Edgar Filing: CEC ENTERTAINMENT INC

form10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 4, 2010

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)

Not applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

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

Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of July 26, 2010, an aggregate of 21,534,893 shares of the registrant’s common stock, par value $0.10 per share were outstanding.

CEC ENTERTAINMENT, INC.

TABLE OF CONTENTS

		Page
PART I	FINANCIAL INFORMATION

ITEM 1.	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets at July 4, 2010 and January 3, 2010	3

	Condensed Consolidated Statements of Earnings for the three and six months ended July 4, 2010 and June 28, 2009	4

	Condensed Consolidated Statement of Changes in Stockholders’ Equity for the six months ended July 4, 2010	5

	Condensed Consolidated Statements of Cash Flows for the six months ended July 4, 2010 and June 28, 2009	6

	Notes to Condensed Consolidated Financial Statements	7

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	25

ITEM 4.	Controls and Procedures	26

PART II	OTHER INFORMATION

ITEM 1.	Legal Proceedings	27

ITEM 1A.	Risk Factors	27

ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27

ITEM 6.	Exhibits	28

SIGNATURES		29

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements.

CEC ENTERTAINMENT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except share information)

	July 4,			January 3,
	2010			2010
ASSETS

Current assets:
Cash and cash equivalents	$	14,649		$	17,361
Accounts receivable		10,119			27,031
Inventories		17,213			18,016
Prepaid expenses		17,435			13,915
Deferred tax asset		3,392			3,392

Total current assets		62,808			79,715

Property and equipment, net		661,729			662,747
Other noncurrent assets		8,284			1,804

Total assets	$	732,821		$	744,266

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Capital lease obligations, current portion	$	915		$	881
Accounts payable		30,067			32,754
Accrued expenses		44,270			33,927
Unearned revenues		8,683			7,641
Accrued interest		1,812			1,077
Derivative instrument liability		3,986			4,459

Total current liabilities		89,733			80,739

Capital lease obligations, less current portion		10,152			10,629
Revolving credit facility borrowings		331,400			354,300
Deferred rent liability		49,371			48,758
Deferred landlord contributions		27,941			28,220
Deferred tax liability		27,368			33,690
Accrued insurance		12,602			12,068
Derivative instrument liability		-			1,154
Other noncurrent liabilities		7,154			6,795

Total liabilities		555,721			576,353

Commitments and contingencies (Note 5)

Stockholders’ equity:
Common stock, $0.10 par value; authorized 100,000,000 shares; 61,435,959 and 61,120,018 shares issued, respectively		6,143			6,112
Capital in excess of par value		431,023			425,717
Retained earnings		741,054			702,414
Accumulated other comprehensive income		1,905			1,140
Less treasury stock, at cost; 39,866,343 and 38,944,354 shares, respectively		(1,003,025	)		(967,470	)

Total stockholders’ equity		177,100			167,913

Total liabilities and stockholders’ equity	$	732,821		$	744,266

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

CEC ENTERTAINMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(Unaudited)

(in thousands, except per share amounts)

	Three Months Ended				Six Months Ended
	July 4,		June 28,		July 4,		June 28,
	2010		2009		2010		2009
REVENUES
Food and beverage sales	$	89,064	$	91,123	$	210,080	$	219,602
Entertainment and merchandise sales		91,065		92,676		215,249		211,257

Company store sales		180,129		183,799		425,329		430,859
Franchise fees and royalties		857		996		1,984		2,069

Total revenues		180,986		184,795		427,313		432,928

OPERATING COSTS AND EXPENSES
Company store operating costs:
Cost of food and beverage (exclusive of items shown separately below)		19,967		20,612		47,586		47,758
Cost of entertainment and merchandise (exclusive of items shown separately below)		7,736		8,360		17,786		19,124

Cost of food, beverage, entertainment and merchandise		27,703		28,972		65,372		66,882
Labor expenses		51,777		52,449		112,372		112,945
Depreciation and amortization		19,836		19,040		39,442		37,954
Rent expense		17,440		16,719		34,926		33,633
Other store operating expenses		29,698		30,285		60,732		60,409

Total company store operating costs		146,454		147,465		312,844		311,823
Advertising expense		8,385		8,637		17,422		18,681
General and administrative expenses		11,436		11,738		25,121		26,255

Total operating costs and expenses		166,275		167,840		355,387		356,759

Operating income		14,711		16,955		71,926		76,169

Interest expense		3,442		3,095		6,112		6,169

Income before income taxes		11,269		13,860		65,814		70,000

Income taxes		6,491		4,866		27,174		26,953

Net income	$	4,778	$	8,994	$	38,640	$	43,047

Earnings per share:
Basic	$	0.22	$	0.39	$	1.77	$	1.88
Diluted	$	0.22	$	0.39	$	1.77	$	1.86

Weighted average shares outstanding:
Basic		21,544		23,048		21,810		22,933
Diluted		21,592		23,214		21,849		23,104

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

CEC ENTERTAINMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For the Six Months Ended July 4, 2010

(Unaudited)

(in thousands, except share information)

	Common Stock						Capital In Excess of			Retained		Accumulated Other Comprehensive			Treasury Stock
	Shares			Amount			Par Value			Earnings		Income			Shares		Amount			Total

Balance at January 4, 2010		61,120,018		$	6,112		$	425,717		$	702,414	$	1,140			38,944,354	$	(967,470	)	$	167,913
Net income		-			-			-			38,640		-			-		-			38,640
Change in fair value of cash flow hedge, net of income taxes of $335		-			-			-			-		(548	)		-		-			(548	)
Hedging loss realized in earnings, net of income taxes of $951		-			-			-			-		1,559			-		-			1,559
Foreign currency translation adjustments, net of income taxes of $38		-			-			-			-		(246	)		-		-			(246	)
Comprehensive income																					39,405

Stock-based compensation costs		-			-			3,748			-		-			-		-			3,748
Stock options exercised		144,644			14			4,615			-		-			-		-			4,629
Restricted stock issued, net of forfeitures		230,116			23			(23	)		-		-			-		-			-
Tax shortfall from stock options and restricted stock		-			-			(901	)		-		-			-		-			(901	)
Restricted stock returned for taxes		(77,711	)		(8	)		(2,734	)		-		-			-		-			(2,742	)
Common stock issued under 401(k) plan		18,892			2			601			-		-			-		-			603
Purchases of treasury stock		-			-			-			-		-			921,989		(35,555	)		(35,555	)

Balance at July 4, 2010		61,435,959		$	6,143		$	431,023		$	741,054	$	1,905			39,866,343	$	(1,003,025	)	$	177,100

