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EX-4.1 - EXHIBIT 4.1 - CEC ENTERTAINMENT INCex4-1.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CEC ENTERTAINMENT INCex32-1.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CEC ENTERTAINMENT INCex31-1.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER - CEC ENTERTAINMENT INCex32-2.htm
EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - CEC ENTERTAINMENT INCex31-2.htm


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


FORM 10-Q
 
 

 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES      EXCHANGE ACT OF 1934
 
For the quarterly period ended September 27, 2009
 
OR

¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from  ________ to ________ 
 
Commission File Number: 001-13687
 

LOGO
CEC ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
 

 
Kansas
 
48-0905805
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
     
4441 West Airport Freeway
Irving, Texas
 
75062
(Address of principal executive offices)
 
(Zip Code)
     
(972) 258-8507
(Registrant’s telephone number, including area code)
     
Not applicable
 (Former name, former address and former fiscal year, if changed since last report)
 
 


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 for 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.  Yes x    No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ¨    No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

Large accelerated filer x   Accelerated filer ¨   Non-accelerated filer ¨   Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨   No x
 
As of October 19, 2009, an aggregate of 22,739,627 shares of the registrant’s common stock, par value $0.10 per share, were outstanding.
 



 
 

 


CEC ENTERTAINMENT, INC.

TABLE OF CONTENTS
 
       
 
Page
PART I
 
FINANCIAL INFORMATION
   
         
ITEM 1.
 
Financial Statements (Unaudited)
   
         
     
3
         
     
 
4
         
     
 
5
         
     
 
6
         
     
7
         
ITEM 2.
   
15
         
ITEM 3.
   
27
         
ITEM 4.
   
27
         
PART II
 
OTHER INFORMATION
   
         
ITEM 1.
   
29
         
ITEM 1A.
   
29
         
ITEM 2.
   
30
         
ITEM 5.
   
30
         
ITEM 6.
   
31
         
 
32
         
         
         
         
         
         
         
         


 
2

 


ITEM 1.  Financial Statements.

CEC ENTERTAINMENT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share information)

   
September 27,
   
December 28,
 
   
2009
   
2008
 
ASSETS
           
             
Current assets:
           
Cash and cash equivalents
  $ 16,039     $ 17,769  
Accounts receivable
    19,069       31,734  
Inventories
    16,322       14,184  
Prepaid expenses
    14,650       11,192  
Deferred tax asset
    3,877       3,878  
                 
Total current assets
    69,957       78,757  
                 
Property and equipment, net
    661,232       666,443  
Other noncurrent assets
    1,912       2,240  
                 
Total assets
  $ 733,101     $ 747,440  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Current liabilities:
               
Current portion of long-term debt
  $ 863     $ 806  
Accounts payable
    31,675       37,116  
Accrued expenses
    31,106       33,716  
Unearned revenues
    6,546       7,575  
Accrued interest
    1,435       3,457  
Derivative instrument liability
    4,547       3,830  
                 
Total current liabilities
    76,172       86,500  
                 
Long-term debt, less current portion
    350,432       413,252  
Deferred rent
    76,712       76,617  
Deferred tax liability
    31,157       23,396  
Accrued insurance
    12,068       11,190  
Derivative instrument liability
    1,840       3,097  
Other noncurrent liabilities
    7,298       4,802  
 
               
Total liabilities
    555,679       618,854  
                 
Commitments and contingencies (Note 5)
               
                 
Stockholders’ equity:
               
Common stock, $0.10 par value; authorized 100,000,000 shares; 61,047,842 and 59,860,722 shares issued, respectively
    6,105       5,986  
Capital in excess of par
    422,388       398,124  
Retained earnings
    696,977       641,220  
Accumulated other comprehensive loss
    375       (1,892 )
Less treasury stock, at cost; 38,308,665 and 37,169,265 shares, respectively
    (948,423 )     (914,852 )
                 
Total stockholders’ equity
    177,422       128,586  
                 
Total liabilities and stockholders’ equity
  $ 733,101     $ 747,440  



The accompanying notes are an integral part of these condensed consolidated financial statements.

 
3

 

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited) 
(in thousands, except per share amounts)

   
Three Months Ended
   
Nine Months Ended
 
   
September 27,
   
September 28,
   
September 27,
   
September 28,
 
   
2009
   
2008
   
2009
   
2008
 
REVENUES
                       
Food and beverage sales
  $ 95,060     $ 100,309     $ 314,662     $ 321,297  
Entertainment and merchandise sales
    101,860       100,569       313,117       315,154  
                                 
Company store sales
    196,920       200,878       627,779       636,451  
Franchise fees and royalties
    898       1,000       2,967       3,097  
                                 
Total revenues
    197,818       201,878       630,746       639,548  
                                 
OPERATING COSTS AND EXPENSES
                               
Company store operating costs:
                               
Cost of food and beverage (exclusive of labor expenses, depreciation and amortization shown separately below)
    21,868       24,829       69,626       75,986  
Cost of entertainment and merchandise (exclusive of labor expenses, depreciation, and amortization shown separately below)
    8,947       8,426       28,071       26,468  
                                 
      30,815       33,255       97,697       102,454  
Labor expenses
    54,593       54,851       167,538       171,523  
Depreciation and amortization
    19,232       18,638       57,186       55,343  
Rent expense
    17,010       16,741       50,643       49,594  
Other store operating expenses
    32,226       32,904       92,635       91,353  
 
                               
Total Company store operating costs
    153,876       156,389       465,699       470,267  
Advertising expense
    9,179       8,660       27,860       26,681  
General and administrative expenses
    11,328       16,083       37,583       43,338  
Asset impairments
    -       -       -       137  
                                 
Total operating costs and expenses
    174,383       181,132       531,142       540,423  
                                 
Operating income
    23,435       20,746       99,604       99,125  
                                 
Interest expense, net
    2,769       5,052       8,938       12,948  
                                 
Income before income taxes
    20,666       15,694       90,666       86,177  
                                 
Income taxes
    7,955       5,793       34,909       32,057  
                                 
Net income
  $ 12,711     $ 9,901     $ 55,757     $ 54,120  
                                 
Earnings per share:
                               
Basic
  $ 0.55     $ 0.44     $ 2.43     $ 2.24  
Diluted
  $ 0.55     $ 0.43     $ 2.42     $ 2.21  
                                 
Weighted average shares outstanding:
                               
Basic
    22,971       22,662       22,949       24,202  
Diluted
    23,021       23,014       23,080       24,523  











The accompanying notes are an integral part of these condensed consolidated financial statements.

