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4: EX-10.3 Material Contract HTML 144K
5: EX-10.4 Material Contract HTML 81K
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7: EX-31.2 Certification -- §302 - SOA'02 HTML 30K
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67: R1 Document and Entity Information HTML 52K
38: R2 Consolidated Balance Sheets HTML 135K
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55: R4 Consolidated Statements of Earnings HTML 101K
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37: R6 Consolidated Statements of Cash Flows HTML 179K
16: R7 Description of Business and Summary of Significant HTML 38K
Accounting Policies
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57: R17 Stock-Based Compensation Arrangements HTML 62K
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75: R20 Subsequent Events HTML 25K
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Accounting Policies (Policies)
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61: R34 Description of Business and Summary of Significant HTML 37K
Accounting Policies - Additional Information
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Accounting Policies - Goodwill and Other
Intangible Assets (Details)
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Accounting Policies - Cash, Cash Equivalents and
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Accounting Policies New Accounting Pronouncements
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72: R39 Property and Equipment - Schedule of Property and HTML 30K
Equipment (Details)
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Indefinite and Definite-lived Intangible Assets
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Estimated Future Amortization Expense (Details)
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Stockholders' Equity (Details)
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(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 ý No ¨
Indicate by check mark whether the registrant has submitted
electronically every Interactive Data File required to be submitted 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 such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:
Large accelerated filer
¨
Accelerated
filer
¨
Non-accelerated filer
ý
Smaller reporting company
¨
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use
the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
As of October 30, 2019, an aggregate of 200 shares of the registrant’s common stock, par value $0.01 per share were outstanding.
The following
table provides a reconciliation of cash, cash equivalents and restricted cash reported within the statements of financial position that sum to the total of the same such amounts shown in the statements of cash flows.
Note 1. Description of Business and Summary of Significant Accounting
Policies:
Description of Business
The use of the terms “CEC Entertainment,” the “Company,”“we,”“us” and “our” throughout these unaudited notes to the interim Consolidated Financial Statements refer to CEC Entertainment, Inc. and its subsidiaries.
We currently operate and franchise Chuck E. Cheese and Peter Piper Pizza family dining and entertainment venues in 47 states and 15 foreign countries and territories. As of September 29, 2019, we and our franchisees operated a total of 738
venues, of which 553 were Company-operated venues located in 44 states and Canada. Our franchisees operated a total of 185 venues located in 14 states and 14 foreign countries and territories, including Chile, Colombia, Costa Rica, Guam, Guatemala, Honduras, Jordan, Mexico, Panama, Peru, Puerto Rico, Saudi Arabia, Trinidad & Tobago, and the United Arab Emirates. As of September 29, 2019, a total of 181 Chuck E. Cheese venues are located in California, Texas, and Florida (178 are Company-operated and three are
franchised locations), and a total of 118 Peter Piper Pizza venues are located in Arizona, Texas, and Mexico (33 are Company-operated and 85 are franchised locations).
All of our venues utilize a consistent restaurant-entertainment format that features both family dining and entertainment areas with a mix of food, entertainment and merchandise. The economic characteristics, products and services, preparation processes, distribution methods and types of customers are substantially similar for each of our venues. Therefore, we aggregate each venue’s operating performance into one reportable segment for financial reporting purposes.
Basis of Presentation
The
Company has a controlling financial interest in International Association of CEC Entertainment, Inc. (the “Association”), a variable interest entity (“VIE”). 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 Chuck E. Cheese 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, as 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 venues that benefit from the Association’s advertising,
entertainment and media expenditures. We eliminate the intercompany portion of transactions with VIEs from our financial results. The assets, liabilities and operating results of the Association are not material to our Consolidated Financial Statements.
The Association Funds are required to be segregated and used for specified purposes. Cash balances held by the Association are restricted for use in our advertising, entertainment and media programs, and are recorded as “Restricted cash” on our Consolidated Balance Sheets. Contributions to the advertising, entertainment and media funds from our franchisees were $2.3 million and $1.8 million for the nine months ended September 29, 2019 and September 30,
2018, respectively. Our contributions to the Association Funds are eliminated in consolidation.
The preparation of these unaudited Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our unaudited Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
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 current fiscal year, which ends on December 29,
2019, and our fiscal year ended December 30, 2018, each consist of 52 weeks. References to the three and nine-month periods ended ended September 29, 2019 and September 30, 2018 are for the 13-week and 39-week periods ended September 29, 2019 and September 30, 2018, respectively.
Interim Financial Statements
The
accompanying Consolidated Financial Statements as of and for the three and nine months ended September 29, 2019 and September 30, 2018 are unaudited and 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 GAAP. In the opinion of management, the Consolidated Financial Statements include all adjustments (consisting solely of normal recurring adjustments) necessary for the fair statement of its consolidated results of operations, financial position and cash flows as of the
dates and for the periods presented in accordance with GAAP and the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). All intercompany accounts have been eliminated in consolidation.
Consolidated results of operations for interim periods are not necessarily indicative of results for the full year. The unaudited 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 for the fiscal year ended December 30, 2018, filed with the SEC on March 12, 2019.
Recently
Adopted Accounting Guidance
Effective December 31, 2018, the beginning of our Fiscal 2019 year, we adopted Accounting Standards Update (“ASU”) ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”) and the subsequent amendment ASU 2018-11, Leases (Topic 842): Target Improvements (“ASU 2018-11”). ASU 2016-02 introduces a new lease model that requires the recognition of lease right-of-use assets and operating lease liabilities on the balance sheet and the disclosure of key information about leasing arrangements. ASU 2018-11 provides for another transition method in addition to the modified retrospective approach required by ASU 2016-02. This
option allows for entities to initially apply ASU 2016-02 at the adoption date and recognize a cumulative adjustment to the opening balance sheet in the period of adoption. The cumulative impact of adopting ASU 2016-02 did not require us to record an adjustment to our opening accumulated deficit as of December 31, 2018 in our Consolidated Balance Sheet.
Upon the adoption of ASU 2016-02, we applied the package of practical expedients included therein, which eliminated the requirements to reassess prior conclusions about lease identification, lease classification, and initial direct costs. We did not elect the hindsight practical expedient, which permits the use of hindsight when determining lease term. Further, we elected a short-term lease exception policy, permitting us to not apply the recognition requirements of this standard
to short-term leases (i.e. leases with terms of 1 year or less) and an accounting policy to account for lease and non-lease components as a single component for real estate operating leases. We also utilized the transition method included in ASU 2018-11. By applying ASU 2016-02 at the adoption date, as opposed to at the beginning of the earliest period presented, the presentation of financial information for periods prior to December 31, 2018 remained unchanged and in accordance with Accounting Standards Codification (“ASC”) 840 Leases (Topic 840). The adoption of ASU 2016-02 resulted in the recognition as of December 31, 2018 of Right-of-Use assets related to our operating leases
of $557.1 million and lease liabilities related to our operating leases of $590.8 million. In addition, as a result of electing to account for lease and non-lease components as a single component for certain classes of assets, lease costs for the three and nine months ended September 29, 2019 include $3.4 million and $10.5 million, respectively, of common area maintenance charges, which was previously included in “Other venue operating expenses” in our Consolidated Statement of Earnings. Other venue operating expenses in our Consolidated Statement of Earnings for the three and nine months ended
September 30, 2018 includes common area maintenance charges of $3.2 million and $10.2 million, respectively. The adoption of the guidance did not have a material impact on our Consolidated Statement of Cash Flows.
Note 2. Unearned Revenues:
Liabilities relating to unused game credits, gift card liabilities and deferred franchise and development fees are included in “Unearned revenues” on our Consolidated Balance Sheets. The following table presents changes in the Company’s Unearned revenue balances during the nine
months ended September 29, 2019:
During the three and nine months ended September 29, 2019, we recognized an asset impairment charge of $8.2 million and $9.5 million, primarily related to 10 and 12 venues, respectively. During the three and nine months ended September 30, 2018, we recognized an asset impairment charge of $5.3
million and $6.9 million primarily related to eight and nine venues, respectively. These impairment charges were the result of a decline in the venues’ financial performance, primarily related to various competitive and economic factors in the market in which the venues are located. As of September 29, 2019, the aggregate carrying value of the property and equipment at impaired venues, after the impairment charges, was $7.2 million for venues impaired in 2019.
Note 4. Intangible Assets, Net:
The
following table presents our indefinite and definite-lived intangible assets at September 29, 2019:
Weighted Average Life (Years)
Gross Carrying Amount
Accumulated
Amortization
Net Carrying Amount
(in thousands)
Chuck E. Cheese tradename
Indefinite
$
400,000
$
400,000
Peter
Piper Pizza tradename
Indefinite
26,700
26,700
Franchise agreements
25
53,300
(10,782
)
42,518
$
480,000
$
(10,782
)
$
469,218
In
connection with the adoption of ASU 2016-02 effective December 31, 2018, we reclassified $6.3 million related to the net carrying amount of our favorable lease definite-lived intangible asset from “Intangible Assets, Net” to “Operating lease right-of-use assets, net” on our Consolidated Balance Sheets. See Note 1. “Description of Business and Summary of Significant Accounting Policies - Recently Adopted Accounting Guidance” and Note 5. “Leases” for further discussion on the adoption of ASU 2016-02.
Amortization expense related to favorable lease agreements was $0.3 million and $1.0 million for the three and nine-month periods ended September 30,
2018, respectively, and is included in “Lease costs” in our Consolidated Statements of Earnings. As described above, in connection with the adoption of ASU 2016-02 at the beginning of Fiscal 2019, our favorable lease definite-lived intangible asset was reclassified from “Intangible Assets, Net” to “Operating lease right-of-use assets, net” and therefore we no longer have any amortization expense related to favorable lease agreements. Amortization expense related to franchise agreements was $0.5 million for both the three months ended September 29, 2019 and September 30, 2018, respectively, and $1.5 million
for both the nine months ended September 29, 2019 and September 30, 2018, respectively, and is included in “Depreciation and amortization” in our Consolidated Statements of Earnings.
Note 5. Leases:
We lease certain venues, warehouses, office space and equipment. The leases generally require us to pay minimum rent, property taxes, insurance, and other maintenance costs. Certain lease agreements include rental payments based on a percentage of retail sales over contractual levels and others include rental payments adjusted periodically for inflation.
Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.
Most of the Company's leases generally have initial terms of 10 to 20 years and include one or more options to renew. The exercise of lease renewal options is at our sole discretion, and based on our history of exercising renewal lease options, our operating lease liabilities typically assume the exercise of two lease renewal options. The depreciable life of assets and leasehold improvements are limited by the expected
lease term.
(1) During the nine months ended September 29, 2019, we recognized impairment charges of $0.2
million against our operating right-of-use lease assets related to three Peter Piper Pizza venues in Oklahoma that were closed in 2018. These impairment charges represent a change in the sublease income assumptions for these locations to reflect a longer than expected period to secure subtenants.
(2) Finance lease assets are recorded net of accumulated amortization of $5.7 million as of September 29, 2019.
As most of our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the current cost of debt on our Secured Credit Facilities
at commencement date in determining the present value of lease payments.