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

CEC ENTERTAINMENT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

	Six Months Ended
	July 4,			June 28,
	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	38,640		$	43,047
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		39,868			38,422
Deferred income taxes		(7,793	)		1,968
Stock-based compensation expense		3,653			4,183
Amortization of landlord contributions		(1,017	)		(1,003	)
Amortization of deferred debt financing costs		141			141
Loss on asset disposals, net		1,277			1,380
Other adjustments		28			(1	)
Changes in operating assets and liabilities:
Accounts receivable		8,419			14,126
Inventories		820			(843	)
Prepaid expenses		(3,524	)		(3,579	)
Accounts payable		712			(2,294	)
Accrued expenses		(146	)		1,001
Unearned revenues		1,039			(973	)
Accrued interest		773			(1,990	)
Income taxes payable		16,620			(2,616	)
Deferred rent liability		640			823
Deferred landlord contributions		768			(164	)

Net cash provided by operating activities		100,918			91,628

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(43,074	)		(32,990	)
Other investing activities		(4,040	)		(136	)

Net cash used in investing activities		(47,114	)		(33,126	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on revolving credit facility		(22,900	)		(54,250	)
Payments on capital lease obligations		(433	)		(397	)
Exercise of stock options		4,629			14,749
Excess tax benefit realized from stock-based compensation		567			1,848
Payment of taxes for returned restricted shares		(2,742	)		(1,351	)
Treasury stock acquired		(35,555	)		(20,083	)

Net cash used in financing activities		(56,434	)		(59,484	)

Effect of foreign exchange rate changes on cash		(82	)		(270	)

Change in cash and cash equivalents		(2,712	)		(1,252	)

Cash and cash equivalents at beginning of period		17,361			17,769

Cash and cash equivalents at end of period	$	14,649		$	16,517

SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	5,198		$	6,537
Income taxes paid, net	$	17,984		$	16,954

NON-CASH INVESTING AND FINANCING ACTIVITIES:
Accrued construction costs	$	4,388		$	3,960
Common stock issued under 401(k) plan	$	603		$	577

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

CEC ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation and Recently Issued Accounting Guidance:

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

All of our stores utilize a consistent restaurant-entertainment format that features both family dining and entertainment areas where each store offers the same general mix of food, beverages, entertainment and merchandise. The economic characteristics, products and services, preparation processes, distribution methods and types of customers are substantially similar for each of our stores. Therefore, we aggregate each store’s operating performance into one reportable operating segment for financial reporting purposes.

Our consolidated financial statements include the accounts of the Company and the International Association of CEC Entertainment, Inc. (the “Association”), a variable interest entity in which we have a controlling financial interest. The Association primarily administers the collection and disbursement of funds (the “Association Funds”) used for advertising, entertainment and media programs that benefit both us and our franchisees. We and our franchisees are required to contribute a percentage of gross sales to these funds and could be required to make additional contributions to fund any deficits that may be incurred by the Association. We include the Association in our consolidated financial statements because we concluded that we are the primary beneficiary of its variable interests because we (a) have the power to direct the majority of its significant operating activities, (b) provide it unsecured lines of credit and (c) own the majority of the store locations that benefit from the Association’s advertising and media expenditures. The assets, liabilities and operating results of the Association are not material to our consolidated financial statements. Because the Association Funds are required to be segregated and used for specified purposes, we do not reflect franchisee contributions as revenue, but rather as an offset to reported expenses. We provide unsecured lines of credit to the Association which it uses to fund deficiencies in its media and advertising funds.

As the contributions we and our franchisees are required to make to the advertising and media funds maintained by the Association are designated and segregated for advertising related activities, the Association acts as an agent for us and our franchisees with regard to these contributions. We consolidate the advertising and media funds into our financial statements on a net basis, whereby contributions from franchisees, when received, are recorded as offsets to reported advertising expenses. Contributions to the advertising and media funds from our franchisees were approximately $0.5 million each for the three months ended July 4, 2010 and June 28, 2009 and approximately $1.2 million each for the six months ended July 4, 2010 and June 28, 2009. Our contributions to the funds eliminate in consolidation.

Interim Financial Statements

The accompanying unaudited condensed consolidated financial statements as of July 4, 2010 and for the three and six month periods ended July 4, 2010 and June 28, 2009 are presented in accordance with the requirements for quarterly reports on Form 10-Q and, consequently, do not include all of the information and footnote disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). In the opinion of management, such financial statements include all adjustments (consisting solely of normal recurring adjustments) necessary for the fair statement of the financial information included herein in accordance with GAAP and the rules and regulations of the Securities and Exchange Commission (the “SEC”). The balance sheet at January 3, 2010 has been derived from the audited financial statements at that date, but does not include all of the information and footnote disclosures required by GAAP for complete financial statements. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates. Results of operations for interim periods are not necessarily indicative of results for the full year. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K filed with the SEC for the fiscal year ended January 3, 2010.

Recently Issued Accounting Guidance

Newly Adopted Accounting Guidance: As of the beginning of our 2010 fiscal year, we adopted a new accounting standard amending the consolidation accounting requirements for a variable interest entity (“VIE”) which now prescribes a qualitative assessment for determining whether a variable interest gives an enterprise a controlling financial interest in a VIE. This new guidance also requires separate presentation of the assets and liabilities of a consolidated VIE on the face of the balance sheet if specific criteria are met. Our adoption of this new standard did not have a material impact on our consolidated financial statements.

CEC ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

1. Basis of Presentation and Recently Issued Accounting Guidance (continued):

Accounting Guidance Not Yet Adopted: In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2009-13 which amends the accounting and reporting guidance for arrangements comprised of multiple products or services (“deliverables”). The FASB’s revised guidance clarifies how an entity determines separate units of accounting in a multiple-deliverable arrangement and requires that revenue be allocated to all arrangement deliverables using the relative selling price method. The revised guidance is effective for the first annual reporting period beginning on or after June 15, 2010 and may be applied prospectively as of the adoption date or retrospectively for all periods presented. Early adoption is permitted provided that the revised guidance is retroactively applied to the beginning of the year of adoption. We will apply this guidance prospectively as of the start of our 2011 fiscal year. We have evaluated this new accounting guidance and our adoption will not have a material effect on our consolidated financial statements.

