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EX-11.2 - EXHIBIT 11.2 COMPUTATION OF PER COMMON SHARE-BASIC - CPI CORPexh11_2.htm
EX-11.1 - EXHIBIT 11.1 COMPUTATION OF PER COMMON SHARE-DILUTED - CPI CORPexh11_1.htm
EX-32.0 - EXHIBIT 32.0 CERTIFICATION BY CEO AND CFO - CPI CORPexh32_0.htm
EX-31.2 - EXHIBIT 31.2 CERTIFICATION BY CFO - CPI CORPexh31_2.htm
EX-31.1 - EXHIBIT 31.1 CERTIFICATION BY CEO - CPI CORPexh31_1.htm
EX-10.51 - EXHIBIT 10.51 EXECUTIVE CHAIRMAN'S AGREEMENT - CPI CORPexh10_51.htm
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

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

For the quarterly period ended July 23, 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 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 Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§299.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     x Yes    o No

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

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

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

As of August 26, 2011, 7,044,984 shares of the registrant’s common stock were outstanding.
 



 
 
 
 



CPI CORP.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
12 AND 24 WEEKS ENDED JULY 23, 2011


 
PART I.
 
FINANCIAL INFORMATION
 
Page
         
   
Item 1.
 
Financial Statements:
   
             
       
Interim Consolidated Balance Sheets
   
       
July 23, 2011 (Unaudited) and February 5, 2011
 
1
             
       
Interim Consolidated Statements of Operations (Unaudited)
   
       
12 and 24 Weeks Ended July 23, 2011 and July 24, 2010
 
3
             
       
Interim Consolidated Statement of Changes in Stockholders'
   
       
Equity (Unaudited) 24 Weeks Ended July 23, 2011
 
4
             
       
Interim Consolidated Statements of Cash Flow (Unaudited)
   
       
24 Weeks Ended July 23, 2011 and July 24, 2010
 
5
             
       
Notes to Interim Consolidated Financial Statements (Unaudited)
 
7
             
   
Item 2.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
  15
             
   
Item 3.
 
Quantitative and Qualitative Disclosures about Market Risk
 
22
             
   
Item 4.
 
Controls and Procedures
 
22
             
PART II.
 
OTHER INFORMATION
   
             
   
Item 6.
 
Exhibits
 
22
     
SIGNATURES
     
23
     
EXHIBIT INDEX
     
24
                       

 
 
 
 

PART I.
 
FINANCIAL INFORMATION

Item 1.
 
Financial Statements

CPI CORP.
Interim Consolidated Balance Sheets - Assets

 
 
in thousands
 
July 23, 2011
       
   
(Unaudited)
   
February 5, 2011
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 2,636     $ 5,363  
Accounts receivable:
               
Trade
    5,130       4,707  
Other
    670       971  
Inventories
    8,344       7,460  
Prepaid expenses and other current assets
    3,940       4,971  
Refundable income taxes
    481       -  
Deferred tax assets
    5,219       5,976  
Assets held for sale
    -       641  
                 
Total current assets
    26,420       30,089  
                 
Property and equipment:
               
Land
    2,185       2,185  
Buildings and building improvements
    25,454       25,343  
Leasehold improvements
    4,303       4,383  
Photographic, sales and manufacturing equipment
    179,994       176,974  
Property not in use (see Note 4)
    3,401       3,401  
Total
    215,337       212,286  
Less accumulated depreciation and amortization
    181,979       176,288  
 Property and equipment, net
    33,358       35,998  
                 
Prepaid debt fees
    1,567       1,838  
Goodwill
    21,987       22,874  
Intangible assets, net
    37,006       37,862  
Deferred tax assets
    11,502       7,166  
Other assets
    8,592       7,973  
                 
TOTAL ASSETS
  $ 140,432     $ 143,800  
                 
 
See accompanying footnotes to the interim consolidated financial statements.


 
1
 
 

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


in thousands, except share and per share data
 
July 23, 2011
       
   
(Unaudited)
   
February 5, 2011
 
LIABILITIES
           
Current liabilities:
           
Accounts payable
  $ 7,277     $ 4,570  
Accrued employment costs
    7,691       8,905  
Customer deposit liability
    16,350       16,403  
Sales taxes payable
    2,229       3,517  
Accrued advertising expenses
    1,428       995  
Accrued expenses and other liabilities
    12,649       14,813  
                 
Total current liabilities
    47,624       49,203  
                 
Long-term debt, less current maturities
    56,200       48,900  
Accrued pension plan obligations
    15,076       14,862  
Other liabilities
    16,119       16,565  
                 
Total liabilities
    135,019       129,530  
                 
CONTINGENCIES (see Note 11)
               
                 
STOCKHOLDERS' EQUITY
               
Preferred stock, no par value, 1,000,000 shares authorized; no shares outstanding
    -       -  
Preferred stock, Series A, no par value, 200,000 shares authorized; no shares outstanding
    -       -  
Common stock, $0.40 par value, 50,000,000 shares authorized; 9,139,527 and 9,129,013 shares outstanding at July 23, 2011, and February 5, 2011, respectively
    3,670       3,652  
Additional paid-in capital
    31,360       30,785  
Retained earnings
    30,901       40,794  
Accumulated other comprehensive loss
    (12,496 )     (12,927 )
      53,435       62,304  
Treasury stock - at cost, 2,097,043 and 2,133,566 shares at  July 23, 2011, and February 5, 2011, respectively
    (47,915 )     (48,050 )
                 
Total CPI Corp. stockholders' equity
    5,520       14,254  
Noncontrolling interest in subsidiary (see Note 2)
    (107 )     16  
                 
Total stockholders' equity
    5,413       14,270  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 140,432     $ 143,800  
                 
 
See accompanying footnotes to the interim consolidated financial statements.



