Attached files

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EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CEC ENTERTAINMENT INCex31-1.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - CEC ENTERTAINMENT INCex32-1.htm
EX-21.1 - SUBSIDIARIES OF THE COMPANY - CEC ENTERTAINMENT INCex21-1.htm
EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - CEC ENTERTAINMENT INCex31-2.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER - CEC ENTERTAINMENT INCex32-2.htm
EX-10.12 - SUMMARY OF DIRECTOR COMPENSATION - CEC ENTERTAINMENT INCex10-12.htm
EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - CEC ENTERTAINMENT INCex23-1.htm


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


FORM 10-K
 
 

 
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES      EXCHANGE ACT OF 1934
 
For the fiscal year ended January 3, 2010
 
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
 


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)
     
     
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $0.10 par value
 
New York Stock Exchange
     
Securities registered pursuant to Section 12(g) of the Act:
None


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨    No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨    No x

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

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 ¨   (Do not check if a smaller reporting company)
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨   No x
 
As of June 26, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the common stock beneficially held by non-affiliates of the registrant was $651,540,731. (For purposes hereof, directors, executive officers and 10% or greater stockholders have been assumed to be affiliates).

As of February 15, 2010, an aggregate of 22,195,251 shares of the registrant’s common stock, par value $0.10 per share, were outstanding.


DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement, to be filed pursuant to Section 14(a) of the Securities Exchange Act of 1934 in connection with the registrant's 2010 annual meeting of stockholders, are incorporated by reference in Part III of this report.

 
 

 





CEC ENTERTAINMENT, INC.

TABLE OF CONTENTS
 
       
 
Page
         
     
3
         
PART I
       
         
ITEM 1.
   
4
         
ITEM 1A.
   
8
         
ITEM 1B.
   
12
         
ITEM 2.
   
13
         
ITEM 3.
   
14
         
ITEM 4.
   
14
         
PART II
       
         
ITEM 5.
   
15
         
ITEM 6.
   
17
         
ITEM 7.
   
18
         
ITEM 7A.
   
33
         
ITEM 8.
   
34
         
ITEM 9.
   
57
         
ITEM 9A.
   
57
         
ITEM 9B.
   
57
         
PART III
       
         
ITEM 10.
   
58
         
ITEM 11.
   
58
         
ITEM 12.
   
58
         
ITEM 13.
   
58
         
ITEM 14.
   
58
         
PART IV
       
         
ITEM 15.
   
58
         
 
59
         
         
         
         
         
         
         
         
         
         


 
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Within this report, unless otherwise indicated, any use of the terms “CEC Entertainment,” the “Company,” “we,” “us” and “our” refer to CEC Entertainment, Inc and its subsidiaries.


Certain statements in this report, other than historical information, may be considered “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, and are subject to various risks, uncertainties and assumptions. Statements that are not historical in nature, and which may be identified by the use of words such as “may,” “should,” “could,” “believe,” “predict,” “potential,” “continue,” “plan,” “intend,” “expect,” “anticipate,” “future,” “project,” “estimate” and similar expressions (or the negative of such expressions) are forward-looking statements. Forward-looking statements are made based on management’s current expectations and beliefs concerning future events and, therefore, involve a number of assumptions, risks and uncertainties, including the risk factors described in Item 1A “Risk Factors” of this Annual Report on Form 10-K. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may differ from those anticipated, estimated or expected. Factors that could cause actual results to differ materially from those contemplated by forward-looking statements include, but are not limited to:
 
·  
Changes in consumer discretionary spending and general economic conditions;
 
·  
Disruptions in the financial markets affecting the availability and cost of credit and our ability to maintain adequate insurance coverage;
 
·  
Our ability to successfully implement our business development strategies;
 
·  
Costs incurred in connection with our business development strategies;
 
·  
Competition in both the restaurant and entertainment industries;
 
·  
Loss of certain key personnel;
 
·  
Increases in food, labor and other operating costs;
 
·  
Changes in consumers’ health, nutrition and dietary preferences;
 
·  
Negative publicity concerning food quality, health, safety and other issues;
 
·  
Continued existence or occurrence of certain public health issues;
 
·  
Disruption of our commodity distribution system;
 
·  
Our dependence on a few global providers for the procurement of games and rides;
 
·  
Adverse affects of local conditions, events and natural disasters;
 
·  
Fluctuations in our quarterly results of operations due to seasonality;
 
·  
Conditions in foreign markets;
 
·  
Risks in connection with owning and leasing real estate;
 
·  
Our ability to adequately protect our trademarks or other proprietary rights;
 
·  
Government regulations, litigation, product liability claims and product recalls;
 
·  
Disruptions of our information technology systems;
 
·  
Application of and changes in generally accepted accounting principles; and
 
·  
Failure to establish, maintain and apply adequate internal control over financial reporting.
 
The forward-looking statements made in this report relate only to events as of the date on which the statements were made. Except as may be required by law, we undertake no obligation to update our forward-looking statements to reflect events and circumstances after the date on which the statements were made or to reflect the occurrence of unanticipated events.

 
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PART    I

ITEM 1.   Business

General

Chuck E. Cheese’s® is a nationally recognized leader in family dining and entertainment. CEC Entertainment, Inc. was incorporated in the state of Kansas in 1980. We consider the family dining and entertainment center business to be our sole reportable operating segment.

Company Overview

We develop, operate and franchise family dining and entertainment centers (also referred to as “stores”) 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.

We believe that the dining and entertainment components of our business are interdependent, and therefore we primarily manage and promote them as an integrated product. Our typical guest experience involves a combination of wholesome family dining and entertainment, comprised of token-operated games and rides, and attractions provided free-of-charge. This integrated product drives our business development strategies as we endeavor to drive guest traffic into our stores, benefiting both dining and entertainment revenue.

The first Chuck E. Cheese’s opened in 1977. Currently, we and our franchisees operate a total of 545 Chuck E. Cheese's stores located in 48 states and six foreign countries or territories. As of January 3, 2010, we operated 497 Company-owned Chuck E. Cheese’s stores located in 44 states and Canada and our franchisees operated a total of 48 stores located in 16 states, Puerto Rico, Guatemala, Chile, Saudi Arabia, and the United Arab Emirates.  See Item 2. “Properties” for more information regarding the number and location of Chuck E. Cheese’s stores.

Business Development Strategy

Our business development strategy is focused on maintaining and evolving our existing stores, developing high sales volume Company-owned stores primarily in densely populated areas, and selling development rights to franchisees in domestic and international markets we do not currently intend to open Company-owned stores.

Existing Stores. We believe that in order to maintain consumer demand for and the appeal of our concept, we must continually reinvest in our existing stores. For our existing stores, we currently utilize the following capital initiatives: (a) major remodels; (b) store expansions; and (c) game enhancements. We believe these capital initiatives are essential to preserving our existing sales and cash flows and provide a solid foundation for long term revenue growth.

We undertake periodic major remodels when there is a need to improve the overall appearance of a store or when we introduce concept changes or enhancements to our stores. The major remodel initiative typically includes increasing the space allocated to the playroom area of the store, increasing the number of games and rides and developing a new exterior and interior identity. We completed nine major remodel initiatives in 2009. We currently expect to complete approximately 16 major remodels in fiscal 2010 at an average cost of approximately $0.6 million per store.
 
 
Store expansions improve the quality of the guests’ experience because the additional square footage allows us to increase the number and variety of games, rides and other entertainment offerings in the expanded stores. In addition to expanding the square footage of a store, store expansions typically include all components of a major remodel and generally result in an increase in the store’s seat count. We completed 26 store expansions in 2009. We currently expect to complete approximately 35 store expansions in fiscal 2010 at an average cost of approximately $1.0 million per store.

We believe game enhancements are necessary to maintain the relevance and appeal of our games and rides. In addition, game enhancements counteract general wear and tear on the equipment and incorporate improvements in game technology. We completed 125 game enhancements in 2009. We currently expect to enhance the games and rides at approximately 181 stores in fiscal 2010 at an average cost of approximately $0.1 million to $0.2 million per store.

New Company Store Development. Our plan for the development of new Company-owned stores focuses on opening high sales volume stores in densely populated areas. During 2009, we added three new Company-owned stores. The new stores we have opened over the past two years have an average square footage of approximately 14,000 to 15,000 square feet and generate average annual sales of approximately $2.0 million per store. We currently expect to add approximately six new Company-owned stores, including one relocation and one store acquired from a franchisee, in fiscal 2010 at an average cost of approximately $2.4 million to $2.6 million per store.

 
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We periodically reevaluate the site characteristics of our stores and will consider relocating a store if certain site characteristics considered essential for the success of a store deteriorate, more desirable property becomes available or we are unable to negotiate acceptable lease terms with the existing landlord.

See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information regarding our capital initiatives and related capital expenditures.

New Domestic Franchise Store Development. We added three new domestic franchise stores in 2009. Currently, our domestic franchisees have rights to develop an additional 12 stores. Under our domestic agreements, we expect to open approximately two domestic franchise stores in fiscal 2010. We are currently offering franchise development rights in approximately 16 domestic markets.

International Growth. We believe that we have an opportunity to further expand the Chuck E. Cheese’s concept globally. We have formalized a strategic plan for worldwide growth and are actively seeking international franchise partners in select countries within Latin America and Central and Western Europe, the Middle East and Asia. In October 2009, we entered into a development agreement providing the rights to eight stores in Chile. Also in October 2009, we entered into a franchise agreement for a store that will be opened in Guam. Finally, in November of 2009 we signed a development agreement providing the rights to develop 25 stores throughout the Middle East.

Store Design

Chuck E. Cheese's are typically located in shopping centers or in free-standing buildings near shopping centers and generally occupy 9,000 to 14,500 square feet in area, averaging approximately 11,500 square feet per store.  Chuck E. Cheese’s stores are typically divided into three areas: (1) a kitchen and related areas (cashier and prize area, salad bar, manager’s office, technician’s office, restrooms, etc.) occupying approximately 35% of the space, (2) a showroom area occupying approximately 25% of the space, and (3) a playroom area occupying approximately 40% of the space. Total table and chair seating in both the showroom and playroom areas generally average between 325 to 425 guests per store. The showroom area of each Chuck E. Cheese's typically features a variety of comic and musical entertainment by computer-controlled robotic characters, together with video monitors and animated props, located on various stage-type settings.

Food and Beverages

Each Chuck E. Cheese's offers a variety of pizzas, sandwiches, appetizers, a salad bar and desserts.  Soft drinks, coffee and tea are also served, along with beer and wine where permitted by local laws.  We believe that the quality of our food compares favorably with that of our competitors. The majority of the food, beverages and other supplies used in Company-owned stores are currently distributed under a system-wide agreement with a major food distributor.  We believe that this distribution system creates certain cost and operational efficiencies for us.

Approximately 49.7%, 50.3% and 51.7% of our total revenues were derived from food and beverage sales during fiscal years 2009, 2008 and 2007, respectively.
 