2. Inventories:

Inventories consisted of the following:

	July 4,		January 3,
	2010		2010
	(in thousands)

Food and beverage	$	3,846	$	4,934
Entertainment and merchandise		13,367		13,082

	$	17,213	$	18,016

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

3. Revolving Credit Facility:

	July 4,		January 3,
	2010		2010
	(in thousands)

Revolving credit facility borrowings	$	331,400	$	354,300

We have a revolving credit facility providing for total borrowings of up to $550.0 million. The credit facility, which matures in October 2012, also includes an accordion feature allowing us, subject to lender approval, to request an additional $50.0 million in borrowings at any time. As of July 4, 2010, there were $331.4 million of borrowings outstanding and $10.7 million of letters of credit issued but undrawn under the credit facility. Based on the type of borrowing, the credit facility bears interest at LIBOR plus an applicable margin of 0.625% to 1.25% determined based on our financial performance and debt levels, or alternatively, the higher of (a) the prime rate or (b) the Federal Funds rate plus 0.50%. As of July 4, 2010, borrowings under the credit facility incurred interest at LIBOR (0.35% - 0.51%) 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.

Including the effect of our interest rate swap contract discussed in Note 4 “Derivative Instrument,” the weighted average effective interest rate incurred on borrowings under our revolving credit facility was 3.0% and 3.0% for the three months ended July 4, 2010 and June 28, 2009, respectively, and was 3.0% and 2.9% for the six months ended July 4, 2010 and June 28, 2009, respectively.

The revolving credit facility agreement contains certain restrictions and conditions that, among other things, require us to maintain financial covenant ratios, including a minimum fixed charge coverage ratio of 1.5 to 1.0 and a maximum leverage ratio of 3.0 to 1.0. Additionally, the terms of the revolving credit facility agreement limit the amount of our repurchases of our common stock and cash dividends we may pay on our common stock based on certain financial covenants and criteria. As of July 4, 2010, we were in compliance with these covenants.

CEC ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

4. Derivative Instrument:

Interest Rate Risk Management

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

Cash Flow Hedge

We have entered into a $150.0 million notional amount interest rate swap contract to effectively convert a portion 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 July 4, 2010. The differential amounts receivable or payable under the swap contract are recorded over the life of the contract as adjustments to interest expense.

We have designated the swap contract as a cash flow hedge. Accordingly, gains or losses from changes in its fair value that are determined to be effective in mitigating our exposure to changes in interest payments on the hedged amount of revolving credit facility debt are reported on the Consolidated Balance Sheets as a component of “Accumulated other comprehensive income (loss).” Throughout the term of the swap contract, the unrealized gains or losses we have reported in accumulated other comprehensive income will be recognized in earnings when the variable interest rate of the debt affects earnings. The ineffective portion of any gains or losses would be recorded immediately in earnings.

The following table summarizes the location and fair value of the derivative instrument in our unaudited Condensed Consolidated Balance Sheets:

		July 4,		January 3,
	Balance Sheet Location	2010		2010
Derivative designated as hedging instrument		(in thousands)

Interest rate swap contract	Derivative instrument liability(1) (2)	$	3,986	$	5,613

(1)	As of July 4, 2010, the estimated fair value was recorded as a $4.0 million current liability.

(2)	As of January 3, 2010, the estimated fair value was comprised of a $4.5 million current liability and a $1.2 million noncurrent liability.

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

	Three Months Ended							Six Months Ended
	July 4,			June 28,				July 4,			June 28,
	2010			2009				2010			2009
Derivative in cash flow hedging relationship	(in thousands, excluding income tax effects)

Loss recognized in accumulated OCI – effective portion:
Interest rate swap contract	$	(93	)		$	(477	)	$	(883	)	$	(1,158	)

Loss reclassified from accumulated OCI into income – effective portion:
Interest expense	$	(1,234	)		$	(982	)	$	(2,510	)	$	(1,655	)

There were no ineffective gains or losses recognized during the three and six months ended July 4, 2010 and June 28, 2009. We expect that approximately $2.5 million, net of taxes, of the change in fair value of the swap contract included in “Accumulated other comprehensive income” as of July 4, 2010 will be realized in earnings as additional interest expense within the next 12 months.

CEC ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

4. Derivative Instrument (continued):

Fair Value Measurement

Our interest rate swap contract is not traded on a public exchange, therefore, its fair value is determined using the present value of expected future cash flows arising from the contract which approximates an amount to be received from or paid to a market participant for this instrument. This valuation methodology utilizes forward interest rate yield curves obtained from an independent pricing service’s quotes of three-month forward LIBOR rates through the swap contract’s maturity. Accordingly, the inputs to our fair value measurement of the interest rate swap are classified within Level 2 of the fair value hierarchy. For more information regarding fair value measurements, refer to Note 1 “Fair Value Measurements” to our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended January 3, 2010.

5. Commitments and Contingencies:

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.

6. Income Taxes:

Our liability for uncertain tax positions increased approximately $2.7 million during the second quarter of 2010 primarily in connection with the current Internal Revenue Service examination of our 2006 and 2007 tax years. In addition, we recognized additional estimated interest expense of approximately $0.7 million related to these matters.

CEC ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

7. Earnings Per Share:

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding during the period. Common shares outstanding consist of shares of our common stock and certain unvested shares of restricted stock containing nonforfeitable dividend rights. Diluted EPS is computed using the weighted average number of common shares and dilutive potential common shares outstanding during the period using the treasury stock method. Potential common shares consist of dilutive stock options and unvested shares of restricted stock that are not considered to be participating securities.

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

	Three Months Ended				Six Months Ended
	July 4,		June 28,		July 4,		June 28,
	2010		2009		2010		2009
	(in thousands, except per share amounts)
Numerator:
Net income	$	4,778	$	8,994	$	38,640	$	43,047

Denominator:
Basic weighted average common shares outstanding		21,544		23,048		21,810		22,933
Potential common shares for stock options and restricted stock		48		166		39		171

Diluted weighted average common shares outstanding		21,592		23,214		21,849		23,104

Earnings per share:
Basic	$	0.22	$	0.39	$	1.77	$	1.88
Diluted	$	0.22	$	0.39	$	1.77	$	1.86

Stock options to purchase 1,599 shares and 699,502 shares of common stock for the three months ended July 4, 2010 and June 28, 2009, respectively, and 40,545 shares and 714,920 shares for the six months ended July 4, 2010 and June 28, 2009, respectively, were not included in the diluted EPS computations because the exercise prices of these options were greater than the average market price of the common shares and, therefore, their effect would be antidilutive.

8. Stock-Based Compensation:

We have stock-based compensation plans pursuant to which we may grant awards of restricted stock and, prior to fiscal 2006, stock options to our employees and non-employee directors. The fair value of all stock-based awards, less estimated forfeitures, is recognized as stock-based compensation expense in the financial statements over the vesting period of the award.

