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CPI Corporation 10-Q 2008 Documents found in this filing:UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
x Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period ended November 8, 2008
or
o Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the transition period from __________ to __________
Commission
file number 1-10204
CPI
Corp.
(Exact
name of registrant as specified in its charter)
Registrant’s
telephone number, including area code: 314/231-1575
Securities
registered pursuant to Section 12(b) of the Act:
Securities
registered pursuant to Section 12(g) of the
Act: None
The
number of shares outstanding of each of the registrant’s classes of Common
Stock, as of December 16, 2008 was: Common Stock, par value $.40
- 6,494,714. CPI
CORP.
INDEX
TO QUARTERLY REPORT ON FORM 10-Q
16
and 40 Weeks Ended November 8, 2008
PART
I. FINANCIAL INFORMATION
Item 1. Financial Statements
Interim
Condensed Consolidated Balance Sheets – Assets
See
accompanying footnotes to the condensed consolidated financial
statements.
1
CPI
CORP.
Interim
Condensed Consolidated Balance Sheets – Liabilities and Stockholders’ (Deficit)
Equity
See
accompanying footnotes to the condensed consolidated financial
statements.
2
Interim
Condensed Consolidated Statements of Operations
(Unaudited)
See accompanying footnotes to the condensed consolidated financial statements. 3
Interim
Condensed Consolidated Statement of Changes in Stockholders’ (Deficit)
Equity
(Unaudited)
Forty
weeks ended November 8, 2008
See accompanying footnotes to the condensed consolidated financial statements. 4
Interim
Condensed Consolidated Statements of Cash Flows
(Unaudited)
See accompanying footnotes to the condensed consolidated financial statements. 5
CPI
CORP.
Interim
Condensed Consolidated Statements of Cash Flows (…continued)
(Unaudited)
See accompanying footnotes to the condensed consolidated financial statements. 6
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
CPI Corp.
(the “Company”) operates 3,062 professional portrait studios as of November 8,
2008, throughout the United States, Canada, Puerto Rico and Mexico, principally
under license agreements with Sears, Roebuck and Co. ("Sears") and lease
agreements with Wal-Mart Stores, Inc. (“Wal-Mart”). 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 8, 2008, the related
Interim Condensed Consolidated Statements of Operations for the 16 and 40 weeks
ended November 8, 2008, and November 10, 2007, the Interim Condensed
Consolidated Statement of Changes in Stockholders’ Equity for the 40 weeks ended
November 8, 2008 and the Interim Condensed Consolidated Statements of Cash Flows
for the 40 weeks ended November 8, 2008, and November 10, 2007, 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. 2007 Annual
Report on Form 10-K for its fiscal year ended February 2, 2008. 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 2007 financial statements to conform
with the current year presentation.
In
October 2008, the Financial Accounting Standards Board (“FASB”) issued FASB
Staff Position (“FSP”) No. FAS 157-3, “Determining the Fair Value of a Financial
Asset When the Market for That Asset is Not Active” (“FSP
157-3”). FSP 157-3 clarifies the application of Statement of
Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,”
(“SFAS No. 157”), which the Company adopted on February 3, 2008, related to
financial assets and financial liabilities, in an inactive market and
demonstrates how the fair value of a financial asset is determined when the
market for that financial asset is inactive. FSP 157-3 was effective
upon issuance, including prior periods for which financial statements had not
been issued. The adoption of FSP 157-3 did not have a material effect
on the Company’s results of operations or financial condition as it did not have
any financial assets in inactive markets as of November 8, 2008.
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities” (“SFAS No. 161”), an amendment to SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities,” (“SFAS No.
133”). The statement requires enhanced disclosures that expand the
disclosure requirements in SFAS No. 133 about an entity’s derivative instruments
and hedging activities. It will require more robust qualitative
disclosures and expanded quantitative disclosures. This statement
will be effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application
encouraged. It is expected that this statement will not have a
material effect on the Company’s financial statements.
