Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark 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 x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant 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
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Accelerated filer
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Non-accelerated filer
x
Smaller reporting company
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Emerging growth company
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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 Act). Yes ¨ No x
As of July 1, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, no voting or non-voting common equity of the registrant was held by non-affiliates.
As of February 25, 2019, an aggregate of 200 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.
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,” “intend,” “may,” “plan, “potential,” “predict,” “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, objectives of management and expected market growth are forward-looking statements. The forward-looking statements are contained principally in Part I, Item 1. “Business”, Part 1, Item 1A. “Risk Factors” and Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K and include, among other things, statements relating to:
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our strategy, outlook and growth prospects;
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our operational and financial targets and dividend policy;
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our planned expansion of the venue base and the implementation of the new design in our existing venues;
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general economic trends and trends in the industry and markets; and
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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:
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negative publicity and changes in consumer preference;
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our ability to successfully expand and update our current venue base;
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our ability to successfully implement our marketing strategy;
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our ability to compete effectively in an environment of intense competition;
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our ability to weather economic uncertainty and changes in consumer discretionary spending;
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increases in food, labor and other operating costs;
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our ability to successfully open international franchises and to operate under the United States and foreign anti-corruption laws that govern those international ventures;
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risks related to our substantial indebtedness;
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failure of our information technology systems to support our current and growing businesses;
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disruptions to our commodity distribution system;
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our dependence on third-party vendors to provide us with sufficient quantities of new entertainment-related equipment, prizes and merchandise at acceptable prices;
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risks from product liability claims and product recalls;
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the impact of governmental laws and regulations and the outcomes of legal proceedings;
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potential liability under certain state property laws;
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fluctuations in our financial results due to new venue openings;
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local conditions, natural disasters, terrorist attacks and other events and public health issues;
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the seasonality of our business;
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inadequate insurance coverage;
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labor shortages and immigration reform;
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loss of certain personnel;
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our ability to adequately protect our trademarks or other proprietary rights;
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our ability to pay our fixed rental payments;
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our ability to successfully integrate the operations of companies we acquire;
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impairment charges for goodwill, indefinite-lived intangible assets or other long-lived assets;
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our failure to maintain adequate internal controls over our financial and management systems; and
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other risks, uncertainties and factors set forth in Part I, Item 1A. “Risk Factors.”
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.
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PART I
ITEM 1. Business.
Company Overview
We believe we are a leading family entertainment and dining company, focused on providing an exciting, fun-filled play and food experience for children and parents alike. We develop, operate and franchise family dining and entertainment centers (also referred to as “venues”) under the names “Chuck E. Cheese’s” (“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 and 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 our guests 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 sophisticated options for adults. We offer families a highly compelling value proposition, where a family of four, for as little as $9 per person, can dine at Chuck E. Cheese's for food, drinks and entertainment, which we believe to be significantly lower than comparable offerings at both casual dining and entertainment alternatives. We believe the combination of wholesome entertainment, family dining and a strong value proposition creates a highly differentiated experience, which appeals to our diverse customer base. We operate 554 venues and have 196 venues operating under franchise arrangements across 47 states and 14 foreign countries and territories as of December 30, 2018.
In Fiscal 2018, we generated $896.1 million in revenue, $20.5 million of net loss and $175.2 million in Adjusted EBITDA. See Item 6. “Selected Financial Data - Non-GAAP Financial Measures” for additional information about Adjusted EBITDA, a reconciliation of net income to Adjusted EBITDA and the calculation of Adjusted EBITDA Margin.
We have developed iconic brands and a highly loyal customer base through our more than 40-year commitment to being a family-fun and entertainment company. Over the last few years, we have invested in revitalizing our guest experience, revamping our menu offering, modifying our marketing message, and reinvigorating our corporate culture. We have made corresponding investments in technology, staff training, and our physical assets. We believe these significant investments position our Company for sustained growth in the future.
Our Brands
Chuck E. Cheese's: Where A Kid Can Be A Kid. Chuck E. Cheese's was founded in 1977 and is a highly recognized brand that uniquely appeals to our primary customer base of families with children between 2 and 12 years of age. Chuck E. Cheese, our iconic, energetic mouse mascot, performs music and entertainment shows along with his friends, providing free entertainment to our guests and driving strong brand recognition. Chuck E. Cheese's venues feature an open and bright setting, which creates an inviting atmosphere for kids and a good line of sight for parents. Showrooms include approximately 75 games, rides and attractions for kids of all ages, including classic skill games, such as arcade basketball, Skee-Ball and Whack-a-Mole, as well as the Ticket Blaster machine where birthday guests can grab as many tickets as possible in 30 seconds. In the third quarter of 2018 we launched All You Can Play (“AYCP”), a first-of-its-kind gaming experience that allows kids access to play every game at Chuck E. Cheese’s as many times as they want on any day, without any restrictions, in all our domestic Company-operated Chuck E. Cheese’s venues. Our menu features fresh, hand-made pizza, sandwiches, boneless and bone-in chicken wings, desserts and beverages, including beer and wine. We also offer high-energy musical entertainment and live performances featuring our iconic Chuck E. Cheese character with frequent appearances on our showroom and gameroom floor. As of December 30, 2018, there were 606 Chuck E. Cheese's locations in 47 states and 14 foreign countries and territories, of which 515 are Company-operated.
