the related costs and accumulated depreciation are removed from the respective accounts and any gain or loss is credited or charged to income.

~~Amounts included~~ Depreciation ~~in Property~~ and ~~Equipment~~amortization ~~representing~~expense ~~assets~~for ~~under~~all ~~capital~~property ~~leases~~ and an ~~installment~~equipment ~~purchase~~for ~~agreement~~fiscal ~~are~~years ~~$0.4 million and $0.6 million as of~~ended January 29, 2006, January 30, 2005 and February 1, 2004 was $14.1 million, $12.8 million, and $11.4 million, respectively.

~~Depreciation and~~ Impairment ~~amortization~~of ~~expense~~Long-Lived ~~for~~Assets—The ~~all~~Company ~~property~~evaluates ~~and~~the ~~equipment~~carrying ~~for~~value ~~fiscal~~of ~~years ended January~~long-lived 30assets, excluding ~~2005~~goodwill, ~~February~~when 1,circumstances ~~2004,~~indicate ~~and~~the ~~February~~carrying 2value of those assets may not be fully recoverable in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting ~~2003~~for ~~was~~the ~~$12~~Impairment or Disposal of Long-Lived Assets.8” ~~million,~~The Company evaluates the ~~$11~~recoverability of long-lived assets held for use by comparing the net carrying value of an asset group to the estimated undiscounted future cash flows (excluding interest) during the remaining life of the asset group.4 ~~million~~If such an evaluation indicates that the future undiscounted cash flows of certain long-lived asset groups are not sufficient to recover the carrying value of such asset groups, ~~and~~the ~~$10~~assets are then adjusted to their fair values.2 ~~million~~There was no impairment in fiscal 2005, 2004 ~~respectively~~and 2003.

Goodwill— SFAS No. 142 “Goodwill and Other Intangible Assets.” requires the use of a non-amortization approach to account for purchased goodwill and certain intangible assets with 62indefinite useful lives. Goodwill is assessed at least annually or more frequently when events or -circumstances indicate that impairment might have occurred.

~~Impairment of~~ In ~~Long-Lived~~evaluating ~~Assets—The Company~~goodwill ~~evaluates~~for ~~the carrying value of long-lived assets~~impairment, ~~excluding~~the ~~goodwill, when~~Company ~~circumstances~~compares ~~indicate~~ the ~~carrying~~fair value of ~~those~~its ~~assets may not be~~retail ~~fully recoverable~~reporting inunit, ~~accordance~~where ~~with~~all ~~Statement~~ of ~~Financial~~the ~~Accounting~~goodwill ~~Standards (“SFAS”)~~is ~~No. 144~~recorded, ~~“Accounting~~to ~~for~~ the ~~Impairment~~carrying orvalue ~~Disposal~~ of ~~Long-Lived~~this reporting ~~Assets,”~~unit. ~~which~~If the ~~Company~~fair ~~adopted~~value ~~February~~of ~~4, 2002. The Company evaluates~~ the ~~recoverability~~ ofreporting ~~long-lived~~unit ~~assets~~is ~~held~~less ~~for~~than ~~use by comparing~~ the ~~net~~ carrying value of ~~an asset group to~~ the ~~estimated undiscounted future cash flows~~reporting ~~(excluding~~unit, ~~interest) during~~ the ~~remaining~~Company ~~life~~compares of the ~~asset~~implied ~~group.~~fair Ifvalue ~~such an evaluation indicates that the future undiscounted cash flows~~ of ~~certain long-lived~~reporting ~~asset~~unit ~~groups~~goodwill ~~are~~with ~~not sufficient to recover~~ the carrying ~~value~~ value of ~~such asset groups,~~ the ~~assets are then adjusted to their fair values~~goodwill. ~~There~~If ~~was no impairment~~the incarrying ~~fiscal~~value ~~2004,~~of ~~2003~~the ~~and~~reporting ~~2002.~~unit

~~Goodwill—Prior~~55 to February 4, 2002, goodwill was amortized on a straight-line basis over 35 years. Other acquired intangibles are amortized on a straight-line basis over their estimated useful lives. On February 4, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangible assets with indefinite useful lives. Goodwill is assessed at least annually, or more frequently when events or circumstances indicate that impairment might have occurred.

~~In evaluating~~ goodwill ~~for~~exceeds ~~impairment,~~ the ~~Company~~implied ~~compares the~~ fair value of ~~its retail~~ reporting unit, where all of the goodwill is recorded, to the carrying value of this reporting unit. If the fair value of the reporting unit is less than the carrying value of the reporting unit, the Company compares the implied fair value of reporting unit goodwill with the carrying value of the goodwill. If the carrying value of the reporting unit goodwill exceeds the implied fair value of that goodwill, the Company would recognize an impairment in an amount equal to that excess.

Deferred Financing Costs—Deferred financing costs ~~primarily~~ consist primarily of fees and expenses incurred in obtaining long-term financing. The deferred costs are amortized over the life of the associated debt, ranging from 54 to 8 years. Accumulated amortization as of ~~January~~ 30January 29, ~~2005~~2006 and January 30, ~~February 1~~2005, ~~2004~~ totaled $45.2 1 million and $24.6 2 million, respectively.

Insurance—The Company is self insured for employee health benefits and participates in large deductible insurance plans relating to workers’ compensation and general property and casualty liabilities. The Company has stop-loss coverage to limit the exposure arising from these claims. Losses for claims filed and claims incurred but not reported are accrued based upon the Company’s estimates of the aggregate liability for uninsured claims incurred using actuarial assumptions followed in the insurance industry and the Company’s historical experience.

Postretirement Benefits—The Company sponsored a postretirement health care plan for certain retirees and employees. During fiscal 2004, the Board of Directors of the Company passed a resolution to terminate this plan. Prior to the termination, the Company measured the cost of its obligations based on actuarial assumptions. This benefit was accrued and covered a very small portion of the Company’s base of employees and retirees. The accrual of $1.1 million was released to income during fiscal 2004 as a result of the termination and is recorded as a reduction in general and administrative expenses in the consolidated statement of operations.

Revenue Recognition and Deferred Costs—Sales are recorded when portraits and/or other merchandise are delivered to customers. Costs incurred relating to portraits processed, or in process, are deferred and included in inventory as incurred and expensed when the related ~~photographic~~ photographic sales are recognized. Deposits made by customers on portraits not yet delivered ~~are~~ are recorded in other current accrued liabilities on the consolidated balance sheets and were $57.4 1 million and $45.3 4 million as of January 30 29, ~~2005~~2006 and ~~February~~ 1January 30, ~~2004~~2005, respectively.

Cost of Sales—Cost of sales ~~consists~~is comprised of the following components: (1) materials and supplies needed for photography and sales, including film and equipment depreciation; (2) the ~~cost~~ cost to produce portraits, including freight, direct labor, depreciation and management of photography and production facilities; (3) the production of directories for churches and other institutions and commissions paid to the host store; and (4) the labor and commissions paid to employees for all ~~phases~~ phases of customer acquisition, photography and sales processes, associated payroll taxes, ~~related~~ related benefits and travel.

- Advertising—Costs associated with advertising are charged to operations at the time the 63advertisement is first distributed. Advertising expenses were $14.4 million, $16.3 million, and -$14.9 million for the years ended January 29, 2006, January 30, 2005 and February 1, 2004, respectively.

Advertising—Costs associated with advertising are charged to operations at the time the advertisement is first distributed. Advertising expenses were $16.3 million, $14.9 million, and $14.5 million for the years ended January 30, 2005, February 1, 2004, and February 2, 2003, respectively.

Studio Pre-opening Costs—Costs of opening new retail studios are charged to operations as incurred.

Income Taxes—Income taxes are accounted for under the asset and liability method. Deferred ~~tax~~ tax assets and liabilities are recognized for the future tax consequences attributable to operating loss and tax credit ~~carryforwards~~carry-forwards as well as differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax ~~bases~~basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided against deferred tax assets if, based on the ~~weight~~ weight of available evidence, the Company determines that it is more likely than not those ~~assets~~ assets will not ~~ultimately be realized. In~~ ~~addition the Company evaluates the need for income tax liabilities under the guidance espoused in SFAS No. 5, “Accounting for Contingencies.”~~

~~Stock-Based~~56 Compensation—Prior to fiscal 2003, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. As such, compensation expense relating to stock options granted to employees was recorded only if the current fair value of the underlying stock exceeded the exercise price on the date of grant. As such, no compensation expense related to stock options was recognized in the consolidated financial statements in fiscal 2002.

~~During the~~ultimately ~~fourth~~be ~~quarter~~realized. ofIn ~~fiscal~~addition ~~2003,~~ the Company ~~elected~~evaluates ~~to adopt~~ the ~~fair value based~~need ~~employee~~for ~~stock-based~~recording ~~compensation~~of ~~expense~~income ~~recognition~~tax ~~provisions of~~liabilities ~~SFAS No.~~under ~~123,~~the ~~“Accounting~~guidance ~~for~~espoused ~~Stock-Based~~in ~~Compensation.”~~ SFAS No. 5, ~~123~~“Accounting states the adoption of the fair value based method is a change to a preferable method of accounting. Management believes use of the fair value based method to record employee stock-based compensation expense is consistent with the accounting for ~~all~~ ~~other forms of compensation~~Contingencies. ”

~~Under~~ Stock-Based Compensation—Prior to fiscal 2003, the Company accounted for its stock option plan ~~prospective~~in ~~transition~~accordance with the provisions of ~~SFAS~~Accounting ~~No.~~Principles ~~123,~~Board as(“APB”) ~~amended~~Opinion ~~by SFAS~~ No. ~~148~~ 25, “Accounting for Stock~~-Based~~ ~~Compensation--Transition~~Issued ~~and~~to ~~Disclosure~~Employees,” ~~the Company~~and ~~adopted~~related ~~the~~interpretations. ~~fair~~As ~~value~~such, ~~method~~compensation expense ~~effective~~relating asto ofstock ~~the~~options ~~beginning~~granted ofto ~~the year in~~employees ~~which~~was ~~the~~recorded ~~decision~~only ~~was~~if ~~made,~~the orcurrent ~~February~~fair 3,value of ~~2003.~~the ~~Prior~~underlying ~~awards~~stock ~~will~~exceeded ~~continue to~~the beexercise ~~accounted~~price ~~for~~on ~~under~~ the ~~intrinsic~~date ~~value~~of ~~method~~grant.

~~The adoption~~ During of the ~~fair~~fourth ~~value~~quarter ~~based~~of ~~method decreased income from operations by $77 and $53 in~~ fiscal ~~2004 and~~ 2003, ~~respectively.~~the ~~The~~Company ~~pro~~elected ~~forma~~to ~~results~~adopt ~~disclosed for~~ the ~~current~~fair ~~year~~value ~~differ~~based employee ~~from~~stock-based ~~the~~compensation ~~actual~~expense ~~results,~~recognition ~~because~~provisions ~~under~~of ~~APB~~SFAS ~~Opinion~~ No. 20 123, “Accounting ~~Changes,~~for Stock-Based Compensation.” ~~the pro forma results are computed as if~~ SFAS No. 123 ~~had~~states ~~been applied for all periods, whereas,~~ the ~~accounting~~adoption ~~under~~of the ~~provisions~~ offair ~~SFAS~~value ~~No.~~based ~~123~~method is ~~applied~~a change ~~only~~ to ~~awards~~a ~~granted~~preferable onmethod orof ~~subsequent to February 3, 2003~~accounting.