 
4

 

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the Nine Months Ended September 27, 2009
(Unaudited)
(in thousands, except share information)
   
Common Stock
   
Capital In Excess of
   
Retained
   
Accumulated Other Comprehensive
   
Treasury Stock
       
   
Shares
   
Amount
   
Par
   
Earnings
   
Loss
   
Shares
   
Amount
   
Total
 
                                                 
Balance at December 29, 2008
    59,860,722     $ 5,986     $ 398,124     $ 641,220     $ (1,892 )     37,169,265     $ (914,852 )   $ 128,586  
Net income
    -       -       -       55,757       -       -       -       55,757  
Change in fair value of cash flow hedge, net of
income taxes of $864
    -       -       -       -       (1,410 )     -       -       (1,410 )
Hedging loss realized in earnings, net of
income taxes of $1,069
    -       -       -       -       1,745       -       -       1,745  
Foreign currency translation adjustments, net of
income taxes of $381
    -       -       -       -       1,932       -       -       1,932  
Comprehensive income
                                                            58,024  
                                                                 
Stock-based compensation costs
    -       -       6,132       -       -       -       -       6,132  
Stock options exercised
    911,799       91       18,191       -       -       -       -       18,282  
Restricted stock issued, net of forfeitures
    309,254       32       (32 )     -       -       -       -       -  
Tax benefit from stock options and
restricted stock
    -       -       756       -       -       -       -       756  
Restricted stock returned for taxes
    (57,726 )     (6 )     (1,358 )     -       -       -       -       (1,364 )
Common stock issued under 401(k) plan
    23,793       2       575       -       -       -       -       577  
Purchases of treasury stock
    -       -       -       -       -       1,139,400       (33,571 )     (33,571 )
                                                                 
Balance at September 27, 2009
    61,047,842     $ 6,105     $ 422,388     $ 696,977     $ 375       38,308,665     $ (948,423 )   $ 177,422  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
5

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)

   
Nine Months Ended
 
   
September 27,
   
September 28,
 
   
2009
   
2008
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 55,757     $ 54,120  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    57,859       55,719  
Deferred income taxes
    8,628       (1,818 )
Stock-based compensation expense
    5,974       4,047  
Deferred lease rentals
    (164 )     633  
Deferred debt financing costs
    211       211  
Loss on asset disposals, net
    2,128       1,441  
Other adjustment
    (8 )     -  
Changes in operating assets and liabilities:
               
Accounts receivable
    12,862       (340 )
Inventories
    (2,138 )     209  
Prepaid expenses
    (3,455 )     1,072  
Accounts payable
    (5,910 )     1,510  
Accrued expenses
    1,111       7,471  
Unearned revenues
    (1,029 )     (354 )
Accrued interest
    (2,022 )     (602 )
Income taxes payable
    (2,373 )     2,074  
                 
Net cash provided by operating activities
    127,431       125,393  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchases of property and equipment
    (51,167 )     (63,008 )
Disposition of property and equipment
    -       2,223  
Other investing activities
    119       (374 )
                 
Net cash used in investing activities
    (51,048 )     (61,159 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net (payments on) proceeds from line of credit
    (62,250 )     76,100  
Payments on capital lease obligations
    (602 )     (560 )
Exercise of stock options
    18,282       19,170  
Excess tax benefit from exercise of stock options
    2,037       389  
Payment of taxes for returned restricted shares
    (1,364 )     (1,028 )
Treasury stock acquired
    (33,571 )     (160,845 )
Other financing activities
    -       (194 )
                 
Net cash used in financing activities
    (77,468 )     (66,968 )
                 
Effect of foreign exchange rate changes on cash
    (645 )     -  
                 
Change in cash and cash equivalents
    (1,730 )     (2,734 )
                 
Cash and cash equivalents at beginning of period
    17,769       18,373  
                 
Cash and cash equivalents at end of period
  $ 16,039     $ 15,639  
                 
SUPPLEMENTAL CASH FLOW INFORMATION:
               
Interest paid
  $ 9,231     $ 12,650  
Income taxes paid, net
  $ 18,845     $ 35,341  
                 
NON-CASH INVESTING AND FINANCING ACTIVITIES:
               
Accrued construction costs
  $ 6,455     $ 6,708  
Common stock issued under 401(k) plan
  $ 577     $ 544  
                 



The accompanying notes are an integral part of these condensed consolidated financial statements.

 
6

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.   Basis of Presentation:

The use of the terms “CEC Entertainment,” “Company,” “we,” “us” and “our” throughout these Notes to Condensed Consolidated Financial Statements refer to CEC Entertainment, Inc. and its subsidiaries.

Interim Financial Statements

The accompanying unaudited condensed consolidated financial statements as of September 27, 2009 and for the three and nine month periods ended September 27, 2009 and September 28, 2008 are presented in accordance with the requirements for quarterly reports under Form 10-Q and, consequently, do not include all of the information and footnote disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”). In the opinion of management, such financial statements include all adjustments (consisting solely of normal recurring adjustments) necessary for the fair statement of the financial information included herein in accordance with U.S. GAAP and the rules and regulations of the Securities and Exchange Commission (the “SEC”). The balance sheet at December 28, 2008 has been derived from the audited financial statements at that date, but does not include all of the information and footnote disclosures required by U.S. GAAP for complete financial statements. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates. Results of operations for interim periods are not necessarily indicative of results for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K filed with the SEC for the fiscal year ended December 28, 2008.

On July 1, 2009, the Financial Accounting Standards Board (“FASB”) launched the FASB Accounting Standards Codification™ (the “FASB Codification”) as the single source of authoritative accounting principles recognized by FASB for the preparation of financial statements in conformity with U.S. GAAP. Refer to Note 10 “Recent Accounting Pronouncements” for further discussion of the FASB Codification and its impact on disclosures within our consolidated financial statements.

Subsequent Events

We recognize the effects of events or transactions that occur after the balance sheet date but before financial statements are issued (“subsequent events”) if there is evidence that conditions related to the subsequent event existed at the date of the balance sheet, including the impact of such events on management’s estimates and assumptions used in preparing the financial statements. Other significant subsequent events that are not recognized in the financial statements, if any, are disclosed in the Notes to Condensed Consolidated Financial Statements. Subsequent events have been evaluated through October 29, 2009, the date we issued these condensed consolidated financial statements.

2.   Inventories:

Inventories consisted of the following:
   
September 27,
   
December 28,
 
   
2009
   
2008
 
   
(in thousands)
 
             
Food and beverage
  $ 3,453     $ 4,400  
Entertainment and merchandise
    12,869       9,784  
                 
    $ 16,322     $ 14,184  

Food and beverage inventories include food, beverage, paper products and other supplies needed for our food service operations. Entertainment and merchandise inventories consist primarily of novelty toy items used as redemption prizes for certain games that may also be sold to our customers, and also include birthday party and other supplies needed for our entertainment operations.