Peter Piper Pizza: Pizza Made Fresh, Families Made Happy. Peter Piper Pizza serves fresh, high-quality handcrafted food, craft beer and wine, and offers state-of-the-art games for all ages. Venues feature a bold design and contemporary layout, with open kitchens revealing much of the handcrafted food preparation, such as fresh mozzarella being shredded off the block, vegetables being hand-chopped, wings being hand-tossed and our Certified Dough Masters crafting pizzas with made-from-scratch dough. Our large, open dining areas provide an enjoyable atmosphere for families and group events, with attentive staff dedicated to providing an enjoyable and memorable experience to each guest. As of December 30, 2018, there were 144 Peter Piper Pizza locations in the United States (also referred to as “U.S.”) and Mexico, of which 39 are Company-operated.
We believe Peter Piper Pizza is complementary to Chuck E. Cheese's, offering guests a pizza-anchored menu and entertainment in ways that create very different experiences from Chuck E. Cheese's. Peter Piper Pizza is a food-first experience with more sophisticated food offerings (e.g., sriracha pizzas) and a décor/layout package that creates more of a neighborhood pizzeria feel for guests. While the venues offer games, the game packages target older children and are generally
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placed in the back of the restaurant behind a glass wall to protect the dining experience for adults. With this approach, Peter Piper Pizza is not only popular with families, but also attracts a guest base that includes many adults without children. In addition to everyday visits for the excellent food, adults without families are common customers for the day-time buffet on their weekday lunch break and frequently choose Peter Piper Pizza's carryout option, which can also be ordered online.
During the fiscal year ended December 30, 2018, approximately 57% and 27% of our Company-operated venue revenue for Chuck E. Cheese's and Peter Piper Pizza, respectively, was from entertainment and merchandise. For the same period, food and beverage made up 43% and 73% of company venue revenue for Chuck E. Cheese's and Peter Piper Pizza, respectively.
Our Company has benefited from the 2014 acquisition of Peter Piper Pizza through the implementation of best corporate practices and synergies from both brands. Peter Piper Pizza has benefited from lower procurement costs under CEC Entertainment's ownership, as Chuck E. Cheese's is one of the largest purchasers of arcade games in the United States. We believe the combination of Chuck E. Cheese's and Peter Piper Pizza positions our brands for sustained growth through the realization of synergies and further implementation of best corporate practices across our brands.
Although these brands are complementary in many ways, we believe that these are distinct concepts that do not directly compete. Peter Piper Pizza operates smaller venues with a primary emphasis on food, resulting in an older customer demographic with higher frequency visits.
Our Competitive Strengths
We attribute our success in large part to our established recognized brands, our unique and differentiated experience, our value-oriented family experience, our diversified and resilient business model and our experienced management team. Our venues are unique in that we combine a wholesome family dining offering with distinctive family-oriented games, rides, activities, shows and other entertainment alternatives, all under one roof and within convenient driving distance from our guests’ homes. Many of our high quality entertainment offerings, including all of our live and interactive shows in Chuck E. Cheese’s venues, guest Wi-Fi in all our venues, and live television in our Peter Piper Pizza venues, can be experienced free of charge. We also offer our guests packaged offerings whereby they can receive a combination of food, drinks and game credits, time blocks or tokens at discounted prices. We believe that we benefit from strong and consistent demand for our entertainment offerings from families who desire high quality, safe, clean, convenient and affordable ways to spend time with their children outside of the home. Our executive management team has significant experience in the leisure, hospitality, entertainment and family dining industries and has significant expertise in operating complex, themed family entertainment businesses.
Our Strategic Plan
Our strategic plan is focused on increasing comparable venue sales, improving profitability and margins and expanding our venues domestically and internationally.
Increase Comparable Venue Sales. Our core strategy to grow comparable venue sales is achieved by protecting and
enhancing the service provided to children through a lively, kid-friendly atmosphere, while improving the experience for adults. During 2018, we delivered experience enhancements through technology investments, attractive game-play packages, new games, remodels of our venues, and menu innovation.
Recent technology investments allow us to offer more compelling offerings to a wider variety of guests:
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Play Pass card system: In 2018, we completed the deployment of our proprietary Play Pass card system at all Company-operated Chuck E. Cheese’s venues. Guests can purchase “points” on reloadable plastic cards and use these cards to play our games.
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AYCP: In the third quarter of 2018, we completed the roll-out of AYCP at all of our domestic Company-operated Chuck E. Cheese’s venues. This product leverages our Play Pass card system and allows guests the option to play unlimited games within a specified period of time. As of December 30, 2018, AYCP accounted for approximately 50% of our entertainment revenues.
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More Tickets: We believe our guests enjoy the thrill of winning tickets and redeeming them for our merchandise. During the third quarter of 2018, we completed the roll-out of higher ticket payouts at our redemption games, coupled with a smaller adjustment to the ticket “prices” of our merchandise.
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Gameplay promotions: Play Pass technology allows us to vary pricing and offerings by geography and day part within a venue. During 2018, we began offering guests promotions that included discounts during slow school days, surge pricing on select weekends and holidays, and traffic-driving deals like discounted AYCP.
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Other initiatives designed to grow sales:
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Remodeling our venues to provide a modern, fresh look: In 2017, we began testing a redesigned concept at seven of our Chuck E. Cheese’s venues which carefully targeted areas to improve family experience and comfort. Changes included a new exterior and signage, brighter interiors, art décor on the walls, digital menu boards, a new star dance stage, and pizza windows that allow guests to view the pizza being made. In 2018, we completed 25 remodels and have plans for 60 in 2019.
