Attached files

file filename
EX-31.2 - CERTIFICATION BY CEO - CPI CORPexh31_2.htm
EX-11.1 - COMPUTATION OF PER COMMON SHARE LOSS-DILUTED - CPI CORPexh11_1.htm
EX-11.2 - COMPUTATION OF PER COMMON SHARE LOSS-BASIC - CPI CORPexh11_2.htm
EX-32.0 - CERTIFICATION BY CFO AND CEO - CPI CORPexh32_0.htm
EX-31.1 - CERTIFICATION BY CFO - CPI CORPexh31_1.htm
EX-10.58 - AMENDMENT TO CHAIRMAN'S AGREEMENT - CPI CORPexh10_58.htm




UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

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

For the quarterly period ended November 14, 2009                                                                                     or

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 1-10204

CPI Corp.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)
 
1706 Washington Ave., St. Louis, Missouri
(Address of principal executive offices)
43-1256674
(I.R.S. Employer Identification No.)
 
63103
(Zip Code)

Registrant’s telephone number, including area code: 314/231-1575

Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
Common Stock, par value $0.40 per share
Name of each exchange on which registered
New York Stock Exchange

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.              o Yes    x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  o Yes    x No
 
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. xYes    o No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  x Yes   o No

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

Large accelerated filer o     Non-accelerated filer o     Accelerated filer x     Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  o Yes    x No

As of December 21, 2009, _,___,___ shares of the registrant’s common stock were outstanding.




 
 
CPI CORP.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
16 and 40 WEEKS ENDED NOVEMBER 14, 2009



PART I.
 
FINANCIAL INFORMATION
 
Page
         
     
Financial Statements:
   
             
       
Interim Consolidated Balance Sheets
   
       
November 14, 2009 (Unaudited) and February 7, 2009
 
1
             
       
Interim Consolidated Statements of Operations (Unaudited)
   
       
16 and 40 weeks Ended November 14, 2009 and November 8, 2008
 
3
             
       
Interim Consolidated Statement of Changes in Stockholders'
   
       
Equity (Unaudited) 40 weeks Ended November 14, 2009
 
4
             
       
Interim Consolidated Statements of Cash Flow (Unaudited)
   
       
40 weeks Ended November 14, 2009 and November 8, 2008
 
5
             
       
Notes to Interim Consolidated Financial Statements (Unaudited)
 
7
             
     
Management's Discussion and Analysis of Financial Condition and Results of Operations
        18
             
     
Quantitative and Qualitative Disclosures about Market Risk
 
27
             
     
Controls and Procedures
 
27
             
PART II.
 
OTHER INFORMATION
   
             
     
Exhibits
 
28
     
     
29
     
     
30
                       

 
 
 


PART I.
 
FINANCIAL INFORMATION

 
Financial Statements

CPI CORP.
Interim Consolidated Balance Sheets - Assets



in thousands
 
November 14, 2009
   
February 7, 2009
 
   
(Unaudited)
       
ASSETS
           
Current assets:
           
     Cash and cash equivalents
  $ 8,286     $ 23,665  
     Accounts receivable:
               
          Trade
    10,711       6,050  
          Other
    926       923  
     Inventories
    9,804       8,489  
     Prepaid expenses and other current assets
    12,436       5,800  
     Refundable income taxes
    457       357  
     Deferred tax assets
    14,259       9,581  
     Assets held for sale
    6,577       6,615  
                 
     Total current assets
    63,456       61,480  
                 
Property and equipment:
               
     Land
    2,185       3,249  
     Buildings and building improvements
    25,184       32,377  
     Leasehold improvements
    4,460       4,406  
     Photographic, sales and manufacturing equipment
    168,780       178,732  
          Total
    200,609       218,764  
     Less accumulated depreciation and amortization
    162,850       167,877  
          Property and equipment, net
    37,759       50,887  
Prepaid debt fees
    2,462       2,262  
Goodwill
    21,759       21,459  
Intangible assets, net
    39,349       40,206  
Deferred tax assets
    8,796       8,359  
Other assets
    7,715       8,202  
                 
          TOTAL ASSETS
  $ 181,296     $ 192,855  
                 
See accompanying footnotes to the interim consolidated financial statements.
 
1
 

CPI CORP.
Interim Consolidated Balance Sheets – Liabilities and Stockholders’ Equity


 
in thousands, except share and per share data
 
November 14, 2009
   
February 7, 2009
 
   
(Unaudited)
       
LIABILITIES
           
Current liabilities:
           
     Current maturities of long-term debt
  $ 22,000     $ 1,150  
     Accounts payable
    6,685       6,816  
     Accrued employment costs
    13,295       10,146  
     Customer deposit liability
    19,599       12,503  
     Sales taxes payable
    4,355       5,284  
     Accrued advertising expenses
    7,479       978  
     Accrued expenses and other liabilities
    13,024       18,133  
                 
     Total current liabilities
    86,437       55,010  
                 
Long-term debt, less current maturities
    75,458       104,578  
Accrued pension plan obligations
    9,502       10,591  
Other liabilities
    16,492       21,841  
                 
     Total liabilities
    187,889       192,020  
                 
CONTINGENCIES (see Note 13)
               
                 
STOCKHOLDERS' EQUITY
               
Preferred stock, no par value, 1,000,000 shares authorized; no shares outstanding
    -       -  
Preferred stock, Series A, no par value, 200,000 shares authorized; no shares
               
     outstanding
    -       -  
Common stock, $0.40 par value, 50,000,000 shares authorized; 9,180,135 and 17,089,788
               
     shares outstanding at November 14, 2009 and February 7, 2009, respectively
    3,672       6,836  
Additional paid-in capital
    28,639       55,413  
Retained earnings
    20,939       183,704  
Accumulated other comprehensive loss
    (10,711 )     (13,114 )
      42,539       232,839  
Treasury stock - at cost, 2,175,591 and 10,270,319 shares at November 14, 2009 and
               
     February 7, 2009, respectively
    (49,132 )     (232,004 )
                 
     Total stockholders' equity
    (6,593 )     835  
                 
     TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 181,296     $ 192,855  
                 
See accompanying footnotes to the interim consolidated financial statements.
 
 
2
CPI CORP.
Interim Consolidated Statements of Operations
(Unaudited)



in thousands, except share and per share data
 
16 Weeks Ended
   
40 Weeks Ended
 
   
November 14, 2009
   
November 8, 2008
   
November 14, 2009
   
November 8, 2008
 
                         
Net sales
  $ 107,286     $ 115,689     $ 282,130     $ 308,619  
                                 
Cost and expenses:
                               
     Cost of sales (exclusive of depreciation and amortization shown below)
    8,032       11,288       21,643       31,412  
     Selling, general and administrative expenses
    99,940       109,552       245,480       269,761  
     Depreciation and amortization
    6,320       8,616       17,913       21,673  
     Other charges and impairments
    1,144       2,092       3,751       4,946  
      115,436       131,548       288,787       327,792  
                                 
Loss from operations
    (8,150 )     (15,859 )     (6,657 )     (19,173 )
                                 
Interest expense
    2,542       3,866       5,961       6,753  
Interest income
    130       87       370       567  
Other income, net
    236       56       253       59  
                                 
Loss before income tax benefit
    (10,326 )     (19,582 )     (11,995 )     (25,300 )
Income tax benefit
    (3,524 )     (6,507 )     (4,094 )     (8,727 )
                                 
Net loss from continuing operations
    (6,802 )     (13,075 )     (7,901 )     (16,573 )
Net loss from discontinued operations
    -       (266 )     -       (625 )
                                 
NET LOSS
  $ (6,802 )   $ (13,341 )   $ (7,901 )   $ (17,198 )
                                 
NET LOSS PER COMMON SHARE
                               
                                 
Net loss per share from continuing operations - diluted
  $ (0.97 )   $ (2.02 )   $ (1.13 )   $ (2.56 )
Net loss per share from discontinued operations - diluted
    -       (0.04 )     -       (0.10 )
Net loss per share - diluted
  $ (0.97 )   $ (2.06 )   $ (1.13 )   $ (2.66 )
                                 
Net loss per share from continuing operations - basic
  $ (0.97 )   $ (2.02 )   $ (1.13 )   $ (2.56 )
Net loss per share from discontinued operations - basic
    -       (0.04 )     -       (0.10 )
Net loss per share - basic
  $ (0.97 )   $ (2.06 )   $ (1.13 )   $ (2.66 )
                                 
Weighted average number of common and common equivalent
                               
     shares outstanding - diluted
    7,003,832       6,479,496       6,987,746       6,467,352  
                                 
Weighted average number of common and common equivalent
                               
     shares outstanding - basic
    7,003,832       6,479,496       6,987,746       6,467,352  
                                 
 
See accompanying footnotes to the interim consolidated financial statements.