~~Employee stock-based~~ Under ~~compensation~~the ~~expense~~prospective ~~determined~~transition ~~using~~provisions ~~the~~of ~~fair~~SFAS ~~value~~No. 123, ~~based~~as ~~method~~amended by SFAS No. 148, ~~applied~~“Accounting ~~prospectively~~for isStock-Based ~~not~~Compensation—Transition ~~necessarily~~and ~~indicative~~Disclosure,” ofthe ~~future~~Company ~~amounts~~adopted ~~when~~ the ~~fair~~ fair value ~~based~~ method ~~will~~effective ~~apply~~as toof ~~all~~the ~~outstanding,~~beginning ~~non-vested~~of ~~awards, as non-vested~~the ~~awards~~year ~~issued~~in towhich ~~employees~~the ~~prior~~decision towas ~~February~~made, or February 3, 2003,. ~~were,~~Prior ~~and~~ awards will continue to be, accounted for ~~using~~under the intrinsic value ~~based provisions of APB Opinion No~~method. ~~25.~~

- The adoption of the fair value based method decreased income from operations by $74, $77 and 64$53 in fiscal 2005, 2004, and 2003 respectively. The pro forma results disclosed for the current -year differ from the actual results, because under APB Opinion No. 20, “Accounting Changes,” the pro forma results are computed as if SFAS No. 123 had been applied for all periods, whereas, the accounting under the provisions of SFAS No. 123 is applied only to awards granted on or subsequent to February 3, 2003.

Employee stock-based compensation expense determined using the fair value based method of SFAS No. 123 applied prospectively is not necessarily indicative of expected compensation expense , as non-vested awards issued to employees prior to February 3, 2003, were accounted for using the intrinsic value based provisions of APB Opinion No. 25.

As required by SFAS 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 for all stock-based awards since fiscal 1995. The Company’s net income as reported and the pro forma amounts are indicated below:

	For the Fiscal Year Ended
	January 30, 2005			February 1, 2004 (as restated; see Note 16)			February 2, 2003 (as restated; see Note 16)
									February 1,
Net income (loss):
									2004
As reported	$	(29,740	)	$	1,322		$	14,435
	January 29,				January 30,				(as restated;
Recorded stock compensation expense		77			53			---
	2006				2005				see Note 16)
Pro forma stock compensation expense		(108	)		(84	)		(31	)
Net income (loss):
Pro forma net income (loss)	$	(29,771	)	$	1,291		$	14,404
As reported	$	(34,442	)		$	(29,740	)		$	1,322
Recorded stock compensation expense		74				77				53
Pro forma stock compensation expense		(92	)			(108	)			(84	)
Pro forma net income (loss)	$	(34,460	)		$	(29,771	)		$	1,291

In December 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (SFAS 123(R)) which replaces SFAS 123 and supersedes APB Opinion No. 25. Under the provisions of SFAS 123(R), companies are required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award beginning the first interim period after December 15, 2005 and accordingly will be adopted by the Company in the first quarter of fiscal year 2006. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award, usually the vesting period. SFAS 123(R) requires that compensation expense be recognized for the unvested portions of existing options granted prior to its effective date and the cost of options granted to employees after the effective date based on the fair value of the stock options at grant date. The impact of adoption of SFAS 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future.

As of January 29, 2006 there was $.02 million of total unrecognized compensation costs related to unvested stock options granted under the Company’s stock option plans prior to the adoption of SFAS 123(R). The cost is expected to be recognized over the 1.2 year weighted-average remaining contractual life. The total fair value of shares vested during fiscal 2005 was nominal.

Fair Value of Financial Instruments—The Company is required to disclose in its consolidated financial statements the fair value of all financial instruments, including assets and liabilities both on and off the balance sheet, for which it is practicable to estimate such fair value. Fair value methods, assumptions and estimates for the Company are as follows:

• Cash and cash equivalents, accounts receivable, prepaid expenses, short-term borrowings, accounts payable—trade and accrued expenses—the carrying amount approximates fair value because of the short maturity of these instruments.

• ~~Noncurrent~~ Non-current liabilities—the carrying amount approximates fair value as such amounts represent long-term workers’ compensation obligations and long-term occupancy obligations.

~~The Company’s~~ Related ~~long-term~~Party ~~debt~~Transactions—The ~~has~~Company ~~fair~~paid ~~values~~a asconsulting fee of ~~January 30~~$150,000 ~~2005~~to ~~and~~a ~~February~~partner ~~1, 2004~~ of ~~approximately~~its ~~$224.1~~principal shareholder ~~million~~in ~~and~~fiscal ~~$253.9~~2005 ~~million,~~and ~~respectively,~~reimbursed ~~and carrying~~its ~~values~~principal ofshareholder ~~$245.9~~for ~~million~~certain ~~and~~expenses ~~$229.9~~incurred ~~million,~~by the ~~respectively.~~shareholder ~~The~~on ~~fair value~~behalf of the ~~publicly~~Company ~~held~~for ~~bonds~~the isyears ~~based~~ended onJanuary 29, ~~quoted~~2006 ~~market~~and ~~prices~~January 30,2005 in asthe amounts of ~~January 30~~$225,000, ~~2005~~ and ~~February 1~~$31,000 ~~2004~~respectively.

~~Related Party~~ Impact of Newly Issued Accounting Standards—~~The~~ In November 2004, the Financial ~~Company~~Accounting ~~reimbursed~~Standards ~~its~~Board ~~principal~~(“FASB”) ~~shareholder~~issued ~~for~~Statement ~~certain~~of ~~expense~~Financial ~~incurred by~~Accounting ~~the~~Standards (“SFAS”) No. ~~shareholder~~151, on“Inventory ~~behalf~~Costs, an amendment of ~~the~~ARB ~~Company~~No. 43, ~~for~~Chapter 4.” ~~the~~SFAS ~~years~~151 ~~ended~~amends ~~January~~ARB 30No. 43, ~~2005,~~Chapter ~~February~~4, 1to clarify that abnormal amounts of idle facility expense, ~~2004~~freight, handling costs, and ~~February~~wasted material 2(spoilage) should be recognized as current period charges. In addition, ~~2003~~SFAS in151 requires that allocation of fixed production overhead to the ~~amounts~~cost of ~~$31,~~conversion ~~$6,~~be ~~and~~based ~~$52~~on the normal capacity of the production facilities. The provision of SFAS 151 shall be effective for the Company beginning on January 30, 2006. The Company believes that the adoption of SFAS 151 will not ~~respectively~~have a material effect on its financial statements.

~~Impact~~58 of Newly Issued Accounting Standards—In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (Revised 2004), “Share-Based Payment.” SFAS No. 123 (Revised 2004) establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123 (Revised 2004) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123 (Revised 2004) is effective for nonpublic entities as of the beginning of the first annual reporting period that begins after December 15, 2005. During the fourth quarter of fiscal 2003, the Company elected to adopt the fair value based employee stock-based compensation expense recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” The Company is currently evaluating the impact SFAS No. 123 (Revised 2004) will have on the Company’s consolidated financial statements.

SFAS No. 153 addresses the measurement of exchanges of non-monetary 65assets. It eliminates the exception from fair value measurement for non-monetary exchanges of similar productive assets and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a non-monetary exchange has commercial substance if the future cash flows of an entity are expected to change significantly as a result of the exchange. This statement is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005 and is not expected to have a significant impact on the Company’s financial statements.

In ~~March~~ May 2005, the FASB issued ~~FASB~~SFAS ~~Interpretation (“FIN”)~~ No. 47 154, “Accounting ~~for~~Changes and Error Corrections, — a ~~Conditional~~replacement ~~Asset~~of ~~Retirement~~APB ~~Obligations~~Opinion No.” 20 ~~FIN~~and FASB Statement No. 3”. 47This ~~clarifies~~Statement ~~that~~establishes, ~~the term~~unless ~~conditional~~impracticable, ~~asset~~retrospective ~~retirement~~application ~~obligation~~ as ~~used~~the inrequired ~~SFAS~~method ~~No. 143, “Accounting~~ for ~~Asset~~ ~~Retirement~~reporting ~~Obligations,”~~a ~~refers~~change toin accounting aprinciple ~~legal~~in ~~obligation~~the toabsence ~~perform~~of anexplicit ~~asset retirement~~transition ~~activity~~requirements inspecific ~~which~~to the ~~timing~~newly adopted ~~and/or~~accounting ~~method~~principle. The provisions of ~~settlement~~this Statement are ~~conditional~~ oneffective afor ~~future~~accounting changes ~~event~~and ~~that~~corrections ~~may~~of orerrors ~~may~~made ~~not~~in befiscal ~~within~~years ~~the~~beginning ~~control~~after ~~of the entity.~~December 15, ~~FIN No~~2005. 47Early adoption is ~~effective~~permitted nofor ~~later~~accounting ~~than~~changes ~~the~~and ~~end~~corrections of errors made in fiscal years ~~ending~~ beginning after ~~December~~the ~~15,~~date ~~2005~~this Statement is issued. The Company isdoes ~~currently~~not ~~evaluating~~believe that the ~~impact FIN~~adoption ~~No. 47~~of this Statement in 2006 will have a material impact on ~~its~~the ~~consolidated~~Company’s financial ~~statements~~position or results of operation.

2. Operations, Liquidity and Other Matters

~~The Company~~ As ~~experienced~~shown ain ~~significant~~the ~~downturn~~accompanying inconsolidated ~~operations~~financial instatements, ~~fiscal~~the ~~2004~~Company ~~which~~incurred ~~resulted in~~ a net loss inof ~~fiscal~~$34.4 million ~~2004~~for the year ended January 29, 2006 and ~~lower~~at ~~gross~~January 29, ~~profit~~2006 asthe ~~compared~~Company’s current ~~to fiscal~~liabilities ~~2003~~exceeded its current assets by $318.7 million ~~This~~(see ~~resulted~~below) inand we reported a shareholders’ deficiency of $204.8 million. In addition, the Company’s ~~non-compliance~~had ~~with~~past ~~certain~~due trade accounts ~~financial~~payable, ~~covenants~~other ~~governing~~than ~~its~~those ~~debt~~owed to AgfaPhoto USA, of $6.8 million and ~~its~~$7.8 million ~~inability~~as toof ~~meet~~January 29, 2006 ~~current~~and January 30, 2005, respectively. These trade accounts payable averaged approximately 28 ~~commitments~~days atand ~~existing~~30 days ~~levels~~past due as of ~~cash~~January 29, ~~flow~~2006 ~~from~~and ~~operations~~January 30, 2005, respectively.

~~Operations~~ As of January 29, 2006 the Company had approximately $274.9 million aggregate principal amount ~~and~~of ~~Liquidity~~indebtedness outstanding. The Company was not in compliance with the terms of certain covenants under various loan agreements. The Company has received temporary waivers from its debt holders, but there can be no assurance that the Company will comply with these covenants or the noteholders will extend the waivers for an additional period during 2006. As a result, substantially all the debt has been classified as a current liability.