The following table illustrates the Company’s future minimum rental payments for non-cancelable leases as of September 29, 2019:
Operating
Leases
(1)
Finance
Leases (2)
Total
(in thousands)
Remainder of 2019
$
22,694
$
548
$
23,242
2020
91,537
2,194
93,731
2021
89,203
2,173
91,376
2022
87,221
2,147
89,368
2023
84,861
1,920
86,781
After
2023
472,432
12,931
485,363
Total lease payments
847,948
21,913
869,861
Less:
interest
276,365
9,435
285,800
Present value of minimum lease payments (3)
$
571,583
$
12,478
$
584,061
__________________
(1)
Operating lease payments include payments related to options to extend lease terms that are reasonably certain of being exercised and exclude legally binding minimum lease payments for leases signed but not yet commenced.
(2) Finance lease payments include payments related to options to extend lease terms that are reasonably certain of being exercised and exclude legally binding minimum lease payments for leases signed but not yet commenced.
(3) The present value of minimum operating lease payments of $49.2 million and $522.4 million are included in “Operating lease liability, current portion” and “Operating lease obligations, less current portion”, respectively, in our Consolidated
Balance Sheet. The present value of minimum finance lease payments of $0.8 million and $11.7 million are included in “Other current liabilities” and “Other noncurrent liabilities”, respectively, in our Consolidated Balance Sheet.
Bank
indebtedness and other long-term debt, net of deferred financing costs, less current portion
$
958,986
$
961,514
We were in compliance with the debt covenants in effect as of September 29, 2019 for both the Secured Credit Facilities and the Senior Notes.
We monitor the capital markets and our capital structure
and make changes from time to time, with the goal of maintaining financial flexibility, preserving or improving liquidity and/or achieving cost efficiency. From time to time we may opportunistically pursue financing transactions. In addition, we may elect to repurchase amounts of our outstanding debt, including the Senior Notes (as defined below under “Senior Unsecured Debt”), for cash, through open market repurchases or privately negotiated transactions with certain of our debt holders, although there is no assurance we will do so.
Secured Credit Facilities
On August 30, 2019the Company entered into a new credit agreement and related security agreements with Credit Suisse AG, Cayman Islands Branch,
as administrative and collateral agent. The new credit agreement provides senior secured financing consisting of:
(i)
a $114 million secured revolving credit facility which includes a $50 million letter of credit sub-facility (collectively the “2019 Revolving Credit Facility”) with a maturity date of August 30, 2024 (the “revolver maturity date); and
(ii)
a
$760 million secured term loan facility (the “2019 Term Loan Facility” and together with the 2019 Revolving Credit Facility, the “2019 Secured Credit Facilities”) with a maturity date of August 30, 2026 (the “term loan maturity date”).
In the event more than $50 million of the Company’s 8.0% Senior Notes maturing February 15, 2022 remain outstanding on the date that is 91 days prior to
the stated maturity date of the notes, the term loan maturity date will spring to such earlier date, November 16, 2021.
The net proceeds from the 2019 Secured Credit Facilities, plus cash on hand, were used to pay the outstanding principal, accrued interest and fees related to our secured credit facilities dated as of February 14, 2014, as amended by an incremental assumption agreement, dated as of May 8, 2018 (the “2014 Secured Credit Facilities”), and debt issuance costs related to the 2019 Secured Credit Facilities. All obligations under the 2014 Secured Credit Facilities have been terminated.
The 2019 secured term loan was issued net
of $30.4 million of original issue discount. We also incurred a total of $15.4 million in debt issuance costs ($13.4 million related to the issuance of the 2019 Term Loan Facility and $2.0 million related to the 2019 Revolving Credit Facility). The debt issuance costs are reflected in our consolidated financial statements as follows:
•
Loss on Extinguishment of Debt: We recorded a loss on extinguishment of debt totaling $2.9 million which includes $0.5 million of fees
paid to lenders in connection with the 2019 Term Loan Facility and wrote off $2.4 million of unamortized deferred financing costs and original issue discount related to the 2014 Secured Credit
Transaction related costs: We expensed third party fees totaling $0.3 million related to legal fees incurred
in connection with the 2019 Term Loan Facility. The transaction related costs are included in “Transaction, severance and related litigation costs” in our Consolidated Statement of Earnings;
•
Interest Expense: We expensed third party fees totaling $0.4 million related to rating agency fees incurred in connection with the 2019 Secured Credit Facilities. These fees are included in “Interest Expense” in our Consolidated Statement of Earnings; and
•
Deferred
Financing Costs: Debt issuance costs totaling $14.2 million related to the 2019 Secured Credit Facilities were capitalized and are included in “Bank indebtedness and other long-term debt, net of deferred financing costs” on our Consolidated Balance Sheets. We also continued to defer $2.1 million of unamortized deferred financing costs related to the 2014 Secured Credit Facilities.
The deferred financing costs related to the 2019 Term Loan Facility and original issue discount are amortized through the 2019 term loan maturity date, and the deferred financing costs related to the 2019 Revolving Credit Facility are being amortized through the 2019 revolver maturity date. The amortization of the deferred financing costs and original issue discount is included in “Interest expense” in
our Consolidated Statements of Earnings.
The 2019 Secured Credit Facilities allow the Company to request one or more incremental term loan facilities and/or increase the commitments under our revolving credit facility in an aggregate amount of up to the sum of (a) $50.0 million plus (b) such additional amount so long as, (i) in the case of loans that rank equally and without preference with the liens on the collateral securing the 2019 Secured Credit Facilities, our net first lien senior secured leverage ratio (the ratio of total consolidated debt secured by first-priority liens on the collateral net of unrestricted cash to the last twelve month’s EBITDA, as defined in the 2019 Senior Credit Facilities agreement) would be no greater than 2.75 to 1.00
and (ii) in the case of loans that rank junior to the liens on the collateral securing the 2019 Secured Credit Facilities, our total net secured leverage ratio (as defined in the 2019 Senior Credit Facilities agreement) would be no greater than 5.00 to 1.00, subject to certain conditions, and receipt of commitments by existing or additional lenders.
The 2019 Secured Credit Facilities include certain mandatory prepayment requirements:
•
Excess Cash Flow- Subject to certain exceptions, to the extent we have excess cash flow determined on an annual basis (as
defined in the 2019 Secured Credit Facilities agreement), we are required to make a mandatory prepayment of term loan principal (reduced by any optional prepayments of principal that may have occurred during the fiscal year) to the extent that 75% (the “required percentage” which is subject to step downs discussed below) times the excess cash flow exceeds $10.0 million. The required percentage steps down from 75% to 50% provided our Net Total Leverage Ratio (the ratio of total consolidated debt including lease related obligations net of unrestricted cash to the last twelve month’s EBITDA, as defined in the 2019 Senior Credit Facilities agreement) is less than or equal to 4.50 to 1.00 and greater
than 4.25 to 1.00, steps down to 25% provided our Net Total Leverage Ratio is less than or equal to 4.25 to 1.00 and greater than 4.00 to 1.00, and steps down to 0% provided our Net Total Leverage Ratio is less than or equal to 4.00 to 1.00.
•
Sales and Disposition of Assets-
Subject to certain exceptions, we are required to make a mandatory prepayment of term loan principal of 100% of the net cash proceeds of all non-ordinary course asset sales, other dispositions of property or certain casualty events, in each case subject to certain exceptions and provided that the Company may (i) reinvest within 12 months or (ii) commit to reinvest those proceeds and does reinvest such proceeds within 18 months in assets to be used in its business, or certain other permitted investments; and
•
Issuance or
incurrence of Debt- Subject to certain exceptions, we are required to make a mandatory prepayment of term loan principal of 100% of the net cash proceeds of any issuance or incurrence of debt, other than proceeds from debt permitted under the 2019 Secured Credit Facilities.
The Company may voluntarily repay outstanding loans under the 2019 Secured Credit Facilities at any time, without prepayment premium or penalty except in connection with a repricing event as described below, subject to customary “breakage” costs with respect to LIBOR rate loans. Any refinancing through the issuance or repricing amendment of any debt that results in a repricing event applicable to the 2019 Term Loan Facility resulting in a lower yield occurring at any time during
the first twelve months following August 30, 2019 will be accompanied by a 1.00% prepayment premium or fee, as applicable.
The 2019 Term Loan Facility requires scheduled quarterly payments equal to $1.9 million (0.25% of the original principal amount) from December 2019 to June 2026, with the remaining balance due at maturity, August 30, 2026.
As of September 29, 2019, we had no borrowings outstanding and an $8.5 million letter of credit issued but undrawn under the 2019 Revolving Credit Facility. As of December 30, 2018 we had a $9.0 million letter of credit issued but undrawn under the revolving credit facility related to the 2014 Senior Secured Facilities.
Borrowings under the 2019 Secured Credit Facilities bear interest at a rate equal to, at the option of the Company, either:
(a) a LIBOR rate determined by reference to the costs of funds for Eurodollar deposits for the interest period relevant to such borrowing, adjusted for certain additional costs, subject to a 1.00% floor; or
(b) a base rate determined by reference to the highest of (i) the federal funds rate plus 0.50%, (ii) the prime rate of Credit Suisse AG, Cayman Islands Branch, and (iii) the one-month adjusted LIBOR plus 1.00%.
In each case the interest rate is also subject to an applicable margin determined as follows:
•2019 Term Loan Facility:
Margin
for Base Rate Loans
Margin for LIBOR Loans
5.50%
6.50
%
•2019 Revolving Credit Facility:
Net Total Leverage Ratio
Margin
for Base Rate Loans
Margin for LIBOR Loans
Greater than 4.80 to 1.00
5.50%
6.50%
Less than or equal to 4.80 to 1.00 but greater than 4.30 to 1.00
5.25%
6.25%
Less
than or equal to 4.30 to 1.00
5.00%
6.00%
During the period from August 30, 2019 through September 29, 2019 the applicable margin for LIBOR borrowings under the 2019 Secured Credit Facilities was 6.50%. During the period from December 31, 2018 through August 29,
2019 and the nine months ended September 30, 2018, the applicable margin for LIBOR borrowings under the 2014 Secured Credit Facilities was 3.25%.
In addition to paying interest on outstanding principal under both the 2019 and 2014 Secured Credit Facilities, the Company is required to pay a commitment fee to the lenders under the respective revolving credit facilities in respect of any unutilized commitments thereunder. The applicable commitment fee rate under the 2019 Revolving Credit Facility is determined as follows:
The Company is also required to pay customary agency fees as well as letter of credit participation fees computed at a rate per annum equal to the applicable margin for LIBOR rate borrowings on the dollar equivalent of the daily stated amount of outstanding letters of credit, plus such letter of credit issuer’s customary documentary and processing fees and charges, and a fronting fee computed at a rate equal to 0.125% per annum on the daily stated amount of each letter of credit.
During the nine months ended September 29, 2019,
the federal funds rate ranged from 1.83% to 2.45%, the prime rate ranged from 5.00% to 5.50% and the one-month LIBOR ranged from 2.02% to 2.52%.
The weighted average effective interest rate incurred on our borrowings under both our 2019 and 2014 Secured Credit Facilities was 6.6% and 5.7% for the nine months ended September 29, 2019 and September 30, 2018,
respectively, which includes amortization of deferred financing costs related to our Secured Credit Facilities, amortization of our Term Loan Facility original issue discount and commitment and other fees related to our Secured Credit Facilities but excludes the Loss on extinguishment of debt.
Obligations under the both the 2019 and 2014 Secured Credit Facilities are unconditionally guaranteed by Parent on a
limited-recourse basis and each of our existing and future direct and indirect material, wholly-owned domestic subsidiaries,
subject to certain exceptions. The obligations are secured by a pledge of our capital stock and substantially all of our assets and those of each subsidiary guarantor, including capital stock of the subsidiary guarantors and 65% of the capital stock of the first- tier foreign subsidiaries that are not subsidiary guarantors, in each case subject to exceptions. Such security interests consist of first priority liens with respect to the collateral.