 
3
 


CPI CORP.
Interim Consolidated Statement of Changes in Stockholders’ Equity
(Unaudited)

Forty weeks ended November 14, 2009

 
in thousands, except share and per share data
                   
Accumulated
             
         
Additional
         
other
   
Treasury
       
   
Common
   
paid-in
   
Retained
   
comprehensive
   
stock,
       
   
stock
   
capital
   
earnings
   
loss
   
at cost
   
Total
 
                                     
Balance at February 7, 2009
  $ 6,836     $ 55,413     $ 183,704     $ (13,114 )   $ (232,004 )   $ 835  
                                                 
Net loss
    -       -       (7,901 )     -       -       (7,901 )
Total other comprehensive income (consisting primarily of
                                               
foreign exchange impact)
    -       -       -       2,403       -       2,403  
                                                 
Total comprehensive loss
                                            (5,498 )
Surrender of employee shares for taxes
    -       -       -       -       (30 )     (30 )
Retirement of treasury stock (8,000,000 shares, at average cost)
    (3,200 )     (25,939 )     (151,527 )     -       180,666       -  
Issuance of common stock and restricted stock awards, net of
                                               
forfeitures (90,347 shares)
    36       (1,653 )     -       -       2,236       619  
Stock-based compensation recognized
    -       818       -       -       -       818  
Dividends ($0.48 per common share)
    -       -       (3,337 )     -       -       (3,337 )
                                                 
Balance at November 14, 2009
  $ 3,672     $ 28,639     $ 20,939     $ (10,711 )   $ (49,132 )   $ (6,593 )
                                                 

See accompanying footnotes to the interim consolidated financial statements.





 
4
 


CPI CORP.
Interim Consolidated Statements of Cash Flows
(Unaudited)


in thousands
 
40 Weeks Ended
 
   
November 14, 2009
   
November 8, 2008
 
Reconciliation of net loss to cash flows provided by (used in) operating activities:
           
             
Net loss
  $ (7,901 )   $ (17,198 )
                 
Adjustments for items not requiring (providing) cash:
               
     Depreciation and amortization
    17,913       21,673  
     Loss from discontinued operations
    -       625  
     Stock-based compensation expense
    818       703  
     Loss on disposition of property and equipment
    976       894  
     Deferred income tax provision
    (4,451 )     (9,753 )
     Pension, supplemental retirement plan and profit sharing expense
    680       1,310  
     Other
    781       515  
                 
Increase (decrease) in cash flow from operating assets and liabilities:
               
     Accounts receivable
    (4,527 )     814  
     Inventories
    (1,097 )     2,248  
     Prepaid expenses and other current assets
    (5,912 )     (8,286 )
     Accounts payable
    (163 )     (3,527 )
     Contribution to pension plan
    (1,245 )     (2,693 )
     Accrued expenses and other liabilities
    (1,524 )     381  
     Income taxes payable
    (98 )     (440 )
     Deferred revenues and related costs
    6,078       (279 )
     Other
    (186 )     (106 )
                 
Cash flows provided by (used in) continuing operations
    142       (13,119 )
                 
Cash flows used in discontinued operations
    -       (534 )
                 
Cash flows provided by (used in) operating activities
    142       (13,653 )
                 
See accompanying footnotes to the interim consolidated financial statements.




 
5
 


CPI CORP.
Interim Consolidated Statements of Cash Flows (continued)
(Unaudited)


 
in thousands
 
40 Weeks Ended
 
   
November 14, 2009
   
November 8, 2008
 
             
Cash flows provided by (used in) operating activities
    142       (13,653 )
                 
Cash flows used in financing activities:
               
     Repayment of long-term debt
    (8,270 )     (8,410 )
     Payment of debt issuance costs
    (943 )     -  
     Proceeds from short-term borrowings
    -       5,500  
     Cash dividends
    (3,337 )     (3,096 )
     Other
    (13 )     (131 )
     Cash flows used in financing activities
    (12,563 )     (6,137 )
                 
Cash flows (used in) provided by investing activities:
               
     Additions to property and equipment
    (4,508 )     (31,198 )
     Proceeds from sale of property and equipment
    1,326       2  
     Other
    130       95  
     Cash flows used in investing activities
    (3,052 )     (31,101 )
                 
Effect of exchange rate changes on cash and cash equivalents
    94       (163 )
                 
Net decrease in cash and cash equivalents
    (15,379 )     (51,054 )
                 
Cash and cash equivalents at beginning of period
    23,665       59,177  
                 
Cash and cash equivalents at end of period
  $ 8,286     $ 8,123  
                 
Supplemental cash flow information:
               
     Interest paid
  $ 5,487     $ 5,807  
                 
     Income taxes paid, net
  $ 440     $ 1,019  
                 
Supplemental non-cash financing activities:
               
     Issuance of treasury stock under the Employee Profit Sharing Plan
  $ 594     $ 521  
                 
     Issuance of restricted stock and stock options to employees and directors
  $ 800     $ 870  
                 
See accompanying footnotes to the interim consolidated financial statements.




 
6
 


CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

NOTE 1   -
DESCRIPTION OF BUSINESS AND INTERIM CONSOLIDATED FINANCIAL STATEMENTS
 
CPI Corp. (the “Company”) operates 2,938 professional portrait studios as of November 14, 2009, throughout the U. S., Canada, Mexico and Puerto Rico, principally under license agreements with Sears, Roebuck and Co. ("Sears") and lease and license agreements with Walmart Stores, Inc. (“Walmart”).  The Company also operates searsphotos.com, a vehicle for the Company’s customers to archive, share portraits via email and order additional portraits and products, and launched a similar website for PictureMe Portrait Studio® in the third quarter of 2009.

The Interim Consolidated Balance Sheet as of November 14, 2009, the related Interim Consolidated Statements of Operations for the 16 and 40 weeks ended November 14, 2009, and November 8, 2008, the Interim Consolidated Statement of Changes in Stockholders’ Equity for the 40 weeks ended November 14, 2009, and the Interim Consolidated Statements of Cash Flows for the 40 weeks ended November 14, 2009, and November 8, 2008, are unaudited.  The interim consolidated financial statements reflect all adjustments (consisting only of normal recurring accruals), which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the CPI Corp. 2008 Annual Report on Form 10-K for its fiscal year ended February 7, 2009.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

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 revenues and expenses during the reporting period.  Significant estimates include, but are not limited to, workers’ compensation and general liability insurance reserves; employee health self-insurance reserves; depreciation; recoverability of long-lived assets and goodwill; establishing restructuring reserves; defined benefit retirement plan assumptions; income tax and other reserves.  Actual results could differ from those estimates.

Certain reclassifications have been made to the 2008 financial statements to conform with the current year presentation, including the reclassification from additional paid in capital to retained earnings, at February 7, 2009, of a $26.9 million adjustment deriving from the retirement of treasury stock in fiscal year 2006, and the reclassification of approximately $2.3 million of unamortized prepaid debt fees from long-term debt.