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Refreshing and improving our marketing: We focus on connecting with kids via national television, gaming and promotional opportunities. We also focus on connecting with moms through national television advertising, digital advertising, cross-promotional coupons, social media, public relations and e-mail.
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Improved menu offerings and birthday reservations: We continue to enhance the guest experience by introducing new menu items, attractive packaging, promotional programs and simplifying our online birthday ordering system.
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“More Cheese” customer loyalty program: In the first quarter of 2018, we launched our first customer loyalty program where guests can earn awards and discounts based on purchases.
Finally, we believe that we can modify pricing, couponing and packaging in select markets across the United States while still continuing to provide our guests with a strong value proposition when compared to other family dining-entertainment options.
Improve Profitability and Margins. Our business model benefits from substantial operating leverage, enabling us to drive margin improvement. We continuously focus on delivering financial performance through expense rationalization across all of our venues and functions. We believe that the deployment of best corporate practices across each of our brands and our corporate functions will yield continued margin improvement. Our general managers at our venues and our corporate management staff typically have revenue, profit and customer satisfaction incentives, which foster a strict focus on both providing a high-quality experience for our guests and expense control. Additionally, we have implemented several new technology investments over the past three years that we believe will drive continued cost savings. These investments include our enhanced labor management tool, a system-wide upgrade of our point-of-sale terminals and an improved venue inventory management system that provides additional visibility into food cost measurements and automates our replenishment cycles. These initiatives have generated cost efficiencies in a number of key areas, including labor, supplies, food and general and administrative expenses, and we expect these cost efficiencies to continue in the future.
Finally, in 2018 we re-aligned the activities of our corporate office in order to more efficiently serve our operators. We expect these efforts to result in approximately $2.5 million in annual savings.
Pursue New Venue Growth Domestically and Internationally. We have a long track record of successful new venue development and will continue to pursue a disciplined venue growth strategy in both new and existing markets where we can achieve strong cash-on-cash returns. For new venue openings, we follow a rigorous due diligence and site selection process and strategically locate our venues within convenient driving distance to large metropolitan areas. Our venues generate strong cash flow and perform consistently well across geographic regions, which demonstrates the portability of our concept to new domestic and international markets. We have a successful track record of opening new Company-operated Chuck E. Cheese's venues at attractive rates of return and believe our existing markets can support additional venues.
As of December 30, 2018, we have 109 international venues operating under franchise arrangements. We plan to grow internationally with existing and new franchise partners. In 2018, we opened 8 new venues collectively in five countries, with one new franchised Chuck E. Cheese venue and one new franchised Peter Piper Pizza venue in the United States and six new franchised Chuck E. Cheese's venues in four other countries.
See Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition, Liquidity and Capital Resources – Capital Expenditures” for more information regarding our capital initiatives and expenditures.
Overview of Operations
Food and Beverage
Each Chuck E. Cheese’s and Peter Piper Pizza venue offers a variety of pizzas, wings, appetizers, salads and desserts, as well as certain gluten-free options. Soft drinks, coffee and tea are also served, along with beer and wine in many locations. Chuck E. Cheese’s venues also offer sandwiches, and most Chuck E. Cheese’s and Peter Piper Pizza venues offer lunch buffet
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options with unlimited pizza, salad, breadsticks and dessert. We continuously focus on delivering a quality-driven product and believe the quality of our food compares favorably with that of our competitors.
Food and beverage sales represented 45.3%, 47.3% and 45.8% of our Company-operated venue sales during Fiscal 2018, Fiscal 2017 and Fiscal 2016, respectively.
Entertainment and Merchandise
Each of our Chuck E. Cheese’s and Peter Piper Pizza venues has a gameroom area, which includes an array of amusement and entertainment options. These options range from classic arcade, redemption and skill games, such as air hockey, skee-ball and basketball, to rides, such as mini trains, motorcycles and various driving games. At Chuck E. Cheese’s, we also offer musical and comical entertainment that features our iconic Chuck E. Cheese character with live performances and frequent appearances on our showroom and gameroom floor, as well as ongoing entertainment featuring music videos and televised skits. Each Peter Piper Pizza venue also offers flat-screen televisions located throughout the dining area. In the first quarter of 2018, we completed the implementation of Play Pass, a new proprietary game card system, in all of our Chuck E. Cheese’s Company-operated venues. Play Pass is similar to a stored value gift card and allows guests to activate games and rides with their own personal card. In addition, in July 2018 we launched AYCP in all of our domestic Chuck E. Cheese’s Company-operated venues. AYCP, a time based play option, allows guests to play unlimited games within a block of time, increasing the number of games, tickets and prizes over Play Pass. More Tickets provides the thrill of winning a greater number of tickets on redemption games. A number of games dispense tickets that can be redeemed by guests for prize merchandise such as toys and plush items. Our guests can also purchase this merchandise directly for cash.
Entertainment and merchandise sales represented 54.7%, 52.7% and 54.2% of our Company-operated venue sales during Fiscal 2018, Fiscal 2017 and Fiscal 2016, respectively.