The 2019 Secured Credit Facilities also contain customary affirmative and negative covenants, and events of default, which limit our ability to, among other things: incur additional debt or issue certain preferred shares; create liens on certain assets; make certain loans or investments (including acquisitions); pay dividends on or make distributions
with respect to our capital stock or make other restricted payments; consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; sell assets; enter into certain transactions with our affiliates; enter into sale-leaseback transactions; change our lines of business; restrict dividends from our subsidiaries or restrict liens; change our fiscal year; and modify the terms of certain debt or organizational agreements. For a period of 18 months following August 30, 2019, we are prohibited from paying dividends to investment funds managed by Apollo or its affiliates.
Our 2019 Revolving Credit Facility includes a springing financial maintenance covenant that requires our net
first lien senior secured leverage ratio not to exceed 5.25 to 1.00. The covenant will be tested quarterly if the 2019 Revolving Credit Facility is more than 30% drawn (excluding outstanding letters of credit) and will be a condition to drawings under the Revolving Credit Facility that would result in more than 30% drawn thereunder.
Senior Unsecured Debt
Our senior unsecured debt consists of $255.0 million aggregate principal amount borrowings of 8.0% Senior Notes due 2022 (the “Senior Notes”). The Senior Notes bear interest at a rate of 8.0% per year payable
February 15th and August 15th each year and mature on February 15, 2022. We may call some or all of the Senior Notes at 102% on or after February 15, 2019 and at 100% on or after February 15, 2020 as set forth in the indenture governing the Senior Notes (the “indenture”).
We paid $6.4 million in debt issuance costs related to the Senior Notes, which we capitalized in “Bank
indebtedness and other long-term debt, net of deferred financing costs” on our Consolidated Balance Sheets. The deferred financing costs are being amortized over the life of the Senior Notes and are included in “Interest expense” in our Consolidated Statements of Earnings.
Our obligations under the Senior Notes are fully and unconditionally guaranteed, jointly and severally, by our present and future direct and indirect wholly-owned material domestic subsidiaries that guarantee our 2019 Secured Credit Facilities.
The indenture contains restrictive covenants that limit our ability to, among other things: (i) incur additional debt or issue certain preferred shares; (ii) create liens on certain assets;
(iii) make certain loans or investments (including acquisitions); (iv) pay dividends on or make distributions in respect of our capital stock or make other restricted payments; (v) consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; (vi) sell assets; (vii) enter into certain transactions with our affiliates; and (viii) restrict dividends from our subsidiaries.
The weighted average effective interest rate incurred on borrowings under our Senior Notes was 8.2% for both the nine months ended September 29, 2019 and September 30, 2018,
which includes amortization of deferred financing costs and other fees related to our Senior Notes.
(1) Includes
amortization of original issue discount.
The weighted average effective interest rate incurred on our borrowings under our 2019 and 2014 Secured Credit Facilities and Senior Notes (including amortized debt issuance costs, amortization of original issue discount, commitment and other fees related to the Secured Credit Facilities and Senior Notes) was 7.0% for the nine months ended September 29, 2019 and 6.3% for the nine months ended September 30, 2018, respectively.
Note
8. Fair Value of Financial Instruments:
Fair value measurements of financial instruments are determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy) has been established.
(1) Excluding
net deferred financing costs and original issue discount.
(2) The unamortized portion of original issue discount was $30.4 million and 1.2 million at September 29, 2019 and December 30, 2018, respectively.
Our financial instruments consist of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, our 2019 and 2014 Secured Credit Facilities and our Senior Notes. The carrying amount of cash and cash equivalents, restricted cash, accounts receivable and accounts payable approximates fair value because of their short maturities.
The estimated fair value of both our 2019 and 2014 Secured Credit Facilities and our Senior Notes was determined by using their respective average of the ask and bid price as of the nearest open market date preceding the reporting period end. The average of the ask and bid price are classified as Level 2 in the fair value hierarchy.
Our non-financial assets, which include long-lived assets, including property, plant and equipment, operating lease right-of-use assets, goodwill and intangible assets, are reported at carrying value and are not required to be measured at fair value on a recurring basis. However, on a periodic basis, or whenever events or changes in circumstances indicate that their carrying value may not be recoverable, we assess our long-lived assets for impairment.
During the nine months ended September
29, 2019 and September 30, 2018, there were no significant transfers among Level 1, 2 or 3 fair value determinations.
Note 9. Other Noncurrent Liabilities:
Other noncurrent liabilities consisted of the following as of the dates presented:
Sale leaseback obligations, less current portion (1)
$
171,729
$
174,520
Lease
related liabilities (2)
—
45,195
Financing lease obligations, less current portion
11,675
12,330
Accrued
insurance
6,724
9,861
Other
5,902
6,534
Total
other noncurrent liabilities
$
196,030
$
248,440
________________
(1)
The sale leaseback obligations are
accounted for under the financing method, rather than as completed sales. Under the financing method the sales proceeds received are included in other long-term liabilities until our continuing involvement with the properties is terminated. The rental payments related to the sale leaseback properties are recorded as interest expense and a reduction of the sale leaseback obligation.
(2)
Lease liabilities totaling $45.2 million were reclassified in connection with the adoption of ASU 2016-02 on December 31, 2018. See Note 1. “Description of Business and Summary of Significant
Accounting Policies - Recently Adopted Accounting Guidance” and Note 5. “Leases” for further discussion on the adoption of ASU 2016-02.
Our effective income tax rate was 27.6% and 18.9% for the three months ended September 29, 2019 and September 30, 2018, respectively. Our effective income tax rate for the three months ended September 29, 2019 differs from the statutory rate primarily due to state income taxes and the unfavorable impact of nondeductible litigation costs related to the Merger (as defined in Note 13. “Consolidating Guarantor Financial Information”),
foreign income taxes (withheld on royalties and franchise fees earned from international franchisees not offset by foreign tax credits due to the foreign tax credit limitation), and certain nondeductible penalties and other expenses, partially offset by the favorable impact of employment-related federal income tax credits. Our effective income tax rate for the three months ended September 30, 2018, differs from the statutory tax rate primarily due to state income taxes, nondeductible litigation costs related to the Merger, foreign income taxes (withheld on royalties and franchise fees earned from international franchisees not offset by foreign tax credits due to the foreign tax credit limitation), non-deductible penalties and other expenses, and an increase in the reserve for uncertain tax positions, partially offset by the favorable
impact of employment-related federal income tax credits.
Our effective income tax rate was 18.5% and 6.8% for the nine-month period ended September 29, 2019 and September 30, 2018, respectively. Our effective income tax rate for the nine-month period ended September 29, 2019 differs from the statutory rate primarily due to state income taxes net of the favorable impact of certain state tax legislation enacted during the second quarter of 2019 that decreased the amount of income subject
to state taxation, nondeductible litigation costs related to the Merger (as defined in Note 13. “Consolidating Guarantor Financial Information”), foreign income taxes (withheld on royalties and franchise fees earned from international franchisees not offset by foreign tax credits due to the foreign tax credit limitation), and certain nondeductible penalties and other expenses, partially offset by the favorable impact of employment-related federal income tax credits. Our effective income tax rate for the nine-month period ended September 30, 2018 differs from the statutory tax rate primarily due to state income taxes including the impact of certain state tax legislation enacted during the second quarter of 2018 that increased the amount of income subject to state taxation, nondeductible litigation costs related to the Merger,
foreign income taxes (withheld on royalties and franchise fees earned from international franchisees not offset by foreign tax credits due to the foreign tax credit limitation), certain non-deductible penalties and other expenses, an increase in the reserve for uncertain tax positions, an increase in a valuation allowance for deferred tax assets associated with a carryforward of certain state tax credits and deferred tax assets relating to our Canada operations that could expire before they are utilized, partially offset by the favorable impact of employment-related federal income tax credits, adjustments to the provisional estimate provided at the end of Fiscal 2017 to account for the impact of the Tax Cuts and Jobs Act (“TCJA”) enacted on December 22, 2017 pursuant to Staff Accounting Bulletin No. 118 (“SAB 118”), a one-time adjustment to deferred tax (the tax effect of the cumulative foreign currency
translation adjustment existing as of January 1, 2018) resulting from the change in our intent to no longer indefinitely reinvest monies loaned to our Canadian subsidiary.
For the periods presented herein, we have used the year-to-date effective tax rate (the “discrete method”), as prescribed by ASC 740-270, Accounting for Income Taxes-Interim Reporting when a reliable estimate of the estimated annual rate cannot be made. We believe at this time, the use of the discrete method is more appropriate than the annual effective tax rate method due to significant variations in the customary relationship between income tax expense and projected annual pre-tax income or
loss which occurs when annual projected pre-tax income or loss nears a relatively small amount in comparison to the differences between income and deductions determined for financial statement purposes versus income tax purposes. Using the discrete method, we have determined our current and deferred income tax expense as if the interim period were an annual period.
Our liability for uncertain tax positions (excluding interest and penalties) was $4.2 million as of September 29, 2019 and $4.3 million as of December 30, 2018 and if recognized would decrease our provision
for income taxes by $3.2 million. Within the next twelve months, we could settle or otherwise conclude certain ongoing income tax audits and resolve uncertain tax positions as a result of expiring statutes of limitations or payment. As such, it is reasonably possible that the liability for uncertain tax positions could decrease by as much as $3.7 million within the next twelve months.
Total accrued interest and penalties related to unrecognized tax benefits was $1.2 million as of September 29, 2019 and $1.1 million as of December 30, 2018, respectively. On
the Consolidated Balance Sheets, we include current accrued interest related to unrecognized tax benefits in “Accrued interest,” current accrued penalties in “Accrued expenses” and noncurrent accrued interest and penalties in “Other noncurrent liabilities.”
The 2014 Equity Incentive Plan provides Parent authority to grant equity incentive stock options, nonqualified stock options, stock appreciation
rights, restricted stock, restricted stock units, stock bonus awards or performance compensation awards to certain directors, officers or employees of the Company. A summary of the options outstanding under the equity incentive plan as of September 29, 2019 and the activity for the nine months ended September 29, 2019 is presented below:
(1) The
weighted average exercise price reflects the original grant date fair value per option as adjusted for the dividend payment made in August 2015.
As of September 29, 2019, we had $1.4 million of total unrecognized share-based compensation expense related to unvested options, which is expected to be amortized over the remaining weighted-average vesting period of 3.9 years.
Stock Awards
During the first quarter of 2019, certain officers of the Company were granted stock bonus awards
under the 2014 Equity Incentive Plan. The number of common shares of Parent awarded was based on the fair market value of Parent’s common stock as of December 31, 2018. The shares granted to the officers were fully vested immediately on the date that they were granted. In addition, during 2019, the Company agreed to issue fully vested common shares of Parent to certain officers of the Company in the first quarter 2020 based on the Company’s financial performance for Fiscal 2019.
The following tables summarize stock-based compensation expense and the associated tax benefit recognized in the Consolidated Financial Statements for the periods presented:
Stock-based compensation costs related to stock awards
$
1,632
$
—
Stock-based
compensation costs related to incentive stock options, net (1)
353
169
Stock-based compensation expense recognized
$
1,985
$
169
Payroll
taxes related to stock awards
$
15
$
—
__________________
(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 venue development
projects, such as the design and construction of a new venue and the remodeling and expansion of our existing venues. Capitalized stock-based compensation costs attributable to our venue development projects are included in “Property and equipment, net” in the Consolidated Balance Sheets.
