QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-13687
____________________________________
CEC ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
____________________________________
Kansas
(State or other jurisdiction of
incorporation or organization)
48-0905805
(IRS Employer
Identification No.)
1707 Market Place Blvd
Irving, Texas
75063
(Address of principal executive offices)
(Zip Code)
(972) 258-8507
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
____________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes 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 31, 2018, an aggregate of 200 shares of the registrant’s common stock, par value $0.01 per share were outstanding.
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’s and Peter Piper Pizza family dining and entertainment venues in 47 states and 14 foreign countries and territories. Our venues provide our guests with a variety of family entertainment and dining alternatives. 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’s 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 $1.8 million and $1.7 million for the nine months ended September 30, 2018 and October 1, 2017, respectively. Our contributions to the Association Funds are eliminated in consolidation. On January 1, 2018 we adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (ASC Topic 606). As a result of the adoption of ASU 2016-15, Statement of Cash Flows (Topic 230) and ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, on January 1, 2018, certain reclassifications have been made in our Consolidated Statements of Cash Flows to conform with the current period presentation.
For further details regarding the impact of these new accounting standards on our Consolidated financial statements see “Recently Issued Accounting Guidance” - “Accounting Guidance Adopted” - below.
We reclassified $1.8 million and $5.6 million, respectively, of depreciation and amortization for the three and nine months ended October 1, 2017 which was previously included in “General and administrative expenses” and we reclassified “Depreciation and amortization” of $25.3 million and $77.5 million, respectively, for the three and nine months ended October 1, 2017 from “Company venue operating costs” to a single classification as “Depreciation and amortization” now shown in “Other costs and expenses” in our Consolidated Statements of Earnings, to conform to the current period’s presentation.
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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Interim Financial Statements
The accompanying Consolidated Financial Statements as of and for the three and nine months ended September 30, 2018 and October 1, 2017 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 31, 2017, filed with the SEC on March 28, 2018.
Recently Issued Accounting Guidance
Accounting Guidance Adopted:
Effective January 1, 2018, we adopted the following Accounting Standards Updates:
(i) ASU 2016-04, Liabilities—Extinguishments of Liabilities (Subtopic 405-20). This amendment provides a narrow scope exception to Liabilities—Extinguishment of Liabilities (Subtopic 405-20) that requires breakage for those liabilities to be accounted for in accordance with the breakage guidance in ASU 2014-09 Revenue From Contracts With Customers (Topic 606). Under the new guidance, if an entity expects to be entitled to a breakage amount for a liability resulting from the sale of a prepaid stored-value product, the entity shall derecognize the amount related to the expected breakage in proportion to the pattern of rights expected to be exercised by the product holder only to the extent that it is probable that a significant reversal of the recognized breakage amount will not subsequently occur. If an entity does not expect to be entitled to a breakage amount for a prepaid stored-value product, the entity shall derecognize the amount related to the breakage when the likelihood of the product holder exercising its remaining rights becomes remote. The adoption of this amendment did not have a significant impact on our Consolidated Financial Statements.
(ii) ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing (“ASU 2016-10”). This amendment updates the revenue guidance on identifying performance obligations and accounting for licenses of intellectual property, changing the FASB's previous proposals on right-of-use licenses and contractual restrictions. We elected the modified retrospective method to apply this standard. Under the modified retrospective method, results for reporting periods beginning on or after January 1, 2018 are presented under the revenue guidance in this amendment, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting treatment. The cumulative impact of adopting this amendment was not material, and as such we did not record an adjustment to our opening accumulated deficit in our Consolidated Balance Sheet as of January 1, 2018. For further details, see Note 2. “Revenue.”