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the financial statements, during fiscal 2004, the Company incurred a net loss of $29.7 million and as of the end of fiscal 2004 and 2003, the Company’s current liabilities exceeded its current assets by $39.4 million and $39.6 million, respectively and its total liabilities exceeded its total assets by $156.0 million and $126.1 million, respectively. As a result, the Company sought sufficient financing to fund operations through fiscal 2005. On July 15, 2005, the Company issued $50 million in 14% senior secured notes due 2009, entered into a ~~new~~ senior secured revolving credit facility that will provide for revolving loans, ~~from time to time,~~ of up to $10.0 million in the aggregate and entered into a separate ~~new~~ letters of credit facility, which will provide for the Company’s letter of credit needs, ~~from time to time,~~ of up to $20.0 million. InAs ~~addition~~of June 12, ~~the~~2006 we ~~Company~~have ~~has~~no ~~obtained~~availability ~~necessary~~under ~~waivers~~our ofrevolver ~~existing~~and ~~defaults~~$5.7 million ~~under~~on ~~its~~our ~~debt agreements~~letters of credit.

~~Foreign~~ The Company’s total indebtedness to AgfaPhoto is approximately $22.8 ~~Tax~~million. ~~Claim~~Approximately $2.1 million is on open account and ~~Forensic~~is ~~Investigation~~currently due and payable. Approximately $20.7 million is subject to a letter agreement dated June 15, 2005 in which AgfaPhoto agreed, under certain conditions, to defer any collection action until June 15, 2006. Further, AgfaPhoto has agreed to subordination terms with respect to other debt of the Company that effectively limits AgfaPhoto’s ability to collect any of the $22.8 million as a secured creditor. On June 15, 2006 the Company’s standstill agreement with AgfaPhoto USA ended. In that agreement, AgfaPhoto USA agreed that it would not take any action to collect certain amounts owed by us for photographic paper, film and chemicals purchased from AgfaPhoto USA . The Company has asked AgfaPhoto USA to extend this agreement to September 30, 2006. While AgfaPhoto USA has stated that it would request such an

~~During~~59 fiscal 2004, the Company became aware of a tax claim from the Servicio de Administracion Tributaria (the “SAT”), the Mexican Tax Authority from the Company’s Mexican subsidiary. The amounts alleged due by SAT consisted of $1.4 million for fiscal years 1997 and 1998 as well as $0.1 million for January through June of 2000 as a result of tax audits for the respective periods. Due to the time lapse of the non- payment, fines, penalties and interest of $4.5 million had been added to the outstanding claim. Following a preliminary investigation by the Company, the Company engaged legal representation in Mexico and the U.S. to assist in negotiating a settlement with SAT, and engaged an independent accounting firm to perform forensic accounting work to determine the extent of suspected fraudulent transactions conducted by former employees of the subsidiary. The Company is currently negotiating a settlement with SAT and has recorded a charge in general and administrative expenses in the statement of operations of $1.5 million in fiscal 2004 reflecting management’s best estimate of the ultimate settlement of this claim.

~~Defaults~~extension from the bankruptcy trustee of its parent company in Germany, there can be no assurance ~~under~~that ~~Debt~~such ~~and~~an ~~Supplier~~extension ~~Agreements~~will be given. Also, to date, AgfaPhoto USA has been working with the Company to resolve amounts owed to them, but there can be no assurance that AgfaPhoto USA will not institute legal action to collect such amounts.

As Each of ~~October~~ ~~31, 2004,~~ the ~~Company~~Senior ~~was~~Notes ~~not~~and inSenior ~~compliance~~Subordinated ~~with~~Notes ~~certain~~contain ~~financial covenants~~cross-default ~~contained~~provisions inthat ~~its~~can ~~prior~~be ~~senior~~triggered ~~secured~~in ~~credit~~the ~~facility agreement.~~event ~~On December~~the 14agent, ~~2004~~trustee, ~~the~~or ~~lenders~~holders, ~~under~~as ~~the~~applicable, ~~Company’s~~should ~~prior~~exercise ~~senior~~their ~~secured~~rights ~~credit facility and the Company executed an amendment~~ to ~~the~~accelerate ~~facility agreement. This amendment granted~~ the ~~Company~~due ~~waivers~~ date of ~~these~~principal ~~covenants~~and ~~from~~interest ~~October~~under ~~31, 2004 through~~any ~~January~~one ~~31,~~of ~~2005.~~such Innotes ~~addition,~~or the ~~mandatory~~prior ~~prepayment~~senior ~~provisions were amended~~secured credit facility.

On June 15, 2006, the Company did not make an interest payment in the amount of $687,500 due on its 133/4% Senior Subordinated Notes Due 2010 (the “Notes”). The 30-day grace period for payment 66of such interest expired on June 14, 2006. As a result, an event of default occurred with respect to the Notes, which default also causes a cross-default under the Company’s credit agreement with its senior lender. The Company is currently in discussions with the holders of the Notes and its senior lender regarding obtaining a forbearance or similar agreement with respect to this interest payment. In the event that an agreement is not reached with the holders of the Notes and the Company’s senior lender, such holders or senior lender will have the right to submit a notice to the Company declaring all principal and interest and other amounts due in respect of the Notes immediately due and payable. While the Company is hopeful that such discussions will be resolved favorably, no assurances can be given that any such agreement will be reached.

On February 4, 2005, the lenders under the Company’s prior senior secured credit facility and the Company executed an additional amendment to the prior senior secured credit facility agreement, effective as of January 31, 2005. Pursuant to this amendment, all defaults under the agreement caused by the Company’s failure to meet certain financial covenants with respect to the period ended October 31, 2004 were waived and certain terms of the agreement were permanently amended, effective January 31, 2005, including certain financial covenants, the interest rate setting mechanism, the mandatory prepayment requirements and other provisions. The mandatory prepayment provisions were modified such that the aggregate principal amount of loans outstanding shall not exceed $15.0 million from December 15, 2005 to January 15, 2006 and from December 15, 2006 to January 15, 2007.

The Company was previously in default of covenants requiring the delivery of its financial statements within 90 days following fiscal year end that are contained in its prior senior secured credit facility agreement (as amended) and agreements related to the Parent Notes (as defined in Note 3) and the Opco Notes (as defined in Note 3). The prior senior secured credit facility, Parent Notes and Opco Notes require the delivery of audited financial statements, without an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern, within 90 days after the end of each fiscal year. With the issuance of these financial statements, the Company has cured the default of that requirement under the prior senior secured credit facility, Parent Notes and Opco Notes.

The lenders under the Company’s prior senior secured credit facility extended the cure period for such default to July 15, 2005 provided there were no other defaults within such cure period that may have caused the cure period to end sooner than July 15, 2005. With regard to the Parent Notes and the Opco Notes, the cure period for such default is 60 days from the receipt of notice from 45% of the holders of such notes to cure such default. No such notice was received.

The Company was previously in default of the covenant contained in the Senior Notes (as defined in Note 3) that requires the Company to timely comply with all filing requirements of the U.S. Securities and Exchange Commission. The Company did not timely file its Annual Report on Form 10-K for the fiscal year ended January 30, 2005. The Company had a period of sixty (60) days following notice from either the Trustee of the Senior Notes or the holders of 25% of the principal amount of the Senior Notes to cure this default. No such notice was received.

Each of the Senior Notes, the Parent Notes and the Opco Notes contain, and the prior senior secured credit facility contained, cross-default provisions that can be triggered, among other things, in the event the agent, trustee, or holders, as applicable, should exercise their rights to accelerate the due date of principal and interest under any one of such notes or the prior senior secured credit facility.

In addition, during fiscal 2004, the Company was not in compliance with its agreement with the Company’s supplier for its North American requirements for photographic paper, film and processing chemistry. The Company has agreed to pay the supplier interest at an annual rate of 6% on past due payables. As of January 30, 2005, the amount of past due payables to the supplier was approximately $15 million. As discussed below, the Company entered into an agreement with the supplier on June 15, 2005. On May 27, 2005, the supplier’s German parent company declared it was insolvent. In the event this insolvency affects the supplier’s ability to provide photographic paper, film, and processing chemistry, management believes the Company can obtain necessary resources from alternate suppliers. Nevertheless, there is no assurance the Company can obtain these resources on the same or similar terms, which could have a material adverse effect on the Company’s liquidity, financial condition and results of operations.

- 67 -

Management’s Plan

The ~~Company’s~~ ~~funding needs for fiscal 2005 depend on many factors, including the~~ Company’s ability to ~~successfully~~meet ~~implement measures to improve~~ its ~~performance. In~~contractual ~~order~~obligations to ~~address~~AgfaPhoto ~~the~~and ~~significant~~its ~~downturn in operations that occurred in fiscal 2004 in the Company’s U.S. Wal~~long-~~Mart~~term ~~permanent~~debt ~~studios,~~and ~~management~~trade ~~has~~creditors, ~~implemented~~is ~~several~~dependent ~~initiatives~~upon ~~since~~ the ~~beginning~~forbearance of ~~fiscal~~its ~~2005~~creditors ~~designed to increase same studio sales. These initiatives are focused on increasing average transaction size per customer~~ and ~~customer~~its ~~traffic.~~ability ~~Examples of these~~to ~~initiatives~~achieve ~~include~~the ~~external~~following ~~recruiting~~objectives, ofor ~~field~~some ~~operations~~combination ~~management, instituting~~thereof: (a) improve ~~new~~operating ~~bonus program for field associates, launching new marketing~~performance ~~initiatives,~~based ~~re-implementing~~on the ~~previously~~initiatives ~~successful~~discussed ~~“Portrait~~below, ~~Smiles” customer~~(b) amend ~~continuity~~its ~~program~~deferred ~~which~~payment ~~was~~agreement ~~previously~~with ~~eliminated in fiscal 2003,~~AgfaPhoto ~~and re-introducing~~on aterms ~~mid-tier~~favorable ~~price point in package offers~~ to ~~improve~~ the ~~customer experience~~Company, ~~and~~(c) seek toadditional ~~encourage~~funds ~~customer~~from ~~trade-ups.~~external ~~The~~sources ~~Company’s~~or ~~growth plans~~restructure ~~assume~~its aexisting ~~continuation~~debt ofobligations, ~~studio openings in Wal-Mart~~ and/or ~~further evaluation of other specialty retail concepts in Wal-Mart retail locations. Management will~~ (d) continue ~~to monitor sales~~, ~~financial~~when ~~results and liquidity position and~~possible, ~~if necessary,~~ ~~will execute further actions~~ to ~~mitigate~~extend ~~concerns~~vendors ~~with~~payable ~~regard~~beyond tousual ~~the Company’s~~payment ~~liquidity position, including, but not limited to, further reductions in general and administrative expenses and capital expenditures~~terms. ~~Despite the initiatives~~While ~~taken,~~ management ~~forecasts~~believes the Company’s ~~will need additional liquidity to meet~~ operating ~~needs~~performance ~~beginning in~~will ~~fiscal 2006. In July 2005~~improve, ~~the Company obtained additional financing of~~ ~~an amount~~there ~~sufficient~~can ~~for~~be ~~the~~no ~~Company~~assurance tothat ~~continue to operate at least through fiscal 2005 and~~ the Company ~~has~~will ~~cured~~be ~~defaults~~successful ~~under~~in ~~its~~implementing ~~various~~any ~~debt agreements. The Company has also obtained waivers~~ of ~~defaults from the lenders~~these ~~under the various debt agreements~~initiatives.

