|UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
FORM 10-K
xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THEFISCAL YEAR ENDED FEBRUARY 5, 2005
OR
oTRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934Commission file number 1-10204
CPI Corp.(Exact name of registrant as specified in its charter)
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|Delaware(State of Incorporation)                                                                                                | 43-1256674
(I.R.S. Employer Identification No.)
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|1706 Washington Ave., St. Louis, Missouri(Address of principal executive offices)                                               | 63103(Zip Code)                                
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|314/231-1575
(Registrants telephone number, including area code: )
Securities registered pursuant to Section 12(b) of the Act:
|                                                                                                                                |                                                
|Title of each class                                                                                                             | Name of each exchange
on which Registered      
|Common Stock $.40 Par Value                                                                                                     | New York Stock Exchange                        
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|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.
xYes    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.
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|TABLE
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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:
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|                                                                                                                           

|                    | APPROXIMATE
AREA IN |         |  | OWNERSHIP                           | 
|------------------- | ------------------- | ------- |  | ----------------------------------- | 
|
|                    |                     |         |  |                                     | 
|St. Louis, Missouri |                     | 270,000 |  | Administration and Photo processing | 
|St. Louis, Missouri |                     | 155,000 |  | Parking Lots                        | 
|St. Louis, Missouri |                     | 57,574  |  | Warehousing                         | 
|St. Louis, Missouri |                     | 16,000  |  | Warehousing                         | 
|Brampton, Ontario   |                     | 40,000  |  | Administration, Warehousing and     | 
|                    |                     |         |  | Photo processing                    | 
|Las Vegas, Nevada   |                     | 21,922  |  | Former Photo processing             | 
|Thomaston,          |                    
|Connecticut         |                     | 25,000  |  | Administration and Photo processing | 

| |     |                                                                  
| | --- | -----------------------------------------------------------------
| | (1) | Lease term expires on June 30, 2008                              
| |     |                                                                  
| | (2) | Lease term expires on October 31, 2005                           
| |     |                                                                  
| | (3) | Lease term expires on May 31, 2005 - closed facility January 2003
| |     |                                                                  

|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
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|Item 5. | Market for Registrants Common Stock, Related Stockholder Matters and Issuer Purchases of Common
Stock
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|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.

|FISCAL YEAR 2004 |   |       | 
|---------------- | - | ----- | 
|
|                 |   |       | 
|First Quarter    | $ | 22.25 | 
|Second Quarter   |   | 16.15 | 
|Third Quarter    |   | 13.42 | 
|Fourth Quarter   |   | 15.61 | 

|FISCAL YEAR 2003 |   |       | 
|---------------- | - | ----- | 
|
|                 |   |       | 
|First Quarter    | $ | 13.65 | 
|Second Quarter   |   | 18.70 | 
|Third Quarter    |   | 22.95 | 
|Fourth Quarter   |   | 23.29 | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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.

|12
|--



|Item 6.      Selected Consolidated Financial Data
|-------------------------------------------------
|                                                 

|thousands except per share data                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|The summary historical consolidated financial data as of and for each of the fiscal years in the five-year period endedFebruary 5, 2005 set forth below have been derived from the Companys audited consolidated financial statements.The information presented below should be read in conjunction with Managements Discussion and Analysis of FinancialCondition and Results of Operations; and the consolidated financial statements and related notes included herein.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

|                                                                   | 2004 |         | 2003 |   | 2002    |   | 2001 |         | 2000 |  
|------------------------------------------------------------------ | ---- | ------- | ---- | - | ------- | - | ---- | ------- | ---- | -
|                                                                   |      |         |      |   |         |   |      |         |      |  
|STATEMENT
      OF OPERATIONS (2) (3) (4)                          |      |         |      |   |         |   |      |         |      |  
|Net
      sales                                                    | $    | 281,865 |      | $ | 299,044 |   | $    | 308,625 |      | $
|Cost
      of sales                                                |      | 36,899  |      |   | 40,070  |   |      | 40,618  |      |  
|Selling,
      general and administrative expenses                 |      | 219,367 |      |   | 227,238 |   |      | 228,456 |      |  
|Depreciation
      and amortization                                |      | 16,391  |      |   | 16,806  |   |      | 20,056  |      |  
|Other
      charges and impairments (1)                            |      | 15,679  |      |   | 5,515   |   |      | 6,042   |      |  
|                                                                   |      |         |      |   |         |   |      |         |      |  
|(Loss)
      income from operations                                |      | (6,471  | )    |   | 9,415   |   |      | 13,453  |      |  
|Interest
      expense, net                                        |      | 954     |      |   | 1,240   |   |      | 1,569   |      |  
|Impairment
      and related obligations of preferred              |      |         |      |   |         |   |      |         |      |  
|security
      interest (1)                                        |      | 9,789   |      |   |        |   |      |        |      |  
|Other
      income, net (5)                                        |      | 263     |      |   | 850     |   |      | 111     |      |  
|Income
      taxes (benefit) expense                               |      | (2,189  | )    |   | 3,183   |   |      | 4,212   |      |  
|                                                                   |      |         |      |   |         |   |      |         |      |  
|(Loss)
      income from continuing operations before              |      |         |      |   |         |   |      |         |      |  
|cumulative
      effect of change in accounting principle          |      | (14,762 | )    |   | 5,842   |   |      | 7,783   |      |  
|Cumulative
      effect of change in accounting principle          |      |        |      |   |        |   |      |        |      |  
|Net
      loss from discontinued operations (2) (3) (4)            |      | (3,746  | )    |   | (4,624  | ) |      | (1,243  | )    |  
|                                                                   |      |         |      |   |         |   |      |         |      |  
|Net
      (loss) earnings                                          | $    | (18,508 | )    | $ | 1,218   |   | $    | 6,540   |      | $
|                                                                   |      |         |      |   |         |   |      |         |      |  
|SHARE AND
      PER SHARE DATA (2) (3) (4)                         |      |         |      |   |         |   |      |         |      |  
|Net
      (loss) earnings from continuing operations - diluted (7) | $    | ((1.87  | )    | $ | 0.72    |   | $    | 0.96    |      | $
|Net
      (loss) earnings from continuing operations - basic (7)   |      | (1.87   | )    |   | 0.72    |   |      | 0.97    |      |  
|Net
      (loss) earnings - diluted                                |      | (2.35   | )    |   | 0.15    |   |      | 0.80    |      |  
|Net
      (loss) earnings - basic                                  |      | (2.35   | )    |   | 0.15    |   |      | 0.81    |      |  
|                                                                   |      |         |      |   |         |   |      |         |      |  
|Dividends                                                          | $    | 0.64    |      | $ | 0.60    |   | $    | 0.56    |      | $
|Average
      shares outstanding - diluted                         |      | 7,888   |      |   | 8,148   |   |      | 8,086   |      |  
|Average
      shares outstanding - basic                           |      | 7,888   |      |   | 8,082   |   |      | 8,040   |      |  
|CASH FLOW
      DATA                                               |      |         |      |   |         |   |      |         |      |  
|Net
      cash provided by operating activities                    |      |         |      |   |         |   |      |         |      |  
|(continuing
      operations only)                                 | $    | 16,408  |      | $ | 32,118  |   | $    | 29,386  |      | $
|Net
      cash used in investing activities                        | $    | (6,626  | )    | $ | (18,199 | ) | $    | (6,244  | )    | $
|Net
      cash used in financing activities (7)                    | $    | (24,758 | )    | $ | (13,929 | ) | $    | (10,644 | )    | $
|                                                                   |      |         |      |   |         |   |      |         |      |  
|Capital
      expenditures (10)                                    | $    | 15,401  |      | $ | 22,764  |   | $    | 8,991   |      | $

|13
|--



|Item 6.      Selected Consolidated Financial Data (continued)thousands
|----------------------------------------------------------------------
|                                                                      

|                                           | 2004 |   | 2003    |  | 2002 |         | 2001 |   | 2000    | 
|------------------------------------------ | ---- | - | ------- |  | ---- | ------- | ---- | - | ------- | 
|                                           |      |   |         |  |      |         |      |   |         | 
|BALANCE SHEET (2) (3) (4)                  |      |   |         |  |      |         |      |   |         | 
|Cash and cash equivalents                  |      | $ | 33,883  |  | $    | 51,011  |      | $ | 57,922  | 
|Current assets                             |      |   | 73,949  |  |      | 93,215  |      |   | 96,522  | 
|Net fixed assets                           |      |   | 41,658  |  |      | 52,735  |      |   | 47,502  | 
|Net assets of discontinued operations      |      |   |        |  |      |        |      |   |        | 
|Assets of business transferred under       |     
|contractual arrangements (8)               |      |   |        |  |      | 8,975   |      |   | 10,041  | 
|Assets of supplemental retirement plan (9) |      |   | 6,141   |  |      | 11,491  |      |   | 13,761  | 
|Other assets                               |      |   | 13,352  |  |      | 2,052   |      |   | 11,464  | 
|Total assets                               |      |   | 135,100 |  |      | 168,468 |      |   | 179,290 | 
|Current liabilities                        |      |   | 71,761  |  |      | 68,799  |      |   | 66,490  | 
|Other liabilities                          |      |   | 23,403  |  |      | 22,254  |      |   | 24,501  | 
|Long-term debt, less current maturities    |      |   | 17,050  |  |      | 25,589  |      |   | 34,116  | 
|Stockholders equity (7)                   |      | $ | 22,886  |  | $    | 51,826  |      | $ | 54,183  | 

|14
|--



|Item 6.      Selected Consolidated Financial Data (continued)thousands
|----------------------------------------------------------------------
|                                                                      

|(1)
      Other charges and impairments:                                                    | 2004 |   | 2003   |  | 2002 |       | 2001 |   | 2000  | 
|------------------------------------------------------------------------------------------- | ---- | - | ------ |  | ---- | ----- | ---- | - | ----- | 
|                                                                                            |      |   |        |  |      |       |      |   |       | 
|Recorded
      as a component of income (loss) from operations:                             |      |   |        |  |      |       |      |   |       | 
|Accruals
      related to accelerated vesting of                                            |      | $ | 3,656  |  | $    |      |      | $ |      | 
|supplemental
      retirement plan benefits                                                 |     
|and
      guaranteed bonuses for 2004 (a)                                                   |     
|Impairment
      charges (b)                                                                |      |   | 6,516  |  |      |      |      |   | 4,171 | 
|Reserves
      for severance and related costs (c )                                         |      |   | 3,430  |  |      | 1,346 |      |   | 889   | 
|Pension
      plan curtailment (d)                                                          |      |   |       |  |      | 2,385 |      |   |      | 
|Consent
      solicitation costs (e)                                                        |      |   | 816    |  |      | 1,663 |      |   |      | 
|Production
      facility closure (f)                                                       |      |   |       |  |      | 121   |      |   | 982   | 
|Contract
      terminations and settlements (g)                                             |      |   | 1,261  |  |      |      |      |   |      | 
|                                                                                            |      |   |        |  |      |       |      |   |       | 
|                                                                                            |      |   | 15,679 |  |      | 5,515 |      |   | 6,042 | 
|Recorded
      as a component of other expense following income                             |     
|(loss)
      from operations:                                                               |     
|Impairment
      and related obligations of preferred security
                interest (h) |      |   | 9,789  |  |      |      |      |   |      | 
|                                                                                            |      |   |        |  |      |       |      |   |       | 
|Total other
      charges and impairments                                                   |      | $ | 25,468 |  | $    | 5,515 |      | $ | 6,042 | 
|                                                                                            |      |   |        |  |      |       |      |   |       | 

| |     |                                                                                                                                                                                                                                                
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (a) | Consists of costs related to accelerated vesting of executive benefits and bonuses.                                                                                                                                                            
| |     |                                                                                                                                                                                                                                                
| | (b) | Consists of write-offs and write-downs of certain previously capitalized technology costs.                                                                                                                                                     
| |     |                                                                                                                                                                                                                                                
| | (c) | Consists of principally of expenses and related costs for employee severance and retirement.                                                                                                                                                   
| |     |                                                                                                                                                                                                                                                
| | (d) | Consists of the charge related to the freeze of future benefit accruals under the pension plan.                                                                                                                                                
| |     |                                                                                                                                                                                                                                                
| | (e) | Consists of professional fees relative to the proxy consent solicitation.                                                                                                                                                                      
| |     |                                                                                                                                                                                                                                                
| | (f) | Consists of expenses related to employee severance and retirement, asset abandonment write-offs and a remaining lease obligation accrual.                                                                                                      
| |     |                                                                                                                                                                                                                                                
| | (g) | Consists of expenses related to non-refundable loan commitment fees as well as charges related to early contract terminations and settlements with certain of the Companys vendors and consultants.                                           
| |     |                                                                                                                                                                                                                                                
| | (h) | In 2004, the Company recorded a $7.7 million valuation reserve against the carrying value of its preferred security interest and accrued lease liability obligations relating to its lease guarantees on certain of Prints Plus retail stores.

|    |                                                                                                                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | In 2004, the Company classified its mobile photography operations and the Mexican Portrait Studio business as discontinued operations and reclassified the prior years consolidated financial statements to reflect this change.                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                        
|(3) | In 2002, the Company classified its former Technology Development segment as a discontinued operation and reclassified the prior years consolidated financial statements to reflect this change.                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                        
|(4) | In 1999, the Company classified the Wall Decor segment as a discontinued operation and reclassified the prior years consolidated financial statements to reflect this change.                                                                                                                                                                         
|    |                                                                                                                                                                                                                                                                                                                                                        
|(5) | In 2001and 2000, the Company, recognized $218,000 in income and $145,000 in expenses, respectively, in other income (expense), net related to the termination of a merger agreement.                                                                                                                                                                   
|    |                                                                                                                                                                                                                                                                                                                                                        
|(6) | In 2003, the Company recognized $503,000 in other income related to a liquidating distribution of the Companys membership interest in General American Life Insurance Co. (GA) when GAs stock was sold to MetLife and $118,000 in other income related to death benefits received from a company owned life insurance policy on a former executive.

|15
|--



|Item 6.      Selected Consolidated Financial Data (continued)
|-------------------------------------------------------------
|                                                             

|(7)  | The Company recorded the repurchase of 406,780 shares of common stock for $6.0 million in 2004, 54,200 shares of common stock for $935,000 in 2003, and 1,211,124 shares of common stock for $28.3 million in 2000.                                                                                                                                                                                                                                                                                                                                   
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(8)  | Assets of business transferred under contractual arrangements resulted from the sale of the discontinued Wall Décor operation. As a result of the deteriorating financial performance of Prints Plus and its subsequent bankruptcy declaration, certain assets related to the Companys preferred security interest in Prints Plus totaling $7.5 million were written off during the Companys third quarter and the Companys revolving line of credit to Prints Plus was repaid  in full and then terminated in the Companys fourth fiscal quarter.
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(9)  | Represents a benefit trust established in 2000 to fund supplemental retirement benefits for certain current and former executives.                                                                                                                                                                                                                                                                                                                                                                                                                    
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(10) | 2003 includes $7.3 million representing an accrued commitment for computer equipment and peripherals that were purchased in the fourth quarter of 2003 and paid for in 2004.                                                                                                                                                                                                                                                                                                                                                                          

|16
|--



|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:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

|                                  | 2004 |  | 2003  |  | 2002 |      
|--------------------------------- | ---- |  | ----- |  | ---- | -----
|                                  |      |  |       |  |      |      
|United States and Puerto Rico:    |      |  |       |  |      |      
|Within full-line Sears stores     |      |  | 864   |  |      | 854  
|Locations not within Sears stores |      |  | 40    |  |      | 48   
|Canada                            |      |  | 117   |  |      | 119  
|                                  |      |  |       |  |      |      
|Total                             |      |  | 1,021 |  |      | 1,021
|                                  |      |  |       |  |      |      

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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.

|17
|--



|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:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

| |  | Exited the Mexican and mobile photography businesses that were draining scarce managerial and financial
resources from the core Sears Portrait Studio business.                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                   
| |  | Terminated a major internal software development project intended to be the foundation for the Companys
ultimate transition to a digital format and instead pursued outsourcing options with third-party
vendors.
| |   |                                                                                                                                                                                                                   
| |  | Upgraded computer hardware in all U.S. studios, improving the performance of legacy DOS-based systems
while preparing the way for a transition to digital.                                                        
| |   |                                                                                                                                                                                                                   
| |  | Restored coverage, training and retention hours in the studios that had been reduced in 2003 in response
to declining sales.                                                                                      
| |   |                                                                                                                                                                                                                   
| |  | Raised prices and tapped more efficient advertising vehicles.                                                                                                                                                     
| |   |                                                                                                                                                                                                                   
| |  | Introduced several new products that contributed approximately $1 million in busy season sales.                                                                                                                   
| |   |                                                                                                                                                                                                                   
| |  | Converted 128 of our U.S. studios to full digital format prior to the 2004 busy season.                                                                                                                           

|                                                                                                                                                                                                                                                                                                                                                                                                                            
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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:
|                                                                                                                                                                                                                                                                                                                                                                                                                            

| |  | Convert most of our portrait studios to a full digital format.                                                                                                                                                                       
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                      
| |  | Leverage digital technology to provide customers greater variety in posing and effects, speedier (including
same-day) fulfillment of portrait orders, a range of new product and service options, and an improved
overall experience.
| |   |                                                                                                                                                                                                                                      
| |  | Transform our overall marketing strategy to expand our target market and focus our message/offers on
quality, service and value rather than price.                                                                                   
| |   |                                                                                                                                                                                                                                      
| |  | Implement various field initiatives to drive improvement in quality, service, productivity and customer
retention.                                                                                                                   

|18
|--



|RESULTS OF OPERATIONS
A summary of consolidated results of operations and key statistics follows:
|-------------------------------------------------------------------------------------------------
|                                                                                                 

|thousands, except share and per share data                                                               | 2004 |   | 2003    |   | 2002 |        
|-------------------------------------------------------------------------------------------------------- | ---- | - | ------- | - | ---- | -------
|                                                                                                         |      |   |         |   |      |        
|Net sales                                                                                                |      | $ | 281,865 |   | $    | 299,044
|Cost and expenses:                                                                                       |     
|Cost of sales (exclusive of depreciation and amortization shown below)                                   |      |   | 36,899  |   |      | 40,070 
|Cost of sales as a percentage of net sales                                                               |      |   | 13.1    | % |      | 13.4   
|Gross margin as a percentage of net sales                                                                |      |   | 86.9    | % |      | 86.6   
|Selling, general and administrative expenses                                                             |      |   | 219,367 |   |      | 227,238
|Selling, general and administrative expenses as a percentage of net sales                                |      |   | 77.8    | % |      | 76.0   
|Depreciation and amortization                                                                            |      |   | 16,391  |   |      | 16,806 
|Other charges and impairments                                                                            |      |   | 15,679  |   |      | 5,515  
|                                                                                                         |      |   |         |   |      |        
|                                                                                                         |      |   | 288,336 |   |      | 289,629
|                                                                                                         |      |   |         |   |      |        
|                                                                                                         |      |   |        
|(Loss) income from continuing operations                                                                 |      |   | (6,471  | ) |      | 9,415  
|Interest expense                                                                                         |      |   | 2,180   |   |      | 2,949  
|Interest income                                                                                          |      |   | 1,226   |   |      | 1,709  
|Impairment and related obligations of preferred security interest                                        |      |   | 9,789   |   |      |       
|Other income, net                                                                                        |      |   | 263     |   |      | 850    
|                                                                                                         |      |   |         |   |      |        
|(Loss) earnings from continuing operations before income tax expense                                     |      |   | (16,951 | ) |      | 9,025  
|Income tax (benefit) expense                                                                             |      |   | (2,189  | ) |      | 3,183  
|                                                                                                         |      |   |         |   |      |        
|Net (loss) earnings from continuing operations                                                           |      |   | (14,762 | ) |      | 5,842  
|Net loss from discontinued operations, net of income tax benefit of$2,201, $2,518 and $656, respectively |      |   | (3,746  | ) |      | (4,624 
|                                                                                                         |      |   |         |   |      |        
|                                                                                                         |      |   |        
|NET (LOSS) EARNINGS                                                                                      |      | $ | (18,508 | ) | $    | 1,218  
|                                                                                                         |      |   |         |   |      |        
|Net (loss) earnings per share - diluted                                                                  |      | $ | (2.35   | ) | $    | 0.15   