In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations,” (“SFAS
No. 141R”). This statement requires the acquiring entity in a business
combination to recognize all (and only) the assets acquired and liabilities
assumed in the transaction, establishes the acquisition-date fair value as the
measurement objective for all assets acquired and liabilities assumed, and
requires additional disclosures by the acquirer. Under this
statement, all business combinations will be accounted for by applying the
acquisition method. SFAS No. 141R is effective for financial
statements issued for fiscal years beginning after December 15,
2008. The Company is currently evaluating the potential impact of
adoption of SFAS No. 141R on its consolidated financial statements.
However, the Company does not expect the adoption of SFAS No. 141R to have
a material effect on its consolidated financial statements.
7
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,”
(“SFAS No. 157”). This statement did not require any new fair value
measurements, but rather, it provided enhanced guidance to other pronouncements
that require or permit assets or liabilities to be measured at fair value. The
changes to current practice resulting from the application of this statement
related to the definition of fair value, the methods used to estimate fair
value, and the requirement for expanded disclosures about estimates of fair
value. This statement became effective for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The
effective date for this statement for all nonfinancial assets and nonfinancial
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis, has been delayed by one
year. The Company adopted the provisions of SFAS No. 157 related to
financial assets and financial liabilities on February 3,
2008. The partial adoption of this statement did not have a material
impact on the Company’s financial statements. It is expected that the remaining
provisions of this statement will not have a material effect on the Company’s
financial statements.
Fair
value is defined as the price at which an asset could be exchanged in a current
transaction between knowledgeable, willing parties or the amount that would be
paid to transfer a liability to a new obligor, not the amount that would be paid
to settle the liability with the creditor. Where available, fair value is based
on observable market prices or parameters or derived from such prices or
parameters. Where observable prices or inputs are not available, valuation
models are applied. These valuation techniques involve some level of management
estimation and judgment, the degree of which is dependent on the price
transparency for the instruments or market and the instruments’
complexity.
Assets
and liabilities recorded at fair value in the condensed consolidated balance
sheets are categorized based upon the level of judgment associated with the
inputs used to measure their fair value. Hierarchical levels, defined by SFAS
No. 157 and directly related to the amount of subjectivity associated with the
inputs to fair valuation of these assets and liabilities, are as
follows:
Determining
which hierarchical level an asset or liability falls within requires significant
judgment. The Company evaluates its hierarchy disclosures each
quarter. The following table summarizes the financial instruments
measured at fair value in the Condensed Consolidated Balance Sheet as of
November 8, 2008:
8
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
SFAS No.
157 requires separate disclosure of assets and liabilities measured at fair
value on a recurring basis, as documented above, from those measured at fair
value on a nonrecurring basis. As of November 8, 2008, no assets or
liabilities were measured at fair value on a nonrecurring basis.
On June
8, 2007, the Company completed its acquisition of substantially all of the
assets (the “Assets”) of Portrait Corporation of America (“PCA”) and certain of
its affiliates (collectively, the “Sellers”) and assumed certain liabilities of
PCA (the “PCA Acquisition”). The PCA Acquisition was made pursuant to the
Purchase and Sale Agreement (the “Purchase Agreement”) dated as of May 1, 2007
by and among the Sellers and the Company, as thereafter amended. The
Company paid $82.5 million in cash, assumed certain liabilities and replaced
certain letters of credit outstanding under PCA’s credit facilities maintained
in bankruptcy. Additionally, fees related to the transaction totaled
$1.5 million. The Company financed the PCA Acquisition with bank
borrowings and amended its existing credit facility in connection with the
closing of the Transaction.
The
operations acquired in the PCA Acquisition are operating within CPI Corp. as the
PictureMe Portrait Studio brand (“PMPS brand”). For purposes of this
report, the PMPS brand includes all studios operating under Wal-Mart agreements;
those in the U.S. are operating as PictureMe Portrait Studios™ and the remainder
as Wal-Mart Portrait Studios. PictureMe Portrait Studio is the sole
operator of portrait studios in Wal-Mart stores and supercenters in the U.S.,
Canada and Mexico. As of November 8, 2008, PictureMe Portrait Studios
operated 2,028 studios worldwide, including 1,656 in the U.S. and Puerto Rico,
254 in Canada and 118 in Mexico.