 
7

 

CEC ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

3.   Long-Term Debt:

      Long-term debt consisted of the following:
   
September 27,
   
December 28,
 
   
2009
   
2008
 
   
(in thousands)
 
             
Revolving credit facility borrowings
  $ 339,600     $ 401,850  
Obligations under capital leases
    11,695       12,208  
                 
      351,295       414,058  
Less current portion of capital leases
    (863 )     (806 )
                 
    $ 350,432     $ 413,252  

We have a revolving credit facility providing for total borrowings of up to $550 million for a term of five years. The credit facility, which matures in October 2012, also includes an accordion feature allowing us, subject to lender approval, to request an additional $50.0 million in borrowings at any time. As of September 27, 2009, there were $339.6 million of borrowings outstanding and $10.0 million of letters of credit issued but undrawn under the credit facility. Based on the type of borrowing, the credit facility bears interest at LIBOR plus an applicable margin of 0.625% to 1.25% determined based on our financial performance and debt levels, or alternatively, the higher of (a) the prime rate or (b) the Federal Funds rate plus 0.50%. As of September 27, 2009, borrowings under the credit facility incurred interest at LIBOR (0.24% - 0.39%) plus 1.00% or the prime rate (3.25%). A commitment fee of 0.1% to 0.3%, depending on our financial performance and debt levels, is payable on a quarterly basis on any unused credit line. All borrowings under the credit facility are unsecured, but we have agreed not to pledge any of our existing assets to secure future indebtedness.

Including the effect of our interest rate swap contract discussed in Note 4 “Derivative Instrument,” the weighted average effective interest rate incurred on borrowings under our revolving credit facility was 2.9% and 4.0% for the three months ended September 27, 2009 and September 28, 2008, respectively, and was 2.9% and 4.2% for the nine months ended September 27, 2009 and September 28, 2008, respectively.

The revolving credit facility agreement contains certain restrictions and conditions that, among other things, require us to maintain financial covenant ratios, including a minimum fixed charge coverage ratio of 1.5 to 1.0 and a maximum leverage ratio of 3.0 to 1.0. Additionally, the terms of the revolving credit facility agreement limit the amount of our repurchases of our common stock and cash dividends we may pay on our common stock based on certain financial covenants and criteria. As of September 27, 2009, we were in compliance with these covenants.

We believe the carrying amount of our revolving credit facility approximates its fair value because interest rates are adjusted regularly to reflect current market rates.

4.   Derivative Instrument:

We have adopted the updated disclosure provisions of Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging (“ASC 815”), which enhances the disclosure requirements about an entity’s derivative instruments and hedging activities (formerly Statement of Financial Accounting Standards No. 161, “Disclosures About Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133,” issued by FASB in March 2008). Under subtopic section 815-10-50 of ASC 815, entities are required to provide qualitative disclosures including (a) how and why they use derivative instruments, (b) how their derivative instruments and related hedged items are accounted for, and (c) how the derivative instruments and related hedged items affect the entity’s financial statements. Additionally, entities must disclose the fair values of derivative instruments and their gains and losses in a tabular format that identifies the location of derivative positions and the effect of their use in the entity’s financial statements. These updated disclosure provisions are presented within this note.

Interest Rate Risk Management

Our revolving credit facility bears interest at variable rates and therefore exposes us to the impact of interest rate changes. To manage this risk, we use an interest rate swap contract to mitigate the variability of the interest payment cash flows and to reduce our exposure to adverse interest rate changes.

 
8

 

CEC ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

4.   Derivative Instrument (continued):

Cash Flow Hedge

On May 27, 2008, we entered into a $150.0 million notional amount interest rate swap contract to effectively convert a portion of our variable rate debt to a fixed interest rate. The contract, which matures in May 2011, requires us to pay a fixed rate of 3.62% while receiving variable payments from the counterparty at the three-month LIBOR rate. Including the 1.00 percentage point applicable margin incurred on our revolving credit facility, the effective interest rate of the swap contract was 4.62% at September 27, 2009. The differential amounts receivable or payable under the swap contract are recorded over the life of the contract as adjustments to interest expense.

We have designated the swap contract as a cash flow hedge. Accordingly, changes in its fair value that are considered to be effective in mitigating our exposure to changes in interest payments on the hedged amount of our revolving credit facility debt are reported on the Consolidated Balance Sheets as a component of “Accumulated other comprehensive income.” Throughout the term of the swap contract, the unrealized gains or losses we have reported in accumulated other comprehensive income will be recognized in earnings consistent with when the variable interest rate of the debt affects earnings. We assess whether the swap contract is highly effective in offsetting the changes in cash flows on the hedged debt based on a comparison of cumulative changes in fair value of the swap to the total change in future cash flows on the notional amount of debt. If the total cumulative change in fair value of the swap contract more than offsets the cumulative change in the present value of expected future cash flows of the hedged debt, the difference would be considered hedge ineffectiveness and be recorded immediately in earnings.

The following table summarizes the location and fair value of the derivative instrument in our Condensed Consolidated Balance Sheets:
     
September 27,
   
December 28,
 
 
Balance Sheet Location
 
2009
   
2008
 
Derivative designated as hedging instrument
   
(in thousands)
 
               
Interest rate swap contract
Derivative instrument liability(1) (2) 
  $ 6,387     $ 6,927  
______________
 
 (1) As of September 27, 2009, the estimated fair value was comprised of a $4.5 million current liability and a $1.8 million noncurrent liability.
 
(2) As of December 28, 2008, the estimated fair value was comprised of a $3.8 million current liability and a $3.1 million noncurrent liability.

The following table summarizes the effect of the derivative instrument on other comprehensive income (“OCI”) and income:

     
Three Months Ended
        Nine Months Ended  
     
September 27,
     
September 28,
     
September 27,
     
September 28,
   
     
2009
     
2008
     
2009
     
2008
 
 
Derivative in cash flow hedging relationship
 
(in thousands, excluding income tax effects)
                   
Loss recognized in accumulated OCI – effective portion:
                             
Interest rate swap contract
  $ (1,116 )   $ (1,312 )   $ (2,274 )   $ (655 )
                                   
Loss reclassified from accumulated OCI into income – effective portion:
                           
Interest expense, net
  $ (1,159 )   $ (348 )   $ (2,814 )   $ (487 )

There were no ineffective gains or losses recognized during the three and nine month periods ended September 27, 2009 and September 28, 2008. We expect that approximately $2.8 million, net of taxes, of the change in fair value of the swap contract included in “Accumulated other comprehensive income” as of September 27, 2009 will be realized in earnings as additional interest expense within the next 12 months.

Fair Value Measurement

Our interest rate swap contract is not traded on a public exchange, therefore its fair value is determined using the present value of expected future cash flows arising from the contract which approximates an amount to be received from or paid to a market participant for this instrument. This valuation methodology utilizes forward interest rate yield curves obtained from an independent pricing service’s quotes of three-month forward LIBOR rates through the swap contract’s maturity. Accordingly, the inputs to our fair value measurement of the interest rate swap are classified within Level 2 of the fair value hierarchy.