 
2
 
 

CPI CORP.
Interim Consolidated Statements of Operations
(Unaudited)


in thousands, except share and per share data
 
12 Weeks Ended
   
24 Weeks Ended
 
   
July 23, 2011
   
July 24, 2010
   
July 23, 2011
   
July 24, 2010
 
                         
Net sales
  $ 70,864     $ 76,414     $ 159,502     $ 171,913  
                                 
Cost and expenses:
                               
Cost of sales (exclusive of depreciation and amortization shown below)
    5,917       5,844       12,311       12,366  
Selling, general and administrative expenses
    67,007       68,880       140,555       142,701  
Depreciation and amortization
    3,738       4,355       7,754       8,820  
Other charges and impairments
    1,719       (1,052 )     4,896       (756 )
      78,381       78,027       165,516       163,131  
                                 
(Loss) income from operations
    (7,517 )     (1,613 )     (6,014 )     8,782  
                                 
Interest expense
    651       1,073       1,319       2,333  
Other income (expense), net
    (36 )     (51 )     96       665  
(Loss) income from operations before income tax (benefit) expense
    (8,204 )     (2,737 )     (7,237 )     7,114  
                                 
Income tax (benefit) expense
    (1,905 )     (920 )     (1,600 )     2,391  
                                 
Net (loss) income
    (6,299 )     (1,817 )     (5,637 )     4,723  
Net loss attributable to noncontrolling interest
    (55 )     -       (140 )     -  
                                 
NET (LOSS) INCOME ATTRIBUTABLE TO CPI CORP.
  $ (6,244 )   $ (1,817 )   $ (5,497 )   $ 4,723  
                                 
NET (LOSS) INCOME PER COMMON SHARE
                               
                                 
Net (loss) income per common share attributable to CPI Corp. - diluted
  $ (0.89 )   $ (0.25 )   $ (0.78 )   $ 0.65  
                                 
Net (loss) income per common share attributable to CPI Corp. - basic
  $ (0.89 )   $ (0.25 )   $ (0.78 )   $ 0.65  
                                 
Weighted average number of common and common equivalent shares outstanding-diluted
    7,040,441       7,318,746       7,016,291       7,249,318  
                                 
Weighted average number of common and common equivalent shares outstanding-basic
    7,040,441       7,318,746       7,016,291       7,244,031  
                                 
 
See accompanying footnotes to the interim consolidated financial statements.


 
3
 
 


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


Twenty-four weeks ended July 23, 2011

 
in thousands, except share and per share data
                   
Accumulated
                   
         
Additional
         
other
   
Treasury
             
   
Common
   
paid-in
   
Retained
   
comprehensive
   
stock,
   
Noncontrolling
       
   
stock
   
capital
   
earnings
   
(loss) income
   
at cost
   
Interest
   
Total
 
                                           
Balance at February 5, 2011
  $ 3,652     $ 30,785     $ 40,794     $ (12,927 )   $ (48,050 )   $ 16     $ 14,270  
                                                         
Net loss
    -       -       (5,497 )     -       -       (140 )     (5,637 )
Total other comprehensive income, net of tax effect (consisting of foreign exchange impact)
    -       -       -       431       -       -       431  
Total comprehensive loss
    -       -       -       -       -       -       (5,206 )
Adjustment to issuance of noncontrolling interest
    -       -       -       -       -       17       17  
Surrender of employee shares for taxes
    -       -       -       -       (690 )     -       (690 )
Purchase and retirement of stock (52,937 shares, at cost)
    (21 )     (178 )     (888 )     -       -       -       (1,087 )
Issuance of common stock and restricted stock awards,  net of forfeitures (87,247 shares)
    37       173       -       -       825       -       1,035  
Stock options exercised
    2       (84 )     -       -       -       -       (82 )
Stock-based compensation recognized
    -       664       -       -       -       -       664  
Dividends ($0.50 per common share)
    -       -       (3,508 )     -       -       -       (3,508 )
                                                         
Balance at July 23, 2011
  $ 3,670     $ 31,360     $ 30,901     $ (12,496 )   $ (47,915 )   $ (107 )   $ 5,413  
                                                         
 
See accompanying footnotes to the interim consolidated financial statements.



 
4
 
 


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

in thousands
 
24 Weeks Ended
 
   
July 23, 2011
   
July 24, 2010
 
             
Reconciliation of net (loss) income to cash flows (used in) provided by operating activities:
           
             
Net (loss) income
  $ (5,637 )   $ 4,723  
                 
Adjustments for items not requiring (providing) cash:
               
Depreciation and amortization
    7,754       8,820  
Amortization of prepaid debt fees
    271       559  
Stock-based compensation expense
    888       1,465  
Gain on sale of assets held for sale
    (159 )     (1,645 )
Deferred income tax provision
    (3,463 )     1,398  
Change in interest rate swap
    -       (1,382 )
Pension, supplemental retirement plan and profit sharing expense
    707       916  
Other
    (8 )     81  
                 
Increase (decrease) in cash flow from operating assets and liabilities:
               
Accounts receivable
    (76 )     (200 )
Inventories
    (840 )     (229 )
Prepaid expenses and other current assets
    1,047       584  
Accounts payable
    2,659       (3 )
Contribution to pension plan
    (513 )     (700 )
Accrued expenses and other liabilities
    (5,371 )     (3,800 )
Income taxes payable
    (728 )     342  
Deferred revenues and related costs
    1,195       662  
Other
    (99 )     58  
                 
Cash flows (used in) provided by operating activities
  $ (2,373 )   $ 11,649  
                 
 
See accompanying footnotes to the interim consolidated financial statements.

 
 
5
 
 


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

in thousands
 
24 Weeks Ended
 
   
July 23, 2011
   
July 24, 2010
 
             
Cash flows (used in) provided by operating activities
    (2,373 )     11,649  
                 
Cash flows provided by (used in) financing activities:
               
Repayment of long-term debt
    -       (13,556 )
Borrowings under revolving credit facility
    72,800       -  
Repayments on revolving credit facility
    (65,500 )     -  
Cash dividends
    (3,508 )     (2,953 )
Purchase of treasury stock
    (1,087 )     -  
Surrender of employee shares for taxes
    (690 )     (183 )
Other
    44       148  
                 
Cash flows provided by (used in) financing activities
    2,059       (16,544 )
                 
Cash flows (used in) provided by investing activities:
               
Additions to property and equipment
    (3,961 )     (8,197 )
Proceeds from sale of assets held for sale
    800       2,369  
Proceeds from liquidation of Rabbi Trust
    760       -  
Other
    8       42  
                 
Cash flows used in investing activities
    (2,393 )     (5,786 )
                 
Effect of exchange rate changes on cash and cash equivalents
    (20 )     (271 )
                 
Net decrease in cash and cash equivalents
    (2,727 )     (10,952 )
                 
Cash and cash equivalents at beginning of period
    5,363       18,913  
                 
Cash and cash equivalents at end of period
  $ 2,636     $ 7,961  
                 
Supplemental cash flow information:
               
Interest paid
  $ 1,137     $ 3,072  
                 
Income taxes paid, net
  $ 2,701     $ 629  
                 
Supplemental non-cash financing activities:
               
Issuance of treasury stock under the Employee Profit Sharing Plan
  $ 800     $ 733  
                 
Issuance of common stock, restricted stock and stock options to employees and directors
  $ 1,755     $ 3,281  
                 

See accompanying footnotes to the interim consolidated financial statements.