(iii) ASU 2016-15, Statement of Cash Flows (Topic 230) and ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash on a retrospective basis. Amounts generally described as restricted cash and restricted cash equivalents are now presented with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. Accordingly, as a result of the adoption of these amendments, we reclassified $0.1 million of restricted cash into cash, cash equivalents and restricted cash as of October 1, 2017 for a total balance of $79.6 million, which resulted in a reduction in net cash provided by operating activities of less than $0.1 million in the Consolidated Statement of Cash Flows for the nine months ended October 1, 2017. The adoption of these amendments did not impact net cash used in investing or financing activities for the six months ended October 1, 2017.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The adoption of these amendments also requires us to reconcile our cash balance on our Consolidated Statements of Cash Flows to the cash balance on our Consolidated Balance Sheets, as well as make disclosures about the nature of restricted cash balances. A reconciliation of “Cash and cash equivalents” and “Restricted cash” as presented in our Consolidated Balance Sheets for the periods presented and “Cash, cash equivalents and restricted cash” as presented in our Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and October 1, 2017 is as follows:
September 30, 2018
December 31, 2017
October 1, 2017
January 1, 2017
(in thousands)
Cash and cash equivalents
$
84,429
$
67,200
$
79,427
$
61,023
Restricted cash
23
112
219
268
Cash, cash equivalents and restricted cash
$
84,452
$
67,312
$
79,646
$
61,291
__________________
(1)
Restricted cash represents cash balances held by the Association that are restricted for use in our advertising, entertainment and media programs (see Note 1 “Description of Business and Summary of Significant Accounting Policies” for further discussion of the Association Funds).
(iv) ASU 2017-04, Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment on a prospective basis. This amendment eliminates Step 2 from the goodwill impairment test, which measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. We early adopted this amendment on January 1, 2018. The adoption of this amendment did not have a significant impact on our Consolidated Financial Statements.
Accounting Guidance Not Yet Adopted:
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) and subsequent amendment ASU 2018-11, Leases (Topic 842): Target Improvements. This new standard introduces a new lease model that requires the recognition of lease assets and lease liabilities on the balance sheet and the disclosure of key information about leasing arrangements. While this new standard retains most of the principles of the existing lessor model under U.S. GAAP, it aligns many of those principles with Accounting Standards Codification (“ASC”) 606: Revenue from Contracts with Customers. ASU 2018-11 allows entities
to change their date of initial application to the beginning of the period of adoption. The new guidance will be effective for us beginning December 31, 2018. We are currently evaluating the impact of the adoption of this guidance on our Consolidated Financial Statements, but we expect this will have a material effect on our balance sheet since the Company has a significant amount of operating and capital lease arrangements.
In February 2018, the FASB issued ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This standard provides companies with an option to reclassify stranded tax effects resulting from enactment of the Tax Cuts and Jobs Act ("TCJA") from accumulated other comprehensive income to retained earnings. This ASU will be effective for us for annual and interim periods beginning on December 31, 2019. Early adoption of this standard is permitted and may be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the tax rate as a result of TCJA is recognized. We do not expect the adoption of this ASU to have a material impact on our results of operations, financial position and cash flows.
In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Target Improvements. This standard allows entities to change their date of initial application to the beginning of the period of adoption. Additionally, this update amends ASC 842 to include a practical expedient under which lessors are not required to separate lease and nonlease components. The new guidance will be effective for us beginning December 31, 2018. We are currently evaluating the impact of the adoption of this guidance on our Consolidated Financial Statements, but we expect this will have a material effect on our balance sheet since the Company has a significant amount of operating and capital lease arrangements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This standard will require entities to disclose the amount of total gains or losses for the period recognized in other comprehensive income that is attributable to fair value changes in assets and liabilities held as of the balance sheet date and categorized within Level 3 of the fair value hierarchy. This ASU will be effective for us for annual and interim periods beginning on December 31, 2020. Early adoption of this standard is permitted.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
We do not expect the adoption of this ASU to have a material impact on our results of operations, financial position and cash flows.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract . Under this standard customers will apply the same criteria for capitalizing implementation costs as they would for an arrangement that has a software license. The adoption of this new guidance prescribes the balance sheet, income statement, and cash flow classification of the capitalized implementation costs and related amortization expense, and additional quantitative and qualitative disclosures. This ASU will be effective for us for annual and interim periods beginning on December 30, 2020. Early adoption of this standard is permitted and may be applied either prospectively to eligible costs incurred on or after the date of the new guidance or retrospectively. We do not expect the adoption of this ASU to have a material impact on our results of operations, financial position and cash flows.
2. Revenue:
Food, beverage and merchandise revenues from company-operated venues are recognized when sold. A portion of our entertainment revenue includes customer purchases of game play credits on Play Pass game cards. We recognize a liability for the estimated amount of unused game play credits which we believe our customers will utilize in the future, based on credits remaining on Play Pass cards and utilization patterns.
