Attached files

file filename
EX-31.2 - EXHIBIT 31.2 CERTIFICATION OF CFO - CPI CORPexh31_2.htm
EX-21.0 - EXHIBIT 21.0 SUBSIDIARIES OF THE REGISTRANT - CPI CORPexh21_0.htm
EX-11.1 - EXHIBIT 11.1 COMPUTATION OF INCOME (LOSS) PER SHARE-DILUTED - CPI CORPexh11_1.htm
EX-32.0 - EXHIBIT 32.0 CERTIFICATION OF CEO AND CFO - CPI CORPexh32_0.htm
EX-23.0 - EXHIBIT 23.0 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - CPI CORPexh23_0.htm
EX-11.2 - EXHIBIT 11.2 COMPUTATION OF INCOME (LOSS) PER SHARE-BASIC - CPI CORPexh11_2.htm
EX-31.1 - EXHIBIT 31.1 CERTIFICATION OF CEO - CPI CORPexh31_1.htm
EX-10.50 - EXHIBIT 10.50 FIRST AMENDMENT TO OFFER OF EMPLOYMENT - CPI CORPexh10_50.htm


 
UNITED STATES 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 February 5, 2011                                                                                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.          oYes    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.  oYes    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. x Yes    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).     o Yes   o No

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.  o

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).     oYes     xNo

As of July 24, 2010, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $147,828,000 based on the closing sales price of the common stock as reported on the New York Stock Exchange.

As of April 15, 2011, 7,004,079 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:
 
Part III of this Annual Report incorporates by reference certain information from the registrant’s definitive proxy statement for the 2011 annual meeting of the shareholders, which the registrant intends to file with the Securities and Exchange Commission no later than 120 days after the close of the registrant’s fiscal year ended February 5, 2011.




 
 
 
 
 
 

TABLE OF CONTENTS
PART I
       
         
Item 1.
 
Business
 
3
Item 1A.
 
Risk Factors
 
8
Item 1B.
 
Unresolved Staff Comments
 
11
Item 2.
 
Properties
 
12
Item 3.
 
Legal Proceedings
 
12
         
PART II
       
         
Item 5.
 
Market for Registrant's Common Equity, Related Stockholder
   
     
Matters and Issuer Purchases of Equity Securities
 
13
Item 6.
 
Selected Consolidated Financial Data
 
16
Item 7.
 
Management's Discussion and Analysis of
   
     
Financial Condition and Results of Operations
 
18
Item 7A.
 
Quantitative and Qualitative Disclosures About
   
     
Market Risk
 
29
Item 8.
 
Financial Statements and Supplementary Data
 
30
Item 9.
 
Changes in and Disagreements with Accountants
   
     
on Accounting and Financial Disclosures
 
67
Item 9A.
 
Controls and Procedures
 
67
         
PART III
       
         
Item 10.
 
Directors, Executive Officers and Corporate Governance
 
69
Item 11.
 
Executive Compensation
 
69
Item 12.
 
Security Ownership of Certain Beneficial Owners
   
     
and Management and Related Stockholder Matters
 
69
Item 13.
 
Certain Relationships and Related Transactions, and Director
   
     
Independence
 
69
Item 14.
 
Principal Accounting Fees and Services
 
70
         
PART IV
       
         
Item 15.
 
Exhibits and Financial Statement Schedules
 
70
     
76






 
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Forward-Looking Statements

The statements contained in this report, and in particular in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section, that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and involve risks and uncertainties.  The Company identifies forward-looking statements by using words such as "preliminary," "plan," "expect," "looking ahead," "anticipate," "estimate," "believe," "should," "intend," and other similar expressions.  Management wishes to caution the reader that these forward-looking statements, such as the Company’s outlook for portrait studios, net income, future cash requirements, cost savings, compliance with debt covenants, valuation allowances, reserves for charges and impairments, capital expenditures and other similar statements, are only predictions or expectations; actual events or results may differ materially as a result of risks facing the Company.  A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled “Risk Factors” beginning on page 8 of this report.  The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

PART I
Item 1.              Business

An Overview of the Company

CPI Corp. (“CPI”, the “Company” or “we”), a Delaware corporation formed in 1982, 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 3,084 studios, as of February 5, 2011, throughout the U.S., Canada, Mexico and Puerto Rico, principally under lease and license agreements with Walmart Stores, Inc. (“Walmart”) and license agreements with Sears, Roebuck and Co. (“Sears”) and Toys “R” Us – Delaware, Inc. (“TRU”).

Since 2007, the Company has provided professional portrait photography for Walmart customers and has been the sole operator of portrait studios in Walmart stores and supercenters in all fifty states in the U.S., Canada, Mexico and Puerto Rico.  For purposes of this report, the Walmart studio operations are operating within CPI Corp. under the trade names PictureMe Portrait Studio® in the U.S., Walmart Portrait Studios in Canada and Estudios Fotografia de Walmart in Mexico, collectively “PMPS” or the “PMPS brand”.  The Company has also provided professional portrait photography for Sears’ customers since 1959 and has been the only Sears portrait studio operator since 1986.

Effective as of April 20, 2010, the Company entered into a license agreement with Toys “R” Us – Delaware, Inc. (“Toys “R” Us” or “TRU”) which grants the Company an exclusive license to operate photo studios in certain Babies “R” Us stores under the Kiddie Kandids name.  The term of the agreement expires on January 31, 2016.  The agreement allows CPI significant operating flexibility and collaborative marketing opportunities and provides for the opening of additional locations through October of 2011.  The agreement contains certain termination rights for both the Company and TRU.  The fees paid to TRU under the agreement are based upon the Gross Sales of the Studios operated under the agreement.  Separately, in the first quarter of 2010, the Company also acquired certain assets of Kiddie Kandids, LLC in an auction approved by the United States Bankruptcy Court for the District of Utah (the “Kiddie Kandids, LLC asset acquisition”).

On January 26, 2011, the Company acquired substantially all of the assets and certain liabilities of Bella Pictures, Inc., a leading provider of branded wedding photography services (the “Bella Pictures® Acquisition”).  The operations acquired through the Bella Pictures® Acquisition are conducted through the Company’s newly formed subsidiary, Bella Pictures Holdings, LLC (“Bella Pictures®”).  The Bella Pictures® Acquisition significantly expands the Company’s mobile photography operations and offers customers high-quality wedding photography and videography services and products in most major U.S. markets through a network of certified photographers and videographers.  The Company’s strong digital capabilities and infrastructure, combined with outstanding customer service skills, will allow it to provide exceptional value to couples across a wide spectrum of offerings and price points, while greatly expanding its sales beyond the traditional holiday season.

As of February 5, 2011, PMPS operates 1,904 studios worldwide, including 1,536 in the U.S. and Puerto Rico, 260 in Canada and 108 in Mexico, Sears Portrait Studios (“SPS” or the “SPS brand”) operates 992 studios worldwide, including 882 in the U.S. and Puerto Rico and 110 in Canada, and Kiddie Kandids Portrait Studios (“KKPS” or the “KKPS brand”) operates 171 studios in the U.S. Approximately $96.9 million, $14.5 million and $2.3 million of long-lived assets are used in our domestic, Canadian and Mexican operations, respectively, as of February 5, 2011.  The Company generated fiscal year 2010 net sales of $340.7 million, $57.6 million and $8.7 million related to its domestic, Canadian and Mexican operations, respectively, which accounted for 84%, 14% and 2% of total revenues in fiscal year 2010, respectively.

 
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We operate websites which support and complement our Walmart, Sears and Toys “R” Us studio operations.  These websites serve as vehicles to archive, share portraits via email (after a portrait session) and order additional portraits and products.  In 2010, revenues from on-line sales and services related to these websites were approximately $3.7 million.  In connection with the Bella Pictures® Acquisition, we also operate a website for Bella Pictures® which serves as a vehicle to reserve/book weddings, select specialized, unique product offerings and view/edit photographs and videos from the wedding day.

The Company’s Products and Services

Each of the Company’s portrait studio brands offers customers a wide range of differentiated portrait products, portrait choices, ordering options and service offerings with digital capabilities.  CPI’s full digital process offers significant advantages compared to other portrait providers, including being the only company that employs trained digital technicians who optimize portrait quality during the manufacturing process.  For definition purposes, a package sitting consists of a fixed number of portraits, all of the same pose, for a relatively low price.  Package customers may buy additional portrait sheets for a fee.  A custom sitting consists of portraits purchased by the sheet and allows for a variety of sizes, poses and backgrounds.  A collection sitting consists of a predetermined number of portraits bundled together at significant savings.

Our PMPS brand focuses on the sales of packages and portrait collections.  Our trial packages are offered in all studios and consist of low-priced advertised “introductory” offers that provide a high volume of portraits with less customization and more limited selections.  Our associates offer customers the opportunity to upgrade to portrait collections in which customers receive a greater variety in terms of poses, sizes and customization.  There are no session fees in our PMPS studios.  Our SPS brand focuses on customized, more traditional portrait solutions that provide a wide variety of selection, customization and an enhanced studio experience.  Our KKPS brand focuses on a variety of contemporary and traditional baby, young children and family photographic styles while offering unique and customizable portrait collections, supplemented by specialty product portrait offerings.  Due to the wide variety and customization allowed within our Sears and Kiddie Kandids studios, the customer is charged a session fee.

Each brand offers customers the opportunity to join a portrait savings club.  Each club requires a one-time membership fee for a certain enrollment period, which is currently one year.  PMPS Portrait Smiles Club, Sears’ Super Saver Program and Kiddie Kandids Portrait Club members receive exclusive and additional savings on products and services and a free portrait sheet on each returning visit.  Additionally, Sears’ Super Saver Program and Kiddie Kandids Portrait Club members pay no session fees for the enrollment period.  Both of these plans were designed to promote customer loyalty while encouraging frequent return visits to the studio.

In SPS and KKPS studios, high-resolution images are transmitted electronically to one of our processing centers for fulfillment and/or customer orders can be printed immediately in the studio.  On-site printing is available for only limited PMPS studios.  All studios offer same-day portraits with full copyright on a portrait CD.  Our processing centers complete the customer’s orders to their specifications and return them to the studio for pick-up.  Orders placed in studios are generally available for pick-up within 5-10 days from the time of order.

PMPS, SPS and KKPS studios have the ability to upload images from any portrait session to our safe and secure websites.  With a code and individualized passwords, our customers can view their images from home, share them via email with family and friends, post them on Facebook and other social media sites and place orders online for portraits or gifts such as personalized t-shirts, mugs, mouse pads and more.

In connection with the Bella Pictures® Acquisition in fiscal year 2010, the Company has significantly expanded its mobile photography operations and offers customers high-quality wedding photography and videography services and products in most major U.S. markets through a national network of certified photographers and videographers.  The Company’s strong digital capabilities and infrastructure, combined with outstanding customer service skills, position us to provide exceptional value to couples across a wide spectrum of offerings and price points, while expanding our sales beyond the traditional holiday season.

Bella Pictures® offers services and products for wedding packages which consist of wedding photographer services to photograph the wedding and the production of digital negative compact discs, prints and various combinations of albums.  Bella Pictures® also offers pre-wedding engagement photography and wedding video services.  Bella Pictures® uses a photojournalistic approach to photographing weddings with the goal of telling the story of the customer’s wedding day.

Bella Pictures®’ customers also have the ability to book/order their wedding services and products through a website the Company maintains.  Through this website, customers can reserve/book weddings, select specialized, unique product offerings and view/edit photographs and videos from the wedding day.


 
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Financial and Other Business Information

See Item 8 – Financial Statements and Supplementary Data for information on our financial condition, including revenues and net earnings for each of the last three fiscal years.  For geographic related information, see Note 1 to the Notes to Consolidated Financial Statements – Summary of Significant Accounting Policies.

The Company’s results of operations for the fiscal year 2010 were adversely impacted as a result of the challenging economic environment, which has continued to affect discretionary purchases such as portraiture.  As part of the Company’s continuing response to the market challenges, it has executed a number of cost reductions, which include delay or cancellation of certain expenditures.  See Item 1A – Risk Factors and Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations for further information related to market challenges.

The Company’s Host Relationships

Walmart

On June 8, 2007, the Company acquired substantially all of the assets of Portrait Corporation of America (“PCA”) and certain of its affiliates and assumed certain liabilities of PCA (the “PCA Acquisition”) and became the sole operator of portrait studios in Walmart Stores and Supercenters in the U.S., Canada, Mexico and Puerto Rico.  The Company operates under the trade names PictureMe Portrait Studio® in the U.S., Walmart Portrait Studios in Canada and Estudios Fotografia de Walmart in Mexico.  As of February 5, 2011, the Company operated 1,904 studios in Walmart locations worldwide and approximately 52% of our fiscal 2010 revenue was derived from sales within Walmart.  In fiscal year 2010, the Company closed 31 Walmart studios due to underperformance.  As of April 18, 2011, the Company has closed 2 such locations in fiscal year 2011.  We are not aware of any specific intentions Walmart has to close a significant number of existing stores that contain our portrait studios.  There can be no assurance that some such closures may not occur in the future thus resulting in the concurrent closure of some of our existing portrait studios.  The closure of a significant number of Walmart stores that result in the closing of related portrait studios, to the extent such closures are not offset by openings of portrait studios in new Walmart stores, could have an adverse impact on the Company’s operations. As part of the PCA Acquisition, we assumed certain preexisting lease and license agreements between PCA and Walmart.  These agreements are summarized below.