 
6
 
 

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

NOTE 1 -
DESCRIPTION OF BUSINESS AND INTERIM CONSOLIDATED FINANCIAL STATEMENTS
 
CPI Corp. ("CPI", the "Company" or "we") is a holding company engaged, through its wholly-owned subsidiaries and partnerships, in selling and manufacturing professional portrait photography of young children, individuals and families and offers other related products and services.  The Company also offers wedding photography and videography services and products through its subsidiary, Bella Pictures Holdings, LLC.

The Company operates 3,073 (unaudited) professional portrait studios as of July 23, 2011, 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.  The Company also operates websites which support and complement its 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.  The Company also operates 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 Interim Consolidated Balance Sheet as of July 23, 2011, the related Interim Consolidated Statements of Operations for the 12 and 24 weeks ended July 23, 2011, and July 24, 2010, the Interim Consolidated Statement of Changes in Stockholders’ Equity for the 24 weeks ended July 23, 2011, and the Interim Consolidated Statements of Cash Flows for the 24 weeks ended July 23, 2011, and July 24, 2010, are unaudited.  The interim consolidated financial statements reflect all adjustments (consisting only of normal recurring accruals), which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented.  The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the CPI Corp. 2010 Annual Report on Form 10-K for its fiscal year ended February 5, 2011.  The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates include, but are not limited to, insurance reserves; depreciation; recoverability of long-lived assets and goodwill; defined benefit retirement plan assumptions and income tax.  Actual results could differ from those estimates.

Certain reclassifications have been made to the 2010 financial statements to conform with the current year presentation.

For purposes of this report, the Walmart studio operations are operating within CPI Corp. under the tradenames 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".

NOTE 2  -
BUSINESS ACQUISITION

On January 26, 2011, the Company acquired substantially all of the assets and certain liabilities of Bella Pictures, Inc., a provider of branded wedding photography services (the “Bella Pictures® Acquisition”).  The Bella Pictures® Acquisition was made pursuant to the Asset Purchase Agreement (the “Agreement”) dated January 26, 2011, by and among Bella Pictures Holdings, LLC, a Delaware limited liability company (“Bella Pictures®” or the “Buyer”), Bella Pictures, Inc., a Delaware corporation (the “Seller”), CPI Corp., a Delaware corporation (“CPI”), and Foundation Capital IV, L.P. (“Foundation Capital”).  In consideration for the Assets purchased, the Buyer issued to the Seller Class A Units in Bella Pictures®, representing a 5% equity interest in Bella Pictures® with a fair value at the date of issuance of approximately $40,000, estimated using a discounted cash flow analysis.  In addition, the Buyer assumed certain liabilities of the Seller, consisting primarily of customer deposits and the obligation to fulfill customer wedding orders booked and outstanding at the date of acquisition.  In addition, the Buyer received approximately $1.4 million in cash from the Seller.  The Company accounted for the acquisition as a business combination under the guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations”.

The purchase price was allocated as of February 5, 2011, based on the Company’s preliminary estimate at that time of the fair value of the tangible and identifiable intangible assets acquired and liabilities assumed.  The Company finalized the purchase price allocation as of its first quarter ended April 30, 2011.  As a result of final purchase price allocation adjustments made during the Company’s first quarter of fiscal 2011, the preliminary estimate of goodwill was reduced by approximately $1.0 million as of April 30, 2011, which the Company considered insignificant to the consolidated financial statements.  Accordingly, the preliminary purchase price allocation as of February 5, 2011 has not been retrospectively adjusted for the final purchase price allocation adjustments.
 
 
 
7
 
 
CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

The following unaudited pro forma summary presents the Company’s revenue, net income, diluted income per common share and basic income per common share as if the Bella Pictures® Acquisition had occurred on the first day of the periods presented (in thousands, except per share data):
 
   
12 Weeks Ended
   
24 Weeks Ended
 
   
July 24, 2010
   
July 24, 2010
 
             
Revenue
  $ 78,315     $ 174,935  
                 
Net loss
    (4,368 )     (1,039 )
Net loss attributable to noncontrolling interest
    (128 )     (288 )
Net loss attributable to CPI Corp.
  $ (4,240 )   $ (751 )
                 
Diluted loss per common share attributable to CPI Corp.
  $ (0.58 )   $ (0.10 )
                 
Basic loss per common share attributable to CPI Corp.
  $ (0.58 )   $ (0.10 )
 
Pro forma adjustments have been made to reflect depreciation and amortization using asset values recognized after applying purchase accounting adjustments.

This pro forma information is presented for informational purposes only and is not necessarily indicative of actual results had the acquisition been effected at the beginning of the periods presented or future results.

NOTE 3  -
INVENTORIES

Inventories consist of:

in thousands
 
July 23, 2011
   
February 5, 2011
 
             
Raw materials - film, paper and chemicals
  $ 1,794     $ 2,130  
Portraits in process
    1,765       1,274  
Finished portraits pending delivery
    142       97  
Frames and accessories
    279       230  
Studio supplies
    2,969       2,556  
Equipment repair parts and supplies
    890       627  
Other
    505       546  
                 
Total
  $ 8,344     $ 7,460  
                 
 
These balances are net of obsolescence reserves totaling $67,000 and $38,000 at July 23, 2011, and February 5, 2011, respectively.






 
8
 
 

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

NOTE 4  -
PROPERTY NOT IN USE

In connection with the Company’s June 8, 2007, acquisition of substantially all of the assets of Portrait Corporation of America (“PCA”) and certain of its affiliates and assumption of certain liabilities of PCA (the “PCA Acquisition”), the Company acquired a manufacturing facility located in Matthews, North Carolina, and excess parcels of land located in Charlotte, North Carolina.  In the third and fourth quarters of 2008, the Company ceased use of the excess parcels of land and the manufacturing facility, respectively, and committed to a plan to sell such assets as they were no longer required by the business.

The Company is actively marketing these assets for sale; however, they do not meet the criteria for “held for sale accounting” under FASB ASC Topic 360, “Property, Plant and Equipment” (“ASC Topic 360”).  Accordingly, the Company has presented these assets within Property and equipment (“Property not in use”), subject to depreciation as applicable.

The assets included in Property not in use are as follows:
 
in thousands
 
July 23, 2011
   
February 5, 2011
 
             
Land
  $ 996     $ 996  
Buildings and building improvements (1)
    2,405       2,405  
                 
Property not in use
  $ 3,401     $ 3,401  
                 
 
 
(1)
Depreciation expense related to the building and building improvements is included in the total accumulated depreciation and amortization line in the Interim Consolidated Balance Sheets.