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

	Three Months Ended						Six Months Ended
	July 4,			June 28,			July 4,			June 28,
	2010			2009			2010			2009
	(in thousands)

Total stock-based compensation cost	$	1,791		$	1,864		$	3,748		$	4,286
Portion capitalized as property and equipment(1)		(50	)		(54	)		(95	)		(103	)

Pre-tax stock-based compensation expense recognized(2)	$	1,741		$	1,810		$	3,653		$	4,183

(1)	We capitalize the portion of stock-based compensation costs related to our design, construction, facilities and legal departments that are directly attributable to our store development projects, such as the design and construction of a new store and the remodeling and expansion of our existing stores. Capitalized stock-based compensation is included in “Property and equipment, net” on the unaudited Condensed Consolidated Balance Sheets.

(2)	Included in “General and administrative expense” in the unaudited Condensed Consolidated Statements of Earnings.

CEC ENTERTAINMENT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

8. Stock-Based Compensation (continued):

As of July 4, 2010, there was $17.6 million of unrecognized pre-tax stock-based compensation cost related to restricted stock that will be recognized over a weighted average remaining vesting period of 1.8 years. All previously granted and currently outstanding stock options are fully vested, as such there is no unrecognized stock-based compensation cost related to stock options.

9. Stockholders’ Equity:

Stock Repurchase Program

Our Board of Directors (the “Board”) has approved a program for us to repurchase shares of our common stock. 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 on October 22, 2007 and October 27, 2009 authorized $200 million increases each. During the six months ended July 4, 2010, we repurchased 921,989 shares of our common stock at an aggregate purchase price of approximately $35.6 million under the repurchase program. As of July 4, 2010, approximately $183.2 million remained available for share repurchases under our repurchase authorization.

The share repurchase authorization approved by the Board does not have an expiration date and the pace of our repurchase activity will depend on factors such as our working capital needs, our debt repayment obligations, our stock price, and economic and market conditions. Our share repurchases may be effected from time to time through open market purchases, accelerated share repurchases or in privately negotiated transactions. Our share repurchase program may be accelerated, suspended, delayed or discontinued at any time.

Stock Options

During the six months ended July 4, 2010, 144,644 shares of common stock were issued from the exercise of stock options for cash proceeds of $4.6 million.

Restricted Stock

During the six months ended July 4, 2010, we granted a total of 237,770 shares of restricted stock to our employees and non-employee directors at a weighted average grant date fair value of $35.77 per share.

During the six months ended July 4, 2010, 7,654 shares of restricted stock were forfeited by employees at a weighted average grant date fair value of $29.57 per share.

During the six months ended July 4, 2010, 77,711 shares of common stock were tendered by employees at an average price per share of $35.20 to satisfy tax withholding requirements on the vesting of shares of restricted stock.

401(k) Plan Contribution

During the six months ended July 4, 2010, we contributed 18,892 shares of our common stock at a cost of approximately $0.6 million to the CEC Entertainment 401(k) Plan in connection with our annual match of employee contributions for the 2009 plan year.

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

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide the readers of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended January 3, 2010. 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

·	Recently Issued Accounting Guidance

Executive Overview

We operate on a 52 or 53 week fiscal year that ends on the Sunday nearest to December 31. Each quarterly period has 13 weeks, except for a 53 week year when the fourth quarter has 14 weeks. Our 2010 fiscal year will consist of 52 weeks and our 2009 fiscal year consisted of 53 weeks. As a result of the 53 week fiscal year in 2009, our 2010 fiscal year began one week later than our 2009 fiscal year. In order to provide useful information to investors to better analyze our business, we have provided below comparable store sales presented on both a fiscal week basis and calendar week basis. Comparable store sales on a fiscal week basis compares the results of our fiscal periods ended July 4, 2010 and June 28, 2009. Comparable store sales for the three months ended July 4, 2010 on a calendar week basis compares the results for the period from April 5, 2010 through July 4, 2010 (weeks 14 through 26 of our 2010 fiscal year) to the results for the period from April 6, 2009 through July 5, 2009 (weeks 15 through 27 of our 2009 fiscal year). Comparable store sales for the six months ended July 4, 2010 on a calendar week basis compares the results for the period from January 4, 2010 through July 4, 2010 (weeks 1 through 26 of our 2010 fiscal year) to the results for the period from January 5, 2009 through July 5, 2009 (weeks 2 through 27 of our 2009 fiscal year). We believe comparable store sales calculated on a same calendar week basis is more indicative of the health of our business. However, we also recognize that comparable store sales growth calculated on a fiscal week basis is a useful measure when analyzing year-over-year changes in our financial statements.

Second Quarter 2010 Highlights

·	Revenues decreased 2.1% during the second quarter of 2010 compared to the same period in 2009.

-	Comparable store sales on a fiscal week basis decreased 3.6%.

-	Comparable store sales on a calendar week basis decreased 2.2%.

-	Weighted average Company-owned store count increased by approximately three stores.

-	Menu prices increased on average 2.5%.

Cost of food, beverage, entertainment and merchandise as a percentage of Company store sales decreased 0.4 percentage points during the second quarter of 2010 compared to the same period in 2009 primarily due to reductions in beverage and paper costs and lower ticket redemptions for prize merchandise, partially offset by higher cheese prices.

Company store operating costs as a percentage of Company store sales increased 1.1 percentage points during the second quarter of 2010 compared to the same period in 2009 primarily due to increased rent and depreciation expenses , and the de-leveraging effect of lower Company store sales. These increases were partially offset by reductions in cost of food, beverage, entertainment and merchandise.

Interest expense increased to $3.4 million during the second quarter of 2010 compared to $3.1 million in the second quarter of 2009 primarily due to interest charges incurred pursuant to tax reserves established during the second quarter of 2010 in connection with the current Internal Revenue Service (“IRS”) examination of prior tax years.

·	Our effective tax rate increased to 57.6% in the second quarter of 2010 compared to 35.1% in the second quarter of 2009, primarily due to unfavorable discrete adjustments to income tax expense in connection with the current IRS examination of our 2006 and 2007 tax years.

Net income for the second quarter of 2010 decreased 46.9% to $4.8 million from $9.0 million in the same period in 2009 and diluted earnings per share decreased 43.6% to $0.22 compared to $0.39 in the same period in 2009. Earnings per share benefited from our cumulative repurchase of 2,697,078 shares of our common stock since the beginning of the second

quarter of 2009, including 468,130 shares we repurchased during the second quarter of 2010.

Overview of Operations

We develop, operate and franchise family dining and entertainment centers under the name “Chuck E. Cheese’s®” in 48 states and six foreign countries or territories. Chuck E. Cheese’s stores feature musical and comic entertainment by robotic and animated characters, arcade-style and skill oriented games, video games, rides and other activities intended to appeal to our primary customer

base of families with children between two and 12 years of age. All of our stores offer dining selections consisting of a variety of beverages, pizzas, sandwiches, appetizers, a salad bar, and desserts.