Effective June 8, 2007, the Company entered into the U.S. Master Lease Agreement (the “Agreement”), negotiated by PCA and Walmart during PCA’s bankruptcy proceedings, which requires us to pay a rental fee to Walmart based upon a percentage of sales of our studios operating in Walmart’s U.S. stores.  On September 8, 2010, the Company entered into an amendment (the “Amendment”) with Walmart to this Agreement which extended the lease term from January 31, 2013 to January 31, 2016, with one three-year option to extend by mutual agreement of the parties.  As of February 5, 2011, we operated 1,536 U.S. studios under this Agreement.

Our relationship with Walmart Canada Corp. is governed by an amended and restated license agreement effective January 1, 2006.  We are required to pay Walmart Canada a license fee based on a percentage of the sales of our portrait studios operated in Walmart’s Canadian stores.  The agreement has a five-year term, and Walmart Canada has an option to renew for two renewal periods of two years each.  Studios that were in operation on the effective date of this agreement are subject to a license schedule, which specifies expiration dates for those specific studios.  Based on this license schedule, our Canadian studios’ licenses expire as follows: 121 in 2011, 111 in 2012, 20 in 2013, 4 in 2014 and 2 in 2015.  Although we anticipate that these agreements will renew, there is no assurance of such.  As of February 5, 2011, we operated 260 studios under the agreement with Walmart Canada.

Within Mexico, our relationship with Nueva Walmart De Mexico, S de R.L. de C.V. ("Nueva Walmart De Mexico") is governed by an agreement dated as of June 1, 2002, for the first 44 studios. New agreements, with the same terms, are entered into as additional studios are added in Mexico. The agreements run for an undefined period of time. Neither party may terminate an agreement for a studio during the studio's first year of operation; thereafter, either party may terminate the agreement with respect to a studio by giving the other party written notice 30 days prior to the termination date.  Under these agreements, Nueva Walmart De Mexico is compensated based upon a percentage of our total sales in all Walmart studios in Mexico.  As of February 5, 2011, we operated in 108 Nueva Walmart De Mexico studios.

Sears

We have enjoyed a strong relationship with Sears for over 50 years under a series of license agreements, the most recent of which was entered into on December 22, 2008, pursuant to which the Company operates professional portrait studios at Sears locations in the U.S.

Pursuant to the terms and subject to the conditions of the License Agreement, we operate professional portrait studios under the name “Sears Portrait Studios.” The term of the License Agreement commenced on January 1, 2009, and ends on December 31, 2014.  The Company has the right to extend the License Agreement for up to four additional years if (i) it makes over a certain amount of capital expenditures with respect to Sears U.S. studios that are approved by Sears within a 12 month period, (ii) the net sales under the contract satisfy certain sales growth targets in 2013 or (iii) the Company pays Sears the amount that we would have owed Sears if the sales growth targets were met (taking into account amounts already paid to Sears).  Under the License Agreement, the Company pays Sears a percentage commission on the net sales of the Sears U.S. studios and shares with Sears a portion of actual savings from operating productivity improvements implemented through the cooperation of the parties.   Under the terms of our existing License Agreement with Sears in the United States, Sears is under no contractual obligation to invite us to open portrait studios in their new stores.  Once we do establish a portrait studio in a new Sears store, that studio is then governed by the terms of our existing License Agreement.

 
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The License Agreement contains certain termination rights for both the Company and Sears.  These termination events include: (i) a breach of the License Agreement that is not cured (if curable) within thirty (30) days of written notice of such breach, (ii) the occurrence of a change of control of the Company without Sears’ consent, (iii) the Company’s conviction or pleading no contest to a felony or the Company engages in any conduct that is likely to materially adversely affect the Company, its Sears U.S. studios or Sears, and (iv) the Company’s failure to maintain appropriate insurance coverage or its failure to pay amounts owed to Sears under the License Agreement when due.  In addition, Sears may terminate the License Agreement solely with respect to any affected Sears U.S. studio due to the closing of a Sears store.

Upon expiration of the term of the License Agreement or upon certain termination events, Sears shall have the right to purchase certain furniture, fixtures and equipment located at the Sears U.S. studios at fair market value, as determined by three independent ASA certified equipment appraisals.

As of February 5, 2011, the Company operated 969 studios located in Sears stores and 23 freestanding studios under the Sears name in the U.S. and approximately 43% of our fiscal 2010 revenue was derived from sales within Sears.  We provide all studio furniture, equipment, fixtures, leasehold improvements and advertising and are also responsible for hiring, training and compensating our employees.  As a Sears licensee in studios located in Sears stores, we enjoy the benefits of using the Sears name, access to prime retail locations, Sears’ daily cashiering and bookkeeping systems, store security services and Sears’ assumption of certain credit card fees and credit and check authorization risks.  Our customers also have the convenience of using their Sears credit cards to purchase our products and services.  As a Sears licensee in freestanding studios under the Sears name in the U.S., we pay rent and utilities at each of these locations and benefit from the use of the Sears name.

The Company operates professional portrait studios in 110 Sears locations in Canada pursuant to a six-year license agreement with Sears Canada, Inc., a subsidiary of Sears (“Sears Canada, Inc.”), effective August 19, 2009.  The Company pays Sears a license fee in Canadian dollars based on total annual net sales.  The Company provides all studio furniture, equipment, fixtures and advertising and is responsible for hiring, training and compensating its employees.

Throughout the period of our relationship with Sears, Sears has never terminated the operation of any of our studios, except in connection with Sears store closings.  In fiscal year 2010, the Company closed 15 related Sears studios.  While Sears has closed 5 such stores as of April 18, 2011, in fiscal year 2011, we are not aware of any specific intentions to close a significant number of existing full-line, mall-based stores that contain our portrait studios.  There can be no assurance that some such closures may not occur in the future thus resulting in the concurrent closure of some of our existing portrait studios.  The closure of a significant number of Sears full-line, mall-based stores that result in the closing of related portrait studios, to the extent such closures are not offset by openings of portrait studios in new Sears stores or other formats or venues, could have an adverse impact on the Company’s operations.  The Company also closed 9 of its freestanding SPS locations due to underperformance as of April 18, 2011, in fiscal year 2011.

Toys “R” Us

Effective as of April 20, 2010, the Company entered into a license agreement with Toys “R” Us (“TRU”) which grants the Company an exclusive license to operate photo studios in certain Babies “R” Us stores under the Kiddie Kandids name.  The term of the agreement expires on January 31, 2016.  The agreement allows CPI significant operating flexibility and collaborative marketing opportunities and provides for the opening of additional locations through October of 2011.  The agreement contains certain termination rights for both the Company and TRU.  The fees paid to TRU under the agreement are based upon the Gross Sales of the Studios operated under the agreement.  As of February 5, 2011, the Company operated 150 studios located in Babies “R” Us stores and 21 Kiddie Kandids mall locations.  Approximately 5% of our fiscal year 2010 revenue was derived from KKPS sales.

The Company provides all studio furniture, equipment, fixtures, leasehold improvements and advertising and is also responsible for hiring, training and compensating its employees.  As a licensee in studios located in Babies “R” Us stores, we enjoy the benefits of access to prime retail locations and store security services.  As a licensee in freestanding mall locations under the Kiddie Kandids name in the U.S., we pay rent and utilities at each of these locations.

 
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Industry Background and Competition

We compete in a highly fragmented domestic professional portrait photography industry, estimated to be over $6.5 billion. The primary customer categories within the industry are babies, preschoolers, school-age children (including youth sports and graduation portraits), adults, families/groups, weddings, passports and churches.  Other categories include: cruise ships, conventions/events, glamour and business portraits.  Our competitors include large studio chains operating in national retailers, other national free-standing portrait studio companies, national school and church photographers and a large number of independent portrait photography and videography providers.  The majority of the industry is comprised of small, independent photography companies and individual photographers.

Like CPI’s studio operations, other portrait photography companies provide services in retail hosts. These companies and their retail hosts include LifeTouch (JC Penney and Target) and Olan Mills (K-Mart, Belk’s, Meijer’s and Macy’s). We believe that we are the largest of these competitors based on revenues generated in the respective retail hosts.  A number of other companies in the professional portrait photography industry operate free-standing studios on a national, regional or local basis.  Among the more sizeable of these companies are Picture People and Portrait Innovations, which operate independent mall-based or strip mall locations.

Our studio competitors generally compete on the basis of the following: price, service, quality, location, product mix and convenience, including the immediate fulfillment of finished portraits at the time of the portrait session.  Many competitors focus heavily on price and commonly feature large portrait packages at aggressively low prices in mass marketing promotions.  Some of these same competitors have eliminated all sitting or session fees.

Our PMPS brand focuses on the sales of packages and portrait collections.  While our products and services are some of the lowest priced in the industry, we do not feel that we are offering lesser value.  In fact, it is our lower price that enables the PMPS customer to attain some of the same products, services and professionalism that higher priced studios offer.  It is an added benefit to the PMPS customer that session fees do not apply.  The SPS brand focuses on customized, more traditional portrait solutions that provide a wide variety of selection, customization and an enhanced studio experience.  Our KKPS brand focuses on a variety of contemporary and traditional baby, young children and family photographic styles while offering unique and customizable portrait collections, supplemented by specialty product portrait offerings.  Except for promotions during the year, the SPS and KKPS brands have not followed the “no session fee ever” practice because we believe a session fee is justified by the professionalism of our photographers, the quality of our equipment, our commitment to service and overall studio experience.  Furthermore, while our products and services are competitively priced, they are not generally the lowest priced in the industry as we focus on offering a better value proposition.  Other competitors, notably Picture People, have emphasized convenience and experience over low price and also the immediate fulfillment of orders in the studio as opposed to longer lead times of central lab fulfillment.

The industry remains in constant transformation brought about by significant advances in digital photographic technology. These technologies have made it possible to capture, manipulate, store and print high-resolution digital images in a decentralized environment. It is this digital evolution that has required industry incumbents to review and adjust their business models while fostering a number of new digital start-ups.  The digital evolution has generated photographic experimentation with the consumer and a “do-it-yourself” mentality that did not exist in years past.  This has impacted overall portrait studio activity and frequency.

Our Bella Pictures® business generally competes on the basis of price, value, service, quality, location and product mix.  Bella Pictures® caters to couples who want the convenience of technology-enabled services with the personal touch of consulting sessions.  It is the only national brand offering customers high-quality wedding photography and videography services and products in most major U.S. markets through a network of certified photographers and videographers.  Bella Pictures’® main competitors are local, independent wedding photography and videography providers.

Seasonality and Inflation

Our business is highly seasonal, with the largest volume occurring in the fourth fiscal quarter, between Thanksgiving and Christmas.  For fiscal years 2010 and 2009, fourth quarter net sales accounted for 32% and 33% of total net sales for the respective years. Historically, most, if not all, of the net earnings for the year are generated in the fourth fiscal quarter.  The timing of Easter, another seasonally important time for portraiture sales, can have a significant impact on the timing of recognition of sales revenues between the Company’s first and second fiscal quarters.  Historically, earlier Easters translate into lower sales due to the closer proximity of the earlier Easter date to the preceding Christmas holiday season during which customers are most portrait-active.  Most of the Company’s Easter-related sales in fiscal years 2010 and 2009, years with an early Easter, were recognized as revenues, in accordance with the Company’s revenue recognition policies reflected in Note 1 in the accompanying Notes to Consolidated Financial Statements, in the respective first fiscal quarters.  The moderate rate of inflation over the past three years has not had a significant effect on the Company’s revenues and profitability.

 
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Suppliers

We purchase photographic paper and processing chemistry from four major manufacturers.  Eastman Kodak provides photographic paper for all central lab fulfillment pursuant to an agreement in effect through July 31, 2011.  Dye sublimation paper used for proof sheets, portrait collages and portrait orders delivered at the end of a sitting in digital studios is provided primarily by Sony (Dai Nippon Printing Co., Ltd. as of April 1, 2011) and Kanematsu.  Fujifilm North America Corp. provides photographic chemistry for central lab fulfillment.  We purchase digital camera and lens components, monitors, computers, printers and other equipment and materials from a number of leading suppliers.

Typically, we do not encounter difficulty in obtaining equipment and materials in the quantity and quality we require and we do not anticipate any problems in obtaining our requirements in the future.