 
9

 

CEC ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

5.   Commitments and Contingencies:

Legal Proceedings

On November 19, 2007, a purported class action lawsuit against us, entitled Ana Chavez v. CEC Entertainment, Inc., et al., Cause No. BC380996 (“Chavez Litigation”), was filed in the Central District Superior Court of California in Los Angeles County. We received service of process on December 21, 2007. On January 9, 2008, a second purported class action lawsuit against us, entitled Cynthia Perez et al. v. CEC Entertainment, Inc., et al., Cause No. BC3853527 (“Perez Litigation”), was filed in the Central District Superior Court of California in Los Angeles County. We were served with the second complaint on January 30, 2008. We removed both cases to Federal court on January 18, 2008 and February 29, 2008, respectively. On March 21, 2008, the Chavez Litigation was remanded back to state court and on April 30, 2008, the Perez Litigation was remanded back to state court. These two cases were then consolidated by the court for procedural purposes in the Superior Court of the State of California in Los Angeles County on June 18, 2008. The Chavez Litigation was filed by a former store employee purporting to represent other similarly situated current and former employees of us in the State of California from November 19, 2003 to March 11, 2009. The lawsuit alleged violations of the state wage and hour laws involving unpaid vacation wages, meal periods, wages due upon termination, waiting time penalties, and unfair competition and sought an unspecified amount in damages. The Perez Litigation was filed by former store employees purporting to represent other similarly situated current and former employees of us in Los Angeles County from January 8, 2004 to March 11, 2009. The lawsuit alleged violations of the state wage and hour laws involving unpaid overtime wages, meal and rest periods, itemized wage statements, waiting time penalties, retaliation, unfair competition, and constructive trust and sought an unspecified amount in damages. We attended formal mediation with representatives of the plaintiffs in both suits and reached a tentative settlement for all of the claims alleged on November 17, 2008. On December 3, 2008, following the tentative settlement, the plaintiffs filed a Consolidated Complaint combining the allegations of the two actions in accordance with the tentative settlement agreement. We then filed an Answer to the Consolidated Complaint on December 16, 2008. The tentative settlement was subject to both preliminary and final approval by the court.  On March 11, 2009, the court granted preliminary approval of the class action settlement.  We commenced efforts to administer the settlement and notice of the settlement, claim forms and opt-out forms were sent to approximately 18,500 class members on March 31, 2009. The class action settlement received final approval from the court on August 14, 2009. Subsequently, the class members and opposing counsel received compensation in accordance with the terms of the settlement. The settlement did not have a material adverse effect on our financial condition or results of operations.

Contingent Liabilities

From time to time we are involved with governmental inquiries, legal proceedings and other claims that are incidental to the conduct of our business. These matters typically involve claims from customers, employees and others involved in operational issues common to the entertainment and food industries. A number of such claims may exist at any given time. In the opinion of our management, none of the claims or proceedings to which we are currently a party to is expected to have a material adverse effect on our financial condition, results of operations or cash flows. When a contingency involving uncertainty as to a possible loss occurs, an estimate of such loss contingency may be accrued as a charge to income and a reserve established on the balance sheet. Management reviews our reserves periodically, and the contingent loss reserve may be increased or decreased in the future to reflect further developments.

6.   Income Taxes:

We file a U.S. federal income tax return and must file income tax returns in multiple state jurisdictions and Canada. During the first quarter of 2009, the Internal Revenue Service (“IRS”) commenced an audit of our 2006 and 2007 tax years.

During the third quarter of 2009, we settled certain issues that arose from the IRS’s examination of our 2003 through 2005 tax years. As a result, we recognized a benefit of approximately $1.1 million from a reduction in our estimated penalties and interest reserves for uncertain tax positions related to these matters.

7.   Earnings Per Share:

Effective December 29, 2008, we adopted the updated guidance now contained in ASC Topic 260, Earnings Per Share (“ASC 260”), relating to share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (formerly FASB Staff Position Emerging Issues Task Force (“EITF”) No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”), issued by FASB in June 2008). Under paragraph 260-10-45-61A of ASC 260, unvested share-based payment awards that include nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are considered participating securities, and the two-class method of computing basic earnings per share (“EPS”) is required for all periods presented.

 
10

 

CEC ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

7.   Earnings Per Share (continued):

Our restricted stock awards granted before May 1, 2009 include nonforfeitable rights to dividends with respect to unvested shares. Therefore, the unvested shares of such restricted stock grants are considered participating securities and must be included in our computation of basic EPS. We have computed EPS to include the unvested portion of pre-May 2009 restricted stock grants in the number of basic weighted average common shares outstanding effective as of the first quarter of 2009 and have adjusted prior period EPS retrospectively for the inclusion of such outstanding unvested shares as required by ASC 260. Upon adopting ASC 260-10-45-61A, basic and diluted EPS decreased (a) $0.01 for the three months ended September 28, 2008, (b) $0.05 and $0.04, respectively, for the nine months ended September 28, 2008 and (c) $0.06 and $0.04, respectively, for the fiscal year 2008.

Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding during the period. Common shares outstanding consist of shares of our common stock and unvested shares of restricted stock that are considered to be participating securities.  Diluted EPS is computed using the weighted average number of common shares and dilutive potential common shares outstanding during the period using the treasury stock method. Potential common shares consist of dilutive stock options and restricted stock awards we granted after May 1, 2009.

The following table sets forth the computation of EPS, basic and diluted:

   
Three Months Ended
   
Nine Months Ended
 
   
September 27,
   
September 28,
   
September 27,
   
September 28,
 
   
2009
   
2008
   
2009
   
2008
 
   
(in thousands, except per share amounts)
 
Numerator:
                       
  Net income
  $ 12,711     $ 9,901     $ 55,757     $ 54,120  
                                 
Denominator:
                               
  Basic weighted average shares outstanding
    22,971       22,662       22,949       24,202  
  Potential common shares for stock options and restricted stock
    50       352       131       321  
                                 
  Diluted weighted average shares outstanding
    23,021       23,014       23,080       24,523  
                                 
Earnings per share:
                               
  Basic
  $ 0.55     $ 0.44     $ 2.43     $ 2.24  
  Diluted
  $ 0.55     $ 0.43     $ 2.42     $ 2.21  

Stock options to purchase 685,400 shares and 723,557 shares of common stock for the three months ended September 27, 2009 and September 28, 2008, respectively, and 705,080 shares and 932,011 shares of common stock for the nine months ended September 27, 2009 and September 28, 2008, respectively, were not included in the diluted EPS computations because the exercise prices of these options were greater than the average market price of the common shares and, therefore, their effect would be antidilutive.

8.   Stock-Based Compensation:

We have stock-based compensation plans pursuant to which we may grant awards of restricted stock or restricted stock units and, prior to fiscal 2006, stock options to our employees and non-employee directors. As of September 27, 2009, we have not issued any restricted stock units. The fair value of all stock-based awards, less estimated forfeitures, is recognized as stock-based compensation expense in the financial statements over the vesting period of the award.

 
11

 

CEC ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

8.   Stock-Based Compensation (continued):

The following table summarizes total pre-tax stock-based compensation expense recognized in the unaudited condensed consolidated financial statements:

   
Three Months Ended
   
Nine Months Ended
 
   
September 27,
   
September 28,
   
September 27,
   
September 28,
 
   
2009
   
2008
   
2009
   
2008
 
   
(in thousands)
 
                         
Total stock-based compensation cost
  $ 1,846     $ 1,495     $ 6,132     $ 4,190  
Portion capitalized as property and equipment
    (55 )     (50 )     (158 )     (143 )
                                 
Pre-tax stock-based compensation expense recognized(1) 
  $ 1,791     $ 1,445     $ 5,974     $ 4,047  
______________
 
 (1) Included in “General and administrative expense” in the unaudited Condensed Consolidated Statements of Earnings.