The PCA
Acquisition was accounted for using the purchase method of accounting in
accordance with SFAS No. 141, “Business Combinations,” (“SFAS No. 141”) and,
accordingly, the results have been included in the Company’s results of
operations from the date of acquisition. The purchase price was
allocated based on fair value of the specific tangible and intangible assets and
liabilities at the time of the acquisition. The excess of the
purchase price over the fair value of assets acquired and liabilities assumed
was recorded as goodwill. The following unaudited pro forma summary
presents the Company’s revenue, net income, basic earnings per share and diluted
earnings per share as if the PCA Acquisition had occurred on the first day of
the period presented (in thousands, except per share
data):
Pro forma adjustments have been made to reflect depreciation and amortization using asset values recognized after applying purchase accounting adjustments. Pro forma results include non-recurring charges from pre-acquisition PCA of $2.8 million for the first three quarters 2007, net of tax. Such charges related to restructuring charges that were incurred by PCA prior to acquisition. This pro
forma information is presented for informational purposes only and is not
necessarily indicative of actual results had the acquisition been effected at
the beginning of the respective periods presented, and is not necessarily
indicative of future results.
9
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
During
the third quarter of 2007, the Company exited its United Kingdom five-studio
operation (the “UK operations”), which was acquired in conjunction with the PCA
Acquisition, and classified the respective sales and operating results as
discontinued. Sales and operating results for the former UK
operations included in discontinued operations are presented in the following
table:
The net loss consists of costs to operate the business until its sale in October 2007 and related asset write-offs since the proceeds from the sale were nominal.
Inventories
consist of:
These balances are net of obsolescence reserves totaling $364,000 and $277,000 at November 8, 2008, and February 2, 2008, respectively.
In
connection with the PCA Acquisition, the Company acquired a warehouse and excess
parcels of land located in Charlotte, North Carolina. In the third
quarter of 2008, the Company decided to list these properties for sale, as they
were no longer required by the business. The Company determined these
properties meet the criteria for “held for sale accounting” under SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets,” and have
presented the respective group of assets separately on the face of the Interim
Condensed Consolidated Balance Sheet as of November 8, 2008.
At the
time an asset qualifies for held for sale accounting, the asset is evaluated to
determine whether or not the carrying value exceeds its fair value less cost to
sell. Any loss as a result of carrying value in excess of fair value
less cost to sell is recorded in the period the asset meets held for sale
accounting. Management judgment is required to assess the criteria
required to meet held for sale accounting, and estimate fair
value. As of November 8, 2008, the carrying values of the respective
assets held for sale did not exceed their fair values less costs to
sell. 10
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
The major
classes of assets included in assets held for sale in the Interim Condensed
Consolidated Balance Sheet as of November 8, 2008, are as follows:
The Company expects the sales of these assets will be completed within a one year time period.
In
connection with the PCA Acquisition, the Company recorded goodwill in the excess
of the purchase price over the fair value of assets acquired and liabilities
assumed in accordance with SFAS No. 141. Under SFAS No. 141,
goodwill is not amortized and instead is periodically evaluated for
impairment. The goodwill is expected to be fully deductible for tax
purposes over 15 years. The following table summarizes the Company’s
goodwill:
The increase in goodwill from February 2, 2008, to November 8, 2008, in relation to the PCA Acquisition, is primarily due to the finalization of the valuation of certain fixed assets acquired and deferred tax assets recorded in conjunction with the PCA Acquisition. The
Company accounts for goodwill under SFAS No. 142, "Goodwill and Other Intangible
Assets," (“SFAS No. 142”) which requires the Company to review goodwill for
impairment on an annual basis, and between annual tests whenever events or
changes in circumstances indicate the carrying amount may not be recoverable.
SFAS No. 142 prescribes a two-phase process for impairment testing of goodwill.
The first phase is a screen for impairment, which compares the Company’s
estimated fair value (market capitalization) to its carrying value (consolidated
net assets). If the carrying value exceeds the estimated fair value
in the first phase, the second phase is performed in which the Company’s
goodwill is written down to its implied fair value, which the Company would
determine based upon a number of factors, including operating results, business
plans and anticipated future cash flows.
The
Company performs its annual impairment test at the end of its second quarter, or
more frequently if circumstances indicate the potential for
impairment. The Company completed its annual impairment test of
goodwill during the second quarter of 2008 and concluded at that time, based
upon a market capitalization significantly in excess of the carrying value of
the Company’s net assets, that no write-downs or impairment charges were
required at that time.