|                                                                                                                     
|---------------------------------------------------------------------------------------------------------------------
|Net
      sales totaled $281.9 million, $299.0 million and $308.6 million in 2004,
      2003 and 2002, respectively.
|                                                                                                                     
|                                                                                                                    
|                                                                                                                     
|                                                                                                                     

|19
|--



| | The Company believes that the reversal in the negative sales trends experienced since late 2003 is
largely attributable to the impact of the following initiatives undertaken throughout the year
and continuing.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                  

| |  | The implementation of a significant computer hardware and printer upgrade in all of our U.S. studios
which improved the performance of our legacy systems while laying the foundation for a transition
to digital.                                
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                   
| |  | The successful conversion of 128 of our studios to full digital format prior to the start of the fourth
quarter busy season. These studios significantly outperformed the analog film studios in the fourth
quarter and continue to do so to date.
| |   |                                                                                                                                                                                                                                                   
| |  | The restoration of coverage and training hours to our studios that had been significantly reduced in
the fiscal 2003 fourth quarter in response to then-declining sales trends.                                                                   
| |   |                                                                                                                                                                                                                                                   
| |  | The effectuation of offer changes and targeted price increases as well as the increased utilization
of more efficient advertising vehicles.                                                                                                       
| |   |                                                                                                                                                                                                                                                   
| |  | The introduction of new products contributing in excess of $1 million in fourth quarter sales.                                                                                                                                                    
| |   |                                                                                                                                                                                                                                                   

| | Net
        sales in 2003 were $299.0 million, representing a 3% decrease from the
        $308.6 million reported in 2002, despite the benefit received from the
        53rd week. The 53rd week favorably impacted net
        sales in 2003 by approximately $3.6 million. The decline in revenues was
        primarily due to a reduced number of sittings within the Sears Portrait
        Studios partially offset by an increase in the average sales per customer
        sitting. In 2003, sittings were down 8% from the sittings generated in
        2002. The average sale per customer in 2003 was 5% higher than the average
        realized in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  | The
        decrease in sittings between 2002 and 2003 was attributable to a number
        of external as well as internal factors. Among the external factors are
        the impacts of continuing competitive pressures, including the opening
        of new competitor locations and severe competitor discounting, especially
        at the beginning of the 2003 holiday season. In addition, the overall
        decline was exacerbated by the negative impacts of the inclement weather
        experienced in February and March 2003 in a large portion of the country.
        Finally, the rate at which customers continue to adopt amateur digital
        photography technologies has accelerated which may be impacting the frequency
        of studio visits. Internal factors potentially negatively impacting sittings
        include the Companys decision to substantially reduce television
        advertising and studio employment costs in the second half and fourth
        quarter of 2003 in response to weaker than anticipated sales performance
        during the first three quarters of 2003. In addition, it is likely that
        some customers visiting our studios are receiving a less than optimal
        experience as a result of ongoing technology and support challenges caused
        by our aging studio infrastructure.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  | The
        increase in average sales per customer between 2002 and 2003 was primarily
        attributable to a continued mix shift toward the higher value custom sittings
        as the decline in package sittings accounted for a substantial portion
        of the reported decline in overall sittings, an increase in the percentage
        of sales related to the March 2003 rollout of digitally enhanced products
        and the Companys decision late in the second quarter of 2002 to
        begin selling custom proof sheets which had previously been provided free
        of charge as part of the custom offer.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

|20
|--



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

| | Cost
        of sales, excluding depreciation and amortization expense, as a percentage
        of net sales was 13.1% in 2004, compared to 13.4% in 2003 and 13.2% in
        2002. Correspondingly, gross margin rates were 86.9% in 2004, 86.6% in
        2003 and 86.8% in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  | The
        decrease in cost of sales from 2003 to 2004 is primarily the result of
        reduced levels of sittings and productivity improvements generated from
        improved manufacturing processes surrounding the second year of production
        of digitally enhanced products. The decreases were partially offset by
        markdowns on merchandise sales of frames and accessories in an effort
        to clear older inventory, higher effective media costs associated both
        with new digital studios as well as inefficiencies related to start-up
        operations of new digital printers in the analog studios and the reversal
        in the third quarter of 2003 of a previously-accrued liability more fully
        discussed in the following paragraph.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  | The
        increase in cost of sales, as a percentage of sales, from 2002 to 2003
        was primarily a result of reduced sitting levels as well as increased
        costs associated with producing and shipping the new digitally enhanced
        product introduced in 2003 referred to as Portrait Creations®. While
        not substantially impacting the overall cost of sales as a percentage
        of sales, 2003 cost of sales were positively impacted in the third quarter
        by the reversal of a previously-accrued liability amounting to approximately
        $600,000 related to minimum usage requirements under a supply contract.
        This reversal related to the favorable renegotiation of the Companys
        supply contract with a vendor. In addition, in the fourth quarter of 2003,
        cost of sales increased by approximately $2.3 million, despite a substantial
        decline in sittings, resulting principally from manufacturing inefficiencies
        in the Companys St. Louis production facility. These inefficiencies
        related to integrating production previously handled by the Companys
        Las Vegas production facility which was closed after the fiscal 2002 holiday
        season and production issues pertaining to the first busy season of producing
        both film and new digitally enhanced products discussed above.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | Selling,
        general and administrative expenses were $219.4 million, $227.2 million
        and $228.5 million for fiscal years 2004, 2003 and 2002, respectively.
        As a percentage of sales, these expenses were 77.8% in 2004, 76.0% in
        2003 and 74.0% in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  | The
        $7.8 million decrease in selling, general and administrative costs is
        principally the result of $3.3 million in planned net reductions in advertising
        costs, lower corporate employment costs of $1.1 million, and $6.3 million
        of net decreases in various other categories of expenses such as travel
        and meetings, studio supplies, and postage and freight. These decreases
        were partially offset by net increases in studio employment costs of $621,000
        related to the broad restoration of coverage and training hours as well
        as the startup operation of digital studios, costs and inefficiencies
        associated both the Companys digital conversion efforts as well
        as with the implementation of the system-wide studio hardware upgrade
        project, increases of $1.7 million in health insurance costs and approximately
        $600,000 in costs related to professional services incurred in conjunction
        with the first year of required internal control reporting under Section
        404 of the Sarbanes-Oxley Act.                                                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  | The
        decline in advertising expenses resulted from a comprehensive evaluation
        of the productivity of the various vehicles utilized, the result of which
        was the elimination of high-cost, low productivity vehicles and reinvestment
        in more cost-effective vehicles that are anticipated to also be more productive
        and targeted. The decline in corporate employment costs resulted from
        the executive and other corporate staff reductions that took place principally
        in the first and second quarters of 2004. The net decreases in the various
        other categories mentioned above resulted from the Companys ongoing
        cost reduction initiatives. The increase in studio employment costs resulted
        from a strategic decision to restore coverage, training and retention
        hours in the studio, especially in the second half of 2004 that had been
        substantially reduced in the second half of 2003 in response to the declining
        sales environment.                                                                                                                                                                                                                                                                                                                                                              
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  | The
        $1.2 million decrease in 2003 from 2002 was primarily the result of $3.3
        million in savings from reduced advertising expense and a $1.4 million
        decrease in commissions due to lower sales volumes. In addition, during
        the third and fourth quarters of 2003, reductions in studio employment
        costs of $1.4 million substantially                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

|21
|--



|  | offset
        comparable increases in such amounts in the first two quarters of 2003.
        The reductions in the third and fourth quarters of 2003 were the result
        of the Companys response to bring studio employment costs as a percentage
        of sales back into line with the lower level of sales than originally
        planned. These savings more than offset 2003 increases compared to the
        prior year in studio supplies and telephone expense, travel and meeting
        costs and pension expense of $1.4 million, $1.1 million and $1.0 million,
        respectively.                                         
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | Depreciation
        and amortization was $16.4 million in 2004, compared to $16.8 million
        in 2003 and $20.1 million in 2002. The slight net decrease in depreciation
        expense between 2003 and 2004 resulted from certain assets becoming fully
        depreciated in 2003, partially offset by increased depreciation charges
        related to increased levels of capital spending in 2003 and continuing
        in 2004. The decrease in depreciation expense between 2002 and 2003 was
        primarily the result of photographic equipment placed in to service in
        1993 and 1994 becoming fully depreciated in 2002.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | Other
        charges and impairments reflect costs incurred from strategic actions
        implemented by the Company to restructure its operations, costs that are
        unpredictable and atypical of the Companys operations and additional
        charges due to asset impairments. The actions taken over the past three
        years are as follows:                                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

|thousands                                                                                                                                  | 2004 |        | 2003 |   | 2002  | 
|------------------------------------------------------------------------------------------------------------------------------------------ | ---- | ------ | ---- | - | ----- | 
|                                                                                                                                           |      |        |      |   |       | 
|Recorded as a Component of Income (Loss) From Operations:                                                                                  |      |        |      |   |       | 
|Accruals related to accelerated vesting of
             supplemental retirement plan benefits
             and guaranteed bonuses for 2004 | $    | 3,656  |      | $ |      | 
|Impairment charges                                                                                                                         |      | 6,516  |      |   |      | 
|Reserves for severance and related costs                                                                                                   |      | 3,430  |      |   | 1,346 | 
|Pension plan curtailment                                                                                                                   |      |       |      |   | 2,385 | 
|Consent solicitation costs                                                                                                                 |      | 816    |      |   | 1,663 | 
|Production facility closure                                                                                                                |      |       |      |   | 121   | 
|Contract terminations and settlements                                                                                                      |      | 1,261  |      |   |      | 
|                                                                                                                                           |      |        |      |   |       | 
|                                                                                                                                           |      | 15,679 |      |   | 5,515 | 
|Recorded as a Component of Other Expense Following Income
     (Loss) From Operations:                                                     |      |        |      |   |       | 
|Impairment and related obligations of preferred
             security interest                                                             |      | 9,789  |      |   |      | 
|                                                                                                                                           |      |        |      |   |       | 
|Total Other Charges and Impairments                                                                                                        | $    | 25,468 |      | $ | 5,515 | 
|                                                                                                                                           |      |        |      |   |       | 

| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Accelerated Vesting of Supplemental Retirement Plan Benefits and Guaranteed Bonuses for 2004                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |  
| |   | In the first quarter of 2004, change of control provisions in executive employment contracts were triggered
as a result of the change in the composition of the Companys Board of Directors resulting from
the completion of the consent solicitation, which is more fully discussed in Note 3 in the accompanying
Notes to Consolidated Financial Statements. As a result, the Company accrued $3.3 million in the
first quarter related to the accelerated vesting of executives benefits covered by the Companys
supplemental retirement plan and $318,000 in 2004 related to guaranteed bonuses provided for in employment
contracts for those covered executives whose employment continues with the Company.

|22
|--



| |  | Impairment Charges                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |   | During the first quarter of 2004, the Companys recently reconstituted Board along with its new
management leadership in the technology function, made a decision to materially alter the Companys
previously planned and recently in-process technology platform that was to serve as the foundation
for the eventual conversion to full digital technology in the portrait studios. As a result of this
decision, certain previously capitalized software development costs related to the development of
the previous platform no longer have future utility to the Company and, accordingly, have been written
off.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  
| |   | During the second and third quarters of 2004, additional strategic decisions were made regarding the
Companys technology platform that necessitated the write-off or write-down of certain other
technology-related assets to their anticipated fair value.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |  
| |   | In the third quarter of 2002, as part of the reorganization activities associated with exiting the

Companys Technology Development segment, as more fully discussed in Note 4 in the accompanying

Notes to Consolidated Financial Statements, certain strategic technology decisions were made that

either reduced or eliminated the future utility of certain historic capitalized technology development

costs necessitating a write-down or write-off of these costs, thus resulting in a charge of $4.2

million. The impacted development activities included a proprietary digital camera development
project
($2.9 million, including $2.5 million in equipment costs), a digital manufacturing system
($445,000)
and, a portion of the store automation system platform ($863,000). In the case of both
the digital
camera project and the digital manufacturing system, the Company has made the decision
to prospectively
utilize commercially available cameras and digital manufacturing software. The
Companys change
in technology direction and its decision to no longer pursue the sale of
technology services to third
parties resulted in the need to write-off a portion of its store automation
system capitalized software code.
| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  | Reserves for Severance and Related Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  

| |   | In 2004, the Company established reserves in the amount of $3.0 million for severance and related costs

consisting principally of potential benefits related to severance pay and supplemental retirement

plan costs associated with the dismissal of certain executives. In the second quarter of 2004 and

during the fourth quarters of 2003 and 2002, a number of support positions in the Companys

corporate headquarters were eliminated resulting in employee severance accruals of approximately

$457,000, $687,000 and $509,000, respectively.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  
| |   | *During the fourth quarter of 2003 and the third quarter of 2002, the Company recognized $659,000 and

$380,000, respectively, in expense consisting principally of severance pay and supplemental retirement

plan benefits related to the early retirement of senior executives.*                                                                                                                                                                                                                                                                         
| |  
| |  | Pension Plan Curtailment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| |  

| |   | During 2003, the Company completed a comprehensive analysis of its retirement plan practices and their

projected costs, especially as they compare to other retail industries. As a result of the analysis,

on February 3, 2004 the Company implemented a freeze of future benefit accruals related to its
Retirement
Plan effective April 1, 2004, except for those employees with ten years of service and
who have attained
age 50 who were grandfathered and whose benefits will continue to accrue. The
Company incurred a
charge of $2.4 million related to the pension plan curtailment.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  
| |  | Consent Solicitation Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  

| | During the second half of 2003 and the first quarter of 2004, the Company incurred $1.7 million and
$816,000, respectively, of professional services costs related to the then ongoing consent solicitation.
Included in the 2004 costs was $152,000 of total consent-related costs incurred by the Knightspoint
Group, which the Company has reimbursed.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|23
|--



| | Production Facility Closure                                                                                                                                                                                                                                                                                                                                                                                         
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                     
|  | During the fourth quarter of 2003, the Company recorded an additional charge of $121,000 relating to

the closure of its Las Vegas manufacturing facility that occurred in the fourth quarter of 2002.

This charge resulted principally from the Companys inability to realize the expected sublease

income on the facility recorded in 2002 as an offset to the remaining lease obligation accrual.             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                     
|  | During the fourth quarter of 2002, management completed a review of its manufacturing capacity. As

a result, the Companys Las Vegas manufacturing facility was closed. This action resulted
  in
  charges of approximately $407,000 in employee severance, $270,000 in accruals, net of expected
  sublease
  income, relating to the remaining lease obligations and $305,000 in asset abandonment
  write-offs.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                     

| | Contract Termination and Settlements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|  | In March 2004, prior to the change of control, the Company received a lending commitment related to

the proposed refinancing of its then-existing debt structure. In exchange for that commitment,
  the
  Company paid a $200,000 non-refundable loan commitment fee. Subsequent to the receipt of the
  commitment
  and prior to its funding, the consent solicitation was completed resulting in the installation
  of
  a new Board of Directors and the lending commitment expired, necessitating the write-off of
  the previously
  capitalized non-refundable fee during the first quarter of 2004. In November 2004,
  the Company received
  a subsequent lending commitment to refinance its existing debt structure that
  was withdrawn by the
  lender requiring the write-off of the $100,000 non-refundable commitment fee
  paid to the lender at
  the time of the commitment.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|  | During 2004, the Company recorded $961,000 of charges related to early contract terminations and settlements

with certain of the Companys vendors and consultants as a result of strategic decisions to

modify such relationships. Included in this amount is an accrual relating to the potential settlement

of a compensation claim by a former consultant to the Company. This former consultant is a relative

of the Companys Chairman of the Board.                                                                                                                                                                                                                                                                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

| | Impairment and Related Obligations of Preferred Security Interest                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  | The impairment and related obligations of preferred security interest represents charges recorded in
  the third quarter of 2004 related to an investment in and operating lease guarantees associated with
  the Companys former Wall Décor Segment, Prints Plus, totaling $9.8 million. These charges
  were necessitated by the significant deteriorating financial performance of Prints Plus during the
  third quarter of 2004 and are more fully discussed in the section of Managements Discussion
  and Analysis entitled Future Cash Flows which follows.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

| | Interest expense was $2.2 million in 2004, compared to $2.9 million in 2003 and $3.6 million
  in 2002. The reduction in interest expense is the result of scheduled principal payments of $8.5
  million made annually in June of each year on the Companys Senior Notes. The principal due
  on these notes at the end of 2004 was $25.7 million down from $34.2 million and 42.7 million in 2003
  and 2002, respectively.                                                                                                                                                                                                                       
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | Interest income was $1.2 million in 2004, as compared to $1.7 million in 2003 and $2.0 million
  in 2002. The decrease in interest income in 2004 compared to 2003 is primarily due to lower average
  invested cash balances and the absence of interest income on an income tax refund received and recorded
  in 2003, partially offset by the impact of slightly higher interest rates earned on average invested
  cash balances. The decrease in interest income in 2003 compared to 2002 is principally due to the
  substantial declines in interest rates during 2003 as well as slightly decreased average cash balances
  during the year.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | The income tax benefit on losses from continuing operations totaled $2.2 million in 2004. The provision
  for income taxes from continuing operations in 2003 and 2002 totaled $3.2 million and $4.2 million,
  respectively. These benefits/provisions resulted in effective tax rates of 12.9% in 2004, 35.3% in
  2003 and 35.1% in 2002.                                                                                                                                                                                                                                                                                                         

|24
|--



|  | The difference in the 2004 effective income tax rate resulted in a lower income tax benefit due to the recording of the valuation allowance on the Companys foreign tax credit and capital loss carry forwards, the tax effects of the Companys foreign operations and the realignment of the Companys officer life insurance program. These benefit reductions were partially offset by an increased current provision relating to an assessment of taxes on prior years resulting from an Internal Revenue Service exam.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | Net losses from discontinued operations were $3.7 million in 2004, $4.6 million in 2003 and $1.2 million
  in 2002. These discontinued operations relate to the Companys previously existing Mexican and
  mobile photography operations and Technology Development segment and are further discussed below.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  | During the second quarter of 2004, the Companys recently reconstituted Board of Directors made
  a strategic decision to exit both the Mexican and mobile photography operations which began operations
  in 2002. This decision was made to allow the Company to enhance focus on the core Sears Portrait
  Studios business as well as to eliminate the ongoing operating dilution associated with these businesses.
  The Company executed and completed its plan to exit both its Mexican and mobile photography operations
  during the second quarter of 2004 and recorded the year-to-date combined losses on the operations
  of its Mexican and mobile operations, including the loss on disposition, net of tax, of $3.7 million,
  as a separate component after net loss from continuing operations. The prior years operating
  activities for these operations have been reclassified to discontinued operations in the accompanying
  Consolidated Statements of Operations. The $3.7 million loss in 2004 compares to a $4.6 million loss
  from such operations in 2003 and $149,000 in 2002.                                                                                                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  | During the third quarter of fiscal 2002, management completed its previously announced review of the
  infrastructure and platform from which it delivers technology development and support services. The
  objectives of the review were to 1) improve focus on and support for the Companys core portraiture
  business, 2) improve organizational functionality and systems flexibility, and 3) eliminate duplicative
  cost structures. Consequently, during the fourth quarter of fiscal 2002, final decisions were made
  and implemented regarding the elimination of the Companys separate technology development segment.
  To achieve the aforementioned objectives, the Company transferred the technology development activities,
  previously performed by its subsidiary Centrics Technology, Inc. (Centrics), back into
  a newly reorganized corporate technology function. In addition, the Company decided not to continue
  to pursue the sale of consulting and software development to third parties. In 2002, through the
  elimination of the Companys separate technology development segment and the transfer of activities
  to the corporate technology function, the Company incurred certain fourth quarter charges related
  to the discontinued operations. The Company incurred approximately $537,000 in employee severance
  pay, $243,000 in remaining lease obligation accruals and $266,000 in asset abandonment write-offs.

|25
|--



|LIQUIDITY AND CAPITAL RESOURCES
    The following table presents a summary of our cash flows for each of the last three fiscal years:
|-------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                     

|thousands                               | 2004 |   | 2003    |   | 2002 |        
|--------------------------------------- | ---- | - | ------- | - | ---- | -------
|                                        |      |   |         |   |      |        
|Net cash provided by (used in):         |      |   |         |   |      |        
|Operating activities (1)                |      | $ | 13,669  |   | $    | 24,623 
|Investing activities                    |      |   | (6,626  | ) |      | (18,199
|Financing activities                    |      |   | (24,758 | ) |      | (13,929
|Effect of exchange rate changes on cash |      |   | 587     |   |      | 594    
|                                        |      |   |         |   |      |        
|Net (decrease) increase in cash         |      | $ | (17,128 | ) | $    | (6,911 
|                                        |      |   |         |   |      |        

|                                                                                                                             
|-----------------------------------------------------------------------------------------------------------------------------
|(1) Includes cash flows used in discontinued operations of $ 2,739, $ 7,495 and $ 1,319 in 2004, 2003 and 2002, respectively.