Franchising
As of December 30, 2018, we franchised a total of 91 Chuck E. Cheese’s venues, with 26 venues located in the United States and 65 venues located in 14 foreign countries and territories, and a total of 105 Peter Piper Pizza venues, with 61 venues located in the United States and 44 venues located in Mexico. We have 18 active development and franchise agreements to open 78 Chuck E. Cheese’s venues in 16 countries, and four signed development and franchise agreements with rights to open another 19 Peter Piper Pizza venues in Texas and one signed development and franchise agreement with rights to open another four venues in Mexico. See Part I, Item 1A. “Risk Factors” for more information regarding the risks associated with franchise development agreements.
Our standard franchise agreements grant the franchisee the right to construct and operate a venue and use our associated trade names, trademarks and service marks in accordance with our standards and guidelines. Most of our existing Chuck E. Cheese’s franchise agreements have an initial term of 15 to 20 years and include a 10-year renewal option. Peter Piper Pizza’s franchise agreements are for a 10-year term and include a 10-year successor agreement on Peter Piper Pizza’s then standard form of agreement. The standard franchise agreement provides us with a right of first refusal should a franchisee decide to sell a venue. We also enter into area development agreements, which grant franchisees exclusive rights to open a specified number of venues in a designated geographic area within a specified period of time. In addition to initial franchise and area development fees, the franchisee is charged a continuing monthly royalty fee equal to a percentage of its gross monthly sales, generally up to 6%, which varies by location and brand.
In 1985, we and our Chuck E. Cheese’s franchisees formed the International Association of CEC Entertainment, Inc. (the “Association”) to discuss and consider matters of common interest relating to the operation of Company-operated and franchised Chuck E. Cheese’s venues. Routine business matters of the Association are conducted by a board of directors, composed of five members appointed by us and five members elected by the franchisees. The Association serves as an advisory council that, among other responsibilities, oversees expenditures, including (a) the costs of development, purchasing and placement of advertising programs, including websites; (b) the costs to develop and improve audio-visual and animated entertainment attractions, as well as the development and implementation of new entertainment concepts; and (c) the purchase of national network television advertising.
The franchise agreements governing existing franchised Chuck E. Cheese’s in the United States currently require each franchisee to pay to the Association a monthly contribution equal to a certain percentage of its gross monthly sales. Additionally, under these franchise agreements, we are required, with respect to Chuck E. Cheese’s Company-operated venues, to contribute at the same rates, or at higher rates in certain instances, as our franchisees. We and our franchisees are also required to spend minimum amounts on local advertising and could be required to make additional contributions to fund any deficits that may be incurred by the Association. Certain franchise agreements governing existing franchised Chuck E. Cheese’s outside of the United States currently require each franchisee to pay a certain percentage of their gross monthly sales to the Association to fund various advertising, media, and entertainment costs.
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We do not currently have any advertising co-ops or a franchise advisory council with our Peter Piper Pizza franchisees, but we reserve the right to require the formation, merger or dissolution of either or both. Franchisees are required to contribute (a) 5% of weekly gross sales to be used to develop, produce, distribute and administer specific advertising, public relations and promotional programs that promote the services offered by system franchisees; and (b) 0.5% of weekly gross sales to be used to research, develop, produce, and support creative ideas and materials for use in commercial advertisements, public relations, and promotional campaigns in the United States and Mexico. We may elect at any time not to collect or maintain all or any portion of the amount contributed to fund advertising related programs and activities and, during such time that we have made such election, the monies not collected must be expended by the franchisees in their own markets. In addition, we are required, with respect to Company-operated Peter Piper Pizza restaurants, to contribute funds on the same basis as our franchisees.
Royalties, franchise and area development fees and other miscellaneous franchise income represented 2.3%, 2.0% and 2.0% of our total consolidated revenues during Fiscal 2018, Fiscal 2017 and Fiscal 2016, respectively.
Foreign Operations
As of December 30, 2018, we operated a total of 11 Company-operated venues in Canada. Our Canadian venues generated total revenues of $15.8 million, $16.6 million, and $15.6 million during the fiscal years ended December 30, 2018, December 31, 2017 and January 1, 2017, respectively, representing 1.8%, 1.9% and 1.7% of our total consolidated revenues, respectively. All of our other international venues are franchised.
These foreign activities, along with our international franchisees, are subject to various risks of conducting business in a foreign country, including fluctuations in foreign currency exchange rates, laws and regulations and economic and political stability. See “Risk Factors” for more information regarding the risks associated with operations located in foreign markets.
Third-Party Suppliers
We use a network of 15 distribution centers operated by a single company to distribute most of the food products and supplies used in our domestic Chuck E. Cheese’s branded venues, five distribution centers for our Canadian Chuck E. Cheese’s branded venues, and four distribution centers for our Peter Piper Pizza branded venues. We believe that alternative third-party distributors are available for our products and supplies, but we may incur additional costs if we are required to replace our distributors or obtain the necessary products and supplies from other suppliers.
We have not entered into any hedging arrangements to reduce our exposure to commodity price volatility; however, we typically enter into short-term purchasing arrangements, which may contain pricing designed to minimize the impact of commodity price fluctuations.
We procure games, rides and other entertainment-related equipment from a limited number of suppliers, some of which are located in China. The number of suppliers from which we purchase games, rides and other entertainment-related equipment, redemption prizes and merchandise has declined due to industry consolidation over the past several years. See Part I, Item 1A. “Risk Factors” for more information regarding the risks associated with our third-party suppliers.