 
Entertainment and Merchandise

Each Chuck E. Cheese’s store generally includes a showroom area featuring musical entertainment presented by robotic and animated characters and playroom area offering arcade-style and skill-oriented games, rides, video games and other forms of entertainment. Tokens are used to activate the games and rides in the playroom area. All of our games and rides are activated with one token. The maximum price our customers may pay for a game token is $0.25; however, we offer game tokens at reduced prices when purchased in larger quantities or as part of a package deal generally comprised of food, beverage and game tokens. A number of skill-oriented games dispense tickets that can be redeemed by guests for prize merchandise such as toys and plush items. Our guests can also purchase this merchandise directly. Also included in the playroom area of our stores are tubes and tunnels suspended from or reaching to the ceiling known as SkyTubes® or other free attractions for young children. We place a limited amount of table and chair seating in the playroom areas of our Company-owned store so that parents can more closely observe and interact with their children as they play the games and ride the rides.

Approximately 49.8%, 49.2% and 47.9% of our total revenues were derived from entertainment and merchandise sales during fiscal years 2009, 2008 and 2007, respectively.

Marketing

The primary customer base for our stores consists of families with children between two and 12 years of age.  We conduct advertising campaigns focused on families with young children that feature the family entertainment experiences available at Chuck E. Cheese's with the primary objective of increasing the frequency of customer visits. The primary advertising medium we use continues to be television, due to its broad access to family audiences and our belief in its ability to effectively communicate the

 
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Chuck E. Cheese's experience.  The television advertising campaigns are supplemented by promotional offers in newspapers, cross promotions with companies that target a similar customer base, our Web site, Internet advertising campaigns and e-mail.

Franchising

As of January 3, 2010, a total of 48 Chuck E. Cheese's stores were operated by our franchisees. Of theses stores, 40 are located domestically in the United States and eight are located internationally in Puerto Rico, Guatemala, Chile, Saudi Arabia, and the United Arab Emirates.

Our standard domestic franchise agreement grants to the franchisee the right to construct and operate a store and use the associated trade names, trademarks and service marks within the standards and guidelines established by us. Most of our existing franchise agreements have an initial term of 15 years and include a 10-year renewal option. However, our current franchise agreement for prospective franchisees will have an initial term of 20 years. The standard agreement provides us with a right of first refusal should a franchisee decide to sell a store.

We and our franchisees created the International Association of CEC Entertainment, Inc. (the “Association”) to discuss and consider matters of common interest relating to the operation of Company-owned and franchised Chuck E. Cheese’s. Routine business matters of the Association are conducted by a board of directors of the Association, composed of five members appointed by us and five members elected by the franchisees. The Association serves as an advisory council, which among other responsibilities, oversees expenditures from the funds established and managed by the Association. These funds include (1) the Advertising Fund, a fund that pays the costs of development, purchasing and placement of system-wide advertising programs, including Internet Web sites, (2) the Entertainment Fund, a fund established to develop and improve audio-visual and animated entertainment attractions, as well as the development and implementation of new entertainment concepts and (3) the Media Fund, a fund primarily designated for the purchase of national network television advertising. The Association is included in our consolidated financial statements.

In addition to an initial franchise fee of $50,000 and a continuing monthly royalty fee equal to 3.8% of gross sales, the franchise agreements governing existing franchised Chuck E. Cheese's in the United States currently require each franchisee to pay to the Association a monthly contribution of 3.4% of gross sales. Additionally, under these franchise agreements, we are required, with respect to Company-owned stores, to spend for local advertising and to contribute to the Advertising Fund and the Entertainment Fund at the same rates as franchisees. We and our franchisees could be required to make additional contributions to fund any deficits that may be incurred by the Association.

Approximately 0.5% of our total revenues were derived from franchise fees and royalties during fiscal years 2009, 2008 and 2007.

Foreign Operations

As of January 3, 2010, we operated a total of 14 Company-owned stores in Canada. During fiscal years 2009, 2008 and 2007, our Canada stores generated total revenues of approximately $20.8 million, $22.8 million and $21.4 million, respectively, representing approximately 2.5%, 2.8% and 2.7% of our total revenues in each respective fiscal year. As of January 3, 2010, we had approximately $20.4 million, or approximately 3.1%, of our long-lived assets located in Canada.

Additionally, as of January 3, 2010, our international franchisees operated a total of eight stores located in Puerto Rico, Guatemala, Chile, Saudi Arabia, and the United Arab Emirates. The total revenues derived from our international franchisees are not material in relation to our total revenues.

These foreign activities are subject to various risks of conducting business in a foreign country, including changes in foreign currency, laws and regulations and economic and political stability. See Item 1A. “Risk Factors” for more information regarding the risks associated with our operations located in foreign markets. As of January 3, 2010, we do not believe that we have a material dependence on these foreign operations.

Competition

The family dining industry and the entertainment industry are highly competitive, with a number of major national and regional chains operating in each of these spaces. In this regard, we compete for customers on the basis of (1) our name recognition; (2) the price, quality, variety, and perceived value of our food and entertainment offerings; (3) the quality of our customer service, and (4) the convenience and attractiveness of our facilities. Although there are other concepts that presently utilize the combined family dining and entertainment format, these competitors primarily operate on a regional or market-by-market basis. To a lesser extent, we may also compete directly and/or indirectly with other dining and entertainment formats including the quick service pizza segment, movie theaters, and themed amusement attractions catering to our target market of families with young children.

We believe that our principal competitive strengths consist of our established recognized brand, the relative quality of the food and service we provide our customer, the quality and variety of our entertainment offerings, and the location and attractiveness of our stores. We also believe that our competitive strengths include our tenured management team’s knowledge of the family dining and

 
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entertainment industries relative to our target market of families with young children.

Intellectual Property

We own various trademarks, including "Chuck E. Cheese’s" and the Chuck E. Cheese character image used in connection with our business, which have been registered with the appropriate patent and trademark offices. The duration of such trademarks is unlimited, subject to continued use. We believe that we hold the necessary rights for protection of the trademarks considered essential to conduct our business. We believe our trade name and our ownership of trademarks in the names and character likenesses featured in the operation of our stores provides us with an important competitive advantage and we actively seek to protect our interest in such property.

Seasonality

Our operating results fluctuate seasonally due to the timing of school vacations, holidays and changing weather conditions. As a result, we typically generate higher sales volumes during the first and third quarters of each fiscal year.  School operating schedules, holidays and weather conditions may affect sales volumes in some operating regions differently than others.  Because of the seasonality of our business, results for any quarter are not necessarily indicative of the results that may be achieved for the full fiscal year.

Government Regulation

We and our franchisees are subject to various federal, state and local laws and regulations affecting the development and operation of Chuck E. Cheese’s, including, but not limited to, those that impose restrictions, levy a fee or tax, or require a permit or license, or other regulatory approval, and those that relate to the operation of video and arcade games and rides, the preparation and sale of food and beverages, the sale and service of alcoholic beverages, and building and zoning requirements. We and our franchisees are also subject to laws governing relationships with employees, including minimum wage requirements, overtime, working and safety conditions, immigration status requirements and child labor laws. A significant portion of our store personnel are paid at rates related to the minimum wage established by federal, state and municipal law and, accordingly, increases in such minimum wage result in higher labor costs to us. We are also subject to the Fair Labor Standards Act, the Americans with Disabilities Act, and Family Medical Leave Act mandates. In addition, we are subject to regulation by the Federal Trade Commission, Federal Communications Commission and must comply with certain state laws which govern the offer, sale and termination of franchises and the refusal to renew franchises.

Working Capital Practices

Our requirement for working capital is not significant since our customers pay for their purchases in cash or credit cards at the time of the sale. Thus, we are able to monetize many of our inventory items before we have to pay our suppliers for such items. Since our accounts payable are generally due in five to 30 days, we are able to carry current liabilities in excess of current assets (commonly referred to as a “net working capital deficit”). We attempt to maintain only sufficient inventory of supplies in our stores to satisfy current operational needs. Our accounts receivable typically consists of credit card receivables, vendor rebates and amounts due from our franchisees. Our current liabilities typically consist of accounts payable, accrued operating expenses (including salaries and wages, certain self-insurance claims and taxes), deferred revenues and interest obligations.

Employees

As of January 3, 2010, we employed approximately 16,800 employees, including approximately 16,400 in the operation of our Company-owned stores and approximately 400 employed in our corporate office. None of our employees are members of any union or collective bargaining group.  We believe that our employee relations are satisfactory, and we have not experienced any work stoppages at any of our stores.

Each Chuck E. Cheese's store typically employs a general manager, one or two managers, an electronic specialist who is responsible for repair and maintenance of the robotic characters, games and rides, and 20 to 45 food preparation and service employees, many of whom work part-time. Our employment varies seasonally, with the greatest number of people being employed during the summer months.

Available Information

Our principal executive offices are located at 4441 W. Airport Freeway, Irving, Texas 75062, and our telephone number is (972) 258-8507. We maintain a Web site at www.chuckecheese.com.

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). You may read and copy any reports, statements and other information filed by us at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549-0102. Please call (800) SEC-0330 for further information on the Public Reference Room. The SEC maintains an Internet Web site (www.sec.gov) that contains reports, proxy and information

 
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statements and other information regarding issuers, including us, that we file electronically with the SEC.

We make available, free of charge, on or through the investor information section of our Web site our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, statements of changes in beneficial ownership of securities, and amendments to those reports and statements as soon as reasonably practicable after electronic filing or furnishing of such material with the SEC. The address for our Web site is www.chuckecheese.com.

Documents available on our Web site include, among others, our (i) Corporate Governance Guidelines, (ii) Code of Business Conduct and Ethics, (iii) Code of Ethics for the Chief Executive Officer, President and Senior Financial Officers (the “Code of Ethics”), (iv) Complaint and Reporting Procedures for Accounting and Auditing Matters, and (v) Charters for the Audit, Compensation, and Nominating/Corporate Governance Committees of the Board of Directors. These documents are also available in print, free of charge, to any stockholder who requests a copy from the Secretary, Meredith W. Bjorck, at 4441 W. Airport Freeway, Irving, Texas 75062. We intend to disclose future amendments to, or waivers from, certain provisions of the Code of Ethics on our Web site.

ITEM 1A.  Risk Factors

Our business operations and the implementation of our business strategy are subject to significant risks inherent in our business, including, without limitation, the risks and uncertainties described below. The occurrence of any one or more of the risks or uncertainties described below and elsewhere in this Annual Report on Form 10-K could have a material adverse effect on our financial condition, results of operations and cash flows. While we believe we have identified and discussed below the key risk factors that affect our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our business, operations, industry, financial position and financial performance in the future. Since these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different.

Risks Related to Our Business

Changes in consumer discretionary spending and general economic conditions could reduce sales at our stores and have an adverse effect on our financial results.

Purchases at our stores are discretionary for consumers and, therefore, our results of operations are susceptible to economic slowdowns and recessions. We are dependent in particular upon discretionary spending by consumers living in the communities in which our stores are located. A significant portion of our stores are clustered in certain geographic areas. A significant weakening in the local economies of these geographic areas, or any of the areas in which our stores are located, may cause consumers to curtail discretionary spending, which in turn could reduce our Company store sales and have an adverse effect on our financial results.