As of September 27, 2009, there was $15.3 million of unrecognized pre-tax stock-based compensation cost related to restricted stock awards that will be recognized over a weighted average remaining vesting period of 1.7 years. As of September 27, 2009, substantially all of our outstanding stock options were fully vested and the amount of unrecognized pre-tax stock-based compensation cost related to stock options which continue to vest through the remainder of fiscal 2009 was not material.

9.   Stockholders’ Equity:

Common Stock Repurchases

We repurchase shares of our common stock under a plan authorized by our Board of Directors (the “Board”). The stock repurchase program, which does not have a stated expiration date, authorized us as of September 27, 2009 to make a total of $600 million of share repurchases in the open market, through accelerated share repurchases or in private transactions. During the nine months ended September 27, 2009, we repurchased 1,139,400 shares through the open market at an aggregate purchase price of approximately $33.6 million. At September 27, 2009, approximately $37.8 million remained available for share repurchases under the $600 million repurchase authorization.

On October 27, 2009, the Board authorized a $200 million increase to the share repurchase authorization bringing the current outstanding share repurchase authorization available to approximately $237.8 million.

Stock Options

During the nine months ended September 27, 2009, 911,799 shares of common stock were issued from the exercise of stock options for cash proceeds of $18.3 million.

Restricted Stock

During the nine months ended September 27, 2009, we granted a total of 351,939 shares of restricted stock to our employees and non-employee directors at a weighted average grant date fair value of $24.65 per share.

During the nine months ended September 27, 2009, 42,685 shares of restricted stock were forfeited by employees at a weighted average grant date fair value of $27.87 per share.

During the nine months ended September 27, 2009, 57,726 shares of common stock were tendered by employees at an average price per share of $23.60 to satisfy tax withholding requirements on the vesting of shares of restricted stock.

401(k) Plan Contribution

During the nine months ended September 27, 2009, we contributed 23,793 shares of common stock to our 401(k) plan at a cost of $0.6 million.

 
12

 

CEC ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

10.   Recent Accounting Pronouncements:

Newly Adopted Accounting Pronouncements

As more fully described in Note 7 “Earnings Per Share,” we adopted the updated guidance of ASC 260 (formerly FSP EITF 03-6-1), which clarifies whether unvested share-based payment awards with nonforfeitable dividend rights should be included in the computation of basic earnings per share and requires that all prior-period EPS data presented be adjusted retrospectively.

In the first quarter of 2009, using the transition provision contained in ASC paragraph 820-10-65-1 (formerly FASB Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157,” issued by FASB in February 2008), we adopted the guidance in ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”), for our nonfinancial assets and liabilities that are measured at fair value on a non-recurring basis. This deferred adoption of ASC 820 applied to our fair value measurements of property and equipment made in connection with periodic impairment assessments. Our adoption of ASC 820 for non-recurring fair value measurements of nonfinancial assets and liabilities in the first quarter of 2009, has not had a material impact on our consolidated financial statements.

In the first quarter of 2009, we adopted the updated guidance of ASC Topic 810, Consolidations (“ASC 810”), relating to the accounting and reporting for noncontrolling ownership interests (“noncontrolling interests”) in consolidated financial statements (formerly Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51,” issued by FASB in December 2007). The updated provisions contained in section 810-10-50 of ASC 810 clarify that noncontrolling interests should be reported in the consolidated financial statements as a separate component of equity and require consolidated net income to be reported for the consolidated group with separate disclosure on the face of the consolidated statement of income for amounts attributable to noncontrolling interests. Our adoption of this updated guidance in the first quarter of 2009 did not have a material impact on our consolidated financial statements.

In the second quarter of 2009, we adopted the guidance contained in ASC Topic 855, Subsequent Events (“ASC 855”) (formerly Statement of Financial Accounting Standards No. 165, “Subsequent Events,” issued by the FASB in May 2009), which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 also clarifies the types of subsequent events an entity shall, or shall not, recognize in the financial statements. Our adoption of ASC 855 did not result in significant changes in our recognition or disclosure of subsequent events in the financial statements. However, it does require us to disclose the date through which we have evaluated subsequent events and the basis for that date. Our evaluation of subsequent events is disclosed in Note 1 “Basis of Presentation.”

In the second quarter of 2009, we adopted the updated guidance of ASC 820 (formerly FASB Staff Position FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” issued by FASB in April 2009) contained in paragraphs 820-10-35-51A to 51H of ASC 820 for estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability. Our adoption of this updated guidance in the second quarter of 2009 did not have a material impact on our consolidated financial statements.

In the second quarter of 2009, we adopted the updated guidance of ASC Topic 825, Financial Instruments, (formerly FASB Staff Position FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” issued by FASB in April 2009) which expands fair value of financial instruments disclosure to interim reporting periods. Refer to Note 3 “Long-Term Debt” for the disclosure required by this updated guidance.

In the third quarter of 2009, we adopted FASB Accounting Standards Update No. 2009-01, “Statement of Financial Accounting Standards No. 168—The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles” which identifies the FASB Codification as the single source of authoritative U.S. GAAP, superseding all then-existing authoritative accounting and reporting standards, except for rules and interpretive releases of the SEC under authority of federal securities laws, which are sources of authoritative U.S. GAAP for SEC registrants. The FASB Codification reorganizes the authoritative literature comprising U.S. GAAP into a topical format. Changes to the FASB Codification are now communicated through an Accounting Standards Update (“ASU”) which is issued for all amendments and updates to authoritative U.S. GAAP promulgated by FASB. ASUs replace accounting changes that historically were issued as FASB Statements, FASB Interpretations, FASB Staff Positions, EITF Abstracts, or other types of accounting standards issued by the FASB. ASUs are not considered authoritative in their own right, but instead serve only to update and provide background information about the guidance and bases for conclusions on the change(s) in the FASB Codification. The FASB Codification does not change our application of U.S. GAAP, and therefore our adoption only affects the way we reference authoritative accounting literature in the notes to consolidated financial statements.

 
13

 

CEC ENTERTAINMENT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

10.   Recent Accounting Pronouncements (continued):

Accounting Pronouncements Not Yet Adopted

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS 167”), which amends the consolidation guidance for a variable interest entity (“VIE”). This pre-Codification Standard has not yet been integrated into the FASB Codification and remains authoritative. SFAS 167 redefines the approach used to determine the “primary beneficiary” (or consolidator) of a VIE, which will be determined using a prescribed qualitative assessment and must be performed on an ongoing basis. Under the new standard, the primary beneficiary of a VIE will be the enterprise that has both: (1) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (2) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. SFAS 167 also requires separate presentation of the assets and liabilities of a consolidated VIE on the face of the balance sheet if specific criteria are met. SFAS 167 is effective as of the beginning of the first fiscal year beginning after November 15, 2009, which will be our 2010 fiscal year beginning January 4, 2010. We are currently evaluating this new standard, but do not expect that our adoption in the first quarter of 2010 will have a material impact on our consolidated financial statements.