As of
November 8, 2008, the end of the Company’s third quarter, the Company’s market
capitalization continued to significantly exceed the carrying value of the
Company’s net assets. Accordingly, no goodwill impairment was deemed
to be indicated at that date, and no impairment analysis was necessary in the
third quarter. The Company will reassess the carrying value of
goodwill at the end of its fourth fiscal quarter, which ends February 7,
2009. If there are indications at that date that goodwill is
impaired, the Company will perform a fair value analysis of its goodwill in
accordance with its policy. If the Company were required to
write-down its goodwill, the resulting non-cash impairment charge could be
significant, which would adversely affect the Company’s financial position and
results of operations.
11
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
Also, in
connection with the PCA Acquisition, the Company acquired intangible assets
related to the host agreement with Wal-Mart and the customer list. These assets
were recorded in accordance with SFAS No. 142, “Goodwill and Other
Intangible Assets” (“SFAS No. 142”). The host agreement with Wal-Mart
and the customer list are being amortized over their useful lives of 21.5 years
and six years, respectively. The following table summarizes the
Company’s amortized intangible assets as of November 8,
2008:
The
Company reviews its intangible assets with definite useful lives under SFAS No.
144, which requires the Company to review for impairment whenever events or
changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. Recoverability of intangible assets with definite useful
lives is measured by a comparison of the carrying amount of the asset to the
estimated future undiscounted cash flows expected to be generated by such
assets. If such assets are considered to be impaired, the impairment
is measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets, which is determined on the basis of discounted cash
flows.
As a
result of the continuing challenging economic and consumer retail environment,
the Company’s management, in connection with the preparation of its 2008 third
quarter financial statements, conducted a sensitivity analysis relating to the
fair value of the Company’s intangible assets with definite useful lives and
concluded no impairment was indicated. This sensitivity analysis will
be reperformed in the fourth fiscal quarter ended February 7,
2009. It is possible that changes in circumstances, existing at that
time or at other times in the future, or in the assumptions and estimates,
including historical and projected cash flow data, utilized by the Company in
its evaluation of the recoverability of its intangible assets with definite
useful lives, could require the Company to write-down its intangible assets and
record a non-cash impairment charge, which could be significant, and would
adversely affect the Company’s financial position and results of
operations.
Included
in both other assets and other liabilities is $6.9 million and $6.3 million as
of November 8, 2008, and February 2, 2008, respectively, related to worker’s
compensation insurance claims that exceed the deductible of the Company and that
will be paid by the insurance carrier. Since the Company is not
released as primary obligor of the liability, it is included in both other
assets as a receivable from the insurance company and in other liabilities as an
insurance liability.
At
November 8, 2008, the Company had outstanding awards under various stock-based
employee compensation plans, which are described more fully in Note 12 of the
Notes to the Consolidated Financial Statements in the Company’s 2007 Annual
Report on Form 10-K. 12
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
Effective
May 29, 2008, the Board of Directors adopted the CPI Corp. Omnibus Incentive
Plan (the "Plan") which was approved by the stockholders at the 2008 Annual
Meeting of Stockholders held on July 17, 2008. The Plan replaced the CPI
Corp. Stock Option Plan, as amended and restated on December 16, 1997, and the
CPI Corp. Restricted Stock Plan, as amended and restated on April 14, 2005
(collectively the "Predecessor Plans") that were previously approved by the
Board of Directors, and no further shares will be issued under the Predecessor
Plans. The Plan will provide the Company with flexibility to award
employees, directors and consultants of the Company (the "Service Providers")
both short- and long-term equity-based and cash incentives. The purposes
of the Plan are (i) to attract and retain highly competent persons; (ii) to
provide incentives to Service Providers that align their interests with those of
the Company's stockholders; and (iii) to promote the success of the business of
the Company. Awards under the Plan are granted by the Compensation
Committee of the Board (the "Committee"), provided that the Board shall be
responsible for administering this Plan with respect to awards to non-employee
directors. The Committee has the authority, among other things, to (i)
select the Service Providers to whom awards may be granted and the types of
awards to be granted to each; (ii) to determine the number of shares to be
covered by each award; (iii) to determine whether, to what extent, and
under what circumstances an award may be settled in cash, common stock, other
securities, or other awards; (iv) to prescribe, amend, and rescind rules and
regulations relating to the Plan; and (v) to make all other determinations and
take all other action described in the Plan or as the Committee otherwise deems
necessary or advisable. Total shares of common stock available for
delivery pursuant to awards under the Plan are 800,000 shares. At
November 8, 2008, 568,879 of these shares were available for future
grants.