The future performance of the U.S. and global economies are uncertain and are directly affected by numerous national and global financial and other factors that are beyond our control. Increases in credit card, home mortgage and other borrowing costs and declines in housing values could weaken the U.S. economy leading to a decrease in consumer spending. It is difficult to predict the severity and the duration of such a decrease. We believe that consumers generally are more willing to make discretionary purchases, including at our stores, during periods in which favorable economic conditions prevail. Further, fluctuations in the retail price of gasoline and the potential for future increases in gasoline and other energy costs may affect consumers’ disposable incomes available for entertainment and dining. Changes in consumer spending habits as a result of a recession or a reduction in consumer confidence are likely to reduce our sales performance, which could have a material adverse affect on our business, results of operations or financial condition. In addition, these economic factors may affect our level of spending on planned capital initiatives at our stores, and thereby impact our future sales.

Disruptions in the financial markets may adversely affect the availability and cost of credit and compromise our ability to maintain adequate insurance coverage.

Disruptions in the financial markets may adversely affect the availability of credit already arranged and the availability and cost of credit in the future. Failures of significant financial institutions could adversely affect our access to and reduce the alternative sources of liquidity needed to operate our business. Any disruption could require us to take measures to conserve cash until the markets stabilize or until alternative credit arrangements or other funding for our business needs can be arranged. Such measures could include deferring or curtailing our capital expenditures and other discretionary uses of cash.

We rely on insurance to mitigate our exposure to catastrophic losses we may sustain to our property, claims by our employees, customers or other third parties. Although we have historically obtained adequate levels of insurance coverage through well rated and capitalized firms, disruptions in the financial markets may affect our ability to obtain coverage under existing policies or purchase insurance under new policies at reasonable rates in the future. Additionally, we are potentially at risk if our insurance carriers become insolvent. As a result, we could potentially be exposed to financial losses which could adversely affect our results of operations.

 
8

 

We may not be successful in the implementation of our business development strategies.

Our continued growth depends, to a significant degree, on our ability to successfully implement our long-term growth strategies.  As part of our long-term growth strategy, we plan to open additional new stores in selected markets, remodel and expand our existing stores and upgrade the games, rides and entertainment at our existing stores. The opening and success of new Chuck E. Cheese’s stores is dependant on various factors, including but not limited to the availability of suitable sites, the negotiation of acceptable lease terms for such locations, our ability to meet construction schedules, our ability to manage such expansion and hire and train personnel to manage the new stores, the potential cannibalization of sales at our adjacent stores located in the market, as well as general economic and business conditions.  Our ability to successfully open new stores or remodel, expand or upgrade the entertainment at existing stores will also depend upon the availability of sufficient capital for such purposes, including operating cash flow, our existing credit facility, future debt financings, future equity offerings or a combination thereof.  There can be no assurance that we will be successful in opening and operating the number of anticipated new stores on a timely or profitable basis.  There can be no assurance that we can continue to successfully remodel or expand our existing facilities or upgrade the games and entertainment.  Our growth is also dependent on our ability to continually evolve and update our business model to anticipate and respond to changing customer needs and competitive conditions. There can be no assurance that we will be able to successfully anticipate changes in competitive conditions or customer needs or that the market will accept our business model.

Part of our growth strategy depends on our ability to attract new franchisees to recently opened markets and the ability of these franchisees to open and operate new stores on a profitable basis. Delays or failures in opening new franchised stores could adversely affect our planned growth.   Our new franchisees depend on the availability of financing to construct and open new stores. If these franchisees experience difficulty in obtaining adequate financing for these purposes, our growth strategy and franchise revenues may be adversely affected.

We may incur significant costs in connection with our business development strategies.

Our long-term growth is dependent on the success of strategic initiatives to increase the number of our stores and enhance the facilities of existing stores.  We incur significant costs each time we open a new store and other expenses when we relocate or remodel existing stores. The expenses of opening, relocating or remodeling any of our stores may be higher than anticipated.  If we are unable to open or are delayed in opening new stores, we may incur significant costs which may adversely affect our financial results.  If we are unable to remodel or are delayed in remodeling stores, we may incur significant costs which may adversely affect our financial results.

We are subject to competition in both the restaurant and entertainment industries.

We believe that our combined restaurant and entertainment center concept puts us in a niche which combines elements of both the restaurant and entertainment industries.  As a result, to some degree, we compete with entities in both industries.  Although other restaurant chains presently utilize the concept of combined family dining-entertainment operations, we believe these competitors operate primarily on a local, regional or market-by-market basis.  Within the traditional restaurant sector, we compete with other casual dining restaurants on a nationwide basis with respect to price, quality and speed of service, type and quality of food, personnel, the number and location of restaurants, attractiveness of facilities, effectiveness of advertising and marketing programs, and new product development. Such competitive market conditions, including the effectiveness of our advertising and promotion and the emergence of significant new competition, could adversely affect our operating results.

We are dependent on the service of certain key personnel.

The success of our business is highly dependent upon the continued employment of Richard M. Frank, our Executive Chairman, Michael H. Magusiak, our President and Chief Executive Officer, and other members of our senior management team.  Although the Company has entered into employment agreements with each of Mr. Frank and Mr. Magusiak, the loss of the services of either of such individuals could have a material adverse effect upon our business and development. Our success will also depend upon our ability to retain and attract additional skilled management personnel to our senior management team and at our operational level.  There can be no assurances that we will be able to retain the services of Messrs. Frank or Magusiak, senior members of our management team or the required operational support at the store level in the future.

We may experience an increase in food, labor and other operating costs.

An increase in food, labor, utilities, insurance and/or other operating costs may adversely affect our financial results. Such an increase may adversely affect us directly or indirectly through our vendors, franchisees and others whose performance have a significant impact on our financial results.

Specifically, any increase in the prices for food commodities, including cheese and wheat, could adversely affect our financial results. The performance of our stores is also adversely affected by increases in the price of utilities on which the stores depend, such as natural gas, whether as a result of inflation, shortages or interruptions in supply, or otherwise. Our business also incurs significant costs for and including among other things, insurance, marketing, taxes, real estate, borrowing and litigation, all of which could increase due to inflation, rising interest rates, changes in laws, competition, or other events beyond our control.

 
9

 


In addition, a number of our employees are subject to various minimum wage requirements. Several states and cities in which we operate stores have established a minimum wage higher than the federally mandated minimum wage.  There may be similar increases implemented in other jurisdictions in which we operate or seek to operate. These minimum wage increases may have an adverse effect on our results of operations.

Changes in consumers’ health, nutrition and dietary preferences could adversely affect our financial results.

Our industry is affected by consumer preferences and perceptions. Changes in prevailing health or dietary preferences and perceptions may cause consumers to avoid certain products we offer in favor of alternative or healthier foods.  If consumer eating habits change significantly and we are unable to respond with appropriate menu offerings, it could adversely affect our financial results.

Negative publicity concerning food quality, health, safety or other issues could adversely affect our financial results.

Food service businesses can be adversely affected by litigation and complaints from guests, consumer groups or government authorities resulting from food quality, illness, injury or other health concerns or operating issues stemming from one store or a limited number of stores. Publicity concerning food-borne illnesses, injuries caused by food tampering and safety issues may negatively affect our operations, reputation and brand.  Such publicity may have a significant adverse impact on our financial results.

Our target market of children between the ages of two and 12 and families with young children may be highly sensitive to adverse publicity that may arise from an actual or perceived negative event within one or more of our stores. There can be no assurance that we will not experience negative publicity regarding one or more of our stores, and the existence of negative publicity could materially and adversely affect our image with our customers and our results of operations.

Public health issues may adversely affect our financial results.

Our business may be impacted by certain public health issues including epidemics, pandemics and the rapid spread of certain illness and contagious diseases (e.g., H1N1 influenza A virus, commonly referred to as the “swine flu”). To the extent that our guests feel uncomfortable visiting public locations, particularly locations with a large number of children, due to a perceived risk of exposure to a public health issue, we could experience a reduction in guest traffic, which could adversely affect our financial results.

We are subject to risks from disruption of our commodity distribution system.

Any disruption in our commodity distribution system could adversely affect our financial results.  We use a single vendor to distribute most of the products and supplies used in our stores.  Any failure by this vendor to adequately distribute products or supplies to our stores could increase our costs and have a material adverse affect on our financial results and our operations.

Our procurement of games and rides is dependant upon a few global providers.

Our ability to continue to procure new games, rides and other entertainment-related equipment is important to our business strategy.  The number of suppliers from which we can purchase games, rides and other entertainment-related equipment is limited due to industry consolidation over the past several years coupled with a lower overall global demand. To the extent that the number of suppliers continues to decline, we could be subject to the risk of distribution delays, pricing pressure, lack of innovation and other associated risks.

Our stores may be adversely affected by local conditions, events and natural disasters.

Certain regions in which our stores are located may be subject to adverse local conditions, events or natural disasters. A natural disaster may damage our stores or other operations which may adversely affect the financial results of the Company. In addition, if severe weather, such as heavy snowfall or extreme temperatures, discourages or restricts customers in a particular region from traveling to our stores, our sales could be adversely affected. If severe weather occurs during the first and third quarters of the year, the adverse impact to our sales and profitability could be even greater than at other times during the year because we generate a significant portion of our sales and profits during these periods. Additionally, demographic shifts in the areas where our stores are located could adversely impact our sales and results of operations.

Our business is highly seasonal and quarterly results may fluctuate significantly as a result of this seasonality.

We have experienced, and in the future could experience, quarterly variations in revenues and profitability as a result of a variety of factors, many of which are outside our control, including the timing of school vacations, holidays and changing weather conditions. We typically experience lower revenues and profitability in the second and fourth quarters than in the first and third quarters. If revenues are below expectations in any given quarter, our operating results will likely be adversely affected for that quarter.

 
10

 

Unanticipated conditions in foreign markets may adversely affect our ability to operate effectively in those markets.

In addition to our stores in the United States, we currently own or franchise stores in Canada, Puerto Rico, Guatemala, Chile, Saudi Arabia and the United Arab Emirates. We intend to expand into additional foreign markets in the future. We and our franchisees are subject to the regulatory and economic and political conditions of any foreign market in which we and our franchisees operate stores. Any change in the laws and regulations and economic and political stability of these foreign markets may adversely affect our financial results. Changes in foreign markets that may affect our financial results include, but are not limited to, taxation, inflation, currency fluctuations, political instability, war, increased regulations and quotas, tariffs and other protectionist measures.

We are subject to risks in connection with owning and leasing real estate.

As an owner and lessee of the land and/or building for our Company-owned stores, we are subject to all of the risks generally associated with owning and leasing real estate, including changes in the supply and demand for real estate in general and the supply and demand for the use of the stores. Any obligation to continue making rental payments with respect to leases for closed stores could adversely affect our financial results.

We may not be able to adequately protect our trademarks or other proprietary rights.

We own certain common law trademark rights and a number of federal and international trademark and service mark registrations and proprietary rights relating to our operations. We believe that our trademarks and other proprietary rights are important to our success and our competitive position. We, therefore, devote appropriate resources to the protection of our trademarks and proprietary rights. The protective actions that we take, however, may not be enough to prevent unauthorized usage or imitation by others, which could harm our image, brand or competitive position and, if we commence litigation to enforce our rights, we may incur significant legal fees.

We cannot be assured that third parties will not claim that our trademarks or menu offerings infringe upon their proprietary rights. Any such claim, whether or not it has merit, may result in costly litigation, cause delays in introducing new menu items in the future, interfere with our international development agreements or require us to enter into royalty or licensing agreements. As a result, any such claim could have a material adverse effect on our business, results of operations, and financial position.