In August 2009, the FASB issued Accounting Standards Update No. 2009-05, “Measuring Liabilities at Fair Value” (“ASU 2009-05”). This update provides amendments to ASC 820 for the fair value measurement of liabilities when a quoted price in an active market is not available. ASU 2009-05 is effective for reporting periods beginning after August 28, 2009, which means that it will be effective for our fourth quarter beginning September 28, 2009. We are currently evaluating ASU 2009-05, but do not expect that our adoption in the fourth quarter of 2009 will have a material impact on our consolidated financial statements.

 
14

 

 ITEM 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

As used in this report, the terms “CEC Entertainment,” “we,” “Company,” “us” and “our” refer to CEC Entertainment, Inc. and its subsidiaries.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide the readers of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended December 28, 2008. Our MD&A is presented in the following sections:
·  
Executive Overview
·  
Overview of Operations
·  
Results of Operations
·  
Financial Condition, Liquidity and Capital Resources
·  
Off-Balance Sheet Arrangements and Contractual Obligations
·  
Critical Accounting Policies and Estimates
·  
Recent Accounting Pronouncements

Executive Overview

Third Quarter 2009 Highlights
·  
Revenues decreased 2.0% during the third quarter of 2009 compared to the same period in 2008.
-  
Comparable store sales decreased 3.1%.
-  
Weighted average Company-owned store count increased by approximately six stores.
-  
Menu prices increased on average 1.5%.

·  
Company store operating costs as a percentage of Company store sales increased 0.2 percentage points during the third quarter of 2009 compared to the same period in 2008.
-  
Depreciation, amortization and rent expenses increased a combined 0.8 percentage points as a percentage of Company store sales, primarily due to ongoing capital initiatives, new store development and the effect of lower sales on our fixed costs.
-  
A 3.8% increase in average hourly wage rates was partially offset by improved labor productivity in our stores.
-  
Other store operating expenses were flat as higher repair and maintenance costs were offset by other operating expenses.
-  
The average price per pound of cheese decreased by approximately 33%.

·  
General and administrative expenses decreased to $11.3 million during the third quarter of 2009 compared to $16.1 million in the third quarter of 2008 primarily due to the non-recurrence of $3.0 million in aggregate loss contingencies related to prior year legal matters and a $0.9 million benefit from the reduction of a federal income tax penalty reserve we recognized in the third quarter of 2009.

·  
Interest expense decreased to $2.8 million during the third quarter of 2009 compared to $5.1 million in the third quarter of 2008 primarily due to a 110 basis point decrease in the average effective interest rates incurred on the outstanding balance of our revolving credit facility during the third quarter of 2009 compared to the third quarter of 2008, as well as a $56.2 million decrease in the average debt balance outstanding between the two quarters.

·  
Net income for the third quarter of 2009 increased 28.4% to $12.7 million from $9.9 million in the same period in 2008 and diluted earnings per share increased 27.9% to $0.55 compared to $0.43 in the same period in 2008. Earnings per share benefited from our repurchase of 494,400 shares of our common stock during the third quarter of 2009.

Financial Reporting Change

In the first quarter of 2009, we adopted the updated guidance of ASC topic 260, Earnings Per Share (formerly FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”), which clarifies whether unvested share-based payment awards with nonforfeitable dividend rights should be included in the computation of basic earnings per share and requires that all prior-period EPS data presented be adjusted retrospectively. Refer to Note 7 “Earnings Per Share” of our condensed consolidated financial statements for a more complete discussion of the updated guidance to ASC 260 and its impact on our earnings per share.

 
15

 

Overview of Operations

We develop, operate and franchise family dining and entertainment centers under the name “Chuck E. Cheese’s®” in 48 states and six foreign countries or territories. Chuck E. Cheese’s stores feature musical and comic entertainment by robotic and animated characters, arcade-style and skill oriented games, video games, rides and other activities intended to appeal to our primary customer
base of families with children between two and 12 years of age. All of our stores offer dining selections consisting of a variety of beverages, pizzas, sandwiches, appetizers, a salad bar, and desserts.

The following table summarizes information regarding the number of Company-owned and franchised stores for the periods presented:
   
Three Months Ended
   
Nine Months Ended
 
   
September 27,
   
September 28,
   
September 27,
   
September 28,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Number of Company-owned stores:
                       
Beginning of period
    496       490       495       490  
New
    -       2       1       3  
Acquired from franchisees
    -       2       -       2  
Closed
    (1 )     (1 )     (1 )     (2 )
End of period
    495       493       495       493  
                                 
Number of franchised stores:
                               
Beginning of period
    48       47       46       44  
New
    -       1       2       4  
Acquired by the Company
    -       (2 )     -       (2 )
Closed
    -       -       -       -  
End of period
    48       46       48       46  

Comparable store sales. Comparable store sales (sales of domestic stores that were open for a period greater than 18 months at the beginning of each respective fiscal year or 12 months for acquired stores) is a key performance indicator used within our industry and is a critical factor when evaluating our performance as it is indicative of acceptance of our strategic initiatives and local economic and consumer trends.

Revenues. Our primary source of revenues is from sales at our Company-owned stores (“Company store sales”) and consists of the sale of food, beverages, game-play tokens and merchandise. A portion of Company store sales comes from sales of value-priced combination packages generally consisting of food, beverage and game tokens (“package deals”) which we promote through in-store menu pricing or coupon offerings. Food and beverage sales include all revenue recognized with respect to stand-alone food and beverage sales as well as the portion of revenue that is allocated from package deals. Entertainment and merchandise sales include all revenue recognized with respect to stand-alone game token sales as well as the portion of revenue that is allocated from package deals. This revenue caption also includes sales of merchandise at our stores.

Franchise fees and royalties include area development and initial franchise fees received from franchisees to establish new stores and royalties charged to franchisees based on a percentage of a franchised store’s sales.

Company store operating costs. Certain costs and expenses relate only to the operation of our Company-owned stores and are as follows:

·  
Cost of food and beverage includes all direct costs of food, beverages and costs of related paper and birthday supplies, less rebates from suppliers;

·  
Cost of entertainment and merchandise includes all direct costs of prizes provided and merchandise sold to our customers, as well as the cost of tickets dispensed to customers and redeemed for prize items;

·  
Labor expenses consist of salaries and wages, related payroll taxes and benefits for store personnel;

·  
Depreciation and amortization expense pertain directly to our store assets;

·  
Rent expense includes lease costs for Company stores, excluding common occupancy costs (e.g. common area maintenance (“CAM”) charges, property taxes, etc.); and

·  
Other store operating expenses which include utilities, repair costs, liability and property insurance, CAM charges, property

 
16

 

·  
taxes, preopening expenses, store asset disposal gains and losses, and all other costs directly related to the operation of a store.