The following tables summarize the changes in stockholder’s equity during the three and nine-month periods ended September 29,
2019 and September 30, 2018, respectively:
On February 14, 2014, CEC Entertainment, Inc. (the “Issuer”) merged with and into an entity controlled by Apollo Global Management, Inc. (“Apollo”) and its subsidiaries, which we refer to as the “Merger.” The Senior Notes issued by the Issuer, in conjunction with the Merger, are our unsecured obligations and are fully and unconditionally, jointly and severally guaranteed by all of our 100% wholly-owned U.S. subsidiaries (the “Guarantors”). Our wholly-owned foreign subsidiaries
and our less-than-wholly-owned U.S. subsidiaries are not a party to the guarantees (the “Non-Guarantors”). The following schedules present the condensed consolidating financial statements of the Issuer, Guarantors and Non-Guarantors, as well as consolidated results, for the periods presented:
Cash
flows provided by (used in) operating activities:
$
68,801
$
17,888
$
(4,214
)
$
82,475
Cash
flows from investing activities:
Purchases of property and equipment
(38,536
)
(15,512
)
(1,154
)
(55,202
)
Development
of internal use software
(1,484
)
(508
)
—
(1,992
)
Proceeds
from the sale of property and equipment
464
—
464
Cash
flows used in investing activities
(39,556
)
—
(16,020
)
—
(1,154
)
—
(56,730
)
Cash
flows from financing activities:
Repayments on senior term loan
(5,700
)
—
—
(5,700
)
Payment
of debt financing costs
(395
)
—
—
(395
)
Payments
on capital lease obligations
(436
)
—
(6
)
(442
)
Payments
on sale leaseback transactions
(2,119
)
—
—
(2,119
)
Cash
flows used in financing activities
(8,650
)
—
—
—
(6
)
—
(8,656
)
Effect
of foreign exchange rate changes on cash
—
—
51
51
Change
in cash, cash equivalents and restricted cash
20,595
—
1,868
—
(5,323
)
—
17,140
Cash,
cash equivalents and restricted cash at beginning of period
59,948
410
6,954
67,312
Cash,
cash equivalents and restricted cash at end of period
$
80,543
$
2,278
$
1,631
$
84,452
Note
14. Related Party Transactions:
We reimburse Apollo Management, L.P. for certain out-of-pocket expenses incurred in connection with travel and Board of Directors related expenses. In addition, CEC Entertainment engages Apollo portfolio companies to provide various services, including security services to its venues, licensed music video content for use in its venues, and employment screening services to its recruiting functions. Included in our Total operating costs and expenses are related expenses totaling $1.1 million and $0.4 million for the three months ended September 29, 2019 and September 30, 2018,
respectively, and $1.8 million and $1.2 million, respectively, for the nine months ended September 29, 2019 and September 30, 2018.
In connection with the 2019 Secured Credit Facilities, an affiliate of Apollo received an arrangement fee of $1.1 million related to the 2019 Term Loan Facility (see Note 7 “Indebtedness and Interest Expense” for further discussion of the 2019 Secured Credit Facilities).
Included in our Accounts Receivable balance are amounts due from Parent totaling $3.0
million and $2.6 million at September 29, 2019 and December 30, 2018, respectively, primarily related to various general and administrative and transaction related expenses paid on behalf of Parent. Our Accrued Expenses balance includes amounts payable to Parent totaling $0.3 million and $0.1 million at September 29, 2019 and December 30, 2018, respectively, primarily related to stock bonus awards granted to certain officers of the
Company (see Note 11 “Stock-Based Compensation Arrangements” for further discussion of stock bonus awards granted to officers).
Note 15. 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 liability with respect to claims or proceedings currently pending against us is not expected to have a material effect on our consolidated financial condition, results of operations or cash flows. All necessary loss accruals based on the probability and estimate of loss have been recorded.
Litigation Related
to the Merger: Following the January 16, 2014 announcement that CEC Entertainment had entered into an agreement (“Merger Agreement”), pursuant to which an entity controlled by Apollo Global Management, Inc. and its subsidiaries merged with and into CEC Entertainment, with CEC Entertainment surviving the merger (“the Merger”), four putative shareholder class actions were filed in the District Court of Shawnee County, Kansas, on behalf of purported stockholders of CEC Entertainment, against A.P. VIII Queso Holdings, L.P., CEC Entertainment, CEC Entertainment's directors, Apollo and Merger Sub (as defined in the Merger Agreement), in connection with the Merger Agreement and the transactions contemplated thereby. These actions were consolidated into one
action (the “Consolidated Shareholder Litigation”) in March 2014, and on July 21, 2015, a consolidated class action petition was filed as the operative consolidated complaint, asserting claims against CEC’s former directors, adding The Goldman Sachs Group (“Goldman Sachs”) as a defendant, and removing all Apollo entities as defendants (the “Consolidated Class Action Petition”). On October 8, 2018, the Plaintiff in the Consolidated Shareholder Litigation appealed the District Court’s decision to dismiss the lawsuit in its entirety, but after conducting oral arguments, on September 27, 2019 the Kansas Court of Appeals affirmed the trial court’s dismissal of the case, and Plaintiff did not file a notice of appeal from this last decision before the expiration of the deadline to do so.
Note
16. Subsequent Events:
The Company has evaluated subsequent events through November 11, 2019, and determined that there have been no events that have occurred that would require adjustments to our disclosures in the consolidated financial statements.
ITEM 2. Management’s
Discussion and Analysis of Financial Condition and Results of Operations.
As used in this report, the terms “CEC Entertainment,” the “Company,”“we,”“us” and “our” refer to CEC Entertainment, Inc. and its subsidiaries.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide the readers of our Consolidated Financial Statements with a narrative from the perspective of our management on our consolidated 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 (i) our Consolidated Financial Statements and related notes included in Part I, Item 1. “Financial Statements” of
this report and (ii) Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 8. “Financial Statements and Supplementary Data” in our Annual Report on Form 10-K for the fiscal year ended December 30, 2018, filed with the Securities and Exchange Commission (“SEC”) on March 12, 2019. Our MD&A includes the following sub-sections:
•
Presentation of Operating Results;
•
Executive
Summary;
•
Key Measure of Our Financial Performance and Key Non-GAAP Measures;
•
Key Income Statement Line Item Descriptions;
•
Results of Operations;
•
Financial
Condition, Liquidity and Capital Resources;
•
Off-Balance Sheet Arrangements and Contractual Obligations;
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 current fiscal year, which ends on December 29, 2019, and our fiscal year ended
December 30, 2018, each consist of 52 weeks. References to the three-month and nine-month periods ended September 29, 2019 and September 30, 2018 are for the 13-week and 39-week periods ended September 29, 2019 and September 30, 2018, respectively.
Seasonality and Variation in Quarterly Results
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 quarter 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.
Executive Summary
General
We develop, operate and franchise family dining and entertainment centers (also referred to as “venues”) under the names “Chuck E. Cheese” (“Where A Kid Can Be A Kid”) and “Peter Piper Pizza” (“Pizza Made Fresh, Families Made Happy”). Our venues deliver a lively, kid-friendly atmosphere
that feature a broad array of entertainment offerings including arcade-style and skill-oriented games, rides, live entertainment shows, and other attractions, with the opportunity for kids to win tickets that they can redeem for prizes. We combine this memorable entertainment experience with a broad and creative menu that combines kid-friendly classics as well as a selection of more sophisticated options for adults.We operate 553 venues and have an additional 185 venues operating under franchise arrangements across 47 states and 15 foreign countries and territories as of September 29, 2019.
The
number of new Company-operated venues and closed franchised venues during the nine months ended September 29, 2019 included one store that was acquired from a franchisee.
Key Measure of Our Financial Performance and Key Non-GAAP Measures
Comparable venue sales. We define “comparable venue sales” as the sales for our domestic Company-operated venues that have been open for more than 18 months as of the beginning of each respective fiscal year or acquired venues we have operated for at least 12 months as of the beginning of each respective fiscal year. Comparable venue sales excludes sales for our domestic Company-operated venues that are expected to be temporarily closed for more than three
months primarily as a result of natural disasters, fires, floods and property damage. Company-operated venues that were temporarily closed for more than three months are included in comparable venue sales once they have been reopened for at least 12 months as of the beginning of each respective fiscal year. We define “comparable venue sales change” as the percentage change in comparable venue sales for each respective fiscal period. We believe comparable venue sales change to be a key performance indicator used within our industry; it is a critical factor when evaluating our performance, as it is indicative of acceptance of our strategic initiatives and local economic and consumer trends.
Adjusted EBITDA and Margin. We define Adjusted EBITDA, a measure used by management to assess operating performance, as net income (loss) plus interest expense, income tax expense (benefit), depreciation and
amortization expense, impairments, gains and losses on asset disposals, and stock based compensation. In addition, Adjusted EBITDA excludes other items we consider unusual or non-recurring and certain other adjustments required or permitted in calculating covenant compliance under the indenture governing our Senior Notes and/or our 2019 and 2014 Secured Credit Facilities (as defined under “Financial Condition, Liquidity and Capital Resources - Debt Financing”). Adjusted EBITDA Margin represents Adjusted EBITDA as a percentage of total revenues.
Key Income Statement Line Item Descriptions
Revenues. Our primary source of revenues is sales at our Company-operated venues (“company
venue sales”), which consist of the sale of food, beverages, unlimited game-play time blocks, game-play credits, and merchandise. A portion of our company venue sales are from sales of value-priced combination packages generally comprised of food, beverage, and through the end of the second quarter of 2018, game plays and/or time blocks, which we promote through in-venue menu pricing, our website and coupon offerings. Beginning in the third quarter of 2018, we offer combination packages comprised of food and beverage only (“Package Deals”), with game plays and/or time blocks available for purchase separately. Prior to the bifurcation
of the “Food and beverage sales” and “Entertainment and merchandise sales” components of combination packages, we allocated the revenues recognized from the sale of combination packages and coupons 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.
Food and beverage sales include all revenues recognized with respect to stand-alone food and beverage sales, and through the end of the second quarter of 2018, the portion of revenues allocated from combination packages and coupons that relate to food and beverage sales. Entertainment and merchandise sales
include all revenues recognized with respect to stand-alone sales of game-play credits and unlimited game-play time blocks, and through the end of the second quarter of 2018, a portion of revenues allocated from combination packages and coupons that relate to entertainment and merchandise.
Franchise fees and royalties are another source of revenues. We earn monthly royalties from our franchisees based on a percentage of each franchise venue’s sales. We also receive development and initial franchise fees to establish new franchised venues, as well as earn fees from the sale of equipment and other items or services to franchisees. We recognize initial and renewal development and franchise fees as revenues on a straight-line basis over the life of the franchise agreement starting when the franchise venue has opened. Our national advertising fund receipts from members of the International Association of CEC Entertainment, Inc.
(the “Association”) are accounted for on a gross basis as revenue from franchisees.
Company venue operating costs. Certain of our costs and expenses relate only to the operation of our Company-operated venues. These costs and expenses are listed and described below:
•
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 tickets issued, stored-value PlayPass and All You Can Play (“AYCP”) cards, prizes provided and merchandise sold to our customers.