We are subject to various government regulations which may adversely affect our operations and financial performance.

The development and operation of our stores are subject to various federal, state and local laws and regulations in many areas of our business, including, but not limited to, those that impose restrictions, levy a fee or tax, or require a permit or license, or other regulatory approval. Difficulties or failure in obtaining required permits, licenses or other regulatory approvals could delay or prevent the opening of a new store, and the suspension of, or inability to renew, a license or permit could interrupt operations at an existing store. We are also subject to laws governing our relationship with employees, including minimum wage requirements, overtime, health insurance mandates, working and safety conditions, immigration status requirements, and child labor laws. Additionally, potential changes in federal labor laws, including “card check” regulations, could result in portions of our workforce being subjected to greater organized labor influence. This could result in an increase to our labor costs.  A significant portion of our store personnel are paid at rates related to the minimum wage established by federal, state and municipal law. Increases in such minimum wage result in higher labor costs, which may be partially offset by price increases and operational efficiencies. Additionally, we are subject to certain laws and regulations that govern our handling of customers’ personal information. A failure to protect the integrity and security of our customers’ personal information could expose us to litigation, as well as materially damage our reputation with our customers. While we endeavor to comply with all applicable laws and regulations, governmental and regulatory bodies may change such laws and regulations in the future, which may require us to incur substantial cost increases. If we fail to comply with applicable laws and regulations, we may be subject to various sanctions, and/or penalties and fines or may be required to cease operations until we achieve compliance, which could have a material adverse effect on our financial results and operations.

We face litigation risks from customers, employees, franchisees and other third parties in the ordinary course of business.

Our business is subject to the risk of litigation by customers, current and former employees, suppliers, stockholders or others through private actions, class actions, administrative proceedings, regulatory actions or other litigation.  The outcome of litigation, particularly class action lawsuits and regulatory actions, is difficult to assess or quantify.  Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time. The cost to defend future litigation may be significant. There may also be adverse publicity associated with litigation that could decrease customer acceptance of our food or entertainment offerings, regardless of whether the allegations are valid or whether we are ultimately found liable.

We are continually subject to risks from litigation and regulatory action regarding advertising to our market of children between the ages of two and 12 years old.  In addition, since certain of our stores serve alcoholic beverages, we are subject to “dram shop” statutes. These statutes generally allow a person injured by an intoxicated person to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. Although we believe we are adequately covered by insurance, a judgment against us under a “dram shop” statute in excess of the liability covered could have a material adverse effect on our

 
11

 

business, financial condition and results of operations.

Under certain circumstances plaintiffs may file certain types of claims which may not be covered by insurance.  In some cases, plaintiffs may seek punitive damages which may also not be covered by insurance. Any litigation we face could have a material adverse effect on our business, financial condition and results of operations.

We face risks with respect to product liability claims and product recalls.

We purchase merchandise from third-parties and offer this merchandise to customers in exchange for prize tickets or for sale. This merchandise could be subject to recalls and other actions by regulatory authorities. Changes in laws and regulations could also impact the type of merchandise we offer to our customers. We have experienced, and may in the future experience, issues that result in recalls of merchandise. In addition, individuals have asserted claims, and may in the future assert claims, that they have sustained injuries from third-party merchandise offered by us, and we may be subject to future lawsuits relating to these claims. There is a risk that these claims or liabilities may exceed, or fall outside of the scope of, our insurance coverage.  Any of the issues mentioned above could result in damage to our reputation, diversion of development and management resources, or reduced sales and increased costs, any of which could harm our business.

We are dependent on certain information technology systems and technologies which may be compromised.

The operation of our business is dependent upon the integrity, security and successful functioning of our computer networks and information systems, including the point-of-sales systems in our stores, data centers that process transactions and various software applications used in our operations. Damage to, or interruption or failure of these systems could result in losses due to disruption of our business operations. These adverse situations could lead to loss of sales or profits or cause us to incur additional development costs. In addition, despite our efforts to secure our computer networks and information systems, security could be compromised or confidential information could be misappropriated resulting in a loss of customers’ personal information, negative publicity, harm to our business and reputation or cause us to incur costs to reimburse third parties for damages.

Our application of and changes in generally accepted accounting principles could affect our reported results of operations.

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles which require us to make estimates and assumptions. The use of estimates is pervasive throughout our financial statements and is affected by management’s judgment. To the extent management’s judgment is incorrect, it could result in an adverse impact on our financial statements and reported results of operations. The authoritative accounting literature related to the development of estimates for insurance, tax and legal reserves, valuation of long-lived assets, stock-based compensation, as well as accounting for leases and hedge accounting are highly complex. Changes in generally accepted accounting principles and interpretations thereof may occur in the future that could adversely affect our reported financial position, results of operations and/or cash flows.

Risks Related to Our Common Stock

A failure to establish, maintain and apply adequate internal control over financial reporting could have a material adverse affect on our business and/or market valuation of our common stock.

We are subject to the ongoing internal control provisions of Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”).  These provisions provide for the identification of material weaknesses in internal control over financial reporting, which is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. As of January 3, 2010, we have concluded that our internal controls over financial reporting are effective; however there can be no assurance that we will be able to maintain all of the controls necessary to remain in compliance with Sarbanes-Oxley in the future. Should we identify any material weaknesses in internal control over financial reporting in the future, there can be no assurance that we will be able to remediate such material weaknesses in a timely manner. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report financial results accurately and timely or to detect and/or prevent fraud. A failure to maintain an effective system of internal control may also result in a negative market reaction in regards to the valuation of our common stock.

ITEM 1B.  Unresolved Staff Comments.

None.

 
12

 

ITEM 2.    Properties.

The following table summarizes information regarding the number and location of stores we and our franchisees operated as of January 3, 2010:
                   
 
 
Domestic
 
Company -
Owned
Stores
   
Franchised
Stores
   
 
Total
 
                   
Alabama
    7       1       8  
Alaska
    1       -       1  
Arizona
    2       7       9  
Arkansas
    6       -       6  
California
    76       5       81  
Colorado
    10       -       10  
Connecticut
    6       -       6  
Delaware
    2       -       2  
Florida
    25       -       25  
Georgia
    16       -       16  
Hawaii
    -       2       2  
Idaho
    1       -       1  
Illinois
    22       -       22  
Indiana
    14       -       14  
Iowa
    5       -       5  
Kansas
    4       -       4  
Kentucky
    4       1       5  
Louisiana
    9       1       10  
Maine
    1       -       1  
Maryland
    14       -       14  
Massachusetts
    11       -       11  
Michigan
    18       -       18  
Minnesota
    5       -       5  
Mississippi
    3       2       5  
Missouri
    8       -       8  
Montana
    -       1       1  
Nebraska
    2       -       2  
Nevada
    5       -       5  
New Hampshire
    2       -       2  
New Jersey
    15       -       15  
New Mexico
    3       -       3  
New York
    21       -       21  
North Carolina
    13       2       15  
North Dakota
    -       1       1  
Ohio
    19       1       20  
Oklahoma
    3       -       3  
Oregon
    1       3       4  
Pennsylvania
    22       1       23  
Rhode Island
    1       -       1  
South Carolina
    7       -       7  
South Dakota
    2       -       2  
Tennessee
    12       -       12  
Texas
    58       -       58  
Utah
    -       3       3  
Virginia
    10       4       14  
Washington
    7       5       12  
West Virginia
    1       -       1  
Wisconsin
    9       -       9  
                         
Total domestic
    483       40       523  
International
                       
                         
Canada
    14       -       14  
Chile
    -       1       1  
Guatemala
    -       2       2  
Puerto Rico
    -       3       3  
Saudi Arabia
    -       1       1  
United Arab Emirates
    -       1       1  
                         
Total international
    14       8       22  
                         
Total system
    497       48       545  

 
13

 

Company Store Leases

Of the 497 Chuck E. Cheese's owned by us as of January 3, 2010, 438 occupy leased premises and 59 occupy owned premises. The current lease terms of these stores will expire at various times from 2010 to 2028 and available lease terms, including options to renew, expire at various times from 2013 to 2043, as described in the table below.

Year of
Expiration
 
Number
of Stores
 
Range of Renewal
Options (Years)
2010
    24  
None to 20
2011
    31  
None to 20
2012
    44  
None to 20
2013
    48  
None to 20
2014
    56  
None to 20
2015 through 2028
    235  
None to 20

The leases of these stores contain terms that vary from lease to lease, although a typical lease provides for an initial primary term of 10 years, with two additional five-year options to renew. It is common for us to take possession of leased premises prior to the commencement of rent payments for the purpose of constructing leasehold improvements. The leases generally require us to pay the cost of repairs, insurance and real estate taxes and, in some instances, may provide for additional rent equal to the amount by which a percentage of gross revenues exceed the minimum rent.

Corporate Office and Warehouse Facilities

We lease a 76,556 square foot office building in Irving, Texas which serves as our corporate office and support services center. This lease expires in May 2015, with options to renew through May 2025.

We also lease a total of 146,142 square feet at two warehouses in Topeka, Kansas which primarily serve as storage and refurbishing facilities for our store fixtures and game equipment. These leases expire in August and September 2013, respectively.

ITEM 3.    Legal Proceedings.

From time to time, we are involved in various inquiries, investigations, claims, lawsuits, and other legal proceedings that are incidental to the conduct of our business. These matters typically involve claims from customers, employees or other third parties involved in operational issues common to the retail, restaurant and entertainment industries. Such matters typically represent actions with respect to contracts, intellectual property, taxation, employment, employee benefits, personal injuries and other matters. A number of such claims may exist at any given time and there are currently a number of claims and legal proceedings pending against us.

In the opinion of our management, after consultation with legal counsel, the amount of ultimate liability with respect to claims or proceedings currently pending against us is not expected to have a material adverse effect on our financial condition, results of operations or cash flows.

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

No matters were submitted to a vote of security holders during the fourth quarter of 2009.

 
14

 

PART   II

ITEM  5.   Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our common stock is listed on the New York Stock Exchange under the symbol "CEC."   The following table sets forth the highest and lowest sale price for our common stock during each quarterly period within the two most recent fiscal years, as reported on the New York Stock Exchange:
   
Fiscal 2009
   
Fiscal 2008
 
   
High
   
Low
   
High
   
Low
 
                         
1st Quarter 
  $ 27.50     $ 19.29     $ 30.65     $ 19.81  
2nd Quarter
  $ 34.77     $ 23.54     $ 39.47     $ 27.87  
3rd Quarter
  $ 34.53     $ 25.41     $ 39.59     $ 25.59  
4th Quarter
  $ 33.23     $ 24.69     $ 34.21     $ 12.96  
 
 
As of February 15, 2010, there were an aggregate of 22,195,251 shares of our common stock outstanding and approximately 1,998 stockholders of record.
 
 
We have not paid any cash dividends on our common stock and have no present intention of paying cash dividends thereon in the future; however, our intent in regards to paying cash dividends is subject to continual review. In addition, pursuant to our revolving credit facility agreement, there are restrictions on the amount of our repurchases of our common stock and cash dividends that we may pay on our common stock based on certain financial covenants and criteria. We currently plan to utilize our earnings to finance anticipated capital expenditures, reduce our long-term debt and potentially repurchase our common stock.
 