NOTE 5  -
GOODWILL AND INTANGIBLE ASSETS

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

The following table summarizes the Company’s goodwill:
 
in thousands
 
July 23, 2011
   
February 5, 2011
 
             
PCA Acquisition
  $ 21,208     $ 21,208  
Bella Pictures Acquisition (1)
    -       983  
Goodwill from prior acquisitions
    512       512  
Translation impact on foreign balances
    267       171  
                 
Balance, end of period
  $ 21,987     $ 22,874  
                 
 
(1)  See Note 2 for explanation of the adjustment to the Bella Pictures® Acquisition goodwill.
 
In the current year, the Company adopted FASB 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 Emerging Issues Task Force)” and determined there was no effect to the Company’s financial statements.

 
9
 
 


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

The Company performs its annual goodwill impairment test at the end of its second quarter, or more frequently if circumstances indicate the potential for impairment.  As of July 23, 2011, the Company has goodwill recorded of approximately $22.0 million, which relates primarily to one goodwill reporting unit – PMPS.  At the end of the Company’s 2011 second fiscal quarter, the Company completed its annual impairment test and concluded that the estimated fair value of its PMPS reporting unit substantially exceeded its carrying value, and therefore, no impairment was indicated.  Key items of consideration in the annual impairment test 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.  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.

In connection with the PCA Acquisition, the Company also acquired intangible assets related to the host agreement with Walmart and the customer list.  These assets were recorded in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”).  The host agreement with Walmart and the customer list are being amortized over their useful lives of 21.5 years using the straight-line method and 6 years using an accelerated method, respectively.  During fiscal year 2010, in connection with the acquisition of certain assets of Kiddie Kandids, LLC in an auction approved by the United States Bankruptcy Court for the District of Utah (the “Kiddie Kandids asset acquisition”) and the Bella Pictures® Acquisition, the Company also acquired a customer list and tradename, respectively.  These assets were recorded in accordance with FASB ASC Topic 350, “Intangibles-Goodwill and Other” (“ASC Topic 350”).  The customer list and tradename are being amortized over their useful lives of 5.5 years using an accelerated method and 10 years using the straight-line method, respectively.  The following table summarizes the Company’s amortized intangible assets as of July 23, 2011 (in thousands):
 
in thousands
 
Net Balance
               
Translation
   
Net Balance
 
   
at Beginning
         
Accumulated
   
Impact of
   
at End
 
   
of Period
   
Adjustments
   
Amortization
   
Foreign Balances
   
of Period
 
                               
Acquired host agreement
  $ 36,719     $ -     $ (1,018 )   $ 346     $ 36,047  
Acquired customer lists
    390       -       (110 )     25       305  
Acquired tradename
    753       (67 )     (32 )     -       654  
    $ 37,862     $ (67 )   $ (1,160 )   $ 371     $ 37,006  
                                         
 
The Company also reviews its intangible assets with definite useful lives, consisting primarily of the PMPS host agreement, whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.  As of July 23, 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.

NOTE 6  -
OTHER ASSETS AND OTHER LIABILITIES

Included in Accrued expenses and other liabilities as of July 23, 2011, and February 5, 2011, is $3.1 million and $4.3 million, respectively, in accrued host commissions and $3.6 million and $3.7 million as of July 23, 2011, and February 5, 2011, respectively, related to accrued worker’s compensation.

Included in both Other assets and Other liabilities is $7.5 million and $7.0 million, as of July 23, 2011, and February 5, 2011, respectively, related to worker’s compensation insurance claims that exceed the deductible of the Company and that will be paid by the insurance carrier.  Since the Company is not released as primary obligor of the liability, it is included in both Other assets as a receivable from the insurance company and in Other liabilities as an insurance liability.


 
10
 
 

CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)
 
NOTE 7  -
STOCKHOLDERS' EQUITY

On August 24, 2011, the Company's Board of Directors authorized an extension of its share repurchase program and an increase in total shares from 1.0 million to 1.5 million shares.   During the 24 weeks ended July 23, 2011, the Company repurchased 52,937 shares of its common stock at an average price of $20.54 per share.
 
On July 29, 2011, the Company declared a third quarter cash dividend of 25 cents per share which was paid on August 15, 2011, in the amount of $1.8 million, to shareholders of record as of August 8, 2011.

On August 10, 2011, the stockholders of the Company approved an amendment to the Articles of Incorporation of the Company to reduce the number of authorized shares of common stock from 50 million shares to 16 million shares.

NOTE 8  -
STOCK-BASED COMPENSATION PLANS

At July 23, 2011, the Company had outstanding awards under various stock-based employee compensation plans, which are described more fully in Note 13 of the Notes to Consolidated Financial Statements in the Company’s 2010 Annual Report on Form 10-K.

On July 17, 2008, the stockholders approved the CPI Corp. Omnibus Incentive Plan (the "Plan").  Total shares of common stock approved for delivery pursuant to awards under the Plan as approved on July 17, 2008, and amended on August 11, 2010, were 1.1 million shares.  The Company has reserved these shares under its authorized, unissued shares.  At July 23, 2011, 497,654 of these shares remained available for future grants.

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

The following table summarizes the changes in stock options during the 24 weeks ended July 23, 2011:

 
               
Weighted-Average
   
Aggregate
 
         
Weighted-Average
   
Remaining Contractual
   
Intrinsic Value (1)
 
   
Shares
   
Exercise Price
   
Life (Years)
   
(in thousands)
 
Options outstanding, beginning of period
    169,166     $ 13.09       5.79     $ -  
Exercised
    (22,500 )     13.58               248  
                                 
Options outstanding, end of period
    146,666     $ 13.02       5.06     $ -  
                                 
Options exercisable at end of period
    10,001     $ 12.21       2.17     $ -  
 
 
(1)  Intrinsic value for activities other than exercises is defined as the difference between the Company's closing stock price on the last trading day of the fiscal 2011 second quarter and the exercise price, multiplied by the number of in-the-money options.  These amounts change based on the quoted market price of the Company's stock.  For exercises, intrinsic value is defined as the difference between the Company's closing stock price on the exercise date and the exercise price, multiplied by the number of options exercised.

Share proceeds received from the exercise of stock options for the 24 weeks ended July 23, 2011, were valued at $306,000 and tax benefits realized from exercised stock options for the 24 weeks ended July 23, 2011, were $94,000.

The Company estimates the fair value of its stock options with market-based performance conditions under the Plan using Monte Carlo simulations.  Weighted-average assumptions used in calculating the fair value of these stock options are included in Note 13 of the Notes to Consolidated Financial Statements in the Company’s 2010 Annual Report on Form 10-K.