We sell gift cards to our customers in our venues and through certain third-party distributors, which do not expire and do not incur a service fee on unused balances. Gift card sales are recorded as deferred revenue when sold and are recognized as revenue when: (a) the gift card is redeemed by the guest or (b) the likelihood of the gift card being redeemed by the guest is remote (“gift card breakage”) and we determine that we do not have a legal obligation to remit the value of the unredeemed gift
card under applicable state unclaimed property escheat statutes. Gift card breakage is determined based upon historical redemption patterns of our gift cards.
On January 1, 2018 we adopted the revenue guidance set forth in ASU 2016-10. Under the new guidance, there is a five-step model to apply to revenue recognition. The five-steps consist of: (i) the determination of whether a contract, an agreement between two or more parties that creates legally enforceable rights and obligations, exists; (ii) the identification of the performance obligations in the contract; (iii) the determination of the transaction price; (iv) the allocation of the transaction price to the performance obligations in the contract; and (v) recognition of revenue when (or as) the performance obligation is satisfied.
ASU 2016-10 requires us to recognize initial and renewal franchise and development fees on a straight-line basis over the life of the related franchise agreement or the renewal period. Historically, we recognized revenue from initial franchise and development fees upon the opening of a franchised restaurant when we completed all of our material obligations and initial services. Additionally, our national advertising fund receipts from Association members are now accounted for on a gross basis as “Franchise fees and royalties,” when historically they were netted against “Advertising expense.” Revenue related to advertising contributions from our franchisees was $0.8 million and $2.6 million in the three and nine months ended September 30, 2018, respectively, and is recorded in “Franchise fees and royalties” in our Consolidated Statement of Earnings.
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 30, 2018:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
3. Property and Equipment
Asset Impairments
During the three and nine months ended September 30, 2018 we recognized impairment charges of $5.3 million and $6.9 million, primarily related to eight and nine venues, respectively. During the three and nine months ended October 1, 2017, we recognized asset impairment charges of $1.8 million primarily related to five venues. 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 30, 2018, the aggregate carrying value of the property and equipment at impaired venues, after the impairment charge, was $5.1 million for venues impaired in 2018.
4. Intangible Assets, Net:
The following table presents our indefinite and definite-lived intangible assets at September 30, 2018:
Weighted Average Life (Years)
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
(in thousands)
Chuck E. Cheese's tradename
Indefinite
$
400,000
$
400,000
Peter Piper Pizza tradename
Indefinite
26,700
26,700
Favorable lease agreements (1)
10
14,880
(8,274
)
6,606
Franchise agreements
25
53,300
(8,734
)
44,566
$
494,880
$
(17,008
)
$
477,872
__________________
(1)
In connection with the Merger, as defined in Note 12 “Consolidating Guarantor Financial Information”, and the acquisition of Peter Piper Pizza in October 2014, we also recorded unfavorable lease liabilities of $10.2 million and $3.9 million, respectively, which are included in “Other current liabilities” and “Other noncurrent liabilities” in our Consolidated Balance Sheets. Such amounts are being amortized over a weighted average life of 10 years, and are included in “Rent expense” in our Consolidated Statements of Earnings.
Amortization expense related to favorable lease agreements was $0.3 million and $0.4 million for the three months ended September 30, 2018 and October 1, 2017, respectively, and $1.0 million and $1.3 million for the nine months ended September 30, 2018 and October 1, 2017, respectively, and is included in “Rent expense” in our Consolidated Statements of Earnings. Amortization expense related to franchise agreements was $0.5 million for both the three months ended September 30, 2018 and October 1, 2017, respectively, and $1.5 million for both the nine months ended September 30, 2018 and October 1, 2017, respectively, and is included in “Depreciation and amortization” in our Consolidated Statements of Earnings.
5. Accounts Payable:
Accounts payable consisted of the following as of the dates presented:
September 30, 2018
December 31, 2017
(in thousands)
Trade and other amounts payable
$
25,476
$
20,492
Book overdraft
10,664
10,882
Accounts payable
$
36,140
$
31,374
The book overdraft balance represents checks issued but not yet presented to banks.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
6. Indebtedness and Interest Expense:
Our long-term debt consisted of the following as of the dates presented:
September 30, 2018
December 31, 2017
(in thousands)
Term loan facility
$
725,800
$
731,500
Senior notes
255,000
255,000
Total debt outstanding
980,800
986,500
Less:
Unamortized original issue discount
(1,288
)
(1,694
)
Deferred financing costs, net
(9,510
)
(11,993
)
Current portion of term loan facility
(7,600
)
(7,600
)
Bank indebtedness and other long-term debt, net of deferred financing costs, less current portion
$
962,402
$
965,213
Secured Credit Facilities
Our secured credit facilities include (i) a $760.0 million term loan facility with a maturity date of February 14, 2021 (the “term loan facility”) and (ii) a $150.0 million senior secured revolving credit facility with an original maturity date of February 14, 2019, which includes a letter of credit sub-facility and a $30.0 million swingline loan sub-facility (the “revolving credit facility” and together with the term loan facility, the “secured credit facilities”). The term loan facility requires scheduled quarterly payments equal to 0.25% of the original principal amount from July 2014 to December 2020, with the remaining balance paid at maturity, February 14, 2021. We had no borrowings outstanding and $9.0 million and $9.9 million, respectively of issued but undrawn letters of credit under the revolving credit facility as of September 30, 2018 and December 31, 2017, respectively.
