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

FORM 10-K

x     ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE
FISCAL YEAR ENDED FEBRUARY 5, 2005

OR

o     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-10204

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

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

Securities registered pursuant to Section 12(b) of the Act:

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  x Yes  o  No

The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price of the New York Stock Exchange on April 19, 2005, of $16.62, was $125,827,078.

The number of shares outstanding of each of the registrant’s classes of Common Stock, as of April 19, 2005 was: Common Stock, par value $.40 – 7,793,236

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Proxy Statement relating to the Annual Meeting Of Shareholders to be held June 23, 2005 are incorporated by reference into Part III of this Report.

(THIS PAGE LEFT INTENTIONALLY BLANK)

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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 OUR PORTRAIT STUDIOS AND OTHER RISKS AS MAY BE DESCRIBED IN THE COMPANY’S FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING THIS FORM 10-K FOR THE YEAR ENDED FEBRUARY 5, 2005.

PART I

Item 1.        Business

An Overview of the Company

CPI Corp. (“CPI”, the “Company” or “we”), a Delaware corporation formed in 1982, is a long-standing leader in the professional portrait photography of young children and families. At February 5, 2005, we operated 1,021 studios throughout the United States, Canada and Puerto Rico principally under license agreements with Sears, Roebuck and Co. (“Sears”). Our revenues of approximately $281 million in fiscal 2004 position us in the top tier of the estimated $1.2 billion pre-school photography market. Management has determined that the Company operates in one segment offering similar products and services in all locations.

We have provided professional portrait photography for Sears customers since 1959 and have been the only Sears portrait studio operator since 1986. Studios are located in all fifty states, Canada and Puerto Rico. Operations in the United States and Puerto Rico are conducted through the Company’s subsidiaries, Consumer Programs Incorporated and CPI Images, LLC, and a partnership, Texas Portraits, L.P. (owned by Consumer Programs Incorporated and another subsidiary, Consumer Programs Partner, Inc.), pursuant to a license agreement with Sears. Approximately $56.0 million of long-lived assets are used in our domestic operations as of February 5, 2005.

In Canada, we operate 117 Sears Portrait Studios through CPI Corp., which was originally organized under the laws of Ontario and which we reorganized under Nova Scotia law at the end of fiscal 2002. With 2004 sales of $20.7 million, our Canadian studios accounted for 7.4% of our revenues. Long-lived assets employed in the Company’s Canadian operations at February 5, 2005 amounted to $5.1 million.

We sold our wall décor business, operated by Prints Plus, Inc., to that company’s management in July 2001. In 2002, we continued our efforts to focus on maximizing the potential of our core photography business by eliminating our technology development segment, which was launched in 2001. Operating through a subsidiary, Centrics Technology, Inc., the segment offered software development and systems consulting for third parties, in addition to continuing the software development historically performed for the Sears Portrait Studios. Near the end of 2002, we reintegrated the portion of the segment dedicated to software development for the portrait studios with our corporate information technology function and discontinued the sale of consulting and software development to third parties.

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During the second half of 2004, we made a strategic decision to exit both our Mexican and mobile photography businesses which began operating in 2002. This decision was made to allow us to focus on our Sears Portrait Studio business as well as to eliminate the significant operating dilution associated with these businesses. Further financial information on continuing and discontinued operations of the Company appears in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and Part II, Item 8, “Financial Statements and Supplementary Data”.

We operate two websites which support and complement our studio operations; searsphotos.com, serves as a vehicle for viewing and sharing portraits (after a portrait session), as well as ordering additional portraits and portrait-related products; searsportrait.com serves as a marketing and information resource conveying details about our products and services, as well as special offers, available in our studios. In 2004, revenues from on-line sales and services were approximately $3.9 million.

The Company’s Products and Services

We offer Sears Portrait Studio customers a wide range of choices. They may select a “package” sitting or a “custom” sitting. The package sitting includes a fixed number of portraits, all of the same pose, for a fixed, relatively low price, and an unlimited number of subjects in the portrait for a session fee of $14.99. Package customers may purchase additional portrait sheets at an additional cost. Mothers of very young children who need a large quantity of portraits often prefer this kind of offer. A custom sitting offers portraits by the sheet, a variety of poses and backgrounds, and an unlimited number of people in the portrait for a session fee of $14.99. Customers who enroll in the Company’s Smile Savers Plan® for a one-time fee of $29.99 pay no sitting or session fees for two years. We designed this plan to promote loyalty and encourage frequent return visits.