Competition
The family dining and entertainment industries are highly competitive, with a number of major national and regional chains operating in each of these markets. In this regard, we compete for customers on the basis of (a) our name recognition; (b) the price, quality, variety, and perceived value of our food and entertainment offerings; (c) the quality of our customer service; and (d) the convenience and attractiveness of our venues. Although there are other concepts that presently utilize the combined family dining and entertainment format, these competitors primarily operate on a regional or market-by-market basis. To a lesser extent, we also compete directly and/or indirectly with other dining and entertainment formats, including full-service and quick-service restaurants appealing to families with young children, the quick service pizza segment, movie theaters, themed amusement attractions, and other entertainment facilities for children.
Intellectual Property
We own various trademarks and proprietary rights, including Chuck E. Cheese’s®, Where A Kid Can Be A Kid®, Peter Piper Pizza® and the Chuck E. Cheese character image used in connection with our business, which have been registered with the appropriate patent and trademark offices. The duration of such trademarks is unlimited, subject to continued use and renewal. We believe that we hold the necessary rights for protection of the trademarks considered essential to conduct our business. We believe our trade names and our ownership of trademarks and proprietary rights in the names and character likenesses featured in the operation of our venues provide us with an important competitive advantage, and we actively seek to protect our interests in such property.
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Seasonality
Our operating results fluctuate seasonally. We typically generate our highest sales volumes during the first quarter of each fiscal year due to the timing of school vacations, holidays and changing weather conditions. School operating schedules, holidays and weather conditions may also affect our 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 our full fiscal year.
Government Regulation
We and our franchisees are subject to various federal, state and local laws and regulations affecting the development and operation of Chuck E. Cheese’s and Peter Piper Pizza venues. For a discussion of government regulation risks to our business, see Part I, Item 1A. “Risk Factors.”
Employees
As of December 30, 2018, we employed approximately 16,800 employees, including approximately 16,400 in the operation of our Company-operated venues and approximately 400 in our corporate offices. Our employees do not belong to any union or collective bargaining group. We believe that our employee relations are satisfactory, and we have not experienced any work stoppages at any of our venues.
Each Chuck E. Cheese’s and Peter Piper Pizza venue typically employs a general manager, senior assistant manager, one or more assistant managers, an electronics specialist who is responsible for repair and maintenance of the show, games and rides, and approximately 25 to 45 food preparation and service employees, many of whom work part-time. Our staffing requirements are seasonal, and the number of people we employ at our venues will fluctuate throughout the year.
Available Information
We make financial information, news releases and other information available on our corporate website at www.chuckecheese.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website as soon as reasonably practicable after we electronically file these reports and amendments, or furnish them to, the United States Securities and Exchange Commission (“SEC”). The information on our website is not, and shall not be deemed to be, part of this report or incorporated into any other filings we make with the SEC. The reports and the other documents we file with the SEC are available on the SEC’s website at www.sec.gov.
ITEM 1A. Risk Factors.
Our business operations and the implementation of our business strategy are subject to significant risks inherent in our business, including, without limitation, the risks and uncertainties described below. The occurrence of any one or more of the risks or uncertainties described below and elsewhere in this Annual Report on Form 10-K could have a material effect on our consolidated financial condition, results of operations and cash flows. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different.
Risks Related to Our Business and Industry
Negative publicity concerning food quality, health, general safety or other issues, and changes in consumer preferences, could negatively affect our brand image and reputation and adversely affect our consolidated financial results.
Food service businesses can be adversely affected by litigation and complaints from guests, consumer groups, or government authorities, resulting from food quality, illness, injury or other health concerns, or operating issues stemming from one venue or a limited number of venues. Publicity concerning food-borne illnesses, injuries caused by food tampering, and general safety issues could negatively affect our operations, reputation and brand. Families with young children may be highly sensitive to adverse publicity that may arise from an actual or perceived negative event within one or more of our venues. We have, from time to time, received negative publicity related to altercations and other safety-related incidents in certain of our venues. There can be no assurance that in the future we will not experience negative publicity regarding one or more of our venues, and the existence of negative publicity could adversely affect our brand image and reputation with our guests and our consolidated financial results.
The speed at which negative publicity can be disseminated has increased dramatically with electronic communication, including social media. Many social media platforms allow for users to immediately publish content without checking the accuracy of the content posted. If we are unable to quickly and effectively respond to such
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information, we may suffer declines in guest traffic, which could adversely impact our consolidated financial results.
In addition, our industry is affected by consumer preferences and perceptions. Changes in prevailing health or dietary preferences and perceptions may cause consumers to avoid certain products we offer in favor of alternative or healthier foods. If consumer eating habits change significantly and we are unable to respond with appropriate menu offerings, it could adversely affect our brand image and consolidated financial results.
Our business may also be impacted by certain public health issues including epidemics, pandemics and the rapid spread of certain illnesses and contagious diseases. To the extent that extensive publicity relating to such events causes our guests to feel uncomfortable visiting or taking their children to public locations, particularly locations with a large number of children, due to a perceived risk of exposure to a public health issue, we could experience a reduction in guest traffic, which could adversely affect our consolidated financial results.
If we are unable to successfully open new venues or appropriately update and evolve our current venue base, our business and our consolidated financial results could be adversely affected.
Our ability to increase revenues and improve financial results depends, to a significant degree, on our ability to successfully implement and refine our long-term growth strategy. As part of our long-term growth strategy, we plan to upgrade the games, rides and entertainment in most of our existing venues, remodel certain of our existing venues and open additional new venues in selected markets.