 
Issuer Purchases of Equity Securities

The following table presents information related to repurchases of our common stock during the fourth quarter of 2009 and the maximum dollar value of shares that may yet be purchased pursuant to our stock repurchase program:

Issuer Purchases of Equity Securities
 
                         
   
 
 
 
 
Total
Number
of Shares
Purchased(1)
   
 
 
 
 
 
Average
Price Paid
Per Share(1)
   
Total
Number of
Shares
Purchased
As Part of
Publicly
Announced
Plans or
Programs
   
 
 
Maximum Dollar Value of Shares
that May Yet Be
Purchased
Under the Plans
or Programs(2)
 
 
 
 
 
 
 
 
Period
                         
Sept. 28 – Oct. 25, 2009
    -       -       -     $ 37,805,555  
Oct. 26 – Nov. 22, 2009
    294,032     $ 29.75       -     $ 229,064,321  
Nov. 23, 2009 – Jan. 3, 2010
    341,904     $ 30.14       -     $ 218,758,993  
Total
    635,689     $ 29.96       -     $ 218,758,993  
 
 (1)
For the period ended November 22, 2009, the total number of shares purchased included 247 shares tendered by employees at an average price per share of $26.65 to satisfy tax withholding requirements on the vesting of restricted stock awards, which are not deducted from shares available to be purchased under our stock repurchase program. Unless otherwise indicated, shares tendered by employees to satisfy tax withholding requirements were considered purchased at the closing price of our common stock on the date of vesting.
 
 (2)
We may repurchase shares of our common stock under a plan authorized by our Board of Directors (the “Board”).  On July 25, 2005, the Board approved a stock repurchase program which authorized us to repurchase from time to time up to $400 million of our common stock and authorized a $200 million increase on October 22, 2007 and a $200 million increase on October 27, 2009. The stock repurchase program, which does not have a stated expiration date, authorizes us to make repurchases in the open market, through accelerated share repurchases or in privately negotiated transactions.

 
15

 

Stock Performance Graph

The graph below compares the annual change in the cumulative total stockholder return on our common stock over the last five fiscal years ended January 3, 2010, with the cumulative total return on the NYSE Composite Index and the S&P SmallCap 600 Restaurants Index. The comparison assumes an investment of $100 on January 2, 2005 in our common stock and in each of the foregoing indices and assumes the reinvestment of dividends. Our stock price performance shown in the graph below may not be indicative of future stock price performance.
 
 
   
Jan. 2
2005
   
Jan. 1
2006
   
Dec. 31
2006
   
Dec. 30
2007
   
Dec. 28
2008
   
Jan. 3
2010
 
                                     
CEC Entertainment
  $ 100.00     $ 85.16     $ 100.70     $ 65.72     $ 58.67     $ 79.86  
NYSE Composite
  $ 100.00     $ 109.36     $ 131.74     $ 144.36     $ 83.76     $ 111.76  
S&P SmallCap 600 Restaurants
  $ 100.00     $ 98.25     $ 110.60     $ 84.83     $ 58.83     $ 77.96  


 
16

 

ITEM 6.  Selected Financial Data.

The following selected financial data presented below should be read in conjunction with Item 7. “Management's Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements under Item 8. “Financial Statements and Supplementary Data.”

   
Fiscal Year(1)
 
   
2009
   
2008
   
2007
   
2006
   
2005
 
   
(in thousands, except per share and store number amounts)
 
Statement of Earnings Data:
                             
Company store sales
  $ 814,563     $ 810,693     $ 781,665     $ 769,241     $ 722,873  
Franchise fees and royalties
    3,783       3,816       3,657       3,312       3,296  
                                         
Total revenues
    818,346       814,509       785,322       772,553       726,169  
                                         
Company store operating costs:
                                       
Cost of food, beverage, entertainment and merchandise (exclusive of items shown separately below)
    128,245       131,416       126,413       121,808       115,930  
Labor expenses
    223,084       223,331       214,147       210,010       202,780  
Depreciation and amortization
    77,101       74,805       70,701       64,292       59,849  
Rent expense
    67,695       65,959       63,734       60,333       57,022  
Other operating expenses
    123,986       119,990       113,789       106,025       98,094  
 
                                       
Total Company store operating costs
    620,111       615,501       588,784       562,468       533,675  
Advertising expense
    36,641       34,736       30,651       32,253       29,294  
General and administrative expenses
    50,629       55,970       51,705       53,037       45,527  
Asset impairments
    -       282       9,638       3,910       360  
                                         
Total operating costs and expenses
    707,381       706,489       680,778       651,668       608,856  
                                         
Operating income
    110,965       108,020       104,544       120,885       117,313  
                                         
Interest expense
    12,017       17,389       13,170       9,508       4,532  
                                         
Income before income taxes
    98,948       90,631       91,374       111,377       112,781  
                                         
Income taxes
    37,754       34,137       35,453       43,120       43,110  
                                         
Net income
  $ 61,194     $ 56,494     $ 55,921     $ 68,257     $ 69,671  
                                         
Per Share Data: (2) (3)
                                       
Earnings per share:
                                       
Basic
  $ 2.68     $ 2.37     $ 1.79     $ 2.08     $ 1.99  
Diluted
  $ 2.67     $ 2.33     $ 1.75     $ 2.03     $ 1.93  
                                         
Weighted average shares outstanding:
                                       
Basic
    22,835       23,825       31,237       32,794       35,091  
Diluted
    22,933       24,199       31,970       33,623       36,188  
                                         
Balance Sheet Data (end of year):
                                       
Cash and cash equivalents
  $ 17,361     $ 17,769     $ 18,373     $ 18,308     $ 12,184  
Total assets
    744,266       747,440       737,893       704,185       651,920  
Revolving credit facility borrowings
    354,300       401,850       316,800       168,200       137,100  
Total long-term debt (4) 
    365,810       414,058       329,875       181,781       149,568  
Stockholders’ equity
    167,913       128,586       217,993       359,206       343,183  
                                         
Number of Stores (end of year):
                                       
Company-owned
    497       495       490       484       475  
Franchised
    48       46       44       45       44  
      545       541       534       529       519  


(1)
We operate on a 52 or 53 week fiscal year ending on the Sunday nearest December 31.  Fiscal year 2009 was 53 weeks in length and all other fiscal years presented were 52 weeks.
(2)
No cash dividends on common stock were paid in any of the years presented.
(3)
Share and per share amounts for 2008, 2007 and 2006 reflect the retrospective application of a new accounting standard adopted as of the beginning of our 2009 fiscal year requiring us to include certain unvested restricted stock awards in the computation of basic earnings per share. Upon adopting this standard, basic and diluted earnings per share decreased (a) $0.06 and $0.04, respectively, for fiscal year 2008, (b) $0.02 and $0.01, respectively, for fiscal year 2007 and (c) $0.01 and $0.01, respectively, for fiscal year 2006. Refer to Note 10 “Earnings Per Share” to our consolidated financial statements for a more complete discussion of this accounting standard.
(4)
Long-term debt includes revolving credit facility borrowings and capital lease obligations.






 
17

 

ITEM 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“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 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

Our MD&A should be read in conjunction with our consolidated financial statements and related notes included in Part II, Item 8 “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

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. References to 2009, 2008 and 2007 are for the fiscal years ended January 3, 2010, December 28, 2008, and December 30, 2007, respectively. Our 2009 fiscal year consists of 53 weeks and our 2008 and 2007 fiscal years each consisted of 52 weeks.

Executive Overview

Fiscal 2009 Summary
·  
Revenues increased 0.5% during 2009 compared to 2008.
-  
Comparable store sales decreased 2.8%.
-  
Weighted average Company-owned store count increased by approximately four stores.
-  
Menu prices increased on average 1.6%.
-  
53rd week in 2009 favorably impacted revenues $19.5 million and comparable Company store sales by 0.5%.

·  
Company store operating costs as a percentage of Company store sales increased 0.2 percentage points during 2009 compared to 2008 primarily due to margin pressure on fixed and semi-fixed store operating costs, partially offset by reductions in the cost of food and beverage attributable to a 31% decline in the average price per pound of cheese and favorable store labor expenses.

·  
Advertising expenses in 2009 increased to $36.6 million compared to $34.7 million in 2008 due to increases in television advertising and Internet-based media expenditures associated with our marketing programs in 2009.

·  
General and administrative expenses decreased to $50.6 million in 2009 compared to $56.0 million in 2008 primarily due to lower performance-based compensation and the non-recurrence of $2.5 million related to prior year legal matters.

·
Interest expense decreased to $12.0 million in 2009 compared to $17.4 million in 2008 primarily due to a 120 basis point decrease in the average effective interest rates incurred on the outstanding balance of our revolving credit facility during 2009 compared to 2008 and a $12.4 million decrease in the average debt balance outstanding between the two periods.

·
Net income in 2009 increased 8.3% to $61.2 million from $56.5 million in 2008 and diluted earnings per share increased 14.6% to $2.67 compared to $2.33 in 2008.  Earnings per share benefited from our cumulative repurchase of 6,686,130 shares of our common stock during the 2009 and 2008 fiscal years. We also estimate that the additional 53rd week in 2009 benefited diluted earnings per share approximately $0.17.

Impact of Share Repurchases

Our Board of Directors (the “Board”) has approved a program for us to repurchase shares of our common stock. During 2009, 2008 and 2007, we repurchased 1,775,089 shares, 4,911,041 shares and 7,887,337 shares, respectively, of our common stock at an aggregate purchase price of approximately $52.6 million, $160.8 million and $248.1 million, respectively, under the repurchase program. These share repurchases reduced our weighted average diluted shares outstanding by 648,243 shares 3,498,151 shares and 2,393,932 shares in 2009, 2008 and 2007, respectively.

Refer to “Fiscal Year 2009 Compared to Fiscal Year 2008 - Diluted Earnings per Share” and “Fiscal Year 2008 Compared to Fiscal Year 2007 - Diluted Earnings per Share” for further discussion of the impact the share repurchases had on our earnings per share growth.

 
18

 

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:
   
Fiscal Year
 
   
2009
   
2008
   
2007
 
                   
Number of Company-owned stores:
                 
Beginning of period
    495       490       484  
New
    3       5       10  
Acquired from franchisees
    -       2       1  
Closed
    (1 )     (2 )     (5 )
End of period
    497       495       490  
                         
Number of franchised stores:
                       
Beginning of period
    46       44       45  
New
    3       4       1  
Acquired by the Company
    -       (2 )     (1 )
Closed
    (1 )     -       (1 )
End of period
    48       46       44  

Comparable store sales. We define comparable store sales as the percentage change in sales for our domestic Company-owned stores that have been open for more than 18 months as of the beginning of each respective fiscal year or 12 months for acquired stores (our “comparable store base”). Relocated stores are excluded from the comparable store base until they are open for more than 18 months as of the beginning of a respective fiscal year. Comparable store sales 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.