•
Labor expenses consist of salaries and wages, bonuses, related payroll taxes and benefits for venue personnel;
•
Lease costs include lease costs for Company-operated venues and, effective the first day of Fiscal 2019, in connection with the adoption of a new lease accounting standards, lease costs include common area maintenance
(“CAM”) charges; and
•
Other venue operating expenses primarily include utilities, repair and maintenance costs, liability and property insurance, property taxes, credit card processing fees, licenses, preopening expenses, venue asset disposal gains and losses, CAM charges (through the end of Fiscal 2018 as discussed under Lease costs above) and all other costs directly related to the operation of a venue.
“Cost of food and beverage” and “Cost of entertainment and merchandise,” as a percentage of Total company venue sales, are influenced both by the cost of products and by the overall mix of our Package Deals and coupon offerings. “Entertainment and merchandise
sales” have higher margins than “Food and beverage sales.”
Advertising expense. Advertising expense includes production costs for television commercials, newspaper inserts, Internet advertising, coupons, media expenses for national and local advertising, consulting fees and other forms of advertising such as social media.
General and administrative expenses. General and administrative expenses represent all costs associated with operating our corporate office, including regional and district management and corporate personnel payroll and benefits, back-office support systems, costs of outsourced functions, and other administrative costs not directly related to the operation of our Company-operated venues.
Depreciation
and amortization. Depreciation and amortization includes expenses that are (i) directly related to our Company-operated venues’ property and equipment, including leasehold improvements, game and ride equipment, furniture, fixtures and other equipment, and (ii) depreciation and amortization of corporate assets and intangibles.
The following table summarizes our
principal sources of company venue sales expressed in dollars and as a percentage of total company venue sales for the periods presented:
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:
Total
cost of food, beverage, entertainment and merchandise (3)
100,550
14.6
%
100,450
14.8
%
Labor
expenses (3)
199,693
29.0
%
194,994
28.8
%
Lease costs (3)
82,102
11.9
%
72,615
10.7
%
Other
venue operating expenses (3)
102,536
14.9
%
113,363
16.7
%
Total
company venue operating costs and expenses (3)
484,881
70.4
%
481,422
71.1
%
Other
costs and expenses:
Advertising expense
34,033
4.8
%
38,010
5.5
%
General
and administrative expenses
42,944
6.1
%
39,519
5.7
%
Depreciation and amortization
73,074
10.3
%
76,804
11.1
%
Transaction,
severance and related litigation costs
402
0.1
%
463
0.1
%
Asset impairments
9,487
1.3
%
6,935
1.0
%
Total
operating costs and expenses
644,821
91.3
%
643,153
92.8
%
Operating income
61,262
8.7
%
50,055
7.2
%
Interest
expense
61,816
8.8
%
56,740
8.2
%
Loss on extinguishment of debt
$
2,910
0.4
%
$
—
—
%
Loss
before income taxes
$
(3,464
)
(0.5
)%
$
(6,685
)
(1.0
)%
__________________
(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 Total company venue sales.
(4)
Due to rounding, percentages presented in the table above may not
sum to total. The percentage amounts for the components of Cost of food and beverage and the Cost of entertainment and merchandise may not sum to total due to the fact that Cost of food and beverage and Cost of entertainment and merchandise are expressed as a percentage of related Food and beverage sales and Entertainment and merchandise sales, as opposed to Total company venue sales.
Company venue sales were $212.3 million and
$215.6 million for the third quarter of 2019 and the third quarter of 2018, respectively. The decrease in company venue sales was primarily attributable to a 0.9% decrease in comparable venue sales, and net revenue deferrals related to a net Play Pass revenue deferral of $0.7 million for the third quarter of 2019 compared to $1.7 million in net breakage for the third quarter of 2018.
Franchise fees and royalties were $5.3 million for both the third
quarter of 2019 and 2018.
Company Venue Operating Costs
The cost of food, beverage, entertainment and merchandise, as a percentage of Total company venue sales, was 14.8% and 15.0% for the third quarter of 2019 and 2018, respectively.
The cost of food and beverage, as a percentage of food and beverage sales, was 23.0% and 24.0% for the third quarter of 2019 and 2018, respectively. The
decrease in the cost of food and beverage on a percentage basis in the third quarter of 2019 was primarily driven by higher average selling prices and favorability in commodity volume.
The cost of entertainment and merchandise, as a percentage of entertainment and merchandise sales, was 8.4% and 8.1% for the third quarter of 2019 and 2018, respectively. The increase
in the cost of entertainment and merchandise on a percentage of sales basis in the third quarter of 2019 reflects the impact of the AYCP and More Tickets initiatives we launched nationally in all of our Chuck E. Cheese Company-operated venues during the third quarter of 2018.
Gross profit, which represents Total revenues less total cost of food, beverage, entertainment and merchandise, as a percentage of Total revenues was 85.6% and 85.3% for the third quarter of 2019 and 2018, respectively.
Labor expenses, as a percentage of sales, were 29.8% and 30.2% for the third
quarter of 2019 and 2018, respectively, as the favorable impact of a decrease in labor hours exceeded wage pressures. Our sales per labor hour improved approximately 4.0% in the third quarter of 2019 from the third quarter of 2018.
Lease costs, as a percentage of sales, were 13.0% and 11.1%, for the third quarter of 2019 and 2018, respectively. Lease costs for the third quarter of 2019 were impacted by the adoption of a new lease standard effective December 31,
2018, the first day of Fiscal 2019, that requires us to recognize lease and non-lease components, such as CAM charges, as lease costs, rather than reflecting CAM charges as Other venue operating expenses. Excluding CAM charges, Lease costs, as a percentage of sales, would have been 11.4% for the third quarter of 2019, primarily reflecting a decrease in Company venue sales.
Other venue operating expenses, as a percentage of sales, were 16.3% and 17.7% for the third quarter of 2019 and 2018, respectively. Other venue operating expenses for the third quarter of
2019 were impacted by the adoption of a new lease standard, as discussed in the previous paragraph under Lease costs. Other venue operating expenses as a percentage of sales, including the impact of CAM charges, would have been 17.9% for the third quarter of 2019, increasing primarily as a result of an increase in insurance costs associated with general liability claims.
Advertising Expense
Advertising expense was $10.8 million and $11.1 million for the third quarter of 2019 and 2018, respectively, due to a planned shift in our marketing strategy away from television to targeted digital
and social media platforms.
General and Administrative Expenses
General and administrative expenses were $13.1 million and $13.2 million for the third quarter of 2019 and 2018, respectively. The decrease in general and administrative expenses for the third quarter of 2019 is primarily due to a decrease in miscellaneous professional services fees.
Transaction, severance and related litigation costs
Transaction, severance and related litigation costs were $0.4 million and $(0.3)
million for the third quarter of 2019 and 2018, respectively. The Transaction, severance and related litigation costs for the third quarter of 2019 relate to third-party costs incurred in connection with the refinancing of our Secured Credit Facilities. See further discussion of the refinancing of our senior secured facilities in “Financial Condition, Liquidity and Capital Resources - Debt Financing” of this report. The Transaction, severance and related litigation costs for the third quarter of 2018 reflect an insurance settlement received relating to legal fees incurred in prior years.
Asset Impairments
In the third quarter of 2019
we recognized an asset impairment charge of $8.2 million primarily related to ten venues, of which none were previously impaired. In the third quarter of 2018, we recognized an asset impairment charge of $5.3 million related to eight venues, of which one was previously impaired. We continue to operate all of the venues that were impaired in the third quarter of 2019 and all but two of the venues that were impaired in the third quarter of 2018. The impairment charge was based on the determination that the financial performance
of these venues was adversely impacted by various competitive and economic factors in the markets in which the venues are located.
Interest Expense
Interest expense was $22.0 million and $19.1 million for the third quarter of 2019 and 2018, respectively. The increase in interest expense is related to an increase in the weighted average effective rate incurred on our borrowings under our 2019 and 2014 Secured Credit Facilities driven by the increase in LIBOR rates and a higher interest margin on our recently refinanced secured credit facilities. The weighted average effective interest rate incurred on our borrowings under our secured credit facilities
was 7.3% and 5.9% for the third quarter of 2019 and 2018, respectively, which includes amortization of deferred financing costs related to our secured credit facilities, amortization of our 2019 and 2014 Term Loan Facility original issue discount and commitment and other fees related to our secured credit facilities. See further discussion of the refinancing of our senior secured facilities in “Financial Condition, Liquidity and Capital Resources - Debt Financing” of this report.
In the third quarter of 2019 we recognized a Loss on Extinguishment of Debt of $2.9 million in connection with the refinancing of our 2014 Secured Credit Facilities. See further discussion of the refinancing of our senior secured facilities in “Financial Condition, Liquidity and Capital Resources - Debt Financing” of this report.
Income Taxes
Our effective income tax rate was 27.6% and 18.9% for the third quarter of 2019 and 2018, respectively. Our effective income tax rate for the third quarter of 2019
differs from the statutory rate primarily due to state income taxes and the unfavorable impact of nondeductible litigation costs related to the Merger (as defined in Note 13. “Consolidating Guarantor Financial Information”), foreign income taxes (withheld on royalties and franchise fees earned from international franchisees not offset by foreign tax credits due to the foreign tax credit limitation), and certain nondeductible penalties and other expenses, partially offset by the favorable impact of employment-related federal income tax credits.
Our effective income tax rate for the third quarter of 2018, differs from the statutory tax rate primarily due to state income taxes, nondeductible litigation costs related to the Merger, foreign income taxes (withheld on royalties and franchise fees earned from international franchisees not offset by foreign tax credits due to the
foreign tax credit limitation), non-deductible penalties and other expenses, and an increase in the reserve for uncertain tax positions, partially offset by the favorable impact of employment-related federal income tax credits.
Company venue sales were $688.9 million and $677.3 million for the first nine months of 2019 and 2018, respectively. The
increase in company venue sales for the first nine months of 2019 was primarily attributable to a 2.7% increase in comparable venue sales, partially offset by a $2.0 million decrease in company venue sales due to temporary store closures and a net reduction of four Company-operated venues. In addition, net revenue deferrals related to PlayPass were $1.2 million for the first nine months of 2019 compared to $3.7 million in net revenue breakage for the first nine months of 2018, which further offset the increase in comparable venue sales.
Franchise
fees and royalties increased from $15.9 million to $17.2 million primarily due to a net increase in average franchise locations during the first nine months of 2019.
Company Venue Operating Costs
The cost of food, beverage, entertainment and merchandise, as a percentage of Total company venue sales, was 14.6% and 14.8% for the first nine months of 2019 and 2018, respectively, as a sales shift towards higher margin Entertainment and merchandise sales from food and beverage sales was offset by cost pressures, primarily related
to the impact of new initiatives launched by the Company in the third quarter of 2018.
The cost of food and beverage, as a percentage of food and beverage sales, was 22.9% and 23.6% for the first nine months of 2019 and 2018, respectively. The decrease in the cost of food and beverage on a percentage basis in the first nine months of 2019 was driven by an increase in average selling prices and favorability in commodity prices and volume.
The cost of entertainment and merchandise,
as a percentage of entertainment and merchandise sales, was 8.1% and 7.5% for the first nine months of 2019 and 2018, respectively. The cost of entertainment and merchandise on a percentage basis for the first nine months of 2019 compared to the first nine months of 2018 was impacted by a combination of the impact of AYCP and More Tickets, which were launched nationally during the third quarter of 2018.
Gross profit, which represents Total revenues less total cost of food, beverage, entertainment and merchandise, as a percentage of Total revenues, was 85.8% and 85.5%
for the first nine months of 2019 and 2018, respectively.