The Company recognized stock-based compensation expense of $43,000, resulting in a deferred tax benefit of $16,000, for the 24 weeks ended July 23, 2011, based on the grant-date fair values of stock options previously granted and the derived service periods.  As of July 23, 2011, total unrecognized compensation cost related to nonvested stock options granted under the Plan was $135,000.  This unrecognized compensation cost will be recognized over a weighted-average period of 1.2 years.
 
 

 
 
11
 
 
CPI CORP.
Notes to Interim Consolidated Financial Statements
(Unaudited)

Issuances of nonvested stock in the 24 weeks ended July 23, 2011, include grants to executive management and certain other management members and employees for fiscal year 2010 performance and/or as part of a long-term incentive plan and issuances to the Executive Chairman of the Board and non-employee Board of Director members for their services to the Company.  All nonvested stock is valued based on the fair market value of the Company’s common stock on the grant date and the value is recognized as compensation expense over the service period.

Changes in nonvested stock are as follows:

   
24 Weeks Ended July 23, 2011
 
         
Weighted-Average
 
   
Shares
   
Grant-Date Value
 
Nonvested stock, beginning of period
    76,121     $ 14.26  
Granted
    82,101       18.73  
Forfeited
    (321 )     21.61  
Nonvested stock, end of period
    157,901     $ 16.57  
                 
Stock-based compensation expense related
               
to nonvested stock
  $ 621,000          
                 
 
For the 24 weeks ended July 23, 2011, total unrecognized compensation cost related to nonvested stock was $1.6 million.  This unrecognized compensation cost will be recognized over a weighted-average remaining period of approximately 1.4 years.

NOTE 9 -
EMPLOYEE BENEFIT PLANS

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

The Company also maintains a noncontributory defined benefit plan providing supplemental retirement benefits for certain current and former key executives.  The cost of providing these benefits is accrued over the remaining expected service lives of the active plan participants.  The supplemental retirement plan is unfunded and as such does not have a specific investment policy or long-term rate of return assumption.  Certain assets previously used to finance these future obligations consisted of investments in a Rabbi Trust.  On July 12, 2011, the Company liquidated the investments held in the Rabbi Trust for $760,000.  Remaining obligations related to current and former key executives will be funded through the Company’s normal operating cash flows.

 
12
 
 


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

The following tables set forth the applicable components of net periodic benefit cost for the defined benefit plans:
 
   
12 Weeks Ended
 
in thousands
 
Pension Plan
   
Supplemental Retirement Plan
 
   
July 23, 2011
   
July 24, 2010
   
July 23, 2011
   
July 24, 2010
 
Components of net periodic benefit costs:
                       
Interest cost
  $ 710     $ 715     $ 18     $ 18  
Expected return on plan assets
    (738 )     (715 )     -       -  
Amortization of net loss (gain)
    386       282       (12 )     (18 )
                                 
Net periodic benefit cost
  $ 358     $ 282     $ 6     $ -  
                                 
   
24 Weeks Ended
 
in thousands
 
Pension Plan
   
Supplemental Retirement Plan
 
   
July 23, 2011
   
July 24, 2010
   
July 23, 2011
   
July 24, 2010
 
Components of net periodic benefit costs:
                               
Interest cost
  $ 1,421     $ 1,431     $ 36     $ 36  
Expected return on plan assets
    (1,476 )     (1,430 )     -       -  
Amortization of net loss (gain)
    772       564       (24 )     (36 )
                                 
Net periodic benefit cost
  $ 717     $ 565     $ 12     $ -  
                                 
 
The Company contributed $1.0 million to its pension plan in the 24 weeks ended July 23, 2011, and estimates it will contribute a further $1.8 million in fiscal year 2011.  Future contributions to the pension plan will be dependent upon legislation, future changes in discount rates and the earnings performance of plan assets.

NOTE 10  -
INCOME TAXES

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

  
The Company had a balance of liability for uncertain tax positions of approximately $2.2 million at both July 23, 2011, and February 5, 2011, respectively.  Within the next 12 months, the Company anticipates the recognition of substantially all remaining uncertain tax benefits due to additional statute closure.  Recognition of these uncertain tax benefits would favorably affect the tax rate.

  
The Company recognizes interest expense and penalties related to the above unrecognized tax benefits within income tax expense.  During the 24 weeks ended July 23, 2011, the Company recognized a credit of $17,000 related to interest and penalties due to the true-up in calculation of expense.  As of July 23, 2011, and February 5, 2011, the Company had approximately $29,000 and $46,000, respectively, accrued for the payment of interest and penalties.

  
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, many states, and Mexican and Canadian jurisdictions.  The Company is generally no longer subject to U.S. federal income tax examination for the years prior to 2006.  The Company is currently under examination by the IRS for the 2008 tax year.  There are currently no ongoing examinations by state or foreign taxing authorities.



 
13
 
 

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

NOTE 11   -
COMMITMENTS AND CONTINGENCIES

Standby Letters of Credit

As of July 23, 2011, the Company had standby letters of credit outstanding in the principal amount of $14.5 million primarily used in conjunction with the Company’s various large deductible insurance programs.

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.

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 asked for 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 Company denied each of the claims asserted by the Plaintiffs, but nevertheless decided to settle the lawsuit for the purpose of avoiding the burden, expense and inconvenience of continuing litigation.  The terms of settlement call for a payment by the Company of $750,000 (inclusive of fees payable to Plaintiffs’ counsel).  The settlement agreement is in the process of being circulated for signatures and is subject to court approval.

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 filed a motion to dismiss on May 19, 2011.

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.



 
14
 
 


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

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

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

EXECUTIVE OVERVIEW

The Company’s Operations

CPI Corp. is a long-standing leader, based on sittings, number of locations and related revenues, in the professional portrait photography of young children, individuals and families.  From a single studio opened by our predecessor company in 1942, we have grown to 3,073 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.

Additionally, in connection with the Bella Pictures® Acquisition in fiscal year 2010, the Company now 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.

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 second quarter in fiscal years 2011 and 2010, the Company’s studio counts were:
 
   
July 23, 2011
   
July 24, 2010
 
Within Walmart stores:
           
United States and Puerto Rico
    1,535       1,534  
Canada
    257       258  
Mexico
    106       104  
                 
Within Sears stores:
               
United States and Puerto Rico
    853       858  
Canada
    110       110  
                 
Within Babies "R" Us stores in the United States
    150       134  
                 
Locations not within above host stores
    62       35  
                 
Total
    3,073       3,033  
                 
 
Locations not within Walmart, Sears or Babies “R” Us stores include 14 free-standing SPS studio locations, 21 Kiddie Kandids mall locations, 19 Shooting Star locations (located within Buy Buy Baby stores) and 8 Portrait Gallery locations.  As of Augsut 30, 2011, the Company operated a total of 180 Kiddie Kandids locations and plans to open an additional 16 locations by the end of September 2011.