The following table summarizes information regarding our average annual comparable store sales and comparable store base:

   
Fiscal Year
 
   
2009
   
2008
   
2007
 
   
(in thousands, except store number amounts)
 
                   
Average annual sales per comparable store (1) 
  $ 1,632     $ 1,633     $ 1,602  
Number of stores included in our comparable store base
    467       453       436  
______________
(1)
Average annual sales per comparable store have been calculated based on the average weekly sales of our comparable store base. The amount of average annual sales per comparable store cannot be used to compute year-over-year comparable store sales increases or decreases due to the change in comparable store base. Additionally, the average annual sales amount for 2009 includes the impact of an additional high sales volume 53rd week. Excluding the 53rd week in 2009, the average annual sales per comparable store was $1,593.

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 comprised 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 standalone 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 standalone 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. We allocate the revenue recognized from the sale of our package deals between “Food and beverage sales” and “Entertainment and merchandise sales” based upon the price charged for each component when it is sold separately, or in limited circumstances our best estimate of selling price if a component is not sold on a standalone basis, which we believe approximates each component’s fair value.

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:

 
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·  
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 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. Our rationale for excluding such costs is as follows:

§  
based on the fact that our store employees are trained to sell and attend to both our dining and entertainment operations, we believe it would be difficult and potentially misleading to assign labor costs between food and beverage sales and entertainment and merchandise sales; and

§  
while certain assets are individually dedicated to either our food service operations or game activities, we also have significant capital investments in shared depreciating assets, such as leasehold improvements, point-of-sale systems, animatronics, and showroom fixtures. Therefore, we believe it would be difficult and potentially misleading to assign depreciation and amortization expense between food and beverage sales and entertainment and merchandise sales.

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 our franchisees.

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.

Results of Operations

Historical Results

The following table summarizes our principal sources of Company store sales expressed in dollars and as a percentage of total Company store sales for the periods presented:
 
   
Fiscal Year
   
2009
   
2008
   
2007
   
(in thousands, except percentages)
                               
Food and beverage sales
  $ 406,635       49.9 %   $ 409,895       50.6 %   $ 405,740       51.9 %
Entertainment and merchandise sales
    407,928       50.1 %     400,798       49.4 %     375,925       48.1 %
                                                 
Company store sales
  $ 814,563       100.0 %   $ 810,693       100.0 %   $ 781,665       100.0 %


 
20

 

The following table summarizes our revenues and expenses expressed in dollars and as a percentage of total revenues (except as otherwise noted) for the periods presented:
 
     
Fiscal Year
 
     
2009
     
2008
     
2007
 
     
(in thousands, except percentages)
 
                                                 
Company store sales
  $ 814,563       99.5 %   $ 810,693       99.5 %   $ 781,665       99.5 %
Franchising activities
    3,783       0.5 %     3,816       0.5 %     3,657       0.5 %
                                                 
Total revenues
  $ 818,346       100.0 %   $ 814,509       100.0 %   $ 785,322       100.0 %
Company store operating costs:
                                               
Cost of food and beverage (1) 
  $ 91,816       22.6 %   $ 96,891       23.6 %   $ 93,693       23.1 %
Cost of entertainment and merchandise (2) 
    36,429       8.9 %     34,525       8.6 %     32,720       8.7 %
                                                 
     Total cost of food, beverage, entertainment and
    merchandise (3)
    128,245       15.7 %     131,416       16.2 %     126,413       16.2 %
Labor expenses (3) 
    223,084       27.4 %     223,331       27.5 %     214,147       27.4 %
Depreciation and amortization (3) 
    77,101       9.5 %     74,805       9.2 %     70,701       9.0 %
Rent expense (3) 
    67,695       8.3 %     65,959       8.1 %     63,734       8.2 %
Other store operating expenses (3) 
    123,986       15.2 %     119,990       14.8 %     113,789       14.6 %
Total Company store operating costs (3) 
    620,111       76.1 %     615,501       75.9 %     588,784       75.3 %
Other costs and expenses:
                                               
Advertising expense
    36,641       4.5 %     34,736       4.3 %     30,651       3.9 %
General and administrative expenses
    50,629       6.2 %     55,970       6.9 %     51,705       6.6 %
Asset impairments
    -       0.0 %     282       0.0 %     9,638       1.2 %
Total operating costs and expenses
    707,381       86.4 %     706,489       86.7 %     680,778       86.7 %
                                                 
Operating income
    110,965       13.6 %     108,020       13.3 %     104,544       13.3 %
Interest expense
    12,017       1.5 %     17,389       2.1 %     13,170       1.7 %
                                                 
Income before income taxes
  $ 98,948       12.1 %   $ 90,631       11.1 %   $ 91,374       11.6 %
______________
(1) Percent amount expressed as a percentage of food and beverage sales.
(2) Percent amount expressed as a percentage of entertainment and merchandise sales
(3) Percent amount expressed as a percentage of Company store sales
Due to rounding, percentages presented in the table above may not add.

Fiscal Year 2009 Compared to Fiscal Year 2008

Our 2009 fiscal year consisted of 53 weeks compared to 52 weeks in 2008. We have estimated the changes in fiscal 2009 operating results compared to fiscal 2008 on a comparable 52-week basis under the caption “53rd Week Impact.”

Revenues

Company store sales increased 0.5% to $814.6 million during 2009 compared to $810.7 million in 2008 primarily due to the additional 53rd week sales of approximately $19.5 million and a weighted average net increase of approximately four Company-owned stores during 2009 as compared to 2008. This increase was partially offset by a decline in our comparable store sales which, including the impact of the additional 53rd week in 2009, decreased 2.8%. We believe our comparable store sales in 2009 were negatively impacted by a restraint in consumer spending due to a weakened economic environment, and to a lesser extent the outbreak of the H1N1 influenza A virus, commonly referred to as the “swine flu.” We believe the greatest impact of the swine flu occurred from April through June 2009. This negative impact to our comparable store sales was partially offset by menu prices which increased on average 1.6% during 2009. Despite the apparent restraint in consumer spending and added pressure from the swine flu, we believe the execution of various strategies we have implemented, including the ongoing capital initiatives at our stores and our continuing efforts to increase the number of birthday parties and fund raising events at our stores worked, in part, to counteract theses negative factors.

Our Company store sales mix was 49.9% food and beverage sales and 50.1% entertainment and merchandise sales during 2009 compared to 50.6% and 49.4%, respectively, in 2008. We believe the shift in sales mix 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.

Company Store Operating Costs

Cost of food and beverage as a percentage of food and beverage sales decreased 1.0 percentage point to 22.6% during 2009 from 23.6% in 2008 primarily due to a $0.59, or 31%, reduction in the average price per pound of cheese in 2009 compared to prices paid in 2008.

Cost of entertainment and merchandise as a percentage of entertainment and merchandise sales increased 0.3 percentage points to 8.9% during 2009 from 8.6% in 2008 primarily due to a 0.2 percentage point increase in costs associated with an attraction that dispenses novelty photo cards, and to a lesser extent increased distributions of prize redemption tickets related to specific promotions during the second and third quarters of 2009.

 
21

 


Labor expense as a percentage of Company store sales decreased 0.1 percentage point to 27.4% during 2009 compared to 27.5% in 2008 primarily due to improved productivity at the store level and a reduction in store personnel performance-based compensation costs associated with our Company store sales decline during 2009, largely offset by a 3.4% increase in average hourly wage rates at our stores.

Depreciation and amortization expense related to our stores increased $2.3 million to $77.1 million during 2009 compared to $74.8 million in 2008 primarily due to the ongoing capital investment initiatives that occurred at our existing stores and new store development.

Store rent expense increased $1.7 million to $67.7 million during 2009 compared to $66.0 million in 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 increased 0.4 percentage points to 15.2% during 2009 compared to 14.8% in 2008 primarily due to higher repair and maintenance costs and the effect of a $0.8 million gain that we recognized in 2008 from the sale of property related to our TJ Hartford’s Grill and Bar (“TJ Hartford’s”). The increase in other store operating expenses as a percentage of Company store sales was partially offset by a reduction in general insurance costs during 2009 compared to 2008.
 
 
Advertising Expense

Advertising expense as a percentage of total revenues increased 0.2 percentage points to 4.5% during 2009 from 4.3% in 2008 primarily due to a combined 0.2 percentage point increase in television advertising and Internet-based media expenditures associated with our marketing programs in 2009.

General and Administrative Expenses

General and administrative expenses decreased $5.3 million to $50.6 million during 2009 from $56.0 million in 2008 primarily due to lower performance-based compensation and a decrease in legal related costs. Performance-based compensation associated with our financial performance for 2009 decreased $3.8 million in 2009 compared to 2008. Litigation related costs decreased approximately $2.5 million primarily due to the non-recurrence of certain prior year legal matters. These decreases were partially offset by increases in other corporate office expenses.

Interest Expense

Interest expense decreased to $12.0 million during 2009 compared to $17.4 million in 2008 primarily due to a 120 basis point decrease in the average effective interest rates incurred and a reduction in the outstanding balance of our revolving credit facility between the two periods. The weighted average effective interest rate incurred on borrowings under our revolving credit facility was 2.9% during 2009 compared to 4.2% in 2008. During 2009, the average debt balance outstanding under our revolving credit facility was $346.3 million compared to $358.6 million during 2008.

Income Taxes

Our effective income tax rate was 38.2% and 37.7% for 2009 and 2008, respectively. The increase in our effective income tax rate was primarily due to the effect of favorable U.S. federal and state tax adjustments we made during 2008, and to a lesser extent unfavorable tax adjustments in 2009.

Diluted Earnings Per Share

Diluted earnings per share increased to $2.67 per share during 2009 from $2.33 per share in 2008 due to a 8.3% increase in our net income and a 5.2% decrease in the number of weighted average diluted shares outstanding between the two periods. The increase in diluted earnings per share between the two periods was impacted by our repurchase of approximately 6.7 million shares of our common stock since the beginning of 2008. We estimate that the decrease in the number of weighted average diluted shares outstanding during 2009 attributable solely to these repurchases benefited our earnings per share growth in 2009 by approximately $0.17. Our estimate is based on the weighted average number of shares repurchased since the beginning 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 fiscal 2008, or the effect of the issuance of restricted stock or exercise of stock options subsequent to the beginning of fiscal 2008.

The diluted earnings per share amounts discussed above reflect the retrospective application of a new accounting standard we adopted as of the beginning of our 2009 fiscal year which requires us to include certain unvested restricted stock awards in the computation of basic earnings per share. Refer to Note 10 “Earnings Per Share” to our consolidated financial statements for a more complete discussion of this new accounting standard.

 
22

 


53rd Week Impact

Our 2009 fiscal year consisted of 53 weeks compared to 52 weeks in 2008, resulting in one additional operating week in the fourth quarter of 2009. The favorable impact to total revenues from the additional operating week was approximately $19.5 million and our 2009 comparable store sales benefited 0.5%. We estimate that the additional operating week benefited 2009 diluted earnings per share approximately $0.17. This benefit was primarily due to the operating leverage obtained from the additional high sales volume 53rd week, particularly related to certain fixed costs, such as depreciation and amortization and rent, that are recognized on a monthly basis as opposed to incremental weekly amounts.