After the customer selects a package or custom session and their preferred backgrounds, the photographer captures images of multiple poses. Our Portrait Preview System allows customers to view each image as it is captured and accept or reject each pose while they are still in the camera room. After the image capture portion of the portrait session is completed, the images are transferred to a monitor at a sales table where customers can view each image and order portraits in the sizes they need, as well as other products, such as greeting cards. At the sales table, a studio associate reviews the images captured with the customer and describes product options, such as digitally enhanced products (black and white, sepia, color accents, etc.) and digital portrait collages featuring multiple poses and a customized message. Customers may take the portrait collage home when they leave the studio on the day of the sitting. They may also purchase a full color proof sheet to take home as soon as the sitting is completed. Other products available from the studio are portraits on disk, passport photos and accessories such as frames and photo albums. New products introduced during the second half of 2004 include our Portrait Study (a unique portrait created from artistic glimpses of each pose), Artist Oil Portraits (a portrait featuring beautiful brush strokes and a texture that emulates a canvas oil painting) and Crystal Portraits (portraits laser etched inside high quality crystal creating a 2D image).

In most of our studios, the customer’s order is transmitted electronically to one of our processing facilities in St. Louis, Missouri; Thomaston, Connecticut or Brampton, Ontario, Canada and the film is then shipped to the applicable processing facility. We then complete the customer’s orders to their specifications and return them to the studio for pick-up approximately 2 1/2 weeks after the order. However, in our digital studios (discussed further below), customer orders are either printed immediately in the studio and/or high-resolution images are transmitted electronically to one of our processing facilities in lieu of film for central fulfillment.

Most studios can upload images captured in a Sears Portrait Studio session to our searsphotos.com website. With a code and individualized passwords, our customers can view their images from home, share them via email with friends and family, and place orders online for portraits or portrait-related gifts such as personalized t-shirts, mugs, mouse pads and more.

We are committed to converting a substantial share of our portrait studios to a full digital format in 2005. The Company believes that the effective deployment of digital technology will enable us to elevate the overall customer experience, offer immediate fulfillment of portrait orders in the studio, develop a range of new product and service offerings and drive significant work-flow efficiencies all leading to renewed differentiation in our market segment

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as well as the ability to tap new customer categories. As of February 5, 2005, we had converted 128 of our domestic studios to a full digital format. Through April 19, 2005, we have now converted a total of 217 domestic studios to our digital format.

The Company’s Relationship with Sears

We have enjoyed a strong relationship with Sears for more than 40 years under a series of license agreements. Over that period, except in connection with Sears store closings, Sears has never terminated the operation of any of our studios. While we are materially dependent on a continuing relationship with Sears, we have no reason to believe that Sears will terminate or materially reduce the scope of our license.

As a Sears licensee, we enjoy the benefits of using the Sears name, access to prime retail locations, Sears’ daily cashiering and bookkeeping system, store security services and Sears’ assumption of credit card fees and credit and check authorization risks. Our customers have the convenience of using their Sears credit cards to purchase our products or services.

As of February 5, 2005, the Company operated 864 studios in full-line Sears stores in the United States under a license agreement that runs through December 31, 2008. Under this agreement, we pay Sears a license fee of 15% of total annual net sales for studios located in Sears stores. The agreement defines net sales as gross sales less customer returns, allowances and sales taxes. We provide all studio furniture, equipment, fixtures, leasehold improvements and advertising, and we are responsible for hiring, training and compensating our employees. We have agreed to indemnify Sears against claims arising from our operation of Sears Portrait Studios.

On August 14, 2003, the Company announced the execution of an amendment to its agreement with Sears eliminating the then existing exclusivity provision from that agreement which effectively precluded us from providing other non-Sears portrait studios photography services in the United States. In return for the removal of the exclusivity provision, the Company, upon certain conditions, has agreed to provide Sears with certain commission adjustments (the “Contingent Payments”) through 2008, the remaining term of the current agreement. The Contingent Payments are triggered only if the Company operates more than 24 domestic non-Sears portrait studios and the rate of growth in total contractual commissions paid to Sears by the Company under the pre-existing agreement does not exceed Sears’ same-store revenue growth rate by specified percentages, up to a maximum of 2%. If both of the above mentioned conditions occur, the Contingent Payments are determined by a formula included in the amendment to the agreement, however, in no event shall such payments exceed $2.5 million annually or $7.5 million cumulatively through 2008, the remaining term of the current agreement. No domestic non-Sears portrait studios were opened in 2003 or 2004 and thus no Contingent Payments were made in either year.