NOTE 2   -
ADOPTION OF NEW ACCOUNTING STANDARDS

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB No. 162” (“SFAS No. 168”).  SFAS No. 168 provided for the FASB Accounting Standards Codification (“ASC” or the “Codification”) to become the single official source of authoritative, nongovernmental U.S. GAAP.  The Codification did not change U.S. GAAP but reorganized existing literature and is effective for interim and fiscal years ending after September 15, 2009.  The Company adopted the provisions of SFAS No. 168 (referenced as ASC Topic 105, “Generally Accepted Accounting Principles” (“ASC Topic 105”) under the Codification) on July 26, 2009.  The effect was not material to the Company’s financial statements; however, references to legacy U.S. GAAP, where appropriate, have been replaced with their respective ASC references.  Additionally, all authoritative U.S. GAAP issued by the FASB after July 1, 2009, has been designed to update the Codification and will now be referred to as Accounting Standards Updates (“ASU”).  ASU No. 2009-01, “Topic 105 – Generally Accepted Accounting Principles – amendments based on SFAS No. 168” issued in June 2009, created ASC Topic 105, as noted above, in the General Principles and Objective Section of the Codification and includes SFAS No. 168 in its entirety, including the accounting standards update instructions.

In September 2009, the FASB issued ASU No. 2009-06, “Income Taxes” (“ASU No. 2009-06”).  ASU No. 2009-06 provides additional implementation guidance to improve current accounting by helping to achieve consistent application of accounting for uncertainty in income taxes and is effective for interim and annual periods ending after September 15, 2009.  The Company adopted the applicable requirements of ASU No. 2009-06 on July 26, 2009, and the effect was not material to the Company’s financial statements.





 
7
 


CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

In August 2009, the FASB issued ASU No. 2009-05, “Fair Value Measurements and Disclosures” (“ASU No. 2009-05”).  ASU No. 2009-05 supplements and amends the guidance in ASC Topic 820, “Fair Value Measurements and Disclosures” to clarify how an entity should measure the fair value of liabilities and outlines alternative valuation methods and a hierarchy for their use.  ASU No. 2009-05 also clarifies that restrictions preventing the transfer of a liability should not be considered as a separate input or adjustment in the measurement of its fair value.  ASU No. 2009-05 is effective for interim and annual periods beginning after issuance of the Update.  The Company adopted the applicable requirements of ASU No. 2009-05 on July 26, 2009, and the effect was not material to the Company’s financial statements.

ASC Topic 855, “Subsequent Events” (“ASC Topic 855”) (formerly SFAS No. 165, “Subsequent Events” issued by the FASB in May 2009 and effective for interim and fiscal years ending after June 15, 2009) establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  In accordance with ASC Topic 855, the Company performed an evaluation of subsequent events through December 21, 2009, the date which the financial statements were issued, and determined no subsequent events had occurred which would require adjustment to or additional disclosure in its interim consolidated financial statements.

ASC Topic 715, “Compensation – Retirement Benefits” (“ASC Topic 715”) (which includes certain disclosure requirements issued under FASB Staff Position SFAS No. 132R-1, “Employers’ Disclosure about Postretirement Benefit Plan Assets”, an amendment of SFAS No. 132 (revised 2003), “Employers’ Disclosure about Pensions and Other Postretirement Benefits”, in December 2008 and effective for fiscal years ending after December 15, 2009) requires more detailed disclosures regarding defined benefit pension plan assets including investment policies and strategies, major categories of plan assets, valuation techniques used to measure the fair value of plan assets and significant concentrations of risk within plan assets.  These enhanced disclosures are required for fiscal years ending after December 15, 2009.  Upon initial application, the enhanced disclosures are not required for earlier periods that are presented for comparative purposes.  The Company is currently evaluating the enhanced disclosure requirements under ASC Topic 715.

NOTE 3   -
FAIR VALUE MEASUREMENTS

FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”) defines fair value, sets a framework for measuring fair value, which refers to certain valuation concepts and practices, and requires certain disclosures about fair value measurements.

Fair value is defined as the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties or the amount that would be paid to transfer a liability to a new obligor, not the amount that would be paid to settle the liability with the creditor.  Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters.

Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity.

Assets and liabilities recorded at fair value in the Interim Consolidated Balance Sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value.  Hierarchical levels, defined by ASC Topic 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:
 
Level 1 -
 
Inputs were unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
     
Level 2 -
 
Inputs (other than quoted prices included in Level 1) were either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
     
Level 3 -
 
Inputs reflected management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration was given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.


 
8
 


CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

Determining which hierarchical level an asset or liability falls within requires significant judgment.  The Company evaluates its hierarchy disclosures each quarter.  The following table summarizes the financial instruments measured at fair value in the Interim Consolidated Balance Sheet as of November 14, 2009 (in millions):


   
Fair Value Measurements
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
Liabilities
                       
Interest rate swap (1)
  $ -     $ 2.7     $ -     $ 2.7  
                                 

                                                             (1)
The total fair value of the interest rate swap is included in Accrued Expenses and Other Liabilities as of November 14, 2009.  This financial instrument was valued using the “income approach” valuation technique.  This method used valuation techniques to convert future amounts to a single present amount.  The measurement was based on the value indicated by current market expectations about those future amounts.  The Company uses its interest rate swap as a means of managing interest rates on its outstanding fixed-rate debt obligations.  Accordingly, the fair market value is estimated to approximate the recorded value of this instrument.  The fair value of the interest rate swap at November 14, 2009, and February 7, 2009, was $2.7 million and $3.5 million, respectively.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

Current Assets and Current Liabilities

Excluding deferred tax assets, the carrying amounts approximate fair value at November 14, 2009, and February 7, 2009, due to the short maturity of these financial instruments.

Deferred Tax Assets, Customer Deposit Liability and Other Long-Term Liabilities

For these financial instruments, fair market value is not practicable to estimate for the following reasons:

Deferred tax assets reverse over a variety of years and reversal periods are subject to future income levels.   These assets are recorded at the ultimate anticipated cash inflow, without regard to the time value of money.

Other assets, customer deposit liability and other long-term liabilities are due in periods that exceed one year and are not traded instruments.   These instruments are recorded at the ultimate anticipated cash value, without regard to the time value of money.

Goodwill and Intangible Assets

The Company uses fair value measurements when it periodically evaluates the recoverability of goodwill, and when it is required to assess the fair value of intangible assets in the event of an indication of impairment.  See further discussion in Note 7 to this Form 10-Q.

Property and Equipment

These assets have been purchased and held over varying timeframes; some are customized for the Company’s own use and resale values for such used items are not readily available.  The Company uses fair value measurements when it is required to estimate the fair value of property and equipment in the event of an indication of impairment.  The recorded value of these assets is further discussed in Note 1 in the CPI Corp. 2008 Annual Report on Form 10-K for its fiscal year ended February 7, 2009.

 
9
 


CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

NOTE 4   -
DISCONTINUED OPERATIONS

During the fourth quarter of 2008, the Company decided to discontinue its Portrait Gallery and E-Church operations.  This decision was made in order to eliminate the unprofitable operations.  Sales and operating results for these operations included in discontinued operations for the 16 and 40 weeks ended November 8, 2008, are presented in the following table:
 
in thousands
 
16 Weeks Ended
   
40 Weeks Ended
 
   
November 8, 2008
   
November 8, 2008
 
Discontinued operations:
           
             
Net sales
  $ 160     $ 304  
                 
Operating loss
  $ 426     $ 998  
Tax benefit
    160       373  
                 
Net loss from discontinued operations
  $ 266     $ 625  
                 
 
The net loss consists of costs to operate the Portrait Gallery and E-Church operations for the 16 and 40 weeks ended November 8, 2008, as well as related asset write-offs.

NOTE 5   -
INVENTORIES
 

Inventories consist of:


in thousands
 
November 14, 2009
   
February 7, 2009
 
             
Raw materials - film, paper and chemicals
  $ 2,929     $ 2,724  
Portraits in process
    2,010       1,313  
Finished portraits pending delivery
    147       261  
Frames and accessories
    438       426  
Studio supplies
    3,134       2,495  
Equipment repair parts and supplies
    728       878  
Other
    418       392  
                 
Total
  $ 9,804     $ 8,489  
                 
These balances are net of obsolescence reserves totaling $165,842 and $149,000 at November 14, 2009, and February 7, 2009, respectively.

 
10
 


CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

NOTE 6   -
ASSETS HELD FOR SALE
 

In connection with its acquisition of substantially all of the assets of Portrait Corporation of America (“PCA”) and certain of its affiliates and the assumption of certain liabilities of PCA on June 7, 2007, (the “PCA Acquisition”), the Company acquired a manufacturing facility located in Matthews, North Carolina, and a warehouse and excess parcels of land located in Charlotte, North Carolina.  In the third and fourth quarters of 2008, the Company ceased use of the warehouse and excess parcels of land, and the manufacturing facility, respectively, and committed to a plan to sell such assets as they were no longer required by the business.  In the first and third quarters of 2009, the Company also ceased use of and committed to a plan to sell its production facilities located in Thomaston, Connecticut, and Brampton, Ontario, as the facilities are no longer required due to the restructuring and consolidation of the Company’s manufacturing processes and the elimination of film production.

The Company determined these properties meet the criteria for “held for sale accounting” under ASC Topic 360, “Property, Plant, and Equipment” (“ASC Topic 360”) and has presented the respective group of assets separately on the face of the Consolidated Balance Sheet as of November 14, 2009, with the exception of the warehouse in Charlotte, North Carolina, which was sold during the second quarter of 2009.  The sale of the warehouse resulted in net proceeds to the Company of $982,000, which was used to pay down outstanding long-term debt in the second quarter of 2009 and resulted in a loss of $123,000, which was recognized in other charges and impairments in the second quarter of 2009.

At the time an asset qualifies for “held for sale accounting”, the asset is evaluated to determine whether or not the carrying value exceeds its fair value less cost to sell.  Any loss as a result of the carrying value being in excess of fair value less cost to sell is recorded in the period the asset meets “held for sale accounting”.  Management judgment is required to assess the criteria required to meet “held for sale accounting”, and estimate the expected net amount recoverable upon sale.  As of November 14, 2009, the carrying values of the respective assets held for sale did not exceed their fair values less costs to sell.  The Company expects the sales of these assets will be completed within approximately a one year time period.

The major classes of assets included in assets held for sale in the Interim Consolidated Balance Sheet are as follows:

in thousands
 
November 14, 2009
   
February 7, 2009
 
             
Land
  $ 2,338     $ 1,473  
Buildings and building improvements
    4,239       5,142  
                 
Assets held for sale
  $ 6,577     $ 6,615  
                 

NOTE 7   -
GOODWILL AND INTANGIBLE ASSETS
 
In connection with the PCA Acquisition, the Company recorded goodwill in the excess of the purchase price over the fair value of assets acquired and liabilities assumed in accordance with SFAS No. 141, “Business Combinations” (“SFAS No. 141”).  Under SFAS No. 141, goodwill is not amortized and instead is periodically evaluated for impairment.  The goodwill is expected to be fully deductible for tax purposes over 15 years.  The following table summarizes the Company’s goodwill:


in  thousands
 
November 14, 2009
   
February 7, 2009
 
             
PCA acquisition
  $ 21,227     $ 21,227  
                 
Goodwill from prior acquisitions
    512       512  
                 
Translation impact on foreign balances
    20       (280 )
    $ 21,759     $ 21,459  
                 



 
11
 


CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

The Company accounts for goodwill under ASC Topic 350, “Intangibles – Goodwill and Other” (“ASC Topic 350”) which requires the Company to test goodwill for impairment on an annual basis, and between annual tests whenever events or changes in circumstances indicate the carrying amount may not be recoverable.  ASC Topic 350 prescribes a two-phase process for impairment testing of goodwill.  The first phase is a screen for impairment, which compares the reporting units’ estimated fair value to their carrying values.  If the carrying value exceeds the estimated fair value in the first phase, the second phase is performed in which the Company’s goodwill is written down to its implied fair value, which the Company would determine based upon a number of factors, including operating results, business plans and anticipated future cash flows.

The Company performs its annual impairment test at the end of its second quarter, or more frequently if circumstances indicate the potential for impairment.  As of July 25, 2009, the end of the Company’s second quarter, the Company completed its annual impairment test and concluded that the estimated fair values of its reporting units exceeded their carrying values, and therefore, no impairment was indicated.  As of November 14, 2009, the end of the Company’s 2009 third quarter, the Company considered possible impairment triggering events since the July 25, 2009, impairment test date, including its market capitalization relative to the carrying value of its net assets, as well as other relevant factors, and concluded that no goodwill impairment was indicated at that date.  The reporting units, for purposes of this test, have fair values substantially in excess of carrying value.

Also, in connection with the PCA Acquisition, the Company acquired intangible assets related to the host agreement with Walmart and the customer list.  These assets were recorded in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”).  The host agreement with Walmart and the customer list are being amortized over their useful lives of 21.5 years using the straight-line method and 6 years using an accelerated method, respectively.  The following table summarizes the Company’s amortized intangible assets as of November 14, 2009.


in thousands
 
Net Balance at
             
 
 
   
Beginning of Period
   
Amortization
   
Translation Impact
of Foreign Balances
   
Net Balance at
End of Period
 
                         
Acquired host agreement
  $ 39,398     $ (1,548 )   $ 982     $ 38,832  
Acquired customer list
    808       (308 )     17       517  
    $ 40,206     $ (1,856 )   $ 999     $ 39,349  
                                 
The Company reviews its intangible assets with definite useful lives under ASC Topic 360, which requires the Company to review for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.  Recoverability of intangible assets with definite useful lives is measured by a comparison of the carrying amount of the asset to the estimated future undiscounted cash flows expected to be generated by such assets.  If such assets are considered to be impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets, which is determined on the basis of discounted cash flows.

NOTE 8   -
OTHER ASSETS AND OTHER LIABILITIES
 

Included in accrued expenses and other liabilities as of November 14, 2009, and February 7, 2009, is $3.0 million and $8.7 million, respectively, in accrued host commissions and $3.9 million and $4.7 million, respectively, related to accrued worker’s compensation.

Included in both other assets and other liabilities is $6.6 million and $6.9 million as of November 14, 2009, and February 7, 2009, respectively, related to worker’s compensation insurance claims that exceed the deductible of the Company and that will be paid by the insurance carrier.  Since the Company is not released as primary obligor of the liability, it is included in both other assets as a receivable from the insurance company and in other liabilities as an insurance liability.

NOTE 9   -
BORROWINGS
 

Effective April 16, 2009, the Company entered into the third amendment (the “Amendment”) to its Credit Agreement to change the interest rate structure and the amortization schedule and to replace preexisting minimum EBITDA and interest coverage covenants with a fixed charge ratio test (as defined, EBITDA minus capital expenditures to fixed charges) and tighten the leverage ratio test (as defined, Funded Debt to EBITDA).  These changes were made to allow for greater flexibility in the event that the economic climate worsens and has an impact on the Company’s earnings.  Further details related to the Amendment are included in the CPI Corp. 2008 Annual Report on Form 10-K.  The Company was in compliance with its covenants under its Credit Agreement as of November 14, 2009.
 
12

CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

Pursuant to the Amendment, the term loan bears interest at the Company’s option, at either a period-based London Interbank Offered Rate (“LIBOR”) plus a spread ranging from 3.25% to 4.00%, or the Base Rate plus a spread ranging from 1.75% to 2.50%.  The Base Rate is determined from the greater of the prime rate, the Federal Funds rate plus 0.50% or the LIBOR Rate plus 1.00% (the “Base Rate”).  Revolving loans are priced at the Base Rate.  The Company is also required to pay a non-use fee of 0.50% per annum on the unused portion of the revolving loans and letter of credit fees of 3.25% to 4.00% per annum.  The interest rate spread in the case of LIBOR and Base Rate loans and the payment of the non-use fees and the letter of credit fees is dependent on the Company’s Ratio of Total Debt to EBITDA (as defined in the Credit Agreement).  If the Company fails to deliver required financial statements and compliance certifications, all of the above interest rates reset to the maximums indicated until five days following the date such statements and certifications are submitted.

In addition, under the Amendment, the mandatory payment schedule requires that unless sooner repaid in whole or part pursuant to the terms of the Credit Agreement, the outstanding principal balance of the term loan is to be repaid in installments of $1.0 million on each of March 31, June 30 and September 30 and $7.0 million on December 31 for all periods after the date of the Amendment, with a final payment being made on the maturity date thereof.

The Company incurred $943,000 in fees paid to creditors associated with this Amendment, which is being amortized over the remainder of the life of the loan in addition to fees that are currently being amortized, the amounts of which are included in prepaid debt fees in the Interim Consolidated Balance Sheet as of November 14, 2009.

In the second quarter of 2009, the Company made a voluntary prepayment of $5.0 million of outstanding principal of the debt.  Additionally, the Company applied proceeds of $982,000 in the second quarter of 2009 from the sale of the Charlotte, North Carolina warehouse to the outstanding principal of the debt in connection with certain mandatory prepayment requirements under its Credit Agreement.  Such amounts have been reduced from long-term debt in the Interim Consolidated Balance Sheet as of November 14, 2009.

On December 21, 2009, the Company made a voluntary debt prepayment of $19.0 million toward the $7.0 million required amortization payment due on December 31, 2009 and a portion of its estimated excess cash flow payment, due May 7, 2010.  The prepaid amount is classified as a current liability.

NOTE 10   -
STOCK-BASED COMPENSATION PLANS AND STOCKHOLDERS’ EQUITY
 

At November 14, 2009, the Company had outstanding awards under various stock-based employee compensation plans, which are described more fully in Note 13 of the Notes to the Consolidated Financial Statements in the Company’s 2008 Annual Report on Form 10-K.

On July 17, 2008, the stockholders approved the CPI Corp. Omnibus Incentive Plan (the "Plan").  The Plan replaced the CPI Corp. Stock Option Plan, as amended and restated on December 16, 1997, and the CPI Corp. Restricted Stock Plan, as amended and restated on April 14, 2005 (collectively the "Predecessor Plans") that were previously approved by the Board of Directors, and no further shares will be issued under the Predecessor Plans.  Total shares of common stock available for delivery pursuant to awards under the Plan are 800,000 shares. At November 14, 2009, 469,896 of these shares were available for future grants.

The Company accounts for stock-based compensation plans in accordance with ASC Topic 718, “Compensation-Stock Compensation” which requires companies to recognize the cost of awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant.

The following table summarizes information about stock options outstanding under the Plan at November 14, 2009.  There was no activity or modifications to stock options under the Plan in the first three quarters of fiscal year 2009.


   
Options Outstanding and Exercisable
       
Weighted-Average
           
Range of
 
Number of Shares
 
Remaining Contractual
 
Weighted-Average
 
Number of Shares
 
Weighted Average
Exercise Prices
 
Outstanding
 
Life (Years)
 
Exercise Price
 
Exercisable
 
Exercise Price
$                 12.21 - 13.58
 
                  217,500
 
                                7.42
 
 $                      13.04
 
                                  -
 
 $                             -
                     
Total
 
                  217,500
 
                                7.42
 
 $                      13.04
 
                                  -
 
 $                             -
                         
 

 
13
CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

As of November 14, 2009, there is no aggregate intrinsic value for the outstanding options (the difference between the Company’s closing stock price on the last trading day of the third quarter of 2009 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on November 14, 2009.  This amount changes based on the quoted market price of the Company’s stock.

The Company estimates the fair value of its stock options with a market-based performance condition under the Plan using Monte Carlo simulations.  Weighted-average assumptions used in calculating the fair value of these stock options are included in Note 13 in the CPI Corp. 2008 Annual Report on Form 10-K for its fiscal year ended February 7, 2009.

The Company recognized stock-based compensation expense of $151,000, resulting in a deferred tax benefit of $52,000 for the 40 weeks ended November 14, 2009, based on the grant-date fair values of stock options granted and the derived service periods.  As of November 14, 2009, total unrecognized compensation cost related to nonvested stock options granted under the Plan was $435,000.  This unrecognized compensation cost will be recognized over a weighted-average remaining period of 2.9 years.

The Company also has stock options issued and outstanding related to its previous amended and restated nonqualified stock option plan, under which certain officers and key employees could receive options to acquire shares of the Company’s common stock.  As of November 14, 2009, under this previous plan, the Company had 15,046 stock options issued and outstanding, with a weighted-average exercise price of $14.30.  There was no activity related to these options during the 40-week period ended November 14, 2009.  The following table summarizes information about stock options outstanding under this previous plan at November 14, 2009:


Options Outstanding and Exercisable
       
Weighted-Average
   
       
Remaining Contractual
 
Weighted-Average
Exercise Price
 
Shares
 
Life (Years)
 
Exercise Price
 $                             12.96
 
                    10,046
 
                                0.93
 
 $                      12.96
                                17.00
 
                      5,000
 
                                0.42
 
                         17.00
             
Total
 
                    15,046
 
                                0.76
 
 $                      14.30
             
As of November 14, 2009, there was no aggregate intrinsic value for the outstanding options (the difference between the Company’s closing stock price on the last trading day of the third quarter of 2009 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on November 14, 2009.   This amount changes based on the quoted market price of the Company’s stock.

Prior to adoption of the new Plan, effective May 29, 2008, the Company had an amended and restated restricted stock plan for which 550,000 shares of common stock had been reserved for issuance to key employees and members of the Board of Directors.  All nonvested stock is valued based on the fair market value of the Company’s common stock on the grant date and the value is recognized as compensation expense over the service period.

On February 18, 2009, the Board of Directors approved a grant of 7,003 shares of nonvested stock to its Chairman of the Board as additional compensation for services rendered.  Shares issued under this grant vested on May 2, 2009.  On April 27, 2009, the Board of Directors approved a grant of 39,386 shares of nonvested stock to certain employees in conjunction with the payment of 2008 performance awards.  On February 25, 2009, and September 8, 2009, the Board of Directors approved grants of 24,160 and 1,711 shares of nonvested stock, respectively, to its members of the Board of Directors in lieu of 2009 board retainer fees and certain committee chair fees they receive as directors of the Company.  On April 27, 2009, the Board of Directors approved a grant of 8,296 shares to its Chairman of the Board.  These shares vested immediately on the grant date.  On May 4, 2009, and July 27, 2009, the Board of Directors approved grants of 4,604 and 2,784 shares of nonvested stock, respectively, to its Chairman of the Board pursuant to the Chairman’s Agreement.  Shares issued under these grants vested on July 25, 2009, and November 14, 2009, respectively.

 
14
 


CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

Changes in nonvested stock are as follows:

 
   
40 Weeks Ended November 14, 2009
 
         
Weighted-Average
 
   
Shares
   
Grant-Date Value
 
Nonvested stock, beginning of period
    1,056     $ 18.95  
Granted
    93,196       8.96  
Vested
    (22,687 )     10.06  
Forfeited
    (5,252 )     6.70  
                 
Nonvested stock, end of period
    66,313     $ 8.92  
                 
Stock-based compensation expense related
               
to nonvested stock
  $ 667,408          
                 
As of November 14, 2009, total unrecognized compensation cost related to nonvested stock was $164,655.  This unrecognized compensation cost will be recognized over a weighted-average remaining period of approximately three months.

On November 16, 2009, the Company declared a fourth quarter cash dividend of 16 cents per share which was paid on December 7, 2009, to shareholders of record as of November 30, 2009.

NOTE 11   -
EMPLOYEE BENEFIT PLANS
 
The Company maintains a qualified, noncontributory pension plan that covers all full-time United States employees meeting certain age and service requirements.  The plan provides pension benefits based on an employee’s length of service and the average compensation earned from the later of the hire date or January 1, 1998, to the retirement date.  On February 3, 2004, the Company amended its pension plan to implement a freeze of future benefit accruals under the plan, except for those employees with ten years of service and who had attained age 50 at April 1, 2004, who were grandfathered and whose benefits continued to accrue.  Effective February 20, 2009, the Company amended its pension plan to implement a freeze of future benefit accruals for the remaining grandfathered participants.  The Company’s funding policy is to contribute annually at least the minimum amount required by government funding standards, but not more than is tax deductible.  Plan assets consist primarily of cash equivalents, fixed income securities, domestic and international equity securities and exchange traded index funds.

The Company also maintains a noncontributory defined benefit plan providing supplemental retirement benefits for certain current and former key executives.  The cost of providing these benefits is accrued over the remaining expected service lives of the active plan participants.  The supplemental retirement plan is unfunded and as such does not have a specific investment policy or long-term rate of return assumption.  However, certain assets will be used to finance these future obligations and consist of investments in a Rabbi Trust.

The following table sets forth the components of net periodic benefit cost for the defined benefit plans:

 
in thousands
 
16 Weeks Ended
   
16 Weeks Ended
 
   
Pension Plan
   
Supplemental Retirement Plan
 
   
November 14, 2009
   
November 8, 2008
   
November 14, 2009
   
November 8, 2008
 
Components of net periodic benefit costs:
                       
    Service cost
  $ -     $ 83     $ -     $ 22  
    Interest cost
    951       923       26       65  
    Expected return on plan assets
    (967 )     (996 )     -       -  
    Amortization of prior service cost
    -       14       -       9  
    Amortization of net loss (gain)
    78       215       (47 )     (18 )
                                 
Net periodic benefit cost
  $ 62     $ 239     $ (21 )   $ 78  
                                 
                                 
in thousands
 
40 Weeks Ended
   
40 Weeks Ended
 
   
Pension Plan
   
Supplemental Retirement Plan
 
   
November 14, 2009
   
November 8, 2008
   
November 14, 2009
   
November 8, 2008
 
Components of net periodic benefit costs:
                               
Service cost
  $ -     $ 207     $ -     $ 55  
Interest cost
    2,378       2,305       65       163  
Expected return on plan assets
    (2,418 )     (2,488 )     -       -  
Amortization of prior service cost
    -       34       -       24  
Amortization of net loss (gain)
    196       537       (116 )     (46 )
                                 
Net periodic benefit cost
  $ 156     $ 595     $ (51 )   $ 196  
                                 
 
 
15
CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

The Company contributed $1.2 million to its pension plan in the first three quarters of 2009 and estimates it will contribute a further $315,000 for fiscal year 2009. Future contributions to the pension plan will be dependent upon legislation, future changes in discount rates and the earnings performance of plan assets.

The Company also maintains a noncontributory pension plan that covers all Sears Portrait Studios Canadian employees meeting certain service requirements.  The plan provides pension benefits based on an employee’s length of service and annual compensation earned.  As of February 28, 2005, the Company amended its plan to implement a freeze of future benefit accruals under the plan, except for those employees with ten or more years of service and who had attained age 50 on that date (the “Grandfathered Members”), who were grandfathered and whose benefits continued to accrue.  On June 10, 2009, the Company amended the plan to implement a freeze of future benefit accruals for the remaining Grandfathered Members, effective July 31, 2009.  The freeze of future benefit accruals for the remaining Grandfathered Members did not have a material effect on the Company’s financial statements.

NOTE 12   -
INCOME TAXES

In accordance with ASC Topic 740, “Income Taxes” which clarifies the accounting for uncertainty in income taxes recognized in the financial statements, the following required information is provided:

· 
Unrecognized tax benefits were approximately $2.7 million at both November 14, 2009, and February 7, 2009.  If these unrecognized tax benefits were recognized, approximately $2.7 million would impact the effective tax rate.  It is not expected the amount of these unrecognized tax benefits will change in the next 12 months.
· 
The Company recognizes interest expense and penalties related to the above-unrecognized tax benefits within income tax expense.  Due to the nature of the unrecognized tax benefits, the Company had $82,000 and $36,000 accrued interest and penalties as of November 14, 2009, and February 7, 2009, respectively.
· 
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, many states, Mexican and Canadian jurisdictions.  The Company is no longer subject to U.S. Federal income tax examination for the years prior to 2003.   There are currently no ongoing examinations by state taxing authorities.

NOTE 13   -
COMMITMENTS AND CONTINGENCIES

Standby Letters of Credit

As of November 14, 2009, the Company had standby letters of credit outstanding in the principal amount of $20.1 million primarily used in conjunction with the Company’s various large deductible insurance programs.

Settlement Commitment

The Company is obligated to remit Sears additional payments as stipulated in the settlement of the previous license agreement.  An amount of $150,000 is due on December 31st in each 6 successive years, commencing December 31, 2009; these amounts have been accrued at present value in the Interim Consolidated Balance Sheet as of November 14, 2009.

Contingent Lease Obligations

In July 2001, the Company announced the completion of the sale of its Wall Décor segment, Prints Plus, which included the ongoing guarantee of certain operating real estate leases of Prints Plus.  As of November 14, 2009, the maximum future obligation to the Company under its guarantee of remaining leases is approximately $443,000 before consideration of replacement tenant income.  To recognize the risk associated with these leases based upon the Company’s past experience with renegotiating lease obligations and the management’s evaluation of remaining lease liabilities, the Company has recorded lease obligation reserves totaling approximately $342,000 at November 14, 2009.  Based on the status of remaining leases, the Company believes that the $342,000 reserve is adequate to cover the potential losses to be realized under the Company’s remaining operating lease guarantees.

 
16
 


CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)


The Company and two of its subsidiaries are defendants in a lawsuit entitled Shannon Paige, et al. v. Consumer Programs, Inc., filed March 8, 2007, in the Superior Court of the State of California for the County of Los Angeles, Case No. BC367546.  The case was subsequently removed to the United States District Court for the Central District of California, Case No. CV 07-2498-FMC (RCx).  The Plaintiff alleges that the Company failed to pay him and other hourly associates for “off the clock” work and that the Company failed to provide meal and rest breaks as required by law.  The Plaintiff is seeking damages and injunctive relief for himself and others similarly situated.  On October 6, 2008, the Court denied the Plaintiffs’ motion for class certification but allowed Plaintiffs to attempt to certify a smaller class, thus reducing the size of the potential class to approximately 200.  Plaintiffs filed a motion seeking certification of the smaller class on November 14, 2008.  The Company filed its opposition on December 8, 2008.  In January 2009, the Court denied Plaintiffs' motion for class certification as to their claims that they worked "off the clock".  The Court also deferred ruling on Plaintiff's motion for class certification as to their missed break claims and stayed the action until the California Supreme Court rules on a pending case on the issue of whether an employer must merely provide an opportunity for employees to take a lunch break or whether an employer must actively ensure that its employees take the break.  The Company believes the claims are without merit and continues its vigorous defense on behalf of itself and its subsidiaries against these claims, however, an adverse ruling in this case could require the Company to pay damages, penalties, interest and fines.

The Company was a defendant in a lawsuit entitled Picture Me Press LLC v. Portrait Corporation of America, et al., Case No. 5:08cv32, which was filed in the United States District Court for the Northern District of Ohio on January 4, 2008.  The suit alleged that the Company’s use of the name PictureMe Portrait Studios® infringed Plaintiff’s trademark for its picture books and sought damages and injunctive relief.   The parties agreed to full resolution of the claims of the case on August 12, 2009. The case was dismissed with prejudice on October 2, 2009.  The matter has resulted in the Company recording a $0.1 million charge in other charges and impairments in the third quarter of 2009, totaling $0.5 million YTD; net of expected (probable) insurance reimbursement of $0.6 million for expenses related to the matter, for which a receivable is recorded as of November 14, 2009.

The Company is also a defendant in other routine litigation, but does not believe these lawsuits, individually or in combination with the cases described above, will have a material adverse effect on its financial condition. The Company cannot, however, give assurances that these legal proceedings will not have a material adverse effect on its business or financial condition.










 
17
 


 
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to provide the reader of the financial statements with a narrative on the Company’s results of operations, financial position and liquidity, significant accounting policies and critical estimates, and the future impact of accounting standards that have been issued but are not yet effective.  Management’s Discussion and Analysis is presented in the following sections: Executive Overview; Results of Operations; Liquidity and Capital Resources; and Accounting Pronouncements and Policies.  The reader should read Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the interim consolidated financial statements and related notes thereto contained elsewhere in this document.

All references to earnings per share relate to diluted earnings per common share unless otherwise noted.

EXECUTIVE OVERVIEW

The Company’s Operations

CPI Corp. is a long-standing leader, based on sittings, number of locations and related revenues, in the professional portrait photography of young children, individuals and families.  From a single studio opened by our predecessor company in 1942, we have grown to 2,938 studios throughout the U.S., Canada, Mexico and Puerto Rico, principally under license agreements with Sears and lease and license agreements with Walmart.  The Company has provided professional portrait photography for Sears’ customers since 1959 and has been the only Sears portrait studio operator since 1986.  CPI is the sole operator of portrait studios in Walmart Stores and Supercenters in the U.S., Canada, Mexico and Puerto Rico.   Management has determined the Company operates as a single reporting segment offering similar products and services in all locations.

As of the end of the third quarter in fiscal years 2009 and 2008, the Company’s studio counts were:
 
   
November 14, 2009
   
November 8, 2008
 
Within Sears stores:
           
United States and Puerto Rico
    873       891  
Canada
    110       110  
                 
Within Walmart stores:
               
United States and Puerto Rico
    1,552       1,656  
Canada
    259       254  
Mexico
    115       118  
                 
Locations not within Sears or Walmart stores
    29       33  
                 
Total
    2,938       3,062  
                 
 
Certain under-performing PMPS studios have been closed since the third quarter of 2008 in order to improve overall financial results.

As of September 17, 2009, all of the Company’s studios are digital.  Effective August 19, 2009, the Company entered into a new six-year license agreement with Sears Canada, pursuant to which the Company will operate professional portrait studios in approximately 110 Sears locations in Canada.  The terms of the agreement provide greater operating flexibility than the previous contract.  As a result of this new agreement, the Company converted all remaining film studios in Canada to a digital format in the 2009 third quarter.  The Company plans to deliver steadily increasing growth through harvesting opportunities from its digital platform to create diversified revenue streams, driving productivity and profitability gains, leveraging its manufacturing capacity and efficiency and implementing aggressive, targeted marketing campaigns.


 
18
 


RESULTS OF OPERATIONS

A summary of consolidated results of operations and key statistics follows:
 
in thousands, except share and per share data
 
16 Weeks Ended
   
40 Weeks Ended
 
   
November 14, 2009
   
November 8, 2008
   
November 14, 2009
   
November 8, 2008
 
                         
Net sales
  $ 107,286     $ 115,689     $ 282,130     $ 308,619  
                                 
Cost and expenses:
                               
     Cost of sales (exclusive of depreciation and amortization shown below)
    8,032       11,288       21,643       31,412  
     Selling, general and administrative expenses
    99,940       109,552       245,480       269,761  
     Depreciation and amortization
    6,320       8,616       17,913       21,673  
     Other charges and impairments
    1,144       2,092       3,751       4,946  
      115,436       131,548       288,787       327,792  
                                 
Loss from operations
    (8,150 )     (15,859 )     (6,657 )     (19,173 )
                                 
Interest expense
    2,542       3,866       5,961       6,753  
Interest income
    130       87       370       567  
Other income, net
    236       56       253       59  
                                 
Loss before income tax benefit
    (10,326 )     (19,582 )     (11,995 )     (25,300 )
Income tax benefit
    (3,524 )     (6,507 )     (4,094 )     (8,727 )
                                 
Net loss from continuing operations
    (6,802 )     (13,075 )     (7,901 )     (16,573 )
Net loss from discontinued operations
    -       (266 )     -       (625 )
                                 
NET LOSS
  $ (6,802 )   $ (13,341 )   $ (7,901 )   $ (17,198 )
                                 
NET LOSS PER COMMON SHARE
                               
                                 
Net loss per share from continuing operations - diluted
  $ (0.97 )   $ (2.02 )   $ (1.13 )   $ (2.56 )
Net loss per share from discontinued operations - diluted
    -       (0.04 )     -       (0.10 )
Net loss per share - diluted
  $ (0.97 )   $ (2.06 )   $ (1.13 )   $ (2.66 )
                                 
Net loss per share from continuing operations - basic
  $ (0.97 )   $ (2.02 )   $ (1.13 )   $ (2.56 )
Net loss per share from discontinued operations - basic
    -       (0.04 )     -       (0.10 )
Net loss per share - basic
  $ (0.97 )   $ (2.06 )   $ (1.13 )   $ (2.66 )
                                 
Weighted average number of common and common equivalent
                               
     shares outstanding - diluted
    7,003,832       6,479,496       6,987,746       6,467,352  
                                 
Weighted average number of common and common equivalent
                               
     shares outstanding - basic
    7,003,832       6,479,496       6,987,746       6,467,352  
                                 
 
 16 weeks ended November 14, 2009 compared to 16 weeks ended November 8, 2008

The Company reported a net loss of $6.8 million, or ($0.97) per diluted share, for the fiscal 2009 third quarter ended November 14, 2009, versus a net loss of $13.3 million, or ($2.06) per diluted share, in the comparable quarter of fiscal 2008.  The Company believes its third quarter fiscal year 2009 results reflect the successful integration and upgrade of the PictureMe Portrait Studio® studios as well as the impact of cost reductions and productivity improvements implemented throughout the organization.

Net sales totaled $107.3 million and $115.7 million in the third quarter of fiscal 2009 and 2008, respectively.
 
·  
Net sales for the fiscal 2009 third quarter decreased $8.4 million, or 7.2%, to $107.3 million from the $115.7 million reported in the third quarter of 2008.  Excluding negative impacts of net revenue recognition change ($3.5 million) and store closures ($2.7 million) and the positive effect of a shift in calendar end of the quarter, comparable same-store sales decreased approximately 7.2%.  The calendar adjustment accounts for the shift in the Veteran’s Day week from the fourth quarter in 2008 to the third quarter in 2009.  Veteran’s Day week initiates the holiday season for portrait activity, and therefore, this adjustment was necessary to achieve comparability.


 
19
 

·  
Net sales from the Company’s PictureMe Portrait Studio® brand (PMPS), on a comparable same-store basis, excluding impacts of net revenue recognition change, loyalty program revenue deferral, store closures and other items, totaling $0.9 million, increased 4.5% in the third quarter of 2009 to $60.7 million from $58.1 million in the third quarter of 2008.  The improved PMPS sales performance for the third quarter was the result of an approximate 24.9% increase in average sale per customer sitting, offset in part by an approximate 16.4% decline in the number of sittings.

·  
During the third quarter of 2009, net sales from the Company’s Sears Portrait Studio brand (SPS), on a comparable same-store basis, excluding impacts of net revenue recognition change, loyalty program revenue deferral, store closures and other items, totaling $1.1 million, was $52.9 million, a decrease of 17.7% from $64.4 million in the third quarter of 2008.  SPS sales performance for the third quarter was the result of a decline of approximately 18.9% in the number of sittings, offset slightly by an increase of 1.5% in sales per sitting.
 
Costs and expenses were $115.4 million in the third quarter of 2009, down from the $131.5 million recorded in the third quarter of 2008.  The Company remains committed to its cost-reduction initiatives and will continue its financial discipline heading into 2010.
 
·  
Cost of sales, excluding depreciation and amortization expense was $8.0 million in the third quarter of 2009, compared with $11.3 million in the third quarter of 2008.  The decrease is principally attributable to lower overall manufacturing production levels, improved productivity due to lab consolidations, the elimination of film and related shipping costs stemming from the PMPS digital conversion, and decreased overhead costs resulting from the integration of the PMPS operations.

·  
Selling, general and administrative (SG&A) expenses were $99.9 million for the third quarter of 2009, compared with $109.6 million in the third quarter of 2008.  The decrease in SG&A expenses primarily relates to lower studio employment costs of $3.0 million due to scheduling improvements and selected operating hour reductions; lower other employment costs of $1.5 million primarily due to changes in exchange rates, cost control and lower sales levels; fiscal 2008 nonrecurring costs of $1.7 million associated with the PMPS digital conversion; elimination of duplicative costs in connection with the PMPS integration totaling $1.3 million; reduced employee insurance costs of $1.3 million due to lower participation and claims levels; reduced workers’ compensation expense of $1.2 million due to improved claims management; and $3.0 million in other cost reductions attributable to cost control initiatives, operating efficiencies and lower sales levels.  These decreases were offset in part by increases in higher average hourly studio rates of approximately $1.2 million in connection with new studio and field initiatives; an increase due to a change in the estimate methods used for recognizing advertising cost of $0.9 million; and increased host commission rates per contractual agreements of  $1.2 million.

·  
Depreciation and amortization expense was $6.3 million in the third quarter of 2009, compared with $8.6 million in the third quarter of 2008.  Depreciation expense decreased due to a reduction in expense related to the streamlining of manufacturing facilities as well as certain assets from the SPS digital conversion that have become fully depreciated in fiscal 2009;  however, it was offset in part by an increase as a result of the digital equipment purchased for the PMPS digital conversion throughout fiscal 2008

·  
In the third quarter of 2009, the Company recognized $1.1 million in other charges and impairments, compared with $2.1 million recognized in the third quarter of 2008.  The current-year charges are primarily associated with lab closures.  The prior-year charges are primarily associated with approximately $0.5 million of litigation costs, $0.7 million of fees incurred in connection with the settlement of the previous Sears license agreement, and $0.9 million of PMPS integration charges, including severance and lab closure costs.

Interest expense was $2.5 million in the third quarter of 2009 compared with $3.9 million in the comparable prior year period.  The decrease in interest expense primarily relates to the change in the interest rate swap value of $1.6 million.

 
20
 


Income tax benefit from continuing operations was $3.5 million in the third quarter of 2009 compared to $6.5 million in the third quarter of 2008.  The resulting effective tax rates were 34.1% in 2009 and 33.2% in 2008.  The change in the effective tax rate in 2009 is primarily attributable to a decrease in Canadian tax rates.

Net losses from discontinued operations were $0 and $266,000 in the third quarters of 2009 and 2008, respectively.  During the fourth quarter of 2008, the Company decided to discontinue its Portrait Gallery and E-Church operations in order to eliminate the unprofitable operations.

40 weeks ended November 14, 2009 compared to 40 weeks ended November 8, 2008

The Company reported a net loss of $7.9 million, or ($1.13) per diluted share, for the first three quarters of fiscal year 2009, ended November 14, 2009, versus a net loss of $17.2 million, or ($2.66) per diluted share, in the comparable prior year period.  The Company believes its first three quarters’ 2009 results reflect the successful integration and upgrade of the PictureMe Portrait Studio® studios as well as the impact of cost reductions and productivity improvements implemented throughout the organization.
 
Net sales totaled $282.1 million and $308.6 million in the first three quarters of fiscal 2009 and 2008, respectively.
 
·  
Net sales for the first three quarters of 2009 decreased $26.5 million, or 8.6% to $282.1 million from the $308.6 million reported in the first three quarters of 2008.  Excluding the negative impacts of store closures ($6.0 million), net revenue recognition change ($4.3 million), revenue deferral related to positive response to the Company’s loyalty programs ($4.2 million), and other net adjustments ($0.9 million),  and the positive effects of a shift in calendar end of the quarter ($5.5 million) and foreign currency translation ($4.9 million), comparable same-store sales decreased $11.7 million, or 3.8%.  The calendar adjustment accounts for the shift in the Veteran’s Day week from the fourth quarter in 2008 to the third quarter in 2009.  Veteran’s Day week initiates the holiday season for portrait activity, and therefore, this adjustment was necessary to achieve comparability.
 
·  
Net sales from the Company’s PictureMe Portrait Studio® brand (“PMPS”), on a comparable same-store basis, excluding impacts of foreign currency translation, store closures, net revenue recognition change, loyalty program revenue deferral and other items, totaling ($12.9) million, increased 10.4%, in the first three quarters of 2009 to $158.1 million from $143.2 million in the first three quarters of 2008.  PMPS sales performance for the first three quarters was the result of an approximate 37.5% increase in average sale per customer sitting, offset in part by an approximate 19.7% decline in the number of sittings.  The Company attributes its increase in average sale per customer sitting primarily to customers’ positive response to the new offerings made possible by the recently completed digital conversion and the implementation of new sales and performance management processes.  The Company believes the sittings decline reflects the difficult economic environment, which has especially pressured customer demand in lower income categories.

·  
Net sales from the Company’s Sears Portrait Studio brand (“SPS”), on a comparable same-store basis, excluding impacts of loyalty program revenue deferral, foreign currency translation, net revenue recognition change, store closures and other items, totaling ($2.2) million, decreased to $136.3 million, a decrease of 16.3%, from the $163.0 million in the first three quarters of 2008.  SPS sales performance for the first three quarters was the result of declines in the number of sittings and sales per sitting of approximately 16.3% and 0.1%, respectively.   The Company believes the decline in SPS brand sales reflects the difficult economic environment, which pressured sittings volumes (particularly in the off-season) and led to an especially pronounced reduction in walk-in business not tied to the Company’s direct marketing programs.  The Company believes declines have been mitigated in part by improving execution of the Company’s customer outreach and loyalty programs.

Costs and expenses were $288.8 million in the first three quarters of 2009, down significantly from the $327.8 million recorded in the first three quarters of 2008.
 
·  
Cost of sales, excluding depreciation and amortization expense, was $21.6 million in the first three quarters of 2009, compared with $31.4 million in the first three quarters of 2008.   The decrease is principally attributable to lower overall manufacturing production levels, improved product mix, increased manufacturing productivity, the elimination of film and related shipping costs stemming from the PMPS digital conversion, and decreased overhead costs resulting from the integration of the PMPS operations.

·  
Selling, general and administrative (“SG&A”) expenses were $245.5 million for the first three quarters of 2009, compared with $269.8 million in the first three quarters of 2008.  The decrease in SG&A expenses primarily relates to lower studio employment costs of $8.7 million due to scheduling improvements and selected operating hour reductions; fiscal 2008 nonrecurring costs of $5.3 million associated with the PMPS digital conversion; lower field and other employment costs of $4.1 million primarily due to restructuring field management, changes in exchange rates, cost control and lower sales levels; elimination of duplicative costs in connection with the PMPS integration totaling $3.8 million; reduced workers’ compensation expense of $2.4 million due to improved claims management; reduced employee insurance costs of $2.4 million related to lower participation and claims levels; and $5.4 million in other net cost reductions attributable to cost control initiatives, operating efficiencies and lower sales levels.  These decreases were offset in part by increases in higher average hourly studio rates of approximately $4.6 million in connection with new studio and field initiatives; and increased host commission rates per contractual agreements of  $3.2 million.

21