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 limited if the economy worsens in the foreseeable future.

 
15
 
 

RESULTS OF OPERATIONS

A summary of consolidated results of operations and key statistics follows:

in thousands, except share and per share data
 
12 Weeks Ended
   
24 Weeks Ended
 
   
July 23, 2011
   
July 24, 2010
   
July 23, 2011
   
July 24, 2010
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Net sales
  $ 70,864     $ 76,414     $ 159,502     $ 171,913  
                                 
Cost and expenses:
                               
Cost of sales (exclusive of depreciation and amortization shown below)
    5,917       5,844       12,311       12,366  
Selling, general and administrative expenses
    67,007       68,880       140,555       142,701  
Depreciation and amortization
    3,738       4,355       7,754       8,820  
Other charges and impairments
    1,719       (1,052 )     4,896       (756 )
      78,381       78,027       165,516       163,131  
                                 
(Loss) income from operations
    (7,517 )     (1,613 )     (6,014 )     8,782  
                                 
Interest expense
    651       1,073       1,319       2,333  
Other income (expense), net
    (36 )     (51 )     96       665  
(Loss) income from operations before income tax (benefit) expense
    (8,204 )     (2,737 )     (7,237 )     7,114  
                                 
Income tax (benefit) expense
    (1,905 )     (920 )     (1,600 )     2,391  
                                 
Net (loss) income
    (6,299 )     (1,817 )     (5,637 )     4,723  
Net loss attributable to noncontrolling interest
    (55 )     -       (140 )     -  
                                 
NET (LOSS) INCOME ATTRIBUTABLE TO CPI CORP.
  $ (6,244 )   $ (1,817 )   $ (5,497 )   $ 4,723  
                                 
NET (LOSS) INCOME PER COMMON SHARE
                               
                                 
Net (loss) income per common share attributable to CPI Corp. - diluted
  $ (0.89 )   $ (0.25 )   $ (0.78 )   $ 0.65  
                                 
Weighted average number of common and common equivalent shares outstanding-diluted
    7,040,441       7,318,746       7,016,291       7,249,318  
                                 
 
12 weeks ended July 23, 2011 compared to 12 weeks ended July 24, 2010

The Company reported net losses of $6.2 million and $1.8 million, or ($0.89) and ($0.25) per diluted share, for the 12-week second quarters ended July 23, 2011, and July 24, 2010, respectively.  Earnings in the period were significantly affected by comparable store sales declines, initial dilution associated with the Bella Pictures® (“Bella”) operations and other charges and impairments.  Foreign currency translation effects and the Kiddie Kandids studio operations did not have a material impact on the Company’s net earnings in the second quarter of 2011.

 Net sales totaled $70.9 million and $76.4 million in the second quarters of fiscal 2011 and 2010, respectively.

  
Net sales for the second quarter of fiscal 2011 decreased $5.5 million, or 7%, to $70.9 million from the $76.4 million reported in the fiscal 2010 second quarter.  Net sales for the 2011 second quarter were positively impacted by the result of the late Easter holiday in the current year ($2.7 million), net studio openings ($1.6 million), Bella sales ($1.2 million), foreign currency translation ($900,000), and other items ($800,000).  Excluding the above impacts, comparable same-store sales in the quarter decreased approximately 17%.

Net sales from the Company’s PictureMe Portrait Studio® (PMPS) brand, on a comparable same-store basis, excluding impacts of net revenue recognition change, foreign currency translation and other items totaling $2.5 million, decreased 16% in the second quarter of 2011 to $33.4 million from $39.7 million in the second quarter of 2010.  The decrease in PMPS sales for the second quarter was the result of an 18% decrease in the number of sittings, offset in part by a 2% increase in average sale per customer sitting.

Net sales from the Company’s Sears Portrait Studio (SPS) brand, on a comparable same-store basis, excluding impacts of net revenue recognition change and other items totaling $800,000, decreased 18% in the second quarter of 2011 to $26.4 million from $32.2 million in the second quarter of 2010.  The decrease in SPS sales for the second quarter was the result of a 14% decline in the number of sittings and a 5% decline in average sale per customer sitting versus the prior-year quarter.
 
 
 
 
16
 
 
Net sales from the Company’s Kiddie Kandids (KK) studio operations increased 58% in the second quarter of 2011 to $4.9 million from $3.1 million in the second quarter of 2010.

The Bella operations contributed approximately $1.2 million in net sales in the second quarter of 2011.

Costs and expenses were $78.4 million in the second quarter of 2011, compared with $78.0 million in the comparable prior-year period.

  
Cost of sales, excluding depreciation and amortization expense, increased to $5.9 million in the second quarter of 2011, from $5.8 million in the second quarter of 2010 primarily due to incremental costs associated with the Bella operations; offset in part by lower overall production levels.

  
Selling, general and administrative (SG&A) expense declined to $67.0 million in the second quarter of 2011, from $68.9 million in the second quarter of 2010, as the benefits of reduced studio and corporate employment costs, employee insurance and host store commissions were offset in part by costs incurred in connection with the KK and Bella operations, which increased SG&A expense by $1.4 million and $1.5 million, respectively, in the 2011 second quarter.

  
Depreciation and amortization expense was $3.7 million in the second quarter of 2011, compared with $4.4 million in the second quarter of 2010.  Depreciation expense decreased as a result of the full depreciation of certain digital assets throughout fiscal 2010.

  
In the second quarter of 2011, the Company recognized a charge of $1.7 million in other charges and impairments, compared with a net credit of $1.1 million in the second quarter of 2010.  The current-quarter charges primarily related to severance and litigation costs.  The prior-year net credit primarily related to the gain on sale of the Brampton, Ontario facility and an early termination fee received from Walmart in relation to certain early PMPS store closures, offset in part by costs incurred in connection with the Kiddie Kandids asset acquisition.

Interest expense declined $422,000 in the second quarter of fiscal 2011 to $651,000 from $1.1 million in the second quarter of fiscal 2010.  The decrease is primarily a result of lower average borrowings and favorable interest rates as a result of the new credit facility, offset in part by a change in the interest rate swap value, which expired in the third quarter of fiscal year 2010.
 
Income tax benefit was $1.9 million and $920,000 in the second quarters of 2011 and 2010, respectively.  The resulting effective tax rates were 23% and 34% in 2011 and 2010, respectively.  The decrease in the effective tax rate in 2011 is due primarily to a higher income ratio in lower tax jurisdictions, a decrease in Canadian rates and an increase in U.S. tax credits.
  