~~Also, as noted~~ The ~~above, the~~ Company’s ~~and~~funding ~~its~~needs ~~supplier of substantially all of its North American requirements~~ for ~~photographic~~fiscal ~~film,~~2006 ~~paper~~ and ~~processing~~beyond ~~chemistry entered~~depend ~~into an agreement~~ on ~~June~~many 15factors, ~~2005~~including tothe Company’s ~~defer~~ability ~~payment~~to onsuccessfully ~~all~~implement ~~amounts outstanding~~measures ~~with~~to ~~the~~improve ~~supplier~~its ~~totaling $20~~performance.7 ~~million~~In asorder ~~of that date until~~to ~~June 15,~~address ~~2006, provided~~ the ~~Company~~significant ~~does~~decline ~~not breach its agreement with the supplier~~ in ~~any~~same ~~other~~store ~~way,~~sales and ~~pays~~corresponding ~~for the Company’s photographic film, paper and chemistry needs on a~~ cash~~-on-delivery~~ ~~basis.~~flow ~~The~~that ~~Company~~occurred is in the ~~process~~ ~~of seeking to amend this supply agreement. The~~ Company’s ~~ability~~U.S. toWal-Mart ~~meet~~permanent ~~this contractual~~studios, ~~obligation~~management inhas ~~June~~implemented ~~2006~~several isinitiatives ~~dependent upon its ability~~ designed to ~~improve operating~~increase ~~performance~~same ~~based~~studio ~~on the initiatives identified above~~sales, ~~and~~maintain ~~its ability to~~increased ~~obtain~~customer ~~additional~~order ~~liquidity in fiscal 2006~~size, ~~including~~increase ~~the~~customer ~~ability to~~traffic, ~~amend this~~and ~~supplier~~reduce ~~contract~~operating ~~on terms favorable to the Company~~costs. ~~There~~Examples ~~can~~of ~~be no assurances the Company will be successful in implementing~~ these are: ~~initiatives.~~

	-		Reorganizing field operations management to put an emphasis on training and retaining studio personnel to include a renewed emphasis on photographer certification;

	-		instituting a new bonus program for our field associates and a new PCA Partner program to recognize superior performance;

	-		launching new marketing initiatives, including selected coordinated marketing efforts with Wal-Mart, increased customer direct mailing programs and inclusion in Wal-Mart’s advertising circulars;

	-		Changing our studio hours to better serve our customers’ demand (this change was based on a detailed study of our sales by hour);

	-		re-introducing a mid-tier price point in our package offers in order to promote customer trade ups and changing our backend packages to increase their value and provide more order flexibility to our customers;

	-		increasing our average front end collection rates on custom ordered portraits which studies

			have shown correlate to increased final collection rates;

	-		looking at our business more qualitatively using focus groups, customer surveys, market testing, etc. to ensure we understand our customers’ needs and address those needs;

	-		more controlled and focused growth with Wal-Mart — working closely with Wal-Mart in fiscal 2005, we opened 176 permanent studios but closed 85 in recognition of the fact that a more selective studio openings schedule better meets both parties objectives;

	-		disciplined expansion internationally — we believe Canada and Mexico provide an attractive platform for international growth and we are assessing the viability of our European operations;

	-		disciplined expansion into non-portrait photography related concepts — with the opening of 12 Fun Factory locations in Wal-Mart, we have the opportunity to expand our presence in Wal-Mart stores with this child-centered, value-priced concept;

	-		critically evaluating all our operations, support and administrative functions, for cost saving opportunities; and

	-		evaluating all business channels for strategic importance and profit contribution and ceasing to operate non-contributing channels.

Adverse business conditions the Company has experienced requires the Company to seek additional funds from external sources or restructure its existing obligations in order to meet its liquidity requirements. The Company has no current arrangements with respect to sources of additional financing, and our covenants under our current credit facilities restrict our ability to incur more debt. There is no assurance that the Company will generate sufficient cash flow from operations to service its debt or meet its other obligations or be successful in restructuring its debt . In the event of a failure to do so, the Company may be forced to file for bankruptcy protection. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments relating to recorded asset amounts or the amount of liabilities which might be necessary as a result of this uncertainty. Additional risks related to the Company’s ability to generate cash from operations and to its substantial indebtedness are discussed under “Item 1A., Risk Factors” in this report.

While management believes its plan as described above to mitigate its decline in same store sales and liquidity and to satisfy its obligations is reasonable, its ultimate success will depend on the extent to which the Company’s Board of Directors and management are able to achieve one or more elements of the strategy described above. The Company cannot give assurance that these strategies will ultimately prove successful, because they are subject to a number of risks and uncertainties beyond the control of the Company, including those discussed under “Item1A., Risk Factors.”

Foreign Tax Claims

The tax claim against the Company’s Mexican subsidiary was settled during the fourth quarter of fiscal 2005 for $1.9 million. During fiscal 2005, Revenue Canada asserted a claim against our Canadian subsidiary relating to transfer pricing for goods and services rendered by our U.S. parent company. The claim related to fiscal years 2000 through 2004 and we are currently challenging this claim and have retained Canadian legal counsel and PriceWaterhouseCoopers to assist us in this process. Management believes this claim can be settled favorably and will not materially impact the Company, but can give no assurance that this will be the case.

Defaults under Debt Agreements

The Company was previously in default of covenants requiring the delivery of its financial statements within 90 days following its fiscal year end that were contained in its prior Senior Secured credit facility agreement (as amended) and agreements related to its Senior Subordinated Discount Notes and its Senior Subordinated Notes. These credit facilities require the delivery of audited financial statements, without an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern, within 90 days after the end of each fiscal year. With the issuance of the Company’s financial statements for the fiscal year ended January 30, 2005 on July 28, 2005, the Company cured these defaults.

The Company was previously in default of the covenant contained in the indenture agreement for its Senior Notes and Senior Secured Notes that requires the Company to timely file all quarterly, annual and current reports with the U.S. Securities and Exchange Commission (“SEC”). The Company did not timely file its Annual Report on Form 10-K for the fiscal year ended January 30, 2005, its Quarterly Report on Form 10-Q for the thirteen weeks ended May 1, 2005, or its Quarterly Report on Form 10-Q for the thirteen weeks ended October 30, 2005. In addition, the Company did not make timely filings on Form 8-K with regard to its hiring of R. David Alexander, on November 2, 2005, as Chairman, President and Chief Executive Officer of the Company, its entry into an amended and restated license agreement with Wal-Mart Canada dated January 1, 2006 and its agreement to pay John Klein, a director of the Company and principal of Jupiter Partners, for services rendered to the Company for the period December 2004 through January 2006. The Company had a period of sixty (60) days following notice from either the Trustee of the Senior Notes or Senior Secured Notes or the holders of 25% of the principal amount of the Senior Notes or Senior Secured Notes to cure such defaults. Notice was received regarding the failure to timely file its Quarterly Report on Form 10-Q for the thirteen weeks ended October 30, 2005. All the defaults described previously were subsequently cured.

The Company is in default of the covenants contained in its Senior Notes and Senior Secured Notes relating to delivery of audited financial statements and timely filing of reports with the SEC described above for its fiscal year ended January 29, 2006. The Company has a period of sixty (60) days following notice from either the Trustee of the Senior Notes or Senior Secured Notes or the holders of 25% of the principal amount of these Notes to cure this default. Notice was received on May 22, 2006 relating to this default. Additionally, we were in default of covenants contained in our Senior Notes and Senior Secured Notes requiring the delivery of our audited financial statements within 90 days after the end of the fiscal year, without an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern. On June 20, 2006, the Company entered into the Third Amendment to Credit Agreement, Waiver, Consent and Forbearance Agreement with its Senior Lender. This agreement provides, among other things, that the Senior Lender waives the requirements to deliver audited financial statements or that such statements will not contain “going concern” language.

3. Debt

~~On June 27,~~ Below 2002, PCA LLC (“Issuer”) and PCA Finance Corp. (“Co-issuer”) issued $165 million of 11.875% senior notes due 2009 (“Senior Notes”) at an offering price of 98.218%. The Senior Notes discount of $2.9 million is being amortized to interest expense using the effective interest method, through August 1, 2009. In connection with this issuance, the Company contributed all of the equity it held in its subsidiaries to PCA LLC, a ~~newly~~summary formed entity, so that all subsidiaries are directly or indirectly owned by PCA LLC. Additionally, PCA LLC entered into an agreement with the Company whereby the Company transferred substantially all of ~~its~~our ~~assets~~short ~~and~~term ~~assigned~~debt ~~all~~as contracts to which it was a party, except for certain instruments relative to its stock option plan and other equity arrangements, to PCA LLC. In accordance with SFAS No. 141, “Business Combinations,” the Company recorded this transfer of equity interests and assets at carrying amounts since the exchange occurred between entities under common control. Payment of the $165 million Senior Notes is unconditionally guaranteedJanuary 29, ~~jointly~~ ~~and severally, by the Company and all of the Issuers’ domestic subsidiaries (other than the Co-issuer) (see Note 14 for guarantor and nonguarantor financial information)~~2006. ~~Interest is paid semi-annually on February~~ ~~1 and August 1 of each year.~~

- 68 -


		Face				Outstanding
Date		Value		Discount		Amounts		Interest			Maturity
Issued	Description	(Million)		(Million)		(Millions)		Rate			Date
6/27/02	Sr. Notes Unsecured (1)	$	165.0	$	1.5	$	163.5		11.875	%	8/1/09
6/27/02	Sr. Subordinated Notes (2)	$	10.0	$	.2	$	9.8		13.75	%	6/27/10
6/27/02	Sr. Subordinated Discount Notes (3)	$	52.3	$	.7	$	51.6		16.5	%	6/27/10
7/15/05	Sr. Secured Notes (4)	$	50.0			$	50.0		14.0	%	6/1/09
7/15/05	Revolving Credit (5)	$	10.0					Floating			5/1/09
7/15/05	Letters of Credit (5)	$	20.0					Floating			5/1/09
	Total Short Term Debt	$	307.3	$	2.4	$	274.9

PCA LLC’s prior senior secured credit facility was entered into on June 27, 2002 for a period of 5 years, which allowed PCA LLC to borrow up to $50.0 million of which $25.0 million may have been letters of credit. Outstanding revolving loans under this credit facility bore interest at a rate equal to the London inter-bank offered rate (“LIBOR”) plus 3.5% or, at PCA LLC’s option, the Alternate Base Rate (which is the higher of (i) the Bank of America, N.A. prime rate and (ii) the Federal Funds rate plus 0.50%) plus 2.5%. PCA LLC may have prepaid loans and reduced the amounts available to PCA LLC at any time by giving prior notice without premium or penalty. PCA LLC was required to prepay loans with 100% of the net cash proceeds of all asset sales by the Company and its subsidiaries (subject to certain restrictions), 100% of the net cash proceeds from the issuance of debt (subject to certain restrictions), and 100% of the net cash proceeds from the issuance of equity by the Company and/or any of its subsidiaries, provided that such net cash proceeds may have been applied to prepay up to 35% of the outstanding Senior Notes. In addition, PCA LLC was subject to mandatory prepayment obligations so that from December 15, 2002 through January 15, 2003 the aggregate principal amount of loans outstanding would not have exceeded $20.0 million, from December 15, 2003 through January 15, 2004 the aggregate principal amount of loans outstanding would not have exceeded $15.0 million, and from December 15 through January 15 of each year thereafter the aggregate principal amount of loans outstanding would not have exceeded $10.0 million. On February 4, 2005, the lenders under PCA LLC’s prior senior secured credit facility and PCA LLC executed an additional amendment to the prior senior secured credit facility agreement, effective as of January 31, 2005. Pursuant to this amendment, all defaults under the agreement caused by the Company’s failure to meet certain financial covenants with respect to the period ended October 31, 2004 were waived and certain terms of the agreement were permanently amended, effective January 31, 2005, including certain financial covenants, the interest rate setting mechanism, the mandatory prepayment requirements and other provisions. The mandatory prepayment provisions were modified such that the aggregate principal amount of loans outstanding would not have exceeded $15.0 million from December 15, 2005 to January 15, 2006 and from December 15, 2006 to January 15, 2007.