The following table summarizes information regarding the number of Company-owned and franchised stores for the periods presented:

	Three Months Ended				Six Months Ended
	July 4,		June 28,		July 4,			June 28,
	2010		2009		2010			2009

Number of Company-owned stores:
Beginning of period		498		495		497			495
New		-		1		-			1
Acquired from franchisees		-		-		1			-
Closed		-		-		-			-
End of period		498		496		498			496

Number of franchised stores:
Beginning of period		48		47		48			46
New		-		1		1			2
Acquired by the Company		-		-		(1	)		-
Closed		-		-		-			-
End of period		48		48		48			48

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.

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 stand-alone food and beverage sales as well as the portion of revenue that is allocated from package deals. Entertainment and merchandise sales include all revenue recognized with respect to stand-alone game token sales as well as the portion of revenue that is allocated from package deals. This revenue caption also includes sales of merchandise at our stores. 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 stand-alone 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:

·	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 expenses that pertain directly to our store assets;

·	Rent expense includes lease costs for Company-owned 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.

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.

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.

Results of Operations

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:

	Three Months Ended								Six Months Ended
	July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
	(in thousands, except percentages)

Food and beverage sales	$	89,064	49.4	%	$	91,123	49.6	%	$	210,080	49.4	%	$	219,602	51.0	%
Entertainment and merchandise sales		91,065	50.6	%		92,676	50.4	%		215,249	50.6	%		211,257	49.0	%

Company store sales	$	180,129	100.0	%	$	183,799	100.0	%	$	425,329	100.0	%	$	430,859	100.0	%

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:

	Three Months Ended								Six Months Ended
	July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
	(in thousands, except percentages)

Company store sales	$	180,129	99.5	%	$	183,799	99.5	%	$	425,329	99.5	%	$	430,859	99.5	%
Franchising activities		857	0.5	%		996	0.5	%		1,984	0.5	%		2,069	0.5	%

Total revenues		180,986	100.0	%		184,795	100.0	%		427,313	100.0	%		432,928	100.0	%
Company store operating costs:
Cost of food and beverage (1)		19,967	22.4	%		20,612	22.6	%		47,586	22.7	%		47,758	21.7	%
Cost of entertainment and merchandise (2)		7,736	8.5	%		8,360	9.0	%		17,786	8.3	%		19,124	9.1	%

Cost of food, beverage, entertainment and merchandise (3)		27,703	15.4	%		28,972	15.8	%		65,372	15.4	%		66,882	15.5	%
Labor expenses (3)		51,777	28.7	%		52,449	28.5	%		112,372	26.4	%		112,945	26.2	%
Depreciation and amortization (3)		19,836	11.0	%		19,040	10.4	%		39,442	9.3	%		37,954	8.8	%
Rent expense (3)		17,440	9.7	%		16,719	9.1	%		34,926	8.2	%		33,633	7.8	%
Other store operating expenses (3)		29,698	16.5	%		30,285	16.5	%		60,732	14.3	%		60,409	14.0	%
Total Company store operating costs (3)		146,454	81.3	%		147,465	80.2	%		312,844	73.6	%		311,823	72.4	%
Other costs and expenses:
Advertising expense		8,385	4.6	%		8,637	4.7	%		17,422	4.1	%		18,681	4.3	%
General and administrative expenses		11,436	6.3	%		11,738	6.4	%		25,121	5.9	%		26,255	6.1	%
Total operating costs and expenses		166,275	91.9	%		167,840	90.8	%		355,387	83.2	%		356,759	82.4	%

Operating income		14,711	8.1	%		16,955	9.2	%		71,926	16.8	%		76,169	17.6	%
Interest expense		3,442	1.9	%		3,095	1.7	%		6,112	1.4	%		6,169	1.4	%

Income before income taxes	$	11,269	6.2	%	$	13,860	7.5	%	$	65,814	15.4	%	$	70,000	16.2	%

(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.

Three Months Ended July 4, 2010 Compared to Three Months Ended June 28, 2009

Revenues

Company store sales decreased 2.0% to $180.1 million during the second quarter of 2010 compared to $183.8 million in the second quarter of 2009 primarily due to a 3.6% decline in same fiscal week comparable store sales, partially offset by a net increase in the number of Company-owned stores and the initial recognition of income from gift card breakage during the second quarter of 2010. On a same calendar week basis, which we believe to be more indicative of the health of our business, comparable store sales decreased 2.2%. Menu prices increased approximately 2.5% during the second quarter of 2010 as compared to the second quarter of 2009. We believe that the decrease in comparable store sales is primarily attributable to the current difficult economic environment, coupled with certain pricing initiatives implemented during the first and second quarters of 2010 that do not appear to have been fully accepted by our consumer.

The weighted average number of Company-owned stores open during the second quarter of 2010 increased by approximately three stores as compared to the same period in 2009. We also benefited during the second quarter of 2010 from a $0.6 million adjustment in food and beverage sales for the initial recognition of breakage income related to unredeemed gift card balances. The recognition of initial breakage income during the second quarter of 2010 is not included in either the fiscal week or calendar week comparable store sales figures. Refer to “Critical Accounting Policies and Estimates” of our MD&A for more information regarding our initial recognition of gift card breakage income.

Our Company store sales mix was 49.4% food and beverage sales and 50.6% entertainment and merchandise sales during the second quarter of 2010 compared to 49.6% and 50.4%, respectively, in the second quarter of 2009. We believe the sales mix shift from food and beverage to entertainment and merchandise is primarily the result of birthday parties during the second quarter of 2010 containing greater components of merchandise and game tokens as compared to the birthday parties offered in the second quarter of 2009, as well as increased token sales during the second quarter of 2010 compared to the second quarter of 2009.

Company Store Operating Costs

Cost of food and beverage as a percentage of food and beverage sales decreased 0.2 percentage points to 22.4% during the second quarter of 2010 compared to 22.6% in the second quarter of 2009 primarily due to reductions in beverage and paper costs, partially offset by higher cheese prices. During the second quarter of 2010, the average price per pound of cheese increased approximately $0.24, or 20%, compared to prices paid in the second quarter of 2009.

Cost of entertainment and merchandise as a percentage of entertainment and merchandise sales decreased 0.5 percentage points to 8.5% during the second quarter of 2010 from 9.0% in the second quarter of 2009. This decrease was primarily due to a specific birthday party promotion in the second quarter of 2009 which resulted in additional prize merchandise costs from increased ticket redemptions. Also in the second quarter of 2009, we incurred additional costs associated with a new attraction that dispensed novelty photo cards.