Fiscal Year 2008 Compared to Fiscal Year 2007

Revenues

Company store sales increased 3.7% to $810.7 million during 2008 compared to $781.7 million in 2007 primarily due to a 2.3% increase in comparable store sales during 2008, a net increase in the number of our Company-owned stores and an average increase in menu prices of 1.7% in 2008 compared to 2007. The weighted average number of Company-owned stores open during 2008 increased by approximately five stores as compared to 2007. We believe that our comparable store sales in 2008 reflect the impact of the various strategies we implemented during the year, including the ongoing capital initiatives at our existing stores, an enhanced marketing plan implemented at the beginning of 2008, implementation of a suggestive sales program and our recent efforts to increase the number of birthday parties and fund raising events at our stores. During 2008, our birthday party sales as a percentage of total Company store sales increased from 12.0% to 12.9%, and fund raising sales as a percentage of total Company store sales increased from 0.7% to 0.9%. Even with the success of these strategies and the increase in Company store sales, we believe that our sales in 2008 were negatively impacted by a restraint in consumer spending attributable to the weakening economy particularly in the last two quarters of 2008. The increase in our comparable store sales growth was also partially offset by the impact of temporary closures of 39 stores (representing approximately 265 store operating days) in the third quarter of 2008 as a result of hurricanes Gustav and Ike. We estimate that these temporary closures decreased our 2008 comparable store sales by approximately 0.2%.

Our Company store sales mix was 50.6% food and beverage sales and 49.4% entertainment and merchandise sales for fiscal 2008 compared to 51.9% and 48.1%, respectively, for 2007.

Revenue from franchise fees and royalties increased 4.3% to $3.8 million during 2008 compared to $3.7 million in 2007 primarily due to our recognition of additional franchise fees attributable to the increase in the number of new franchise stores that opened during 2008. During 2008, four new franchise stores opened and we acquired two franchise stores. Domestic franchise comparable store sales decreased 2.4% in 2008 as compared to 2007.

Company Store Operating Costs

Cost of food and beverage as a percentage of food and beverage sales increased 0.5% to 23.6% during 2008 from 23.1% in 2007 primarily due to higher commodity prices and beverage costs. During 2008, the average price per pound of cheese increased approximately $0.13, or 8%, and the average price per pound of dough increased approximately $0.12, or 29%, compared to prices paid in 2007. Increases attributable to the average prices per pound of cheese and dough and our increased buffalo wing usage represented approximately a 1.0% combined increase in food costs as a percentage of food and beverage sales. These increases were partially offset by a reduction of approximately 0.9% as a percentage of food and beverage sales in total pizza costs attributable to our implementation of an enhanced cheese product and a resizing of our medium and large pizzas during the first two quarters of 2008. Beverage costs increased due to a non-cash charge to our vendor rebate allowance of approximately $0.9 million, or approximately 0.2% as a percentage of food and beverage sales, that we recorded in the third quarter of 2008. Additionally, costs associated with an enhanced birthday party package we introduced during 2008 increased approximately 0.2% as a percentage of food and beverage sales.

Cost of entertainment and merchandise as a percentage of entertainment and merchandise sales decreased 0.1% to 8.6% during 2008 from 8.7% in 2007.

Labor expense as a percentage of Company store sales increased 0.1% to 27.5% during 2008 compared to 27.4% in 2007 primarily due to a 3.6% increase in average hourly wage rates at our stores, higher group medical expenses and performance based compensation costs related to field operations personnel. These increases were partially offset by a 3.1% increase in revenue per hourly labor hour.

Depreciation and amortization expense related to our stores increased $4.1 million to $74.8 million during 2008 compared to $70.7 million in 2007 primarily due to the ongoing capital investment initiatives occurring at our existing stores and new store development.



 
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Store rent expense increased $2.2 million to $66.0 million during 2008 compared to $63.7 million in 2007 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 increased 0.2% to 14.8% during 2008 compared to 14.6% in 2007 primarily due to increases in insurance related costs and, to a lesser extent, increases in other store operating expense and were partially offset by the leverage from our sales increase. Insurance related costs were approximately $2.7 million higher during 2008 compared to 2007 due to a favorable prior year adjustment to workers compensation and general liability reserves recorded in 2007 and losses we incurred from hurricanes Gustav and Ike during the third quarter of 2008 which were not covered by our insurance. Property taxes increased approximately $2.0 million, or 0.2% as a percentage of Company store sales, during 2008 primarily due to a favorable adjustment to our accrued property taxes in the prior year. This increase was offset by a $2.4 million, or 0.3% as a percentage of Company store sales, reduction in asset disposal costs primarily attributable to charges for our store remodeling initiatives during 2008 which did not recur to the same extent as had been incurred in 2007. Other store operating costs in 2008 also benefited from a $0.8 million gain that we recognized in the second quarter of 2008 from the sale of property related to TJ Hartford’s.

Advertising Expense

Advertising expense as a percentage of total revenues increased 0.4% to 4.3% during 2008 from 3.9% in 2007 primarily due to increased television advertising, newspaper inserts and online media costs associated with our enhanced marketing programs in 2008.

General and Administrative Expenses

General and administrative expenses as a percentage of total revenues increased 0.3% to 6.9% during 2008 from 6.6% in 2007 primarily due to higher corporate office compensation expense and litigation related costs. Total corporate office compensation expense increased $4.6 million, or 0.4% as a percentage of total revenues, during 2008 compared to 2007 primarily due to higher performance-based compensation costs associated with our financial performance in 2008. Litigation related costs increased approximately $2.5 million, or 0.3% as a percentage of total revenues, primarily due to the accrual of $1.3 million in aggregate contingent losses and a $1.3 million increase in legal fees related to ongoing legal matters. These increases were partially offset by reductions in other corporate office expenses, including the non-recurrence of approximately $0.5 million of professional service fees associated with the review of our stock option granting practices that concluded in the first quarter of 2007 and the benefit from approximately $2.4 million, or 0.3% as a percentage of total revenues, of 2007 tax related charges which did not recur in 2008.

Asset Impairments

Impairments related to our store assets were $0.3 million during 2008 compared to $9.6 million in 2007. The $0.3 million asset impairment charge during 2008 related to two stores, one of which had been previously impaired and the other which we decided to close prior to the end of its expected lease term. In 2007, we recorded impairment charges of $9.6 million related to six stores, one of which we closed in the first quarter of 2008. We recognized these asset impairment charges due to the decline in the stores’ estimated fair values which had been adversely affected by economic and competitive factors in the markets in which the stores are located. Due to the negative impact of these factors, we determined that the forecasted cash flows for these stores were insufficient to recover the carrying amount of their assets and, as a result, an impairment charge was necessary because the estimated fair value of the stores’ long-lived assets had declined below their carrying amount.

Interest Expense

Interest expense increased to $17.4 million during 2008 compared to $13.2 million in 2007 primarily due to an increase in the average debt balance outstanding under our revolving credit facility during 2008 as compared to the prior year. During 2008, the average debt balance under our revolving credit facility increased to approximately $358.6 million compared to $178.8 million in 2007 primarily due to our repurchases of our common stock during the first two quarters of 2008. The effect of the debt increase was partially offset by lower average interest rates in 2008, which declined by approximately 210 basis points compared to average interest rates in 2007. The weighted average effective interest rate incurred on borrowings under our revolving credit facility was 4.2% during 2008 compared to 6.3% in 2007.

Income Taxes

Our effective income tax rate was 37.7% and 38.8% during 2008 and 2007, respectively. The decrease in our effective income tax rate was primarily due to reductions in certain unfavorable permanent tax differences, other discrete tax adjustments made during 2008 and an increase in available federal tax credits.

Diluted Earnings Per Share

Diluted earnings per share increased to $2.33 per share during 2008 from $1.75 per share in 2007 due to a 1.0% increase in our net income and a 24.3% decrease in the number of weighted average diluted shares outstanding between the two periods. The increase

 
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in diluted earnings per share between the two periods was impacted by our repurchase of approximately 12.8 million shares of our common stock since the beginning of fiscal 2007. We estimate that the decrease in the number of weighted average diluted shares outstanding during 2008 attributable solely to these repurchases benefited our earnings per share growth in 2008 by approximately $0.41. Our estimate is based on the weighted average number of shares repurchased since the beginning of fiscal 2007 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 fiscal 2007, or the effect of the issuance of restricted stock or exercise of stock options subsequent to the beginning of fiscal 2007.

The diluted earnings per share amounts discussed above reflect the retrospective application of a new accounting standard we adopted as of the beginning of our 2009 fiscal year which requires us to include certain unvested restricted stock awards in the computation of basic earnings per share. Refer to Note 10 “Earnings Per Share” to our consolidated financial statements for a more complete discussion of this new accounting standard.

Financial Condition, Liquidity and Capital Resources

Overview of Liquidity

Funds generated by our operating activities, available cash and cash equivalents, and our revolving credit facility continue to be our most significant sources of liquidity. We believe funds generated from our expected results of operations and available cash and cash equivalents will be sufficient to finance our business development strategies and capital initiatives for the next year. Our revolving credit facility is also available for additional working capital needs and investment opportunities. However, in the event of a material decline in our sales trends, there can be no assurance that we will generate cash flows at or above our current levels.

Our primary requirements for cash provided by operating activities relate to planned capital expenditures, servicing our debt and may include repurchases of our common stock.

We do not enter into any material development or contractual purchase obligations in connection with our business development strategy. As a result, with respect to our planned capital expenditures, including spending that pertains to our new store development and capital initiatives, we believe that we have the flexibility necessary to manage our liquidity by promptly deferring or curtailing our capital spending.

The following tables present summarized financial information that we believe is helpful in evaluating our liquidity and capital resources:
   
Fiscal Year
 
   
2009
   
2008
   
2007
 
   
(in thousands)
 
                   
Net cash provided by operating activities
  $ 154,258     $ 144,182     $ 162,742  
Net cash used for investing activities
    (72,931 )     (85,478 )     (108,647 )
Net cash used for financing activities
    (80,568 )     (58,034 )     (54,030 )
Effect of foreign exchange rate changes on cash
    (1,167 )     (1,274 )     -  
                         
Change in cash and cash equivalents
  $ (408 )   $ (604 )   $ 65  
                         
Interest paid 
  $ 12,317     $ 16,542     $ 10,721  
Income taxes paid, net
  $ 20,454     $ 46,696     $ 27,016  

   
At Year End
 
   
2009
   
2008
 
   
(in thousands)
 
             
Cash and cash equivalents
  $ 17,361     $ 17,769  
Revolving credit facility borrowings
  $ 354,300     $ 401,850  
Available unused commitments under revolving credit facility
  $ 185,743     $ 138,706  

Sources and Uses of Cash – Fiscal Year 2009 Compared to Fiscal Year 2008

Net cash provided by operating activities increased $10.1 million to $154.3 million during 2009 from $144.2 million in 2008. The increase was primarily attributable to increases in net income and non-cash adjustments, partially offset by changes in our operating assets and liabilities.

Our cash interest payments decreased $4.2 million to $12.3 million during 2009 from $16.5 million in 2008 primarily due to a reduction in the prevailing rates of interest incurred on our borrowings in 2009 as compared to the prior year, partially offset by payments of approximately $0.5 million we made during 2009 in connection with various state tax settlements.

Our cash payments for income taxes, net of refunds we received, decreased $26.2 million to $20.5 million during 2009 compared

 
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to payments of $46.7 million in 2008 primarily due to our payment of $6.3 million in 2008 to the Internal Revenue Service for the settlement of certain federal income tax examination issues and a $5.5 million refund we received during the first quarter of 2009 related to excess 2008 federal income tax payments.

