10-Q 1 cpi_10q111205.htm CPI CORP 10Q - 3RD QUARTER FY 2005 CPI Corp 10Q - 3rd Quarter FY 2005
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[ X  ]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
QUARTERLY PERIOD ENDED NOVEMBER 12, 2005


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

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 and [2] has been subject to such filing requirements for the past 90 days.   [ X ] Yes  [   ] No
 
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).                     [ X ] Yes  [   ] No

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

As of December 15 2005, the Registrant had 7,875,143 common shares outstanding. 








CPI CORP.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
16 Weeks and 40 Weeks Ended November 12, 2005

 

 
     
PAGE
 PART I.
 FINANCIAL  INFORMATION    
       
 
  Item 1.  Financial Statements  
       
     Interim Condensed Consolidated Balance Sheets  
     November 12, 2005 (Unaudited) and February 5, 2005
   1
       
     Interim Condensed Consolidated Statements of Operations (Unaudited)  
     16 and 40 Weeks Ended November 12, 2005 and November 13, 2004
3
       
     Interim Condensed Consolidated Statement of Changes in Stockholder's Equity  
     (Unaudited) 40 Weeks Ended November 12, 2005
4
       
     Interim Condensed Consolidated Statements of Cash Flows (Unaudited)  
     40 Weeks Ended November 12, 2005 and November 13, 2004
5
       
     Notes to Interim Condensed Consolidated Financial Statements (Unaudited)
7
       
   Item 2.  Management's Discussion and Analysis of Financial Condition and  
 
     Results of Operations
11
       
   Item 3.  Quantitative and Qualitative Disclosures about Market Risk 
19
       
   Item 4.  Controls and Procedures
20
       
 PART II.
OTHER INFORMATION
    
       
   Item 6.  Exhibits
20
       
 Signatures    
21
       
 Exhibit Index    
22








CPI CORP.
Interim Condensed Consolidated Balance Sheets - Assets

PART I. FINANCIAL INFORMATION

Item 1 Financial Statements

   
November 12, 2005
  
February 5, 2005
  
thousands
  
(Unaudited)
      
           
ASSETS
          
Current assets:
          
    Cash and cash equivalents
  
$
7,784
  
$
33,883
  
    Restricted cash-collateral for outstanding letters of credit
    
-
   
6,154
 
    Accounts receivable:
              
        Due from licensor stores
    
16,509
    
7,365
 
        Other
    
106
    
326
 
    Inventories
    
11,206
    
10,521
 
    Prepaid expenses and other current assets
    
7,646
    
6,905
 
    Deferred tax assets
    
9,030
    
8,795
 
               
    Total current assets
    
52,281
    
73,949
 
               
Property and equipment:
              
    Land
    
2,765
   
2,765
 
    Building improvements
    
26,453
   
26,684
 
    Leasehold improvements
    
6,436
   
6,005
 
    Photographic, sales and manufacturing equipment
    
130,426
   
183,979
 
        Total
    
166,080
   
219,433
 
    Less accumulated depreciation and amortization
    
120,371
   
177,775
 
        Property and equipment, net
    
45,709
   
41,658
 
Assets of business transferred under contractual arrangements:
              
    Preferred security
    
7,000
   
7,000
 
    Accrued dividends on preferred security
    
1,172
   
689
 
    Impairment reserve related to preferred security interest
    
(8,172
)
  
(7,689
)
Other investments - supplemental retirement plan
    
6,116
   
6,141
 
Deferred tax assets
    
14,725
    
11,734
 
Other assets, net of amortization of $1,359 at both November 12, 2005 and February 5, 2005
              
 
    
1,358
   
1,618
 
    TOTAL ASSETS
  
$
120,189
  
$
135,100
  
               
See accompanying notes.
              
 



1

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


   
November 12, 2005
  
February 5, 2005
  
thousands, except share and per share data
  
(Unaudited)
      
           
LIABILITIES
          
Current liabilities:
          
    Current maturities of long-term debt
  
$
8,580
  
$
8,580
  
    Accounts payable
    
11,946
   
13,011
 
    Accrued employment costs
    
13,052
   
12,463
 
    Customer deposit liability
    
26,547
   
21,828
 
    Accrued severance
    
4,581
   
4,205
 
    Income taxes payable
    
1,796
   
2,872
 
    Sales taxes payable
    
2,647
   
1,886
 
    Accrued advertising expenses
    
2,147
   
1,568
 
    Accrued expenses and other liabilities
    
6,638
   
5,348
 
               
    Total current liabilities
    
77,934
   
71,761
 
               
Long-term debt, less current maturities
    
8,493
   
17,050
 
Accrued pension obligations
    
13,127
   
13,993
 
Supplemental retirement plan obligations
    
3,881
   
4,512
 
Customer deposit liability
    
3,133
   
4,334
 
Other liabilities
    
471
   
564
 
               
    Total liabilities
    
107,039
   
112,214
 
               
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; 18,514,686 and 18,432,779
              
    shares outstanding at November 12, 2005 and February 5, 2005, respectively
    
7,406
   
7,373
 
Additional paid-in capital
    
54,764
   
53,301
 
Retained earnings
    
194,881
   
206,812
 
Accumulated other comprehensive loss
    
(9,943
)
  
(10,505
)
     
247,108
   
256,981
 
Treasury stock - at cost, 10,639,543 and 10,672,236 at November 12, 2005 and
              
    February 5, 2005, respectively
    
(233,541
)
  
(234,031
 ) 
Unamortized deferred compensation-restricted stock
    
(417
)
  
(64
 ) 
    Total stockholders' equity
    
13,150
   
22,886
 
    TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  
$
120,189
  
$
135,100
  
               
See accompanying notes.
              


 
2

CPI CORP.
Interim Condensed Consolidated Statements of Operations
(Unaudited)
 
   
16 Weeks Ended
  
40 Weeks Ended
  
thousands, except share and per share data
  
 
 
 
 
 
 
 
  
   
November 12, 2005
 
November 13, 2004
 
November 12, 2005
 
November 13, 2004
  
                   
Net sales
  
$
78,470
  
$
78,820
  
$
188,999
  
$
182,366
  
                           
Cost and expenses:
                          
Cost of sales (exclusive of depreciation and
    amortization shown below)
    
9,833
   
10,576
   
25,178
   
24,938
 
Selling, general and administrative expenses
    
66,231
   
69,300
   
158,540
   
157,537
 
Depreciation and amortization
    
6,209
   
4,893
   
15,258
   
12,434
 
Other charges and impairments
    
803
    
1,707
   
2,379
   
15,211
 
     
83,076
   
86,476
   
201,355
   
210,120
 
                           
Loss from continuing operations
    
(4,606
)
  
(7,656
)
  
(12,356
)
  
(27,754
)
                           
Interest expense
    
440
   
599
   
1,300
   
1,730
 
Interest income
    
91
   
351
   
411
    
900
 
Other income, net
    
20 
    
58
   
228
   
208
 
Impairment and related obligations of preferred security
    interest
    
-
   
9,644
     -    
9,644
 
                           
Loss from continuing operations before income tax
    benefit
    
(4,935
)
  
(17,490
)
  
(13,017
)
  
(38,020
)
Income tax benefit
    
1,837
   
4,052
 
  
4,844
   
10,413
 
                           
Net loss from continuing operations
    
(3,098
)
  
(13,438
)
  
(8,173
)
  
(27,607
)
Net loss from discontinued operations, net of income
    tax benefit
    
-
   
(7
)
  
-
   
(3,744
)
                           
NET LOSS
  
$
(3,098
)
$
(13,445
)
$
(8,173
)
$
(31,351
)
                           
NET LOSS PER COMMON SHARE
                          
                           
Net loss per share from continuing operations - diluted
  
$
(0.39
)
$
(1.73
)
$
(1.04
)
$
(3.48
)
Net loss per share from discontinued operations - diluted
    
-
   
-
   
-
   
(0.47
)
Net loss per share - diluted
  
$
(0.39
)
$
(1.73
)
$
(1.04
)
$
(3.95
)
                           
Net loss per share from continuing operations - basic
  
$
(0.39
)
$
(1.73
)
$
(1.04
)
$
(3.48
)
Net loss per share from discontinued operations - basic
    
-
   
-
   
-
   
(0.47
)
Net loss per share - basic
  
$
(0.39
)
$
(1.73
)
$
(1.04
)
$
(3.95
)
                           
Dividends per share
  
$
0.16
  
$
0.16
  
$
0.48
  
$
0.48
  
                           
Weighted average number of common and common
                         
    equivalent shares outstanding-diluted
    
7,871,465
   
7,751,697
   
7,846,450
   
7,927,306
 
Weighted average number of common and common
                         
    equivalent shares outstanding-basic
    
7,871,465
   
7,751,697
   
7,846,450
   
7,927,306
 
                           
See accompanying notes.
                          


 

3

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

 

 
   
 Forty weeks ended November 12, 2005
  
                               
               
 
      
 
      
       
 
      
Accumulated
  
 
  
 Deferred 
      
thousands, except share and
  
Common
  
Additional
paid-in
  
Retained
  
other
comprehensive
  
Treasury
stock,
  
compensation -
restricted
      
per share data
  
stock
  
capital
  
earnings
  
loss
  
at cost
  
stock
  
Total
  
                               
Balance at February 5, 2005
  
$
7,373
  
$
53,301
  
$
206,812
  
$
(10,505
)
$
(234,031
)
$
(64
)
$
22,886
  
                                             
Net loss
    
-
   
-
   
(8,173
)
  
-
   
-
   
-
   
(8,173
)
Foreign currency translation adjustment
    
-
   
-
   
-
   
562
   
-
   
-
   
562
 
Total comprehensive loss
    
-
   
-
   
(8,173
)
  
562
   
-
   
-
   
(7,611
)
Issuance of common stock to
                                            
    employee benefit plans, restricted
                                            
    stock awards and option exercises
                                            
    (114,600 shares)
    
33
   
1,463
   
-
   
-
   
490
   
(940
)
  
1,046
 
Dividends ($.48 per common share)
    
-
   
-
   
(3,758
)
  
-
   
-
   
-
   
(3,758
)
Amortization of deferred
                                            
    compensation - restricted stock
    
-
   
-
   
-
   
-
   
-
   
587
   
587
 
                                             
Balance at November 12, 2005
  
$
7,406
  
$
54,764
  
$
194,881
  
$
(9,943
)
$
(233,541
)
$
(417
)
$
13,150
  
                                             
See accompanying notes.
                                            

 


 
 








 




4

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

 

   
40 Weeks Ended
  
thousands
  
 
  
 
  
   
November 12, 2005
  
November 13, 2004
  
Reconciliation of net loss from continuing operations to cash flows (used in) provided by
    operating activities:
          
           
Net loss from continuing operations
  
$
(8,173
)
$
(27,607
)
               
Adjustments for items not requiring cash:
              
    Depreciation and amortization
    
15,258
   
12,434
 
          Stock-based compensation expense     672     9  
    Loss on disposition of property, plant and equipment
    
374
   
1,058
 
    Deferred income taxes    
(3,226
 )    (1,793 ) 
    Deferred revenues and related costs
    
3,004
 
  
7,414
 
    Pension expense     1,184     1,036  
    Accrued interest on preferred security
    
-
 
  
(484
)
    Accelerated vesting of supplemental retirement plan benefits
    
-
   
3,338
 
    Impairment and related obligations of preferred security interest
    
-
   
9,644
 
    Other impairment charges
    
-
   
5,083
 
    Other
   
606
    
736 
  
               
(Increase) decrease in current assets:
              
    Receivables and inventories
    
(9,609
)
  
(13,908
)
    Refundable income taxes
    
-
   
(9,098
)
    Prepaid expenses and other current assets
    
(53
)  
(2,092
)
               
(Decrease) increase in current liabilities:
              
    Accounts payable
    
(1,064
)
  
(1,170
)
    Contribution to pension plan     (2,050 )    -  
    Accrued expenses and other liabilities
    
3,465
 
  
5,665
 
    Income taxes payable
    
(1,076
)
  
-
 
               
Cash flows used in continuing operations
    
(688
)
  
(9,735
)
Cash flows used in discontinued operations
    
-
   
(2,736
)
Cash flows used in operating activities
  
$
(688
)
$
(12,471
)
               
See accompanying notes.
              

 



 




5

CPI CORP.
Interim Condensed Consolidated Statements of Cash Flows (continued)
(Unaudited)
 
   
40 Weeks Ended
  
thousands
  
 
  
 
  
   
November 12, 2005
  
November 13, 2004
  
           
Cash flows used in operating activities
  
$
(688
)
$
(12,471
)
               
Cash flows (used in) provided by financing activities:
              
    Repayment of long-term obligations
    
(8,580
)
  
(8,580
)
    Reduction in restricted cash-collateral for outstanding letters of credit
    
6,154
   
-
 
    Proceeds from option exercises
    
119
   
933
 
    Cash dividends
    
(3,758
)
  
(3,832
)
    Purchase of treasury stock
    
-
   
(6,008
)
    Cash flows used in financing activities
    
(6,065
)
  
(17,487
)
               
Cash flows (used in) provided by investing activities:
              
    Additions to property and equipment
    
(19,835
)
  
(13,212
)
    Proceeds from sales of property and equipment
    
118
    
363
 
    Proceeds from sales of assets held for sale
    
49
    
-
 
    Changes in loan receivable:
              
        Borrowings
    
-
   
(37,593
)
        Repayments
    
-
   
33,975
 
    Increases in assets held by Rabbi Trust
    
(232
)
  
(456
)
    Proceeds from Rabbi Trust used for supplemental retirement plan payments
    
257
   
1,935
 
    Distribution of Rabbi Trust funds in excess of related obligations     -     3,800  
    Cash flows used in investing activities
    
(19,643
)
  
(11,188
)
               
Effect of exchange rate changes on cash and cash equivalents
    
297
    
1,058
 
               
Net decrease in cash and cash equivalents
    
(26,099
)
  
(40,088
)
               
Cash and cash equivalents at beginning of period
    
33,883
   
51,011
 
               
Cash and cash equivalents at end of period
  
$
7,784
  
$
10,923
  
               
Supplemental cash flow information:
              
    Interest paid
  
$
959
  
$
1,278
  
    Income taxes paid
  
$
128
  
$
216
 
               
Supplemental non-cash financing activities:
              
    Issuance of treasury stock under the employee profit sharing plan
  
$
490
  
$
554
  
    Issuance of restricted stock to employees and directors
  
$
1,200
  
$
25
  
               
Repayment of borrowings against cash surrender value of life insurance
              
    via liquidation of related policies
  
$
-
  
$
1,548
  
               
Executive retirement stock option modification
  
$
177
  
$
-
  
               
See accompanying notes.
              
 
6

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

NOTE 1 - DESCRIPTION OF BUSINESS AND INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company operates 1,050 professional portrait studios as of November 12, 2005 throughout the United States, Canada and Puerto Rico principally under license agreements with Sears, Roebuck and Co. ("Sears"). The Company also operates searsphotos.com, a vehicle for the Company’s customers to archive, share portraits via email and order additional portraits and products.

The Interim Condensed Consolidated Balance Sheet as of November 12, 2005, the related Interim Condensed Consolidated Statements of Operations for the 16 and 40 weeks ended November 12, 2005 and November 13, 2004, the Interim Condensed Consolidated Statement of Changes in Stockholders’ Equity for the 40 weeks ended November 12, 2005 and the Interim Condensed Consolidated Statements of Cash Flows for the 40 weeks ended November 12, 2005 and November 13, 2004, are unaudited. The interim condensed 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 condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the CPI Corp. 2004 Annual Report on Form 10-K for its fiscal year ended February 5, 2005. 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. Actual results could differ from those estimates.

Certain reclassifications have been made to the 2004 financial statements to conform with the current year presentation.

NOTE 2 - INVENTORIES
 
The following table sets forth the components of inventory:
          
           
thousands
  
November 12, 2005
  
February 5, 2005
  
           
Raw materials - film, paper, chemicals
  
$
4,158
  
$
3,750
  
Portraits in process
    
1,861
   
1,555
 
Finished portraits pending delivery
    
 917
    
496
 
Frames and accessories
    
1,222
   
1,286
 
Studio supplies
    
2,227
    
2,197
 
Other 
    
821
    
1,237
 
               
Total
  
$
11,206
  
$
10,521
  

NOTE 3 - BORROWINGS

On April 15, 2005, the Company entered into a new $30.0 million (reducing to $25 million in February 2006 and $20 million in February 2007) unsecured bank revolving credit facility (the “Revolving Facility”), which will expire on April 13, 2007 and carries a variable interest rate charged at either LIBOR or prime rate funds, with an applicable margin added.

Concurrent with the closing of the Revolving Facility, the Company amended its existing Senior Note agreement to allow it to incur additional indebtedness without violating the debt to equity ratio covenant included in the original agreement. The covenants of the amended Senior Note Agreement now principally mirror those included in the Revolving Facility.

At November 12, 2005, the Company had $17.1 million outstanding under its existing Senior Note Agreement and no borrowings against its $30.0 million Revolving Facility.

 
7

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

Effective November 30, 2005, the Company entered into an Amended and Restated Credit Agreement (the "Credit Agreement").  The Credit Agreement is a three-year, term and revolving credit facility in an amount up to $43 million, consisting of an $18 million term loan and a $25 million revolving loan with a sub-facility for letters of credit in an amount not to exceed $15 million.  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) substantially all of the assets of the Company and such subsidiaries.  Borrowings and letters of credit under the Credit Agreement bear interest, at the Company’s option, at a variable rate based on either LIBOR or an alternative rate (as described in the Credit Agreement), with an applicable margin added. The revolving loan is charged a non-use fee, which varies based on the Company’s leverage ratio. Unless sooner paid, the outstanding principal balance of the term loan is to be repaid in five equal semi-annual installments beginning June 30, 2006 and a final payment on November 30, 2008.  The Credit Agreement and other ancillary loan documents contain terms, provisions, and events of default customary for transactions of this type.  The proceeds of the term loan were used to prepay in full all of the outstanding principal, accrued and unpaid interest and make-whole amount due and owing under the Company's Senior Note agreement.
 
NOTE 4 - OTHER CHARGES AND IMPAIRMENTS
 
Other charges and impairments totaled $803,000 for the quarter ended November 12, 2005.  The current quarter’s charges are principally attributable to additional reserves and related costs associated with ongoing litigation, partially offset by favorable settlements in other matters, coupled with write-offs and write-downs of assets in connection with the Company’s conversion to digital technology.
 
NOTE 5 - STOCK-BASED COMPENSATION PLANS
 
At November 12, 2005, the Company had various stock-based employee compensation plans, which are described more fully in Note 8 of the Notes to Consolidated Financial Statements in the Company’s 2004 Annual Report on Form 10-K. The Company accounts for those plans in accordance with APB No. 25, “Accounting For Stock Issued to Employees”, and related Interpretations. Had the Company accounted for these plans in accordance with SFAS 123, "Accounting for Stock-Based Compensation", the fair value recognition effect would have been additional costs of $.05 and $.07, respectively, for the 16 and 40 weeks of the prior year, and no net effect in the current year.

On April 14, 2005, the Board of Directors approved a grant of 34,562 shares of restricted stock to its Chairman of the Board who had been acting in an executive officer capacity since October 6, 2004, when the Company formed its Office of the Chief Executive. The compensation award included the grant, without restrictions, of 17,281 shares of the Company’s common stock and 17,281 shares of restricted stock that vested ratably from April 2005 through September 2005. The total fair value of the award at the date of the grant was $519,121. The fair value of the 17,281 shares awarded, without restrictions, amounted to $259,561, $175,000 of which represented compensation for fiscal 2004 and was recorded as such in the Company’s Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended February 5, 2005.
 
During August 2005, the Board of Directors approved grants of 5,587 and 14,085 shares of restricted stock to its Chief Operating Officer and its Chief Executive Officer, which vest ratably over three and five years, respectively.   The total fair value of the August 2005 awards at the dates of the grant was $350,016. 
 
During the 16 and 40 weeks ended November 12, 2005, $190,000 and $672,000 of compensation expense was recorded related to restricted and unrestricted stock.

8

CPI CORP.
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)
 
NOTE 6 - 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. Previously, 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 continue to accrue. 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 marketable equity securities funds, guaranteed interest contracts, cash equivalents, immediate participation guarantee contracts and government bonds.

The Company also maintains a noncontributory defined benefit plan providing supplemental retirement benefits for certain current and former 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 assumptions. However, certain assets will be used to finance these future obligations and consist of investments in a Rabbi Trust.

The following tables set forth the components of net periodic benefit cost for the defined benefit plans:
   
 16 Weeks Ended
  
   
 Pension Plan
  
Supplemental Retirement Plan
  
thousands
  
 November 12, 2005
  
November 13, 2004
  
November 12, 2005
  
November 13, 2004
  
                    
Components of net periodic benefit cost:
                   
    Service cost
  
$
155
  
$
157
  
$
35
  
$
62
  
    Interest cost
    
867
   
831
   
77
   
119
 
    Expected return on plan assets
    
(858
)
  
(903
)
  
-
   
-
 
    Amortization of prior service cost
    
14
   
14
   
9
   
12
 
    Amortization of net (gain) loss
    
294
   
134
   
(6
)
      
    Settlement expense (gain)
    
-
   
-
   
-
   
(55
)
                           
Net periodic benefit cost
  
$
472
  
$
233
  
$
115
  
$
138
  
                           

   
 40 Weeks Ended
  
   
 Pension Plan
  
Supplemental Retirement Plan
  
thousands
  
 November 12, 2005
  
November 13, 2004
  
November 12, 2005
  
November 13, 2004
  
                    
Components of net periodic benefit cost:
                   
    Service cost
  
$
389
  
$
628
  
$
86
  
$
145
  
    Interest cost
    
2,169
   
2,078
   
192
   
292
 
    Expected return on plan assets
    
(2,146
)
  
(2,257
)
  
-
   
-
 
    Amortization of prior service cost
    
34
   
34
   
24
   
22
 
    Amortization of net (gain) loss
    
738
   
554
   
(14
)
  
-
 
    Accelerated vesting
    
-
   
-
   
-
   
3,338
 
    Settlement expense
    
-
   
-
   
-
   
31
 
    Curtailment expense
    
-
   
-
   
-
   
230
 
                           
Net periodic benefit cost
  
$
1,184
  
$
1,037
  
$
288
  
$
4,058
  
                           
 
Based upon the results of its actuarial report for the 2004 plan year, the Company made a voluntary contribution to its pension plan in the amount of $2,050,000 on  September 15, 2005.
 
9
 
CPI CORP.
Notes to Interim Condensed Consolidated Financial Statements
(Unaudited)

NOTE 7 - CONTINGENCIES

Standby Letters of Credit
 
As of November 12, 2005, the Company had outstanding standby letters of credit in the principal amount of $6.3 million used primarily in conjunction with the Company’s self insurance programs. On May 17, 2005, the Company replaced all previously-held collateralized standby letters of credit with new letters of credit issued under the Company’s new revolving credit facility. Accordingly, the restricted cash which had been deposited as cash collateral as of February 5, 2005 has been returned to the Company to be used for general corporate purposes.
 
Litigation
 
The Company is a defendant in various lawsuits. It is the opinion of management that the ultimate liability, if any, resulting from such lawsuits will not materially affect the consolidated financial position or results of operations of the Company.

Contingent Lease Obligations

In July 2001, the Company announced the completion of the sale of its Wall Décor segment which included the ongoing guarantee of certain operating real estate leases of Prints Plus. As of November 12, 2005, the maximum future obligation to the Company under its guarantee of these leases is $3.7 million. To recognize the risk associated with these leases and based upon the Company’s past experience with renegotiating lease obligations, a $1.0 million reserve was established in 2001 at time of the sale. As a result of the significant deterioration in the financial performance of Prints Plus in the third quarter of 2004, including its subsequent bankruptcy filing, all of which is more fully described in Note 12 to the Company’s Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended February 5, 2005,  the Company recorded an additional $2.1 million of lease obligation reserves resulting in the total lease reserves at November 12, 2005 of $3.1 million. Based on the progress of the bankruptcy case to-date, including Prints Plus’ receipt of debtor-in-possession financing on May 18, 2005, and the continued operations of selected locations of Prints Plus, the Company believes that the $3.1 million reserve is adequate to cover the potential losses to be realized under the Company’s operating lease guarantees. 
 
To assist Prints Plus in obtaining the above-mentioned debtor-in-possession financing facility, the Company guaranteed $300,000 of the facility by posting a letter of credit with the lender.
 
NOTE 8 - SUBESQUENT EVENT
 
Effective December 21, 2005, the Company’s Board of Directors authorized the repurchase of up to 1,500,000 shares of its common stock through a Dutch Auction self-tender offer. The tender offer is expected to commence during the week of December 26, 2005 and extend through approximately the end of January 2006. Depending upon market conditions immediately prior to the commencement of the tender offer, the tender offer price is expected to range from $17.00 to $20.00 per share. At the envisioned size, the tender offer is, in part, subject to the successful completion of an amendment to the Company’s current credit facility which, among other things, would increase the term loan portion of the facility. In addition, the tender offer is subject to market, economic, business and other customary conditions affecting the Company. The offer will be subject to the terms and conditions described in offering materials that the Company intends to mail to the Company’s stockholders and file with the SEC during the week of December 26, 2005.

The Company anticipates funding the purchase of shares tendered in the tender offer through a combination of cash on hand and funds derived from the funding of the anticipated amendment to its existing credit facility. To the extent that the amendment to the credit agreement is not completed, the Company may need to amend the terms of the tender offer to reduce the number of shares sought.
 
CPI’s Board of Directors has authorized this tender offer as a prudent use of financial resources given CPI’s business, assets and current stock price and as an efficient means to provide value to stockholders. The offer represents an opportunity for CPI to return cash to stockholders who elect to tender their shares while at the same time increasing non-tendering stockholders’ proportional interest in CPI.
 
10
 
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 in conjunction with the interim condensed consolidated financial statements and related notes thereto contained elsewhere in this document.
 
EXECUTIVE OVERVIEW
 
The Company’s Operations
 
CPI Corp. is a long-standing leader, based on sittings and related revenues, in the professional portrait photography of young children and families. From a single studio opened by our predecessor company in 1942, we have grown to 1,050 studios throughout the United States (“U.S.”), Canada and Puerto Rico, principally under license agreements with Sears. We have provided professional portrait photography for Sears’ customers since 1959 and have been the exclusive Sears portrait studio operator since 1986.  As of the end of the third quarter in fiscal 2005 and 2004, the Company’s studio counts were:
 
   
 
  
 
   
November 12, 2005
  
November 13, 2004
 
        
 United States and Puerto Rico:        
     Within full-line Sears mall-based stores  
859
  
860
     Locations not within Sears stores  
40
  
40
     Within Sears Essential/Grand stores  
36
  
4
         
 Canada  
115
  
117
         
 Total  
1,050
  
1,021
         

The above totals include three studios temporarily closed due to damage to the related Sears' stores from the recent severe hurricane season.  It is anticipated that reopenings for these studios will occur in early 2006.  During the third quarter of 2005, the Company completed its plan to transition all of its U.S. studios to full digital technology, converting 268 studios to full digital format.  During fiscal 2005 through November 12, 2005, the Company has opened new, all-digital portrait studios in 32 Sears Essential and/or Sears Grand formats, bringing the total of such new studios to 36.  No additional new studio openings are anticipated through fiscal year end.
 


11

RESULTS OF OPERATIONS

A summary of consolidated results of operations and key statistics were as follows:
 
   
16 Weeks Ended
  
40 Weeks Ended
  
 thousands, except per share data  
November 12, 2005
  
November 13, 2004
  
November 12, 2005
  
November 13, 2004
  
                   
Net sales
  
$
78,470
  
$
78,820
  
$
188,999
  
$
182,366
  
                           
Cost and expenses:
                          
Cost of sales (exclusive of depreciation and amortization
    shown below)
    
9,833
   
10,576
   
25,178
   
24,938
 
Cost of sales as a percentage of net sales
    
12.5
%
  
13.4
%
  
13.3
%
  
13.7
%
Gross margin as a percentage of net sales
    
87.5
%
  
86.6
%
  
86.7
%
  
86.3
%
Selling, general and administrative expenses
    
66,231
   
69,300
   
158,540
   
157,537
 
Selling, general and administrative expenses as a
    percentage of net sales
    
84.4
%
  
87.9
%
  
83.9
%
  
86.4
%
Depreciation and amortization
    
6,209
   
4,893
   
15,258
   
12,434
 
Other charges and impairments
    
803
    
1,707
   
2,379
   
15,211
 
     
83,076
   
86,476
   
201,355
   
210,120
 
                           
Loss from continuing operations
    
(4,606
)
  
(7,656
)
  
(12,356
)
  
(27,754
)
                           
Interest expense
    
440
   
599
   
1,300
   
1,730
 
Interest income
    
91
    
351
   
411
    
900
 
Other income, net
    
20
    
58
   
228
   
208
 
Impairment and related obligations of preferred security
    interest
    
-
   
9,644
   
-
   
9,644
  
Loss from continuing operations before income tax
    benefit
    
(4,935
)
  
(17,490
)
  
(13,017
)
  
(38,020
)
                           
Income tax benefit
    
1,837
   
4,052
   
4,844
   
10,413
 
                           
Net loss from continuing operations
    
(3,098
)
  
(13,438
)
  
(8,173
)
  
(27,607
)
Net loss from discontinued operations, net of income tax
    benefit
    
-
   
(7
)
  
-
   
(3,744
)
                           
NET LOSS
  
$
(3,098
)
$
(13,445
)
$
(8,173
)
$
(31,351
)
                           
Net loss per share from continuing operations - diluted
  
$
(0.39
)
$
(1.73
)
$
(1.04
)
$
(3.48
)
Net loss per share from discontinued operations - diluted
    
-
   
-
   
-
   
(0.47
)
                           
Net loss per share - diluted
  
$
(0.39
)
$
(1.73
)
$
(1.04
)
$
(3.95
)
                           

16 weeks ended November 12, 2005 compared to 16 weeks ended November 13, 2004

The Company reported a net loss for the 16-week third quarter ended November 12, 2005 of $3.1 million or $0.39 per diluted share, compared to a net loss of $13.4 million, or $1.73 per diluted share, for the comparable quarter of fiscal 2004. The overall results for the third quarter of fiscal 2005 were impacted by the recording of other charges and impairments totaling $504,000 on an after-tax basis related principally to additional reserves and related costs associated with ongoing litigation, partially offset by favorable settlements in other matters, coupled with write-offs and write-downs of assets in connection with the Company's conversion to digital technology.  The third quarter of fiscal 2004 was significantly impacted by the recording of other charges and impairments totaling $1.3 million on an after-tax basis and $7.4 million of after-tax charges recorded as impairment and related obligations of preferred security interest.   The other charges and impairments in 2004 relate to the asset write-downs and write-offs resulting from on going changes in strategic technology direction.  The impairment and related obligations of preferred security interest related to an investment  in and operating lease guarantees associated with the Company's former Wall Decor segment, Prints Plus, and were necessitated by significant deteriorating financial performance of that entity.
 
12

Net sales totaled $78.5 million and $78.8 million in the third quarter of fiscal 2005 and 2004, respectively.

·  
Net sales for the third quarter of 2005 were essentially flat with the $78.8 million reported in the third quarter of 2004.  The third quarter of 2005 includes approximately $615,000 in sales related to new studios opened throughout fiscal 2005. The 2005 third quarter sales performance was the result of a 25% decline in sittings almost totally offset by a 33% increase in average sale per customer sitting. Sales for the quarter were positively impacted by $3.7 million resulting from a reduced backlog of portraits in process or pending delivery to customers at the end of the third quarter.  This reduction in backlog is primarily attributable to the increased number of digital studios which, due to their faster processing, both through central and on-site fulfillment, have lower levels of undelivered portraits.  The Company attributes the sittings decline to a number of internal and external factors.  The Company’s marketing program has undergone extensive changes designed to transition to everyday values, reduce dependence on coupons and promotional activity, and prepare the way for a significant repositioning of the Sears Portrait Studio brand in conjunction with the completion of the digital rollout. At the same time, the Company broadly tested various offer changes designed to reflect the differentiated value proposition offered by its digital studios. While positively impacting average transaction size, these offer changes have resulted in the loss of more price-sensitive customers to lower priced competitors. Historically, sittings and sales have rapidly accelerated from October through the Thanksgiving and Christmas holidays. The Company believes that this acceleration has shifted forward in 2005 due to customer reaction to shorter lead times related to both central and same day fulfillment. As a result, the Company’s third quarter sittings and sales were negatively impacted by this shift while the fourth quarter is expected to benefit. The Company also believes that the continuing proliferation of amateur digital photography may be reducing portrait activity, especially during periods such as the Company’s third quarter, which are marked by the absence of significant holidays. Finally, sales were also negatively impacted by the severe hurricane season that principally affected studios in Alabama, Florida, Louisiana, Mississippi and Texas.
 
Costs and expenses were $83.1 million in the third quarter of 2005, compared with $86.5 million in the comparable prior year period.

· 
Cost of sales, excluding depreciation and amortization expense, was $9.8 million in the third quarter of 2005 compared with $10.6 million in the comparable prior year period. Cost of sales as a percentage of net sales was 12.5% in the third quarter of 2005, compared to 13.4% in the comparable quarter in 2004. Correspondingly, gross margin rates were 87.5% and 86.6% in the third quarter of 2005 and 2004, respectively.  The decrease in cost of sales resulted from lower overall production levels due to the decline in sittings as well as savings related to reduced purchases of film and lower shipping costs, both resulting from the digital conversion. These decreases were partially offset by increased costs associated with the production of new and specialty products not previously available in the analog film environment. In addition, both periods were significantly affected by workers’ compensation costs. 
 
·  
Selling, general and administrative (“SG&A”) expenses were $66.2 million and $69.3 million for the third quarter of 2005 and 2004, respectively. As a percentage of sales, these expenses were 84.4% in 2005 and 87.9% in 2004.   Selling, general and administrative expenses decreased primarily as a result of a decrease in studio employment costs of $1.2 million, which is net of $552,000 of additional costs related to the reduction in sales backlog, a decrease of $625,000 in advertising costs and a decrease of $1.3 million in numerous other expense categories, all resulting from the Company’s ongoing cost containment efforts. The decrease in studio employment costs resulted from the decline in sittings volume as well as the positive impact of initiatives launched in the first half of 2005 to improve labor scheduling and productivity. Advertising costs declined principally as a result of the elimination of broadcast media and related production costs in the current year.  In addition, a more targeted focus in terms of type and frequency of media utilized also resulted in reduced spending.
 
·  
Depreciation and amortization was $6.2 million in the third quarter of 2005, compared to $4.9 million in the comparable quarter of 2004. The increase in depreciation and amortization is entirely attributable to significant investments that have been made in connection both with a studio-wide hardware and printer upgrade in 2004 and the recently completed digital conversion of U.S. studios.
 
13
 
·  
Other charges and impairments reflect costs incurred from strategic actions implemented by the Company to restructure its operations, costs that are unpredictable and typical of the Company’s operations and additional charges due to asset impairments. In the third quarter of 2005 and 2004, the Company recognized $803,000 and $1.7 million, respectively, in other charges and impairments.   The decrease in other charges and impairments primarily reflects third quarter 2004 impairment charges related to a change in technology strategy, partially offset by 2005 third quarter charges principally attributable to additional reserves and related costs associated with ongoing litigation and reduced by favorable settlements in other matters, coupled with write-offs and write-downs of assets in connection with the Company’s conversion to digital technology.

·  
Interest expense was $440,000 in the third quarter of 2005 compared to $599,000 in the comparable prior year quarter. The reduction in interest expense is the result of scheduled annual principal payments totaling $8.6 million made in June 2005 reducing the outstanding balance of the Senior Notes.
 
·  
Interest income was $91,000 in the third quarter of 2005 compared to $351,000 in the third quarter of 2004.  The third quarter of 2004 included $193,000 of accrued preferred security dividends that were subsequently fully reserved in the fourth quarter of 2004 as a result of the deteriorating financial performance of Prints Plus, the Company’s former Wall Décor segment. Excluding these accrued dividends, interest income decreased between 2004 and 2005, partially offset by lower invested balances due to the impact of higher interest rates.
 
·  
The impairment and related obligations of preferred security interest charges in the third quarter of 2004 related to an investment in an operating lease guarantees associated with its former Wall Decor segment, Prints Plus, totaling $9.6 million.  These charges were necessitated by the significant deteriorating financial performance of Prints Plus and are more fully discussed in the section of Management's Discussion and Analysis entitled "Contingencies" which follows.           
 
·  
Income tax benefits on losses from continuing operations were $1.8 million and $4.1 million in the third quarter of 2005 and 2004, respectively. These benefits resulted in effective tax rates of 37.2% in 2005 and 23.2% in 2004. The lower effective income tax rate in the third quarter of 2004 was attributable to permanent differences associated with taxable gains primarily resulting from the surrender of company-owned life insurance policies held by a Rabbi Trust as funding vehicles for the Company’s supplemental executive retirement plan and non-deductible expenditures related to the termination of certain Company executives.
 
14

40 weeks ended November 12, 2005 compared to 40 weeks ended November 13, 2004

The Company reported a net loss for the 40-weeks ended November 12, 2005 of $8.2 million or $1.04 per diluted share, compared to a net loss of $31.4 million or $3.95 per diluted share for the comparable 40 weeks ended November 13, 2004.   The first three quarters of 2005 were impacted by the recording of other charges and impairments totaling $2.4 million, $1.5 on an after-tax basis, or $0.19 per diluted share, relating principally to repositioning of the executive management team, including separation costs associated with executive retirements and additional reserves and related costs associated with ongoing litigation, offset in part by favorable settlements in other matters.  The overall results for the 40 weeks ended November 13, 2004 were significantly impacted by the recording of other charges and impairments totaling $15.2 million and by the recording of other non-operating charges discussed earlier related to Prints Plus totaling $9.6 million.  On an after-tax basis, the other charges and impairments and the other non-operating charges totaled $18.0 million or $2.28 per diluted share.  The results for the first three quarters of 2004 were also significantly impacted by the $3.7 million net after-tax loss recorded on the discontinuation of the Mexico and mobile photography operations.   The other charges and impairments consist principally of additional costs incurred by the Company in the first three quarters of 2004 related to the then-ongoing consent solicitation contest, accruals triggered by various change of control provisions included in certain executive employment contracts and accruals, and reserves and charges resulting from personnel and strategic direction decisions made by the Company’s  Board of Directors.
 
Net sales totaled $189.0 million and $182.4 million for the 40 weeks of fiscal 2005 and 2004, respectively.

·   
 Net sales for  2005 increased $6.6 million, or 3.6%, to $189.0 million from the $182.4 million reported in  2004. The comparability of the sales for the first three quarters of 2005 versus 2004 was not significantly impacted by the opening of portrait studios in new Sears Essential stores during the first half of 2005.  The overall increase in sales is due to a 22.1% increase in average sales per customer sitting, partially offset by a 15.3% year-over-year decline in sittings.  The Company attributes the increase in year-to-date sales to the impacts of the following initiatives undertaken throughout the second half of 2004 and continuing to date:
 
o  
The implementation of a significant computer hardware and printer upgrade which improved the performance of legacy systems while laying the foundation for a transition to digital.
 
o  
The successful conversion of all U.S. studios to full digital format which out performs the historical  analog film studio results.  Such conversion was completed ahead of schedule.

o  
The restoration of coverage and training hours in the studios that had been significantly reduced in the first half of 2004 in response to then-declining sales trends.

o  
The effectuation of various offer changes and targeted price increases as well as the utilization of more efficient advertising vehicles.

Similar to the preceding discussion of 16-week results, year-to-date sales  were positively impacted by approximately $4.5 million resulting from a reduction of the backlog of portraits in process or pending delivery to customers at the end of the third quarter of 2005.  Historically, sittings and sales have rapidly accelerated from October through the Thanksgiving and Christmas holidays. The Company believes that this acceleration has shifted forward in 2005 due to customer reaction to shorter lead times related to both central and same day fulfillment. As a result, the Company’s third quarter sittings and sales were negatively impacted by this shift while the fourth quarter should benefit. Finally, the Company believes that early 2005 sales growth was moderated somewhat by a lower level of marketing intensity in the the beginning of the first quarter as well as the possible negative effects of an early Easter, a seasonally-important time for portraiture sales. Historically, the Company has generally recognized lower Easter-related sales in those years when Easter falls earlier on the calendar.
 
Costs and expenses were $201.4 million for fiscal 2005, compared with $210.1 million in the comparable prior year.

·  
Cost of sales, excluding depreciation and amortization expense, was $25.2 million in  2005 compared with $24.9 million in the comparable prior year. Cost of sales as a percentage of net sales was 13.3% for 2005, compared to 13.7% in 2004. Correspondingly, gross margin rates were 86.7% and 86.3% for 2005 and 2004, respectively.   The increase in cost of sales is primarily attributable to start-up costs and inefficiencies (both in-studio and central lab) in connection with the digital conversion and approximately $1.9 million of costs associated with new and specialty products not previously available in the analog film environment.  This was partially offset by lower overall production levels due to the decline in sittings as well as savings related to reduced purchases of film and lower shipping costs, both resulting from the digital conversion, totaling approximately $1.3 million.  In addition, during 2004 the Company incurred high costs associated with mark downs on merchandise sales of frames and accessories in an effort to clear older inventory, the absence of which has had a favorable impact of $934,000.  
 
15
 
·  
Selling, general and administrative (“SG&A”) expenses were $158.5 million and $157.5 million for  2005 and 2004, respectively. As a percentage of sales, these expenses were 83.9% in 2005 and 86.4% in 2004.  Selling, general and administrative expenses increased primarily as a result of an increase in studio employment costs of $2.9 million and increased commission on higher sales of $965,000. Offsetting these effects are decreases of $1.6 million in advertising costs, $1.4 million in medical costs, and $900,000 in numerous other expense categories, all resulting from the Company’s ongoing cost containment efforts.  Studio employment increased in the first half due to the restoration of scheduled reductions that were in place most of the first three quarters of 2004, an increase in the average U.S. hourly rate which brought year-to-date cost up $1.5 million and additional costs related to the reduction in sales backlog totaling $998,000.  This was offset by a third quarter 2005 decrease due to the decline in sittings volume and the positive impact of initiatives launched in the first half of 2005 to improve labor scheduling and productivity.  Advertising costs declined principally as a result of the elimination of broadcast media and related production costs in the current year.  In addition, a more targeted focus in terms of type and frequency of media utilized also resulted in reduced spending.  Medical costs have decreased as a result of lower claim volumes and an absence of materially high individual claims during the quarter.
 
·  
Depreciation and amortization was $15.2 million in  2005, compared to $12.4 million in  2004.  The increase in depreciation and amortization is attributable to significant investments that have been made in connection both with a studio-wide hardware and printer upgrade in 2004 and the recently completed digital conversion of U.S. studios
 
·  
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. In the first three quarters of 2005 and 2004, the Company recognized $2.4 million and $15.2 million, respectively, in other charges and impairments.  The decrease in other charges and impairments primarily reflects 2004 charges related to a change in technology strategy and executive retirements and repositioning, partially offset by the incurrence of 2005 year-to-date charges principally attributable to additional reserves and related costs associated with management changes and ongoing litigation and reduced by favorable settlements in other matters, coupled with write-offs and write-downs of assets in connection with the Company’s conversion to digital technology.
 
·  
Interest income was $411,000 in 2005 compared to $900,000 in 2004.  The first half of 2004 included $483,000 of accrued preferred security dividends that were subsequently fully reserved in the fourth quarter of 2004 as a result of the deteriorating financial performance of Prints Plus, the Company's former Wall Decor segment.  Excluding these accrued dividends, interest income slightly decreased due to lower average balances.
 
·  
The impairment and related obligations of preferred security interest charges in the third quarter of 2004 related to an investment in and operating lease guarantees associated with its former Wall Decor segment, Prints Plus, totaling $9.6 million.  These charges were necessitated by the significant deteriorating financial performance of Prints Plus and are more fully discussed in the section of Management's Discussion and Analysis entitled "Contingencies" which follows.
 
·  
Income tax benefits on losses from continuing operations were $4.8 million and $10.4 million in 2005 and 2004, respectively.  These benefits resulted in effective tax rates of 37.2% in 2005 and 27.4% in 2004.  The lower effective income tax rate in the first three quarters of 2004 was attributable to permanent differences associated with taxable gains primarily resulting from the surrendering of company-owned life insurance policies held by a Rabbi Trust and previously used as funding vehicles for the Company's supplemental executive retirement plan and non-deductible expenditures related to the termination of certain Company executives.
 
 
 
16
 
LIQUIDITY AND CAPITAL RESOURCES
 
The following table presents a summary of our cash flows for the first three quarters of 2005 and 2004.
 
       
40 Weeks Ended
  
 thousands  
 
  
November 12, 2005
  
November 13, 2004
  
               
 Net cash (used in) provided by:            
Operating activities
        
$
(688
)
$
(12,471
)
Investing activities
          
(19,643
)
  
(11,188
)
Financing activities
          
(6,065
)
  
(17,487
)
Effect of exchange rate changes on cash
          
297
    
1,058
 
                     
Net decrease in cash
        
$
(26,099
)
$
(40,088
)
                     

Net Cash Used In Operating Activities

Net cash used in operating activities was $688,000 during the 40 weeks of 2005 compared to $12.5 million in  2004. Cash flows used in discontinued operations were $2.7 million in 2004 and zero in 2005.   During 2004, expenses and charges related to the change of control of the Company’s Board of Directors and strategic leadership changes were incurred for which payments occur over a period of time. A decrease in related payments in the first three quarters of  2005 as compared to the first three quarters of  2004 increased cash flow by approximately $407,000. A tax refund of $680,000 in 2005 increased cash flow.  Offsetting this, the third quarter of 2005 includes a pension contribution of $2.1 million.   The remaining change of approximately $9.0 million is primarily attributable to improved operating results and the timing of payments year-to-date 2005 over the same period of 2004. 

Net Cash Used In Investing Activities

Net cash used in investing activities during the 40 weeks of 2005 was $19.6 million compared to $11.2 million in  2004. The $8.4 million increase in cash used for investing activities is primarily related to a $6.6 million increase in capital expenditures during the first three quarters of 2005 and proceeds from the Rabbi Trust (the funding vehicle for the Company's supplemental executive retirement plan) in 2004 which exceeded 2005 levels by $5.3 million causing decreased cash flow.   These uses were partially offset by a decrease of $3.6 million in revolving loans outstanding to Prints Plus between 2004 and 2005. The increase in capital expenditures is primarily the result of the Company’s conversion of  studios to digital technology while the decrease in the revolving loans outstanding to Prints Plus is the result of the repayment of such loans and the concurrent termination of the revolving credit agreement with them.  Proceeds from the Rabbi Trust in 2004 were used to fund $1.9 million in retirement obligations under the Company's supplemental retirement plan, with the remainder used for general corporate purposes.

Net Cash Used In Financing Activities

Net cash used in financing activities was $6.1 million in the 40 weeks of 2005 compared to $17.5 million in  2004. The $11.4 million decrease in net cash used was primarily related to a reduction of $6.2 million in restricted cash representing collateral for outstanding letters of credit in the second half of 2005 and a $6.0 million repurchase of Company shares in a negotiated transaction in the second half of 2004. This was partially offset by an $814,000 decrease in cash proceeds from option exercises. In the second quarter of 2005, the Company replaced all of the outstanding collateralized standby letters of credit with new letters of credit issued under the Company’s new revolving credit facility. Accordingly, the restricted cash which had been deposited as cash collateral has been returned to the Company for general corporate purposes.
 
Effective November 30, 2005, the Company entered into an Amended and Restated Credit Agreement (the "Credit Agreement").  The Credit Agreement is a three-year, term and revolving credit facility in an amount up to $43 million, consisting of an $18 million term loan and a $25 million revolving loan with a sub-facility for letters of credit in an amount not to exceed $15 million.  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) substantially all of the assets of the Company and such subsidiaries.  Borrowings and letters of credit under the Credit Agreement bear interest, at the Company’s option, at a variable rate based on either LIBOR or an alternative rate (as described in the Credit Agreement), with an applicable margin added. The revolving loan is charged a non-use fee, which varies based on the Company’s leverage ratio. Unless sooner paid, the outstanding principal balance of the term loan is to be repaid in five equal semi-annual installments beginning June 30, 2006 and a final payment on November 30, 2008.  The Credit Agreement and other ancillary loan documents contain terms, provisions, and events of default customary for transactions of this type.  The proceeds of the term loan were used prepay in full all of the outstanding principal, accrued and unpaid interest and make-whole amount due and owing under the Company's Senior Note agreement.
 
17
 
Debt Covenants

At November 12, 2005, the Company had $17.1 million outstanding under its existing Senior Note Agreement and no borrowings against its $30.0 million Revolving Credit Facility. The Company was in compliance with all the covenants under its Senior Note Agreement and its Revolving Facility as of November 12, 2005.
 
Off-Balance Sheet Arrangements

Other than stand-by letters of credit to support various self-insurance programs and the ongoing guarantee of certain operating real estate leases of Prints Plus, both of which are more fully discussed in the following Contingencies section, the Company has no additional off-balance sheet arrangements.

Contingencies

The Company uses stand-by letters of credit to support its various self-insurance programs. As of November 12, 2005, the Company had standby letters of credit outstanding in the principal amount of $6.3 million.

In July 2001, the Company announced the completion of the sale of its Wall Décor segment which included the ongoing guarantee of certain operating real estate leases of Prints Plus. As of November 12, 2005, the maximum future obligation to the Company under its guarantee of these leases is $3.7 million. To recognize the risk associated with these leases and based upon the Company’s past experience with renegotiating lease obligations, a $1.0 million reserve was established in 2001 at time of the sale. As a result of the significant deterioration in the financial performance of Prints Plus in the third quarter of 2004, including its subsequent bankruptcy filing, all of which is more fully described in Note 12 to the Company’s Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended February 5, 2005, the Company recorded an additional $2.1 million of lease obligation reserves bringing the total reserve at November 12, 2005 to $3.1 million. Based on the progress of the bankruptcy case to-date, including Prints Plus’ receipt of debtor-in-possession financing on May 18, 2005, and the continued operations of selected locations of Prints Plus, the Company believes that the $3.1 million reserve is adequate to cover the potential losses to be realized under the Company’s operating lease guarantees.

To assist Prints Plus in obtaining the above-mentioned debtor-in-possession financing facility, the Company guaranteed $300,000 of the facility by posting a letter of credit with the lender.
 
Liquidity

Cash flows from operations, cash and cash equivalents on hand and the borrowing capacity under the Company’s Credit Agreement represent the expected sources of funds to meet its obligations and commitments, including debt service, annual dividends to shareholders, planned capital expenditures and normal operating needs. At the beginning of 2005, the Company estimated capital spending to approximate $27 million for the year.  At the end of its second quarter, the estimate was revised downward to $25 million principally as a result of the reduction in the number of planned new studios to be opened in the second half in Sears Essential stores.  Now, based on the accelerated completion and under-budget execution of the Company's U.S. digital conversion, the Company expects total fiscal 2005 capital spending to approximate $22 million or less. 
 
Effective December 21, 2005, the Company’s Board of Directors authorized the repurchase of up to 1,500,000 shares of its common stock through a Dutch Auction self-tender offer. The tender offer is expected to commence during the week of December 26, 2005 and extend through approximately the end of January 2006. Depending upon market conditions immediately prior to the commencement of the tender offer, the tender offer price is expected to range from $17.00 to $20.00 per share. At the envisioned size, the tender offer is, in part, subject to the successful completion of an amendment to the Company’s current credit facility which, among other things, would increase the term loan portion of the facility. In addition, the tender offer is subject to market, economic, business and other customary conditions affecting the Company. The offer will be subject to the terms and conditions described in offering materials that the Company intends to mail to the Company’s stockholders and file with the SEC during the week of December 26, 2005.

The Company anticipates funding the purchase of shares tendered in the tender offer through a combination of cash on hand and funds derived from the funding of the anticipated amendment to its existing credit facility. To the extent that the amendment to the credit agreement is not completed, the Company may need to amend the terms of the tender offer to reduce the number of shares sought.
 
CPI’s Board of Directors has authorized this tender offer as a prudent use of financial resources given CPI’s business, assets and current stock price and as an efficient means to provide value to stockholders. The offer represents an opportunity for CPI to return cash to stockholders who elect to tender their shares while at the same time increasing non-tendering stockholders’ proportional interest in CPI.
 
18
 
ACCOUNTING PRONOUNCEMENTS AND POLICIES

Adoption of New Accounting Standards

In December 2004, FASB issued FASB Staff Position (“FSP”) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP 109-2”), which provides guidance under FASB Statement No. 109, “Accounting for Income Taxes,” with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Act”) on enterprises’ income tax expense and deferred tax liability. The Jobs Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying FASB Statement No. 109. We expect to make our repatriation determination during the fourth quarter of 2005. Accordingly, as provided for in FSP 109-2, we have not adjusted our tax expense or deferred tax liability to reflect the repatriation provisions of the Jobs Act.
  
Application of Critical Accounting Policies

The Company’s significant accounting policies are discussed in the Notes to the Consolidated Financial Statements that are included in the Company’s 2004 Annual Report on Form 10-K that is filed with the Securities and Exchange Commission. In most cases, the accounting policies utilized by the Company are the only ones permissible under U.S. Generally Accepted Accounting Principles for businesses in our industry. However, the application of certain of these policies 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 accounting policies and estimates that can have a significant impact on the operating results, financial position and footnote disclosures of the Company are described in the Management Discussion and Analysis of Financial Condition and Results of Operations in the Company’s 2004 Annual Report on Form 10-K.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

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 Act of 1995, and involve risks and uncertainties. Management wishes to caution the reader that these forward-looking statements, such as the Company’s outlook for portrait studios, future cash requirements, compliance with debt covenants, valuation allowances, reserves for charges and impairments and capital expenditures, 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: customer demand for the Company’s products and services, the Company’s ability to obtain financing when needed under reasonable terms, the overall level of economic activity in the Company’s major markets, competitors' actions, manufacturing interruptions, dependence on certain suppliers, changes in the Company’s relationship with Sears and the impact of the Kmart/Sears merger, fluctuations in operating results, the ultimate impact of the Prints Plus bankruptcy, the attraction and retention of qualified personnel, unforeseen difficulties arising from installation and operation of new equipment in its portrait studios, the Company’s conversion to a full digital format, future cash balances sufficient to meet our operating needs, compliance with debt covenants 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 year ended February 5, 2005. The Company does not undertake any obligation to update any of these forward-looking statements for any reason.

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 changes in foreign exchange rates. As the Company's long-term debt obligations represent only 16% of liabilities and related interest is less than 1% of sales, exposure to changes in interest rates is minimal. The Company's exposure to changes in foreign exchange rates relates to its Canadian operations and is also minimal, as these operations constitute 8.6% of the Company's total assets at November 12, 2005 and 7.4% of the Company's total net sales for the 40 weeks then ended.
 
 
19
 
 
Item 4. Controls and Procedures
 
An evaluation of the Company’s disclosure controls and procedures (as defined in Section 13(a)-14(c) of the Securities Exchange Act of 1934 (the “Act”) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

In the quarter ended November 12, 2005, the Company did not make any changes to its internal controls over financial reporting that have reasonably affected, or are reasonably likely to affect, the Company’s internal control over financial reporting. In addition, since the date of this evaluation to the filing date of this Quarterly Report, there have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
 
 
 
 
PART II. OTHER INFORMATION
 

 
Item 6. Exhibits

a.     Exhibits
 
     An Exhibit Index has been filed as part of this Report on Page E-1.


 
 
 
 
 
 

 


20

CPI CORP.



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/  Gary W. Douglass
_______________________________________
Gary W. Douglass
Executive Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)

Dated: December 22, 2005


By:       /s/  Dale Heins
______________________________________
Dale Heins
Vice President, Corporate Controller
(Principal Accounting Officer)

Dated: December 22, 2005






















21

CPI Corp.

E-1
EXHIBIT INDEX


 
 

10.84  
Amended and Restated Credit Agreement dated as of November 30, 2005. (the "Credit Agreement"), among the Company, the financial
institutions that are or may from time to time become parties thereto and LaSalle Bank National Association, an administrative agent and
arranger for the Lenders (incorporated in reference to the Company's Current Report on Form 8-K filed with the SEC on December 8, 2005).
 
10.85  
Guaranty and Collateral Agreement dated as of November 30, 2005 among CPI Corp. and the other parties thereto, as guarantors, and
LaSalle Bank National Association, an administrative agent (incorporated by reference to the Company's Current Report on Form 8-K
filed with the SEC on December 8, 2005).
 
11.1  
Computation of Per Share Earnings - Diluted - for the 16 and 40 weeks ended November 12, 2005 and November 13, 2004

11.2  
Computation of Per Share Earnings - Basic - for the 16 and 40 weeks ended November 12, 2005 and November 13, 2004
 
31.1  
Certification Pursuant to Rule 13a-14(a) Under the Securities and Exchange Act of 1934 by the Chief Executive Officer
 
31.2  
Certification Pursuant to Rule 13a-14(a) Under the Securities and Exchange Act of 1934 by the Executive Vice President, Finance
and 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 Executive Vice President, Finance and Chief Financial Officer



























22