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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.

|26
|--



|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:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

| |  | The ratio of consolidated debt to earnings before interest, taxes, depreciation and amortization (EBITDA)
  must be less than 300% of EBITDA;                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                                                                                      
| |  | The ratio of consolidated earnings before interest, taxes, depreciation, amortization and lease rental expense (EBITDAR) to fixed charges (income taxes, dividends, interest expense, current maturities of debt and lease expenses) must be greater than 200%, and
| |   |                                                                                                                                                                                                                                                                      
| |  | The ratio of consolidated debt to consolidated capitalization must remain less than 55% upon the incurrence of new debt.                                                                                                                                             

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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.

|27
|--



|Future Cash Flows
To facilitate an understanding of the Companys contractual obligations and other commitments,
the following information is provided:
|-------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                       

|                           | PAYMENTS DUE BY YEAR (in thousands) |  
|-------------------------- | ----------------------------------- | -
|
|
|                           |                                     |  
|Contractual obligations:   |                                     |  
|Long-term debt             |                                     | $
|Operating leases           |                                     |  
|Purchase obligations for   |                                    
|materials and services (1) |                                     |  
|Other liabilities (2)      |                                     |  
|                           |                                     |  
|TOTAL                      |                                     | $
|                           |                                     |  
|                           |                                     |  

|                                 | AMOUNT OF COMMITMENT EXPIRATION PER YEAR
      (in thousands) |  
|-------------------------------- | ------------------------------------------------------------- | -
|
|
|                                 |                                                               |  
|Other commitments:               |                                                               |  
|Standby letters of credit (3)    |                                                               | $
|Contingent lease obligations (4) |                                                               |  
|                                 |                                                               |  
|TOTAL                            |                                                               | $
|                                 |                                                               |  

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Amount represents outstanding purchase commitments at February 5, 2005. The purchase commitments principally
  relate to future services to be received related to marketing, database maintenance and telecommunications.
  In addition, they relate to commitments for inventory purchases of such items as photographic paper
  and frames and accessories, as well as hardware and other equipment related to the in-process conversion
  of our existing studios to digital format and the opening of new studios.                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(2) | Amounts consist primarily of accruals for severance and related costs of $4.2 million, guaranteed bonuses
  for 2004 of $318,000, $280,000 of accruals related to contract terminations and settlements and the
  remaining lease obligations on a closed production facility of $100,000 all recorded in our February
  5, 2005 balance sheet. The severance accruals consist principally of potential benefits related to
  severance pay and related costs and supplemental retirement plan costs associated with the dismissal
  of certain executives. The guaranteed bonuses relate to those bonuses provided for in employment
  contracts for those covered executives whose employment continues with the Company. Certain of these
  severance amounts are being contested by the Company. Notwithstanding the potential reduction of
  certain of these amounts through settlement negotiations and litigation, such amounts are recorded
  at the contractual amounts due.

|28
|--



| | The table does not include our deferred income tax liability, accruals for self-insured losses and
  pension benefits because it is not certain when these liabilities will become due. We did not make
  any contributions to our pension plan in 2004 and do not expect to do so in 2005. Future contributions
  to our pension plan will be dependent upon recently passed legislation, future changes in discount
  rates and the earnings performance of our plan assets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | As indicated in Note 9 in the accompanying Notes to Consolidated Financial Statements, the projected
  benefit obligation of the Companys pension plan exceeded plan assets by $17.5 million at the
  end of 2004 and $13.8 million at the end of 2003. This $3.7 million increase in the underfunded status
  between 2004 and 2003 resulted from a $4.6 million growth in the projected benefit obligation from
  $45.3 million to $49.9 million being only partially offset by a growth in the fair value of plan
  assets of $900,000. The projected benefit obligation grew as a result of annual costs associated
  with service costs, interest costs and actuarial losses all determined in accordance with Statement
  of Financial Accounting Standards No. 87. All three of these cost components actually decreased in
  2004 from 2003 partially as a result of the Companys decision in early 2004 to freeze benefits
  under the plan. The $900,000 growth in fair value of plan assets in 2004 resulted from actual returns
  on plan assets of $2.5 million offset by benefit payments of $1.6 million. As noted above, the Company
  does not expect to contribute to the pension plan in 2005. The Critical Accounting Estimates section
  and Note 9 in the accompanying Notes to Consolidated Financial Statements provide a more complete
  description of the status of the Companys pension plan.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | In addition, the table does not include $8.7 million in purchase commitments the Company entered into
  subsequent to year-end related to its 2005 digital conversion of all or a substantial number of its
  Sears Portrait Studios as well as the expansion into planned Sears Essential locations. This amount
  includes approximately $7.5 million for hardware and related costs as well as approximately $1.2
  million in obligations related to the software for the studio photography and manufacturing fulfillment
  digital systems.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

|(3) | We use stand-by letters of credit to support our various self-insurance programs. The letters of credit generally having a one-year maturity and are renewed annually.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(4) | 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 February
  5, 2005, the maximum future obligation to the Company under its guarantee of these leases is $5.2
  million. To recognize the risk associated with these leases and based upon the Companys past
  experience with renegotiating lease obligations, a $1.0 million reserve was established in 2001 at
  time of the sale. As a result of the significant deterioration in the financial performance of Prints
  Plus in the third quarter of 2004, including its subsequent bankruptcy filing, all of which is more
  fully described in Note 12 to the Companys Consolidated Financial Statements, the Company recorded
  an additional $2.1 million of lease obligation reserves brining the total reserve at February 5,
  2005 to $3.1 million. Based on the progress of the bankruptcy cases to-date, the Company believes
  that the $3.1 million reserve is adequate to cover the potential losses to be realized under the
  Companys operating lease guarantees.

|                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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.

|29
|--



|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.*
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|30
|--



|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.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|31
|--



|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.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|32
|--



|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.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|33
|--



|Item 8. | Financial Statements and Supplemental Data           |                                                                                    |  |      
|------- | ---------------------------------------------------- | ---------------------------------------------------------------------------------- |  | -----
|        |                                                      |                                                                                    |  |      
|(a)     | INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |                                                                                    |  |      
|        |                                                      |                                                                                    |  |      
|        | -                                                    | Reports of Independent Registered Public Accounting Firm                           |  | 35-37
|        | -                                                    | Consolidated Balance Sheets as of February 5, 2005 and February 7, 2004            |  | 38-39
|        | -                                                    | Consolidated Statements of Operations for the fiscal years ended                   | 
|        |                                                      | February 5, 2005, February 7, 2004 and February 1, 2003                            |  | 40   
|        | -                                                    | Consolidated Statements of Changes in Stockholders Equity                         | 
|        |                                                      | for the fiscal years ended February 5, 2005, February 7, 2004 and February 1, 2003 |  | 41   
|        | -                                                    | Consolidated Statements of Cash Flows for the fiscal years ended February 5, 2005, | 
|        |                                                      | February 7, 2004 and February 1, 2003                                              |  | 42-43
|        | -                                                    | Notes to Consolidated Financial Statements                                         |  | 44-73

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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.

|34
|--



|Report of Independent Registered Public Accounting Firm
To the Board of DirectorsCPI 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.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|            
|------------
|/s/ KPMG LLP
|            
|KPMG LLP    

|                                      
|--------------------------------------
|St. Louis, Missouri
    April 20, 2005

|35
|--



|Report of Independent Registered Public Accounting Firm
The Board of DirectorsCPI 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 Frameworkissued 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.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|36
|--



|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 Frameworkissued 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 Frameworkissued 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.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|            
|------------
|/s/ KPMG LLP
|            
|KPMG LLP    

|                                      
|--------------------------------------
|St. Louis, Missouri
    April 20, 2005

|37
|--



|CPI CORP.Consolidated Balance Sheets  Assets
|---------------------------------------------
|                                             

|thousands                                                          | February 5, 2005 |   | February 7, 2004 |  
|------------------------------------------------------------------ | ---------------- | - | ---------------- | -
|                                                                   |                  |   |                  |  
|ASSETS                                                             |                  |   |                  |  
|Current assets:                                                    |                 
|Cash and cash equivalents                                          |                  | $ | 33,883           |  
|Restricted cash - collateral for outstanding letters of credit     |                  |   | 6,154            |  
|Accounts receivable:                                               |                 
|Due from licensor stores                                           |                  |   | 7,365            |  
|Other                                                              |                  |   | 326              |  
|Inventories                                                        |                  |   | 10,521           |  
|Prepaid expenses and other current assets                          |                  |   | 6,905            |  
|Refundable income taxes                                            |                  |   |                 |  
|Deferred tax assets                                                |                  |   | 8,795            |  
|                                                                   |                  |   |                  |  
|Total current assets                                               |                  |   | 73,949           |  
|                                                                   |                  |   |                  |  
|Property and equipment:                                            |                 
|Land                                                               |                  |   | 2,765            |  
|Building improvements                                              |                  |   | 26,684           |  
|Leasehold improvements                                             |                  |   | 6,005            |  
|Photographic, sales and manufacturing equipment                    |                  |   | 183,979          |  
|                                                                   |                  |   |                  |  
|Total                                                              |                  |   | 219,433          |  
|Less accumulated depreciation and amortization                     |                  |   | 177,775          |  
|                                                                   |                  |   |                  |  
|Property and equipment, net                                        |                  |   | 41,658           |  
|Assets of business transferred under contractual arrangements:     |                 
|Preferred security                                                 |                  |   | 7,000            |  
|Accrued dividends on preferred security                            |                  |   | 689              |  
|Loan receivable                                                    |                  |   |                 |  
|Impairment reserve related to preferred security interest          |                  |   | (7,689           | )
|Assets of supplemental retirement plan:                            |                 
|Cash surrender value of life insurance policies (net of borrowings |                 
|of $1,548 at February 7, 2004)                                     |                  |   |                 |  
|Other investments                                                  |                  |   | 6,141            |  
|Deferred tax assets                                                |                  |   | 11,734           |  
|Other assets, net of amortization of $1,359 at both                |                 
|February 5, 2005 and February 7, 2004                              |                  |   | 1,618            |  
|                                                                   |                  |   |                  |  
|TOTAL ASSETS                                                       |                  | $ | 135,100          |  
|                                                                   |                  |   |                  |  

|                                                             
|-------------------------------------------------------------
|See accomapanaying notes to consolidated finacial statements.

|38
|--



|CPI CORP.Consolidated Balance Sheets - Liabilities and Stockholders Equity
|---------------------------------------------------------------------------
|                                                                           

|thousands,
      except share and per share data                                             | February 5,
      2005 |   | February 7,
      2004 |  
|-------------------------------------------------------------------------------------------- | ---------------------- | - | ---------------------- | -
|                                                                                             |                        |   |                        |  
|LIABILITIES                                                                                  |                        |   |                        |  
|Current liabilities:                                                                         |                       
|Current
      maturities of long-term debt                                                   |                        | $ | 8,580                  |  
|Accounts
      payable                                                                       |                        |   | 13,011                 |  
|Accrued
      employment costs                                                               |                        |   | 12,463                 |  
|Customer
      deposit liability                                                             |                        |   | 21,828                 |  
|Accrued
      severance                                                                      |                        |   | 4,205                  |  
|Income
      taxes payable                                                                   |                        |   | 2,872                  |  
|Sales
      taxes payable                                                                    |                        |   | 1,886                  |  
|Accrued
      advertising expenses                                                           |                        |   | 1,568                  |  
|Accrued
      expenses and other liabilities                                                 |                        |   | 5,348                  |  
|                                                                                             |                        |   |                        |  
|Total
      current liabilities                                                              |                        |   | 71,761                 |  
|                                                                                             |                        |   |                        |  
|Long-term
      debt, less current maturities                                                |                        |   | 17,050                 |  
|Accrued pension
      obligations                                                            |                        |   | 13,993                 |  
|Supplemental
      retirement plan obligations                                               |                        |   | 4,512                  |  
|Customer
      deposit liability                                                             |                        |   | 4,334                  |  
|Other liabilities                                                                            |                        |   | 564                    |  
|                                                                                             |                        |   |                        |  
|Total
      liabilities                                                                      |                        |   | 112,214                |  
|                                                                                             |                        |   |                        |  
|STOCKHOLDERS
      EQUITY                                                                   |                       
|Preferred
      stock, no par value, 1,000,000 shares authorized; no shares      outstanding |                        |   |                       |  
|Preferred
      stock, Series A, no par value, 200,000 shares authorized;                    |                       
|no
      shares outstanding                                                                  |                        |   |                       |  
|Common stock,
      $.40 par value, 50,000,000 shares authorized; 18,432,779 and             |                       
|18,360,238
      shares issued at February 5, 2005 and February 7, 2004,                     |                       
|respectively                                                                                 |                        |   | 7,373                  |  
|Additional
      paid in capital                                                             |                        |   | 53,301                 |  
|Retained
      earnings                                                                      |                        |   | 206,812                |  
|Accumulated
      other comprehensive loss                                                   |                        |   | (10,505                | )
|                                                                                             |                        |   |                        |  
|                                                                                             |                        |   | 256,981                |  
|Treasury
      stock - at cost, 10,672,236 and 10,292,503 shares at                          |                       
|February
      5, 2005 and at February 7, 2004, respectively                                 |                        |   | (234,031               | )
|Unamortized
      deferred compensation- restricted stock                                    |                        |   | (64                    | )
|                                                                                             |                        |   |                        |  
|Total
      stockholders equity                                                             |                        |   | 22,886                 |  
|                                                                                             |                        |   |                        |  
|TOTAL
      LIABILITIES AND STOCKHOLDERS EQUITY                                             |                        | $ | 135,100                |  
|                                                                                             |                        |   |                        |  

|                                                             
|-------------------------------------------------------------
|See accomapanaying notes to consolidated finacial statements.

|39
|--



|CPI CORP.Consolidated Statements of OperationsFifty-two weeks ended February 5, 2005, Fifty-three weeks ended February 7, 2004 andFifty-two weeks ended February 1, 2003
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                        

|thousands,
      except share and per share data                                     | 2004 |           | 2003 |   | 2002      |  
|------------------------------------------------------------------------------------ | ---- | --------- | ---- | - | --------- | -
|                                                                                     |      |           |      |   |           |  
|Net
      sales                                                                      | $    | 281,865   |      | $ | 299,044   |  
|                                                                                     |      |           |      |   |           |  
|Cost
      and expenses:                                                            
|Cost
      of sales (exclusive of depreciation and amortization shown below)         |      | 36,899    |      |   | 40,070    |  
|Selling,
      general and administrative expenses                                   |      | 219,367   |      |   | 227,238   |  
|Depreciation
      and amortization                                                  |      | 16,391    |      |   | 16,806    |  
|Other
      charges and impairments                                                  |      | 15,679    |      |   | 5,515     |  
|                                                                                     |      |           |      |   |           |  
|                                                                                     |      | 288,336   |      |   | 289,629   |  
|                                                                                     |      |           |      |   |           |  
|                                                                                     |      |           |     
|(Loss)
      income from continuing operations                                       |      | (6,471    | )    |   | 9,415     |  
|                                                                                     |      |           |      |   |           |  
|Interest
      expense                                                               |      | 2,180     |      |   | 2,949     |  
|Interest
      income                                                                |      | 1,226     |      |   | 1,709     |  
|Impairment
      and related obligations of preferred security interest              |      | 9,789     |      |   |          |  
|Other
      income, net                                                              |      | 263       |      |   | 850       |  
|                                                                                     |      |           |      |   |           |  
|(Loss) earnings
      from continuing operations before income tax (benefit) expense |      | (16,951   | )    |   | 9,025     |  
|                                                                                     |      |           |      |   |           |  
|Income
      tax (benefit) expense                                                   |      | (2,189    | )    |   | 3,183     |  
|                                                                                     |      |           |      |   |           |  
|Net (loss)
      earnings from continuing operations                                 |      | (14,762   | )    |   | 5,842     |  
|Net
      loss from discontinued operations, net of income tax benefit of $2,201,    |     
|$2,518 and
      $656, respectively                                                  |      | (3,746    | )    |   | (4,624    | )
|                                                                                     |      |           |      |   |           |  
|                                                                                     |      |           |     
|NET
      (LOSS) EARNINGS                                                            | $    | (18,508   | )    | $ | 1,218     |  
|                                                                                     |      |           |      |   |           |  
|NET
      (LOSS) EARNINGS PER COMMON SHARE                                          
|                                                                                     |      |           |      |   |           |  
|Net
      (loss) earnings per share from continuing operations - diluted             | $    | (1.87     | )    | $ | 0.72      |  
|Net loss
      per share from discontinued operations - diluted                      |      | (0.48     | )    |   | (0.57     | )
|                                                                                     |      |           |      |   |           |  
|Net
      (loss) earnings per share - diluted                                        | $    | (2.35     | )    | $ | 0.15      |  
|                                                                                     |      |           |      |   |           |  
|Net (loss)
      earnings per share from continuing operations - basic               | $    | (1.87     | )    | $ | 0.72      |  
|Net
      loss per share from discontinued operations - basic                        |      | (0.48     | )    |   | (0.57     | )
|                                                                                     |      |           |      |   |           |  
|Net (loss)
      earnings per share - basic                                          | $    | (2.35     | )    | $ | 0.15      |  
|                                                                                     |      |           |      |   |           |  
|Dividends
      per share                                                            | $    | 0.64      |      | $ | 0.60      |  
|                                                                                     |      |           |      |   |           |  
|Weighted
      average number of common and common equivalent                       
|shares
      outstanding-diluted                                                     |      | 7,888,404 |      |   | 8,148,164 |  
|Weighted
      average number of common and common equivalent                       
|shares outstanding-basic                                                             |      | 7,888,404 |      |   | 8,081,619 |  

|                                                             
|-------------------------------------------------------------
|See accomapanaying notes to consolidated finacial statements.