The opening and success of new Chuck E. Cheese's and Peter Piper Pizza venues is dependent on various factors, including but not limited to the availability of suitable sites, the negotiation of acceptable lease terms for such locations, our ability to meet construction schedules, our ability to manage such expansion and hire and train personnel to manage the new venues, our ability to obtain, for acceptable cost, building and other permits and approvals including liquor licenses, the potential cannibalization of sales at any adjacent venues located in the market, as well as general economic and business conditions. Our ability to successfully open new venues or remodel, expand or upgrade the entertainment at existing venues will also depend upon the availability of sufficient capital for such purposes, including operating cash flow, our existing credit facility, future debt financings, future equity offerings, or a combination thereof. There can also be no assurance that we will be successful in opening and operating the number of anticipated new venues on a timely or profitable basis. There can be no assurance that we can continue to successfully remodel or expand our existing facilities or upgrade the games and entertainment or obtain a reasonable return on such investments.
Our growth is also dependent on our ability to continually evolve and update our business model to anticipate and respond to changing customer preferences and competitive conditions. There can be no assurance that we will be able to successfully anticipate changes in competitive conditions or customer preferences or that the market will accept our business model. If revenues and/or operating results are lower than our current estimates, we may incur additional charges for asset impairments in the future, which could adversely impact our consolidated financial results. Additionally, we incur significant costs each time we open a new venue and other expenses when we relocate or remodel existing venues. The expenses of opening, relocating, or remodeling any of our venues may be higher than anticipated. If we are unable to open or are delayed in opening new or relocated venues, we may incur significant costs, which could adversely affect our consolidated financial results. If we are unable to remodel or are delayed in remodeling venues, we may incur significant costs, which could adversely affect our business and our consolidated financial results.
We may not be successful in the implementation of our marketing strategy, which could adversely affect our business and our consolidated financial results.
Our long-term growth is dependent on the success of strategic initiatives to effectively market and advertise our concept to our target audience. In recent years, we have made significant changes to our marketing and advertising strategy, including (a) the introduction of an updated Chuck E. Cheese character; (b) a change in the mix of our media expenditures; (c) an increase in advertising directed to parents; and (d) promoting our brand and reasons to visit on television and online. There can be no assurance that these changes to our traditional media strategy, which was heavily weighted towards kids' television advertising, free-standing inserts in newspapers, and significant couponing, will be effective at reaching customers or be accepted by customers. If we are not effective in reaching our target audience with our new marketing and advertising strategy or if these changes are not accepted by guests, we may incur additional advertising costs, and our business and our consolidated financial results could be adversely affected.
The restaurant and entertainment industries are highly competitive, and that competition could harm our business and our consolidated financial results.
We believe that our combined restaurant and entertainment center concept puts us in a niche, which combines elements of both the restaurant and entertainment industries. As a result, we compete with entities in both industries. The family dining industry and the entertainment industry are highly competitive, with a number of major national and regional
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chains operating in each of these spaces. Although other restaurant brands presently utilize the concept of combined family dining-entertainment operations, we believe these competitors operate primarily on a local, regional or market-by-market basis. Within the traditional restaurant sector, we compete with other casual dining restaurants on a nationwide basis with respect to price, quality, and speed of service; type and quality of food; personnel; the number and location of restaurants; attractiveness of facilities; effectiveness of advertising; and marketing programs and new product development. To a lesser extent, our competition also includes quick service restaurants with respect to pricing, service, experience, and perceived value. Within the entertainment sector, we compete with movie theaters, bowling alleys, theme parks, and other family-oriented concepts on a nationwide basis with respect to perceived value and overall experience. Additionally, children's interests and opportunities for entertainment continue to expand. If we are unable to successfully evolve our concept, including new food and entertainment offerings, we may lose market share to our competition. These competitive market conditions, including the emergence of significant new competition, could adversely affect our business and our consolidated financial results.
Economic uncertainty and changes in consumer discretionary spending could reduce sales at our venues and have an adverse effect on our business and our consolidated financial results.
Purchases at our venues are discretionary for consumers; therefore, our consolidated results of operations are susceptible to economic slowdowns and recessions. We are dependent in particular upon discretionary spending by consumers living in the communities in which our venues are located. A significant portion of our venues are clustered in certain geographic areas. As of December 30, 2018, a total of 181 Chuck E. Cheese's venues are located in California, Texas, and Florida (178 are Company-operated and three are franchised locations), and a total of 135 Peter Piper Pizza venues are located in Arizona, Texas, and Mexico (34 are Company-operated and 101 are franchised locations). A significant weakening in the local economies of these geographic areas, or any of the areas in which our venues are located, may cause consumers to curtail discretionary spending, which in turn could reduce our Company venue sales and have an adverse effect on our business and our consolidated financial results.