(1)		Redeemable at the Company’s option at the greater of 101% or make–whole premium plus accrued and unpaid interest.

(2)		Interest payable semi-annually in arrears.

(3)		$30 million face value, interest added to principal through 6/27/07. Thereafter interest payable in cash semi-annually in arrears.

(4)		Interest payable monthly.

(5)		Interest payable monthly at a floating rate of 5.0% over the prime or LIBOR rate until July 30, 2006. Thereafter, interest is at a floating rate of 1.75%-3.00% or 3.75%-5.00% over prime or LIBOR respectively. Borrowing may be limited based on the Company’s trailing twelve months EBITDA.

~~Also on June~~ The ~~27,~~debt ~~2002,~~facilities ~~PCA~~contain ~~International,~~various ~~Inc.,~~covenants ~~predecessor~~which tomay ~~Portrait~~limit ~~Corporation of America,~~or ~~Inc.,~~restrict ~~issued~~the ~~$30.0~~incurrence ~~million~~ of ~~senior subordinated discount notes~~ ~~(“Parent Notes”)~~indebtedness, ~~PCA~~the ~~LLC~~creation ~~issued~~of ~~$10.0~~liens, ~~million~~mergers, ofconsolidations, ~~senior~~transactions ~~subordinated~~with ~~notes~~affiliates, ~~(“Opco~~amendments ~~Notes”)~~to ~~and~~material ~~PCA~~agreements, ~~International~~investments, ~~Inc.~~dividends ~~issued warrants to purchase common stock~~ and ~~preferred~~asset ~~stock~~sales ofby the Company ~~related to both the Parent Notes and the Opco Notes~~. ~~The~~We ~~value of the warrants at the time of issuance, $1.6 million,~~are ~~has~~also ~~been~~subject ~~treated as a discount~~ to ~~the~~customary ~~Parent~~financial ~~Notes~~covenants ~~and~~including ~~the~~a ~~Opco~~fixed ~~Notes~~charge ~~with the discount~~coverage ~~being~~ratio ~~amortized to interest expense through June 27, 2010~~requirement.

The ~~Parent~~Company’s ~~Notes~~debt ~~are~~obligations ~~subordinated to the guarantee of the new senior secured credit facility and the Senior Notes by Portrait Corporation of America, Inc. The Parent Notes bear interest~~ at ~~a rate of 16.5% per year. Through June 27~~January 29, ~~2007, interest~~ ~~will~~2006 be added to the outstanding principal amount of the Parent Notes semiannually, in arrears (“paid-in-kind interest”). After June 27, 2007, interest will be payable in cash semiannually in arrears at the rate of 16.5%. In fiscal 2004 and fiscal 2003, as a result, $6.5 million and $5.6 million, respectively, was added to the outstanding principal amount. Portrait Corporation of America, Inc. must repay in full all amounts outstanding under the Parent Notes by June 27, 2010. Portrait Corporation of America, Inc. may repay amounts outstanding in whole or in part at specified premiums at any time. The Parent Notes contain negative covenants and other restrictions that, among other things, subject to certain restrictions, restrict the Company’s and its subsidiaries’ ability to engage in certain activities. At January 30, 2005, ~~the Company~~is ~~was~~summarized ~~in compliance with such covenants.~~ as follows:

The Opco Notes are subordinated to the new senior secured credit facility and the Senior Notes and are guaranteed by Portrait Corporation of America, Inc. and all of PCA LLC’s domestic subsidiaries (other than the Co-issuer). The Opco Notes bear interest payable in cash semiannually, in arrears, at a rate of 13.75% per year. PCA LLC must repay in full all amounts outstanding under the Opco Notes by June 27, 2010. PCA LLC may repay amounts outstanding in whole or in part at specified premiums at any time. The Opco Notes contain negative covenants and other restrictions that, among other things, subject to certain restrictions, restrict the Company’s and its subsidiaries’ ability to engage in certain activities. At January 30, 2005, the Company was in compliance with such covenants.


	January 29, 2006		January 30, 2005
Senior Notes, net of discount	$	163,555	$	163,142
Senior Secured Credit Facility		50,000		29,000
Senior Subordinated Notes (Opco Notes), net of discount		9,778		9,728
Senior Subordinated Discount Notes (Parent Notes), net of discount		51,588		43,776

-63 ~~69 -~~

The net proceeds of $157.1 million from the issuance of the Senior Notes by PCA LLC were used, together with borrowings under the prior senior secured credit facility ($24.9 million) and the net proceeds from the sale of the Opco Notes ($9.7 million), to pay a dividend to the Company ($191.7 million). The Company used such dividend, together with the net proceeds from the sale of the Parent Notes ($29.1 million), to repay its previously outstanding senior secured credit facility ($113.3 million), its previously outstanding senior subordinated term loans ($105.1 million), and related interest and fees ($2.4 million). As a result of these extinguishments, the Company realized a loss on the early extinguishment of debt in fiscal 2002, of $4.6 million. The loss was comprised of $10.2 million for the write-off of deferred financing costs less $5.6 million for the write-off of accrued effective interest on retired increasing rate debt.


	January 29, 2006		January 30, 2005
Other		34		216

Total debt		274,955		245,862
Less—current portion of long-term debt		21		182

Long-term debt	$	274,934	$	245,680

The Company’s ~~long-term~~scheduled contractual debt atmaturities ~~January~~for ~~30,~~the ~~2005~~next ~~and~~five ~~February~~fiscal 1,years ~~2004~~and thereafter isare ~~summarized~~ as follows:

	January 30, 2005			February 1, 2004
2006		21
Senior Notes, net of discount	$	163,142		$	162,729
2007		—
Senior Secured Credit Facility		29,000			20,000
2008		—
Senior Subordinated Notes (Opco Notes), net of discount		9,728			9,678
2009		215,000
Senior Subordinated Discount Notes (Parent Notes), net of discount		43,776			37,088
2010 and thereafter		62,266
Other		216			442
Total debt maturities		277,287
Total debt		245,862			229,937
Debt discounts		(2,332	)
Less—current portion of long-term debt		182			10,279
Total debt	$	274,955
Long-term debt	$	245,680		$	219,658

The Company’s scheduled contractual debt maturities (prior to the July 15, 2005 issuance of Senior Secured Notes, discussed in Note 17) for the next five fiscal years and thereafter are as follows:

2005	$	14,182
2006		21
2007		15,013
2008		---
2009		165,000
2010 and thereafter		54,592
Total debt maturities		248,808
Debt discounts		(2,946	)
Total debt	$	245,862

4. Derivative Instruments

Series A Redeemable Convertible Preferred Stock

In connection with a 1999 recapitalization, the Company issued $15 million of its ~~Series~~ Series A preferred stock for net 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 provisions of the Series A preferred stock. ~~Upon~~On ~~the~~December 20, ~~filing of~~ 2002 restated articles of incorporation onwere ~~December 20, 2002,~~filed modifying the liquidation and redemption provisions of the Series A preferred ~~stock were~~ ~~modified~~stock. The redemption of the Series A preferred stock by the Company will be at the option of the holders of the ~~Series A~~ preferred stock, rather than being mandatorily redeemable on April 30, 2011. ~~Also,~~The ~~the~~ redemption price of the Series A preferred stock and the amount payable upon certain extraordinary events will be $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 preferred stock is convertible plus all declared and unpaid dividends. As a result of the change in these provisions, the Company has determined the embedded derivative in the Series A preferred stock no longer meets the requirements for bifurcation and separate accounting under the provisions of SFAS No. 133.

-5. Inventories ~~70 -~~

~~Upon the adoption~~ The ofcomponents ~~SFAS No. 133 in fiscal 2001, the Series A preferred stock met the definition~~ of ainventory ~~hybrid~~are ~~instrument. This hybrid instrument was~~ comprised of ~~a debt~~ ~~instrument (mandatorily redeemable preferred stock), as~~ the ~~host contract,~~following: and an embedded derivative consisting of the conversion option, which derived its value, in part, based on the changes in fair value of the Company’s common stock. The embedded derivative instrument was not clearly and closely related to the underlying debt instrument since the economic characteristics and risks associated with this derivative were based on equity prices. Therefore, in accordance with SFAS No. 133, the Company separated the embedded derivative instrument from the hybrid instrument 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.

In order to determine the SFAS No. 133 transition adjustment associated with the Series A preferred stock, the Company first determined the initial carrying amount of the embedded derivative instrument based on its relative fair value as of the date that it was issued. The Company then separated the fair value of the embedded derivative instrument from the preferred stock and the resulting difference in the initial carrying amount, after separation of the embedded derivative, has been accounted for as a discount on the underlying preferred stock. The carrying amount of the preferred stock as of January 29, 2001 (date of adoption of SFAS No. 133) was then determined based on its initial fair value adjusted for any subsequent activity, such as amortization of the discount arising from the separation of the embedded derivative instrument. The carrying amount of the embedded derivative instrument as of January 29, 2001 was also determined based on its fair value as of that date. The difference between the carrying amount of the preferred stock as of January 29, 2001, just prior to the adoption of SFAS No. 133, and the sum of the adjusted carrying amount of the underlying preferred stock and fair value of the embedded derivative instrument as of January 29, 2001, resulted in a one-time after-tax charge to earnings of approximately $1.7 million, which was classified as a component of the cumulative effect of accounting change in the consolidated statement of operations, and an adjustment to the carrying value of the preferred stock of $7.8 million.


	January 29,		January 30,
	2006		2005
Photographic developing materials	$	4,552	$	4,366
Photographic supplies		5,528		5,089
Sales supplies		1,265		1,061
Repair parts		999		923
Total Inventory	$	12,344	$	11,439

~~Changes in the fair value of the embedded derivative instrument were classified as mark-to-market derivative expense in the consolidated statement of operations~~6. In ~~fiscal~~Other ~~2002,~~Accrued ~~the mark-to-market change in the fair value of the derivative~~Liabilities instrument resulted in a charge of $2.8 million. On December 20, 2002, the Company changed the redemption and liquidation provisions. On that date the value of the derivative was determined to be $27.3 million. Given the change in the liquidation and redemption provisions of the Series A preferred stock 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 preferred stock on the balance sheet. The carrying amount of the Series A preferred stock after this reclassification on December 20, 2002 was $15.0 million. The embedded derivative balance in excess of the amount required to increase the carrying amount of the Series A preferred stock to its redemption value of $15.0 million, or $20.4 million, was reclassified into Additional Paid-in Capital.