Labor expense as a percentage of Company store sales increased 0.2 percentage points to 28.7% during the second quarter of 2010 compared to 28.5% in the second quarter of 2009 primarily due to higher worker's compensation claims and increased unemployment taxes and other benefits. Improved labor utilization of our hourly labor force partially offset a 3.7% increase in average hourly wage rates at our stores.

Depreciation and amortization expense related to our stores increased $0.8 million to $19.8 million during the second quarter of 2010 compared to $19.0 million in the second quarter of 2009 primarily due to the ongoing capital investment initiatives occurring at our existing stores and new store development.

Store rent expense increased $0.7 million to $17.4 million during the second quarter of 2010 compared to $16.7 million in the second quarter of 2009 primarily due to an increase in our leased properties resulting from our expansions of existing stores and new store development.

Other store operating expenses as a percentage of Company store sales remained consistent at 16.5% during the second quarter of 2010 and 2009 as the net effect of various cost reductions helped offset the de-leveraging impact of a lower sales base on the fixed component of store operating expenses.

Advertising Expense

Advertising expense as a percentage of total revenues decreased 0.1 percentage point to 4.6% during the second quarter of 2010 from 4.7% in the second quarter of 2009 primarily due to lower television media costs, partially offset by an increase in television advertising expenditures for local market commercials during the second quarter of 2010.

General and Administrative Expenses

General and administrative expenses decreased $0.3 million to $11.4 million during the second quarter of 2010 from $11.7 million in the second quarter of 2009 primarily due to a net reduction in various corporate office overhead costs.

Interest Expense

Interest expense increased to $3.4 million during the second quarter of 2010 compared to $3.1 million in the second quarter of 2009 primarily due to interest charges of $0.7 million incurred pursuant to tax reserves established during the second quarter of 2010 exceeding amounts recognized in the second quarter of 2009, partially offset by a decrease in the interest expense incurred under our revolving credit facility during the second quarter of 2010.

Income Taxes

Our effective income tax rate increased to 57.6% during the second quarter of 2010 compared to 35.1% in the second quarter of 2009, primarily due to unfavorable discrete adjustments of $2.4 million we recorded to income tax expense during the second quarter of 2010 in connection with the current IRS examination of our 2006 and 2007 tax years, partially offset by the effect of favorable state and foreign tax adjustments.

Diluted Earnings Per Share

Diluted earnings per share decreased to $0.22 per share for the second quarter of 2010 from $0.39 per share in the second quarter of 2009 primarily due to a 46.9% decrease in our net income, partially offset by a 7.0% decrease in the number of weighted average diluted shares outstanding between the two periods. The decrease in diluted earnings per share between the two periods was impacted by our repurchase of approximately 2.7 million shares of our common stock since the beginning of the second quarter of 2009. We estimate that the decrease in the number of weighted average diluted shares outstanding during the second quarter of 2010 attributable solely to these repurchases benefited our earnings per share growth in the second quarter of 2010 by approximately $0.01. Our estimate is based on the weighted average number of shares repurchased since the beginning of the second quarter of 2009 and includes consideration of the estimated additional interest expense attributable to increased borrowings under our revolving credit facility to finance the repurchases. Our computation does not include the effect of share repurchases prior to the second quarter of 2009, or the effect of the issuance of restricted stock or exercise of stock options subsequent to the second quarter of 2009.

Six Months Ended July 4, 2010 Compared to Six Months Ended June 28, 2009

Revenues

Company store sales decreased 1.3% to $425.3 million during the first six months of 2010 compared to $430.9 million in the first six months of 2009 primarily due to a 2.4% decline in same fiscal week comparable store sales, partially offset by a net increase in the number of Company-owned stores and the initial recognition of income from gift card breakage during the second quarter of 2010. On a same calendar week basis, which we believe to be more indicative of the health of our business, comparable store sales decreased 0.5%. The difference between fiscal week and calendar week comparable store sales is primarily attributable to the effect of an additional operating week in our 2009 fiscal year which caused the seasonally strong first week of the 2010 calendar year to shift into the fourth quarter of 2009. Menu prices increased approximately 1.9% during the first six months of 2010 as compared to the first six months of 2009. We believe that the decrease in comparable store sales is primarily attributable to the current difficult economic environment, coupled with certain pricing initiatives implemented during the first and second quarters of 2010 that do not appear to have been fully accepted by our consumer.

The weighted average number of Company-owned stores open during the first six months of 2010 increased by approximately three stores as compared to the same period in 2009. We also benefited during the first six months of 2010 from a $0.6 million adjustment in food and beverage sales for the initial recognition of breakage income related to unredeemed gift card balances. The recognition of initial breakage income during the first six months of 2010 is not included in either the fiscal week or calendar week comparable store sales figures. Refer to “Critical Accounting Policies and Estimates” of our MD&A for more information regarding our initial recognition of gift card breakage income.

Our Company store sales mix was 49.4% food and beverage sales and 50.6% entertainment and merchandise sales during the first six months of 2010 compared to 51.0% and 49.0%, respectively, in the first six months of 2009. We believe the sales mix shift from food and beverage to entertainment and merchandise is primarily the result of birthday party packages in the current year containing greater components of merchandise and game tokens as compared to the packages offered in the first six months of 2009, as well as increased token sales in the current year. The Company store sales mix during the first six months of 2010 is consistent with our recent historical trend of food and beverage sales versus entertainment and merchandise sales.

Company Store Operating Costs

Cost of food and beverage as a percentage of food and beverage sales increased 1.0 percentage point to 22.7% during the first six months of 2010 from 21.7% in the first six months of 2009 primarily due to an increase in cheese prices. During the first six months of 2010, the average price per pound of cheese increased approximately $0.24, or 20%, compared to prices paid in the first six months of 2009. These increases were partially offset by a reduction in paper costs during the first six months of 2010.

Cost of entertainment and merchandise as a percentage of entertainment and merchandise sales decreased 0.8 percentage points to 8.3% during the first six months of 2010 from 9.1% in the first six months of 2009. This decrease was primarily due to a specific birthday party promotion in the second quarter of 2009 which resulted in additional prize merchandise costs from increased ticket redemptions and margin pressure associated with the liquidation of certain prize inventory in the first quarter of 2009. Also in the first six months of 2009, we incurred additional costs associated with a new attraction that dispensed novelty photo cards.

Labor expense as a percentage of Company store sales increased 0.2 percentage points to 26.4% during the first six months of 2010 compared to 26.2% in the first six months of 2009 primarily due to higher worker's compensation claims and increased unemployment taxes and other benefits. Improved labor utilization of our hourly labor force offset a 3.7% increase in average hourly wage rates at our stores.