The future performance of the United States and global economies is uncertain and is directly affected by numerous national and global financial, political and other factors that are beyond our control. Our target market of families with young children can be highly sensitive to adverse economic conditions, which may impact their desire to spend discretionary dollars, resulting in lower customer traffic levels in our venues. Increases in credit card debt, home mortgage and other borrowing costs and declines in housing values could further weaken the United States, Mexican or Canadian economies, leading to a further decrease in discretionary consumer spending. In addition, reduced consumer confidence as a result of a recession, job losses, home foreclosures, investment losses in the financial markets, personal bankruptcies, and reduced access to credit may also result in lower levels of traffic to our venues. Moreover, our customer traffic may be impacted by major changes in United States fiscal policy. Also, while the current administration’s policies in many areas are still uncertain at this time, certain types of policies regarding immigration, development and investment could adversely affect our business. While there is currently a substantial lack of clarity and uncertainty around the likelihood, timing and details of any such policies and reforms, such policies and reforms may materially and adversely affect customer confidence and our business. We believe that consumers generally are more willing to make discretionary purchases, including at our venues, during periods in which favorable economic conditions prevail. Further, fluctuations in the retail price of gasoline and the potential for future increases in gasoline and other energy costs may affect consumers' disposable incomes available for entertainment and dining. Changes in consumer spending habits as a result of a recession or a reduction in consumer confidence are likely to reduce our customer traffic and sales performance, which could have an adverse effect on our business and our consolidated financial results. In addition, these economic factors could affect our level of spending on planned capital initiatives at our venues, and thereby impact our future sales, and could also result in potential asset impairments and venue closures.
Increases in food, labor, and other operating costs could adversely affect our consolidated financial results.
For the 2018 fiscal year, 45.3% of company venue sales revenue came from food and beverage sales as compared to the 54.7% of company venue sales revenue resulting from entertainment and merchandise sales. As a result, the performance of our venues is affected by changes in the costs for food products we purchase, including but not limited to cheese, dough, produce, chicken, and beef. The commodity prices for these food products vary throughout the year and may be affected by changes in supply, demand, and other factors beyond our control. We have not entered into any hedging arrangements to reduce our exposure to commodity price volatility associated with commodity prices; however, we typically enter into short-term purchasing arrangements, which may contain pricing designed to minimize the impact of commodity price fluctuations. An increase in our food costs could negatively affect our profit margins and adversely affect our consolidated financial results.
Several states and cities in which we operate venues have established a minimum wage higher than the federally-mandated minimum wage. There may be similar increases implemented in other jurisdictions in which we operate or seek to operate. Additionally, a number of our employees could be subject to changes in federal or state rules and regulations concerning increases to salary and compensation levels necessary for white collar workers to be classified as exempt in 2019 and beyond, as well as state-specific laws governing relative pay for male and female employees and/or employees of different
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races and/or ethnicities and policies to establish more predictable work schedules. Such changes in the minimum wage and other wage or salary requirements could increase our labor costs and could have an adverse effect on our profit margins and our consolidated financial results.
The performance of our venues could also be adversely affected by increases in the price of utilities on which the venues depend, such as electricity and natural gas, whether as a result of inflation, shortages or interruptions in supply, or otherwise. Our business also incurs significant costs for, among other things, insurance, marketing, taxes, real estate, borrowing, and litigation, all of which could increase due to inflation, rising interest rates, changes in laws, competition, or other events beyond our control, which could have an adverse effect on our consolidated financial results.
Our strategy to open international franchised venues may not be successful and may subject us to unanticipated conditions in foreign markets, which could adversely impact our business and our ability to operate effectively in those markets.
Part of our growth strategy depends on our ability to attract new international franchisees and the ability of these franchisees to open and operate new venues on a profitable basis. As we do not have a long history of significant international growth experience, there can be no assurance that we will be able to successfully execute this strategy in the future. Delays or failures in identifying desirable franchise partners and opening new franchised venues could adversely affect our planned growth. Moreover, our franchisees depend on the availability of financing to construct and open new venues. If these franchisees experience difficulty in obtaining adequate financing, our growth strategy and franchise revenues could be adversely affected. Additionally, our growth strategy depends on the ability of our international franchisees to learn and implement our business strategy, while adapting to the local culture. There can be no assurance that the Chuck E. Cheese's and Peter Piper Pizza concepts will be accepted in targeted international markets.
Currently, our international franchisees operate venues in 14 countries. We and our franchisees are subject to the regulatory, economic, and political conditions of any foreign market in which our franchisees operate venues. Any change in the laws, regulations, and economic and political stability of these foreign markets could adversely affect our consolidated financial results. Changes in foreign markets that could affect our consolidated financial results include, but are not limited to, taxation, inflation, currency fluctuations, political instability, economic instability, war or conflicts, increased regulations and quotas, tariffs, and other protectionist measures. Additionally, our long-term growth strategy includes adding franchisees in additional foreign markets in the future. To the extent unfavorable conditions exist in the foreign markets we plan to expand into or we are unable to secure intellectual property rights sufficient to operate in such foreign markets, we and our international franchise partners may not be successful in opening the number of anticipated new venues on a timely and profitable basis. Delays or failures in opening new foreign market venue locations could adversely affect our planned growth and result in increased attendant costs.
Our business dealings with foreign franchisees and vendors are subject to United States and foreign anti-corruption law, and investigations or enforcement actions brought under such law could adversely impact our business and our ability to operate effectively in those markets.
As a business that regularly enters into negotiations and contractual relationships with franchisees and vendors located in foreign countries, we are subject to the requirements of the United States Foreign Corrupt Practices Act and other domestic and foreign laws and regulations governing such activities. Although we have a strong compliance program that includes regular training and reinforcement of our employees who represent us in dealings with foreign individuals and entities on the laws impacting such dealings, we may be faced with investigations or enforcement actions by the United States or foreign governments arising from such dealings. Responding to such investigations or enforcement actions would be costly and may divert management's attention and resources from the regular operation of our business, and together with any fines, penalties, or other actions ordered by governmental authorities, could adversely affect our business and consolidated financial results.