Types of
awards authorized under the Plan include (i) stock options to purchase shares of
common stock, including ISO's and nonstatutory stock options, which will be
granted with an exercise price not less than 100% of the fair market value of
the common stock on the date of grant; (ii) stock appreciation rights (“SAR's”),
which confer the right to receive an amount, settled in cash, common stock or
other awards, equal to the excess of the fair market value of a share of common
stock on the date of exercise over the exercise price of the SAR; (iii)
restricted stock, which is common stock subject to restrictions on
transferability and other restrictions, with respect to which a participant has
the voting rights of a stockholder during the period of restriction; (iv)
restricted stock units, which are awards of a right to receive shares of the
Company’s common stock and are subject to restrictions on transferability and
other restrictions; (v) performance awards, including performance shares or
performance units, which are settled after an applicable performance period has
ended to the extent to which corresponding performance goals have been achieved
and (vi) other awards, including awards that are payable in shares of common
stock or the value of which is based on the value of shares of common stock, and
awards to be settled in cash or other property other than common
stock.
A copy of
the Plan is included in Annex A within the Company’s 2008 Proxy filed with the
U.S. Securities and Exchange Commission on June 23, 2008.
The
Company accounts for stock-based compensation plans in accordance with SFAS No.
123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which requires
companies to recognize the cost of awards of equity instruments, such as stock
options and restricted stock, based on the fair value of those awards at the
date of grant.
As of
November 8, 2008, 217,500 stock options have been granted under the
Plan. Of these total stock options, 157,500 vest in three increments
on their anniversary dates. The first increment vests on the first
anniversary date and is exercisable when the common stock trades in excess of
$25.00 for a minimum of 20 consecutive trading days, the second increment vests
on the second anniversary date and is exercisable when the common stock trades
in excess of $45.00 for a minimum of 20 consecutive trading days and the third
increment vests on the third anniversary and is exercisable when the common
stock trades in excess of $65.00 for a minimum of 20 consecutive trading
days. An additional 30,000 of these share options vest on February 7,
2009, and are exercisable with respect to 10,000 shares when each of the three
market conditions noted above are met. The remaining 30,000 shares
vest on February 6, 2010, and are exercisable with respect to 15,000 shares when
the $45.00 and $65.00 market conditions noted above are met. For all
share options, if the target common stock price is met for a minimum of 20
consecutive trading days prior to the vesting schedules noted above, the
exercise dates would be the vesting schedule dates. These stock
options were granted during the third quarter of fiscal year 2008 and expire on
various dates through 2018. 13
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
The
following table summarizes information about stock options outstanding under the
Plan at November 8, 2008:
The Company estimates the fair value of its stock options under the Plan using Monte Carlo simulations. The Company has determined that its historical stock price volatility is an appropriate indicator of expected volatility. In the absence of a reasonable historical pattern of stock option exercises in relation to these types of stock options, the Company has determined a 50% post-vest exercise rate is appropriate. This assumes that exercise will occur at the mid-point of vesting and expiration of the stock options. The volatility and interest rate presented in the table below reflect the expected term assuming a 50% post-vest exercise rate. The expected dividend yield is estimated using the last dividend distribution prior to the grant date and the stock value on the grant date. The interest rate is determined based on the implied yield available on U.S. Treasury zero-coupon issues in effect at the time of grant with a remaining term equal to the expected term of the award. The Company’s weighted-average assumptions are presented as follows:
The weighted-average grant-date fair value per share of stock options granted was $3.09 for the 40 weeks ended November 8, 2008. The Company recognized stock-based compensation expense of $44,000 for the 40 weeks ended November 8, 2008, based on the grant-date fair values of stock options granted and the derived service periods. As of November 8, 2008, total unrecognized compensation cost related to non-vested stock options granted under the Plan was $629,000. This unrecognized compensation cost will be recognized over a weighted-average period of 4 years. The