Labor expenses, as a percentage of sales, were 29.0% and 28.8% for the first nine months of 2019 and 2018, respectively, as wage pressures exceeded the favorable impact of a decrease in labor hours on higher sales. Our sales per labor hour improved approximately 5.2% in the first nine months of 2019 from the first nine months of 2018.
Lease costs, as a percentage of sales, were 11.9%
and 10.7%, for the first nine months of 2019 and 2018, respectively. Lease costs for the first nine months of 2019 were impacted by the adoption of a new lease standard effective December 31, 2018, the first day of Fiscal 2019, that requires us to recognize lease and non-lease components, such as CAM charges, as lease costs, rather than reflecting CAM charges as Other venue operating expenses. Excluding CAM charges, Lease costs, as a percentage of sales, would have been 10.4% for the first nine months of 2019, reflecting an increase in Company venue sales.
Other venue operating costs, as a percentage of sales, were 14.9% and 16.7% for the first nine months of 2019 and 2018, respectively. Other venue operating expenses for the first nine months of 2019 were impacted by the adoption of a new lease standard, as discussed in the previous paragraph under Lease costs. Other venue operating expenses as a percentage of sales, including the impact of CAM charges, would have been 16.4% for the first nine months of 2019, reflecting savings initiatives and efficiencies in general operating costs. The favorable impact of these savings was
partially offset by an increase in bank and credit card service fees, as the percentage of credit card sales increased in the first nine months of 2019 from the first nine months of 2018.
Advertising Expense
Advertising expense was $34.0 million and $38.0 million for the first nine months of 2019 and 2018, respectively, due to a planned shift in our marketing strategy away from television to targeted digital and social media platforms.
General and Administrative Expenses
General and administrative expenses were $42.9
million and $39.5 million for the first nine months of 2019 and 2018, respectively. The increase in general and administrative expenses in the first nine months of 2019 is primarily due to an increase in performance-based compensation as a result of improved operating results.
Depreciation and Amortization
Depreciation and amortization was $73.1 million and $76.8 million for the first nine months of 2019 and 2018, respectively. The decrease in depreciation
and amortization is primarily due to the impact of six venue closures and non-cash venue impairments recorded in 2018.
Transaction, Severance and Related Litigation Costs
Transaction, severance and related litigation costs were $0.4 million and $0.5 million for the first nine months of 2019 and 2018, respectively. The Transaction, severance and related litigation costs for the first nine months of 2019 relate to legal fees incurred in connection with Merger related litigation costs. The Transaction, severance and related litigation costs for the first
nine months of 2018 relate to $0.2 million in legal fees incurred in connection with Merger related litigation, and severance payments of $0.3 million.
Asset Impairments
In the first nine months of 2019 we recognized an asset impairment charge of $9.5 million primarily related to 12 venues, of which none were previously impaired. In the first nine months of 2018, we recognized an asset impairment charge of $6.9 million related to 9 venues, of which one
was previously impaired. We continue to operate all of the venues that were impaired in the first nine months of 2019 and all but three of the venues that were impaired in the first nine months of 2018. The impairment charge was based on the determination that the financial performance of these venues was adversely impacted by various competitive and economic factors in the markets in which the venues are located.
Interest Expense
Interest expense was $61.8 million and $56.7 million for the first nine months of 2019 and 2018,
respectively. The increase in interest expense is related to an increase in the weighted average effective rate incurred on our borrowings under both our 2019 and 2014 Secured Credit Facilities, driven by the increase in LIBOR rates and a higher interest margin on our recently refinanced secured credit facilities. The weighted average effective interest rate incurred on our borrowings under our secured credit facilities was 6.6% and 5.7% for the first nine months of 2019 and 2018, respectively, which includes amortization of deferred financing costs related to both our 2019 and 2014 Secured Credit Facilities, amortization of our 2019 and 2014 Term Loan Facility original issue discount and commitment and other fees related to our secured credit facilities. See further discussion of the refinancing
of our senior secured facilities in “Financial Condition, Liquidity and Capital Resources - Debt Financing” of this report.
Loss on Extinguishment of Debt
In the first nine months of 2019 we recognized a Loss on Extinguishment of Debt of $2.9 million in connection with the refinancing of our 2014 Secured Credit Facilities. See further discussion of the refinancing of our senior secured facilities in “Financial Condition, Liquidity and Capital Resources - Debt Financing” of this report.
Our effective income tax rate was 18.5% and 6.8% for the first nine months of 2019 and 2018, respectively. Our effective income tax rate for the first nine months of 2019 differs from the statutory rate primarily due to state taxes net of the favorable impact of certain state tax legislation enacted during the second quarter of 2019 that decreased the amount of income subject to state taxation, nondeductible litigation costs related to the Merger (as defined in Note 13. “Consolidating Guarantor Financial Information”), foreign income taxes (withheld on royalties and franchise fees earned from international franchisees not offset by foreign tax credits due to the foreign tax credit limitation),
and certain nondeductible penalties and other expenses, partially offset by the favorable impact of employment-related federal income tax credits.
Our effective income tax rate for the first nine months of 2018 differs from the statutory tax rate primarily due to state income taxes including the impact of certain state tax legislation enacted during the second quarter of 2018 that increased the amount of income subject to state taxation, nondeductible litigation costs related to the Merger, foreign income taxes (withheld on royalties and franchise fees earned from international franchisees not offset by foreign tax credits due to the foreign tax credit limitation), certain non-deductible penalties and other expenses, an increase in the reserve for uncertain tax positions, an increase in a valuation allowance for deferred tax assets associated with a carryforward of certain state
tax credits and deferred tax assets relating to our Canada operations that could expire before they are utilized, partially offset by the favorable impact of employment-related federal income tax credits, adjustments to the provisional estimate provided at the end of Fiscal 2017 to account for the impact of the TCJA enacted on December 22, 2017 pursuant to SAB 118, a one-time adjustment to deferred tax (the tax effect of the cumulative foreign currency translation adjustment existing as of January 1, 2018) resulting from the change in our intent to no longer indefinitely reinvest monies loaned to our Canadian subsidiary.
Financial Condition, Liquidity and Capital Resources
Overview of Liquidity
We
finance our business activities through cash flows provided by our operations.
The primary components of working capital are as follows:
•
our guests pay for their purchases in cash or credit cards at the time of the sale and the cash from these sales is typically received before our related accounts payable to suppliers and employee payroll become due;
•
frequent inventory turnover results in a limited investment required in inventories; and
•
our
accounts payable cash management strategies.
As a result of these factors, our requirement for working capital is not significant and we are able to operate with a net working capital deficit (current liabilities in excess of current assets), similar to other companies in the restaurant industry. As part of our capital allocation strategy, we may elect from time to time to retire certain of our debt obligations through voluntary prepayments or open market purchases.
The following tables present summarized consolidated financial
information that we believe is helpful in evaluating our liquidity and capital resources as of and for the periods presented:
Net cash provided by operating activities was $115.6 million and $82.5
million in the nine months ended September 29, 2019 and September 30, 2018, respectively. The increase in net cash provided by operating activities is primarily due to income tax refunds and favorable fluctuations in our working capital.
Net cash used in investing activities was $61.0 million and $56.7 million in the nine months ended September 29, 2019 and September 30, 2018, respectively. Net cash used in investing activities in the
nine months ended September 29, 2019 and September 30, 2018 relates primarily to capital expenditures.
Net cash used in financing activities was $12.7 million and $8.7 million in the nine months ended September 29, 2019 and September 30, 2018, respectively. The net cash used in financing activities for the nine months ended September 29, 2019 includes (i) $5.9
million in loan costs and third party legal and other professional fees paid, net of proceeds received, in connection with the refinancing of our secured credit facilities occurring in the third quarter of 2019, (ii) principal payments on our 2014 Secured Credit Facilities and (iii) other lease related obligations. See further discussion below under Debt Financing - Secured Credit Facilities. Net cash used in financing activities for the nine months ended September 30, 2018 relates primarily to principal payments on our 2014 Secured Credit Facilities and other lease related obligations.
Debt Financing
Secured Credit Facilities
On August 30,
2019the Company entered into a new credit agreement and related security agreements with Credit Suisse AG, Cayman Islands Branch, as administrative and collateral agent. The new credit agreement provides senior secured financing consisting of:
(i)
a $114 million secured revolving credit facility which includes a $50 million letter of credit sub-facility (collectively the “2019 Revolving Credit Facility”) with a maturity date of August 30,
2024 (the “revolver maturity date); and
(ii)
a $760 million secured term loan facility (the “2019 Term Loan Facility” and together with the 2019
Revolving Credit Facility, the “2019 Secured Credit Facilities”) with a maturity date of August 30, 2026
(the “term loan maturity date”).
In the event more than $50 million of the Company’s 8.0% Senior Notes maturing February 15, 2022 remain outstanding on the date that is 91 days prior to the stated maturity date of the notes, the term loan maturity date will spring to such earlier date, November 16, 2021.
The net proceeds from the 2019 Secured Credit Facilities, plus cash on hand, were used to pay the outstanding principal, accrued interest and fees related to our
secured credit facilities dated as of February 14, 2014, as amended by an incremental assumption agreement, dated as of May 8, 2018 (the “2014 Secured Credit Facilities”), and debt issuance costs related to the 2019 Secured Credit Facilities. All obligations under the 2014 Secured Credit Facilities have been terminated.
The 2019 secured term loan was issued net of $30.4 million of original issue discount. We also incurred a total of $15.4 million in debt issuance costs ($13.4 million related to the issuance of the 2019 Term Loan Facility and $2.0 million
related to the 2019 Revolving Credit Facility). The debt issuance costs are reflected in our consolidated financial statements as follows:
•
Loss on Extinguishment of Debt: We recorded a loss on extinguishment of debt totaling $2.9 million which includes $0.5 million of fees paid to lenders in connection with the 2019 Term Loan Facility and wrote off $2.4 million of unamortized deferred financing costs and original issue discount related to the 2014 Secured Credit Facilities;
•
Transaction
related costs: We expensed third party fees totaling $0.3 million related to legal fees incurred in connection with the 2019 Term Loan Facility. The transaction related costs are included in “Transaction, severance and related litigation costs” in our Consolidated Statement of Earnings;
•
Interest Expense: We expensed third party fees totaling $0.4 million related to rating agency fees incurred in connection with the 2019 Secured Credit Facilities. These fees are included in “Interest Expense” in our Consolidated Statement of Earnings; and
•
Deferred
Financing Costs: Debt issuance costs totaling $14.2 million related to the 2019 Secured Credit Facilities were capitalized and are included in “Bank indebtedness and other long-term debt, net of deferred financing costs” on our Consolidated Balance Sheets. We also continued to defer $2.1 million of unamortized deferred financing costs related to the 2014 Secured Credit Facilities.
The deferred financing costs related to the 2019 Term Loan Facility and original issue discount are amortized through the 2019 term loan maturity date, and the deferred financing costs related to the 2019 Revolving Credit Facility are being amortized through the 2019 revolver maturity date. The amortization of the deferred financing costs and original issue discount is included in “Interest expense” in
our Consolidated Statements of Earnings.