Depreciation and amortization expense related to our stores increased $1.5 million to $39.4 million during the first six months of 2010 compared to $38.0 million in the first six months of 2009 primarily due to the ongoing capital investment initiatives occurring at our existing stores and new store development.

Store rent expense increased $1.3 million to $34.9 million during the first six months of 2010 compared to $33.6 million in the first six months of 2009 primarily due to an increase in our leased properties resulting from our expansions of existing stores and new store development.

Other store operating expenses as a percentage of Company store sales increased 0.3 percentage points to 14.3% during the first six months of 2010 compared to 14.0% in the first six months of 2009 primarily due to an increase in our self-insurance reserves in 2010 as compared to 2009, and the de-leveraging effect of a lower sales base on the fixed component of store operating expenses.

Advertising Expense

Advertising expense as a percentage of total revenues decreased 0.2 percentage points to 4.1% during the first six months of 2010 from 4.3% in the first six months of 2009 primarily due to lower television media costs compared to the same period last year, timing variances in our advertising activities between the two periods attributed to the shift in our 2010 fiscal weeks and reductions in certain media expenditures during the first six months of 2010.

General and Administrative Expenses

General and administrative expenses decreased $1.1 million to $25.1 million during the first six months of 2010 from $26.3 million in the first six months of 2009 primarily due to higher stock-based compensation in the first six months of 2009 associated with an $0.8 million forfeiture estimate adjustment in the first quarter of 2009 and the effect of a net reduction in various corporate office overhead costs during the first six months of 2010 as compared to the same period in 2009.

Interest Expense

Interest expense decreased to $6.1 million during the first six months of 2010 compared to $6.2 million in the first six months of 2009 due to a decrease in interest expense incurred on our revolving credit facility primarily attributable to a decrease in the outstanding debt balance between the two periods. During the first six months of 2010, the average debt balance outstanding under our revolving credit facility was $320.2 million compared to $354.2 million during the first six months of 2009. This decrease was partially offset by interest charges of $0.7 million incurred pursuant to tax reserves established during the second quarter of 2010 exceeding amounts recognized in the first six months of 2009.

Income Taxes

Our effective income tax rate was 41.3% and 38.5% for the first six months of 2010 and 2009, respectively. The increase in our effective tax rate was primarily due to unfavorable discrete adjustments of $2.4 million we recorded to income tax expense during the second quarter of 2010 in connection with the current IRS examination of our 2006 and 2007 tax years, partially offset by the effect of favorable state and foreign tax adjustments.

Diluted Earnings Per Share

Diluted earnings per share decreased to $1.77 per share for the first six months of 2010 from $1.86 per share in the first six months of 2009 primarily due to a 10.2% decrease in our net income, partially offset by a 5.4% decrease in the number of weighted average diluted shares outstanding between the two periods. The decrease in diluted earnings per share between the two periods was impacted by our repurchase of approximately 2.7 million shares of our common stock since the beginning of the first quarter of 2009. We estimate that the decrease in the number of weighted average diluted shares outstanding during the first six months of 2010 attributable solely to these repurchases benefited our earnings per share growth in the first six months of 2010 by approximately $0.13. Our estimate is based on the weighted average number of shares repurchased since the beginning of the first quarter of 2009 and includes consideration of the estimated additional interest expense attributable to increased borrowings under our revolving credit facility to finance the repurchases. Our computation does not include the effect of share repurchases prior to the 2009 fiscal year, or the effect of the issuance of restricted stock or exercise of stock options subsequent to the beginning of the first quarter of 2009.

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 and servicing our debt. We may also use cash from operations to make 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:

	Six Months Ended
	July 4,			June 28,
	2010			2009
	(in thousands)

Net cash provided by operating activities	$	100,918		$	91,628
Net cash used for investing activities		(47,114	)		(33,126	)
Net cash used for financing activities		(56,434	)		(59,484	)
Effect of foreign exchange rate changes on cash		(82	)		(270	)

Change in cash and cash equivalents	$	(2,712	)	$	(1,252	)

Interest paid	$	5,198		$	6,537
Income taxes paid, net	$	17,984		$	16,954

	July 4,		January 3,
	2010		2010
	(in thousands)

Cash and cash equivalents	$	14,649	$	17,361
Revolving credit facility borrowings	$	331,400	$	354,300
Available unused commitments under revolving credit facility	$	207,941	$	185,743

Cash Flows – Operating Activities

Net cash provided by operating activities increased $9.3 million to $100.9 million during the first six months of 2010 from $91.6 million in the first six months of 2009. The increase was primarily attributable to changes in the operating liabilities component of our working capital and the receipt of a $1.8 million franchise development fee during the first quarter of 2010 and a $1.7 million increase in the amount of vendor rebates received during the first six months of 2010 compared to the same period in 2009, partially offset by the effect of lower sales during the first six months of 2010.

Our cash interest payments decreased $1.3 million to $5.2 million during the first six months of 2010 from $6.5 million in the first six months of 2009 primarily due to a reduction in the average debt balance outstanding under our revolving credit facility between the two periods and payments of approximately $0.5 million we made in connection with various state tax settlements in the first six months of 2009 which did not recur in the first six months of 2010.

Our cash payments for income taxes, net of refunds received, increased $1.0 million to $18.0 million during the first six months of 2010 from $17.0 million in the first six months of 2009 primarily due to various states increasing the required amount of estimated payments due as of the second quarter of 2010 as compared to the second quarter of 2009.

Cash Flows – Investing Activities

Net cash used in investing activities increased $14.0 million to $47.1 million during the first six months of 2010 from $33.1 million in the first six months of 2009, primarily due to an increase in the number of capital spending initiatives for our existing stores

which affected 113 stores during the first six months of 2010 compared to 68 stores during the same period in 2009 and cash payments associated with the acquisition of assets used in the operation of franchised store locations.

The following table summarizes information regarding the number of capital spending initiatives we completed during each of the periods presented:

	Six Months Ended
	July 4,		June 28,
	2010		2009

Existing Company-owned store initiatives:
Major remodels		6		4
Store expansions		10		9
Game enhancements		97		55
Total completed		113		68

Company-owned stores added		1		1

Cash Flows – Financing Activities

Net cash used in financing activities decreased $3.1 million to $56.4 million during the first six months of 2010 from $59.5 million in the first six months of 2009 primarily due to a $31.4 million reduction in net repayments on our revolving credit facility between the two periods, partially offset by an increase in our share repurchase activity and a decrease in proceeds obtained through the exercise of employee stock options. During the first six months of 2010, our repurchases of common stock increased $15.5 million to $35.6 million compared to $20.1 million during the same period last year. Also, during the first six months of 2010, cash proceeds obtained through the exercise of employee stock options decreased $10.1 million between the two periods attributed to a decline in the number of exercisable awards outstanding.