24 weeks ended July 23, 2011 compared to 24 weeks ended July 24, 2010

The Company reported a net loss of $5.5 million, or ($0.78) per diluted share, for the 24-week period ended July 23, 2011, compared to net income of $4.7 million, or $0.65 per diluted share, for the 24-week period ended July 24, 2010.  Earnings in the period were significantly affected by comparable store sales declines, start-up costs and initial dilution associated with the Bella operations and other charges and impairments, offset in part by the positive KK studio operations contribution.  Foreign currency translation effects did not have a material impact on the Company’s net earnings in the first half of 2011.

 Net sales totaled $159.5 million and $171.9 million in the first half of fiscal 2011 and 2010, respectively.

  
Net sales for the first half of fiscal 2011 decreased $12.4 million, or 7%, to $159.5 million from the $171.9 million reported in the fiscal 2010 first half.  Net sales for the 2011 first half were positively impacted by net studio openings ($7.0 million), Bella sales ($2.1 million), foreign currency translation ($1.6 million), net revenue recognition change ($800,000) and E-commerce ($800,000) and negatively impacted by other items ($500,000).  Excluding the above impacts, comparable same-store sales in the first half decreased approximately 14%.

Net sales from the Company’s PMPS brand, on a comparable same-store basis, excluding impacts of foreign currency translation and other items totaling $1.6 million, decreased 12% in the first half of 2011 to $83.1 million from $94.6 million in the first half of 2010.  The decrease in PMPS sales for the first half was the result of a 16% decrease in the number of sittings, offset in part by a 5% increase in average sale per customer sitting.


 
17
 
 

Net sales from the SPS brand, on a comparable same-store basis, excluding the negative impact of studio closings and the positive impact of other items totaling ($300,000), decreased 16% in the first half of 2011 to $61.2 million from $73.3 million in the first half of 2010.  The decrease in SPS sales for the first half was the result of a 12% decline in the number of sittings and a 5% decline in average sale per customer sitting versus the prior-year period.

Net sales from the Company’s Kiddie Kandids (KK) studio operations increased 238% in the first half of 2011 to $10.4 million from $3.1 million in the first half of 2010.

The Bella operations contributed approximately $2.1 million in net sales in the first half of 2011.

Costs and expenses were $165.5 million in the first half of 2011, compared with $163.1 million in the comparable prior-year period.

  
Cost of sales, excluding depreciation and amortization expense, was fairly constant at $12.3 million and $12.4 million in the first half of 2011 and 2010, respectively, primarily due to incremental costs associated with the Bella operations, offset in part by lower overall production levels.

  
Selling, general and administrative (SG&A) expense declined to $140.6 million in the first half of 2011, from $142.7 million in the first half of 2010, as the benefits of reduced studio and corporate employment costs, employee insurance, host store commissions and advertising were offset in part by costs incurred in connection with the KK and Bella operations, which increased SG&A expense by $5.7 million and $3.4 million, respectively, in the first half of 2011, and increased payroll tax expense as a result of higher unemployment tax rates.

  
Depreciation and amortization expense was $7.8 million in the first half of 2011, compared with $8.8 million in the first half of 2010.  Depreciation expense decreased as a result of the full depreciation of certain digital assets throughout fiscal 2010.

  
In the first half of 2011, the Company recognized a charge of $4.9 million in other charges and impairments, compared with a net credit of $756,000 in the first half of 2010.  The current-year charges primarily related to litigation costs, severance and costs incurred in connection with the Bella Pictures® Acquisition.  The prior-year net credit primarily related to the gain on sale of the Brampton, Ontario facility and an early termination fee received from Walmart in relation to certain early PMPS store closures, offset in part by costs incurred in connection with the Kiddie Kandids asset acquisition.

Interest expense declined $1.0 million in the first half of fiscal 2011 to $1.3 million from $2.3 million in the first half of fiscal 2010.  The decrease is primarily a result of lower average borrowings and favorable interest rates as a result of the new credit facility, offset in part by a change in the interest rate swap value, which expired in the third quarter of fiscal year 2010.
 
Income tax (benefit) expense was ($1.6 million) and $2.4 million in the first half of 2011 and 2010, respectively.  The resulting effective tax rates were 22% and 34% in 2011 and 2010, respectively.  The decrease in the effective tax rate in 2011 is due primarily to a higher income ratio in lower tax jurisdictions, a decrease in Canadian rates and an increase in U.S. tax credits.

LIQUIDITY AND CAPITAL RESOURCES

The following table presents a summary of the Company’s cash flows for the first half of 2011 and 2010:
 
in thousands
 
24 Weeks Ended
 
   
July 23, 2011
   
July 24, 2010
 
   
(Unaudited)
   
(Unaudited)
 
Net cash (used in) provided by:
           
Operating activities
  $ (2,373 )   $ 11,649  
Financing activities
    2,059       (16,544 )
Investing activities
    (2,393 )     (5,786 )
Effect of exchange rate changes on cash
    (20 )     (271 )
Net decrease in cash
  $ (2,727 )   $ (10,952 )
                 

 
 
 
18
 
 
 
Net Cash (Used In) Provided By Operating Activities

Net cash (used in) provided by operating activities was ($2.4 million) and $11.6 million during the first half of 2011 and 2010, respectively.  The change in cash used in the first half of 2011 compared to cash provided from the first half of 2010 is primarily due to an increase in cash used as a result of the change in net operating loss and the timing of payments related to changes in the various balance sheet accounts totaling approximately $11.3 million, an increase in taxes paid of $2.0 million and an increase in litigation spend of $3.0 million.  These increases are offset in part by reduced interest paid of $2.3 million.

Net Cash Provided By (Used In) Financing Activities

Net cash provided by (used in) financing activities was $2.1 million and ($16.5 million) in the first half of 2011 and 2010, respectively.  The change in cash related to financing activities is primarily attributable to the net borrowings of $7.3 million under the revolving credit facility in the first half of 2011 compared to repayments of $13.6 million of long-term debt under the Company’s former credit facility in the first half of 2010, the Company’s repurchase of $1.1 million of its common stock in the first half of 2011, an increase in cash dividends paid of $555,000 and an increase in the surrender of employee shares for taxes of $507,000.

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 four-year revolving credit facility, expiring in August 2014, 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 credit facility provides the Company greater flexibility to pursue financial and strategic opportunities.  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.

As of July 23, 2011, the Company had $56.2 million outstanding under its credit facility.  In 2010, the Company used the proceeds from the new credit facility 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 are being amortized over the life of the revolving commitment.
 
 
 
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The Company was in compliance with all the covenants under its Credit Agreement as of July 23, 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 related to this agreement was $1.4 million for the first half of fiscal year 2010, which is included in Interest expense for such period.