The 2019 Secured Credit Facilities allow the Company to request one or more incremental term loan facilities and/or increase the commitments under our revolving credit facility in an aggregate amount of up to the sum of (a) $50.0 million plus (b) such additional amount so long as, (i) in the case of loans that rank equally and without preference with the liens on the collateral securing the 2019 Secured Credit Facilities, our net first lien senior secured leverage ratio (the ratio of total consolidated debt secured by first-priority liens on the collateral net of unrestricted cash to the last twelve month’s EBITDA, as defined in the 2019 Senior Credit Facilities agreement) would be no greater than 2.75 to 1.00
and (ii) in the case of loans that rank junior to the liens on the collateral securing the 2019 Secured Credit Facilities, our total net secured leverage ratio (as defined in the 2019 Senior Credit Facilities agreement) would be no greater than 5.00 to 1.00, subject to certain conditions, and receipt of commitments by existing or additional lenders.
The 2019 Secured Credit Facilities include certain mandatory prepayment requirements:
•
Excess Cash Flow- Subject to certain exceptions, to the extent we have excess cash flow determined on an annual basis (as
defined in the 2019 Secured Credit Facilities agreement), we are required to make a mandatory prepayment of term loan principal (reduced by any optional prepayments of principal that may have occurred during the fiscal year) to the extent that 75% (the “required percentage” which is subject to step downs discussed below) times the excess cash flow exceeds $10.0 million. The required percentage steps down from 75% to 50% provided our Net Total Leverage Ratio (the ratio of total consolidated debt including lease related obligations net of unrestricted cash to the last twelve month’s EBITDA, as defined in the 2019 Senior Credit Facilities agreement) is less than or equal to 4.50 to 1.00 and greater
than 4.25 to 1.00, steps down to 25% provided our Net Total Leverage Ratio is less than or equal to 4.25 to 1.00 and greater than 4.00 to 1.00, and steps down to 0% provided our Net Total Leverage Ratio is less than or equal to 4.00 to 1.00.
•
Sales and Disposition of Assets-
Subject to certain exceptions, we are required to make a mandatory prepayment of term loan principal of 100% of the net cash proceeds of all non-ordinary course asset sales,
other dispositions of property or certain casualty events, in each case subject to certain exceptions and provided that the Company may (i) reinvest within 12 months or (ii) commit to reinvest those proceeds and does reinvest such proceeds within 18 months
in assets to be used in its business, or certain other permitted investments; and
•
Issuance or incurrence of Debt- Subject to certain exceptions, we are required to make a mandatory prepayment of term loan principal of 100% of the net cash proceeds of any issuance or incurrence of debt, other than proceeds from debt permitted under the 2019 Secured Credit Facilities.
The Company may voluntarily repay outstanding loans under the 2019 Secured Credit Facilities at any time, without prepayment premium or penalty except in connection with a repricing
event as described below, subject to customary “breakage” costs with respect to LIBOR rate loans. Any refinancing through the issuance or repricing amendment of any debt that results in a repricing event applicable to the 2019 Term Loan Facility resulting in a lower yield occurring at any time during the first twelve months following August 30, 2019 will be accompanied by a 1.00% prepayment premium or fee, as applicable.
The 2019 Term Loan Facility requires scheduled quarterly payments equal to $1.9 million (0.25% of the original principal amount) from December 2019 to June 2026, with the remaining
balance due at maturity, August 30, 2026.
As of September 29, 2019, we had no borrowings outstanding and an $8.5 million letter of credit issued but undrawn under the 2019 Revolving Credit Facility. As of December 30, 2018 we had a $9.0 million letter of credit issued but undrawn under the revolving credit facility related to the 2014 Senior Secured Facilities.
Borrowings under the 2019 Secured Credit Facilities bear interest at a rate equal to, at the option of the
Company, either:
(a) a LIBOR rate determined by reference to the costs of funds for Eurodollar deposits for the interest period relevant to such borrowing, adjusted for certain additional costs, subject to a 1.00% floor; or
(b) a base rate determined by reference to the highest of (i) the federal funds rate plus 0.50%, (ii) the prime rate of Credit Suisse AG, Cayman Islands Branch, and (iii) the one-month adjusted LIBOR plus 1.00%.
In each case the interest rate is also subject to an applicable margin determined as follows:
•2019 Term Loan Facility:
Margin
for Base Rate Loans
Margin for LIBOR Loans
5.50%
6.50%
•2019 Revolving Credit Facility:
Net Total Leverage Ratio
Margin for Base
Rate Loans
Margin for LIBOR Loans
Greater than 4.80 to 1.00
5.50%
6.50%
Less than or equal to 4.80 to 1.00 but greater than 4.30 to 1.00
5.25%
6.25%
Less
than or equal to 4.30 to 1.00
5.00%
6.00%
During the period from August 30, 2019 through September 29, 2019 the applicable margin for LIBOR borrowings under the 2019 Secured Credit Facilities was 6.50%. During the period from December 31, 2018 through August 29,
2019 and the nine months ended September 30, 2018, the applicable margin for LIBOR borrowings under the 2014 Secured Credit Facilities was 3.25%.
In addition to paying interest on outstanding principal under both the 2019 and 2014 Secured Credit Facilities, the Company is required to pay a commitment fee to the lenders under the respective revolving credit facilities in respect of any unutilized commitments thereunder. The applicable commitment fee rate under the 2019 Revolving Credit Facility is determined as follows:
The Company is also required to pay customary agency fees as well as letter of credit participation fees computed at a rate per annum equal to the applicable margin for LIBOR rate borrowings on the dollar equivalent of the daily stated amount of outstanding letters of credit, plus such letter of credit issuer’s customary documentary and processing fees and charges, and a fronting fee computed at a rate equal to 0.125%
per annum on the daily stated amount of each letter of credit.
During the nine months ended September 29, 2019, the federal funds rate ranged from 1.83% to 2.45%, the prime rate ranged from 5.00% to 5.50% and the one-month LIBOR ranged from 2.02% to 2.52%.
The weighted average effective interest rate incurred on our borrowings under both our 2019 and 2014 Secured Credit Facilities was 6.6% and 5.7%
for the nine months ended September 29, 2019 and September 30, 2018, respectively, which includes amortization of deferred financing costs related to our Secured Credit Facilities, amortization of our Term Loan Facility original issue discount and commitment and other fees related to our Secured Credit Facilities but excludes the Loss on extinguishment of debt.
Obligations under the both the 2019 and 2014 Secured Credit Facilities are unconditionally guaranteed by Parent on a limited-recourse basis and each of our existing and future direct and indirect material, wholly-owned domestic subsidiaries, subject
to certain exceptions. The obligations are secured by a pledge of our capital stock and substantially all of our assets and those of each subsidiary guarantor, including capital stock of the subsidiary guarantors and 65% of the capital stock of the first- tier foreign subsidiaries that are not subsidiary guarantors, in each case subject to exceptions. Such security interests consist of first priority liens with respect to the collateral.
The 2019 Secured Credit Facilities also contain customary affirmative and negative covenants, and events of default, which limit our ability to, among other things: incur additional debt or issue certain preferred shares; create liens on certain assets; make certain loans or investments (including acquisitions); pay dividends on or make distributions with
respect to our capital stock or make other restricted payments; consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; sell assets; enter into certain transactions with our affiliates; enter into sale-leaseback transactions; change our lines of business; restrict dividends from our subsidiaries or restrict liens; change our fiscal year; and modify the terms of certain debt or organizational agreements. For a period of 18 months months following August 30, 2019, we are prohibited from paying dividends to investment funds managed by Apollo or its affiliates.
Our 2019 Revolving Credit Facility includes a springing financial maintenance covenant that requires our net
first lien senior secured leverage ratio not to exceed 5.25 to 1.00. The covenant will be tested quarterly if the 2019 Revolving Credit Facility is more than 30% drawn (excluding outstanding letters of credit) and will be a condition to drawings under the Revolving Credit Facility that would result in more than 30% drawn thereunder.
Senior Unsecured Debt
Our senior unsecured debt consists of $255.0 million aggregate principal amount borrowings of 8.0% Senior Notes due 2022 (the “Senior Notes”). The Senior Notes bear interest at a rate of 8.0% per year payable
February 15th and August 15th each year and mature on February 15, 2022. We may call some or all of the Senior Notes at 102% on or after February 15, 2019 and at 100% on or after February 15, 2020 as set forth in the indenture governing the Senior Notes (the “indenture”).
We paid $6.4 million in debt issuance costs related to the Senior Notes, which we capitalized in “Bank
indebtedness and other long-term debt, net of deferred financing costs” on our Consolidated Balance Sheets. The deferred financing costs are being amortized over the life of the Senior Notes and are included in “Interest expense” in our Consolidated Statements of Earnings.
Our obligations under the Senior Notes are fully and unconditionally guaranteed, jointly and severally, by our present and future direct and indirect wholly-owned material domestic subsidiaries that guarantee our 2019 Secured Credit Facilities.
The indenture contains restrictive covenants that limit our ability to, among other things: (i) incur additional debt or issue certain preferred shares; (ii) create liens on certain assets;
(iii) make certain loans or investments (including acquisitions); (iv) pay dividends on or make distributions in respect of our capital stock or make other restricted payments; (v) consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; (vi) sell assets; (vii) enter into certain transactions with our affiliates; and (viii) restrict dividends from our subsidiaries.
The weighted average effective interest rate incurred on borrowings under our Senior Notes was 8.2% for both the nine months ended September 29, 2019 and September 30, 2018,
which includes amortization of deferred financing costs and other fees related to our Senior Notes.
Capital Expenditures
We focus our capital expenditures on reinvestment into our existing Company-operated Chuck E. Cheese and Peter Piper Pizza venues through various planned capital initiatives and the development or acquisition of additional Company-
operated venues. During the nine months ended September 29, 2019, we completed
252 game enhancements and 20 major remodels related to the re-imaging effort to update Chuck E. Cheese locations to a new look and feel.
We have funded and expect to continue to fund our capital expenditures through existing cash flows from operations. Capital expenditures in the first nine months of 2019 totaled approximately $61.2 million.
The following table reconciles the approximate total capital spend by initiative to our Consolidated Statements of Cash Flows for the periods presented:
Growth capital spend includes major remodels, including the re-imaging effort to update Chuck E. Cheese venues to a new
look and feel, venue expansions, new venue development, including relocations, and franchise acquisitions.
(2) Maintenance capital spend includes game enhancements, general venue capital expenditures and corporate capital expenditures.
We currently estimate our capital expenditures in 2019 will total approximately $95 million to $105 million, inclusive of maintenance capital, growth capital and IT related capital.
Off-Balance Sheet Arrangements and Contractual Obligations
As of September 29, 2019,
we had no off-balance sheet financing arrangements as described in Regulation S-K Item 303(a)(4)(ii).
For information regarding our contractual obligations, refer to “Off Balance Sheet Arrangements and Contractual Obligations” in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 30, 2018, filed with the SEC on March 12, 2019.
See further discussion of our indebtedness and future debt obligations in “Financial Condition, Liquidity and Capital Resources - Debt Financing” of this report. There have been no other material changes to our contractual obligations
since December 30, 2018.
Critical Accounting Policies and Estimates
Information with respect to our critical accounting policies and estimates, which we believe could have the most significant effect on our reported consolidated results and require difficult, subjective or complex judgment by management are described under “Critical Accounting Policies and Estimates” in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 30, 2018, filed with the SEC on March 12,
2019. Except for the adoption of Accounting Standards Update ASU 2016-12, Leases (Topic 842) and subsequent amendment ASU 2018-11, Leases (Topic 842): Target Improvements, there has been no other material change to the information concerning our critical accounting policies and estimates since December 30, 2018 (see Note 1. “Description of Business and Summary of Significant Accounting Policies” to our Consolidated Financial Statements included in Part I, Item 1. “Financial Statements” of this report).