|40
|--



|CPI CORP.Consolidated Statements of Changes in Stockholders EquityFifty-two weeks ended February 5, 2005, Fifty-three weeks ended February 7, 2004 andFifty-two weeks ended February 1, 2003
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                             

|                                                                        |   |       | Additional |   |        | Accumulated
      other |         | Treasury |   | Deferred
      compensation |         |  
|----------------------------------------------------------------------- | - | ----- | ---------- | - | ------ | ----------------------- | ------- | -------- | - | --------------------------- | ------- | -
|
|                                                                        |   |       |            |   |        |                         |         |          |   |                             |         |  
|Balance
      at February 2, 2002                                       | $ | 7,281 |            | $ | 49,845 |                         | $       | 231,980  |   | $                           | (5,386  | )
|                                                                        |   |       |            |   |        |                         |         |          |   |                             |         |  
|Net
      earnings                                                      |   |      |            |   |       |                         |         | 6,540    |   |                             |        |  
|Total
      other comprehensive loss                                    |   |      |            |   |       |                         |         |         |   |                             | (5,317  | )
|                                                                        |   |       |            |   |        |                         |         |         
|Total
      comprehensive income                                        |   |       |            |   |        |                         | 1,223   |         
|Issuance
      of common stock to                                      
|employee
      stock plans and                                         
|option
      exercises (86,263 shares)                                  |   | 34    |            |   | 1,366  |                         |         |         |   |                             |        |  
|Dividends
      ($0.56 per common share)                                |   |      |            |   |       |                         |         | (4,498   | ) |                             |        |  
|Amortization
      of deferred                                         
|compensation
      - restricted stock                                   |   |      |            |   |       |                         |         |         |   |                             |        |  
|                                                                        |   |       |            |   |        |                         |         |          |   |                             |         |  
|Balance
      at February 1, 2003                                       | $ | 7,315 |            | $ | 51,211 |                         | $       | 234,022  |   | $                           | (10,703 | )
|                                                                        |   |       |            |   |        |                         |         |          |   |                             |         |  
|Net
      earnings                                                      |   |      |            |   |       |                         |         | 1,218    |   |                             |        |  
|Total
      other comprehensive income                                  |   |      |            |   |       |                         |         |         |   |                             | 1,104   |  
|                                                                        |   |       |            |   |        |                         |         |         
|Total
      comprehensive income                                        |   |       |            |   |        |                         | 2,322   |         
|Issuance
      of common stock to                                      
|employee
      stock plans and                                         
|option
      exercises (72,232 shares)                                  |   | 29    |            |   | 1,061  |                         |         |         |   |                             |        |  
|Dividends
      ($0.60 per common share)                                |   |      |            |   |       |                         |         | (4,846   | ) |                             |        |  
|Purchase
      of treasury stock                                       
|(54,200
      shares)                                                   |   |      |            |   |       |                         |         |         |   |                             |        |  
|Amortization
      of deferred                                         
|compensation
      - restricted stock                                   |   |      |            |   |       |                         |         |         |   |                             |        |  
|                                                                        |   |       |            |   |        |                         |         |          |   |                             |         |  
|Balance
      at February 7, 2004                                       | $ | 7,344 |            | $ | 52,272 |                         | $       | 230,394  |   | $                           | (9,599  | )
|                                                                        |   |       |            |   |        |                         |         |          |   |                             |         |  
|Net
      loss                                                          |   |      |            |   |       |                         |         | (18,508  | ) |                             |        |  
|Total
      other comprehensive loss                                    |   |      |            |   |       |                         |         |         |   |                             | (906    | )
|                                                                        |   |       |            |   |        |                         |         |         
|Total
      comprehensive loss                                          |   |       |            |   |        |                         | (19,414 | )       
|Issuance
      of common stock to                                      
|employee
      benefit plans,                                          
|restricted
      stock awards and                                      
|option
      exercises (99,588 shares)                                  |   | 29    |            |   | 1,029  |                         |         |         |   |                             |        |  
|Dividends
      ($0.64 per common share)                                |   |      |            |   |       |                         |         | (5,074   | ) |                             |        |  
|Purchase
      of treasury stock, at                                   
|cost
      (406,780 shares)                                             |   |      |            |   |       |                         |         |         |   |                             |        |  
|Amortization
      of deferred
         compensation - restricted stock |   |      |            |   |       |                         |         |         |   |                             |        |  
|                                                                        |   |       |            |   |        |                         |         |          |   |                             |         |  
|Balance
      at February 5, 2005                                       | $ | 7,373 |            | $ | 53,301 |                         | $       | 206,812  |   | $                           | (10,505 | )
|                                                                        |   |       |            |   |        |                         |         |          |   |                             |         |  

|                                                             
|-------------------------------------------------------------
|See accomapanaying notes to consolidated finacial statements.

|41
|--



|CPI CORP.Consolidated Statements of Cash FlowsFifty-two weeks ended February 5, 2005, Fifty-three weeks ended February 7, 2004 andFifty-two weeks ended February 1, 2003
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                        

|thousands                                                                 | 2004 |   | 2003    |   | 2002 |       
|------------------------------------------------------------------------- | ---- | - | ------- | - | ---- | ------
|                                                                          |      |   |         |   |      |       
|Reconciliation
      of net (loss) earnings from continuing operations to |      |   |         |   |      |       
|cash
      flows provided by operating activities:                        |     
|                                                                          |      |   |         |   |      |       
|Net
      (loss) earnings from continuing operations                      |      | $ | (14,762 | ) | $    | 5,842 
|Adjustments
      for items not requiring cash:                           |     
|                                                                          |      |   |         |   |      |       
|Depreciation
      and amortization                                       |      |   | 16,391  |   |      | 16,806
|Loss
      on disposition of property, plant and equipment                |      |   | 1,437   |   |      | 303   
|Gain
      on sale of assets held for sale                                |      |   | (391    | ) |      |      
|Deferred
      income taxes                                               |      |   | (6,811  | ) |      | 14    
|Deferred
      revenues and related costs                                 |      |   | (2,899  | ) |      | (2,887
|Post-closing
      adjustment on Preferred Security                       |      |   |        |   |      |      
|Accrued
      interest on Preferred Security                              |      |   | (629    | ) |      | 5     
|Impairment
      and related obligations of preferred security interest   |      |   | 9,789   |   |      |      
|Accelerated
      vesting of supplemental retirement plan benefits        |      |   | 3,338   |   |      |      
|Other
      impairment charges                                            |      |   | 5,083   |   |      |      
|Other                                                                     |      |   | 1,278   |   |      | 2,755 
|                                                                          |      |   |         |   |      |       
|Decrease
      (increase) in current assets:                              |     
|Receivables
      and inventories                                         |      |   | 683     |   |      | 1,519 
|Refundable
      income taxes                                             |      |   | 2,166   |   |      | 4,646 
|Prepaid
      expenses and other current assets                           |      |   | (345    | ) |      | (880  
|                                                                          |      |   |         |   |      |       
|Increase
      (decrease) in current liabilities:                         |     
|Accounts
      payable                                                    |      |   | (2,249  | ) |      | 5,146 
|Accrued
      expenses and other liabilities                              |      |   | 1,457   |   |      | (1,151
|Income
      taxes payable                                                |      |   | 2,872   |   |      |      
|                                                                          |      |   |         |   |      |       
|Cash flows
      provided by continuing operations                        |      |   | 16,408  |   |      | 32,118
|Cash
      flows used in discontinued operations                          |      |   | (2,739  | ) |      | (7,495
|                                                                          |      |   |         |   |      |       
|Cash flows
      provided by operating activities                         |      | $ | 13,669  |   | $    | 24,623
|                                                                          |      |   |         |   |      |       

|                                                             
|-------------------------------------------------------------
|See accomapanaying notes to consolidated finacial statements.

|42
|--



|CPI CORP.Consolidated Statements of Cash Flows (continued)Fifty-two weeks ended February 5, 2005, Fifty-three weeks ended February 7, 2004 andFifty-two weeks ended February 1, 2003
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                    

|thousands                                                               | 2004 |   | 2003    |   | 2002 |        
|----------------------------------------------------------------------- | ---- | - | ------- | - | ---- | -------
|                                                                        |      |   |         |   |      |        
|Cash
      flows provided by operating activities                       |      | $ | 13,669  |   | $    | 24,623 
|                                                                        |      |   |         |   |      |        
|Cash flows
      provided by (used in) financing activities:            |     
|Repayment
      of long-term obligations                                |      |   | (8,580  | ) |      | (8,580 
|Restricted
      cash - collateral for outstanding letters of credit    |      |   | (6,154  | ) |      |       
|Proceeds
      from borrowings against cash surrender value             |     
|of
      life insurance                                                 |      |   |        |   |      | 289    
|Repayment
      of borrowings against cash surrender value              |     
|of
      life insurance                                                 |      |   |        |   |      | (337   
|Issuance
      of common stock to employee stock plans                  |     
|and
      option exercises                                              |      |   | 1,058   |   |      | 480    
|Cash
      dividends                                                    |      |   | (5,074  | ) |      | (4,846 
|Purchase
      of treasury stock                                        |      |   | (6,008  | ) |      | (935   
|                                                                        |      |   |         |   |      |        
|Cash
      flows used in financing activities:                          |      |   | (24,758 | ) |      | (13,929
|                                                                        |      |   |         |   |      |        
|Cash flows
      (used in) provided by investing activities:            |     
|Additions
      to property and equipment                               |      |   | (15,401 | ) |      | (22,764
|Proceeds
      from sale of property and equipment                      |      |   | 577     |   |      |       
|Proceeds
      from sale of assets held for sale                        |      |   | 932     |   |      |       
|Redemptions
      of preferred security                                 |      |   |        |   |      | 2,500  
|Changes
      in loan receivable:                                       |     
|Borrowings                                                              |      |   | (43,380 | ) |      | (61,079
|Repayments                                                              |      |   | 45,295  |   |      | 59,639 
|Purchases
      of investment securities in Rabbi Trust                 |      |   | (455    | ) |      | (2,843 
|Proceeds
      from sales of investment securities in Rabbi Trust       |      |   | 5,806   |   |      | 6,348  
|                                                                        |      |   |         |   |      |        
|Cash
      flows used in investing activities                           |      |   | (6,626  | ) |      | (18,199
|                                                                        |      |   |         |   |      |        
|Effect
      of exchange rate changes on cash and cash equivalents      |      |   | 587     |   |      | 594    
|                                                                        |      |   |         |   |      |        
|Net (decrease)
      increase in cash and cash equivalents              |      |   | (17,128 | ) |      | (6,911 
|                                                                        |      |   |         |   |      |        
|Cash
      and cash equivalents at beginning of year                    |      |   | 51,011  |   |      | 57,922 
|                                                                        |      |   |         |   |      |        
|Cash
      and cash equivalents at end of year                          |      | $ | 33,883  |   | $    | 51,011 
|                                                                        |      |   |         |   |      |        
|Supplemental
      cash flow information:                               |     
|Interest
      paid                                                     |      | $ | 2,236   |   | $    | 2,907  
|                                                                        |      |   |         |   |      |        
|Income
      taxes (refunded) paid                                      |      | $ | (1,657  | ) | $    | (4,230 
|                                                                        |      |   |         |   |      |        
|Supplemental
      non-cash financing activities:                       |     
|Issuance
      of common stock under the employee Profit Sharing Plan   |      | $ |        |   | $    | 610    
|                                                                        |      |   |         |   |      |        
|                                                                        |      |   |         |   |      |        
|Issuance
      of treasury stock under the employee Profit Sharing Plan |      | $ | 554     |   | $    |       
|                                                                        |      |   |         |   |      |        
|Repayment
      of borrowings against cash surrender value of life      |     
|insurance
      via liquidation of related policies                     |      | $ | 1,548   |   | $    |       
|                                                                        |      |   |         |   |      |        

|                                                             
|-------------------------------------------------------------
|See accomapanaying notes to consolidated finacial statements.

|43
|--



|CPI CORP.Notes to Consolidated Financial Statements
  NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
CPI Corp. (the Company) is a holding company engaged, through its wholly-owned subsidiaries
and partnerships, in selling and manufacturing professional portrait photography of babies, children,
adults and family groups and offers other related products and services.
The Company operates 1,021 (unaudited) professional portrait studios as of February 5,
2005 throughout the United States, Canada and Puerto Rico principally under license agreements with
Sears, Roebuck and Co. (Sears). The Company also operates searsphotos.com, an on-line
photofinishing service as well as a vehicle for the Companys customers to archive, share portraits
via email and order additional portraits and products.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All
significant intercompany accounts and transactions are eliminated in consolidation. Certain items
in prior years have been reclassified to conform to the current year presentation.
Fiscal Year
The Companys fiscal year ends on the first Saturday of February. Unless otherwise stated, references
to years in this report relate to fiscal years rather than to calendar years.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

| | Fiscal year |  | Ended                  |  | Weeks |  | 
| | ----------- |  | ---------------------- |  | ----- |  | 
|
| | 2004        |  | February
      5, 2005 |  | 52    |  | 
| | 2003        |  | February
      7, 2004 |  | 53    |  | 
| | 2002        |  | February
      1, 2003 |  | 52    |  | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Business Concentrations
      Volume of business  The Companys customers are not concentrated in any specific geographic region. Due to the widely dispersed nature of the Companys nationwide retail business across millions of customers, no single customer accounted for a significant amount of the Companys sales.
      Revenues  Substantially all of the Companys revenues in 2004, 2003 and 2002 were derived from sales at permanent portrait studios operating under the Sears Portrait Studio name. These studios operate under agreements with Sears in the United States, Canada and Puerto Rico that require the Company to pay license fees to Sears based on net sales.
    Sources of supply  The Company purchases photographic paper, film and chemistry from three major manufacturers. The Company purchases software for its digital studios and its digital manufacturing system from a single vendor. The Company purchases other equipment and materials for all its operations from a number of suppliers and is not dependent upon any other supplier for any specific kind of equipment or materials. The Company has had no difficulty in the past obtaining sufficient products and materials to conduct its operations and believes its relationships with suppliers are good.

|44
|--



|CPI CORP.Notes to Consolidated Financial Statements
  Foreign operations  Included in the Companys consolidated balance sheets at February 5,
2005 and February 7, 2004 are long-lived assets of $5.1 million and $1.7 million, respectively employed
in the Companys Canadian operations. Net sales related to the Canadian operations were $20.7
million, $22.1 million, and $21.6 million in fiscal 2004, 2003, and 2002, respectively.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Significant estimates include, but
are not limited to workers compensation and employee health insurance liability self-insurance
reserves; depreciation; recoverability of long-lived assets; establishing restructuring, income tax
and other reserves; and defined benefit retirement plan assumptions. Actual results could differ
from those estimates.
Foreign Currency Translations
Assets and liabilities of foreign operations are translated into U.S. dollars at the exchange rate
in effect on the balance sheet date, while income and expense accounts are translated at the average
rates in effect during each fiscal year. Gains and losses on foreign currency translations are included
in the determination of accumulated other comprehensive income (loss) for the year. These gains amounted
to $620,000, $1.7 million, and $403,000, in 2004, 2003, and 2002, respectively.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less
to be cash equivalents.
Inventories
Inventories include raw material inventories of film, paper and chemicals and are stated at the lower
of cost or market, with cost of substantially all inventories being determined by the first-in, first-out
(FIFO) method and the remainder by the last-in, first-out (LIFO) method. Costs incurred relating
to portraits processed pending delivery to customers, or in-process, are inventoried and expensed
when the related sales revenue is recognized.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation and amortization on property and equipment is computed principally using the straight-line
method over estimated useful lives of the respective assets. A summary of estimated useful lives
is as follows:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                 |  |               
| | ----------------------------------------------- |  | --------------
| | Building improvements                           |  | 15 to 19 years
| | Leasehold improvements                          |  | 5 to 15 years 
| | Photographic, sales and manufacturing equipment |  | 3 to 10 years 

|                                                                                                                                                                                                                                                                                                                                   
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|During 2004, the Company removed from service, and wrote-off the related assets and accumulated depreciation totaling $28.2 million representing fully depreciated property and equipment primarily related to its replacement of computer hardware in all U.S. studios and the conversion of 128 studios to a full digital format.