On May 8, 2018 we entered into an incremental assumption agreement with certain of our revolving credit facility lenders to extend the maturity on $95.0 million of the revolving credit facility through November 16, 2020. In connection with the extension of the maturity date, we agreed to the following covenants for the benefit of the revolving credit facility lenders: (a) with respect to each fiscal year (commencing with the fiscal year ending December 30, 2018), to the extent we have excess cash flow (as defined in the secured credit facilities agreement), we are required to make a mandatory prepayment of term loan principal equal to at least 75% (subject to step-downs based on our net first lien senior secured leverage ratio) of the amount of excess cash flow that exceeds $10 million less any optional prepayments of principal that may have occurred during the fiscal year and (b) we shall not incur additional first lien debt in connection with certain acquisitions, mergers or consolidations unless our net first lien senior secured leverage ratio is not greater than 3.65 to 1.00 on a pro forma basis. The maturity date of the amount of the revolving credit facility that was not extended remains February 14, 2019.
The term loan was issued net of $3.8 million of original issue discount. We also paid $17.8 million and $3.8 million in debt financing costs related to the term loan facility and revolving credit facility (inclusive of costs incurred in connection with the May 8, 2018 incremental assumption agreement), respectively. All debt financing costs were capitalized in “Bank indebtedness and other long-term debt, net of deferred financing costs” on our Consolidated Balance Sheets. The original issue discount and deferred financing costs related to the term loan facility are amortized over the life of the term loan facility, and the deferred financing costs related to the revolving credit facility are being amortized through November 16, 2020, and are included in “Interest expense” on our Consolidated Statements of Earnings.
Borrowings under the secured credit facilities bear interest at a rate equal to, at our option, either (a) a London Interbank Offered Rate (“LIBOR”) determined by reference to the costs of funds for Eurodollar deposits for the interest period relevant to such borrowings, adjusted for certain additional costs, subject to a 1.00% floor in the case of term loans or (b) a base rate determined by reference to the highest of (i) the federal funds effective rate plus 0.50%; (ii) the prime rate of Deutsche Bank AG New York Branch; and (iii) the one-month adjusted LIBOR plus 1.00%, in each case plus an applicable margin. The base applicable margin is 3.25% with respect to LIBOR borrowings and 2.25% with respect to base rate borrowings under the
term loan facility and base rate borrowings and swingline borrowings under the revolving credit facility. The applicable margin
for LIBOR borrowings under the term loan facility is subject to one step-down from 3.25% to 3.00% based on our net first lien senior secured leverage ratio and the applicable margin for LIBOR borrowings under the revolving credit facility is subject to two step-downs from 3.25% to 3.00% and 2.75% based on our net first lien senior secured leverage ratio. During the nine
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
months ended September 30, 2018, the applicable margin for LIBOR borrowings under both the term loan facility and the revolving credit facility was 3.25%.
In addition to paying interest on outstanding principal under the secured credit facilities, we are required to pay a commitment fee to the lenders under the revolving credit facility with respect to the unutilized commitments thereunder. The base applicable commitment fee rate under the revolving credit facility is 0.50% per annum and is subject to one step-down from 0.50% to 0.375% based on our net first lien senior secured leverage ratio. During the nine months ended September 30, 2018 the commitment fee rate was 0.50%. We are 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 such letter of credit.
During the nine months ended September 30, 2018, the federal funds rate ranged from 1.34% to 2.18%, the prime rate ranged from 4.50% to 5.25% and the one-month LIBOR ranged from 1.55% to 2.26%.
The weighted average effective interest rate incurred on our borrowings under our secured credit facilities was 5.7% and 4.7% for the nine months ended September 30, 2018 and October 1, 2017, 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.