Net cash used in investing activities decreased $12.5 million to $72.9 million during 2009 from $85.5 million in 2008 primarily due to our adding fewer Company-owned stores in 2009 and reductions in general capital maintenance activities at our stores and capital spending at our corporate office compared to 2008. Cash flows from investing activities during 2008 also included the receipt of cash proceeds of approximately $2.1 million from our sale of property related to TJ Hartford’s.

Net cash used in financing activities increased $22.5 million to $80.6 million during 2009 from $58.0 million in 2008, primarily due to our repayment during 2009 of borrowings under our revolving credit facility, partially offset by a reduction in our share repurchase activity. During 2009, we made repayments of $47.6 million on the outstanding debt balance under our revolving credit facility, compared to 2008 when we increased our borrowings by $85.1 million. Also, during 2009, our repurchases of our common stock decreased $108.2 million to $52.6 million, compared to $160.8 million in 2008.

Sources and Uses of Cash – Fiscal Year 2008 Compared to Fiscal Year 2007

Net cash provided by operating activities decreased $18.6 million to $144.2 million during 2008 from $162.7 million in 2007 primarily attributable to a $15.8 million federal income tax refund received in 2007 in connection with the implementation of certain tax strategies.

Our cash interest payments increased $5.8 million to $16.5 million during 2008 from $10.7 million in 2007 primarily due to an increase in the average debt balance outstanding under our credit facility as compared to the prior year, partially offset by a reduction in the prevailing rates of interest incurred on our borrowings in 2008 as compared to 2007.

Our cash payments for income taxes, net of refunds we received, increased $19.7 million to $46.7 million during 2008 compared to payments of $27.0 million in 2007 primarily due to the refund of $15.8 million received in 2007, a $6.3 million payment made to the Internal Revenue Service in the third quarter of 2008 for the settlement of certain federal income tax examination issues, and an increase in estimated federal and state income tax payments made during 2008.

Net cash used in investing activities decreased $23.2 million to $85.5 million during 2008 from $108.6 million in 2007, primarily due to a $21.3 million decrease in capital expenditures in 2008 attributable to a decrease in the number of our new store openings and a change in the mix of capital initiatives impacting our existing stores. During 2008, we opened or acquired from franchisees, four fewer stores than we had in 2007, which contributed to a $7.7 million reduction in our capital expenditures. Also during 2008, the number of major remodels decreased by 37 units, the number of store expansions increased by only one unit and the number of game enhancements increased by 31 units as compared to the prior year, providing for a $24.7 million reduction in our capital expenditures from the prior year. These decreases were partially offset by an increase in expenditures for general store maintenance. Cash flows from investing activities during 2008 also included the receipt of cash proceeds of approximately $2.1 million from our sale of property related to TJ Hartford’s.

Net cash used in financing activities increased $4.0 million to $58.0 million during 2008 from $54.0 million in 2007, primarily due to a decrease in proceeds obtained through the exercise of employee stock options in 2008 compared to 2007. The amount of proceeds we obtained from the exercise of stock options decreased $26.1 million to $19.2 million in 2008 from $45.3 million in 2007 due to a 67% decline in the number of option shares exercised during 2008. Also, due to the reduction in our repurchases of our common stock during 2008, we decreased the amount of borrowings we drew under our revolving credit facility by $63.6 million during 2008 compared to 2007. During 2008, our repurchases of our common stock decreased $87.2 million to $160.8 million, compared to $248.1 million in 2007.

Sources of Liquidity

We currently finance our business activities through cash flows provided by our operations and, if necessary, from borrowings under our revolving credit facility.

Our requirement for working capital is not significant since our customers pay for their purchases in cash or credit cards at the time of the sale. Thus, we are able to monetize many of our inventory items before we have to pay our suppliers for such items. Since our accounts payable are generally due in five to 30 days, we are able to operate with a net working capital deficit (current liabilities in excess of current assets). Our net working capital deficit decreased to $1.0 million at January 3, 2010 from $7.7 million at December 28, 2008, primarily due to decreases in accounts payable and accrued interest costs in 2009 compared to 2008.

Our ability to access our revolving credit facility is subject to our compliance with the terms and conditions of the credit facility agreement, including our maintenance of certain prescribed financial ratio covenants, as more fully described below.

 
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Debt Financing

Our revolving credit facility agreement provides for total borrowings of up to $550.0 million for a term of five years.  The credit facility, which matures in October 2012, also includes an accordion feature which allows us, subject to lender approval, to request an additional $50.0 million in borrowings at any time. As of January 3, 2010, there were $354.3 million of borrowings and $10.0 million of letters of credit issued but undrawn under our 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 January 3, 2010, borrowings under the credit facility incurred interest at LIBOR (0.23% - 0.25%) plus 1.00% or prime (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.

During 2009, we reduced the outstanding debt balance under our revolving credit facility by $47.6 million to $354.3 million as of January 3, 2010 from $401.9 million as of December 28, 2008, by applying excess cash flows generated from operations during the period towards the repayment of debt.

Including the effect of our interest rate swap contract, the weighted average effective interest rate incurred on borrowings under our revolving credit facility was 2.9%, 4.2% and 6.3% in 2009, 2008 and 2007, respectively.

Our revolving credit facility agreement contains a number of covenants, including covenants requiring maintenance of the following financial ratios as of the end of any fiscal quarter:

a consolidated fixed charge coverage ratio of not less than 1.5 to 1.0, based upon  the  ratio  of (a) consolidated  EBITR (as defined in the revolving credit facility agreement) for the last four fiscal quarters to (b) the sum  of consolidated  interest  charges  plus consolidated rent expense during  such  period.

a consolidated leverage ratio of not greater than 3.0 to 1.0, based upon  the  ratio  of (a) the quarter-end consolidated funded indebtedness (as defined in the revolving credit facility agreement) to (b) consolidated EBITDA (as defined in the revolving credit facility agreement) for the last four fiscal quarters.

Our revolving credit facility is the primary source of committed funding from which we finance our planned capital expenditures, strategic initiatives, such as repurchases of our common stock, and certain working capital needs. Non-compliance with the financial covenant ratios could prevent us from being able to access further borrowings under our revolving credit facility, require us to immediately repay all amounts outstanding under the revolving credit facility, and increase our cost of borrowing. As of January 3, 2010, we were in compliance with these covenant ratios, with a consolidated fixed charge coverage ratio of 2.4 to 1 and a consolidated leverage ratio of 1.9 to 1.

Interest Rate Swap

We have entered into an interest rate swap contract to effectively convert $150.0 million of our variable rate revolving credit facility 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 January 3, 2010. The differential amounts receivable or payable under the swap contract are recorded over the life of the contract as adjustments to interest expense.

As of January 3, 2010, the estimated fair value of the swap contract was a liability of approximately $5.6 million. Refer to Note 7 “Derivative Instrument” of our consolidated financial statements for a more complete discussion of our interest rate swap contract.

Capital Expenditures

We believe that in order to maintain consumer demand for and the appeal of our concept, we must continually reinvest in our existing stores. For our existing stores, we currently utilize the following capital initiatives: (a) major remodels, (b) store expansions, and (c) game enhancements. We believe these capital initiatives are essential to preserving our existing sales and cash flows and provide a solid foundation for long term revenue growth.

 
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The following table summarizes information regarding the number of capital initiatives for existing Company stores we completed during each of the periods presented:
 
   
Fiscal Year
 
   
2009
   
2008
   
2007
 
                   
Major remodels
    9       15       52  
Store expansions
    26       20       19  
Game enhancements
    125       125       94  
Total completed
    160       160       165  

Major remodels. We undertake periodic major remodels when there is a need to improve the overall appearance of a store or when we introduce concept changes or enhancements to our stores. The major remodel initiative typically includes increasing the space allocated to the playroom area of the store, increasing the number of games and rides, and developing a new exterior and interior identity. We incur an average cost of approximately $0.6 million per store for major remodels.

        Store expansions. We believe store expansions improve the quality of our guests’ experience because the additional square footage allows us to increase the number and variety of games, rides and other entertainment offerings in the expanded stores. In addition to expanding the square footage of a store, store expansions typically include all components of a major remodel and generally result in an increase in the store’s seat count. We consider our investments in store expansions to generally be discretionary in nature. In undertaking store expansions, our objective is to improve the appeal of our stores and to respond to sales growth opportunities as they arise. We incur an average cost of approximately $1.0 million per store for expansions.

        Game enhancements. We believe game enhancements are necessary to maintain the relevance and appeal of our games and rides. In addition, game enhancements counteract general wear and tear on the equipment and incorporate improvements in game technology. We incur an average cost of approximately $0.1 million to $0.2 million per store for game enhancements.

Since the lifecycles of our store format and our games are largely driven by changes in consumer behaviors and preferences, we believe that our capital initiatives involving major remodels and game enhancements are required in order to keep pace with consumer entertainment expectations. As a result, we view our major remodel and game enhancement initiatives as a means to maintaining and protecting our existing sales and cash flows. While we are hopeful that our major remodels and game enhancements will contribute to incremental sales growth, we believe that our capital spending with respect to expansions of existing stores will more directly lead to growth in our comparable store sales and cash flow.  We typically invest in expansions when we believe there is a potential for sales growth and, in some instances, in order to maintain sales in stores that compete with other large-box competitors. We believe that expanding the square footage and entertainment space of a store increases our guest traffic and enhances the overall customer experience, which we believe will contribute to the growth of our long-term comparable store sales. The objective of an expansion or remodel that increases space available for entertainment is not intended to exclusively improve our entertainment sales, but rather is focused on impacting overall Company store sales through increased guest traffic and satisfaction.

New Company store development. Our plan for new store development is primarily focused on opening high sales volume stores in densely populated areas. During 2009, we added three new Company-owned stores. The cost of a new store varies depending upon many factors including the size of the store, whether we acquire land and whether the store is located in an in-line or freestanding building. We incur an average cost of approximately $2.5 million per new store.

Fiscal 2010 Capital Plan

Our future capital expenditures are expected to be primarily for the development of new stores and reinvestment into our existing store base through various capital initiatives. We estimate capital expenditures in fiscal 2010 will total approximately $94 million to $100 million, including approximately $67 million related to capital initiatives for our existing stores, approximately $15 million related to new store development and the acquisition of franchise stores, and the remainder for other store initiatives, general store requirements and corporate capital expenditures. We plan to fund these capital expenditures through cash flow from operations and, if necessary, borrowings under our revolving credit facility.

Our preliminary capital spending plan for fiscal 2010 is projected to impact approximately 232 of our existing Company-owned store locations compared to 160 during 2009. In fiscal 2010, we currently expect to complete approximately 16 major remodels, approximately 35 store expansions and approximately 181 game enhancements. Our plan for the number of store expansions in fiscal 2010 represents a 35% increase over 2009. Our decision to increase the number of store expansions is based on our expectation that the return on invested capital related to these expansions will be comparable to our historical returns generated from store expansions.

We currently expect to add approximately six new Company-owned stores, including one relocation and one store acquired from a franchisee, in fiscal 2010 at an average cost of approximately $2.4 million to $2.6 million per store.

Share Repurchases

Our Board has approv