|45
|--



|CPI CORP.Notes to Consolidated Financial Statements
Expenditures for improvements are capitalized, while normal repair and maintenance costs are charged
to expense as incurred. When properties are disposed of, the related cost and accumulated depreciation
are removed from the respective accounts, and any gain or loss is credited or charged to income.
In accordance with Accounting Standards Executive Committee Statement of Position (SOP)
98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,
photographic, sales and manufacturing equipment includes amounts related to the capitalization of
certain costs incurred in connection with developing or obtaining software for internal use.
Long-lived Asset Recoverability
In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting
for the Impairment or Disposal of Long-lived Assets, long-lived assets, primarily property
and equipment, are tested for recoverability whenever events or changes in circumstances indicate
that their carrying amount may not be recoverable. The SFAS No. 144 impairment test is a two-step
process. If the carrying value of the asset exceeds the expected future cash flows (undiscounted
and without interest) from the asset, an impairment is indicated. The impairment loss recognized
is the excess of the carrying value of the asset over its fair value.
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.*
Revenue Recognition and Deferred Costs
Sales revenues are recorded when portraits and/or other merchandise are delivered to customers. Costs
incurred relating to portraits processed pending delivery to customers, or in-process, are inventoried
and expensed when the related photographic sales revenue is recognized.
The Company offers a customer loyalty program (Smile Savers Plan®) under which a customer pays
a one-time fee and in return pays no sitting fees for unlimited portrait sessions over the twenty-four
month period covered by the program. The entire Smile Savers Plan® fee received is deferred
and amortized into revenues on a straight-line basis over the twenty-four month period of the customers
program.
Advertising Costs
The Company expenses costs associated with newspaper, magazines and other media advertising the first
time the advertising takes place. Certain direct-response advertising costs are capitalized. Direct-response
advertising consists of direct mail advertisements and certain broadcast costs. Such capitalized
costs are amortized over the expected period of future benefits following the delivery of the direct
media in which it appears.
The consolidated balance sheets include capitalized direct-response advertising costs of $914,000 and
$1.3 million at February 5, 2005 and February 7, 2004, respectively. Advertising expense for 2004,
2003, and 2002 was $30.0 million, $33.3 million, and $36.6 million, respectively.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|46
|--



|CPI CORP.Notes to Consolidated Financial Statements
Defined Benefit Plans
For purposes of its retirement plans, the Company utilizes a measurement date of December 31. At the
measurement date, plan assets are determined based on fair value. The net pension and supplemental
executive retirement benefits obligations and the related periodic costs are based on, among other
things, assumptions of the discount rate, estimated return on plan assets and salary increases. These
obligations and related periodic costs are measured using actuarial techniques and assumptions. The
actuarial cost method used to compute the pension liabilities and related expense is the projected
unit method. Market related value of assets are valued with a five-year phase-in of gains and losses
since January 1, 2001.
Income Taxes
The Company provides deferred income tax assets and liabilities based on the estimated future tax effects
of operating losses and tax credit carry forwards, as well as the differences between the financial
and tax bases of assets and liabilities based on currently enacted tax laws. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply in the years in which those
temporary differences are expected to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the period that includes the
enactment date. The tax balances and income tax expense 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.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|47
|--



|CPI CORP.Notes to Consolidated Financial Statements
Stock-based Compensation Plans
At February 5, 2005, the Company had various stock-based employee compensation plans which are described
more fully in Note 8. The Company accounts for those plans in accordance with APB No. 25, Accounting
For Stock Issued to Employees, and related Interpretations. No stock-based employee compensation
cost was 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. The following table illustrates
the effect on net earnings and earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123, Accounting for Stock-Based Compensation.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

|thousands,
      except per share data                                                                                                                                   | 2004 |         | 2003 |   | 2002  |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---- | ------- | ---- | - | ----- | -
|                                                                                                                                                                         |      |         |      |   |       |  
|Net
      (loss) earnings - as reported                                                                                                                                  | $    | (18,508 | )    | $ | 1,218 |  
|Less:
      Total stock-based employee
          compensation expense determined under fair 
          value based method for all awards, net of
          related taxes |      | (621    | )    |   | (179  | )
|                                                                                                                                                                         |      |         |      |   |       |  
|Net (loss)
      earnings - pro forma                                                                                                                                    | $    | (19,129 | )    | $ | 1,039 |  
|                                                                                                                                                                         |      |         |      |   |       |  
|(Loss) earnings
      per common share - basic                                                                                                                          
|As
      reported                                                                                                                                                        | $    | (2.35   | )    | $ | 0.15  |  
|Pro
      forma                                                                                                                                                          | $    | (2.42   | )    | $ | 0.13  |  
|                                                                                                                                                                         |      |         |      |   |       |  
|(Loss)
      earnings per common share - diluted                                                                                                                        
|As
      reported                                                                                                                                                        | $    | (2.35   | )    | $ | 0.15  |  
|Pro
      forma                                                                                                                                                          | $    | (2.42   | )    | $ | 0.13  |  

|Per Share Calculations
      Basic earnings per common share is computed by dividing net earnings or losses attributable to common shareholders by the weighted-average number of common shares outstanding for the periods presented. Diluted earnings per common share also include the dilutive effect of potential common shares (primarily dilutive stock options) outstanding during the period for the periods presented.
      Industry Segment Information
      In years prior to 2002, the Company reported results in two business segments, Portrait Studios and Technology Development. As is more fully discussed in Note 4, in the fourth quarter of 2002, the Company exited the previously-existing Technology Development segment. Accordingly, the selected industry segment information called for by SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, is no longer applicable and thus is not presented. As a result of the discontinued Technology Development segment, the Company now only operates in one segment.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|48
|--



|CPI CORP.
    Notes to Consolidated Financial Statements
  NOTE 2  RECENTLY ISSUED 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.
NOTE 3  CHANGE OF CONTROL
On November 6, 2003, Knightspoint Partners I, L.P. and other entities participating with them (Knightspoint
Group) filed with the SEC preliminary consent materials relating to the Knightspoint Groups
commencement of a solicitation of the Companys stockholders. The purpose of the consent solicitation
was to, among other things, remove seven of the nine members of the Companys Board of Directors,
decrease the size of the Board to eight directors and elect six Knightspoint Group nominees to the
Board. On January 23, 2004, the Knightspoint Group filed with the SEC definitive consent solicitation
materials. The Company also filed definitive proxy materials with the SEC on February 20, 2004 relating
to its opposition to the Knightspoint Groups consent solicitation. On March 18, 2004, the Knightspoint
Group delivered to the Company written consents. On March 24, 2004, an independent inspector certified
that the consents delivered by Knightspoint Group represented a majority of the Companys outstanding
common stock consenting to the election of the Knightspoint Groups nominees as directors of
the Company, the removal of seven of the nine members of the sitting Board and the adoption of the
Knightspoint Groups proposals included in such consents.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|49
|--



|CPI CORP.Notes to Consolidated Financial Statements
The material change in the composition of the Board resulting from the Knightspoint Groups successful
consent solicitation triggered change of control provisions in various employment and stock option
agreements between the Company and certain of its executives and employees. As a result of the change
of control, in the first quarter of 2004 the Company accrued $3.3 million related to the accelerated
vesting of executives benefits covered by the Companys supplemental retirement plan.
Throughout 2004, the Company also accrued $318,000 of guaranteed bonuses provided for in employment
contracts for those covered executives whose employment continues with the Company.
NOTE 4  DISCONTINUED OPERATIONS
Technology Development Segment
During the third quarter of fiscal 2002, management completed a review of the infrastructure and platform
from which it delivers technology development and support services. The objectives of the review
were to 1) improve focus on and support for the Companys core portraiture business, 2) improve
organizational functionality and systems flexibility, and 3) eliminate duplicative cost structures.
Consequently, during the fourth quarter of fiscal 2002, final decisions were made and implemented
regarding the elimination of the Companys separate technology segment. To achieve the aforementioned
objectives, the Company transferred the technology development activities, previously performed by
its subsidiary Centrics Technology, Inc. (Centrics), back into a newly reorganized corporate
technology function. In addition, the Company decided to no longer pursue the sale of consulting
and software development to third parties. Net revenues from such sales amounted to approximately
$636,000 in 2002.
For financial reporting purposes, in 2002 the Company classified its former Technology Development
segment as a discontinued operation. Also, through the elimination of the Companys separate
technology segment and the transfer of activities to the corporate technology function, the Company
incurred certain fourth quarter charges in 2002 related to the discontinued operations, including
approximately $537,000 in employee severance pay, $243,000 in remaining lease obligation accruals
and $266,000 in asset abandonment write-offs. The loss from discontinued operations for the Technology
Development segment recorded in 2002 was $1.1 million, net of an income tax benefit of $577,000.
Mexican and Mobile Photography Operations
During the second quarter of 2004, the Companys recently reconstituted Board of Directors made
a strategic decision to exit both the Mexican and mobile photography operations which began operations
in 2002. This decision was made to allow the Company to enhance focus on the core Sears Portrait
Studios business as well as to eliminate the ongoing operating dilution associated with these businesses.
The Company executed and completed its plan to exit both its Mexican and mobile photography operations
during the second quarter of and recorded the year-to-date combined losses on the operations of its
Mexican and mobile operations, including the loss on disposition, net of tax, of $3.7 million, as
a loss from discontinued operations. The $3.7 million loss in 2004 compares to a $4.6 million
loss from such operations in 2003 and $149,000 in 2002. The prior years operating activities
for these operations have been reclassified to discontinued operations in the accompanying Consolidated
Statements of Operations.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|50
|--



|CPI CORP.Notes to Consolidated Financial Statements
Sales and operating results for the former Mexican and mobile photography operations and the Technology
Development segment included in discontinued operations are presented in the following table:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                      | Mexican Operation              |       
|------------------------------------- | ------------------------------ | ------
|                                      |                                |       
|
|                                      |                                |       
|                                      |                                |       
|Net Sales                             | $                              | 781   
|                                      |                                |       
|                                      |                                |       
|Operating loss                        | $                              | (948  
|Loss on disposition                   |                                | (2,528
|Tax benefit                           |                                | 1,287 
|                                      |                                |       
|                                      |                                |       
|Net loss from discontinued operations | $                              | (2,189
|                                      |                                |       
|                                      |                                |       
|                                      | Mobile Photography Operation   |       
|                                      |                                |       
|thousands                             |                                | 2004  
|                                      |                                |       
|                                      |                                |       
|Net Sales                             | $                              | 1,020 
|                                      |                                |       
|Operating loss                        | $                              | (1,550
|Loss on disposition                   |                                | (921  
|Tax benefit                           |                                | 914   
|                                      |                                |       
|                                      |                                |       
|Net loss from discontinued operations | $                              | (1,557
|                                      |                                |       
|                                      |                                |       
|                                      | Technology Development Segment |       
|                                      |                                |       
|thousands                             |                                | 2004  
|                                      |                                |       
|                                      |                                |       
|Net Sales                             | $                              |      
|                                      |                                |       
|Operating loss                        | $                              |      
|Loss on disposition                   |                                |      
|Tax benefit                           |                                |      
|                                      |                                |       
|                                      |                                |       
|Net loss from discontinued operations | $                              |      
|                                      |                                |       
|                                      |                                |       
|                                      | Total Discontinued Operations  |       
|                                      |                                |       
|thousands                             |                                | 2004  
|                                      |                                |       
|                                      |                                |       
|Net Sales                             | $                              | 1,801 
|                                      |                                |       
|Operating loss                        | $                              | (2,498
|Loss on disposition                   |                                | (3,449
|Tax benefit                           |                                | 2,201 
|                                      |                                |       
|                                      |                                |       
|Net loss from discontinued operations | $                              | (3,746
|                                      |                                |       

|51
|--



|CPI CORP.Notes to Consolidated Financial Statements
The loss on disposition of the former Mexican and mobile photography operations and the Technology
Development segment consist of the following costs:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                    | Non-cash Charges |       | Accruals/Proceeds |   | Total Loss on Disposition | 
|--------------------------------------------------- | ---------------- | ----- | ----------------- | - | ------------------------- | 
|                                                    |                  |       |                   |   |                           | 
|
|                                                    |                  |       |                   |   |                           | 
|thousands                                           |                  |       |                   |   |                           | 
|Asset disposals, impairments
        and write-offs | $                | 2,136 |                   | $ | 848                       | 
|Proceeds on sale of assets                          |                  |      |                   |   |                          | 
|Lease settlements                                   |                  |      |                   |   |                          | 
|Employee severance                                  |                  |      |                   |   |                          | 
|Other                                               |                  |      |                   |   |                          | 
|                                                    |                  |       |                   |   |                           | 
|Total loss on disposition                           | $                | 2,136 |                   | $ | 848                       | 
|                                                    |                  |       |                   |   |                           | 

|There were no reserve balances related to discontinued operations included in the Companys Consolidated Balance Sheet as of February 5, 2005.
      NOTE 5  BORROWINGS
      Short-term
      There were no short-term borrowings outstanding at February 5, 2005 or February 7, 2004. 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 in February 2006 and $20 million in February 2007) unsecured bank revolving credit facility (the Revolving Facility), which will expire on April 13, 2007 and carries a variable interest rate charged at either LIBOR or prime rate funds, with an applicable margin added. 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.
      Long-term
      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%. The Company incurred $591,000 in issuance costs associated with the private placement of the notes. These costs are being amortized using the effective interest method over the ten-year life of the notes.
      The Note Agreement also requires that the Company maintain certain financial ratios and comply with certain restrictive covenants. As of February 5, 2005, the Company was in compliance with all the covenants. 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.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|52
|--



|CPI CORP.Notes to Consolidated Financial Statements
Outstanding debt obligations are as follows:
|------------------------------------------------------------------------------------------------

| | thousands                                       | February 5, 2005 |        | February 7, 2004 |  
| | ----------------------------------------------- | ---------------- | ------ | ---------------- | -
| |                                                 |                  |        |                  |  
| | Senior notes, net of unamortized issuance costs | $                | 25,630 |                  | $
| |                                                 |                  |        |                  |  
| | Less: current maturity                          |                  | 8,580  |                  |  
| |                                                 |                  |        |                  |  
| |                                                 | $                | 17,050 |                  | $
| |                                                 |                  |        |                  |  

|As of February 5, 2005, long-term debt maturities for the next three fiscal years are as follows:
|-------------------------------------------------------------------------------------------------

| | thousands                  |  
| | -------------------------- | -
| | 2005                       | $
| | 2006                       |  
| | 2007                       |  
| |                            |  
| |                            | $
| | Unamortized issuance costs |  
| |                            |  
| |                            | $
| |                            |  

|NOTE 6  STOCKHOLDERS EQUITY
      Share Repurchase Program
      On June 3, 2003, the Board of Directors authorized the Company to repurchase up to 5% of its common shares on the open market from time to time depending on market conditions. Under this authorization, the Company purchased 54,200 shares of stock for $935,000 at an average price of $17.26 during 2003. As of February 5, 2005, the Company had remaining authorization to repurchase 350,843 shares.
      In 2004, the Company purchased 406,780 shares of its common stock in a negotiated transaction. The Company paid $14.77 per share, for a total purchase price of $6.0 million.
      Shareholder Rights Plan
    In 2000, the Board of Directors renewed its Shareholders Rights Plan (Rights Plan) under which holders of CPI Corp. common stock after March 2000 are granted a dividend distribution of one right (a Right) for each share of Company common stock held. Each right entitles stockholders to buy one one-hundredth of a share of Series A Participating Preferred Stock of the Company at an exercise price of $96.00. Each preferred share fraction is designed to be equivalent in voting and dividend rights to one share of common stock.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|53
|--



|CPI CORP.Notes to Consolidated Financial Statements
The Rights will be exercisable and will trade separately from the shares of common stock only if a
person or group, with certain exceptions, acquires beneficial ownership of 20% or more of the shares
of common stock or commences a tender or exchange offer that would result in such person or group
beneficially owning 20% or more of the shares of common stock. Prior to this time, the Rights will
not trade separately from the common stock. The Company may redeem the Rights at $.001 per Right
at any time prior to the occurrence of one of these events. All Rights expire on March 13, 2010.
Each right will entitle its holders to purchase, at the Rights then-current exercise price, common
stock of CPI Corp. having a value of twice the Rights exercise price. This amounts to the right
to buy common stock of the Company at half price. Rights owned by the party triggering the exercise
of Rights will not be exercisable. In addition, if after any person has become a 20%-or-more stockholder,
the Company is involved in a merger or other business combination transaction with another person
in which its shares of common stock are exchanged or converted, or sells 50% or more of its assets
or earning power to another person, each Right will entitle its holder to purchase, at the Rights
then-current exercise price, shares of common stock of such other person having a value of twice
the Rights exercise price.
Comprehensive Income and Accumulated Other Comprehensive Loss
The following table shows the computation of comprehensive income (loss):
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|thousands                                           | 2004 |         | 2003 |   | 2002  |  
|--------------------------------------------------- | ---- | ------- | ---- | - | ----- | -
|                                                    |      |         |      |   |       |  
|                                                    |      |         |      |   |       |  
|Net (loss) earnings                                 | $    | (18,508 | )    | $ | 1,218 |  
|                                                    |      |         |      |   |       |  
|Other comprehensive (loss) income:                  |      |         |      |   |       |  
|Foreign currency translation adjustments            |      | 620     |      |   | 1,668 |  
|Minimum pension liability (1)                       |      | (1,526  | )    |   | (564  | )
|                                                    |      |         |      |   |       |  
|Total accumulated other comprehensive (loss) income |      | (906    | )    |   | 1,104 |  
|                                                    |      |         |      |   |       |  
|                                                    |      |         |      |   |       |  
|Total comprehensive (loss) income                   | $    | (19,414 | )    | $ | 2,322 |  
|                                                    |      |         |      |   |       |  

|                                                                                                                                                     
|-----------------------------------------------------------------------------------------------------------------------------------------------------
|(1) Net of tax benefit of $936, $345 and $3,506 for 2004, 2003 and 2002, respectively.                                                               
|                                                                                                                                                     
|                                                                                                                                                     
|The following table displays the components of accumulated other comprehensive loss as of February 5, 2005,


February 7, 2004 and February 1, 2003 :
|                                                                                                                                                     

|thousands                                | 2004 |        | 2003 |   | 2002  | 
|---------------------------------------- | ---- | ------ | ---- | - | ----- | 
|                                         |      |        |      |   |       | 
|                                         |      |        |      |   |       | 
|Foreign currency translation adjustments | $    | 1,585  |      | $ | 2,205 | 
|Minimum pension liability, net of taxes  |      | 8,920  |      |   | 7,394 | 
|                                         |      |        |      |   |       | 
|Accumulated other comprehensive loss     | $    | 10,505 |      | $ | 9,599 | 
|                                         |      |        |      |   |       | 

|54
|--



|CPI CORP.Notes to Consolidated Financial Statements
      NOTE 7  OTHER CHARGES AND IMPAIRMENTS
    Other charges and impairments included the following:
|----------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                          

|thousands                                                                                                                                 | 2004 |        | 2003 |   | 2002  | 
|----------------------------------------------------------------------------------------------------------------------------------------- | ---- | ------ | ---- | - | ----- | 
|                                                                                                                                          |      |        |      |   |       | 
|Recorded as a Component of Income (Loss) From Operations:                                                                                 |      |        |      |   |       | 
|Accruals related to accelerated vesting of
            supplemental retirement plan benefits 
            and guaranteed bonuses for 2004 | $    | 3,656  |      | $ |      | 
|                                                                                                                                          |      |        |      |   |       | 
|Impairment charges                                                                                                                        |      | 6,516  |      |   |      | 
|Reserves for severance and related costs                                                                                                  |      | 3,430  |      |   | 1,346 | 
|Pension plan curtailment                                                                                                                  |      |       |      |   | 2,385 | 
|Consent solicitation costs                                                                                                                |      | 816    |      |   | 1,663 | 
|Production facility closure                                                                                                               |      |       |      |   | 121   | 
|Contract terminations and settlements                                                                                                     |      | 1,261  |      |   |      | 
|                                                                                                                                          |      |        |      |   |       | 
|                                                                                                                                          |      |        |      |   |       | 
|                                                                                                                                          |      | 15,679 |      |   | 5,515 | 
|                                                                                                                                          |      |        |      |   |       | 
|Recorded as a Component of Other Expense Following Income                                                                                 |      |        |      |   |       | 
|(Loss) From Operations:                                                                                                                   |      |        |      |   |       | 
|Impairment and related obligations of preferredsecurity interest                                                                          |      | 9,789  |      |   |      | 
|                                                                                                                                          |      |        |      |   |       | 
|                                                                                                                                          |      |        |      |   |       | 
|Total Other Charges and Impairments                                                                                                       | $    | 25,468 |      | $ | 5,515 | 
|                                                                                                                                          |      |        |      |   |       | 

|Accelerated Vesting of Supplemental Retirement Plan Benefits and Guaranteed Bonuses for 2004
      In the first quarter of 2004, change of control provisions in executive employment contracts were triggered as a result of the change in the composition of the Companys Board of Directors resulting from the completion of the consent solicitation, which is more fully discussed in Note 3 in the accompanying Notes to Consolidated Financial Statements. As a result, the Company accrued $3.3 million in the first quarter related to the accelerated vesting of executives benefits covered by the Companys supplemental retirement plan and $318,000 in 2004 related to guaranteed bonuses provided for in employment contracts of those covered executives whose employment continues with the Company
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|55
|--



|CPI CORP.Notes to Consolidated Financial Statements
Impairment Charges
During the first quarter of 2004, the Companys recently reconstituted Board along with its new
management leadership in the technology function, made a decision to materially alter the Companys
previously planned and recently in-process technology platform that was to serve as the foundation
for the eventual conversion to full digital technology in the portrait studios. As a result of this
decision, certain previously capitalized software development costs related to the development of
the previous platform no longer have future utility to the Company and, accordingly, have been written
off resulting in a charge of $3.1 million.
During the second and third quarters of 2004, additional strategic decisions were made regarding the
Companys technology platform that necessitated the write-off or write-down of certain other
technology-related assets to their anticipated fair value, thus resulting in charges totaling $3.5
million.
In the third quarter of 2002, as part of the reorganization activities associated with exiting the