Sources of Liquidity

We currently finance our business activities through cash flows provided by our operations and, as 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, enabling us 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 increased to $26.9 million at July 4, 2010 from $1.0 million at January 3, 2010 primarily due to variations in the timing and amount of payments for income taxes and collection of vendor rebates, combined with increases in our accrued expenses attributed to an unfavorable adjustment to our income tax liability during the second quarter of 2010.

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.

Debt Financing

During the first six months of 2010, we reduced the outstanding debt balance under our revolving credit facility by $22.9 million to $331.4 million from $354.3 million as of January 3, 2010. Including the effect of our interest rate swap contract, the weighted average effective interest rate incurred on borrowings under our revolving credit facility was 3.0% and 3.0% for the three months ended July 4, 2010 and June 28, 2009, respectively, and was 3.0% and 2.9% for the six months ended July 4, 2010 and June 28, 2009, 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 July 4, 2010, we were in compliance with these covenant ratios, with a consolidated fixed charge coverage ratio of 2.29 to 1 and a consolidated leverage ratio of 1.82 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% as of July 4, 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 July 4, 2010, the estimated fair value of the swap contract was a liability of approximately $4.0 million. Refer to Note 4 “Derivative Instrument” of our condensed consolidated financial statements for a more complete discussion of our interest rate swap contract.

Capital Expenditures

Our future capital expenditures are expected to be primarily for reinvestment into our existing Company-owned store base through various capital initiatives and the development or acquisition of additional Company stores. We estimate capital expenditures in 2010 will total approximately $100.0 million to $103.0 million, including approximately $67.0 million to $68.0 million related to capital initiatives for our existing stores, approximately $20.0 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.

The following tables summarize information regarding the expected number of and estimated average cost for our projected capital expenditures activities during each of the periods presented:

			Projection for Remainder of		Projected Completions		Estimated
	Completed Through Second Quarter		Fiscal Year		Fiscal Year		Average Cost
	2010		2010		2010		Per Project
							(in millions)
Investment in existing Company-owned stores:
Major remodels		6		9		15	$	0.6
Store expansions		10		22		32	$	1.0
Game enhancements		97		113		210	$	0.1 to $0.2
Total		113		144		257

New Company store development and franchise store acquisitions		1		8		9	$	2.3 to $2.4

	Projected Completions		Actual Completions		Increase
	Fiscal Year		Fiscal Year		Over Prior
	2010		2009		Fiscal Year

Investment in existing Company-owned stores:
Major remodels		15		9		6
Store expansions		32		26		6
Game enhancements		210		125		85
Total		257		160		97

New Company store development and franchise store acquisitions		9		3		6

Investment in Existing Company-owned Stores. We believe that in order to maintain consumer demand for and the appeal of our concept, we must continually reinvest in our existing Company-owned 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.

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. A major remodel initiative typically includes interior design modifications that allow us to more effectively utilize space allocated to the playroom area of the store, increasing the number of games and rides, and developing a new exterior and interior identity.

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 our 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.

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 and ride technology.

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. We expect the cost of opening such new stores will vary 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. Also, from time to time we will consider acquiring existing franchise locations.

Share Repurchases

Our Board of Directors (the “Board”) has approved a program for us to repurchase shares of our common stock. 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 on October 22, 2007 and October 27, 2009 authorized $200 million increases each. During the six months ended July 4, 2010, we repurchased 921,989 shares of our common stock at an aggregate purchase price of approximately $35.6 million, and as of July 4, 2010, approximately $183.2 million remained available for share repurchases under our repurchase authorization.

repurchases or in privately negotiated transactions. Our share repurchase program may be accelerated, suspended, delayed or discontinued at any time.

Off-Balance Sheet Arrangements and Contractual Obligations

As of July 4, 2010, we had no off-balance sheet financing arrangements as described in Regulation S-K Item 303(a)(4)(ii) and we believe there has been no material change in our contractual obligations since the end of fiscal year 2009.

For information regarding our contractual obligations, refer to “Off Balance Sheet Arrangements and Contractual Obligations” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended January 3, 2010.

Critical Accounting Policies and Estimates

Our unaudited condensed consolidated financial statements are prepared in accordance with GAAP which requires us to make estimates and assumptions that affect the reported values of assets and liabilities at the date of the financial statements, the reported amount of revenues and expenses during the reporting period, and the related disclosures of contingent assets and liabilities. The use of estimates is pervasive throughout our financial statements and is affected by management judgment and uncertainties. Our estimates, assumptions and judgments are based on historical experience, current market trends and other factors that we believe to be relevant and reasonable at the time the consolidated financial statements are prepared. We continually evaluate the information used to make these estimates as our business and the economic environment change. Actual results may differ materially from these estimates under different assumptions or conditions. Results of operations of interim periods are not necessarily indicative of results for the full year.

Information with respect to our critical accounting policies and estimates which we believe could have the most significant effect on our reported results and require difficult, subjective or complex judgment by management are described under “Critical Accounting Policies and Estimates” in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended January 3, 2010. We believe that as of July 4, 2010 there has been no material change to the information concerning our critical accounting policies and estimates, with the exception of our estimate for gift card breakage discussed below.

We sell gift cards to our customers in our stores and through certain third party distributors which do not expire or incur a service fee on unused balances. Gift card sales are recorded as an unearned gift card revenue liability when sold and are recognized as revenue when: (i) the gift card is redeemed by the customer, or (ii) the likelihood of the gift card being redeemed by the customer is remote (“gift card breakage”) and we determine that we do not have a legal obligation to remit the value of the unredeemed gift card under applicable state unclaimed property escheat statutes. Gift card breakage is determined based upon historical redemption patterns of our gift cards. During the second quarter of 2010, we concluded that we had sufficient historical transaction data to estimate breakage for gift cards we have been selling in our stores and through certain third-party distributors, and based on our analysis we recorded a cumulative gift card breakage adjustment of $0.6 million. Breakage income from gift cards is included in “Food and beverage sales.”

Recently Issued Accounting Guidance

Refer to Note 1 “Basis of Presentation and Recently Issued Accounting Guidance” of our unaudited condensed consolidated financial statements included in Part I, Item 1 “Financial Statements” of this Quarterly Report on Form 10-Q for a description of the recently issued accounting guidance that we have not yet adopted, including a discussion of our expected date of adoption and anticipated effects on our results of operations and financial position and the new accounting guidance we have recently adopted.

Cautionary Note Regarding Forward-Looking Statements

Certain statements in this report, other than historical information, may be considered “forward-looking statements” within the meaning of the “safe harbor” provisi