Company also has stock options issued and outstanding related to its previous
incentive plan. The following table summarizes the status of the
Company’s stock options under the previous plan as of November 8, 2008, and
changes during the 40-week period then ended:
14
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
The
following table summarizes information about stock options outstanding under the
Company’s previous plan at November 8, 2008:
On March 5, 2008, the Board of Directors approved a grant of 18,015 shares of restricted stock to certain employees in conjunction with the payment of 2007 performance awards. On March 5, 2008, and September 15, 2008, the Board of Directors approved grants of 10,294 and 1,336 shares, respectively, of restricted stock to its members of the Board of Directors in lieu of 2008 board retainer fees and certain committee chair fees they receive as directors of the Company. On May 29, 2008, the Board of Directors approved a grant of 14,706 shares of restricted stock to its Chairman of the Board as additional compensation for services rendered in 2007. Shares issued under these four grants will vest on February 7, 2009. Additionally, on September 22, 2008, the Board of Directors approved a grant of 4,095 shares of restricted stock to its Chairman of the Board as part of the Chairman’s Agreement. Shares issued under this grant vested on November 8, 2008. Changes
in restricted stock are as follows:
As of November 8, 2008, total unrecognized compensation cost related to non-vested restricted stock was $273,000. This unrecognized compensation cost will be recognized over a weighted-average period of 3 months. On
September 22, 2008, the Compensation Committee of the Board of Directors
approved a grant of 8,190 shares of common stock to its Chairman of the Board as
part of the Chairman’s Agreement. Compensation expense recognized in
relation to this grant totaled $100,000. 15
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
The
Company maintains a qualified, noncontributory pension plan that covers all
full-time United States employees meeting certain age and service
requirements. The plan provides pension benefits based on an
employee’s length of service and the average compensation earned from the later
of the hire date or January 1, 1998, to the retirement date. On
February 3, 2004, the Company amended its pension plan to implement a freeze of
future benefit accruals under the plan, except for those employees with ten
years of service and who had attained age 50 at April 1, 2004, who were
grandfathered and whose benefits continued to accrue. The Company’s
funding policy is to contribute annually at least the minimum amount required by
government funding standards, but not more than is tax
deductible. Plan assets consist primarily of cash equivalents, fixed
income securities, domestic and international equity securities and exchange
traded index funds.
The
Company also maintains a noncontributory defined benefit plan providing
supplemental retirement benefits for certain current and former
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 table sets forth the components of net periodic benefit cost for the
defined benefit plans:
The Company contributed $2.7 million to its pension plan in the first three quarters of 2008 and estimates it will contribute a further $465,000 for fiscal year 2008. Future contributions to the pension plan will be dependent upon legislation, future changes in discount rates and the earnings performance of plan assets. Due to adverse conditions in the equity markets, the Company’s pension plan is likely to experience negative returns for fiscal year 2008. This may result in increased required contributions to the plan by the Company in fiscal year 2009. 16
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
The
Company adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109,
“Accounting for Income Taxes” (“SFAS No. 109”)” (“FIN 48”) on February 4,
2007. As a result of the implementation of FIN 48, there was no
impact on the financial statements of the Company. The following
information required by FIN 48 is provided:
Standby
Letters of Credit
As of
November 8, 2008, the Company had outstanding standby letters of credit in the
principal amount of $20.6 million primarily used in conjunction with the
Company’s self-insurance programs.
Legal
Proceedings
The
Company and two of its subsidiaries are defendants in a lawsuit entitled Shannon Paige, et al. v.
Consumer Programs, Inc., filed March 8, 2007, in the Superior Court of
the State of California for the County of Los Angeles, Case No.