Net Cash Used In Investing Activities

Net cash used in investing activities was $2.4 million during the first half of 2011 compared to $5.8 million during the first half of 2010.  The net decrease in cash used was primarily attributable to the decrease in capital spend of $4.2 million due in part to the acquisition of certain Kiddie Kandids assets in the first half of 2010, a $1.6 million decrease in proceeds received from the sale of certain assets held for sale and the liquidation of the Rabbi Trust of $760,000 in the second quarter of 2011.

Off-Balance Sheet Arrangements

Other than standby letters of credit primarily used to support the Company’s various large deductible insurance programs, the Company has no additional significant off-balance sheet arrangements.

Commitments and Contingencies

Standby Letters of Credit

As of July 23, 2011, the Company had standby letters of credit outstanding in the principal amount of $14.5 million primarily used in conjunction with the Company’s various large deductible insurance programs.

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 the Company expects will meet its obligations and commitments, including debt service, annual dividends to shareholders, planned capital expenditures, which are estimated to approximate $8.0 million for fiscal year 2011, and normal operating needs.

ACCOUNTING PRONOUNCEMENTS AND POLICIES

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 critical accounting policies are discussed in the “Management's Discussion and Analysis of Financial Condition and Results of Operations” section in the Company’s 2010 Annual Report on Form 10-K, and below.

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, are 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.  As of July 23, 2011, no impairment was indicated.





 
20
 
 
 
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 goodwill impairment test at the end of its second quarter, or more frequently if circumstances indicate the potential for impairment.  As of July 23, 2011, the Company has goodwill recorded of approximately $22.0 million, which relates primarily to one goodwill reporting unit – PMPS.  At the end of the Company’s 2011 second fiscal quarter, the Company completed its annual impairment test and concluded that the estimated fair value of its PMPS reporting unit substantially exceeded its carrying value, and therefore, no impairment was indicated.  Key items of consideration in the annual impairment test 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.  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 July 23, 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.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

The statements contained in this report 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 with respect to the integration of the Bella Pictures® business, 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.  Such risks include, but are not limited to: the Company's dependence on Walmart, Sears and Toys “R” Us, the approval of the Company’s business practices and operations by Walmart, Sears and Toys “R” Us, the termination, breach, limitation or increase of the Company's expenses by Walmart under the lease and license agreements and Sears and Toys “R” Us under the license agreements, the integration of the Bella Pictures® operations into the Company and the continued development and operation of the Bella Pictures® business, customer demand for the Company's products and services, the development and operation of the Kiddie Kandids business, the economic recession and resulting decrease in consumer spending, manufacturing interruptions, dependence on certain suppliers, competition, dependence on key personnel, fluctuations in operating results, a significant increase in piracy of the Company's photographs, widespread equipment failure, compliance with debt covenants, restrictions on the Company’s business imposed by agreements governing its debt, implementation of marketing and operating strategies, outcome of litigation and other claims, impact of declines in global equity markets to the pension plan, impact of foreign currency translation and other risks as may be described in the Company’s filings with the Securities and Exchange Commission, including its Form 10-K for the fiscal year ended February 5, 2011, as originally filed on April 21, 2011.  The risks described above do not include events that the Company does not currently anticipate or that it currently deems immaterial, which may also affect its results of operations and financial condition.  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” included in the Company’s 2010 Annual Report on Form 10-K for the fiscal year ended February 5, 2011, as originally filed on April 21, 2011, with the Securities and Exchange Commission.  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.
 
 
21
 
 
 
 
Item 3.
 
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 July 23, 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 $562,000.

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 10% of the Company’s total assets and 16% of the Company’s total sales as of and for the 24 weeks ended July 23, 2011.  A hypothetical 10% unfavorable change in the Canadian-to-U.S. dollar exchange rate would cause an approximate $1.4 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 3% of the Company’s total sales as of and for the 24 weeks ended July 23, 2011.

Item 4.
 
Controls and Procedures

a)  
Evaluation of Disclosure Controls and Procedures

The Company’s management maintains disclosure controls and procedures that are designed to provide reasonable assurances that information required to be disclosed in the reports it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms. These controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.  In designing and evaluating disclosure controls and procedures, we have recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objective.  Management is required to apply judgment in evaluating its controls and procedures.

Under the supervision of and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, the Company conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of July 23, 2011.  Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of July 23, 2011.

b)  
Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the quarter ended July 23, 2011, which were identified in connection with management’s evaluation required by paragraph (d) of Rule 13a-15 of the Securities Exchange Act of 1934, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II.    OTHER INFORMATION

Items 1, 1A, 2, 3, 4 and 5 are inapplicable and have been omitted.


Item 6.
 
Exhibits

Exhibits:    An Exhibit index has been filed as part of this Report on Page E-1 and is incorporated herein by reference.


 
22
 
 


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



CPI CORP.
(Registrant)


By:          /s/Dale Heins
_____________________________________
Dale Heins
Executive Vice President, Finance,
Chief Financial Officer and Treasurer
(Principal Financial Officer)


By:           /s/Rose O'Brien
____________________________________
Rose O'Brien
Vice President, Corporate Controller
(Principal Accounting Officer)







Date: September 1, 2011

 
23
 
 



CPI CORP.
E-1
EXHIBIT INDEX

 
EXHIBIT
   
NUMBER
 
DESCRIPTION
     
10.51*
 
Executive Chairman's Agreement by and between CPI Corp. and David Meyer, dated April 19, 2010, filed within this Form 10-Q as Exhibit 10.51.
     
11.1
 
Computation of Per Common Share (Loss) Income - Diluted - for the 12 and 24 weeks ended July 23, 2011, and July 24, 2010.
     
11.2
 
Computation of Per Common Share (Loss) Income - Basic - for the 12 and 24 weeks ended July 23, 2011, and July 24, 2010.
     
31.1
 
Certification Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 by the Chief Executive Officer.
     
31.2
 
Certification Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 by the Chief Financial Officer.
     
32.0
 
Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by the Chief Executive Officer and the Chief Financial Officer.
     
101.INS^
 
XBRL Instance Document
     
101.SCH^
 
XBRL Taxonomy Schema Document
     
101.CAL^
 
XBRL Taxonomy Calculation Linkbase Document
     
101.DEF^
 
XBRL Taxonomy Definition Linkbase Document
     
101.LAB^
 
XBRL Taxonomy Label Linkbase Document
     
101.PRE^
 
XBRL Taxonomy Presentation Linkbase Document
     
 
 * Management contract or compensatory plan available to employees, officers or directors.
 
 ^ In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed "furnished" and "not filed". 
 
24