Companys Technology Development segment, as more fully discussed in Note 4 in the accompanying

Notes to Consolidated Financial Statements, certain strategic technology decisions were made that

either reduced or eliminated the future utility of certain historic capitalized technology development

costs necessitating a write-down or write-off of these costs, thus resulting in a charge of $4.2

million. The impacted development activities included a proprietary digital camera development
project
($2.9 million, including $2.5 million in equipment costs), a digital manufacturing system
($445,000)
and, a portion of the store automation system platform ($863,000). In the case of both
the digital
camera project and the digital manufacturing system, the Company has made the decision
to prospectively
utilize commercially available cameras and digital manufacturing software. The
Companys change
in technology direction and its decision to no longer pursue the sale of
technology services to third
parties resulted in the need to write-off a portion of its store automation
system capitalized software code.
Reserves for Severance and Related Costs
In 2004, the Company established reserves in the amount of $3.0 million for severance and related costs

consisting principally of potential benefits related to severance pay and supplemental retirement

plan costs associated with the dismissal of certain executives. In the second quarter of 2004 and

during the fourth quarters of 2003 and 2002, a number of support positions in the Companys

corporate headquarters were eliminated resulting in employee severance accruals of approximately

$457,000, $687,000 and $509,000, respectively.
*During the fourth quarter of 2003 and the third quarter of 2002, the Company recognized $659,000 and

$380,000, respectively, in expense consisting principally of severance pay and supplemental retirement

plan benefits related to the early retirement of senior executives.*
Pension Plan Curtailment
During 2003, the Company completed a comprehensive analysis of its retirement plan practices and their

projected costs, especially as they compare to other retail industries. As a result of the analysis,

on February 3, 2004 the Company implemented a freeze of future benefit accruals related to its
Retirement
Plan effective April 1, 2004, except for those employees with ten years of service and
who have attained
age 50 who were grandfathered and whose benefits will continue to accrue. The
Company incurred a
charge of $2.4 million related to the pension plan curtailment.
Consent Solicitation Costs
During the second half of 2003 and the first quarter of 2004, the Company incurred $1.7 million and
$816,000, respectively, of professional services costs related to the then-ongoing consent solicitation.
Included in the 2004 costs was $152,000 of total consent-related costs incurred by the Knightspoint
Group, which the Company has reimbursed.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|56
|--



|CPI CORP.Notes to Consolidated Financial Statements
Production Facility Closure
During the fourth quarter of 2003, the Company recorded an additional charge of $121,000 relating to

the closure of its Las Vegas manufacturing facility that occurred in the fourth quarter of 2002.

This charge resulted principally from the Companys inability to realize the expected sublease

income on the facility recorded in 2002 as an offset to the remaining lease obligation accrual.
During the fourth quarter of 2002, management completed a review of its manufacturing capacity. As

a result, the Companys Las Vegas manufacturing facility was closed. This action resulted
in
charges of approximately $407,000 in employee severance, $270,000 in accruals, net of expected
sublease
income, relating to the remaining lease obligations and $305,000 in asset abandonment
write-offs.
Contract Termination and Settlements
In March 2004, prior to the change of control, the Company received a lending commitment related to

the proposed refinancing of its then-existing debt structure. In exchange for that commitment,
the
Company paid a $200,000 non-refundable loan commitment fee. Subsequent to the receipt of the
commitment
and prior to its funding, the consent solicitation was completed resulting in the installation
of
a new Board of Directors and the lending commitment expired, necessitating the write-off of
the previously
capitalized non-refundable fee during the first quarter of 2004. In November 2004,
the Company received
a subsequent lending commitment to refinance its existing debt structure that
was withdrawn by the
lender requiring the write-off of the $100,000 non-refundable commitment fee
paid to the lender at
the time of the commitment.
During 2004, the Company recorded $961,000 of charges related to early contract terminations and settlements

with certain of the Companys vendors and consultants as a result of strategic decisions to

modify such relationships. Included in this amount is an accrual relating to the potential settlement

of a compensation claim by a former consultant to the Company. This former consultant is a relative

of the Companys Chairman of the Board.
Impairment and Related Obligations of Preferred Security Interest
The impairment and related obligations of preferred security interest represents charges recorded in
2004 related to an investment in and operating lease guarantees associated with the Companys
former Wall Décor Segment, Prints Plus, totaling $9.8 million. These charges were necessitated
by the significant deteriorating financial performance of Prints Plus during the third quarter of
2004 and are more fully discussed in Note 12 in the accompanying Notes to Consolidated Financial
Statements.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|57
|--



|CPI CORP.Notes to Consolidated Financial Statements
The following is a summary of the 2003 and 2004 activity in the reserves established in connection
with the Companys restructuring and other initiatives:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                              

|thousands                                                                           | Reserve
      Balance
      Feb. 1, 2003 |       | 2003
      Charges |   | Asset
      Write-
      Downs/
      Impairments |  | Cash
      Payments |     | Reclassify
      to
      Long-Term
      Pension
      Liability |   | Reserve
      Balance
      Feb. 7, 2004 |  
|----------------------------------------------------------------------------------- | ---------------------------------------- | ----- | ------------------ | - | ------------------------------------------------- |  | ------------------- | --- | ----------------------------------------------------------------- | - | ---------------------------------------- | -
|                                                                                    |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|Recorded
      as a component of income (loss)                                      |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|from
      operations:                                                              |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|Reserves
      for severance and related costs                                      | $                                        | 562   |                    | $ | 1,346                                             |  | $                   |    |                                                                   | $ | (1,192                                   | )
|Pension
      plan curtailment                                                      |                                          |      |                    |   | 2,385                                             |  |                     |    |                                                                   |   |                                         |  
|Consent
      solicitation costs                                                    |                                          |      |                    |   | 1,663                                             |  |                     |    |                                                                   |   | (1,196                                   | )
|Production
      facility closure                                                   |                                          | 688   |                    |   | 121                                               |  |                     | (16 | )                                                                 |   | (479                                     | )
|                                                                                    |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|                                                                                    |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|                                                                                    |                                          | 1,250 |                    |   | 5,515                                             |  |                     | (16 | )                                                                 |   | (2,867                                   | )
|                                                                                    |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|Recorded
      as a component of other expense                                      |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|following
      income (loss) from operations:                                      |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|Impairment
      and related obligations
            of preferred security interest |                                          | 1,000 |                    |   |                                                  |  |                     |    |                                                                   |   |                                         |  
|                                                                                    |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  
|Total Other
      Charges and Impairments                                           | $                                        | 2,250 |                    | $ | 5,515                                             |  | $                   | (16 | )                                                                 | $ | (2,867                                   | )
|                                                                                    |                                          |       |                    |   |                                                   |  |                     |     |                                                                   |   |                                          |  

|58
|--



|CPI CORP.Notes to Consolidated Financial Statements
|---------------------------------------------------

|thousands                                                                                                                                                       | Reserve
      Balance
      Feb. 7, 2004 |       | 2004
      Charges |       | Asset
      Write-
      Downs/
      Impairments |  | Cash
      Payments |         | Reclassify
      to Accrued
      Severance |   | Reclassify
      to
      Supplemental
      Retirement Plan
      Obligations |   | Reserve
      Balance
      Feb. 5, 2005 |       
|--------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------- | ----- | ------------------ | ----- | ------------------------------------------------- |  | ------------------- | ------- | ------------------------------------------- | - | ------------------------------------------------------------------------------ | - | ---------------------------------------- | ------
|                                                                                                                                                                |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|Recorded
      as a component of income (loss)                                                                                                                  |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|from
      operations:                                                                                                                                          |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|Accruals
      related to accelerated vesting of
              supplemental retirement
      plan 
              benefits and guaranteed
      bonuses for 2004 | $                                        |      |                    | $     | 3,656                                             |  | $                   |        |                                             | $ |                                                                               |   | $                                        | (1,326
|                                                                                                                                                                |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|Impairment
      charges                                                                                                                                        |                                          |      |                    |       | 6,516                                             |  |                     | (6,516  | )                                           |   |                                                                               |   |                                          |      
|Reserves
      for severance and related costs                                                                                                                  |                                          | 716   |                    |       | 3,430                                             |  |                     |        |                                             |   | (1,236                                                                         | ) |                                          | 1,326 
|Consent
      solicitation costs                                                                                                                                |                                          | 467   |                    |       | 816                                               |  |                     |        |                                             |   | (1,283                                                                         | ) |                                          |      
|Production
      facility closure                                                                                                                               |                                          | 314   |                    |       |                                                  |  |                     |        |                                             |   | (214                                                                           | ) |                                          |      
|Contract
      terminations and settlements                                                                                                                     |                                          |      |                    |       | 1,261                                             |  |                     |        |                                             |   | (981                                                                           | ) |                                          |      
|                                                                                                                                                                |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|                                                                                                                                                                |                                          | 1,497 |                    |       | 15,679                                            |  |                     | (6,516  | )                                           |   | (3,714                                                                         | ) |                                          |      
|                                                                                                                                                                |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|Recorded
      as a component of other expense                                                                                                                  |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|following
      income (loss) from operations:                                                                                                                  |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|Impairment
      and related obligations 
             of preferred security interest                                                                           |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|                                                                                                                                                                | 1,000                                    |       |                    | 9,789 |                                                   |  | (7,689              | )       |                                             |  |                                                                                |   |                                         |       
|                                                                                                                                                                |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       
|Total Other
      Charges and Impairments                                                                                                                       | $                                        | 2,497 |                    | $     | 25,468                                            |  | $                   | (14,205 | )                                           | $ | (3,714                                                                         | ) | $                                        |      
|                                                                                                                                                                |                                          |       |                    |       |                                                   |  |                     |         |                                             |   |                                                                                |   |                                          |       

|The reserves related to accelerated vesting of supplemental retirement plan benefits are expected to be paid according to the terms of the plan agreement as those current and former employees reach age 65. The 2004 guaranteed bonuses and reserves related to severance and related costs are expected to be paid or settled in 2005. The reserve related to the remaining lease obligation of the former Las Vegas production facility will be paid in 2005. The reserves relating to the Companys guarantee of certain retail store leases of Prints Plus are expected to be paid or settled during 2005.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|59
|--



|CPI CORP.Notes to Consolidated Financial Statements
NOTE 8  STOCK-BASED COMPENSATION PLANS
As of February 5, 2005, the Company offers a stock option and restricted stock plan, both of which
have been approved by the Companys shareholders. Expenses recognized for 2004, 2003 and 2002
with respect to the Restricted Stock Plan were $14,000, $12,000 and $14,000, respectively. No expenses
were recognized for the Stock Option Plan. Until terminated by the Board of Directors on August 14,
2003, the Company also offered a Voluntary Stock Option Plan. No expenses were recognized for the
Voluntary Stock Option Plan in 2002 or 2003.
The following descriptions reflect pertinent information with respect to the individual plans:
Stock Option Plan
The Company has an amended and restated non-qualified stock option plan, under which certain officers
and key employees may receive options to acquire shares of the Companys common stock. Awards
of stock options and the terms and conditions of such awards are subject to the discretion of the
Stock Option Committee created under the plan and consisting of members of the Compensation Committee
of the Board of Directors, all of whom are independent directors. A total of 1,700,000 shares have
been authorized for issuance under the plan. Options generally vest over three to five years and
become exercisable over the vesting period, or at the end of the vesting period. Options generally
expire in six to eight years.
In accordance with SFAS No. 123, Accounting for Stock-Based Compensation, the fair value
of each option grant is estimated on the date of grant using the Black-Scholes option pricing model
with the assumptions listed in the following table:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

|                         | 2004 |  | 2003 |         | 2002 | 
|------------------------ | ---- |  | ---- | ------- | ---- | 
|                         |      |  |      |         |      | 
|Dividend yield           |      |  |      | 2.9     | %    | 
|Stock volatility factor  |      |  |      | 24.0    | %    | 
|Risk-free interest rate  |      |  |      | 3.0     | %    | 
|Expected life of options |      |  |      | 8 years |      | 

|60
|--



|CPI CORP.Notes to Consolidated Financial Statements
Changes in stock options are as follows:
|--------------------------------------------------------------------------------------------
|                                                                                            

|                                                               | 2004 |          | 2003 |   | 2002  | 
|-------------------------------------------------------------- | ---- | -------- | ---- | - | ----- | 
|                                                               |      |          |      |   |       | 
|
|                                                               |      |          |      |   |       | 
|Beginning
      of year balance                                |      | 530,206  |      | $ | 19.17 | 
|Granted                                                        |      | 4,968    |      |   | 22.14 | 
|Cancelled
      or expired                                     |      | (239,259 | )    |   | 20.76 | 
|Exercised                                                      |      | (66,445  | )    |   | 13.29 | 
|                                                               |      |          |      |   |       | 
|End
      of year balance                                      |      | 229,470  |      | $ | 19.28 | 
|                                                               |      |          |      |   |       | 
|Reserved
      for future grant at year-end                    |      | 921,242  |      |   |       | 
|Exercisable                                                    |      | 229,470  |      | $ | 19.28 | 
|Fair value
      of options granted during 
          the year |      |          |      | $ | 4.29  | 

|The following table summarizes information about stock options outstanding at February 5, 2005:
|-----------------------------------------------------------------------------------------------
|                                                                                               

|                | Options Outstanding |  | Options Exercisable |        
|--------------- | ------------------- |  | ------------------- | -------
|                |                     |  |                     |        
|
|                |                     |  |                     |        
|$12.96 - $14.37 |                     |  |                     | 90,197 
|$15.40 - $20.45 |                     |  |                     | 51,982 
|$24.87 - $27.13 |                     |  |                     | 87,291 
|                |                     |  |                     |        
|Total           |                     |  |                     | 229,470
|                |                     |  |                     |        

|Restricted Stock Plan
The Company
has an amended and restated restricted stock plan that has 250,000 shares of CPI
Corp. common stock reserved for issuance to key employees. In 2004, 5,205
restricted shares were issued. Of these 5,205 shares 3,365 vest over a
three-year period and 1,840 shares vest over one year. Of the grants previously
awarded, no shares were forfeited in 2004, 2003 or 2002. At the Companys
annual meeting of stockholders held on July 22, 2004, the stockholders approved
an additional 100,000 shares to be reserved for issuance under the plan and
approved an amendment allowing members of the Board of Directors to become
participants in the plan. As of February 5, 2005, 202,948 shares are issued and
outstanding under this plan and 147,052 shares are reserved for issuance.
Restricted stock is valued based on the fair market value of the Companys
common stock on the grant date and the value is amortized over the vesting
period.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|61
|--



|CPI CORP.Notes to Consolidated Financial Statements
On April 14, 2005, the Board of Directors approved a grant of 34,562 shares of restricted stock
to its Chairman of the Board who has been acting in an executive officer capacity since October 6,
2004, when the Company formed its Office of the Chief Executive. The compensation award included
the grant, without restrictions, of 17,281 shares of the Companys common stock and 17,281 shares
of restricted stock that vests ratably from April 2005 through September 2005. The total fair value
of the award at the date of the grant was $519,121. The fair value of the 17,281 shares awarded,
without restrictions, amounted to $259,561, $175,000 of which represented compensation for fiscal
2004 and was recorded as such in the accompanying Consolidated Financial Statements
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|62
|--



|CPI CORP.Notes to Consolidated Financial Statements
NOTE 9  EMPLOYEE BENEFIT PLANS
|-----------------------------------------------------------------------------------
|                                                                                   

|thousands                                                                                    | 2004 |  | 2003 |       | 2002 |  
|-------------------------------------------------------------------------------------------- | ---- |  | ---- | ----- | ---- | -
|                                                                                             |      |  |      |       |      |  
|Profit sharing                                                                               |      |  | $    | 405   |      | $
|Pension plan expense                                                                         |      |  |      | 1,211 |      |  
|Pension plan curtailment loss                                                                |      |  |      |      |      |  
|Supplemental retirement plan expense                                                         |      |  |      | 524   |      |  
|Supplemental retirement plan expense -accelerated vesting from 
           change of control |      |  |      | 3,655 |      |  
|Supplemental retirement plan curtailment loss                                                |      |  |      |      |      |  
|                                                                                             |      |  |      |       |      |  
|Total                                                                                        |      |  | $    | 5,795 |      | $
|                                                                                             |      |  |      |       |      |  

|Profit Sharing
      Under the Companys profit-sharing plan, as amended and restated, eligible employees may elect to invest from 1% to 25% of their base compensation in a trust fund, the assets of which are invested in securities other than Company stock. The Company matches at 50% of the employees investment contributions, up to a maximum of 5% of the employees compensation. The Companys matching contributions are made in shares of its common stock which vest incrementally at 20% per year of service or 100% once an employee has five years of service with the Company. Expenses related to the profit-sharing plan are accrued in the year to which the awards relate, based on the fair market value of the Companys common stock to be issued, determined as of the date earned. The Company provided 27,047, 47,699 and 32,624 shares to satisfy its obligations under the plan for 2004, 2003 and 2002, respectively, and recognized $405,000, $