~~5. Other~~64 ~~Accrued Liabilities~~

Other accrued liabilities are comprised of the following:

	January 30, 2005		February 1, 2004
	January 30,			January 30,
Accrued taxes other than income	$	2,655	$	2,587
	2006			2005
Other accrued expenses		6,398		3,260
Accrued taxes other than income		1,217		$	2,655
Customer deposits		5,414		4,272
Other accrued expenses		4,968			6,398
Total other accrued liabilities	$	14,467	$	10,119
Deferred revenue		2,917			—
Customer deposits		7,063			5,414
Total other accrued liabilities	$	16,165		$	14,467

-7. Other Liabilities ~~71 -~~

6. Other Liabilities

Other liabilities are comprised of the following:

	January 30, 2005		February 1, 2004
	January 30,			January 30,
Accrued interest	$	695	$	628
	2006			2005
Long-term portion of retiree benefit obligation		---		1,061
Accrued interest	$	790		$	695
Long-term portion of workers’ compensation obligations		4,~~053~~158		~~3,916~~	4,053
Long-term occupancy obligations		95131		74	95
Total other liabilities	$	45,~~843~~079	$	~~5,679~~$	4,843

78. Income Taxes

Portrait Corporation of America, Inc. and its domestic subsidiaries file a consolidated federal income tax return. The components of income tax (provision) benefit are as follows:

	For the Fiscal Year Ended
	Fiscal Year Ended
	January 30, 2005			February 1, 2004			February 2, 2003
	January 29,				January 30,				February 1,
Current:
	2006				2005				2004
Federal	$	---		$	77		$	(200	)
Current:
State		---			(476	)		(26	)
Federal	$	—			$	—			$	77
Foreign		(1,329	)		(95	)		(52	)
State		—				—				(476	)
Total current		(1,329	)		(494	)		(278	)
Foreign		—				(1,329	)			(95	)
Deferred:
Total current		—				(1,329	)			(494	)
Federal		2,229			(2,581	)		(2,386	)
Deferred:
State		678			(158	)		377
Federal		9,081				2,229				(2,581	)
Foreign		1,001			1,085			(1,488	)
State		1,952				678				(158	)
Valuation allowance change		(17,348	)		---			18,592
Foreign		41				1,001				1,085
Total deferred		(13,440	)		(1,654	)		15,095
Valuation allowance change		(11,074	)			(17,348	)			—
Total (provision) benefit	$	(14,769	)	$	(2,148	)	$	14,817
Total deferred		—				(13,440	)			(1,654	)
Total (provision) benefit	$	—			$	(14,769	)		$	(2,148	)

For the years ended January 30 29, ~~2005~~2006, ~~February 1~~January 30, ~~2004~~2005, and February 2 1, ~~2003~~2004, the ~~provision~~ provision for income taxes differs from the amount of income tax determined by using the applicable U.S. statutory rate. The determination of the Company’s provision for income taxes requires significant judgment and the use of estimates to interpret and apply complex international and domestic tax laws. Reserves are established when, despite management’s belief the Company’s tax return positions are fully supportable, management believes certain positions may be successfully challenged. The consolidated tax provision includes the impact of changes to accruals that are considered appropriate, as well as the related net interest and penalties, if applicable. When facts and circumstances change, these reserves are adjusted through the provision for income taxes. As of January 30, 2005 and February 1, 2004, the Company had accrued $1.9 million and $0.6 million, respectively, for probable liabilities resulting from possible tax assessments by various taxing authorities.

-65 ~~72 -~~

estimates to interpret and apply complex international and domestic tax laws. Reserves are established when, despite management’s belief that the Company’s tax return positions are fully supportable, management believes certain positions may be successfully challenged. The consolidated tax provision includes the impact of changes to accruals that are considered appropriate, as well as the related net interest and penalties, if applicable. When facts and circumstances change, these reserves are adjusted through the provision for income taxes. As of January 29, 2006 and January 30, 2005, the Company had accrued $1.7 million and $1.9 million, respectively, for probable liabilities resulting from possible tax assessments by various taxing authorities.

A reconciliation of the amount computed by applying the U.S. statutory federal income tax rate to income before income taxes of the Company to the consolidated income tax (provision) benefit follows:

	For the Fiscal Year Ended
	January 30, 2005						February 1, 2004						February 2, 2003
	January 29,								January 30,								February 1,
	Amount			Percent			Amount			Percent			Amount			Percent
	2006								2005								2004
Tax (provision) benefit at U.S. statutory federal rates	$	5,090			34	%	$	(1,180	)		(34	)%	$	130			34	%
	Amount				Percent				Amount				Percent				Amount			Percent
Expenses not deductible		(197	)		(1	)		(210	)		(6	)		(228	)		(60	)
Tax (provision) benefit at U.S. statutory federal rates	$	11,710				34	%		$	5,090				34	%		$	(1,180	)		(34	)%
State income tax (provision) benefit, net of federal income tax (provision) benefit		447			3			(416	)		(13	)		(475	)		(124	)
Expenses not deductible		34				(1	)			(197	)			(1	)			(210	)		(6	)
Additional foreign subsidiary taxes		(1,941	)		(13	)		334			10			(1,868	)		(488	)
State income tax (provision) benefit, net of federal income tax (provision) benefit		1,268				4				447				3				(416	)		(13	)
Mark-to-market derivative expense		---			---			---			---			(944	)		(247	)
Additional foreign subsidiary taxes		(1,488	)			—				(1,941	)			(13	)			334			10
Non-deductible interest		(~~820~~959	)		(5	)(3	)	~~(676~~	)	(820	~~(19~~)	)		(15	)		~~---~~	(676	)		(19	)
Valuation allowance		(1711,~~348~~074	)		~~(117~~	)(36	)	~~---~~		(17,348	~~---~~)			~~18,592~~(117	)		~~4,866~~	—			—
Other		---			---			---			---			(389	)		(102	)
Release of tax reserves		269				1
Total (provision) benefit	$	(14,769	)		(99	)%	$	(2,148	)		(62	)%	$	14,817			3,879	%
Other		240				1				—				—				—			—
Total (provision) benefit	$	0				0	%		$	(14,769	)			(99	)%		$	(2,148	)		(62	)%

-67 ~~73 -~~

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at January 30 29, ~~2005~~2006 and ~~February~~ 1January 30, ~~2004~~2005 are as follows:

	January 30, 2005			February 1, 2004
	January 29,				January 30,
Deferred tax assets:
	2006				2005
Current:
Deferred tax assets:
Inventory, principally due to obsolescence reserve	$	237		$	207
Current:
Workers’ compensation accrual		1,271			1,055
Inventory, principally due to obsolescence reserve	$	242			$	237
Deferred revenue		1,612			---
Workers’ compensation accrual		1,271				1,271
Other		254			343
Deferred revenue		1,507				1,612
Valuation allowance		(2,086	)		---
Other		630				254
Net current deferred tax assets		1,288			1,605
Valuation allowance		(2,807	)			(2,086	)
Noncurrent:
Net current deferred tax assets		843				1,288
Alternative minimum tax and other tax credits		1,333			1,365
Non-current:
Net operating loss carryforward (federal, state, foreign)		16,944			14,494
Alternative minimum tax and other tax credits		1,333				1,333
Postretirement benefits		---			460
Net operating loss carry-forward (federal, state, foreign)		26,191				16,944
Intangibles		29(147	)		89	29
Stock option, principally due to compensation element		803			~~778~~	803
Interest expense deferred for tax		36,~~933~~118			~~2,008~~	3,933
Workers’ compensation accrual		1,~~662~~935			~~1,519~~	1,662
Other		~~---~~60			17	—
Valuation allowance		(1525,~~339~~692	)		~~(77~~	)(15,339	)
Net noncurrent deferred tax assets		9,365			20,653
Net non-current deferred tax assets		10,601				9,365
Total deferred tax assets		1011,~~653~~444			~~22,258~~	10,653
Deferred tax liabilities:
Current:
Prepaid expenses		(~~1,179~~843	)		~~---~~	(1,179	)
Noncurrent:
Non-current:
Plant and equipment, principally due to differences in depreciation		(910,~~474~~601	)		~~(8,818~~	)(9,474	)
Total deferred tax liabilities		(1011,~~653~~444	)		~~(8,818~~	)(10,653	)
Net deferred tax assets	$	~~---~~0		$	~~13,440~~$	0

For the fiscal year ended January 30 29, ~~2005~~2006, a valuation allowance was provided against ~~the~~ the deferred tax assets since management concluded it was more likely than not that such deferred tax assets would ultimately not be realized.

At ~~January~~ 30January 29, ~~2005~~2006, the Company had gross U.S. federal, foreign and state net operating loss carry-forwards ~~carryforwards~~ of approximately $33 57 million, $8 12 million and $4 6 million, respectively, expiring in various amounts beginning 2010 through 2025. Additionally, the Company has minimum tax credit carry-forwards ~~carryforwards~~ with indefinite expiration of approximately $1 million.

89. Employee Benefits

The Company has a profit sharing plan with annual discretionary contributions by the ~~Company~~ Company as directed by the Board of Directors for all employees who meet certain eligibility requirements. The Company made no contributions in fiscal ~~2004~~2005, fiscal ~~2003~~2004, or fiscal ~~2002~~2003.

-68 ~~74 -~~

The Company also sponsors a 401(k) plan for all employees. Employees may elect to ~~contribute~~ contribute up to seventy-five percent of their gross wages. The Company did not contribute to this plan in fiscal ~~2004~~2005, ~~2003~~2004 and ~~2002~~2003.

The Company previously provided health and life insurance benefits, effective ~~February~~ February 1, 1992, to those persons already retired on February 1, 1992 and to those employees who were 55 years of age with 5 years of service on February 1, 1992. ~~The~~On ~~plan~~June 29, ~~provides~~2004, ~~for~~the ~~annual~~Board ~~benefits~~ of ~~$2,000~~Directors ~~(single) or $4,000~~of ~~(married)~~the ~~toward~~Company ~~the~~passed ~~purchase~~a ofresolution ~~supplemental~~to ~~health~~terminate ~~care~~this ~~coverage~~plan. AnAs ~~eligible employee~~a ~~who~~result ~~retired~~of ~~after~~this ~~February 1~~termination, ~~1992~~the Company ~~could~~recognized ~~have~~a ~~received~~reduction ~~benefits after attaining~~in the ~~age~~accrued ofbenefit ~~65.~~cost ~~The~~for this plan ~~was~~and ~~closed~~a tocorresponding reduction ~~new participants~~ in ~~March 1993~~ general and ~~only~~administrative ~~employees~~expenses inof ~~the~~$1.1 million, ~~plan~~representing ~~prior~~a toreversal ~~March~~of ~~1993~~future costs ~~were~~accrued ~~eligible~~under ~~for benefits~~the plan.

~~On June 29, 2004, the Board of Directors of the Company passed a resolution to terminate this plan~~10. AsCommitments ~~a result of this termination, the Company recognized a reduction in the accrued benefit cost for this plan~~ and ~~a corresponding reduction in~~Contingencies ~~general and administrative expenses of $1.1 million, representing a reversal of future costs accrued under the plan.~~

The ~~weighted~~ ~~average~~Company ~~discount~~is ~~rate~~committed ~~used~~under inlease ~~determining~~arrangements ~~the~~covering ~~accumulated postretirement~~certain ~~benefit~~computer ~~obligation~~and ~~was~~office equipment. ~~approximately~~The 6%approximate atminimum ~~February~~rental 1,payments ~~2004. There~~under ~~were~~existing nonon-cancelable ~~assumptions~~leases ~~for~~with initial ~~trends~~or ~~since~~remaining ~~the~~terms ~~Company’s~~of ~~obligation~~more ~~was~~than ~~limited to~~one ~~the~~year ~~dollar~~at ~~amounts~~January 29, ~~previously~~2006 ~~stated.~~are as follows:

The following tables set forth the change in projected benefit obligation and funded status of the health and life insurance benefits plan as of January 30, 2005 and February 1, 2004:


	Operating		Capital
Fiscal Year	Leases		Leases
2006		874		24
2007		391		13
2008		167		—
2009		21		—
2010		0		—
2011		0		—

Total	$	1,453	$	37

Less amounts representing interest				3

Total principal on capital leases			$	34

	January 30, 2005			February 1, 2004
Change in benefit obligation:
Benefit obligation at beginning of year	$	1,191		$	1,220
Benefits paid		(80	)		(134	)
Net periodic benefit cost		---			68
Actuarial (gain) loss		(1,111	)		37
Benefit obligation at end of year	$	---		$	1,191
Plan assets	$	---		$	---
Funded status	$	---		$	(1,191	)
Accrued benefit cost	$	---		$	(1,191	)

Certain of the Company’s operating lease agreements have renewal options. Rental expense for all operating leases was $1.8 million, $1.7 million, and $1.3 million for the fiscal years ended January 29, 2006, January 30, 2005 and February 1, 2004, respectively.