CPI operates most of its U.S. studios in full digital platform utilizing the software of two vendors for its studio photography digital systems.  Our contracts with our software vendors allow CPI to scale the use of the software as necessary to support all of our current and prospective studios.  The Company also has internally developed software that is fully functional in a small number of its U.S. studios.

Intellectual Property

We own certain registered service marks and trademarks, including Portrait Creations®, Smile Savers Plan®, PictureMe Portrait Studio®, BigShots®, The Portrait Gallery®, Bella®, Bella Pictures® and Studio Blue®, which have been registered with the United States Patent and Trademark Office.  Our rights to these trademarks will continue as long as we comply with the usage, filing and other legal requirements relating to the renewal of trademarks.

The Company’s Employees

As of February 5, 2011, the Company employed approximately 12,500 employees, including approximately 7,600 part-time and temporary employees.

The Company Website and Periodic Reports

The Company’s website address is www.cpicorp.com.  We make available on the Investor Relations page of the website, free of charge, press releases, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”).  References to the Company’s website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.

Environmental Regulation

Our operations are subject to commonly applicable environmental protection statutes and regulations. We do not expect that compliance with federal, state and local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment will have a material effect on our capital expenditures, earnings or competitive position.  At present, we have not been identified as a potentially responsible party under the Comprehensive Environmental Responses, Compensation and Liability Act and have not established any reserves or liabilities relating to environmental matters under this Act.

Item 1A.             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 2011, and beyond, to differ materially from those expressed in any forward-looking statements made by us or on our behalf.  The risks and uncertainties described below are not the only ones facing us and do not include other events that we do not currently anticipate or that we currently deem immaterial that may also affect our results of operations and financial condition.

We are materially dependent upon Walmart, Sears and Toys “R” Us.

Substantially all of our sales are derived from sales in Walmart, Sears and Toys “R” Us stores.  Therefore, we are materially dependent upon our relationship with Walmart, Sears and Toys “R” Us, the continued goodwill of Walmart, Sears and Toys “R” Us and the integrity of their brand names in the retail marketplace.  Any deterioration in our host relationships could have a material adverse effect on us.

 
8
 
 
Because we represent only a small fraction of Walmart, Sears and Toys “R” Us revenues, any deterioration of any host relationship would have a far greater effect on us than on our hosts.

In addition, our competitive posture could be weakened by negative changes in Walmart, Sears or Toys “R” Us.

Our portrait studios in Walmart and Toys “R” Us are substantially dependent on customer traffic generated by our host retail stores, and if the customer traffic through these host stores decreases due to the economy or for any other reason, our sales could be materially and adversely affected.

Our business practices and operations need to be acceptable to our hosts.

Our business practices and procedures must at all times be acceptable to Walmart, Sears and Toys “R” Us.  In addition, under our agreements there are substantial contractual rights, the most significant of which are described more fully in “Item 1. Business,” which the host can exercise in a manner that can have a material adverse effect on us.  Consequently, in the future, we may be required to make changes to our business practices and procedures, including with regard to advertising and promotions, product offerings, studio facilities and technology in response to host 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.

Our hosts may terminate, breach, otherwise limit or increase our expenses under our agreements.

Our Walmart, Sears and Toys “R” Us studios in the U.S., Canada and Mexico are operated pursuant to certain license and lease agreements.  Our agreements have the following expiration dates: for our U.S. and Puerto Rico Walmart studios, January 2016; for our Canada Walmart Studios, 121 in 2011, 111 in 2012, 20 in 2013, 4 in 2014 and 2 in 2015; for our Mexico Walmart studios, with 30-day notice after one year of operation; for our U.S. Sears studios, December 2014; for our Canada Sears studios, August 2015; for our Puerto Rico Sears studios, December 2014; and for our U.S. Toys “R” Us studios, January 2016.  These agreements are more fully described in “Item 1. The Company’s Host Relationships.”

Walmart and Sears are under no obligation to renew these agreements.  The agreement with Toys “R” Us provides the Company and Toys “R” Us terms to renew the agreement under certain conditions.  Our hosts may also seek to increase the fees we pay under our agreements upon renewal of the agreements.  We do not have the contractual right to close any poorly performing locations without Walmart’s or Sears’ consent.  Under our agreement with Toys “R” Us, the Company and Toys “R” Us may close certain underperforming locations under specified conditions.  In addition, our agreements do not prohibit Walmart, Sears or Toys “R” Us from selling many of the tangible goods we sell, or from processing digital photos in other departments within their stores.  Furthermore, there is always the risk that Walmart, Sears or Toys “R” Us might breach our agreements. The loss or breach of the agreements could have a material adverse effect on us.  An adverse change in any other aspects of our business relationship with Walmart, Sears or Toys “R” Us, including the reduction of the number of studios operated pursuant to such arrangements or a decision by Walmart, Sears or Toys “R” Us to license or lease studios to other persons, could have a material adverse effect on us.

We may not be able to realize the anticipated benefits from the Bella Pictures® Acquisition.

Achieving the anticipated benefits of the Bella Pictures® Acquisition depends on the timely, efficient and successful execution of a number of events, including integrating the Bella Pictures® business into the Company.  Factors that could affect the Company’s ability to achieve these benefits include:

o  
Difficulty in integrating and managing personnel, financial reporting and other systems used by the Bella Pictures® business into the Company;
o  
The failure of the Bella Pictures® business to perform in accordance with the Company’s expectations; and
o  
Failure to achieve anticipated synergies between the Company’s business and the Bella Pictures® business.

If the Bella Pictures® business does not operate as anticipated, it could materially harm the Company’s business, financial condition and results of operations.  The integration of Bella Pictures® will place significant demands on administrative, operational and financial resources, and there is no assurance that the Company will be able to successfully integrate the Bella Pictures® business.  Failure to successfully integrate the Bella Pictures® business with CPI, and to successfully manage the challenges presented by the integration process, may prevent the Company from achieving anticipated benefits of the acquisition and could have a material adverse effect on the business.

 
9
 
 

The economic recession has materially impacted consumer spending and may adversely affect our financial position.
 
Consumer discretionary spending has been materially and adversely impacted by the current recession, job losses, volatile energy and food costs, greater levels of unemployment, higher levels of consumer debt, declines in home values and in the value of consumers' investments and savings, restrictions on the availability of credit and other negative economic conditions which have affected consumer confidence and disposable income.  If consumer discretionary spending further declines, demand for our products could decrease and we may be forced to discount our merchandise, which in turn could reduce our revenues, gross margins, operating cash flows and earnings.  In addition, higher transportation costs, higher costs of labor, insurance and healthcare, and other negative economic factors may increase our cost of sales and operating expenses.  Additionally, our business is highly seasonal, with the largest volume occurring in the fourth fiscal quarter, between Thanksgiving and Christmas. The fourth quarters in fiscal 2010 and 2009 accounted for approximately 32% and 33% of total net sales for the respective years.  As a result, any adverse impact on our fourth quarter operating results would significantly impact annual operating results.  Our fourth quarter operating results may fluctuate significantly based on many factors, including holiday spending patterns, prevailing economic conditions and weather conditions.

The agreements governing our debt impose restrictions on our business.

On August 30, 2010, the Company entered into the Credit Agreement (the “Credit Agreement”) which makes available to the Company a revolving credit facility, which includes letters of credit, and replaces the Company’s former facility.  The Credit Agreement provides the Company greater flexibility to pursue financial and strategic opportunities to enhance shareholder value.  Our Credit Agreement contains covenants and requires financial ratios and tests, which impose restrictions on our business.  Our ability to comply with these restrictions 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 the principal when due, could result in a default under the Credit Agreement.  If our lenders were unwilling to enter into an amendment or provide a waiver, such defaults would permit our lenders to declare all amounts borrowed from them to be due and payable, together with accrued and unpaid interest, and the ability to borrow under this Credit Agreement could be terminated.  If we are unable to repay debt to our lenders, these lenders could proceed against the collateral securing that debt.

A substantial or prolonged material adverse impact on our results of operations and financial condition could affect our ability to satisfy the financial covenants in our Credit Agreement, which could result in our having to seek amendments or waivers from our lenders to avoid the termination of commitments and/or the acceleration of the maturity of amounts that are outstanding under our Credit Agreement.

Our inability to remain competitive could have a detrimental impact on our results of operations.
 
The professional portrait photography industry is highly competitive. Evolving technology and business relationships may make it easier and cheaper for our competitors and potential competitors to develop products or services similar to ours or to sell competing products or services in our markets.  Likewise, the proliferation of amateur digital photography is making customers more discerning and demanding and has adversely affected overall portrait activity/frequency.

The companies in our industry compete on the basis of price, service, quality, location, product mix and convenience of retail distribution channel.  If the Company cannot continue to provide perceived value for our customers, this could have a material adverse impact on sales and profitability.  To compete successfully, we must continue to remain competitive in areas of price, service, quality, location, product mix and convenience of distribution.

If our key suppliers become unable to continue to provide us supplies under our current contracts, we will need to obtain an alternative source of supplies. If we enter into an agreement to obtain such supplies at less desirable terms, our financial condition and results of operations could be materially adversely affected.

As described in “Item 1. Suppliers,” the Company purchases photographic paper, dye sublimation paper and processing chemistry from several suppliers.  The Company operates most of its U.S. studios in full digital platform utilizing the software of two vendors for its studio photography digital systems.  If these companies become unable to continue to provide us supplies or services under our current arrangements or if prices are increased dramatically, we will need to obtain alternative sources of supplies or services.

Although 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 currently have in place. If we enter into an agreement to obtain such supplies at less desirable terms, our financial condition and results of operations could be materially adversely affected.

Should the Company be forced to replace its digital software vendors, related costs could increase and production could be disrupted for a period of time, which could have a material adverse impact on the results of operations.

 
10
 
 
If we lose our key personnel, our business may be adversely affected.

Our continued success depends upon, to a large extent, the efforts and abilities of our key employees, particularly our executive management team.  We cannot assure you of the continued employment of any members of management. Competition for qualified management personnel is strong.  The loss of the services of our key employees or the failure to retain qualified employees when needed could materially adversely affect us.

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 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.

The Company currently operates most of its U.S. studios in full digital platform utilizing the software of two vendors for its studio photography digital systems.  Any material delay in the vendors’ networking environment, coupled with a failure to identify and implement alternative solutions, could have an adverse effect upon the operations of the business.  Although the Company has internally developed software utilized in certain of its U.S. studios, should our software vendors no longer operate, the Company may be forced to roll out its software to all studios, which could be costly and could delay digital production for a period of time.  Although on-site printing is an available alternative to central printing in the Sears’ digital environment, it currently would be difficult and costly for on-site printing to replace central fulfillment during the holiday busy season.  On-site printing is available for only limited PMPS studios.  Any disruption of our processing systems for any reason could adversely impact our business, financial condition and results of operations.

We are subject to litigation and other claims that could have an adverse effect on our business.

We are a defendant in two pending legal proceedings related to allegations that the Company failed to pay certain employees for “off the clock” work and provide meal and rest breaks as required by law.  Additionally, the Company is a defendant in a lawsuit regarding alleged improper use of confidential information.  While we believe the claims are without merit and continue our vigorous defense, the outcomes of these proceedings are difficult to assess and quantify and therefore we cannot determine whether the financial impact, if any, will be material to our financial position or results of operations.  The defense of these actions may be both time consuming and expensive.  If these legal proceedings were to result in unfavorable outcomes, they could have material adverse effects on our business, financial position and results of operations.

The impact of declines in global equity markets on asset values and interest rates used to value the liabilities in our pension plan and changes in rules and regulations may result in higher pension costs and the need to fund the pension plan in future years in material amounts.

The impact of declines in the global equity and bond markets on asset values may result in higher pension costs and may increase and accelerate the need to fund the pension in future years.  The determination of pension expense and pension funding are based on a variety of rules and regulations.  Changes in these rules and regulations could impact the calculation of pension plan liabilities and the valuation of pension plan assets.  They may also result in higher pension costs and accelerate and increase the need to fully fund the pension plan.

We are subject to currency fluctuations from our operations within non-U.S. markets.

For our operations conducted in Canada and Mexico, transactions are typically denominated in local currencies.  Accordingly, certain costs of our operations in these foreign locations are also denominated in those local currencies.  Because our financial statements are stated in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies, have had, and will continue to have, an impact on our reported financial results.

Item 1B.             Unresolved Staff Comments

None.