659,000 and $582,000 in expenses relating to the awards during those same time periods.
      Defined Benefit Plans
      The Company maintains a qualified, noncontributory pension plan that covers all full-time United States employees meeting certain age and service requirements. The plan provides pension benefits based on an employees length of service and the average compensation earned from the later of the hire date or January 1, 1998 to the retirement date. The Companys funding policy is to contribute annually at least the minimum amount required by government funding standards, but not more than is tax deductible. Plan assets consist primarily of marketable equity securities funds, guaranteed interest contracts, cash equivalents, immediate participation guarantee contracts and government bonds.
    Plan amendments effective at the beginning of fiscal 2002 increased the annual maximum compensation used to calculate benefits from $100,000 to $200,000, subject to adjustments to conform to IRS maximums. 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 have attained age 50 at April 1, 2004 who were grandfathered and whose benefits will continue to accrue. The Company recognized a curtailment loss of $2.4 million in the fourth quarter of 2003 related to this action. The current year information disclosed below includes the impact of these amendments.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|63
|--



|CPI CORP.Notes to Consolidated Financial Statements
The Company seeks to maximize returns and minimize risk of the plans investment portfolio by
diversifying the risks of the portfolio over many different industries and sectors. The targeted
allocations are indicated below. The Companys pension plan weighted average asset allocations
at December 31, 2004 and December 31, 2003, by asset category, are as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                

|                  |  |  | Plan Assets at December 31 |    
|----------------- |  |  | -------------------------- | ---
|
|
|                  |  |  |                            |    
|Equity securities |  |  |                            | 60 
|Debt securities   |  |  |                            | 40 
|                  |  |  |                            |    
|Total             |  |  |                            | 100
|                  |  |  |                            |    

|The Company uses a variety of outside sources to determine the overall expected long term rate of return on plan assets. The expectation is created based on the asset allocation assumptions noted and the selection of the most efficient blend of returns and risk characteristics. In developing this rate, assumptions were made about the number of asset classes used, expected return of each class, the associated risk inherent in the asset class and the correlation between the asset classes.
      The Company also maintains a noncontributory defined benefit plan providing supplemental retirement benefits for certain current and former key executives. The cost of providing these benefits is accrued over the remaining expected service lives of the active plan participants. Net supplemental retirement benefit costs for 2004, 2003 and 2002 were $524,000, $1.6 million and $984,000, respectively. 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 amounting to $6.1 million and $11.5 million at February 5, 2005 and February 7, 2004, respectively. In 2005, the Company expects to pay approximately $320,000 of supplemental retirement plan benefit payments from the assets of the Rabbi Trust.
      The measurement dates for the pension and supplemental executive retirement plans are December 31, 2004 and December 31, 2003, which correlate to the Companys fiscal years ended February 5, 2005 and February 7, 2004, respectively.
      The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as follows:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|thousands | Pension
      Benefits |        | Supplemental
      Benefits |  
|--------- | ---------------------- | ------ | --------------------------- | -
|          |                        |        |                             |  
|2005      | $                      | 1,900  |                             | $
|2006      |                        | 2,000  |                             |  
|2007      |                        | 2,100  |                             |  
|2008      |                        | 2,200  |                             |  
|2009      |                        | 2,400  |                             |  
|2010-2014 |                        | 13,000 |                             |  

|The Company does not expect to contribute to the pension plan in 2005.
|----------------------------------------------------------------------

|64
|--



|CPI CORP.Notes to Consolidated Financial Statements
The following table summarizes benefit obligation and plan asset activity for the retirement plans:
|-------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                |   |        
|----------------------------------------------- | - | -------
|
|                                                |   |        
|
|                                                |   |        
|
|                                                |   |        
|Projected
      benefit obligation              |   |        
|Benefit
      obligation at beginning of year   | $ | 45,307 
|Service
      cost                              |   | 745    
|Interest
      cost                             |   | 2,702  
|Actuarial
      losses (gains)                  |   | 2,785  
|Benefit
      payments                          |   | (1,641 
|Plan
      amendments                           |   |       
|Change
      of control - accelerated vesting   |   |       
|Curtailment
      adjustment                    |   |       
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|Benefit
      obligation at end of year (1) (2) | $ | 49,898 
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|Fair value
      of plan assets                 |   |        
|Fair
      value at beginning of year           | $ | 31,546 
|Actual
      return on plan assets              |   | 2,507  
|Employer
      contributions (3)                |   |       
|Benefit
      payments                          |   | (1,641 
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|Fair
      value at end of year                 | $ | 32,412 
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|Funded
      status                             |   |        
|Funded
      status at end of year              | $ | (17,486
|Unrecognized
      transition obligation        |   |       
|Unrecognized
      prior service cost           |   | 221    
|Unrecognized
      net loss (gain)              |   | 15,954 
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|Net
      amount recognized                     | $ | (1,311 
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|Components
      of consolidated balance sheet  |   |        
|Accrued
      benefit liability                 | $ | (15,890
|Intangible
      asset                          |   | 221    
|Accumulated
      other comprehensive loss      |   | 14,358 
|                                                |   |        
|                                                |   |        
|                                                |   |        
|                                                |   |        
|Net
      amount recognized                     | $ | (1,311 
|                                                |   |        

|   
|---
|(1)
|   
|(2)
|   
|(3)

|65
|--



|CPI CORP.Notes to Consolidated Financial Statements
The following table sets forth the components of net periodic benefit cost for the retirement plans:
|--------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                        

|                                                 | Pension Plan |        | Supplemental Retirement Plan |  
|------------------------------------------------ | ------------ | ------ | ---------------------------- | -
|                                                 |              |        |                              |  
|
|                                                 |              |        |                              |  
|Components of net periodic benefit cost          |              |        |                              |  
|Service cost                                     | $            | 745    |                              | $
|Interest cost                                    |              | 2,702  |                              |  
|Expected return on plan assets                   |              | (2,934 | )                            |  
|Amortization of transition obligation            |              |       |                              |  
|Amortization of prior service cost               |              | 44     |                              |  
|Amortization of net loss                         |              | 654    |                              |  
|Change of control - accelerated vesting          |              |       |                              |  
|Net loss due to settlements                      |              |       |                              |  
|Curtailment reduction in transition obligation   |              |       |                              |  
|                                                 |              |        |                              |  
|Net periodic benefit cost                        |              | 1,211  |                              |  
|Curtailment loss                                 |              |       |                              |  
|                                                 |              |        |                              |  
|Net periodic benefit cost after curtailment loss | $            | 1,211  |                              | $
|                                                 |              |        |                              |  

|The following table sets forth the weighted-average plan assumptions and other data:
|------------------------------------------------------------------------------------
|                                                                                    

|                                                                                                 | Pension
      Plan |      | Supplemental
      Retirement Plan | 
|------------------------------------------------------------------------------------------------ | ------------------ | ---- | ---------------------------------- | 
|                                                                                                 |                    |      |                                    | 
|
|                                                                                                 |                    |      |                                    | 
|Weighted-average
      assumprions used to determinebenefit
      obligations at fiscal year end |                    |      |                                    | 
|Discount rate                                                                                    |                    | 5.75 | %                                  | 
|Rate
      of increase in future compensation                                                    |                    | 3.75 | %                                  | 
|Weighted-average
      assumprions used to determine                                             |                    |      |                                    | 
|net
      periodic benefit cost                                                                  |                    |      |                                    | 
|Discount
      rate                                                                              |                    | 5.75 | %                                  | 
|Expected
      long-term return on plan assets                                                   |                    | 8.75 | %                                  | 
|Rate
      of increase in future compensation                                                    |                    | 3.75 | %                                  | 

|66
|--



|CPI CORP.Notes to Consolidated Financial Statements
    The following table provides the required information for the pension plan and supplemental retirement plan as in both cases benefit obligations are in excess of plan assets:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                      

|                               | Pension Plan |  | Supplemental Retirement Plan |       
|------------------------------ | ------------ |  | ---------------------------- | ------
|
|
|                               |              |  |                              |       
|Projected benefit obligation   |              |  | $                            | 49,898
|Accumulated benefit obligation |              |  |                              | 48,303
|Fair value of plan assets      |              |  |                              | 32,412

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The Company also maintains a noncontributory pension plan that covers all Canadian employees meeting
certain service requirements. The plan provides pension benefits based on an employees length
of service and annual compensation earned. The Company contributed approximately $385,000 and $252,000
to this retirement plan in calendar 2004 and 2003, respectively. Plan assets were $1.7 million as
of December 31, 2004 and $1.3 million as of December 31, 2003, and consisted of several Canadian
equity and fixed income funds and a global equity fund. No liability is reflected in the Companys
consolidated financial statements as the plan is fully funded.
  NOTE 10 INCOME TAXES
The total income tax (benefit) provision is summarized in the following table:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

|thousands                            | 2004 |  | 2003 |        | 2002 |  
|------------------------------------ | ---- |  | ---- | ------ | ---- | -
|                                     |      |  |      |        |      |  
|Total income tax (benefit) provision |      |  |      |        |      |  
|Continuing operations                |      |  | $    | (2,189 | )    | $
|Discontinued operations              |      |  |      | (2,201 | )    |  
|                                     |      |  |      |        |      |  
|Total income tax (benefit) provision |      |  | $    | (4,390 | )    | $
|                                     |      |  |      |        |      |  

|                                                                                
|--------------------------------------------------------------------------------
|The components of income tax expense (benefits) from continuing operations were:
|                                                                                

|thousands                            | 2004 |  | 2003 |        | 2002 |  
|------------------------------------ | ---- |  | ---- | ------ | ---- | -
|                                     |      |  |      |        |      |  
|Federal                              |      |  |      |        |      |  
|Current                              |      |  | $    | 2,801  |      | $
|Deferred                             |      |  |      | (5,121 | )    |  
|                                     |      |  |      |        |      |  
|Federal income tax                   |      |  |      | (2,320 | )    |  
|                                     |      |  |      |        |      |  
|State                                |      |  |      |        |      |  
|Current                              |      |  |      | 276    |      |  
|Deferred                             |      |  |      | (648   | )    |  
|                                     |      |  |      |        |      |  
|State income tax                     |      |  |      | (372   | )    |  
|                                     |      |  |      |        |      |  
|Foreign                              |      |  |      |        |      |  
|Current                              |      |  |      | 387    |      |  
|Deferred                             |      |  |      | 116    |      |  
|                                     |      |  |      |        |      |  
|Foreign income tax                   |      |  |      | 503    |      |  
|                                     |      |  |      |        |      |  
|Total income tax provision (benefit) |      |  | $    | (2,189 | )    | $
|                                     |      |  |      |        |      |  

|67
|--



|CPI CORP.Notes to Consolidated Financial Statements                                                                                                   
|------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                      
|A reconciliation of expected income tax expense at the federal statutory rate of 34% to the Companys
applicable income tax expense (benefit) follows:
|                                                                                                                                                      

|thousands                                   | 2004 |  | 2003 |        | 2002 |  
|------------------------------------------- | ---- |  | ---- | ------ | ---- | -
|                                            |      |  |      |        |      |  
|Tax at statutory rate                       |      |  | $    | (5,763 | )    | $
|State income tax, at statutory rate, net of |      |  |      | (246   | )    |  
|federal tax benefit                         |      |  |      |        |      |  
|Tax effect of:                              |      |  |      |        |      |  
|Nondeductible expenses                      |      |  |      | 270    |      |  
|Tax credits and exclusions                  |      |  |      | (562   | )    |  
|Officers life insurance                     |      |  |      | 784    |      |  
|Valuation allowance                         |      |  |      | 3,296  |      |  
|Foreign taxes                               |      |  |      | 260    |      |  
|Tax settlements                             |      |  |      | (228   | )    |  
|Other items                                 |      |  |      |       |      |  
|                                            |      |  |      |        |      |  
|Applicable income taxes (benefit)           |      |  | $    | (2,189 | )    | $
|                                            |      |  |      |        |      |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|In preparing its tax return, the Company is required to interpret complex tax laws and regulations and utilize income and cost allocation methods to determine its taxable income. On an ongoing basis, the Company is subject to examination by federal, state and foreign taxing authorities that may give rise to differing interpretation of the complex laws, regulations and methods. Due to the nature of the examination process, it generally takes years before these examinations are completed and matters are resolved. As of February 5, 2005, the Company is under examination for its federal tax return filed for fiscal years 2000-2002. In addition, examinations by various state taxing authorities date back to fiscal 1997. At February 5, 2005, the Company had recorded a current payable and an adjustment to certain long-term deferred tax assets to reflect the agreement with the Internal Revenue Service related to certain temporary differences.




 In addition, the Company has accrued interest expense that is expected to be assessed by the Service. At February 5, 2005, the Company believes that the aggregate amount of any additional tax liabilities that may arise from other examinations by taxing authorities, if any, will not have a material adverse effect on the financial condition, results of operations or cash flows of the Company.
    Deferred income tax assets and liabilities reflect the tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for the same items for income tax reporting purposes.

|68
|--



|CPI CORP.Notes to Consolidated Financial Statements                                                      
|---------------------------------------------------------------------------------------------------------
|                                                                                                         
|The components of the Companys net deferred tax assets as of February 5, 2005 and February 7,
2004 were:
|                                                                                                         

|thousands                                                              | 2004 |  | 2003 |       
|---------------------------------------------------------------------- | ---- |  | ---- | ------
|                                                                       |      |  |      |       
|Deferred tax assets                                                    |      |  |      |       
|Federal, state and foreign operating loss carry forwards               |      |  | $    | 15,659
|Pension and supplemental retirement benefits                           |      |  |      | 7,568 
|Reserves, principally due to accrual for financial reporting purposes  |      |  |      | 5,527 
|Revenue recognition, principally due to SAB 101                        |      |  |      | 773   
|Federal and foreign tax credit carry forwards                          |      |  |      | 3,475 
|                                                                       |      |  |      |       
|Gross deferred tax assets                                              |      |  |      | 33,002
|Deferred tax liabilities                                               |      |  |      |       
|Property and equipment, principally due to differences in depreciation |      |  |      | (8,697
|Other                                                                  |      |  |      | (87   
|                                                                       |      |  |      |       
|Gross deferred tax liabilities                                         |      |  |      | (8,784
|Valuation allowance                                                    |      |  |      | (3,689
|                                                                       |      |  |      |       
|                                                                       |      |  |      |       
|Net deferred tax asset                                                 |      |  | $    | 20,529
|                                                                       |      |  |      |       

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|As of February 5, 2005, the Company had available approximately $33.6 million in U.S. federal net operating loss carry forwards which expire beginning in 2023 and $7.0 million in capital loss carry forwards which expire in 2009. Also, the Company had available approximately $1.0 million of foreign tax credit carry forwards which expire in tax years 2012 and 2013 and $2.4 million of tax credit carry forwards which expire beginning in 2023.
      The Company regularly assesses the likelihood that deferred tax assets will be recovered through future taxable income. To the extent, the Company believes that it is more likely than not that a deferred tax asset will not be realized, a valuation allowance is established. At February 5, 2005, the Company had a valuation allowance of approximately $3.7 million to fully reserve for deferred tax assets related to foreign tax credit carry forwards and capital loss carry forwards which are expected to expire unused. Its managements belief that the remaining deferred tax asset meet the criteria for realization, including the existence of a history of taxes paid sufficient to support the realization of deferred tax assets.
      Undistributed earnings of the Companys Canadian subsidiary were approximately $8.6 million at February 5, 2005. The American Jobs Creation Act (AJCA) was enacted on October 22, 2004. The AJCA created a temporary incentive for U.S. multinationals to repatriate accumulated earnings outside the United States by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. The Company may elect to apply this provision to qualifying earnings repatriations in either fiscal year ended 2005 or 2006. As of February 5. 2005, the Company has not provided deferred taxes on foreign earnings because the determination of unrecognized deferred U.S. tax liability for undistributed earnings of international subsidiaries is not practicable. However, it is estimated that foreign withholding taxes of $430,000 may be payable if such earnings were distributed. Due to the complexity of the repatriat




ion provision, the Company is still evaluating the effects of this provision on its plan for repatriation of foreign earnings and does not expect to be able to complete this evaluation until after the Congress or the Treasury Department provides additional guidance clarifying key elements of the provision.

|69
|--



|CPI CORP.
    Notes to Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|NOTE 11  COMMITMENTS AND CONTINGENCIES
  Operating Lease Commitments
The Company leases various premises and equipment under noncancellable operating lease agreements with
initial terms in excess of one year and expiring at various dates through fiscal year 2009. The leases
generally provide for the lessee to pay maintenance, insurance, taxes and certain other operating
costs of the leased property. In addition to the minimum rental commitments, certain of these operating
leases provide for contingent rentals based on a percentage of revenues in excess of specified amounts.
Rental expense during 2004, 2003, and 2002 on all operating leases was $1.8 million, $1.9 million,
and $3.3 million, respectively.
Minimum rental payments under operating leases with initial terms in excess of one year at February
5, 2005, are as follows:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

|2005                   |  |  | $ | 1,238 | 
|---------------------- |  |  | - | ----- | 
|2006                   |  |  |   | 723   | 
|2007                   |  |  |   | 354   | 
|2008                   |  |  |   | 79    | 
|2009                   |  |  |   | 11    | 
|                       |  |  |   |      
|Total minimum payments |  |  | $ | 2,405 | 
|                       |  |  |   |      

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Standby Letters of Credit
      As of February 5, 2005, the Company had standby letters of credit outstanding in the principal amount of $6.2 million used in conjunction with the Companys self-insurance programs. These letters of credit are collateralized by cash on deposit at the issuing bank in the amount of $6.2 million.
      Purchase Commitments
      As of February 5, 2005, the Company had outstanding purchase commitments for goods and services of $9.2 million.
      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 February 5, 2005, the maximum future obligation to the Company under its guarantee of these leases is $5.2 million. To recognize the risk associated with these leases and based upon the Companys past experience with renegotiating lease obligations, a $1.0 million reserve was established in 2001 at time of the sale. As a result of the significant deterioration in the financial performance of Prints Plus in the third quarter of 2004, including its subsequent bankruptcy filing, all of which is more fully described in Note 12 to the Consolidated Financial Statements, the Company recorded an additional $2.1 million of lease obligation reserves bringing the total reserve at February 5, 2005 to $3.1 million. Based on the progress of the bankruptcy




case to-date and the continued operations of selected locations of Prints Plus, the Company believes that the $3.1 million reserve is adequate to cover the potential losses to be realized under the Companys operating lease guarantees.

|70
|--



|CPI CORP.Notes to Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Contingent Commission Payments
  On August 14, 2003, the Company announced the execution of an amendment with Sears eliminating the
then-existing exclusivity provisions from that agreement. 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 2004 or 2003
and thus no Contingent Payments were made in either year.
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 lawsuits will not
materially affect the consolidated financial position or results of operations of the Company.
NOTE 12  ASSETS OF BUSINESS TRANSFERRED UNDER CONTRACTUAL ARRANGEMENTS
Since the completion of the sale of its former Wall Décor segment (Prints Plus) in 2001 to Prints
Plus former management, the Company has had a continuing financial interest in Prints Plus.
This continuing financial interest is represented by a preferred security carrying a 9% annual dividend
rate, a secured revolving line of credit to Prints Plus, and operating lease guarantees related to
certain of Prints Plus retail store locations.
The Preferred Security was initially valued at $11.0 million at the date of the sale of Prints Plus
and through voluntary redemptions has been paid down to $7.0 million at February 5, 2005. Further,
the outstanding balance on the secured revolving line of credit was paid in full from proceeds of
holiday season cash receipts of Prints Plus resulting in no outstanding advances at February 5, 2005.
As of February 5, 2005, the maximum future obligations to the Company under it lease guarantees is
$5.2 million, before any landlord negotiations or subleasing.
The operating performance of Prints Plus significantly deteriorated during its quarter ended November
13, 2004 and subsequent thereto. As a result, during the third quarter of 2004, the Company determined
that it was probable that the remaining carrying value of the Preferred Security at November 13,
2004 ($7.0 million) and the related accrued dividends ($544,000) will not be recoverable. In addition,
it is likely that the Company will incur a liability related to its ongoing guarantees of certain
of Prints Plus operating leases. Accordingly at November 13, 2004, the Company recorded an
additional $2.1 million in accrued lease liability obligations relating to its lease guarantees.
During the fourth quarter of 2004, the Company also established a reserve related to the additional
fourth quarter dividends accrued relating to the Preferred Security in the amount of $145,000. Accordingly,
as of February 5, 2005, the Company has recorded an impairment reserve of approximately $7.7 million
related to the Preferred Security and related dividends and $3.1 million in accrued lease liability
obligations relating to its lease guarantees. The amount advanced under its secured revolving line
of credit was paid in full during the fourth quarter of 2004 and the underlying agreement was terminated.

|71
|--



|CPI CORP.Notes to Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|During the Companys fourth quarter, Prints Plus filed a voluntary petition for relief in the
  United States Bankruptcy Court for the District of Massachusetts under Chapter 11 of the United States
  Bankruptcy Code. At February 5, 2005, based upon an analysis of the Companys exposure under
  the operating lease guarantees, taking into account the progress of the bankruptcy case to date including
  those leases rejected in bankruptcy, the Company believes it has accrued sufficient liabilities for
  obligations under these operating leases. If successful in its reorganization efforts, Prints Plus
  is not expected to emerge from its Chapter 11 reorganization until at least mid-2005.
  NOTE 13 FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates are made at a specific point in time, based on relevant market information and
information about the financial instrument. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
Cash and Cash Equivalents, Receivables, Accounts Payable and Accrued Expenses
The carrying amounts approximate fair value at February 5, 2005 and February 7, 2004 due to the short
maturity of these financial instruments.
Long-Term Debt
The fair value of the Companys long-term debt is estimated based on quoted market prices for
similar debt issues with the similar remaining maturities. On February 5, 2005, the carrying value
and estimated fair market value of the Companys long-term debt was $25.7 million and $26.8
million, respectively. On February 7, 2004, the carrying value and estimated fair market value of
the Companys debt was $34.2 million and $34.6 million, respectively.

|72
|--



|CPI CORP.Notes to Consolidated Financial Statements    
|-------------------------------------------------------
|                                                       
|NOTE 14  SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
|                                                       

|thousands, except per share data                 |  |  |   |        |   |   |        |  
|------------------------------------------------ |  |  | - | ------ | - | - | ------ | -
|
|
|                                                 |  |  |   |       
|Net sales                                        |  |  | $ | 54,925 |   | $ | 48,621 |  
|Gross margin                                     |  |  |   | 47,234 |   |   | 41,950 |  
|Net (loss) earnings from continuing operations   |  |  |   | (7,649 | ) |   | (6,519 | )
|Net (loss) earnings from discontinued operations |  |  |   | (1,149 | ) |   | (2,588 | )
|Net (loss) earnings                              |  |  |   | (8,798 | ) |   | (9,107 | )
|                                                 |  |  |   |        |   |   |        |  
|Net (loss) earnings per share from continuing    |  |  |   |        |   |   |        |  
|operations - diluted                             |  |  | $ | (0.95  | ) | $ | (0.82  | )
|Net (loss) earnings per share from discontinued  |  |  |   |        |   |   |        |  
|operations - diluted                             |  |  | $ | (0.14  | ) | $ | (0.32  | )
|Net (loss) earnings per share - diluted          |  |  | $ | (1.09  | ) | $ | (1.14  | )
|                                                 |  |  |   |        |   |   |        |  
|Net (loss) earnings per share from continuing    |  |  |   |        |   |   |        |  
|operations - basic                               |  |  | $ | (0.95  | ) | $ | (0.82  | )
|Net (loss) earnings per share from discontinued  |  |  |   |        |   |   |        |  
|operations - basic                               |  |  | $ | (0.14  | ) | $ | (0.32  | )
|Net (loss) earnings per share - basic            |  |  | $ | (1.09  | ) | $ | (1.14  | )
|                                                 |  |  |   |        |   |   |        |  
|Weighted average number of common and            |  |  |   |        |   |   |        |  
|equivalent shares - diluted                      |  |  |   | 8,101  |   |   | 7,988  |  
|Weighted average number of common and            |  |  |   |        |   |   |        |  
|equivalent shares - basic                        |  |  |   | 8,101  |   |   | 7,988  |  

|
|

|                                                       | QUARTER
      ENDED: |       
|------------------------------------------------------ | -------------------- | ------
|
|                                                       |                      |       
|Net
      sales                                        | $                    | 56,180
|Gross margin                                           |                      | 48,357
|Net
      (loss) earnings from continuing operations   |                      | (2,277
|Net (loss)
      earnings from discontinued operations |                      | (453  
|Net
      (loss) earnings                              |                      | (2,730
|                                                       |                      |       
|Net (loss)
      earnings per share from continuing    |                      |       
|operations
      - diluted                             | $                    | (0.28 
|Net
      (loss) earnings per share from discontinued  |                      |       
|operations - diluted                                   | $                    | (0.06 
|Net (loss)
      earnings per share - diluted          | $                    | (0.34 
|                                                       |                      |       
|Net
      (loss) earnings per share from continuing    |                      |       
|operations - basic                                     | $                    | (0.28 
|Net (loss)
      earnings per share from discontinued  |                      |       
|operations
      - basic                               | $                    | (0.06 
|Net
      (loss) earnings per share - basic            | $                    | (0.34 
|                                                       |                      |       
|Weighted
      average number of common and equivalent |                      |       
|shares
      - diluted                                 |                      | 8,101 
|Weighted
      average number of common and equivalent |                      |       
|shares - basic                                         |                      | 8,101 

|73
|--



|Item 9.        Change in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
Item 9A.     Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
As of the end of the period covered by this report, management, including members of the Office of
the Chief Executive and our Chief Financial Officer, evaluated the effectiveness of the design and
operation of our disclosure controls and procedures with respect to the information generated for
use in this annual report. The evaluation was based in part upon reports and affidavits provided
by a number of executives. Based upon, and as of the date of that evaluation, members of the Office
of the Chief Executive and our Chief Financial Officer concluded that the disclosure controls and
procedures were effective to provide reasonable assurances that information required to be disclosed
in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the Commissions rules and forms.
There was no change in our internal control over financial reporting during 2004 that has materially
affected, or is reasonably likely to materially affect, our internal control over financial reporting.
In designing and evaluating the disclosure controls and procedures, our management recognized that
any controls and procedures, no matter how well designed and operated, can provide only reasonable,
not absolute, assurance of achieving the desired control objectives and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of possible controls and
procedures. Based upon the above evaluation, CPIs management believes that its controls do
provide such reasonable assurance.
Managements Report on Internal Control Over Financial Reporting
CPIs management is responsible for establishing and maintaining adequate internal control over
financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended).
Our internal control system was designed to provide reasonable assurance to CPIs management
and board of directors regarding the preparation and fair presentation of published financial statements.
CPIs management has assessed the effectiveness of our internal control over financial reporting
as of February 5, 2005. In making this assessment, we used the criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated
Framework. Based on managements assessment utilizing these criteria we believe that, as of
February 5, 2005, our internal control over financial reporting was effective. Our independent auditors,
KPMG, LLP have audited managements assessment of our internal control over financial reporting
as stated in their report on pages 36 and 37.
Item 9B.     Other Information
Not
Applicable.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|74
|--



|PART III                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Item 10.                  Directors
and Executive Officers of the Registrant
  Information required under this Item will be contained in the Registrants 2004 Proxy Statement

to be filed with the SEC within 120 days of the end of the Registrants fiscal year 2004 and

is incorporated herein by reference and will be delivered to stockholders in connection with the

Annual Shareholders meeting to be held on June 23, 2005.
Item 11.                 
Executive Compensation
Information required under this Item will be contained in the Registrants 2004 Proxy Statement

to be filed with the SEC within 120 days of the end of the Registrants fiscal year 2004 and

is incorporated herein by reference and will be delivered to stockholders in connection with the

Annual Shareholders meeting to be held on June 23, 2005.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

|Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|-------- | ----------------------------------------------------------------------------------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Information required under this Item will be contained in the Registrants 2004 Proxy Statement

to be filed with the SEC within 120 days of the end of the Registrants fiscal year 2004 and

is incorporated herein by reference and will be delivered to stockholders in connection with the

Annual Shareholders meeting to be held on June 23, 2005.
Item 13.                  Certain
Relationships and Related Transactions
Information required under this Item will be contained in the Registrants 2004 Proxy Statement

to be filed with the SEC within 120 days of the end of the Registrants fiscal year 2004 and

is incorporated herein by reference and will be delivered to stockholders in connection with the

Annual Shareholders meeting to be held on June 23, 2005.
Item 14.                  Principal
Accounting Fees and Services
Information required under this Item will be contained in the Registrants 2004 Proxy Statement,
to be filed with the SEC within 120 days of the end of the Registrants fiscal year 2004 and
is incorporated herein by reference and will be delivered to stockholders in connection with the
Annual Shareholders meeting to be held on June 23, 2005.

|75
|--



|PART IV                                                                                                                
|-----------------------------------------------------------------------------------------------------------------------
|                                                                                                                       
|Item 15.                  Exhibits
and Financial Statement Schedules
  (a) CERTAIN DOCUMENTS FILED AS PART OF FORM 10-K
|                                                                                                                       

|(1.) | FINANCIAL STATEMENTS                                          |  |  | PAGES |  | 
|---- | ------------------------------------------------------------- |  |  | ----- |  | 
|     |                                                               |  |  |       |  | 
|     | -    Reports of Independent Registered Public Accounting Firm |  |  | 35-37 |  | 
|     | -    Consolidated Balance Sheets as of                        |  |  |       |  | 
|     | February 5, 2005 and February 7, 2004                         |  |  | 38-39 |  | 
|     | -    Consolidated Statements of Operations for                |  |  |       |  | 
|     | the fiscal years ended February 5, 2005,                      |  |  |       |  | 
|     | February 7, 2004 and February 1, 2003                         |  |  | 40    |  | 
|     | -    Consolidated Statements of Changes in                    |  |  |       |  | 
|     | Stockholders Equity for the fiscal years ended               |  |  |       |  | 
|     | February 5, 2005, February 7, 2004 and February 1, 2003       |  |  | 41    |  | 
|     | -    Consolidated Statements of Cash Flows for                |  |  |       |  | 
|     | the fiscal years ended February 5, 2005,                      |  |  |       |  | 
|     | February 7, 2004 and February 1, 2003                         |  |  | 42-43 |  | 
|     | -    Notes to Consolidated Financial Statements               |  |  | 44-73 |  | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2.)  FINANCIAL STATEMENT SCHEDULES
      Schedules to the consolidated financial statements required by Regulation S-X are omitted since the required information is included in the footnotes.
      (3.) EXHIBITS FILED UNDER ITEM 601 OF REGULATION S-K
    The exhibits to this Annual Report on Form 10-K are listed on the accompanying index and are incorporated herein by reference or are filed as part of this Annual Report on Form 10-K.

|76
|--



|(a) EXHIBIT INDEX
|-----------------
|EXHIBIT INDEX    
|                 

|                   | 
|------------------ | 
|**EXHIBIT
NUMBER** | 
|                   | 
|                   | 
|(3.1)              | 
|                   | 
|(3.2)              | 
|                   | 
|(3.4)              | 
|                   | 
|(3.5)              | 
|                   | 
|(3.6)              | 
|                   | 
|(3.7)              | 
|                   | 
|(3.8)              | 
|                   | 
|(3.9)              | 
|                   | 
|(3.10)             | 
|                   | 
|(3.11)             | 
|                   | 
|(4.1)              | 
|                   | 
|(4.2)              | 
|                   | 
|(4.3)              | 
|                   | 
|(4.4)              | 
|                   | 
|(4.5)              | 

|77
|--



| |  | EXHIBIT INDEX (Continued)
| |  | -------------------------
| |  |                          

|                       | 
|---------------------- | 
|**EXHIBIT
    NUMBER** | 
|                       | 
|                       | 
|(10.1)                 | 
|                       | 
|(10.6)                 | 
|                       | 
|(10.7)                 | 
|                       | 
|(10.8)                 | 
|                       | 
|(10.9)                 | 
|                       | 
|(10.10)                | 
|                       | 
|(10.11)                | 
|                       | 
|(10.12)                | 
|                       | 
|(10.13)                | 
|                       | 
|(10.14)                | 
|                       | 
|(10.15)                | 
|                       | 
|(10.16)*               | 
|                       | 
|(10.17)*               | 
|                       | 
|(10.18)*               | 
|                       | 
|(10.19)*               | 

|78
|--



|                       | 
|---------------------- | 
|                       | 
|                       | 
|**EXHIBIT
    NUMBER** | 
|                       | 
|                       | 
|(10.20)*               | 
|                       | 
|(10.21)*               | 
|                       | 
|(10.22)*               | 
|                       | 
|(10.23)*               | 
|                       | 
|(10.24)*               | 
|                       | 
|(10.25)*               | 
|                       | 
|(10.26)*               | 
|                       | 
|(10.27)                | 
|                       | 
|(10.28)                | 
|                       | 
|(10.29)                | 
|                       | 
|(10.30)                | 
|                       | 
|(10.31)                | 
|                       | 
|(10.32)                | 

|79
|--



| |  | EXHIBIT INDEX (Continued)
| |  | -------------------------
| |  |                          

|                       | 
|---------------------- | 
|**EXHIBIT
    NUMBER** | 
|                       | 
|                       | 
|(10.33)                | 
|                       | 
|(10.34)                | 
|                       | 
|(10.35)                | 
|                       | 
|(10.36)                | 
|                       | 
|(10.37)                | 
|                       | 
|(10.38)                | 
|                       | 
|(10.39)                | 
|                       | 
|(10.40)                | 
|                       | 
|(10.41)                | 
|                       | 
|(10.42)*               | 
|                       | 
|(10.43)                | 
|                       | 
|(10.44)                | 
|                       | 
|(10.45)                | 

|80
|--



| |  | EXHIBIT INDEX (Continued)
| |  | -------------------------
| |  |                          

|                         | 
|------------------------ | 
|**EXHIBIT
      NUMBER** | 
|                         | 
|                         | 
|(10.46)                  | 
|                         | 
|(10.47)                  | 
|                         | 
|(10.48)                  | 
|                         | 
|(10.49)                  | 
|                         | 
|(10.50)*                 | 
|                         | 
|(10.51)                  | 
|                         | 
|(10.52)                  | 
|                         | 
|(10.53)                  | 
|                         | 
|(10.54)                  | 
|                         | 
|(10.55)*                 | 
|                         | 
|(10.56)                  | 
|                         | 
|(10.57)                  | 
|                         | 
|(10.58)*                 | 
|                         | 
|(10.59)*                 | 

|81
|--



| |  | EXHIBIT INDEX (Continued)
| |  | -------------------------
| |  |                          

|                         | 
|------------------------ | 
|**EXHIBIT
      NUMBER** | 
|                         | 
|                         | 
|(10.60)                  | 
|                         | 
|(10.61)                  | 
|                         | 
|(10.62)                  | 
|                         | 
|(10.63)*                 | 
|                         | 
|(10.64)                  | 
|                         | 
|(10.65)                  | 
|                         | 
|(10.66)                  | 
|                         | 
|(10.67)                  | 
|                         | 
|(10.68)                  | 
|                         | 
|(10.69)                  | 
|                         | 
|(10.70)                  | 
|                         | 
|(10.71)                  | 
|                         | 
|(10.72)                  | 

|82
|--



| |  | EXHIBIT INDEX (Continued)
| |  | -------------------------
| |  |                          

|                                                                                                                                         | 
|---------------------------------------------------------------------------------------------------------------------------------------- | 
|**EXHIBIT
      NUMBER**                                                                                                                 | 
|                                                                                                                                         | 
|                                                                                                                                         | 
|(10.73)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.74)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.75)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.76)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.77)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.78)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.79)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.80)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.81)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.82)                                                                                                                                  | 
|                                                                                                                                         | 
|(10.83)                                                                                                                                  | 
|                                                                                                                                         | 
|* Employment contract is automatically renewed and extended for one year unless terminated by the Board of    Directors of the employee.

|83
|--



| |  | EXHIBIT INDEX (Continued)
| |  | -------------------------
| |  |                          

|                         | 
|------------------------ | 
|**EXHIBIT
      NUMBER** | 
|                         | 
|                         | 
|(10.84)                  | 
|                         | 
|(10.85)                  | 
|                         | 
|(10.86)                  | 
|                         | 
|(10.87)                  | 
|                         | 
|(10.88)                  | 
|                         | 
|(10.89)                  | 
|                         | 
|(10.90)                  | 
|                         | 
|(10.91)                  | 
|                         | 
|(10.92)                  | 
|                         | 
|(10.93)                  | 
|                         | 
|(10.94)                  | 
|                         | 
|(10.95)                  | 
|                         | 
|(11.1)                   | 
|                         | 
|(11.2)                   | 

|84
|--



| |  | EXHIBIT INDEX (Continued)
| |  | -------------------------
| |  |                          

|                         |                                                        
|------------------------ | -------------------------------------------------------
|**EXHIBIT
      NUMBER** |                                                        
|                         |                                                        
|                         |                                                        
|(14.0)                   |                                                        
|                         |                                                        
|(21.0)                   |                                                        
|                         |                                                        
|(23.0)                   |                                                        
|                         |                                                        
|(31.1)                   |                                                        
|                         |                                                        
|(31.2)                   |                                                        
|                         |                                                        
|(31.3)                   |                                                        
|                         |                                                        
|(32.0)                   |                                                        
|                         |                                                        
|                         |                                                        
|(b)                      | FINANCIAL STATEMENT SCHEDULE REQUIRED BY REGULATION S-X
|                         |                                                        
|                         | See Item 15(a)(2)                                     

|85
|--



|SIGNATURES
      Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 21st day of April 2005.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                               

| | CPI CORP.
| | ---------
| |          
| | BY:      
| |          
| |          
| |          
| |          

|                                                                                                                                                                                            
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.
|                                                                                                                                                                                            

|SIGNATURES OF DIRECTORS AND PRINCIPAL OFFICERS |  |                                
|---------------------------------------------- |  | -------------------------------
|                                               |  |                                
|                                               |  | **Signature**                  
|                                               |  |                                
|                                               |  |                                
|/s/                                            |  | David M. Meyer                 
|                                               |  | and Member of the Office of the
|                                               |  | (David M. Meyer)               
|                                               |  |                                
|/s/                                            |  | James J. Abel                  
|                                               |  |                                
|                                               |  | (James J. Abel)                
|                                               |  |                                
|/s/                                            |  | Michael S. Koeneke             
|                                               |  |                                
|                                               |  | (Michael S. Koeneke)           
|                                               |  |                                
|/s/                                            |  | Mark R. Mitchell               
|                                               |  |                                
|                                               |  | (Mark R. Mitchell)             
|                                               |  |                                
|/s/                                            |  | John Turner White, IV          
|                                               |  |                                
|                                               |  | (John Turner White, IV)        
|                                               |  |                                
|/s/                                            |  | Gary W. Douglass               
|                                               |  | Finance and Chief Financial    
|                                               |  | (Gary W. Douglass)             
|                                               |  |                                
|                                               |  |                                
|/s/                                            |  | Jack Krings                    
|                                               |  | and Member of the Office of the
|                                               |  | (Jack Krings)                  
|                                               |  |                                
|/s/                                            |  | Kimberly A. LaBelle            
|                                               |  | Principal Accounting Officer   
|                                               |  | (Kimberly A. LaBelle)          

|86
|--