Our “Cost of food and beverage” and “Cost of entertainment and merchandise”  mentioned above do not include an allocation of (i) store employee payroll, related taxes and benefit costs and (ii) depreciation and amortization expense associated with Company-store assets. We believe that presenting store-level labor costs and depreciation and amortization expense in the aggregate provides the most informative financial reporting presentation.

Advertising expense. Advertising expense includes production costs for television commercials, newspaper inserts, Internet advertising, coupons and media expenses for national and local advertising, with offsetting contributions from the Advertising Fund, a fund that pays the costs of development, purchasing and placement of system-wide advertising programs, and the Media Fund, a fund designed primarily for the purchase of national network television advertising made by the International Association of CEC Entertainment, Inc. pursuant to our franchise agreements.

General and administrative expenses. General and administrative expenses represent all costs associated with our corporate office operations, including regional and district management and corporate personnel payroll and benefits, depreciation and amortization of corporate assets and other administrative costs not directly related to the operation of a store location.

Asset impairments. Asset impairments (if any) represent non-cash charges we record to write down the carrying amount of long-lived assets within stores that are not expected to generate sufficient projected cash flows in order to recover their net book value.

Seasonality

Our sales volumes fluctuate seasonally and are generally higher during the first and third quarters of each fiscal year. Holidays, school operating schedules and weather conditions may affect sales volumes seasonally in some of our operating regions. Due to the seasonality of our business, the results of any particular quarter may not necessarily be indicative of the results that may be achieved for the full year or any other quarter.

Fiscal Year

We operate on a 52 or 53 week fiscal year that ends on the Sunday nearest to December 31. Each quarterly period has 13 weeks, except for a 53 week year when the fourth quarter has 14 weeks. Our 2009 fiscal year will consist of 53 weeks and our 2008 fiscal year consisted of 52 weeks.


 
17

 

Results of Operations

The following table summarizes our principal sources of revenues expressed in dollars and as a percentage of total revenues for the periods presented:
   
Three Months Ended
   
Nine Months Ended
 
   
September 27, 2009
   
September 28, 2008
   
September 27, 2009
   
September 28, 2008
 
   
(in thousands, except percentages)
 
                                                 
Food and beverage sales
  $ 95,060       48.1 %   $ 100,309       49.7 %   $ 314,662       49.9 %   $ 321,297       50.2 %
Entertainment and merchandise sales
    101,860       51.5 %     100,569       49.8 %     313,117       49.6 %     315,154       49.3 %
                                                                 
Company store sales
    196,920       99.5 %     200,878       99.5 %     627,779       99.5 %     636,451       99.5 %
Franchising activities
    898       0.5 %     1,000       0.5 %     2,967       0.5 %     3,097       0.5 %
                                                                 
Total revenues
  $ 197,818       100.0 %   $ 201,878       100.0 %   $ 630,746       100.0 %   $ 639,548       100.0 %
______________
Due to rounding, percentages presented in the table above may not add.

The following table summarizes our costs and expenses expressed in dollars and as a percentage of Company store sales (except as otherwise noted) for the periods presented:
   
Three Months Ended
   
Nine Months Ended
 
   
September 27, 2009
   
September 28, 2008
   
September 27, 2009
   
September 28, 2008
 
   
(in thousands, except percentages)
 
Company store operating costs:
                                               
Cost of food and beverage (as a percentage of food and beverage sales) 
  $  21,868       23.0 %   $  24,829       24.8 %   $  69,626       22.1 %   $  75,986       23.6 %
Cost of entertainment and merchandise (as a percentage of
entertainment and merchandise sales)
        8,947       8.8 %         8,426       8.4 %         28,071       9.0 %         26,468       8.4 %
                                                                 
      30,815       15.6 %     33,255       16.6 %     97,697       15.6 %     102,454       16.1 %
Labor expenses
    54,593       27.7 %     54,851       27.3 %     167,538       26.7 %     171,523       26.9 %
Depreciation and amortization
    19,232       9.8 %     18,638       9.3 %     57,186       9.1 %     55,343       8.7 %
Rent expense
    17,010       8.6 %     16,741       8.3 %     50,643       8.1 %     49,594       7.8 %
Other store operating expenses
    32,226       16.4 %     32,904       16.4 %     92,635       14.8 %     91,353       14.4 %
Total Company store operating costs
    153,876       78.1 %     156,389       77.9 %     465,699       74.2 %     470,267       73.9 %
Other costs and expenses (as a percentage of total revenues):
                                                               
Advertising expense
    9,179       4.6 %     8,660       4.3 %     27,860       4.4 %     26,681       4.2 %
General and administrative expenses
    11,328       5.7 %     16,083       8.0 %     37,583       6.0 %     43,338       6.8 %
Asset impairments
    -       0.0 %     -       0.0 %     -       0.0 %     137       0.0 %
Total operating costs and expenses
    174,383       88.2 %     181,132       89.7 %     531,142       84.2 %     540,423       84.5 %
                                                                 
Operating income (as a percentage of total revenues) 
    23,435       11.8 %     20,746       10.3 %     99,604       15.8 %     99,125       15.5 %
Interest expense, net (as a percentage of total revenues) 
    2,769       1.4 %     5,052       2.5 %     8,938       1.4 %     12,948       2.0 %
                                                                 
Income before income taxes (as a percentage of total revenues) 
  $ 20,666       10.4 %   $ 15,694       7.8 %   $ 90,666       14.4 %   $ 86,177       13.5 %
______________
Due to rounding, percentages presented in the table above may not add.

Three Months Ended September 27, 2009 Compared to Three Months Ended September 28, 2008

Revenues

Company store sales decreased 2.0% to $196.9 million during the third quarter of 2009 compared to $200.9 million in the third quarter of 2008 primarily due to a 3.1% decrease in comparable store sales, partially offset by a net increase in the number of Company-owned stores. The weighted average number of Company-owned stores open during the third quarter of 2009 increased by approximately six stores as compared to the same period in 2008. Menu prices increased on average 1.5% during the third quarter of 2009. We believe that our sales in the third quarter of 2009 were negatively impacted primarily by a restraint in consumer spending due to the current economic conditions, and to a lesser extent the outbreak of the H1N1 influenza A virus, commonly referred to as the “swine flu.”
 
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Our Company store sales mix was 48.3% food and beverage sales and 51.7% entertainment and merchandise sales during the third quarter of 2009 compared to 49.9% and 50.1%, respectively, in the third quarter of 2008. We believe the sales mix shift from food and beverage to entertainment and merchandise is primarily the result of birthday party packages in the current year containing greater components of game tokens and merchandise as compared to the third quarter in 2008 and a decline in stand-alone meal purchases in favor of promotional package deals that contain game tokens.

We believe that if economic conditions continue to impact consumer spending or if the outbreak of the “swine flu” continues or worsens during the last quarter of the year, our sales trends during the remainder of the 2009 fiscal year could be negatively impacted. The severity and duration of any impact to our financial results from these factors is currently uncertain.