BC367546. The case was subsequently removed to the United States
District Court for the Central District of California, Case No. CV 07-2498-FMC
(RCx). The Plaintiff alleges that the Company failed to pay him and
other hourly associates for “off the clock” work and that the Company failed to
provide meal and rest breaks as required by law. The Plaintiff is
seeking damages and injunctive relief for himself and others similarly
situated. On October 6, 2008, the Court denied the Plaintiffs’ motion
for class certification but allowed Plaintiffs to attempt to certify a smaller
class. Plaintiffs filed a motion seeking certification of a smaller
class on November 14, 2008. The Company filed its opposition on
December 8, 2008. A hearing on the Plaintiffs’ new motion is
scheduled for January 12, 2009. The Company believes the claim is
without merit and continues its vigorous defense on behalf of itself and its
subsidiaries against these claims, however, an adverse ruling in this case could
require the Company to pay damages, penalties, interest and fines.
The
Company is a defendant in a lawsuit entitled Picture Me Press LLC v. Portrait Corporation
of America, et al., Case No. 5:08cv32,
which was filed in the United States District Court for the Northern District of
Ohio on January 4, 2008. The suit alleges that the Company’s
operation of PictureMe! Portrait Studios infringes on Plaintiff’s trademark for
its picture books and seeks damages and injunctive relief. The case
is in the discovery stages and the Plaintiff has yet to quantify its claim for
damages. The Company believes the case is without merit and will
vigorously defend itself. However, intellectual property litigation
such as this case is expensive and time consuming, and if the claim were to result
in an unfavorable outcome, it could result in significant monetary
liability or prevent the Company from operating portions of its business under
current trademarks used by the Company. In addition, an adverse
resolution of this claim could require the Company to obtain licenses to use
intellectual property rights belonging to third parties, which may be expensive
to procure, or possibly to cease using those rights altogether. Any
of these results could have a material
adverse effect on the Company’s business, financial position and results of
operations. The Company has denied the claim alleged by the
Plaintiff and filed counterclaims against the Plaintiff. The Company
cannot, however, give assurances that the outcome of this case will not have a
material adverse effect on its business or financial condition.
The
Company is also a defendant in other routine litigation, but does not believe
these lawsuits, individually or in combination with the cases described above,
will have a material adverse effect on its financial condition. The Company
cannot, however, give assurances that these legal proceedings will not have a
material adverse effect on its business or financial condition. 17
CPI
CORP.
Notes
to Interim Condensed Consolidated Financial Statements
(Unaudited)
Sears
Agreement
The
Company is currently in the final year of a 10-year contract with Sears that
governs the operations of its U.S. Sears Portrait Studios. The
Company and Sears are currently in discussions regarding a new, multi-year
agreement.
Contingent
Commission Payments
The
Company, upon certain conditions, is required to provide Sears with certain
commission adjustments (the “Contingent Payments”) through 2008, the remaining
term of the current U.S. 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 levels specified in the
agreement. If both of the above mentioned conditions occur, the Contingent
Payments are determined by a formula included in 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. As a
result of the addition of the PictureMe Portrait Studios in 2007, this provision
applies and a pro rata portion of the related commission adjustments has been
accrued in the third quarter 2008 consolidated financial
statements.
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 8, 2008, the maximum future
obligation to the Company under its guarantee of remaining leases is
approximately $1.0 million. To recognize the risk associated with
these leases based upon the Company’s past experience with renegotiating lease
obligations and the management’s evaluation of remaining lease liabilities, the
Company has recorded lease obligation reserves totaling approximately $740,000
at November 8, 2008. Based on the status of remaining leases, the
Company believes that the $740,000 reserve is adequate to cover the potential
losses to be realized under the Company’s remaining operating lease
guarantees.
18
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, individuals and
families. From a single studio opened by our predecessor company in
1942, we have grown to 3,062 studios throughout the U.S., Canada, Puerto Rico
and Mexico, principally under license agreements with Sears and lease agreements
with Wal-Mart. The Company has provided professional portrait
photography for Sears’ customers since 1959 and has been the only Sears portrait
studio operator since 1986.
On June
8, 2007, the Company completed the PCA Acquisition. The results of the acquired
operations have been included in the consolidated financial statements since
that date. As a result of the PCA Acquisition, CPI is the sole
operator of portrait studios in Wal-Mart stores and supercenters in the U.S.,
Canada, Puerto Rico and Mexico. Management has determined that
the Company operates in one segment offering similar products and services in
all locations.
As of the
end of the third quarter in fiscal 2008 and 2007, the Company’s studio counts
were:
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