Effective January 1, 2006, the Company has agreed to purchase 100% of its North American requirements for color negative film from Kodak during the period beginning January 1, 2006 and ending June 30, 2007, except that the Company may purchase up to 1% of its North American requirements for film from other vendors for testing and evaluation. The Company has agreed to ~~components~~purchase a minimum number of ~~net~~rolls ~~periodic~~of ~~benefit~~color ~~costs~~negative ~~are~~film asfrom ~~follows:~~Kodak during the period. In the event the Company fails to purchase a minimum number of rolls of film, Kodak may recover from the Company an amount equal to the difference between the actual number of rolls purchased and the minimum requirement.

	For the Fiscal Year Ended
	January 30, 2005		February 1, 2004		February 2, 2003
Interest cost	$	---	$	68	$	67
Amortization		---		---		(11	)
Net periodic benefit costs	$	---	$	68	$	56

Effective December 8, 2005, the Company has agreed to purchase 100% of its North American requirements for photographic paper and chemicals from Fuji during the period beginning January 1, 2006 and ending June 30, 2007. The Company has agreed to purchase a minimum square footage of paper from Fuji during the period, and will be subject to a penalty on any amount by which this minimum purchase requirement exceeds the number of square feet of paper actually purchased under the supply agreement.

-69 ~~75 -~~

Of The Company leases 47 locations for its Hometown Threads® business, purchased on October 22, 2004 as described in Note 14, from Wal-Mart pursuant to separate leases, the first of which was ~~above~~entered ~~accrued~~into ~~postemployment~~on ~~costs~~May 15, $12000.1 ~~million~~Hometown Threads® franchisees sublease all of these locations. The leases are for a term of 5 years each with the option to renew for an additional 5 years provided the Company gives Wal-Mart at ~~February~~least 1,180 days ~~2004~~notice isof ~~included~~the desire to renew. The sub-lessees pay inrent ~~Other~~directly ~~Liabilities~~to Wal-Mart, but, in the ~~accompanying~~event ~~consolidated~~a ~~balance~~franchisee ~~sheets~~does not pay the rent, ~~while~~the Company is $0liable to Wal-Mart for any such unpaid rent.1 The amounts of these subleases not included in the ~~million~~table isof ~~classified~~non-cancelable asleases ~~Other~~with ~~Accrued~~initial ~~Liabilities~~or atremaining ~~February~~terms 1of more than one year at January 29, ~~2004.~~2006 are as follows:

9. Commitments and Contingencies


Fiscal Year	Amount
2006		662
2007		607
2008		482
2009		260
2010		112


Total	$	2,123

The Company is committed under lease arrangements covering certain computer and office equipment. The approximate minimum rental payments under existing non-cancelable leases with initial or remaining terms of more than one year at January 30, 2005 are as follows:

Fiscal Year	Operating Leases		Capital Leases
2005	$	1,363	$	24
2006		823		24
2007		492		13
2008		270		---
2009		125		---
2010 and thereafter		88		---
Total	$	3,161	$	61
Less amounts representing interest				8
Total principal on capital leases			$	53

Certain of the Company’s operating lease agreements have renewal options. Rental expense for all operating leases was $1.7 million, $1.3 million, and $0.9 million for the fiscal years ended January 30, 2005, February 1, 2004 and February 2, 2003, respectively.

Prior to February 4, 2002, the Company had a long-term non-cancelable supply agreement for the purchase of film, photographic paper and processing chemistry. On February 4, 2002, the Company entered into a new supply agreement. This agreement is for a period of five years and requires the Company to purchase substantially all of its annual North American requirements for photographic paper, film and processing chemistry during the period of the agreement from the supplier. There are no minimum or maximum purchase requirements under this supply agreement. As of January 30, 2005, the Company was not in compliance with this agreement due to exceeding payment terms. However, during fiscal 2004 the Company agreed to pay the supplier interest at an annual rate of 6% on past due payables. As a result, the Company recognized $0.4 million in interest expense related to these past due payables. The Company and this supplier entered into an agreement on June 15, 2005 to defer payment on all amounts outstanding with the supplier totaling $20.7 million as of that date until June 15, 2006, provided the Company does not breach its agreement with the supplier in any other way, and pays for the Company’s photographic film, paper and chemistry needs on a cash-on-delivery basis. The Company is currently negotiating a revised agreement with this supplier. On May 27, 2005, the supplier’s German parent company declared it was insolvent.

The Company leases 33 locations for its Hometown Threads® business, purchased on October 22, 2004 as described in Note 13, from Wal-Mart pursuant to separate leases, the first of which was entered into on May 15, 2000. Hometown Threads® franchisees sublease 32 of these locations and the Company operates one location as a company-owned store. The leases are for a term of 5 years each with the option to renew for an additional 5 years provided the Company gives Wal-Mart at least 180 days notice of the desire to renew. The sublessees, the 32 franchisees, pay rent directly to Wal-Mart, but, in the event a franchisee does not pay the rent, the Company is liable to Wal-Mart for any such unpaid rent. The amounts of these subleases not included in the table of non-cancelable leases with initial or remaining terms of more than one year at January 30, 2005 are as follows:

- 76 -

Fiscal Year	Amount
2005	$	559
2006		520
2007		448
2008		319
2009		112
Total	$	1,958

The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a materially adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.

1011. Redeemable Convertible Preferred Stock—Series A

On May 3, 1999, the Company completed the sale of 15,000 shares of its Series A preferred stock to Jupiter Partners II L.P. (“Jupiter Partners”) for net cash consideration of $14.9 million ($1,000 per share). Series A preferred stockholders are entitled to receive a dividend or distribution when the Board of Directors declares a dividend or makes any other distribution to the holders of common stock. Such dividend or distribution to Series A preferred stockholders will be equal to the amount of dividend or distribution that would be paid on the common stock into which the Series A preferred stock is convertible. Any such amounts shall be paid to the holders of Series A preferred stock at the same time such dividend is paid to holders of common stock. No such dividends have been declared.

~~The~~ Each share of the Series A preferred stock has voting rights equal to 125 shares of common stock, and at any time at the option of the holder, can be converted into 125 shares of the Company’s common stock, subject to adjustment for certain events. The Series A preferred ~~stock~~ stockholders shall also have the right to appoint one director to the Company’s Board of Directors.

Prior to December 20, 2002, the Company was required to redeem, to the extent it had legally available funds, all of the shares of Series A preferred stock on April 30, 2011. At the time of redemption, the Company was to have paid to the holders of Series A preferred stock the greater of $1,000 per share or the fair market value of the common stock into which such Series A preferred stock shares are convertible, plus all declared and unpaid dividends. In the event that the Company did not have sufficient legally available funds on such date to redeem all outstanding shares of the Series A preferred stock, then the Company would redeem on the redemption date the number of shares of the Series A preferred stock which it had legally available funds to redeem. The shares not redeemed on the redemption date would have been redeemed in whole or from time to time in part on the first date on which the Company had legally available funds for the redemption. Upon the filing of restated articles of incorporation on December 20, 2002, the liquidation and redemption provisions of the Series A preferred stock were modified. The redemption of the Series A preferred stock by the Company is now at the option of the holders of the Series A preferred stock, rather than being mandatorily redeemable on April 30, 2011. Also, the redemption price of the Series A preferred stock and the amount payable upon certain extraordinary events will be $1,000 per share plus all declared and unpaid dividends. For the year ended January 30 29, ~~2005~~2006, the Company had no declared but unpaid dividends.

-70 ~~77 -~~

1112. Stock Options and Warrants

Stock Options—The 1996 Omnibus Long-Term Compensation Plan (the “1996 Plan”) provides for the ~~issuance~~ issuance of up to 811,550 shares of the Company’s common stock (the same number that had been available for issuance under the Company’s 1990 Non-Qualified Stock Option Plan (the “1990 Plan”) and the 1992 Non-Qualified Stock Option Plan (the “1992 Plan”)). The 1996 Plan replaced and superseded the 1990 Plan and the 1992 Plan, except with respect to options and shares of common stock issued and outstanding under those plans which will continue to be governed by the terms of such plans. The 1996 Plan is designed to give the Board of Directors flexibility to adapt the long-term incentive compensation of key employees to changing business conditions through a variety of long-term incentive awards. Under the 1996 Plan, the Compensation Committee may approve the grant of employee Stock Options, ~~Stock~~ Stock Appreciation Rights (“SARs”), Performance Restricted Stock Awards, Performance Awards, and performance units (collectively, “Awards”) to senior level employees of the Company. In addition, the 1996 Plan provides for the grant of stock options to ~~nonemployee~~non-employee directors upon their election to the Board and allows ~~nonemployee~~non-employee directors to elect to take their compensation as directors in the form of options.

The Company has also adopted the PCA International, Inc. Stock Option Plan (the “New ~~Option~~ Option Plan”) in 1998. The purpose of the New Option Plan is to provide for certain officers, directors and key personnel of the Company and certain of its affiliates an equity-based incentive to maintain and to enhance the performance and profitability of the Company. The New Option Plan authorizes the ~~Company~~ Company to grant to participants options to purchase up to 555,000 shares of common stock. In In addition to the 555,000 shares of common stock authorized under the New Option Plan, the Company’s Board of Directors authorized options to purchase up to an additional 100,000 shares of the Company’s common stock for newly hired employees, promoted employees and in recognition of outstanding employee performance. The program relating to these options is administered on substantially similar terms as the New Option Plan.

Subject to the provisions of the New Option Plan, the option committee (the “Committee”) appointed by the Board of Directors, or any persons designated by the Committee, will have sole and complete authority to determine the participants to whom options will be granted, the number of shares to be covered by each option, the exercise price and the conditions and limitations applicable to the exercise thereof. As provided in each stock option agreement and in the New Option Plan, options become exercisable over time. Except to the extent otherwise provided in the applicable stock option agreement, each option vests ratably over 5 years.

Warrants—In addition, in fiscal 2000 the Company issued warrants for the purchase of 254,150 shares of its common stock at an exercise price of $0.20 per share ~~and in fiscal 2001 the Company issued warrants for the purchase of 254,150 shares of its common stock at an exercise price of $0~~.~~20 per share. Warrants issued in~~ ~~fiscal 2001 for the purchase of 254,150 shares of the Company’s common stock were cancelled on June 27, 2002.~~

Also on June 27, 2002, the Company issued warrants for the purchase of 52,460 shares of its common stock at an exercise price of $0.01 per share and 287 shares of its Series A preferred stock at an exercise price of $0.01 per share.