As of February 5, 2005, we operated 37 freestanding studios in the United States under the Sears name in locations not within a Sears store. The Company pays Sears a license fee of 7.5% of total annual net sales per studio in these locations. We pay rent and utilities at each of these locations and provide all studio furniture, equipment, fixtures, leasehold improvements and advertising. We are also responsible for hiring, training and compensating our employees. These studios benefit from the use of the Sears name and Sears’ payment for credit card fees and check clearance systems.

All 117 Canadian studios operate under a license agreement with Sears Canada, Inc., a subsidiary of Sears. Until January 1, 2003, an agreement negotiated in 1977 renewed automatically on a year-to-year basis but was terminable by either party on 60 days’ notice. As of January 1, 2003, a three-year agreement, stated in Canadian dollars, governs our Canadian studio operations. The license fee under the former agreement was 15% of total annual net sales through December 31, 2002. For 2003, the license fee was set at the greater of $4.4 million or 13% of the first $30 million of annual net sales and 8% of annual net sales above $30 million. In 2004 and continuing through 2005, the license fee is 13% of the first $30 million annual net sales and 8% for annual net sales greater than $30 million. The Company provides all studio furniture, equipment, fixtures, leasehold improvements and advertising and is responsible for hiring, training and compensating our employees.

During 2004, Sears initiated certain strategic changes in its business that we believe will have a positive impact on our Sears Portrait Studios operations. In September 2004, Sears acquired 50 stores from Kmart Holding

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 Corporation (“Kmart”). This acquisition represented a significant step in Sears’ strategy to grow its store base through off-mall expansion. On November 17, 2004, Sears and Kmart announced a definitive merger agreement that would combine Sears and Kmart into a major new retail company named Sears Holdings Corporation (“Holdings”). Shareholders of both Kmart and Sears approved the merger on March 24, 2005. Holdings, now the nation’s third largest retailer, has combined sales of approximately $55 billion in annual revenues, 2,350 full-line and off-mall stores, and 1,100 specialty retail stores in the United States.

In February 2005, primarily as a result of the Kmart store acquisition discussed above, Sears announced the launch of a new, mid-sized off-mall format — Sears Essentials — to offer products integral to home and family life, such as appliances, lawn and garden, tools, home electronics, apparel and home fashions as well as convenience items such as health and beauty, pantry, household and paper products, pet supplies and toys. The first 25 Sears Essentials stores, all of which are part of the pre-merger acquisition from Kmart, are scheduled to open in spring 2005.

We have been asked by Sears to open portrait studios in 16 of the first 25 Sears Essential stores and expect to open an additional 20 studios in the remaining 25 Kmart stores acquired by Sears before the merger. In addition, Holdings have recently announced plans to convert approximately 400 existing Kmart locations to the Sears Essential format over the next three years. As a result, we now expect opening potentially in excess of 70 brand new portrait studios in planned Sears Essential stores in fiscal 2005. These studios, generally occupying a smaller footprint and containing only one camera room, will be fully digital from inception. We believe that this planned growth in Sears Essential stores will provide CPI with the opportunity for significant growth in its existing portrait studio count.

Under the terms of our existing license agreement with Sears in the United States, Sears is under no contractual obligation to invite us to open portrait studios in new Sears Essential stores or any other new Sears stores. However, as discussed above, they have done so in a number of their planned new stores and based on ongoing discussions with their representatives and our recent experience, we expect to open portrait studios in 70 or more planned Sears Essential stores in 2005. Once we do establish a portrait studio in a new Sears store, that studio is then governed by the terms of our existing license agreement.

While Sears has not indicated to us any specific intentions to close a significant number of its existing full-line, mall-based stores that contain our portrait studios, there can be no assurance that some such closures may not occur in the future thus resulting in the concurrent closure of some of our existing portrait studios. The closure of a significant number of Sears full-line, mall-based stores that result in the closing of related portrait studios, to the extent such closures are not offset by openings of portrait studios in new Sears Essential stores could have an adverse impact on the Company’s operations.

Industry Background and Competition

Through our relationship with Sears, we have been at the forefront of developing the now highly competitive professional portrait photography market. Although our primary portrait subjects are pre-school children, we also attract families, school-age children and adults. During the 1990’s, the mass-market professional portrait studio industry became intensely competitive in the United States as the number of permanent studios grew from an estimated 2,555 (including 867 Sears Portrait Studios) in 1990 to a peak of approximately 4,805 (including 902 Sears Portrait Studios) in 1996. As of February 5, 2005, we estimate that there were approximately 4,578 permanent studios in operation in the United States.