 
11
 
 

Item 2.              Properties

The following table sets forth certain information concerning the Company’s principal facilities as of February 5, 2011:
 

   
APPROXIMATE
         
   
AREA IN
     
OWNERSHIP
 
LOCATION
 
SQUARE FEET
 
PRIMARY USES
 
OR LEASE
 
Matthews, North Carolina
 
                 860,000
 
Unoccupied Administration and Portrait processing facility (includes 696,000 square feet in land)
 
Owned
(1)
Charlotte, North Carolina
 
                 372,000
 
Administration, Warehousing and Portrait processing (includes 315,000 square feet in land)
 
Owned
 
Charlotte, North Carolina
 
                 348,000
 
Undeveloped, industrial land
 
Owned
(1)
St. Louis, Missouri
 
                 341,000
 
Headquarters, Administration and Portrait processing (includes 31,000 square feet in land)
 
Owned
 
St. Louis, Missouri
 
                 159,000
 
Parking Lots
 
Owned
 
St. Louis, Missouri
 
                   53,000
 
Warehousing
 
Leased
(2)
Charlotte, North Carolina
 
                   51,000
 
Parking Lots
 
Owned
 
Sandy City, Utah
 
                   41,000
 
Unoccupied Administration (includes 24,000 square feet in land)
 
Owned
(3)
Brampton, Ontario
 
                     5,000
 
Administration
 
Leased
(4)

(1)
 
Properties are not in use.  See Note 7 to the Notes to Consolidated Financial Statements for further discussion.
(2)
 
Lease term expires on July 31, 2018.
(3)
 
Property is held for sale.  See Note 7 to the Notes to Consolidated Financial Statements for further discussion.
(4)
 
Lease term expires on June 30, 2015.

Studio license/lease agreements

As of February 5, 2011, the Company operates portrait studios in host stores under license and lease agreements as shown below:

NUMBER
       
OF STUDIOS
 
COUNTRY
 
LICENSOR/LESSOR
                1,536
 
United States and Puerto Rico
 
Walmart
                   859
 
United States and Puerto Rico
 
Sears
                            150
 
United States
 
Toys "R" Us
                   260
 
Canada
 
Walmart Canada Corp.
                   110
 
Canada
 
Sears Canada, Inc.
                   108
 
Mexico
 
Nueva Walmart de Mexico, S, de R.L. de C.V.
                     61
 
United States studios not
 
Third parties - generally leased for at least 3 years
     
in Walmart, Sears or Toys "R" Us
   
with some having renewal options
 
The Company pays Walmart, Sears and Toys “R” Us a fee based on annual sales within the respective host stores.  This fee covers the Company’s use of space in the host stores, the use of the Walmart name in Canada and Mexico and the use of the Sears and Kiddie Kandids names.  The Company also pays Sears a fee related to certain cost savings for reduced operating hours.  No separate amounts are paid to hosts expressly for the use of space.

The Company believes that the facilities used in its operations are adequate for its present and anticipated future operations.

Item 3.              Legal Proceedings

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.
 

 
12
 
 
 
The Company and two of its subsidiaries are defendants in a lawsuit entitled Chrissy Larkin, et al. v. CPI Corporation, Consumer Programs, Inc., d/b/a Sears Portrait Studios and CPI Images, LLC, d/b/a Sears Portrait Studios, filed August 12, 2010, in the United States District Court for the Western District of Wisconsin, Civil No. 3:10-cv-00411-wmc.  The Plaintiffs filed a second Amended Complaint on March 15, 2011.  The Plaintiffs allege that the defendants failed to pay them for all compensable time worked to provide rest and meal periods under applicable laws and to reimburse them for business related expenses.  The Plaintiffs’ actions are based on alleged violations of the laws of a number of states and the Fair Labor Standards Act.  The Plaintiffs are seeking damages, declaratory and injunctive relief and statutory penalties for themselves and others similarly situated.  The Company and its subsidiaries filed an answer on September 27, 2010, and an answer to the Second Amended Complaint on April 7, 2011.  The parties are in discovery.  The Company will contest collective action and class certification.  Because of the very early stage of the litigation, the Company is unable to predict or otherwise assess the outcome of these proceedings.
 
The Company is a defendant in a lawsuit entitled TPP Acquisition, Inc. v. CPI Corp., filed April 1, 2011, as amended on April 18, 2011, in the Supreme Court of the State of New York, County of New York, Index No. 650883/2011.  Plaintiff acquired the assets of The Picture People, Inc. on or about March 1, 2011.  The Company was a competing bidder for the assets.  Plaintiff alleges that the Company has improperly used information obtained under a confidentiality agreement to interfere with Plaintiff’s business relations with landlords of Picture People studios and to engage in unfair competition.  Plaintiff seeks injunctive relief and damages of not less than $40 million.  The Company believes that the lawsuit is without merit and anticipates pursuing multiple counterclaims.
 
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.
 
PART II

Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Price Range of Common Stock and Cash Dividends

Since April 17, 1989, the Company's common stock has been traded on the New York Stock Exchange under the symbol CPY.
 
The following tables set forth the high and low closing prices of the common stock reported by the New York Stock Exchange and the dividends declared for each full quarterly period during the Company's last two fiscal years.
 
FISCAL YEAR 2010
                 
(ending February 5, 2011)
 
HIGH
   
LOW
   
DIVIDEND
 
First Quarter
  $ 28.63     $ 12.57     $ 0.16  
Second Quarter
    31.91       21.31       0.25  
Third Quarter
    28.03       18.73       0.25  
Fourth Quarter
    30.80       19.43       0.25  
 
FISCAL YEAR 2009
                 
(ending February 6, 2010)
 
HIGH
   
LOW
   
DIVIDEND
 
First Quarter
  $ 10.86     $ 6.00     $ 0.16  
Second Quarter
    18.80       9.90       0.16  
Third Quarter
    18.78       9.99       0.16  
Fourth Quarter
    15.00       11.60       0.16  
 

 
13
 
 

Performance Graph

The following graph compares the five-year cumulative returns of $100 invested in (a) the Company (“CPY”), (b) the Standard & Poor’s 500 Index (“S&P 500”), and (c) the Russell 2000 Index (“Russell 2000”), assuming the reinvestment of all dividends.  The Russell 2000 index was selected because it encompasses similarly sized companies to the Company.  The measurement dates for the purposes of determining the stock price of the Company correspond to the fiscal year end (i.e., the first Saturday in February of each year reflected).  The corresponding measurement dates for the S&P 500 and the Russell 2000 are January 31st of each of the years reflected.
 
                                                                        
                    
 
2006
2007
2008
2009
2010
2011
CPY
             100.00
              296.16
                115.14
                  43.91
                 84.56
             131.32
S&P 500
             100.00
              114.32
                111.80
                  69.24
                 91.90
             112.03
Russell 2000
             100.00
              110.40
                  99.73
                  63.36
                 87.13
             114.28
 
Shareholders of Record

As of April 15, 2011, the closing sales price of the Company’s common stock was $21.59 per share with 7,004,079 shares outstanding and 1,225 holders of record.

Dividends

The Company intends, from time to time, to pay cash dividends on its common stock, as its Board of Directors deems appropriate, after consideration of the Company's operating results, financial condition, cash requirements, restrictions imposed by Delaware law and credit agreements, including maximum limits of cash to be used to pay for dividends, general business conditions and such other factors as the Board of Directors deems relevant.

 
14
 
 

Issuer Repurchases of Equity Securities

On August 25, 2010, the Company’s Board of Directors approved a stock repurchase program.  During the fourth quarter of fiscal year 2010, the Company repurchased 324,716 shares of its common stock at an average price of $22.19 per share under this program, as detailed in the table below.  The Company did not repurchase any of its equity securities during the fourth quarter of fiscal year 2009.

               
Total Number of
   
Maximum Number
 
               
Shares Purchased
   
of Shares that May
 
   
Total Number of
   
Average Price
   
as Part of Publicly Announced Plans
   
Yet Be Purchased
Under the Plans
 
Period
 
Shares Purchased (1)
   
Paid per Share
   
Programs (1)
   
or Programs (2)
 
November 14, 2010 - December 13, 2010
    -     $ -       -       1,000,000  
 
                               
December 14, 2010 - January 13, 2011
    289,049       22.33       289,049       710,951  
 
                               
January 14, 2011 - February 5, 2011
    35,667       20.77       35,667       675,284  
                                 
Total
    324,716     $ 22.19       324,716          
                                 
 
(1)  
On August 25, 2010, the Company's Board of Directors authorized a 1.0 million share open market repurchase program.  The expiration date of the program is August 25, 2011.

(2)  
Subsequent to the 2010 fiscal year end, the Company repurchased an additional 52,937 shares of its common stock at an average price of $20.54 per share.  The remaining maximum number of shares that may yet be purchased under the program as of April 20, 2011, is 622,347 shares.

 
15
 
 

Item 6.               Selected Consolidated Financial Data

The summary historical consolidated financial data as of and for each of the fiscal years in the five-year period ended February 5, 2011, set forth below have been derived from the Company’s audited consolidated financial statements. The information presented below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included herein.  Fiscal year 2008 includes 53 weeks compared to 52 weeks for all other fiscal years presented below.  The 2007 PCA Acquisition affected the operating result trends as depicted in the table below.  Certain of this data has been reclassified to conform with the current year presentation.
 
 
in thousands except share and per share data
 
2010
   
2009
   
2008
   
2007
   
2006
 
                               
STATEMENT OF OPERATIONS (1)
                             
Net sales
  $ 407,035     $ 422,371     $ 462,548     $ 423,429     $ 292,973  
Cost of sales (exclusive of depreciation and amortization shown below)
    28,263       30,626       43,280       47,135       30,211  
Selling, general and administrative expenses
    337,490       339,138       377,310       326,568       218,282  
Depreciation and amortization
    17,962       22,740       29,432       27,291       16,861  
Other charges and impairments (2)
    5,092       3,294       13,557       7,695       1,241  
                                         
Income (loss) from continuing operations
    18,228       26,573       (1,031 )     14,740       26,378  
Interest expense, net (3)
    3,843       6,936       8,527       8,818       1,815  
Other income (expense), net (4)
    929       (44 )     190       175       1,031  
Income tax expense (benefit)
    3,413       5,796       (2,644 )     2,080       9,164  
                                         
Net income (loss) from continuing operations
    11,901       13,797       (6,724 )     4,017       16,430  
Net loss from discontinued operations, net of tax (1)
    -       -       (961 )     (441 )     (103 )
                                         
Net income (loss)
    11,901       13,797       (7,685 )     3,576       16,327  
Net loss attributable to noncontrolling interest
    (7 )     -       -       -       -  
Net income (loss) attributable to CPI Corp.
  $ 11,908     $ 13,797     $ (7,685 )   $ 3,576     $ 16,327  
                                         
SHARE AND PER SHARE DATA (1)
                                       
Net income (loss) from continuing operations - diluted (5)
  $ 1.64     $ 1.97     $ (1.03 )   $ 0.63     $ 2.58  
Net income (loss) from continuing operations - basic (5)
  $ 1.64     $ 1.97     $ (1.03 )   $ 0.63     $ 2.59  
Net income (loss) attibutable to CPI Corp. - diluted (5)
  $ 1.64     $ 1.97     $ (1.18 )   $ 0.56     $ 2.56  
Net income (loss) attibutable to CPI Corp. - basic (5)
  $ 1.64     $ 1.97     $ (1.18 )   $ 0.56     $ 2.57  
                                         
Dividends
  $ 0.91     $ 0.64     $ 0.64     $ 0.64     $ 0.64  
Average shares outstanding - diluted (5)
    7,272       7,020       6,510       6,416       6,376  
Average shares outstanding - basic (5)
    7,257       6,993       6,510       6,391       6,353  
                                         
CASH FLOW DATA (continuing operations only)
                                       
Net cash provided by operating activities
  $ 39,067     $ 31,289     $ 12,663     $ 39,872     $ 37,993  
Net cash (used in) provided by financing activities
  $ 43,735     $ (33,494 )   $ (13,419 )   $ 90,788     $ (43,567 )
Net cash used in investing activities
  $ (8,821 )   $ (2,876 )   $ (33,488 )   $ (97,653 )   $ (2,358 )
                                         
Capital expenditures
  $ 13,490     $ 5,234     $ 36,074     $ 14,884     $ 2,760  
 

 
16
 
 

Item 6.               Selected Consolidated Financial Data (continued)
 
in thousands
 
2010
   
2009
   
2008
   
2007
   
2006
 
                               
BALANCE SHEET
                             
     Cash and cash equivalents
  $ 5,363     $ 18,913     $ 23,665     $ 59,177     $ 26,294  
     Current assets
    30,089       53,555       61,480       92,835       55,164  
     Net fixed assets
    35,998       34,169       50,887       56,280       26,693  
     Goodwill and intangible assets (6)
    60,736       60,380       61,665       62,956       512  
     Other assets
    16,977       18,487       18,823       27,152       11,379  
     Total assets
    143,800       166,591       192,855       239,223       93,748  
     Current liabilities
    49,203       62,432       55,010       83,051       49,407  
     Long-term debt, less current maturities
    48,900       57,855       104,578       105,728       8,333  
     Other liabilities
    31,427       36,116       32,432       33,470       23,209  
     Stockholders' equity (5)
    14,270       10,188       835       16,974       12,799  
 
(1)  
The following business areas were classified as discontinued operations in the years indicated.  The financial statements for the periods prior to the classification were reclassified to reflect these changes:

-  
In 2008, Portrait Gallery and E-Church operations.
-  
In 2007, the UK Operations which were acquired in connection with the PCA Acquisition.