Obligations under the secured credit facilities are unconditionally guaranteed by Queso Holdings Inc. (“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 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.
Our revolving credit facility includes a springing financial maintenance covenant that requires our net first lien senior secured leverage ratio not to exceed 6.25 to 1.00 (the ratio of consolidated net debt secured by first-priority liens on the collateral to the last twelve months’ EBITDA, as defined in the senior credit facilities). The covenant will be tested quarterly if the 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 redeem some or all of the senior notes at certain redemption prices 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 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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The weighted average effective interest rate incurred on borrowings under our senior notes was 8.2% for both the nine months ended September 30, 2018 and October 1, 2017, which included amortization of deferred financing costs and other fees related to our senior notes.
Interest Expense
Interest expense consisted of the following for the periods presented:
Three Months Ended
September 30, 2018
October 1, 2017
(in thousands)
Term loan facility (1)
$
9,946
$
8,014
Senior notes
5,083
5,083
Capital lease obligations
394
434
Sale leaseback obligations
2,628
2,647
Amortization of deferred financing costs
923
1,001
Other
95
272
Total interest expense
$
19,069
$
17,451
Nine Months Ended
September 30, 2018
October 1, 2017
(in thousands)
Term loan facility (1)
$
28,747
$
23,240
Senior notes
15,248
15,248
Capital lease obligations
1,253
1,264
Sale leaseback obligations
7,880
7,949
Amortization of deferred financing costs
2,878
3,004
Other
734
869
Total interest expense
$
56,740
$
51,574
__________________
(1) Includes amortization of original issue discount.
The weighted average effective interest rate incurred on our borrowings under our 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 6.3% for the nine months ended September 30, 2018 and 5.6% for the nine months ended October 1, 2017, respectively.
We were in compliance with the debt covenants in effect as of September 30, 2018 for both the secured credit facilities and the senior notes.
7. 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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The following table presents information on our financial instruments as of the periods presented:
September 30, 2018
December 31, 2017
Carrying Amount (1)
Estimated Fair Value
Carrying Amount (1)
Estimated Fair Value
(in thousands)
Financial Liabilities:
Bank indebtedness and other long-term debt:
Current portion
$
7,600
$
7,366
$
7,600
$
7,220
Long-term portion (2)
971,912
930,715
977,206
937,662
Bank indebtedness and other long-term debt:
$
979,512
$
938,081
$
984,806
$
944,882
_________________
(1) Excluding net deferred financing costs.
(2) Net of original issue discount.
Our financial instruments consist of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, our 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 our secured credit facilities, term loan facility and senior notes was determined by using the respective average of the ask and bid price of our outstanding borrowings under our term loan facility and the senior notes 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, 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 30, 2018 and October 1, 2017, there were no significant transfers among Level 1, 2 or 3 fair value determinations.
8. Other Noncurrent Liabilities:
Other noncurrent liabilities consisted of the following as of the dates presented:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
9. Income Taxes:
Our income tax expense consists of the following for the periods presented:
Three Months Ended
September 30, 2018
October 1, 2017
(in thousands)
Federal and state income taxes
$
(2,451
)
$
(5,533
)
Foreign income taxes (1)
238
312
Income tax benefit
$
(2,213
)
$
(5,221
)
Nine Months Ended
September 30, 2018
October 1, 2017
(in thousands)
Federal and state income taxes
$
(1,167
)
$
1,145
Foreign income taxes (1)
713
695
Income tax expense (benefit)
$
(454
)
$
1,840
_________________
(1) Including foreign taxes withheld.
Our effective income tax rates for the three and nine months ended September 30, 2018 were 18.9% and 6.8%, respectively, as compared to 32.0% and 90.2%, respectively, for the three and nine months ended October 1, 2017. Our effective income tax rate for the three and nine months ended September 30, 2018 was impacted by the reduction in the U.S. federal statutory corporate income tax rate from 35% to 21% resulting from the Tax Cuts and Jobs Act (TCJA) signed into law on December 22, 2017, return-to-provision adjustments including those related to the true up of provisional estimates provided in 2017 to account for the impact of the TCJA pursuant to SAB118, and the impact of employment-related federal income tax credits, offset by the negative impact of nondeductible litigation costs related to the Merger, nondeductible penalties, a net increase in our liability for uncertain tax positions, and state and foreign taxes. Our effective income tax rate for the nine months ended September 30, 2018 was further impacted by the unfavorable results of state tax legislation enacted during the second quarter that increased the amount of income subject to state taxation and a one-time adjustment to deferred taxes (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 previously loaned to our Canadian subsidiary recorded in the first quarter. Our effective income tax rates for the three and nine months ended October 1, 2017 differed from the statutory rate primarily due to state income taxes and the favorable impact of employment-related federal income tax credits.