The rapid expansion of the marketplace was accompanied by highly promotional offers featuring large packages of portraits for a small, fixed price. We responded initially with promotional pricing to maintain market share and shortly thereafter with technological advances and an aggressive studio expansion and remodeling program in an effort to distinguish our products and services. By the end of the 1990s, we had invested approximately $150 million to rollout new technology-based products system wide and to remodel and expand more than 600 studios in the U.S. from an average of 800 square feet to approximately 1,400 square feet. Studios operated by competitors range from one camera room with a small waiting and sales area to more spacious locations with multiple camera rooms and sales areas, such as ours.

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There are presently five major participants in the preschool portrait segment of the industry. In addition to CPI, the largest players in our industry are PCA, which operates studios principally in Wal-Mart stores, LifeTouch, which provides portrait studio services principally in J.C. Penney and Target stores, Olan Mills, which operates studios in Kmart as well as freestanding locations, and Picture People (owned by Hallmark) which operates independent mall-based locations. Independent photographers compose most of the balance of the competition though several all-digital portrait providers have recently entered into the industry as well.

Industry players compete generally on the basis of price, service, quality, location, product mix and convenience (including the immediate fulfillment of finished portraits at the time of the portrait sitting). Many competitors focus heavily on price and commonly feature large portrait packages at aggressive, low prices in weekly mass marketing campaigns. Some of these same competitors have additionally eliminated charges for the portrait capture (generally characterized as a sitting or session fee. Except for targeted promotions to new mothers, we have not followed this practice because we believe a sitting fee is justified by the professionalism of our photographers, the quality of our equipment, and our overall studio environment. Furthermore, while our products and services are competitively priced, they are not the lowest priced in the industry. Other competitors, notably Picture People, have emphasized convenience and experience over price and, especially, the immediate fulfillment of orders in the studio as opposed to the long lead times of central lab fulfillment.

The industry is in the midst of a major transformation today wrought by significant advances in digital photographic technology. New digital technologies, among other things, have made it possible to capture, manipulate, store and print high-resolution digital images in a distributed, decentralized environment. These evolving capabilities have required that industry incumbents review and adjust their business models and have also encouraged a number of new digital entrants to enter our marketplace. Likewise, the proliferation of amateur digital photography appears to be making customers more discerning and demanding and may possibly be impacting overall portrait activity/frequency.

Seasonality and Inflation 

Our business is highly seasonal, with the largest volume occurring in the fourth fiscal quarter, between Thanksgiving and Christmas. For fiscal years 2004, 2003 and 2002, fourth quarter sales accounted for 35%, 34% and 36%, respectively, of total net sales for the year. In addition, in each of the last three fiscal years all of the net earnings for the year were generated in the fourth fiscal quarter. The timing of Easter, another seasonally important time for portraiture sales, has a significant impact on the timing of recognition of sales revenues between the Company’s first and second fiscal quarters. Most of the Company’s Easter-related sales in 2004 and 2003, earlier Easters, were recognized as revenues, in accordance with the Company’s revenue recognition policies reflected in Note 1 in the accompanying Notes to Consolidated Financial Statements, in the first fiscal quarter while such sales in 2002, a late Easter, were principally recognized in the second fiscal quarter.

The moderate rate of inflation over the past three years has not had a significant effect on the Company’s revenues and profitability.

Suppliers

To ensure consistent, high quality finished portraits, we purchase photographic paper, film and portrait processing chemistry from three major manufacturers. Eastman Kodak provides photographic paper and film for all Sears Portrait Studios pursuant to an agreement in effect through December 31, 2005. Dye sublimation paper used for proof sheets, portrait collages and full portrait orders delivered at the end of a sitting in certain of our full digital studios is provided by Sony, and we purchase portrait processing and finishing chemistry from Fuji-Hunt. We purchase camera and lens components, monitors, computers, printers and other equipment and materials from a number of leading suppliers.

Historically, with the exception of certain replacement parts for equipment utilized in our studios further discussed below, we have not encountered difficulty in obtaining equipment and materials in the quantity and quality we require and we do not anticipate any problems in obtaining our requirements in the future. We enjoy good relationships with our vendors.

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In 2003 and 2002, and to a lesser extent in 2004 following our U.S. studio computer hardware and printer upgrade, aging equipment in our studios created difficulties both repairing and acquiring replacement parts. Although the above-mentioned studio hardware upgrade alleviated problems with computers and printers, our film cameras remain a support challenge as replacement parts are scarce and outside maintenance resources are nonexistent. We have, therefore, internalized most all repairs for our film cameras and have built an internal knowledge base and repair capability to support our studio equipment. These challenges are naturally abating as we progress with our digital rollout plans; retirements of analog studio equipment have added to our store of replacement parts, and the increasing shift toward digital is gradually reducing our reliance on aging equipment. The first step in that process was the studio computer hardware and printer upgrade completed in 2004 followed by the conversion of 128 of our studios to full digital format. Our plans call for us to convert substantially all of the remainder of our studios to full digital format in 2005.

In conjunction with the conversion of the initial studios to full digital format as well as for our remaining planned conversions, we have utilized the software of a single vendor for our studio photography and manufacturing fulfillment digital systems. Our contract with our software vendor allows CPI to scale the use of the software as necessary to support all of our current and prospective studios and labs. We are actively working with the vendor to adapt it’s manufacturing software to meet our volume and workflow requirements. Any material delay in effectively adapting the vendor’s software to our manufacturing environment, coupled with a failure to identify and implement alternative solutions, could have an adverse effect upon the operations of the business.

Intellectual Property

We own certain registered service marks and trademarks, including Portrait Creations® and Smile Savers Plan®, which have been registered with the United States Patent and Trademark Office. Our rights to these trademarks in conjunction with our operation of Sears Portrait Studios will continue as long as we comply with the usage, filing and other legal requirements relating to the renewal of trademarks.

The Company’s Employees

As of February 5, 2005, we had approximately 8,800 employees, including approximately 6,100 part-time and temporary employees.

The Company Website and Periodic Reports

Our Annual Reports on Form 10-K, including this Form 10-K, as well as our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports are available, free of charge, on the Investor Relations portion of our website, www.cpicorp.com. These reports are available as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. References to the Company’s website address do not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.

Environmental Regulation

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

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Item 2.        Properties

         The following table sets forth certain information concerning the Company’s principal facilities:

As of February 5, 2005, the Company operated 864 portrait studios in Sears stores in the United States pursuant to the license agreements with Sears and 117 studios in Canada under a separate license agreement with Sears Canada, Inc. The Company pays Sears a license fee based on total annual net sales. This license fee covers the Company’s use of space in the Sears stores, the use of Sears’ name and related intellectual property, and all services provided by Sears. No separate amounts are paid to Sears expressly for the use of space. The Company operates 40 portrait studios in shopping centers that do not have Sears stores, which are generally leased for at least three years with some having renewal options. See Part I, Item 1. “BUSINESS, The Company’s Relationship with Sears” for more information on the Sears license agreements.

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

The Company’s physical properties owned or leased are all considered commercial property.

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Item 3.        Legal Proceedings

The Company is a defendant in various lawsuits arising in the ordinary course of business. It is the opinion of management that the ultimate liability, if any, resulting from such suits will not materially affect the consolidated financial position or results of operations of the Company.

Item 4.        Submission of Matters to a Vote of Security Holders

No matters were submitted to stockholders for a vote during the fourth quarter of fiscal year 2004.

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PART II

Price Range of Common Stock and Dividends

Since April 17, 1989, the Company’s common stock has been traded on the New York Stock Exchange under the symbol CPY.

The following tables set forth the high and low sales prices of the common stock reported by the New York Stock Exchange and the dividends declared for each full quarterly period during the Company’s last two fiscal years.

Shareholders of Record

As of April 19, 2005, the market price of the Company’s common stock was $16.62 per share with 7,793,236 shares outstanding and 1,541 holders of record.

Dividends

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

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Item 6.      Selected Consolidated Financial Data

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Item 6.      Selected Consolidated Financial Data (continued)

thousands

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Item 6.      Selected Consolidated Financial Data (continued)

thousands

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Item 6.      Selected Consolidated Financial Data (continued)

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Item 7.        Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Unless otherwise noted, 2004 and 2002 results reflect a 52-week period while 2003 results reflect a 53-week period. All references to earnings per share relate to diluted earnings per common share.

EXECUTIVE OVERVIEW

The Company’s Operations

CPI Corp. is a long-standing leader, based on sittings and related revenues, in the professional portrait photography of young children and families. From the single studio opened by its predecessor company in 1942, we have grown to 1,021 studios throughout the United States, 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 only Sears portrait studio operator since 1986.

As of the end of the last three fiscal years, the Company’s studio counts were:

During 2004, the Company converted 128 of its U.S. studios to a full digital format. These locations marked the beginning of a plan to transition a substantial share of our studios to full digital technology in 2005.

Competitive Factors/Trends/Challenges

As previously discussed, the mass-market professional studio industry is facing challenging and difficult industry conditions. These include relatively stagnant growth, industry sitting declines, heavy promotional activity, the proliferation of Wal-Mart studios with convenient locations and aggressively-priced portrait package offers, the emergence of competitors (notably Picture People) with perceived differentiation and offering immediate fulfillment of portrait orders, and the rapid evolution of both amateur and professional digital technology.

The competitive and other external factors cited above, coupled with the likely less than optimal experience that certain of our customers have experienced over the past several years due to technology and support challenges caused in part by an aging studio infrastructure and certain other operational issues, have resulted in a declining sittings trend in our Sears Portrait Studios. Our sittings volumes declined by nearly 20% from 2002 to 2004. Although a portion of the sittings decline has been offset by increases in our average customer sales, overall net sales over the same time period have declined from $308.6 million in 2002 to $281.9 million in 2004.

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On March 24, 2004, the Knightspoint Group successfully completed their consent solicitation resulting in, among other things, the replacement of all but two of the Company’s then-existing directors with the slate proposed by the Knightspoint Group. Shortly thereafter, the Company’s new Board conducted a comprehensive review of the Company’s operations and competitive position and formulated a range of new operating initiatives for the Company. As a result of that review, the Company has taken the following actions, among others, in an effort to improve operations, increase customer satisfaction and retention and reverse the declining trend in sales:

We believe the foregoing initiatives have already begun to show tangible benefits. Late in the third quarter of 2004, we experienced a partial reversal in the negative sales trend we experienced in the first half of the year and which had continued into the early part of the third quarter. In the fourth quarter, on a comparable week basis, the positive sales trend continued.

Our plan of action for 2005 is to:

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RESULTS OF OPERATIONS

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

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Costs and expenses were $288.3 million in 2004, compared with $289.6 million in 2003 and $295.2 million in 2002.

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LIQUIDITY AND CAPITAL RESOURCES

The following table presents a summary of our cash flows for each of the last three fiscal years:

Net Cash Provided By Operating Activities

Net cash provided by operating activities was $13.7 million in 2004 as compared to $24.6 million and $28.1 million in 2003 and 2002, respectively. The decrease in cash provided in 2004 compared to 2003 resulted primarily from lower earnings in 2004 offset by non-cash impairment charges of $5.1 million, the impairment and related obligations of the preferred security interest in Prints Plus of $9.8 million and accelerated vesting of supplemental retirement benefits of $3.3 million. In addition, deferred tax assets increased $6.8 million due to an increase in net operating loss carry forwards, partially offset by additional deferred tax liability associated with bonus tax depreciation in 2004. Also, there was a net decrease in liabilities of $5.9 million due principally to an accrual for the purchase commitment for computer equipment and peripherals that was recorded in the fourth quarter of 2003 (see below) and paid for in 2004. The decrease in cash provided in 2003 as compared to 2002 resulted primarily from lower earnings in 2003 and a $4.2 million impairment charge recorded in 2002 partially offset by a $4.4 million tax refund received in the first quarter of 2003 and the $7.3 million accrued purchase commitment for computer equipment and peripherals that was recorded in the fourth quarter of 2003.

Net Cash Used In Investing Activities

Net cash used in investing activities during 2004 was $6.6 million. This compares with cash used in investing activities of $18.2 million and $6.2 million in 2003 and 2002, respectively. The decrease in cash used for investing activities in 2004 as compared to 2003 is due to decreased accrual basis capital expenditures of $7.4 million partially offset by proceeds of $1.5 million from the sale of equipment. In addition, there were increases in net cash provided by sales of investment securities in the Rabbi Trust (the funding vehicle for the Company’s supplemental executive retirement plan), the net proceeds of which were partially used to fund retirement obligations under the Company’s supplemental retirement plan and a net decrease of $3.4 million in amounts due under the loan receivable with Prints Plus. The increase in cash used for investing activities in 2003 as compared to 2002 is primarily the result of increased capital expenditures of $13.8 million, partially offset by increases in net cash provided by sales of investment securities in the Rabbi Trust.

Net Cash Used In Financing Activities

Net cash used in financing activities was $24.8 million in 2004 compared to $13.9 million in 2003 and $10.6 million in 2002. The increase in net cash used in 2004 was primarily a result of a repurchase of shares of the Company’s common stock in a negotiated transaction in the amount of $6.0 million and $6.2 million of restricted cash deposited as collateral with the issuing bank of the Company’s outstanding letters of credit in the same amount. The increase in net cash used in 2003 was primarily a result of a $1.3 million decrease in proceeds from borrowing against cash surrender value of life insurance and $935,000 used for open market share repurchases.

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The Company has a $60.0 million Senior Note Agreement (the “Note Agreement”) privately placed with two major insurance companies. The Note Agreement was entered into in June 1997. The notes issued pursuant to the Note Agreement call for annual principal payments beginning in 2001 with the final payment due in 2007. Interest on the notes is payable semi-annually, in June and December, at an average effective fixed rate of 7.46%. As of February 5, 2005, the outstanding principal balance due under the Note Agreement was $25.6 million.

The Note Agreement contains a number of covenants imposing certain restrictions on our business. The most significant of these covenants require that:

As of February 5, 2005, the Company was in compliance with all debt covenants.

In the fourth quarter of 2004, the Company terminated its then-existing $7.5 million revolving credit facility, which was used solely to support outstanding letters of credit used in its self-insurance programs. As a result of the termination of the revolving credit facility, the Company deposited $6.2 million in cash as collateral with the bank that has issued the outstanding letters of credit. On April 15, 2005, the Company entered into a new $30.0 million (reducing to $25 million February 2006 and $20 million in February 2007) unsecured bank revolving credit facility (the “Revolving Facility”) which will expire on April 15, 2007 and carries a variable interest rate charged at either LIBOR or prime funds rate, with an applicable margin added. The Company expects to replace its outstanding letters of credit with substitute letters of credit issued by the bank providing the Revolving Facility thus allowing the Company to reclaim its cash collateral currently on deposit with the current issuing bank.

Concurrent with the closing of the Revolving Facility, the Company amended the above mentioned 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.

Off-Balance Sheet Arrangements

Other than stand-by letters of credit used to support our 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 “Other Commitments” table below, the Company has no additional off-balance sheet arrangements.

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Future Cash Flows

To facilitate an understanding of the Company’s contractual obligations and other commitments, the following information is provided:

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Liquidity

Cash flows from operations, cash and cash equivalents on hand and the seasonal borrowing capacity under the Company’s new Revolving Facility, represent our expected sources of funds in 2005 to meet our obligations and commitments, including debt service, annual dividends to shareholders, planned capital expenditures which are estimated to be approximately $27 million in fiscal 2005 and normal operating needs.

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ACCOUNTING PRONOUNCEMENTS AND POLICIES

Adoption of New Accounting Standards

In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, “Inventory Costs”. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. The Company does not expect the adoption of SFAS No. 151 to have a material impact on its consolidated financial statements.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets”, an amendment of APB Opinion No. 29, “Accounting for Nonmonetary Transactions”. SFAS No. 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 is effective for fiscal periods beginning after June 15, 2005. The Company does not expect the adoption of SFAS No. 153 to have a material impact on its consolidated financial statements.

In December 2004, the FASB issued SFAS No. 123(R) (revised 2004), “Share-Based Payment”. This statement replaces SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards will be remeasured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. This standard is effective for the first annual period beginning after June 15, 2005. Historically, the Company has elected to follow the intrinsic value method in accounting for its employee stock options and employee stock purchase plans. No stock-based compensation costs were reflected in net income, as no options granted under those plans had an exercise price less than the market value of the underlying common stock on the date of grant. Upon the adoption of SFAS No. 123(R), the Company will be required to expense stock options over the vesting period in its statement of operations. In addition, the Company will need to recognize expense over the remaining vesting period associated with unvested options outstanding on the date of adoption. For 2004, 2003 and 2002, total stock-based employee compensation expense, net of related tax effects, determined under this new standard would have been $621,000, $179,000 and $220,000, respectively.