(2)  
Other charges and impairments:
 
in thousands
 
2010
   
2009
   
2008
   
2007
   
2006
 
                               
Impairment charges (a)
  $ 1,871     $ 300     $ 739     $ -     $ -  
Kiddie Kandids integration costs (b)
    1,335       -       -       -       -  
Severance and related costs (c)
    538       970       2,046       2,035       878  
Bella Pictures® Acquisition costs (d)
    472       -       -       -       -  
Other transition related costs - PCA Acquisition (e)
    388       527       1,255       2,817       -  
Gain on sale of Brampton facility (f)
    (1,473 )     -       -       -       -  
Sears fees related to the settlement of the previous license
   agreement (g)
    -       -       7,527       2,500       -  
Proxy contest fees (h)
    -       871       -       -       -  
Other  (i)
    1,961       626       1,990       343       363  
                                         
Total Other Charges and Impairments
  $ 5,092     $ 3,294     $ 13,557     $ 7,695     $ 1,241  
                                         
 
 (a)   Consists primarily of 2010, 2009 and 2008 impairment charges related to the Matthews, North Carolina facility.
 (b)   Relates to certain integration costs incurred in connection with the Kiddie Kandids, LLC asset acquisition.
 (c)  
Consists principally of expenses and related costs for employee severance, retirements and repositioning.  Specifically, in 2008 and 2007, the cost primarily related to the PCA Acquisition.
 (d)   Relates to certain costs incurred in connection with the Bella Pictures® Acquisition, primarily related to legal and consulting fees.
 (e)   Consists of integration-related costs relative to the PCA Acquisition.
 (f)   Represents the gain on sale of the Brampton, Ontario facility in 2010.
 (g)   Consists of certain fees and charges related to the settlement of the previous Sears license agreement.
 (h)   Relates to certain fees incurred in connection with the proxy contest in 2009.
 (i)   Costs in 2010 primarily related to legal expense incurred in connection with the Chrissy Larkin vs. CPI Corp. case and the write-off of debt fees related to the Company’s former credit facility as a result of its new revolving credit facility; offset in part by an early termination fee received from Walmart in relation to certain early PMPS studio closures.  Costs in 2009 primarily related to net legal expense incurred in connection with the settlement of the Picture Me Press LLC vs. Portrait Corporation of America case.  Costs in 2008 primarily related to legal expense incurred for the settlement of the Portraits International of the Southwest vs. CPI Corp. case and in connection with the Picture Me Press LLC vs. Portrait Corporation of America case.  Costs in 2007 primarily related to the write-off of software that is no longer used in the business.  Costs in 2006 represent professional service expense in connection with a strategic alternative review and the write-off of certain legacy equipment that is no longer used in the business.
 
 
 
17
 
 

(3)
 
In 2010, 2009, 2008 and 2007, includes (income) expense of ($2.0 million), ($1.5 million), $617,000 and $2.9 million, respectively, in connection with marking the interest rate swap agreement to its market value.  The interest rate swap agreement expired on September 17, 2010.
     
(4)
 
In 2010, the Company recorded an $803,000 translation gain related to intercompany balances that are payable in the foreseeable future.
 
In 2004, the Company recorded accrued lease liability obligations relating to its lease guarantees on certain of Prints Plus’ retail stores.  As the total guarantee related to these leases had decreased with the passage of time, the payment of rents by Prints Plus and the settlement by the Company of certain leases rejected in bankruptcy, the related liability was reduced by $887,000 in 2006 to reflect management’s revised estimate of remaining potential loss.
     
(5)
 
The Company recorded the repurchase of 1,658,607 shares of common stock for $32.4 million in 2006.
     
(6)
 
In connection with the Bella Pictures® Acquisition in 2010, the Company acquired a tradename and additional goodwill. At the time of the PCA Acquisition in 2007, the Company acquired a host agreement and customer list with Walmart and additional goodwill.  See Note 8 to the Notes to Consolidated Financial Statements for further discussion.

Item 7.               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 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.

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 3,084 studios throughout the U.S., Canada, Mexico and Puerto Rico, principally under lease and license agreements with Walmart and license agreements with Sears and Toys “R” Us.  CPI is the sole operator of portrait studios in Walmart stores and supercenters in all 50 states in the U.S., Canada, Mexico and Puerto Rico, as well as Babies “R” Us stores in the U.S.  The Company has provided professional portrait photography for Sears’ customers since 1959 and has been the only Sears portrait studio operator since 1986.

CPI entered into a license agreement, effective as of April 20, 2010, with Toys “R” Us (“TRU”) which grants CPI an exclusive license to operate photo studios in certain Babies “R” Us stores under the Kiddie Kandids name.  The term of the agreement expires on January 31, 2016.  The agreement allows CPI significant operating flexibility and collaborative marketing opportunities and provides for the opening of additional locations through October of 2011.  The agreement contains certain termination rights for both the Company and TRU.  The fees paid to TRU under the agreement are based upon the Gross Sales of the Studios operated under the agreement.  Separately, in the first quarter of 2010, the Company also acquired certain assets of Kiddie Kandids, LLC in an auction approved by the United States Bankruptcy Court for the District of Utah (the “Kiddie Kandids, LLC asset acquisition”).  The Company evaluated the asset purchase under the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations” (“ASC Topic 805”) and determined the purchase was an asset acquisition rather than a business combination.  Accordingly, the purchase of such assets has been classified as an asset acquisition in the accompanying consolidated financial statements.

On January 26, 2011, the Company acquired substantially all of the assets and certain liabilities of Bella Pictures, Inc., a leading provider of branded wedding photography services (the “Bella Pictures® Acquisition”).  The operations acquired through the Bella Pictures® Acquisition are conducted through the Company’s subsidiary, Bella Pictures Holdings, LLC (“Bella Pictures®”).  The Bella Pictures® Acquisition significantly expands the Company’s mobile photography operations and offers customers high-quality wedding photography and videography services and products in most major U.S. markets through a network of certified photographers and videographers.  The Company’s strong digital capabilities and infrastructure, combined with outstanding customer service skills, will allow it to provide exceptional value to couples across a wide spectrum of offerings and price points, while greatly expanding its sales beyond the traditional holiday season.  The Company evaluated the Bella Pictures® Acquisition under the guidance in ASC Topic 805 and determined it was a business combination.  Accordingly, the results have been included in the accompanying consolidated financial statements from the date of acquisition.

 
18
 
 
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 last three fiscal years, the Company’s studio counts were:
 
   
2010
 
2009
 
2008
 
               
Within Walmart stores:
             
United States and Puerto Rico
    1,536     1,549     1,642  
Canada
    260     260     259  
Mexico
    108     114     118  
                     
Within Sears stores:
                   
United States and Puerto Rico
    859     871     887  
Canada
    110     110     110  
                     
Within Babies "R" Us stores in the United States
    150     -     -  
                     
Locations not within above host stores
    61     31     30  
                     
Total
    3,084     2,935     3,046  
                     
 
Certain under-performing PMPS studios have been closed since 2008 in order to improve overall financial results.  Locations not within Walmart, Sears or Babies “R” Us stores include 23 free-standing SPS studio locations, 21 Kiddie Kandids mall locations and 17 Shooting Star locations (located within Buy Buy Baby stores).

The Company continues to seek opportunities from its digital platform to create diversified revenue streams, drive productivity and profitability gains, leverage its manufacturing capacity and efficiency and implement aggressive, targeted marketing campaigns.  Such opportunities may be restrained if the economy worsens in the foreseeable future.
 

 
19
 
 

RESULTS OF OPERATIONS

A summary of consolidated results of operations and key statistics follows:
 
in thousands, except per share data
 
2010
   
2009
   
2008
 
                   
Net sales
  $ 407,035     $ 422,371     $ 462,548  
                         
Cost and expenses:
                       
Cost of sales (exclusive of depreciation and amortization shown below)
    28,263       30,626       43,280  
Selling, general and administrative expenses
    337,490       339,138       377,310  
Depreciation and amortization
    17,962       22,740       29,432  
Other charges and impairments
    5,092       3,294       13,557  
      388,807       395,798       463,579  
                         
Income (loss) from continuing operations
    18,228       26,573       (1,031 )
                         
Interest expense
    3,860       7,030       8,529  
Interest income
    17       94       2  
Other income (expense), net
    929       (44 )     190  
Income (loss) from continuing operations before income tax expense (benefit)
    15,314       19,593       (9,368 )
                         
Income tax expense (benefit)
    3,413       5,796       (2,644 )
                         
Net income (loss) from continuing operations
    11,901       13,797       (6,724 )
                         
Net loss from discontinued operations, net of income tax benefit
    -       -       (961 )
 
                       
Net income (loss)
    11,901       13,797       (7,685 )
Net loss attributable to noncontrolling interest
    (7 )     -       -  
NET INCOME (LOSS) ATTRIBUTABLE TO CPI CORP.
  $ 11,908     $ 13,797     $ (7,685 )
                         
NET INCOME (LOSS) PER COMMON SHARE
                       
                         
Net income (loss) per share from continuing operations - diluted
  $ 1.64     $ 1.97     $ (1.03 )
Net loss per share from discontinued operations - diluted
    -       -       (0.15 )
Net income (loss) per share attibutable to CPI Corp. - diluted
  $ 1.64     $ 1.97     $ (1.18 )
                         
Weighted average number of common and common equivalent shares outstanding - diluted
    7,272       7,020       6,510  

2010 versus 2009 and 2009 versus 2008
 
Unless otherwise noted, the fiscal year 2010 results include the 52-weeks ended February 5, 2011, compared to 52-weeks in fiscal year 2009, which ended February 6, 2010, and 53-weeks in fiscal year 2008, which ended February 7, 2009.

Net sales totaled $407.0 million, $422.4 million and $462.5 million in 2010, 2009 and 2008, respectively.

·  
Net sales for 2010 decreased $15.4 million, or 4%, to $407.0 million from the $422.4 million reported in 2009.  Excluding the positive impacts of net store openings ($15.3 million), foreign currency translation ($4.9 million), E-commerce ($1.5 million) and other items totaling $200,000, comparable same-store sales decreased approximately 9% from the prior year.  The Bella Pictures® Acquisition on January 26, 2011, did not materially affect the Company’s 2010 net sales.

Net sales from the Company’s PMPS brand, on a comparable same-store basis, excluding impacts of store closures, foreign currency translation, E-commerce, net revenue recognition change and other items, totaling $2.7 million, decreased 5% in fiscal 2010 to $208.0 million from $219.1 million in fiscal 2009.  The decrease in PMPS sales performance in 2010 was the result of a 10% decline in the number of sittings, offset in part by a 6% increase in average sale per customer sitting.

Net sales from the Company’s SPS brand, on a comparable same-store basis, excluding impacts of store closures, foreign currency translation, net revenue recognition change and other items, totaling ($700,000), decreased 13% in fiscal 2010 to $171.2 million from $197.3 million in fiscal 2009.  The decrease in SPS sales in 2010 was the result of an 11% decline in the number of sittings and a 3% decline in average sale per customer sitting.

Net sales from the Company’s Kiddie Kandids studio operations, excluding the impact of net revenue recognition change and other items totaling ($900,000), contributed $20.8 million in net sales in 2010.

 
20
 
 
Net sales for 2009 decreased $40.1 million, or 9%, to $422.4 million from the $462.5 million reported in 2008.  Excluding the negative impacts of store closures ($8.9 million), the 53rd week in the prior year ($7.0 million), net revenue recognition change ($4.1 million), revenue deferral related to positive response to the Company’s loyalty programs ($4.0 million), foreign currency translation ($1.9 million) and other net impacts ($1.1 million), comparable same-store sales decreased approximately 3%.

Net sales from the Company’s PMPS brand, on a comparable same-store basis, excluding impacts of store closures, net revenue recognition change, the 53rd week in the prior year, foreign currency translation and other items, totaling ($19.1 million), increased 9% in fiscal 2009 to $222.8 million from $204.1 million in fiscal 2008.  The improved PMPS sales performance for fiscal 2009 was the result of an approximate 24% increase in average sale per customer sitting, reflecting customers’ positive response to the offerings made possible by the digital conversion as well as new sales and performance management processes, offset in part by an approximate 12% decline in the number of sittings.

During fiscal 2009, net sales from the Company’s SPS brand, on a comparable same-store basis, excluding impacts of the 53rd week in the prior year, loyalty program revenue deferral, store closures and other items, totaling ($7.9 million), were $198.8 million, a decrease of 14% from $231.2 million in fiscal 2008.  SPS sales performance for fiscal 2009 was the result of a decline of approximately 15% in the number of sittings, offset slightly by an increase of 2% in average sale per customer sitting.

Costs and expenses were $388.8 million in 2010, compared with $395.8 million in 2009 and $463.6 million in 2008.