-71 ~~78 -~~

At ~~January~~ 30January 29, ~~2005~~2006, the range of exercise prices and the weighted average ~~remaining~~ remaining contractual life of common stock options and warrants outstanding are as follows:

			Common Stock Options and Warrants Outstanding
				Common Stock Options
Exercise Prices	Number Outstanding		Weighted Average Remaining Contractual Life			Number of Common Stock Options and Warrants Exercisable
				and Warrants Outstanding
$0.01		52,460		5.4			52,460
								Weighted Average		Number of
$0.20		254,150		1.6			254,150
				Number				Remaining		Common Stock Options
$8.00		294,300		1.7			294,300
	Exercise Prices			Outstanding				Contractual Life		and Warrants Exercisable
$18.50		5,000		3.1			5,000
	$	0.01			52,460				4.4		52,460
$26.50		303,450		1.9			300,950
	$	0.20			254,150				0.6		254,150
$30.00		147,000		4.3			99,050
	$	8.00			406,800				3.0		280,550
Total		1,056,360					1,005,910
	$	18.50			5,000				2.1		5,000
	$	26.50			186,950				3.6		118,950
	$	30.00			124,500				4.8		90,200
	Total				1,029,860						801,310

The ~~weighted~~ weighted average fair value per option granted in fiscal ~~2003~~2005 was $0, and ~~2002 was~~ $7.79, ~~and~~in ~~$8.27,~~fiscal ~~respectively~~2003. No options were granted in fiscal 2004. The weighted average fair value of warrants granted in fiscal 2002 was $30.48. No warrants were granted in fiscal ~~2004~~2005 and ~~2003~~2004. The Company valued its stock ~~options~~ options and warrants using the Black-Scholes option valuation method.

Weighted average fair value per option	January 30, 2005 (1)			February 1, 2004			February 2, 2003
	January 29,				January 30,				February 1,
Assumption used:
Weighted average fair value per option	2006				2005				2004
Weighted average expected volatility		N/A			40	%		40	%
Assumption used:
Weighted average expected dividend yield		N/A			0	%		0	%
Weighted average expected volatility		40	%			N/A				40	%
Weighted average risk-free interest rate		N/A			3.85	%		4.80	%
Weighted average expected dividend yield		0	%			N/A				0	%
Weighted average expected life, in years		N/A			8.00			8.00
Weighted average risk-free interest rate		4.45	%			N/A				3.85	%
Weighted average expected life, in years		8.00				N/A				8.00

_______________

(1) No options were granted in fiscal 2004.

Estimated volatility was based on an analysis of a comparable company because the Company’s stock is not publicly traded.

-72 ~~79 -~~

The following table sets forth information regarding the common stock option plans and warrants:

	Number of Common Shares			Weighted Average Price
	Number of				Weighted
Options and warrants outstanding February 3, 2002		1,313,897		$	11.68
	Common				Average
Options cancelled		(57,597	)		(10.75	)
	Shares				Price
Warrants cancelled		(254,150	)		(0.20	)
Options and warrants outstanding February 1, 2004		1,066,110			$	14.19
Options granted		5,000			30.00
Options cancelled		(9,750	)			(18.44	)
Warrants granted		52,460			0.01
Options and warrants outstanding January 30, 2005		1,056,360				14.15
Options and warrants outstanding February 2, 2003		1,059,610			13.99
Options cancelled		(257,500	)			(26.45	)
Options cancelled		(41,800	)		(28.04	)
Options granted		231,000				17.10
Options granted		49,500			30.00
Options and warrants outstanding January 29, 2006		1,029,860			$	11.73
Options exercised		(1,200	)		(8.00	)
Options and warrants outstanding February 1, 2004		1,066,110			14.19
Options cancelled		(9,750	)		(18.44	)
Options and warrants outstanding January 30, 2005		1,056,360		$	14.15

1213. Business Segments

The Company has two reportable segments, Retail and Institutional. The Retail segment serves customers in retail stores ~~and military bases~~ in the U.S., Canada, Mexico, Germany and the U.K. The Institutional segment serves institutional markets such as church congregations.

The Company evaluates performance based on sales and Adjusted EBITDA. The Company defines Adjusted EBITDA as income (loss) before cumulative effect of accounting change plus other expense, early extinguishments of debt, interest, taxes, depreciation and amortization. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in Note 1 to the consolidated financial statements.

Adjusted EBITDA is presented herein because the Company believes it to be relevant and ~~useful~~ useful to investors as it is used by management to evaluate the operating performance of the Company. Management also uses Adjusted EBITDA for planning and forecasting 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 other expense and the loss on ~~early~~ early extinguishments 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. Adjusted EBITDA is not a measure of financial performance under Generally Accepted Accounting Principles (“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. In addition, because other companies may present items similarly titled to “Adjusted EBITDA,” but determined with differing adjustments, Adjusted EBITDA as presented herein should not be used to evaluate the Company’s performance by comparison to any similarly titled measures presented by other companies. While management believes 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; therefore, management ~~utilizes Adjusted EBITDA as an operating performance~~ ~~measure in conjunction with a comparable GAAP measure such as net income and/or income from operations.~~

-73 ~~80 -~~

Business Segment Data
	Retail			Institutional			Consolidated
For the year ended January 30, 2005
Net loss	$	(27,441	)	$	(2,299	)	$	(29,740	)
Reconciling items:
Depreciation and amortization		12,642			176			12,818
Income tax provision		14,029			740			14,769
Interest income		(8	)		---			(8	)
Interest expense		31,368			1,099			32,467
Adjusted EBITDA	$	30,590		$	(284	)	$	30,306
For the year ended February 1, 2004
Net income (loss)	$	2,490		$	(1,168	)	$	1,322
Reconciling items:
Depreciation and amortization		11,225			183			11,408
Income tax provision		2,132			16			2,148
Interest income		(10	)		---			(10	)
Interest expense		29,532			1,184			30,716
Adjusted EBITDA	$	45,369		$	215		$	45,584
For the year ended February 2, 2003
Net income (loss)	$	16,940		$	(2,505	)	$	14,435
Reconciling items:
Depreciation and amortization		9,962			206			10,168
Income tax benefit		(14,143	)		(674	)		(14,817	)
Interest income		(14	)		---			(14	)
Interest expense		27,247			1,377			28,624
Other expense		2,652			124			2,776
Early extinguishment of debt		4,424			145			4,569
Adjusted EBITDA	$	47,068		$	(1,327	)	$	45,741

utilizes Adjusted EBITDA as an operating performance measure in conjunction with a comparable GAAP measure such as net income (loss) and/or income from operations.

For the year ended January 30, 2005
Sales	$	313,126	$	10,427		$	323,553
Adjusted EBITDA	$	30,590	$	(284	)	$	30,306
Total assets	$	165,786	$	1,006		$	166,792
For the year ended February 1, 2004
Sales	$	312,357	$	12,457		$	324,814
Adjusted EBITDA	$	45,369	$	215		$	45,584
Total assets	$	162,435	$	1,230		$	163,665
For the year ended February 2, 2003
Sales	$	282,309	$	14,307		$	296,616
Adjusted EBITDA	$	47,068	$	(1,327	)	$	45,741

-Business Segment Data ~~81 -~~

Geographic Data
	Retail				Institutional				Consolidated
	United States			Canada			Mexico			Other Foreign		Consolidated
For the year ended January 29, 2006
January 30, 2005
Net (loss)	$	(33,043	)		$	(1,399	)		$	(34,442	)
Sales	$	287,548		$	25,179		$	9,359		$	1,467	$	323,553
Reconciling items:
Long-term assets	$	114,654		$	7,848		$	2,310		$	2,348	$	127,160
Depreciation and amortization		13,950				151				14,101
Deferred tax assets	$	---		$	---		$	---		$	---	$	---
Interest income		(25	)			—				(25	)
February 1, 2004
Interest expense		37,642				1,143				38,785
Sales	$	294,067		$	21,466		$	8,446		$	835	$	324,814
Early debt extinguishment		980				—				980
Long-term assets	$	108,051		$	6,449		$	2,092		$	1,892	$	118,484
Adjusted EBITDA	$	19,504			$	(105	)		$	19,399
Deferred tax assets	$	13,440		$	---		$	---		$	---	$	13,440
For the year ended January 30, 2005
February 2, 2003
Net (loss)	$	(27,441	)		$	(2,299	)		$	(29,740	)
Sales	$	272,628		$	17,018		$	6,876		$	94	$	296,616
Reconciling items:
Depreciation and amortization		12,642				176				12,818
Income tax provision		14,029				740				14,769
Interest income		(8	)			—				(8	)
Interest expense		31,368				1,099				32,467
Adjusted EBITDA	$	30,590			$	(284	)		$	30,306
For the year ended February 1, 2004
Net income (loss)	$	2,490			$	(1,168	)		$	1,322
Reconciling items:
Depreciation and amortization		11,225				183				11,408
Income tax benefit		2,132				16				2,148
Interest income		(10	)			—				(10	)
Interest expense		29,532				1,184				30,716
Adjusted EBITDA	$	45,369			$	215			$	45,584
For the year ended January 29, 2006
Sales	$	316,153			$	9,363			$	325,516
Adjusted EBITDA	$	19,504			$	(105	)		$	19,399
Total assets	$	159,224			$	2,086			$	161,310
For the year ended January 30, 2005
Sales	$	313,126			$	10,427			$	323,553
Adjusted EBITDA	$	30,590			$	(284	)		$	30,306
Total assets	$	165,786			$	1,006			$	166,792
For the year ended February 1, 2004
Sales	$	312,357			$	12,457			$	324,814
Adjusted EBITDA	$	45,369			$	215			$	45,584
Total assets	$	162,435			$	1,230			$	163,665

~~13. Acquisitions,~~75 ~~Goodwill and Intangible Assets~~

~~At January~~Geographic ~~31, 2005, February 2, 2004 and February 3, 2003, the fair value of~~Data ~~the retail reporting unit exceeded the carrying value of that reporting unit. As a result, the Company recognized no impairments of goodwill in these fiscal years.~~

On October 22, 2004, PCA LLC, a wholly-owned subsidiary of the Company, acquired certain assets and assumed certain liabilities of Hometown Threads LLC (“Hometown Threads®”) from Hirsch International Corp. The results of operations of Hometown Threads®have been included in the consolidated financial statements since that date. Pro forma results for prior periods are not considered material. Hometown Threads® is an operator and franchisor of retail stores specializing in embroidery services and the personalization of gifts. The majority of Hometown Threads® stores are located in U.S. Wal-Mart stores. The purchase price was $1.5 million with $1.1 million paid at closing, $0.2 million to be paid under certain conditions and $0.2 million in assumed liabilities. The excess of the purchase price over the fair value of the net identifiable assets acquired, which included a trademark valued at $0.1 million, has been recorded as goodwill in the amount of $1.3 million.


							Other
	United States		Canada		Mexico		Foreign		Consolidated
January 29, 2006
Sales	$	283,697	$	29,448	$	10,466	$	1,905	$	325,516

Long-term assets	$	121,211	$	8,278	$	2,525	$	1,947	$	133,961

Deferred tax assets	$			—		—		—	$


January 30, 2005
Sales	$	287,548	$	25,179	$	9,359	$	1,467	$	323,553

Long-term assets	$	121,477	$	7,848	$	2,310	$	2,348	$	133,983

Deferred tax assets	$	108	$	—	$	—	$	—	$	108


February 1, 2004
Sales	$	294,067	$	21,466	$	8,446	$	835	$	324,814

14. Acquisitions, Goodwill and Intangible Assets

At January 29, 2006, January 30, 2005 and February 2, 2004, the fair value of

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