Recently Issued Accounting Guidance
Refer
to Note 1 “Description of Business and Summary of Significant Accounting Policies” to our Consolidated Financial Statements included in Part I, Item 1. “Financial Statements” of this report for a description of recently issued accounting guidance.
Adjusted EBITDA, a measure used by management to assess operating performance, is defined as Net income (loss) plus interest expense, income tax expense (benefit), depreciation and amortization expense, impairments, gains and losses on asset disposals,
and stock based compensation. In addition, Adjusted EBITDA excludes other items we consider unusual or non-recurring and certain other adjustments required or permitted in calculating covenant compliance under our Secured Credit Facilities and the indenture governing our Senior Notes (see discussion of our Senior Notes in Note 7. “Indebtedness and Interest Expense” to our Consolidated Financial Statements included in Part I, Item 1. “Financial Statements” and above under the heading “Financial Condition, Liquidity and Capital Resources - Debt Financing”).
Adjusted EBITDA is presented because we believe that it provides useful information to investors regarding our operating performance and our capacity to incur and service debt and fund capital expenditures. We believe that Adjusted EBITDA is used by many investors,
analysts and rating agencies as a measure of performance. We also present Adjusted EBITDA because it is substantially similar to Credit Agreement EBITDA, a measure used in calculating financial ratios and other calculations under our debt agreements, except for excluding (i) the annualized full year effect of Company-operated and franchised venues that were opened and closed during the year, (ii) the projected annualized run-rate expected to be achieved from major remodels under development, and (iii) the full-year effect of costs savings resulting from contract negotiations with suppliers, and investments in productivity enhancements or other operational initiatives. By reporting Adjusted EBITDA, we provide a basis for comparison of our business operations between current, past and future periods by excluding items that we do not believe are indicative of our core operating performance.
Our definition of Adjusted EBITDA allows for the exclusion of certain non-cash and other income and expense items that are used in calculating net income (loss) from continuing operations. However, these are items that may recur, vary greatly and can be difficult to predict. They can represent the effect of long-term strategies as opposed to short-term results. In addition, certain of these items can represent the reduction of cash that could be used for other corporate purposes. These measures should not be considered as alternatives to operating income, cash flows from operating activities or any other performance measures derived in accordance with GAAP as measures of operating performance, or cash flows as measures of liquidity. These measures have important limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Because of these
limitations, we rely primarily on our U.S. GAAP results and use Adjusted EBITDA and Adjusted EBITDA Margin, only supplementally.
Represents (i) the removal of the non-cash portion
of rent expense relating to the impact of straight-line rent and the amortization of cash incentives and allowances received from landlords, plus (ii) the actual cash received from landlord incentives and allowances in the period in which it was received.
(5)
Represents the actual cash received for franchise fees received in the period for post-acquisition franchise development agreements, which we do not start recognizing into revenue until the franchise venue is opened.
(6)
Represents revenue related to unearned
franchise fees that were removed in purchase accounting, and therefore were not recorded as revenue.
(7)
Relates to start-up and marketing costs incurred prior to the opening of new Company-operated venues and generally consists of payroll, recruiting, training, supplies and rent incurred prior to venue opening.
(8)
Represents non-recurring income and expenses primarily related to (i) legal fees, claims and settlements related to litigation in respect of the Merger; (ii) severance expense and executive termination
benefits; (iii) legal claims and settlements related to employee class action lawsuits and settlements; (iv) one-time loss on extinguishment of debt related to the refinancing of our 2014 Secured Credit Facilities; (v) professional and legal fees incurred in connection with our 2019 Secured Credit Facilities; (vi) sales and use taxes relating to prior periods; (vii) professional fees incurred in connection with one-time strategic corporate and tax initiatives, such as accounting and consulting fees related to the acquisition of Peter Piper Pizza (such as transfer pricing and cost segregation); (viii) legal fees incurred in connection with certain potential transactions the Company did not pursue; (ix) removing current period property losses and insurance recoveries relating to prior period business interruption losses at certain venues, primarily relating to disaster recoveries, such
as natural disasters, fires, floods and property damage; (x) one-time costs related to the early termination of a supplier contract in connection with the transition to a new supplier; (xi) one-time marketing expenses related to the grand openings of our re-imaged Chuck E. Cheese venues; and (xii) one-time training and travel-related costs incurred in connection with training venue employees in connection with the implementation of our PlayPass initiative and the re-imaging effort of the venues in our Chuck E. Cheese portfolio.
This report contains forward-looking statements, which involve risks and uncertainties. These forward-looking statements are generally identified by the use of forward-looking terminology, including the terms “anticipate,”“believe,”“could,”“estimate,”“expect,”“intent,”“may,”“plan,”“predict,”“potential,”“project,”“should,”“target,”“will,”“would” and, in each case, their negative or other various or comparable terminology. All statements other than statements of historical facts contained in this report, including statements regarding our strategy, future operations, future financial position, future revenue, projected costs, prospects, plans, objections of management and
expected market growth 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 Part I, Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 30, 2018, filed with the SEC on March 12, 2019. 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. There are a number of important factors that could cause actual results or events to differ materially from those indicated by such forward-looking statements,
including, but are not limited to:
•
our strategy, outlook and growth prospects;
•
our operational and financial targets and dividend policy;
•
our planned expansion of the venue base and the implementation of the new design in our existing venues;
•
general
economic trends and trends in the industry and markets; and
•
the competitive environment in which we operate.
These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Important factors that could cause our results to vary from expectations include, but are not limited to:
•
negative
publicity and changes in consumer preferences;
•
our ability to successfully expand and update our current venue base;
•
our ability to successfully implement our marketing strategy;
•
our ability to compete effectively in an environment of intense competition;
•
our
ability to weather economic uncertainty and changes in discretionary spending;
•
increases in food, labor and other operating costs;
•
the impact of labor scheduling legislation;
•
our ability to successfully open international franchises and to operate under the United States and foreign anti-corruption
laws that govern those international ventures;
•
risks related to our substantial indebtedness;
•
failure of our information technology systems to support our current and growing business;
•
disruptions to our commodity distribution system;
•
our
dependence on third-party vendors to provide us with sufficient quantities of new entertainment-related equipment, prizes and merchandise at acceptable prices;
•
risks from product liability claims and product recalls;
•
the impact of governmental laws and regulations and the outcomes of legal proceedings;
•
potential
liability under certain state property laws;
•
fluctuations in our financial results due to new venue openings;
•
local conditions, natural disasters, terrorist attacks and other events and public health issues;
•
the seasonality of our business;
•
inadequate
insurance coverage;
•
labor shortages and immigration reform;
•
loss of certain personnel;
•
our ability to protect our trademarks or other proprietary rights;
•
our
ability to pay our fixed rental payments;
•
impairment charges for goodwill, indefinite-lived intangible assets or other long-lived assets;
•
our ability to successfully integrate the operations of companies we acquire;
our
failure to maintain adequate internal controls over our financial and management systems; and
•
other risks, uncertainties and factors set forth in Part I, Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 30, 2018, filed with the SEC on March 12, 2019.
The forward-looking statements made in this report reflect our views with respect to future events as of the date of this report and are based on assumptions and subject to risks and uncertainties.
Given these uncertainties, undue reliance should not be placed on these forward-looking statements. These forward-looking statements represent our estimates and assumptions only as of the date of this report and, except as required by law, we undertake no obligation to update or review publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this report. We anticipate that subsequent events and developments will cause our views to change. This report should be read completely and with the understanding that our actual future results may be materially different from what we expect. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments we may undertake. We qualify all of our forward-looking statements by these cautionary statements.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to various types of market risk in the normal course of business, including the impact of interest rates, commodity price changes and foreign currency fluctuation.
Interest Rate Risk
We are exposed to market risk from changes in the variable interest rates related to borrowings from our 2019 Secured Credit Facilities. All of our borrowings outstanding under the 2019 Secured Credit Facilities, $760 million as of September 29, 2019, accrue interest at variable rates. Assuming the 2019 Revolving Credit Facility remains undrawn, each 1% change
in assumed interest rates, excluding the impact of our 1% interest rate floor, would result in a $7.6 million change in annual interest expense on indebtedness under the 2019 Secured Credit Facilities.
Commodity Price Risk
We are exposed to commodity price changes related to certain food products that we purchase, primarily related to the prices of cheese and dough, which can vary throughout the year due to changes in supply, demand, and other factors. We have not entered into any hedging arrangements to reduce our exposure to commodity price volatility associated with such commodity prices; however, we typically enter into short-term purchasing contracts, which may contain pricing arrangements designed to minimize the impact of commodity price
fluctuations, and derivative instruments such as futures contracts to mitigate our exposure to commodity price fluctuations.
For the three months ended September 29, 2019 and September 30, 2018, the average cost of a block of cheese was $1.94 and $1.77, respectively. The estimated increase in our food costs from a hypothetical 10% increase in the average cost of a block of cheese would have been $0.2 million and $0.3 million
for the three months ended September 29, 2019 and September 30, 2018, respectively. For the nine months ended September 29, 2019 and September 30, 2018, the average cost of a block of cheese was $1.78 and $1.72, respectively. The estimated increase in our food costs from a hypothetical 10% increase in the average cost of a block of cheese would have been $0.7 million
and $0.8 million for the nine months ended September 29, 2019 and September 30, 2018, respectively.
For the three and nine months ended September 29, 2019 and September 30, 2018, the average cost of dough per pound was $0.47. The estimated increase in our food costs from a hypothetical 10% increase in the average cost of dough per pound would have been $0.1
million for both the three months ended September 29, 2019 and September 30, 2018. The estimated increase in our food costs from a hypothetical 10% increase in the average cost of dough per pound would have been $0.3 million and $0.4 million for the nine months ended September 29, 2019 and September 30, 2018, respectively.
Foreign Currency Risk
We
are exposed to foreign currency fluctuation risk associated with changes in the value of the Canadian dollar relative to the U.S. dollar as we operate a total of 10 Company-operated venues in Canada. For the three and nine months ended September 29, 2019, our Canadian venues generated operating income of less than $0.1 million and $0.7 million, respectively, compared to our consolidated operating income of $3.8 million and $61.3 million, respectively.
Changes in the
currency exchange rate result in cumulative translation adjustments and are included in “Accumulated other comprehensive income (loss)” on our Consolidated Balance Sheets and potentially result in transaction gains or losses, which are included in our earnings. The low and high currency exchange rates for a Canadian dollar into a United States dollar for the three and nine months ended September 29, 2019 were $0.750. $0.767, $0.733 and $0.767, respectively. A hypothetical 10% devaluation in the average quoted U.S. dollar-equivalent of the Canadian dollar exchange rate during the three and nine months ended September 29,
2019 would have decreased our reported consolidated operating results by $0.1 million for both the three and nine months ended September 29, 2019.
53
ITEM 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures under the supervision and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, as of the end of the period covered by this report. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, has concluded that our disclosure controls and procedures were effective as of September 29, 2019 to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended, was (a) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms; and (b) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
During
the quarterly period covered by this report there has been no change in our internal processes over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Refer to Note 15 “Commitments
and Contingencies” to our Consolidated Financial Statements included in Part I, Item 1. “Financial Statements” of this report for a discussion of our legal proceedings.
ITEM 1A. Risk Factors.
We believe there have been no material changes in our risk factors from those disclosed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 30, 2018, filed with the SEC on March 12, 2019.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