·  
Cost of sales, excluding depreciation and amortization expense, was $28.3 million, $30.6 million, and $43.3 million in 2010, 2009 and 2008, respectively.

Cost of sales, excluding depreciation and amortization expense, declined in 2010 from 2009 levels.  The decrease was principally attributable to lower overall production levels, as well as continuing productivity improvements.  The decrease was offset in part by a change in product mix and an increase in carrier rates.

Cost of sales, excluding depreciation and amortization expense, declined in 2009 from 2008 levels.  The decrease principally resulted from lower production levels, improved productivity due to lab consolidations, elimination of film and related shipping costs stemming from the PMPS digital conversion, savings from in-house production of greeting cards, reduced on-site printing costs and decreased overhead costs resulting from the integration of the PMPS operations.

·  
Selling, general and administrative (“SG&A”) expense was $337.5 million, $339.1 million and $377.3 million for fiscal years 2010, 2009, and 2008, respectively.  The decrease in 2010 was primarily due to reductions in SPS and PMPS studio employment costs from improved scheduling, selected operating hour reductions and studio closures, reduced advertising costs, a decline in host commission expense due to lower sales levels and a reduction in corporate bonuses for fiscal 2010.  These decreases were offset significantly by costs associated with the newly opened Kiddie Kandids studios, increased expenses amortized as the result of a higher level of stock-based compensation performance awards made for the 2009 fiscal year, an adverse commission adjustment ($1.5 million) arising from greater than expected sales declines and higher pension, employee insurance and workers’ compensation costs due to changes in discount rates, unfavorable claim activity and loss experience adjustments, respectively.
 
SG&A expense fell to $339.1 million in fiscal 2009, compared with $377.3 million in fiscal 2008.  The decrease in SG&A expense primarily relates to lower studio employment costs due to scheduling improvements and selected operating hour reductions; the impact of the 53rd week in the prior year; fiscal 2008 nonrecurring costs associated with the PMPS digital conversion; elimination of duplicative costs in connection with the PMPS integration; reduced employee insurance costs due to plan changes and lower participation and claims levels; reduced workers’ compensation expense due to improved claims management; reduced marketing expense due to reduced direct mail expense and improvements in studio marketing and acquisition programs; and other cost reductions attributable to cost-control initiatives, operating efficiencies and lower sales levels.  These decreases were offset in part by increases in incentive pay in connection with new studio and field initiatives and corporate bonuses.

·  
Depreciation and amortization expense was $18.0 million in 2010 compared to $22.7 million in 2009 and $29.4 million in 2008.

Depreciation expense decreased in 2010 from 2009 levels as a result of the full depreciation of certain assets acquired in connection with the 2005 digital conversion of SPS and 2007 acquisition of PCA and the closure of certain PMPS locations during the past two fiscal years.

 
21
 
 

Depreciation and amortization expense in 2009 decreased from 2008 due to the full depreciation of certain assets acquired in connection with both the 2005 digital conversion of SPS and the 2007 acquisition of PCA; the closure of certain facilities in fiscal 2008 and early fiscal 2009; and an adjustment made in the prior year to write-off Mexico film equipment no longer required after the digital conversion.  These decreases were offset in part by an increase as a result of the digital equipment purchased for the PMPS digital conversion throughout fiscal 2008.

·  
Other charges and impairments reflect costs incurred from strategic actions implemented by the Company to restructure its operations, costs that are unpredictable and atypical of the Company’s operations and additional charges due to asset impairments.  Actions taken during 2010, 2009 and 2008 are as follows:
 
in thousands
 
2010
   
2009
   
2008
 
                   
Impairment charges (a)
  $ 1,871     $ 300     $ 739  
Kiddie Kandids integration costs (b)
    1,335       -       -  
Severance and related costs (c)
    538       970       2,046  
Bella Pictures® Acquisition costs (d)
    472       -       -  
Other transition related costs - PCA Acquisition (e)
    388       527       1,255  
Gain on sale of Brampton facility (f)
    (1,473 )     -       -  
Sears fees related to the settlement of the previous license agreement (g)
    -       -       7,527  
Proxy contest fees (h)
    -       871       -  
Other (i)
    1,961       626       1,990  
                         
Total Other Charges and Impairments
  $ 5,092     $ 3,294     $ 13,557  
                         
 
(a)  
During 2010, 2009 and 2008, the Company incurred $1.9 million, $300,000 and $739,000, respectively, related to the write-down of its Matthews, North Carolina, facility asset value.
 
(b)  
Charges relate to certain integration costs incurred in 2010 in connection with the Kiddie Kandids, LLC asset acquisition.

(c)  
Charges in 2010 primarily related to executive severance costs and severance costs resulting from the termination of employees in connection with the restructuring of operational support.

Charges in 2009 primarily related to severance costs resulting from the termination of employees in connection with the closure of the film lab facility in Canada due to the digital conversion of the SPS Canada studios.

Charges in 2008 primarily related to severance costs resulting from the termination of employees in connection with the integration of operations of the PCA Acquisition into CPI.

(d)  
Charges relate to certain costs incurred in 2010 in connection with the Bella Pictures® Acquisition, primarily related to legal and consulting fees.

(e)  
During 2010, expense primarily related to lab closure-related costs.

During 2009, expense primarily related to lab closure-related costs of $1.1 million.  This expense was offset in part by a $546,000 net gain recognized on the sale of certain properties previously held for sale.

During 2008, expense primarily related to lab closure-related costs of $902,000.  The remainder of expense related to professional service and consultant costs associated with the transition.

(f)  
Represents the gain on sale of the Brampton, Ontario facility in 2010.

(g)  
In 2008, the Company incurred certain fees and charges in relation to the settlement of the previous Sears license agreement.

(h)  
Charges relate to certain fees incurred in connection with the proxy contest in 2009.

(i)  
Costs in 2010 primarily related to legal expense of $1.5 million incurred in connection with the Chrissy Larkin vs. CPI Corp. case and the $1.1 million write-off of debt fees related to the Company’s former credit facility as a result of its new revolving credit facility.  These costs were offset in part by an early termination fee of $504,000 received from Walmart in relation to certain early PMPS studio closures.

 
22
 
 

Costs in 2009 primarily related to net legal expense of $527,000 incurred in connection with the settlement of the Picture Me Press LLC vs. Portrait Corporation of America case, as well as the write-off of certain Canada film inventory due to the digital conversion of the SPS Canada studios.  These expenses were offset in part by a reduction in certain lease obligation reserves of $288,000.

Costs in 2008 primarily related to legal expense of $913,000 incurred for the settlement of the Portraits International of the Southwest vs. CPI Corp. case and $866,000 incurred in connection with the Picture Me Press LLC vs. Portrait Corporation of America case.  The remainder of the expense related to executive recruitment expense and a contract negotiation with a director.

Interest expense was $3.9 million in 2010 compared to $7.0 million in 2009 and $8.5 million in 2008.  The decrease in 2010 from 2009 primarily resulted from lower average borrowings and favorable interest rates as a result of the new credit facility, as well as a change in the interest rate swap value, which expired in the third quarter of 2010.  The decrease in 2009 from 2008 was primarily the result of adjustments to the fair value of the interest rate swap agreement that decreased interest expense by $2.0 million and $2.3 million in 2009 and 2008, respectively.

The income tax provision was $3.4 million in 2010 compared to $5.8 million in 2009 and a benefit of ($2.6 million) in 2008.  The resulting effective tax rates were 22%, 30% and (28%) in 2010, 2009 and 2008, respectively.  The change in the effective tax rate in 2010 was primarily due to certain tax benefits recognized related to a previous uncertain tax position and miscellaneous tax return adjustments.  The effective tax rate in 2009 includes the effect of recognizing a $2.0 million net foreign tax credit benefit related to a previous year.

Net loss from discontinued operations was $961,000 in 2008.  In 2008, the Company decided to discontinue its Portrait Gallery and E-Church operations in order to eliminate the unprofitable operations.

LIQUIDITY AND CAPITAL RESOURCES

The following table presents a summary of the Company’s cash flows for each of the last three fiscal years:
 
in thousands
 
2010
   
2009
   
2008
 
                   
Net cash (used in) provided by:
                 
Operating activities (1)
  $ 39,067     $ 31,289     $ 11,847  
Financing activities
    (43,735 )     (33,494 )     (13,419 )
Investing activities
    (8,821 )     (2,876 )     (33,488 )
Effect of exchange rate changes on cash
    (61 )     329       (452 )
Net decrease in cash
  $ (13,550 )   $ (4,752 )   $ (35,512 )
                         
 
(1)  
Includes cash flows used in discontinued operations of $816,000 in 2008.

Net Cash Provided By Operating Activities

Net cash provided by operating activities was $39.1 million in 2010 compared to $31.3 million and $11.8 million in 2009 and 2008, respectively.  Cash flows in 2010 increased from 2009 levels primarily due to a $4.7 million decline in Walmart commissions due to lower sales levels in 2010 and accelerated Walmart commissions in 2009, a $5.1 million decline in Sears commissions due to lower sales levels in 2010, a decrease in advertising spend of $2.5 million and reduced interest paid of $2.3 million.  These increases were offset in part by the change in net operating income and the timing of payments related to changes in the various balance sheet accounts totaling approximately $6.8 million.

Cash flows in 2009 increased from 2008 primarily due to payment reductions over the prior year related to digital training and travel of $5.8 million, fees in connection with the settlement of the previous Sears license agreement of $5.4 million, employee insurance of $3.9 million, severance and integration-related payments of $2.5 million, interest of $1.9 million, pension of $1.6 million and worker’s compensation of $1.1 million.  These were offset in part by the timing of payments related to changes in the various balance sheet accounts totaling $2.7 million.

Net Cash Used In Financing Activities

Net cash used in financing activities was $43.7 million, $33.5 million and $13.4 million in 2010, 2009 and 2008, respectively.  The increase in cash used in 2010 is primarily attributable to the Company’s repurchase of $7.2 million of its common stock in 2010, an increase in cash dividends paid of $2.2 million, an increase in the payment of debt issuance costs of $600,000, and a net increase in the repayment of debt of $454,000.

 
23
 
 
The increase in cash used in 2009 compared to 2008 was primarily attributable to an increase in repayment of long-term debt.  In addition to the mandatory payments made pursuant to the mandatory payment schedule in the Company’s former credit agreement (the “former agreement”), the Company made voluntary prepayments of $17.0 million of outstanding principal of the debt during 2009.  Additionally, the Company applied proceeds of $1.9 million in 2009 from the sale of the Charlotte, North Carolina warehouse and the Thomaston, Connecticut facility to the outstanding principal of the debt in connection with certain mandatory prepayment requirements under the former agreement.

In connection with the PCA Acquisition on June 8, 2007, the Company amended and restated its former agreement to a five-year term and revolving credit facility in an amount up to $155 million, consisting of a $115 million term loan and a $40 million revolving loan with a sub-facility for letters of credit in an amount not to exceed $25 million.  The Company incurred $2.7 million in issuance costs associated with this second amended and restated agreement.  Effective April 16, 2009, the Company entered into the third amendment to its former agreement to change the interest rate structure and 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, Total 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.    The Company incurred $943,000 in fees paid to creditors associated with this Amendment.

On August 30, 2010, the Company entered into the Credit Agreement (the “Credit Agreement”) with the financial institutions that are or may from time to time become parties thereto and Bank of America, N.A., as administrative agent for the lenders, and as swing line lender and issuing lender.  The Credit Agreement makes available to the Company a revolving credit facility which includes letters of credit and replaces the Company’s former facility.

The Credit Agreement is a new four-year revolving credit facility in an amount of up to $105 million, with a sub-facility for letters of credit in an amount not to exceed $25 million.  In addition, the Company, at its option, may choose to increase the revolving commitment up to an additional $20 million.  The new credit facility provides the Company greater flexibility to pursue financial and strategic opportunities to enhance shareholder value.  The obligations of the Company under the Credit Agreement are secured by (i) a guaranty from certain material direct and indirect domestic subsidiaries of the Company, and (ii) a lien on substantially all of the assets of the Company and such subsidiaries.

The revolving loans under the Credit Agreement bear interest, at the Company’s option, at either the London Interbank Offered Rate (“LIBOR”) plus a spread ranging from 2.25% to 3.0%, or an alternative base rate plus a spread ranging from 1.25% to 2.0%.  The alternative base rate is the greater of Bank of America, N.A. prime rate, the Federal Funds rate plus 0.5% or the one month British Bankers’ Association LIBOR plus 1.0% (the “Base Rate”).  The Company is also required to pay a non−use fee of 0.4% to 0.5% per annum on the unused portion of the revolving loans and letter of credit fees of 2.25% to 3.0% per annum. The interest rate spread in the case of LIBOR and Base Rate loans and the payment of the non−use and letter of credit fees is dependent on the Company’s Total Funded Debt to EBITDA ratio, as defined in the Credit Agreement.  Interest on each Base Rate loan is payable quarterly in arrears and at maturity.  Interest on each LIBOR loan is payable on the last day of each Interest Period, as defined in the Credit Agreement, relating to such loan, upon a repayment of such loan and at maturity.