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed to complete the accounting for certain income tax effects of the TCJA. Pursuant to SAB118, we included provisional estimates for the impact of the TJCA in our consolidated financial statements for the fiscal year ended December 31, 2017, noting that actual results may differ from the provisional estimates, due to, among other things, changes in our interpretations and assumptions relating to the changes made by the TCJA and additional guidance that is anticipated to be issued by the U.S. Treasury and Internal Revenue Service regarding (i) the newly enacted increase in bonus depreciation for qualifying assets acquired and placed in service after September 27, 2017, (ii) the expansion of the limitation under Section 162(m) relating to the deductibility of executive compensation in excess of $1.0 million, and (iii) the one-time transition tax, net of foreign tax credits and operating losses, on earnings of foreign subsidiaries that were previously deferred from U.S. tax. SAB118 further states that any adjustments made to the provisional amounts under SAB 118 should be recorded as discrete adjustments in the period identified and not to extend beyond the one-year measurement provided in SAB 118. During the nine months ended September 30, 2018, we recognized a $0.5 million return-to-provision adjustment discrete tax benefit relating to the provisional estimates required to account for TCJA that normally would not have impacted our effective tax rate (deductions in 2017’s tax return at 35% with the offset to deferred taxes at 21%). The final adjustments to the provisional estimates will be completed in the fourth quarter of 2018.
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
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
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 $4.6 million as of September 30, 2018 and $3.9 million as of December 31, 2017 and if recognized would decrease our provision for income taxes by $3.3 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 $3.9 million within the next twelve months.
Total accrued interest and penalties related to unrecognized tax benefits as of September 30, 2018 and December 31, 2017 was $1.1 million and $1.0 million, respectively. On the Consolidated Balance Sheets, we include current interest related to unrecognized tax benefits in “Accrued interest,” current penalties in “Accrued expenses” and noncurrent accrued interest and penalties in “Other noncurrent liabilities.”
10. Stock-Based Compensation Arrangements:
The 2014 Equity Incentive Plan provides Parent authority to grant equity incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, stock bonus awards or performance compensation awards to certain directors, officers or employees of the Company. A summary of the options outstanding under the equity incentive plan as of September 30, 2018 and the activity for the nine months ended September 30, 2018 is presented below:
Stock Options
Weighted Average Exercise Price (1)
Weighted Average Remaining Contractual Term
Aggregate Intrinsic Value
($ per share)
($ in thousands)
Outstanding stock options, December 31, 2017
2,349,288
$9.00
Options Granted
112,769
$13.73
Options Exercised
(7,745
)
$9.96
Options Forfeited
(421,614
)
$10.47
Outstanding stock options, September 30, 2018
2,032,698
$8.93
5.8
$
—
Stock options expected to vest, September 30, 2018
1,386,999
$9.12
5.9
$
—
Exercisable stock options, September 30, 2018
491,588
$8.32
5.5
$
—
__________________
(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 30, 2018, we had $0.7 million of total unrecognized share-based compensation expense related to unvested options, which is expected to be amortized over the remaining weighted-average period of 2.9 years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
The following table summarizes stock-based compensation expense and the associated tax benefit recognized in the Consolidated Financial Statements for the periods presented:
Three Months Ended
September 30, 2018
October 1, 2017
(in thousands)
Stock-based compensation costs
$
(55
)
$
187
Portion capitalized as property and equipment (1)
(3
)
(3
)
Stock-based compensation expense recognized
$
(58
)
$
184
Nine Months Ended
September 30, 2018
October 1, 2017
(in thousands)
Stock-based compensation costs
$
178
$
531
Portion capitalized as property and equipment (1)
(9
)
(11
)
Stock-based compensation expense recognized
$
169
$
520
__________________
(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.
11. Stockholder’s Equity:
The following table summarizes the changes in stockholder’s equity during the nine months ended September 30, 2018:
On February 14, 2014, CEC Entertainment, Inc. (the “Issuer”) merged with and into an entity controlled by Apollo Global Management, LLC 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: