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

EXECUTIVE OVERVIEW

The Company's Operations

CPI Corp. is a long-standing leader, based on sittings and related revenues, in the professional portrait photography of young children, individuals and families. From a single studio opened by our predecessor company in 1942, we have grown to 3,061 studios throughout the U.S., Canada, Puerto Rico and Mexico, principally under license agreements with Sears and lease agreements with Wal-Mart. The Company has provided professional portrait photography for Sears' customers since 1959 and has been the only Sears portrait studio operator since 1986.

On June 8, 2007, the Company completed the PCA Acquisition. The results of the acquired operations have been included in the consolidated financial statements since that date. As a result of the PCA Acquisition, CPI is the sole operator of portrait studios in Wal-Mart stores and supercenters in the U.S., Canada, Puerto Rico and Mexico. Management has determined that the Company operates in one segment offering similar products and services in all locations.

As of the end of the second quarter in fiscal 2008 and 2007, the Company's studio counts were:

                                                      July 19, 2008    July 21, 2007
Within Sears or Sears Grand Stores:
          United States and Puerto Rico                          890             893
          Canada                                                 110             112

Within Wal-Mart Stores:
          United States and Puerto Rico                        1,657           1,703
          Canada                                                 254             254
          Mexico                                                 117             107
          United Kingdom                                           -               5

Locations not within Sears or Wal-Mart stores                     33              33

Total                                                          3,061           3,107

As of August 21, 2008, the Company operated 1,583 U.S. and Canadian studios in full digital format. The PictureMe Portrait Studios acquired in 2007 were all analog film studios at the date of acquisition. The installation of a new digital lab sufficient to handle the worldwide fulfillment requirements of the PictureMe Portrait Studio business was completed in the first quarter of 2008 and has been in operation for the full second quarter. The company is also testing new sales and marketing programs and studio work processes and implementing new performance management systems in the field. As of the end of the second quarter, the Company has transferred all material PMPS operations to the Company's existing support platform and plans to convert to digital technology the remainder of its U.S. and Canadian studios in the third quarter of 2008 and substantially all of its Mexican studios prior to the end of 2008, at which time the Company plans to discontinue its analog film fulfillment operations.

RESULTS OF OPERATIONS

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

thousands, except per share data                     12 Weeks Ended                          24 Weeks Ended
                                            July 19, 2008       July 21, 2007       July 19, 2008       July 21, 2007
                                                                 (Restated)                              (Restated)

Net sales                                  $        89,630     $        68,103     $       193,074     $       125,864

Cost and expenses:
   Cost of sales (exclusive of
depreciation and amortization shown
below)                                               8,495               7,982              18,987              13,000
   Selling, general and administrative
expenses                                            79,853              58,315             163,764             103,514
   Depreciation and amortization                     5,585               6,177              13,096               9,590
   Other charges and impairments                       318               1,417               1,112               1,445
                                                    94,251              73,891             196,959             127,549
Loss from operations                                (4,621 )            (5,785 )            (3,885 )            (1,685 )

Interest expense                                     1,366               1,561               2,887               2,008
Interest income                                        118                 411                 480                 716
Other income (expense), net                             (2 )                52                   3                   4

Loss before income tax benefit                      (5,871 )            (6,886 )            (6,289 )            (2,973 )
Income tax benefit                                  (2,270 )            (2,390 )            (2,432 )            (1,032 )

Net loss from continuing operations                 (3,601 )            (4,496 )            (3,857 )            (1,941 )

Net loss from discontinued operations                    -                (105 )                 -                (105 )

NET LOSS                                   $        (3,601 )   $        (4,601 )   $        (3,857 )   $        (2,046 )

NET LOSS PER COMMON SHARE

Net loss per share from continuing
operations - diluted                       $         (0.56 )   $         (0.70 )   $         (0.60 )   $         (0.30 )
Net loss per share from discontinued
operations - diluted                       $             -     $         (0.02 )   $             -     $         (0.02 )
Net loss per share - diluted               $         (0.56 )   $         (0.72 )   $         (0.60 )   $         (0.32 )

Impact of the PCA Purchase Price Allocation

The purchase price of the PCA Acquisition was preliminarily allocated based on fair value of the specific tangible and intangible assets acquired and liabilities assumed at the time of the acquisition pursuant to a valuation. The excess of the total purchase price over the fair value of the assets acquired and liabilities assumed at closing was recorded as goodwill, which is subject to annual impairment review. The Company has completed its assessment of the acquisition and the allocation of the purchase price, see Note 3 for further details. The purchase accounting adjustments that had a material impact on the Company's financial position and results of operations include:

Deferred Revenue and Undelivered Receivables

Prior to the acquisition, the deferred revenue related to the PCA Acquisition was $10.0 million. The purchase accounting adjustment to reflect the deferred revenue balance at its fair value was $9.0 million, which resulted in a beginning deferred revenue balance related to the PCA Acquisition on June 8, 2007 of $964,000. This adjustment had the effect of reducing revenue in periods subsequent to the acquisition. This adjustment had no impact on second quarter results in 2008 and resulted in lower total revenue of $8.1 million for the period June 8, 2007 through July 21, 2007, which reduced gross profit, operating income and income before taxes.

Depreciation

As a result of the purchase accounting associated with the PCA Acquisition, fixed assets were recorded at approximately $35.0 million. The initial annual depreciation for PCA assets is approximately $17.8 million.

Amortization of Acquired Intangible Assets

As a result of the purchase accounting associated with the PCA Acquisition, $46.8 million was allocated to intangible assets related to the host agreements with Wal-Mart ($43.7 million) and the customer lists ($3.1 million). The host agreements with Wal-Mart and the customer lists are being amortized over their useful lives. This results in higher expense in depreciation and amortization expense relative to intangible assets. The initial annual amortization is approximately $3.8 million. Additionally, $21.2 million was allocated to goodwill.

Acquisition Related Interest Expense

To fund the PCA Acquisition, the Company entered into the Second Amended and Restated Credit Agreement, which provides for a $115.0 million term loan and a $40.0 million revolving credit facility. Outstanding long-term debt at the date of the PCA Acquisition increased from $16.7 million to $115.0 million. This refinancing results in higher interest expense when compared to the Company's historical financial statements prior to the acquisition.

12 weeks ended July 19, 2008 compared to 12 weeks ended July 21, 2007

The Company reported a loss per diluted share of ($0.56) for the 12-week second quarter ended July 19, 2008 compared to ($0.72) in the comparable quarter of fiscal 2007. Net loss for the second quarter of 2008 was $3.6 million versus $4.6 million in the corresponding prior year period. The operations of the PMPS brand are included for the full twelve weeks of second quarter 2008 but only for the six-week period of ownership in second quarter 2007. The results reflect an improved operating contribution from the PMPS brand due to reduced overheads, increased operating efficiencies and an improved product mix and customer transaction average, which more than offset the impact of decreased PMPS sales and extraordinary spending on digital conversion and training.

Net sales totaled $89.6 million and $68.1 million in the second quarter of fiscal 2008 and 2007, respectively.

? Net sales for the second quarter of 2008 increased $21.5 million, or 31.6%, to $89.6 million from the $68.1 million reported in the second quarter of 2007. The Company believes that both brands' second quarter results reflect a challenging economic environment including a substantial rise in gasoline and food prices, which is affecting discretionary purchases such as portraiture.

Sears Portrait Studio division ("SPS") net sales for the second quarter of 2008 decreased $5.4 million, or 10.2%, to $47.8 million from the $53.2 million reported in the second quarter of 2007. The 2008 second quarter SPS net sales performance was the result of an 11.4% decline in sittings, partially offset by a 1.5% increase in average sale per customer sitting.

Net sales related to the Company's PMPS brand increased to $41.8 million in the second quarter of 2008 from $14.9 million in the second quarter of 2007. Second quarter 2008 includes twelve weeks of net sales as compared to only six weeks for the second quarter 2007. Additionally, a purchase accounting adjustment related to the deferred revenue at the date of acquisition resulted in a one-time decrease in net sales of $8.2 million for the 2007 second quarter. On a comparable basis, PMPS net sales for the fiscal 2008 second quarter represent an approximate 4.7% decrease in same store sales versus the comparable period of the prior year (results from the period February 4, 2007 to June 8, 2007 not reported in the Company's historical results). This sales performance resulted from an approximate 20.1% increase in average sale per customer sitting attributable to the digital conversion of the PictureMe Portrait Studios, offset by an approximate 20.6% decline in sittings. The Company believes, based on customer surveys, that higher gas and foods prices are having a relatively greater impact on the PMPS business due to a generally more price-sensitive customer base.

Costs and expenses were $94.3 million in the second quarter of 2008, compared with $73.9 million in the comparable prior year period.

? Cost of sales, excluding depreciation and amortization expense, was $8.5 million in the second quarter of 2008 compared with $8.0 million in the comparable prior year period. The increase in cost of sales is attributable to the inclusion of twelve weeks of PMPS cost of sales in the second quarter of 2008, compared to only six weeks for the second quarter of 2007, partially offset by decreased production costs resulting from lower overall manufacturing production levels, additional gains in manufacturing productivity, improved product mix and savings on film and shipping costs that result directly from the PMPS digital conversion.

? Selling, general and administrative ("SG&A") expenses were $79.9 million and $58.3 million for the second quarter of 2008 and 2007, respectively. The increase in second quarter 2008 SG&A costs is primarily attributable to the inclusion of twelve weeks of PMPS costs, compared to only six weeks for the second quarter of 2007. The comparison is also affected by $1.8 million of digital training and travel costs related to the conversion of PMPS studios incurred during the quarter, the recording of contingent commissions due to Sears as a result of the PMPS acquisition as well as non-recurring reductions in SG&A in the prior year period of approximately $4.4 million resulting from the deferred revenue purchase accounting adjustment and $832,000 attributable to a change in the Company's vacation and sick pay policy. These increases were partially offset by a reduction in expense due to the elimination of duplicate costs and the streamlining of operations related to the PMPS brand, as well as reduced host sales commissions due to lower sales.

? Depreciation and amortization was $5.6 million in the second quarter of 2008, compared to $6.2 million in the comparable quarter of 2007. Depreciation expense declined as certain assets acquired for the 2004-2005 SPS digital conversion and with the 2007 PCA Acquisition are now fully depreciated. This is offset by the inclusion of twelve weeks of PMPS costs compared to only six weeks in the second quarter of 2007.

? In the second quarter of 2008 and 2007, the Company recognized $318,000 and $1.4 million, respectively, in other charges and impairments associated with the PMPS Acquisition, which include severance costs, severance accruals, cure costs related to contracts assumed and other integration-related costs relative to the PMPS Acquisition.

Interest expense was $1.4 million in the second quarter of 2008, compared to $1.6 million in the comparable period of the prior year. The decrease in interest expense is primarily the result of lower interest rates and a $589,000 adjustment to the fair value of an interest rate swap agreement, offset by higher average borrowings after the refinancing of the Credit Agreement, as well as increased fees for letters of credit.

Interest income was $118,000 in the second quarter of 2008 compared to $411,000 in the second quarter of 2007. This decrease is primarily attributable to lower invested balances in 2008 as compared to 2007, the result of higher capital spending in 2008 related to the digital conversion of the PictureMe Portrait Studios.

Income tax benefit was $2.3 million in the second quarter of 2008 as compared to $2.4 million in the second quarter of 2007. The resulting effective tax rates were 38.7% in 2008 and 34.7% in 2007. The increase in the effective tax rate in 2008 is primarily attributable to a 1.0% increase in the Federal tax rate resulting from greater projected taxable income over the prior year and the decrease in Federal employment tax credits as a percentage of the increased taxable income. These increases were partially offset by a 1.0% decrease in the Canadian tax rates effective January 1, 2008.

24 weeks ended July 19, 2008 compared to 24 weeks ended July 21, 2007

The Company reported a net loss for the 24-week first half of 2008 of $3.9 million, or ($0.60) per diluted share, compared to a net loss of $2.0 million, or ($0.32) per diluted share, for the comparable first half of fiscal 2007. The operations of the PMPS brand are included for the full twenty-four weeks of the first half of 2008, but only for the six-week period of ownership in the first half of 2007. First half 2008 results were significantly impacted by ongoing transitional expenses associated with the PMPS brand and reflect an improved operating contribution from the PMPS brand due to reduced overheads, increased operating efficiencies and an improved product mix and customer transaction average, which more than offset the impact of decreased PMPS sales and extraordinary spending on digital conversion and training.

Net sales totaled $193.1 million and $126.0 million in the first half of fiscal 2008 and 2007, respectively.

? Net sales for the first half of 2008 increased $67.1 million, or 53.3%, to $193.1 million from the $126.0 million reported in the first half of 2007.

The Company believes that both brands' initial first half results were negatively impacted by the timing of Easter, a seasonally important time for portraiture sales, which fell two weeks earlier in 2008 than in 2007. Historically, an earlier Easter translates into lower sales due to its closer proximity to the preceding Christmas holiday season during which customers are most portrait-active. The Company also believes the results reflect a challenging economic environment including a substantial rise in gasoline and food prices which is affecting discretionary purchases such as portraiture.

SPS net sales for the first half of 2008 decreased $10.2 million, or 9.2%, to $100.9 million from the $111.1 million reported in the first half of 2007. This decrease resulted from an 11.0% decrease in customer sittings, partially offset by a 2.4% increase in average sales per customer sitting.

Net sales related to the Company's PMPS brand increased to $92.2 million in the first half of 2008 from $14.9 million in the first half of 2007. The first half of 2008 includes twenty-four weeks of net sales as compared to only six weeks for the first half of 2007. Additionally, a purchase accounting adjustment related to the deferred revenue at the date of acquisition resulted in a one-time decrease in net sales of $8.2 million for the 2007 first half. On a comparable basis, PMPS net sales for the fiscal 2008 first half represent an approximate 9.5% decrease in same store sales versus the comparable period of the prior year (results from the period February 4, 2007 to June 8, 2007 not reported in the Company's historical results). This sales performance resulted from an approximate 22.5% decline in sittings, offset by an approximate 16.8% increase in average sale per customer sitting attributable to the digital conversion of the PictureMe Portrait Studios. The Company believes, based on customer surveys, that higher gas and foods prices are having a relatively greater impact on the PMPS business due to a generally more price-sensitive customer base.

Costs and expenses were $197.0 million in the first half of 2008, compared with $127.5 million in the comparable prior year.

? Cost of sales, excluding depreciation and amortization expense, was $19.0 million in the first half of 2008 compared with $13.0 million in the comparable prior year period. The increase in cost of sales is attributable to the inclusion of twenty-four weeks of PMPS cost of sales in the second quarter of 2008, compared to only six weeks for the second quarter of 2007, partially offset by decreased production costs resulting from lower overall manufacturing production levels, additional gains in manufacturing productivity, improved product mix and savings on film and shipping costs that result directly from the PMPS digital conversion.

? Selling, general and administrative ("SG&A") expenses were $163.8 million and $103.5 million for the first half of 2008 and 2007, respectively. The increase in first half 2008 SG&A costs is primarily attributable to the inclusion of twenty-four weeks of PMPS costs, compared to only six weeks in the first half of 2007. The comparison is also affected by $3.0 million of digital training and travel costs related to the conversion of PMPS studios incurred during the first half, the recording of contingent commissions due to Sears as a result of the PMPS acquisition as well as non-recurring reductions in SG&A in the prior year period of approximately $4.4 million from the deferred revenue purchase accounting adjustment and $1.7 million attributable to a change in the Company's vacation and sick pay policy. These increases were partially offset by lower studio employment costs and reductions in expense due to the elimination of duplicate costs and the streamlining of operations related to the PMPS brand, as well as reduced host sales commissions due to lower sales.

? Depreciation and amortization was $13.1 million in the first half of 2008, compared to $9.6 million in the comparable half of 2007. This increase is attributable to the inclusion of twenty-four weeks of PMPS costs, compared to only six weeks in the first half of 2007. This was partially offset by a decline in depreciation as certain assets acquired for the 2004-2005 SPS digital conversion and with the 2007 PCA Acquisition are now fully depreciated.

? In the first half of 2008 and 2007, the Company recognized $1.1 million and $1.4 million, respectively, in other charges and impairments associated with the PMPS Acquisition, which include severance costs, severance accruals, cure costs related to contracts assumed and other integration-related costs relative to the PMPS Acquisition.

Interest expense was $2.9 million in the first half of 2008 compared to $2.0 million in the comparable half of the prior year. The increase in interest expense is primarily the result of higher average borrowings after the refinancing of the Credit Agreement. This was partially offset by lower interest rates and an adjustment to the fair value of an interest rate swap agreement that decreased interest expense by $1.2 million.

Interest income was $480,000 in the first half of 2008 compared to $716,000 in the first half of 2007. This decrease is primarily attributable to lower invested balances in 2008 as compared to 2007, the result of higher capital spending in 2008 related to the digital conversion of the PictureMe Portrait Studios.