The Credit Agreement and related loan documents contain terms and provisions (including representations, covenants and conditions) customary for transactions of this type.  The financial covenants include a leverage ratio test (as defined, Total Funded Debt to EBITDA) and an interest coverage ratio test (as defined, EBITDA minus capital expenditures to interest expense).  Other covenants include limitations on lines of business, additional indebtedness, liens and negative pledge agreements, incorporation of other debt covenants, guarantees, investments and advances, cancellation of indebtedness, restricted payments, modification of certain agreements and instruments, inconsistent agreements, leases, consolidations, mergers and acquisitions, sale of assets, subsidiary dividends, and transactions with affiliates.

The Credit Agreement also contains customary events of default, including nonpayment of the principal of any loan or letter of credit obligation, interest, fees or other amounts; inaccuracy of representations and warranties; violation of covenants; certain bankruptcy events; cross−defaults to other material obligations and other indebtedness (if any); change of control of events; material judgments; certain ERISA−related events; and the invalidity of the loan documents (including the collateral documents).  If an event of default occurs and is continuing under the Credit Agreement, the lenders may terminate their obligations thereunder and may accelerate the payment by the Company and the subsidiary guarantors of all of the obligations due under the Credit Agreement and the other loan documents.

The proceeds of the revolving loans may be used for working capital purposes and general business purposes, for acquisitions permitted under the Credit Agreement, for capital expenditures (including retail store expansions and conversion to digital photography), for refinancing existing debt and to pay dividends and distributions on the Company’s capital securities to the extent permitted thereunder, and to make purchases or redemptions of the Company’s capital securities to the extent permitted thereunder.

 
24
 
 

As of February 5, 2011, the Company had $48.9 million outstanding under the Credit Agreement.  In the third quarter of 2010, the Company used the proceeds from the Credit Agreement to pay down the remaining debt on the former facility.  The Company incurred approximately $1.5 million in issuance costs in 2010 associated with the new credit facility.  These fees will be amortized on a straight-line basis over the life of the revolving commitment since there are no borrowings or repayments scheduled.  The Company wrote off $1.1 million in unamortized debt fees in 2010 related to the former facility.  This charge was recorded in Other charges and impairments in 2010.

The Company was in compliance with all the covenants under its Credit Agreement as of February 5, 2011.

As part of the Company’s former credit facility, the Company had entered into an interest rate swap agreement to manage the interest rate risk on a portion of its term loan.  This swap agreement expired on September 17, 2010.  The fixed rate gain (loss) related to this agreement was $2.0 million, $1.5 million and ($617,000) for 2010, 2009 and 2008, respectively, which is included in Interest expense for those respective periods.

Additionally, on August 25, 2010, the Company’s Board of Directors authorized a 1.0 million share open market repurchase program. Purchases under the share repurchase program may be made at the Company's discretion, subject to market conditions, in the open market, in privately-negotiated transactions or otherwise.  The Company repurchased 324,716 shares under this program in the fourth quarter of fiscal year 2010.

Net Cash Used In Investing Activities

Net cash used in investing activities was $8.8 million, $2.9 million and $33.5 million in 2010, 2009 and 2008, respectively.  The increase in cash used in 2010 was primarily attributable to the increase in capital spend of $8.3 million due in part to the acquisition and purchase of certain Kiddie Kandids assets in 2010, remodel expenditures in certain PMPS studios, and certain hardware and software.  This increase in cash used was offset in part by the proceeds received from the Bella Pictures® Acquisition of $1.4 million and a $1.2 million increase in proceeds received from the sale of certain assets held for sale.

The decrease in cash used in 2009 from 2008 primarily relates to a decrease in capital expenditures of $30.8 million as the digital conversion was completed by the end of 2008.  This decrease is offset in part by a decrease of $2.5 million related to the proceeds received and distribution of funds in excess of related obligations from the Rabbi Trust and proceeds of $1.9 million from the sale of certain assets previously held for sale during 2009.

Benefit Plans

The Company has defined benefit and defined contribution pension plans, as described in Note 14 to the Notes to Consolidated Financial Statements.  We fund these plans based on the minimum amounts required by law plus such amounts we deem appropriate.

Off-Balance Sheet Arrangements

Other than standby letters of credit primarily used to support the Company’s various large deductible insurance programs, which are more fully discussed in the “Other Commitments” table below, the Company has no additional off-balance sheet arrangements.

Future Cash Flows

To facilitate an understanding of the Company’s contractual obligations and other commitments, the tables below are provided.  The Company is self-insured with stop-loss coverage for medical insurance and has a large deductible program for worker’s compensation and general liability insurance.  The Company has established reserves for claims under these plans that have been reported but not paid and incurred but not reported.  As of February 5, 2011, estimated reserves for these claims totaled $9.9 million.  These reserves have been excluded from the tables below, as we are uncertain as to the timing of when cash payments may be required.

The tables below also exclude our deferred income tax, rental and license host fee liabilities and pension plan contributions beyond 2011, as the liabilities are not currently estimable and/or it is not certain when they will become due, as well as $2.2 million of long-term liabilities for unrecognized tax benefits for various tax positions taken and $46,000 of related accrued federal, state and local interest and penalties.  These liabilities may increase or decrease over time as a result of tax examinations, and given the status of examinations, the Company cannot reliably estimate the period of any cash settlement with the respective taxing authorities.
 

 
25
 
 
 
       
in thousands
 
PAYMENTS DUE BY PERIOD
 
                                       
2016 and
 
   
Total
   
2011
   
2012
   
2013
   
2014
   
2015
   
Beyond
 
Contractual obligations:
                                         
                                           
Long-term debt (1)
  $ 48,900     $ -     $ -     $ -     $ 48,900     $ -     $ -  
Interest expense (2)
    6,742       1,741       1,932       1,949       1,120       -       -  
Operating leases
    8,420       1,803       1,704       1,565       1,419       1,425       504  
Purchase obligations for
                                                       
materials and services (3)
    4,307       3,729       538       40       -       -       -  
Pension plan contributions (4)
    2,849       2,849       -       -       -       -       -  
Sears Agreement fees (5)
    500       150       150       150       150       -       -  
Other liabilities (6)
    1,019       1,000       8       7       4       -       -  
                                                         
TOTAL
  $ 72,737     $ 11,272     $ 4,332     $ 3,711     $ 51,593     $ 1,425     $ 504  
                                                         
 
in thousands
 
AMOUNT OF COMMITMENT EXPIRATION PER PERIOD
 
                                       
2016 and
 
   
Total
   
2011
   
2012
   
2013
   
2014
   
2015
   
Beyond
 
Other commitments:
                                         
                                           
Standby letters of credit (7)
  $ 14,801     $ 14,801     $ -     $ -     $ -     $ -     $ -  
Interest expense (8)
    404       404       -       -       -       -       -  
                                                         
TOTAL
  $ 15,205     $ 15,205     $ -     $ -     $ -     $ -     $ -  
                                                         
 
(1)
 
Amount represents the total principal due on the Company’s revolving credit facility as of February 5, 2011.  The facility expires in August 2014.  See Note 10 to the Notes to Consolidated Financial Statements.  This balance could increase or decrease substantially through the expiration date based on the Company’s future repayments and borrowings due to operations and strategic initiatives.
     
(2)
 
Amounts represent the expected cash payments of the Company’s interest expense on its revolving credit facility, as of February 5, 2011, calculated based on the rates included in the Credit Agreement, effective August 30, 2010.  These amounts could increase or decrease depending on the Company’s future revolving credit facility levels.
     
(3)
 
Amount represents outstanding purchase commitments at February 5, 2011.  The purchase commitments relate principally to marketing initiatives, database maintenance contracts, photographic paper, manufacturing supplies and telecommunication services.
 
(4)
 
The Company anticipates it will make a contribution of approximately $2.8 million to the pension plan in 2011.  Obligations beyond 2011 are not currently estimable.  Future contributions to the pension plan will be dependent upon legislation, future changes in discount rates and the earnings performance of the plan assets.
 
(5)
 
The Company is obligated to remit to Sears additional payments as stipulated in the settlement of the previous license agreement and the current license agreement.  A $150,000 payment is due to Sears on December 31 of each year through 2014 as part of the settlement of the previous license agreement.
     
(6)
 
Amounts consist primarily of severance and related costs, which are recorded at the contractual amounts due.
     
(7)
 
The Company primarily uses standby letters of credit to collateralize its various large deductible insurance programs.  The letters of credit generally have a one-year maturity and have auto renewal clauses.
     
(8)
 
Amount represents the expected cash payments of the Company’s interest expense on its standby letters of credit.
 
 
 
26
 
 

Liquidity

Cash flows from operations, cash and cash equivalents and the borrowing capacity under the Company’s revolving credit facility, represent expected sources of funds in 2011 that will meet the Company’s obligations and commitments, including debt service, annual dividends to shareholders, planned capital expenditures, which are estimated to approximate $10.0 million for fiscal year 2011, and normal operating needs.

ACCOUNTING PRONOUNCEMENTS AND POLICIES

Adoption of New Accounting Standards

In December 2010, the FASB issued ASU No. 2010-29, “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force (EITF))” (“ASU No. 2010-29”).  ASU No. 2010-29 clarifies the acquisition date that should be used for reporting the pro forma financial information disclosure in Topic 805 when the comparative financial statements are presented.  ASU No. 2010-29 also improves the usefulness of the pro forma revenue and earnings disclosures by requiring a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination.  ASU No. 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  Early adoption is permitted.  The Company adopted the applicable requirements of ASU No. 2010-29 on February 6, 2011, and there was no effect to the Company’s financial statements.

In December 2010, the FASB issued ASU No. 2010-28, “Intangibles – Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB EITF)” (“ASU No. 2010-28”).  ASU No. 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts.  As a result, current generally accepted accounting principles will be improved by eliminating an entity’s ability to assert that a reporting unit is zero or negative despite the existence of qualitative factors that indicate goodwill is more likely than not impaired.  As a result, goodwill impairments may be reported sooner than under current practice.  ASU No. 2010-28 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010.  Early adoption is not permitted.  The Company is currently evaluating the impact of the adoption of ASU No. 2010-28 on the Company’s financial statements.

In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures about Fair Value Measurements” (“ASU No. 2010-06”).  ASU No. 2010-06 amends existing disclosure requirements under ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”) by adding required disclosures about items transferring into and out of levels 1 and 2 in the fair value hierarchy; adding separate disclosures about purchases, sales, issuances, and settlements on a gross basis relative to level 3 measurements; and clarifying, among other things, the existing fair value disclosures about inputs and valuation techniques and the level of disaggregation.  The new disclosures and clarifications of existing disclosures are effective for interim and annual periods beginning after December 15, 2009, except for the requirement to provide level 3 activity of purchases, sales, issuances and settlements on a gross basis, which is effective for interim and annual periods beginning after December 15, 2010.  The Company adopted the applicable requirements of ASU No. 2010-06 on February 7, 2010, with the exception of the requirement to provide level 3 activity of purchases, sales, issuances and settlements on a gross basis, as this is not effective until the Company’s first quarter of fiscal year 2011, and there was no effect to the Company’s financial statements.

In October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (a consensus of the FASB EITF)” (“ASU No. 2009-13”).  ASU No. 2009-13 significantly improves the reporting of transactions to more closely reflect the underlying economics of the transactions by requiring allocation of the overall consideration to each deliverable using the estimated selling price in the absence of vendor-specific objective evidence or third-party evidence of selling price for deliverables.  Additionally, ASU No. 2009-13 will improve financial reporting because the relative selling price method spreads any discount in an arrangement across all of the deliverables in that arrangement rather than allocating the entire discount to the delivered items.  The disclosures required by ASU No. 2009-13 also significantly improve financial reporting by providing users of financial statements with greater transparency of how a vendor allocates revenue in its arrangements, the significant judgments made, and changes to those judgments in allocating that revenue, and how those judgments affect the timing and amount of revenue recognition.  ASU No. 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted.  The Company adopted the applicable requirements of ASU No. 2009-13 on February 6, 2011, and is currently assessing the effect, if any, on the Company’s financial statements.

 
27
 
 

Application of Critical Accounting Policies

The application of certain of the accounting policies utilized by the Company requires significant judgments or a complex estimation process that can affect the results of operations and financial position of the Company, as well as the related footnote disclosures.  The Company bases its estimates on historical experience and other assumptions that it believes are reasonable.  If actual amounts are ultimately different from previous estimates, the revisions are included in the Company’s results of operations for the period in which the actual amounts become known.  The Company’s significant accounting policies are discussed in Note 1 to the Notes to Consolidated Financial Statements; critical estimates inherent in these accounting policies are discussed in the following paragraphs.