Application of Critical Accounting Policies

The preparation of financial statements requires the Company to estimate the effect of various matters that are inherently uncertain as of the date of the financial statements. Each of these required estimates varies in regard to the level of judgment involved and its potential impact on the Company’s reported financial results. Estimates are deemed critical when a different estimate could have reasonably been used or where changes in the estimate are reasonably likely to occur from period to period, and would materially impact the Company’s financial condition, changes in financial condition or results of operations. The Company’s significant accounting policies are discussed in Note 1 in the accompanying Notes to Consolidated Financial Statements; critical estimates inherent in these accounting policies are discussed in the following paragraphs.

Self-insurance reserves

The Company is self-insured for certain losses relating to workers’ compensation, general liability, business auto usage and employee medical claims. The Company has stop-loss coverages to limit the exposure arising from these claims. Self-insurance losses for claims filed and claims incurred but not reported are accrued based upon the Company’s estimates of the aggregate liability for uninsured claims incurred using actuarial assumptions followed in the insurance industry and the Company’s historical experience. Loss estimates are adjusted based upon actual claims settlements and reported claims.

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Income taxes

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

Defined benefit retirement plans

The plan obligations and related assets of defined benefit retirement plans are presented in Note 9 in the accompanying Notes to Consolidated Financial Statements. Plan assets, which consist primarily of marketable equity and debt instruments, are valued using market quotations. Plan obligations and the annual pension expense are determined by independent actuaries and through the use of a number of assumptions. Key assumptions in measuring the plan obligations include the discount rate, the rate of salary increases and the estimated future return on plan assets. In determining the discount rate, the Company utilizes the yield on high-quality, fixed-income investments currently available with maturities corresponding to the anticipated timing of the benefit payments. Salary increase assumptions are based upon historical experience and anticipated future management actions. Asset returns are based upon the anticipated average rate of earnings expected on the invested funds of the plans. At February 5, 2005, the actuarial assumptions of the Company’s plans were: discount rate 5.75%; long-term rate of return on plan assets 8.75%; and assumed salary increases 3.75%.

The Company has made certain other estimates that, while not involving the same degree of judgment, are important to understanding the Company’s financial statements. These estimates are in the areas of assessing recoverability of long-lived assets and in establishing reserves in connection with restructuring initiatives and other charges and with respect to the Company’s operating lease guarantees related to its former Wall Décor segment. On an ongoing basis, management evaluates its estimates and judgments in these areas based on its substantial historical experience and other relevant factors. Management’s estimates as of the date of the financial statements reflect its best judgment giving consideration to all currently available facts and circumstances. As such, these estimates may require adjustment in the future, as additional facts become known or as circumstances change.

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

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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 our portrait studios and other risks as may be described in the Company’s filings with the Securities and Exchange Commission, including this From 10-K for the year ended February 5, 2005.

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Item 7A.                 Quantitative and Qualitative Disclosures About Market Risk

Market risks relating to the Company’s operations result primarily from changes in interest rates and changes in foreign exchange rates. The Company’s debt obligations have primarily fixed interest rates; therefore, the Company’s exposure to changes in interest rates is minimal. The Company’s exposure to changes in foreign exchange rates relative to the Canadian operations is also minimal, as Canadian operations constitute only 9.9% of the Company’s total assets and 7.4% of the Company’s total sales as of end for the year ended February 5, 2005.

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The Company’s fiscal year ends the first Saturday of February. Accordingly, fiscal years 2004 and 2002 ended February 5, 2005 and February 1, 2003, respectively, and consisted of 52 weeks and fiscal year 2003 ended February 7, 2004 and consisted of 53 weeks. Throughout the “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” section, reference to 2004, 2003 or 2002 will mean the fiscal year ended February 5, 2005, February 7, 2004 and February 1, 2003, respectively.

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Report of Independent Registered Public Accounting Firm

To the Board of Directors
CPI Corp.:

We have audited the accompanying consolidated balance sheets of CPI Corp. (the Company) as of February 5, 2005 and February 7, 2004, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended February 5, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CPI Corp. as of February 5, 2005 and February 7, 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended February 5, 2005, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of February 5, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated April 20, 2005 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

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Report of Independent Registered Public Accounting Firm

The Board of Directors
CPI Corp.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that CPI Corp. (the Company) maintained effective internal control over financial reporting as of February 5, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

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In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of February 5, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by COSO. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 5, 2005, based on criteria established in Internal Control — Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of February 5, 2005 and February 7, 2004, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended February 5, 2005, and our report dated April 20, 2005 expressed an unqualified opinion on those consolidated financial statements.

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CPI CORP.
Consolidated Balance Sheets – Assets

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

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