Company Store Operating Costs

Cost of food and beverage as a percentage of food and beverage sales decreased 1.8 percentage points to 23.0% during the third quarter of 2009 from 24.8% in the third quarter of 2008 primarily due to a decline in cheese prices and the effect of a prior year adjustment of our beverage costs. During the third quarter of 2009, the average price per pound of cheese decreased approximately $0.62, or 33%, compared to prices paid in the third quarter of 2008 resulting in a 1.1 percentage point cost reduction. Cost of food and beverage in the third quarter of 2008 included the effect of a non-recurring charge to our vendor rebate allowance which increased beverage costs by approximately 0.9 percentage points during the prior year period.

Cost of entertainment and merchandise as a percentage of entertainment and merchandise sales increased 0.4 percentage points to 8.8% during the third quarter of 2009 from 8.4% in the third quarter of 2008 primarily due to a 0.2 percentage point increase attributable to additional costs associated with an attraction that dispenses novelty photo cards and an estimated 0.1 percentage point increase attributable an in-store promotion involving the distribution of additional prize redemption tickets.

Labor expense as a percentage of Company store sales increased 0.4 percentage points to 27.7% during the third quarter of 2009 compared to 27.3% in the third quarter of 2008 primarily due to approximately a 0.3 percentage point increase in health benefit costs, a decline in comparable store sales and an increase in hourly wage rates, partially offset by improved productivity of our hourly labor force and a 0.3 percentage point reduction in store personnel performance-based compensation costs associated with our Company store sales decline during fiscal 2009. During the third quarter of 2009, a 3.8% increase in average hourly wage rates at our stores was partially offset by a 1.1% increase in revenue per hourly labor hour at our stores.

Depreciation and amortization expense related to our stores increased $0.6 million to $19.2 million during the third quarter of 2009 compared to $18.6 million in the third quarter of 2008 primarily due to the ongoing capital investment initiatives occurring at our existing stores and new store development.

Store rent expense increased $0.3 million to $17.0 million during the third quarter of 2009 compared to $16.7 million in the third quarter of 2008 primarily due to an increase in the number of leased properties resulting from our new store development and to a lesser extent expansions of existing stores.
 
 
Other store operating expenses as a percentage of Company store sales were flat at 16.4% for both the third quarter of 2009 and 2008. During the third quarter of 2009, higher repair and maintenance costs were offset by reductions in other operating expenses.

Advertising Expense

Advertising expense as a percentage of total revenues increased 0.3 percentage points to 4.6% during the third quarter of 2009 from 4.3% in the third quarter of 2008 primarily due to a combined 0.2 percentage point increase in television and Internet-based media expenditures associated with our marketing programs in 2009 and a 0.1 percentage point increase attributable to the costs of certain promotional activities that took place during the third quarter of 2009.

General and Administrative Expenses

General and administrative expenses as a percentage of total revenues decreased 2.3 percentage points to 5.7% during the third quarter of 2009 from 8.0% in the third quarter of 2008 primarily due to the non-recurrence of prior year legal related costs and a favorable adjustment to a tax penalty reserve during the third quarter of 2009. Prior year legal related costs included the unfavorable effect of an accrual in the third quarter of 2008 of $3.0 million in aggregate loss contingencies. During the third quarter of 2009, we settled certain issues related to a federal income tax examination of our 2003 through 2005 tax years and realized a $0.9 million benefit from the reduction of a tax penalty reserve.

Interest Expense, Net

Interest expense decreased to $2.8 million during the third quarter of 2009 compared to $5.1 million in the third quarter of 2008 primarily due to a 110 basis point decrease in the average effective interest rates incurred on the outstanding balance of our revolving credit facility and a decrease in the average debt balance outstanding between the two quarters. During the third quarter of 2009, the average debt balance outstanding under our revolving credit facility was $334.1 million compared to $390.3 million during the third quarter of 2008.


 
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Income Taxes

Our effective income tax rate was 38.5% and 36.9% for the third quarters of 2009 and 2008, respectively. The increase in our effective income tax rate was primarily due to the effect of favorable state and U.S. federal tax adjustments in the third quarter of 2008, and to a lesser extent unfavorable tax adjustments in the third quarter of 2009.

Diluted Earnings Per Share

Diluted earnings per share increased to $0.55 per share for the third quarter of 2009 from $0.43 per share in the third quarter of 2008 due to a 28.4% increase in our net income between the two quarters. The increase in diluted earnings per share between the two quarters was impacted by our repurchase of approximately 1.1 million shares of our common stock since the beginning of the third quarter of 2008. We estimate that the decrease in the number of weighted average diluted shares outstanding during the third quarter of 2009 attributable solely to these repurchases benefited our earnings per share growth in the third quarter of 2009 by approximately $0.01. Our estimate is based on the weighted average number of shares repurchased since the beginning of the third quarter of 2008 and includes consideration of the estimated additional interest expense attributable to increased borrowings under our revolving credit facility to finance the repurchases. Our computation does not include the effect of share repurchases prior to the third quarter of 2008, or the effect of the issuance of restricted stock or exercise of stock options subsequent to the third quarter of 2008.

Nine Months Ended September 27, 2009 Compared to Nine Months Ended September 28, 2008

Revenues

Company store sales decreased 1.4% to $627.8 million during the first nine months of 2009 compared to $636.5 million in the first nine months of 2008 primarily due to a 2.7% decrease in comparable store sales, partially offset by a net increase in the number of Company-owned stores. The weighted average number of Company-owned stores open during the first nine months of 2009 increased by approximately five stores as compared to the same period in 2008. Menu prices increased on average 1.7% during the first nine months of 2009. We believe that our sales in the first nine months of 2009 were negatively impacted by a restraint in consumer spending due to the current economic conditions. Additionally, we believe that the outbreak of the H1N1 influenza A virus, commonly referred to as the “swine flu,” unfavorably impacted our sales results during the first nine months of 2009 primarily from the last week of April through the first week of June 2009.

Our Company store sales mix was 50.1% food and beverage sales and 49.9% entertainment and merchandise sales during the first nine months of 2009 compared to 50.5% and 49.5%, respectively, in the first nine months of 2008. We believe the sales mix shift from food and beverage to entertainment and merchandise is primarily the result of increased sales of promotional package deals and birthday parties containing greater components of game tokens and merchandise.

We believe that if economic conditions continue to impact consumer spending or if the outbreak of the “swine flu” continues or worsens during the last three months of the year, our sales trends during the remainder of the 2009 fiscal year could be negatively impacted. The severity and duration of any impact to our financial results from these factors is currently uncertain.

Company Store Operating Costs

Cost of food and beverage as a percentage of food and beverage sales decreased 1.5 percentage points to 22.1% during the first nine months of 2009 from 23.6% in the first nine months of 2008 primarily due to a decline in cheese prices and the effect of a prior year adjustment of our beverage costs recorded in the third quarter of 2008. During the first nine months of 2009, the average price per pound of cheese decreased approximately $0.72, or 38%, compared to prices paid in the first nine months of 2008. Cost of food and beverage in the first nine months of 2008 included the effect of a non-recurring charge to our vendor rebate allowance we recorded in the third quarter of 2008 which increased beverage costs by approximately 0.3 percentage points during the prior year period.