Long-Lived Asset Recoverability

In accordance with ASC Topic 360, “Property, Plant and Equipment” (“ASC Topic 360”) long-lived assets, primarily property and equipment, are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable.  The impairment tests, as prescribed under ASC Topic 360, is a two-step process.  If the carrying value of the asset exceeds the expected future cash flows (undiscounted and without interest) from the asset, impairment is indicated.  The impairment loss recognized is the excess of the carrying value of the asset over its fair value.   During the third quarter of 2010, the Company recorded a $1.9 million impairment charge in Other charges and impairments related to its Matthew facility previously classified as “held for sale”, as the carrying value exceeded its fair value; see Note 7 to the Notes to Consolidated Financial Statements.  As of February 5, 2011, no additional impairment was indicated.
 
Recoverability of Goodwill and Acquired Intangible Assets

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-step process for impairment testing of goodwill.  The first step is a screen for impairment, which compares the reporting unit’s estimated fair value to its carrying value.  If the carrying value exceeds the estimated fair value in the first step, the second step 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 24, 2010, the end of the Company’s 2010 second quarter, the Company completed its annual impairment test and concluded at that time that the estimated fair value of its reporting unit substantially exceeded its carrying value, and therefore, no impairment was indicated.

As of February 5, 2011, the Company has goodwill recorded of $22.9 million, which relates primarily to one goodwill reporting unit – PMPS.  At the end of the Company’s 2010 fiscal year, the Company considered possible impairment triggering events since the July 24, 2010, impairment test date.  Key items of consideration included the Company’s market capitalization relative to the carrying value of its net assets, estimates of future cash flows, the most significant assumption being the Company’s expectation of future PMPS studio sales levels, and other relevant factors, and concluded that no goodwill impairment was indicated at that date, and consequently its PMPS goodwill reporting unit is currently not at risk of failing the step-one impairment test.  However, if market conditions at the studio or host store levels significantly deteriorate, which would result in lower than expected PMPS studio sales, the Company may be required to record a non-cash impairment charge, which could be significant, and would adversely affect the Company’s financial position and results of operations.

The Company also reviews its intangible assets with definite useful lives, consisting primarily of the PMPS host agreement, 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.

As of February 5, 2011, the Company considered possible impairment triggering events, including projected cash flow data, as well as other relevant factors, and concluded that no impairment was indicated at that date.  However, if market conditions at the studio or host store levels significantly deteriorate, which would result in lower than expected PMPS studio sales, or if there are changes in circumstances, assumptions or estimates, including historical and projected cash flow data, utilized by the Company in its evaluation of the recoverability of its intangible assets with definite useful lives, it is possible that the Company would be required to write-down its intangible assets and record a non-cash impairment charge, which could be significant, and would adversely affect the Company’s financial position and results of operations.

 
28
 
 
Self-insurance Reserves

The Company is self-insured with stop-loss coverage for medical insurance and has a large deductible program for worker’s compensation and general liability insurance.  The Company has established reserves for claims under these plans that have been reported but not paid and incurred but not reported.  These reserves are 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. Loss estimates are adjusted based upon actual claims settlements and reported claims.

Income Taxes

The Company provides deferred income tax assets and liabilities based on the estimated future tax effects of operating losses and tax credit carryforwards, as well as the differences between the financial and tax bases of assets and liabilities based on currently enacted tax laws.  Deferred tax assets and liabilities are measured using the 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. The tax balances and income tax expense (benefit) recognized by the Company are based on management’s interpretation of the tax laws of multiple jurisdictions.  Income tax expense (benefit) also reflects the Company’s best estimates and assumptions regarding, among other things, the level of future taxable income, interpretation of the tax laws and tax planning.  The Company assesses temporary differences that result from differing treatments of certain items for tax and accounting purposes.  These differences result in deferred tax assets and liabilities, which are shown on our consolidated balance sheet.  The Company must assess the likelihood that deferred tax assets will be realized.  To the extent the Company believes that realization is not likely, a valuation allowance is established.  When a valuation allowance is established or increased in an accounting period, a corresponding tax expense is recorded in our consolidated statement of operations.

Defined Benefit Retirement Plans

The plan obligations and related assets of defined benefit retirement plans are presented in Note 14 in the accompanying Notes to Consolidated Financial Statements. Plan assets, which consist primarily of marketable equity and debt instruments, are valued using market quotations. Plan obligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions. Key assumptions in measuring the plan obligations include the discount rate, the rate of salary increases and the estimated future return on plan assets. In determining the discount rate, the Company utilizes the yield on high-quality, fixed-income investments currently available with maturities corresponding to the anticipated timing of the benefit payments.  Asset returns are based upon the anticipated average rate of earnings expected on the invested funds of the plans.  Actuarial assumptions used in the Company’s plans at February 5, 2011, are included in Note 14 to the Notes to Consolidated Financial Statements.  Effective February 20, 2009, the Company implemented a freeze of future benefit accruals related to its pension plan for the remaining grandfathered participants.  See further discussion in Note 14 to the Notes to Consolidated Financial Statements.

The Company has made certain other estimates that, while not involving the same degree of judgment, are important to understanding the Company’s financial statements. These estimates are in the areas of establishing reserves or accruals in connection with restructuring or other business changes.  On an ongoing basis, management evaluates its estimates and judgments in these areas based on its substantial historical experience and other relevant factors.  Management’s estimates as of the date of the financial statements reflect its best judgment giving consideration to all currently available facts and circumstances.  As such, these estimates may require adjustment in the future, as additional facts become known or as circumstances change.

The Company’s management has discussed the development and selection of these critical accounting policies with the Audit Committee of the Company’s Board of Directors and the Audit Committee has reviewed the Company’s disclosure relating to it in this Management Discussion and Analysis of Financial Condition and Results of Operations section.

Item 7A.             Quantitative and Qualitative Disclosures About Market Risk

Market risks relating to the Company’s operations result primarily from changes in interest rates and foreign exchange rates.

At February 5, 2011, all of the Company’s debt obligations have floating interest rates.  The impact of a 1% change in interest rates affecting the Company’s debt would increase or decrease interest expense by approximately $489,000.

 
29
 
 

The Company’s net assets, net earnings and cash flows from its Canadian and Mexican operations are based on the U.S. dollar equivalent of such amounts measured in the respective country’s functional currency.  Assets and liabilities are translated to U.S. dollars using the applicable exchange rates as of the end of a reporting period.  Revenues, expenses and cash flows are translated using the average exchange rate during each period.  The Company’s Canadian operations constitute 12% of the Company’s total assets and 14% of the Company’s total sales as of and for the year ended February 5, 2011.  A hypothetical 10% unfavorable change in the Canadian-to-U.S. dollar exchange rate would cause an approximate $1.0 million decrease to the Company’s net asset balance and could materially adversely affect its revenues, expenses and cash flows.  The Company’s exposure to changes in foreign exchange rates relative to the Mexican operations is minimal, as Mexican operations constitute only 2% of the Company’s total assets and 2% of the Company’s total sales as of and for the year ended February 5, 2011.

Item 8.               Financial Statements and Supplementary Data
 
(a)
FINANCIAL STATEMENTS
 
PAGES
     
 
-
 
Report of Independent Registered Public Accounting Firm
 
31
 
-
 
Consolidated Balance Sheets as of February 5, 2011 and February 6, 2010
 
32
 
-
 
Consolidated Statements of Operations for the fiscal years ended
   
   
February 5, 2011, February 6, 2010 and February 7, 2009
 
34
 
-
 
Consolidated Statements of Changes in Stockholders' Equity
   
   
for the fiscal years ended February 5, 2011, February 6, 2010 and February 7, 2009
 
35
 
-
 
Consolidated Statements of Cash Flows for the fiscal years ended February 5, 2011,
   
   
February 6, 2010 and February 7, 2009
 
36
 
-
 
Notes to Consolidated Financial Statements
 
39
 
The Company's fiscal year ends the first Saturday of February.  Accordingly, fiscal year 2010 ended February 5, 2011, and consisted of 52 weeks, fiscal year 2009 ended February 6, 2010, and consisted of 52 weeks, and fiscal year 2008 ended February 7, 2009, and consisted of 53 weeks. Throughout the "Financial Statements and Supplemental Data" section, references to 2010, 2009 and 2008 represent the fiscal years ended February 5, 2011, February 6, 2010, and February 7, 2009, respectively.
 

 
30
 
 



Report of Independent Registered Public Accounting Firm

 
The Board of Directors and Stockholders
CPI Corp.:
 
We have audited the accompanying consolidated balance sheets of CPI Corp. and subsidiaries (the Company) as of February 5, 2011 and February 6, 2010, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended February 5, 2011. These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CPI Corp. and subsidiaries as of February 5, 2011 and February 6, 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended February 5, 2011, in conformity with U.S. generally accepted accounting principles.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), CPI Corp.’s internal control over financial reporting as of February 5, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated April 20, 2011 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
 
/s/ KPMG LLP
_________________________________
 
KPMG LLP
 
St. Louis, Missouri
 
April 20, 2011
 





 
31
 
 

CPI CORP.
Consolidated Balance Sheets – Assets
 
in thousands
 
February 5, 2011
   
February 6, 2010
 
             
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 5,363     $ 18,913  
Accounts receivable:
               
Trade
    4,707       5,960  
Other
    971       880  
Inventories
    7,460       7,465  
Prepaid expenses and other current assets
    4,971       5,396  
Refundable income taxes
    -       1,350  
Deferred tax assets
    5,976       7,253  
Assets held for sale
    641       6,338  
                 
Total current assets
    30,089       53,555  
                 
Property and equipment:
               
Land
    2,185       2,185  
Buildings and building improvements
    25,343       25,289  
Leasehold improvements
    4,383       4,491  
Photographic, sales and manufacturing equipment
    176,974       168,371  
Property not in use (see Note 7)
    3,401       -  
Total
    212,286       200,336  
Less accumulated depreciation and amortization
    176,288       166,167  
 Property and equipment, net
    35,998       34,169  
                 
Prepaid debt fees
    1,838       2,237  
Goodwill
    22,874       21,720  
Intangible assets, net
    37,862       38,660  
Deferred tax assets
    7,166       7,701  
Other assets
    7,973       8,549  
                 
TOTAL ASSETS
  $ 143,800     $ 166,591  
                 
 
See accompanying footnotes to the consolidated financial statements.





 
32
 
 


CPI CORP.
Consolidated Balance Sheets - Liabilities and Stockholders’ Equity

in thousands, except share and per share data
 
February 5, 2011
   
February 6, 2010
 
             
LIABILITIES
           
Current liabilities:
           
Current maturities of long-term debt
  $ -     $ 19,686  
Accounts payable
    7,583       4,390  
Accrued employment costs
    8,905       9,878  
Customer deposit liability
    16,403       11,528  
Income taxes payable
    215       -  
Sales taxes payable
    3,767       3,929  
Accrued advertising expenses
    995       1,062  
Accrued expenses and other liabilities
    11,335       11,959  
                 
Total current liabilities
    49,203       62,432  
                 
Long-term debt, less current maturities
    48,900       57,855  
Accrued pension plan obligations
    14,862       17,724  
Other liabilities
    16,565       18,392  
                 
Total liabilities
    129,530       156,403  
                 
CONTINGENCIES (see Note 16)
               
                 
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, $.40 par value, 50,000,000 shares authorized; 9,129,013 and 9,184,081 shares outstanding at
               
February 5, 2011, and February 6, 2010, respectively
    3,652       3,674  
Additional paid-in capital
    30,785       29,017  
Retained earnings
    40,794       41,516  
Accumulated other comprehensive loss
    (12,927 )     (14,887 )
      62,304       59,320  
                 
Treasury stock - at cost, 2,133,566 and 2,175,591 shares at February 5, 2011 and February 6, 2010, respectively
    (48,050     (49,132
                 
Total CPI Corp. stockholders' equity
    14,254       10,188  
Noncontrolling interest in subsidiary (see Note 4)
    16       -  
                 
Total stockholders' equity
    14,270       10,188  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 143,800     $ 166,591  
                 
 
See accompanying footnotes to the consolidated financial statements.


 
33
 
 

CPI CORP.
Consolidated Statements of Operations

Fifty-two weeks ended February 5, 2011, Fifty-two weeks ended February 6, 2010, and Fifty-three weeks ended February 7, 2009

in thousands, except share and per share data
 
2010
   
2009
   
2008
 
                   
Net sales
  $ 407,035     $ 422,371     $ 462,548  
                         
Cost and expenses:
                       
Cost of sales (exclusive of depreciation and amortization shown below)
    28,263       30,626       43,280  
Selling, general and administrative expenses
    337,490       339,138       377,310  
Depreciation and amortization
    17,962       22,740       29,432  
Other charges and impairments
    5,092       3,294       13,557  
      388,807       395,798       463,579  
                         
Income (loss) from operations
    18,228       26,573       (1,031 )
                         
Interest expense
    3,860       7,030       8,529  
Interest income
    17       94       2  
Other income (expense), net
    929       (44 )     190