Income tax benefit was $2.4 million for the first half of 2008 compared to $1.0 million in the first half of 2007. The resulting effective tax rates were 38.7% in 2008 and 34.7 % in 2007. The increase in the effective tax rate in 2008 is primarily attributable to a 1.0% increase in the Federal tax rate resulting from greater projected taxable income over the prior year and the decrease in Federal employment tax credits as a percentage of the increased taxable income. These increases were partially offset by a 1.0% decrease in the Canadian tax rates effective January 1, 2008.

LIQUIDITY AND CAPITAL RESOURCES

The following table presents a summary of the Company's cash flows for first
half of 2008 and 2007:

thousands                                           24 Weeks Ended
                                           July 19, 2008       July 21, 2007
                                                                (Restated)
Net cash (used in) provided by:
   Operating activities                   $        (4,950 )   $         8,199
   Financing activities                           (10,312 )            94,104
   Investing activities                           (24,788 )           (86,110 )
Effect of exchange rate changes on cash               150                 154

Net (decrease) increase in cash           $       (39,900 )   $        16,347

Net Cash (Used In) Provided By Operating Activities

Net cash used in operating activities was $5.0 million during the first half of 2008 compared to net cash provided of $8.2 million in the comparable period of 2007. Cash flows in the first half of 2008 decreased from the first half of 2007 levels primarily due to to the timing of payments related to changes in various balance sheet accounts totaling $4.7 million, $3.5 million related to a change in the payment schedule for Wal-Mart commissions per the related contract, $3.0 million for digital training and travel related to the ongoing conversion, increased spending for interest cost ($1.0 million) and severance and integration-related costs associated with the acquisition of PCA ($865,000).

Net Cash (Used In) Provided By Financing Activities

The increase in cash used in financing activities in the first half of 2008 is primarily attributable to events which did not recur in 2008. These include 2007 net borrowing of $98.3 million related to the PCA Acquisition and the release of $1.0 million of restricted cash, offset by the payment of debt issuance costs of $2.6 million in 2007. Additionally, the purchase of treasury stock related to the surrender of shares by certain employees to satisfy personal tax liabilities, in connection with the vesting of restricted stock, decreased $372,000 in 2008 as compared to 2007. Offsetting this was a use of $8.1 million for long term debt repayments in the first half of 2008.

At July 19, 2008, the Company had $106.3 million outstanding under its existing Credit Agreement. The Company was in compliance with all the covenants under its Credit Agreement as of July 19, 2008.

Net Cash Used In Investing Activities

Net cash used in investing activities was $24.8 million during the first half of 2008 as compared to $86.1 million during the first half of 2007. This decrease was primarily attributable to the PCA Acquisition and related costs in 2007 totaling $82.6 million, offset in part by an increase in capital expenditures in the first half of 2008 as compared to the first half of 2007 due to the ongoing digital conversion of the PictureMe Portrait Studios.

Off-Balance Sheet Arrangements

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

Contingencies

Standby Letters of Credit

As of July 19, 2008, the Company had outstanding standby letters of credit in the principal amount of $20.6 million primarily used in conjunction with the Company's self-insurance programs.

Contingent Commission Payments

The Company, upon certain conditions, is required to provide Sears with certain commission adjustments (the "Contingent Payments") through 2008, the remaining term of the current U.S. agreement. The Contingent Payments are triggered only if the Company operates more than 24 domestic non-Sears portrait studios and the rate of growth in total contractual commissions paid to Sears by the Company under the pre-existing agreement does not exceed levels specified in the agreement. If both of the above mentioned conditions occur, the Contingent Payments are determined by a formula included in the agreement. However, in no event shall such payments exceed $2.5 million annually or $7.5 million cumulatively through 2008, the remaining term of the current agreement. As a result of the addition of the PictureMe Portrait Studios in 2007, this provision applies and a pro rata portion of the related commission adjustments have been accrued in the second quarter 2008 consolidated financial statements.

Contingent Lease Obligations

In July 2001, the Company announced the completion of the sale of its Wall Décor segment, which included the ongoing guarantee of certain operating real estate leases of Prints Plus. As of July 19, 2008, the maximum future obligation to the Company under its guarantee of remaining leases is approximately $1.0 million. To recognize the risk associated with these leases based upon the Company's past experience with renegotiating lease obligations and the . . .