If we are unable to maintain and protect our information technology systems and technologies, we could suffer disruptions in our business, damage our reputation with customers, and incur substantial costs.
The operation of our business is heavily dependent upon the implementation, integrity, security, and successful functioning of our computer networks and information systems, including the point-of-sales systems in our venues, data centers that process transactions, the enterprise resource planning system, the Chuck E. Cheese and Peter Piper Pizza brand websites, the birthday reservation system, and various software applications used in our operations. In the ordinary course of our business, we also collect and store on our computer networks and information systems sensitive data, including intellectual property, our proprietary business information and that of our customers, suppliers and business partners, and personally identifiable information of our customers and employees. A failure of our systems to operate effectively as a result of a cyber-attack, damage to, interruption, or failure of any of these systems could result in a failure to meet our reporting obligations, material misstatements in our financial statements, or losses due to the disruption of our business operations.
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These adverse situations could also lead to loss of sales or profits or cause us to incur additional development costs. While we purchase insurance coverage related to network security and privacy to limit the cost of any such failure or cyber-attack our coverage may not be sufficient to reimburse us for all of the costs we may incur in the event of a cyber-attack. Despite our efforts to secure our computer networks and information systems, security could be compromised or confidential information could be misappropriated, resulting in a loss of customers' or employees' personal information, negative publicity or harm to our business and reputation that could cause us to incur costs to reimburse third parties for damages or to pay governmental fines, or cause a decrease in guest traffic.
Any disruption of our commodity distribution system could adversely affect our business and our consolidated financial results.
We use a network of 15 distribution centers operated by a single company to distribute most of the food products and supplies used in our domestic Chuck E. Cheese's branded venues, five distribution centers for our Canadian Chuck E. Cheese’s branded venues and four distribution centers for our Peter Piper Pizza branded venues. Any failure by these distributors to adequately distribute products or supplies to our venues could increase our costs and have an adverse effect on our business and our consolidated financial results. Although we believe that alternative third-party distributors are available for our products and supplies, we may incur additional costs if we are required to replace our distributors or obtain the necessary products and supplies from other suppliers, and there can be no assurance that our business would not be disrupted.
Our procurement of games, rides, entertainment-related equipment, redemption prizes, and merchandise is dependent upon a few global providers, the loss of any of which could adversely affect our business and our consolidated financial results.
Our ability to continue to procure new games, rides, entertainment-related equipment, redemption prizes and merchandise is important to our business strategy. The number of suppliers from which we can purchase these items is limited due to industry consolidation over the past several years. To the extent that the number of suppliers continues to decline, we could be subject to risks of distribution delays, pricing pressure and lack of innovation, among other things. Furthermore, some of our suppliers are located in China, and continuing and increasing tension between the United States and Chinese governments could also result in interruptions in our ability to procure these products, which could adversely affect our business and our consolidated financial results.
We face risks with respect to product liability claims and product recalls, which could adversely affect our reputation, business and consolidated financial results.
We purchase merchandise from third parties and offer this merchandise to customers in exchange for prize tickets or for sale. This merchandise could be subject to recalls and other actions by regulatory authorities. Changes in laws and regulations could also impact the type of merchandise we offer to our customers. We have experienced, and may in the future experience, issues that result in recalls of merchandise. In addition, individuals may in the future assert claims or file lawsuits alleging that they have sustained injuries from third-party merchandise offered by us. There is a risk that these claims or liabilities may exceed, or fall outside of the scope of, our insurance coverage. Any of the issues mentioned above could result in damage to our reputation, diversion of development and management resources, or reduced sales and increased costs, any of which could adversely affect our business and our consolidated financial results.
We are subject to various government regulations, which could adversely affect our business and our consolidated financial results.
The development and operation of our venues are subject to various federal, state, and local laws and regulations in many areas of our business, including but not limited to those that impose restrictions, levy a fee or tax, or require a permit, license or other regulatory approval, and those that relate to the operation of redemption, video, and arcade games and rides, the preparation of food and beverages, the sale and service of alcoholic beverages, and building and zoning requirements. Difficulties or failure in obtaining required permits, licenses, or other regulatory approvals could delay or prevent the opening of a new venue, remodel or expansion, and the suspension of, or inability to renew, a license or permit could interrupt operations at an existing venue.
We are also subject to laws and regulations governing our relationship with our employees, including those related to minimum wage requirements, exempt status, overtime, health insurance mandates, working and safety conditions, immigration status requirements, child labor, non- discrimination, and scheduling practices. Additionally, changes in federal labor laws, including card verification regulations, could result in portions of our workforce being subjected to greater organized labor influence, which could result in an increase to our labor costs. A significant portion of our venue personnel are paid at minimum wage rates established by federal, state and municipal law. Increases in the minimum wage result in higher labor costs, which may be only partially offset by price increases and operational efficiencies. We are also subject to certain laws and regulations that govern our handling of customers' personal information. A failure to protect the integrity and security of our customers' personal information could expose us to litigation and regulatory enforcement action, as well as materially damage
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our reputation.
We are also subject to the rules and regulations of the Federal Trade Commission and various state laws regulating the offer and sale of franchises. The Federal Trade Commission and various state laws require that we furnish a franchise disclosure document containing certain information to prospective franchisees, and a number of states require registration of the franchise disclosure document with state authorities. State laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states, and bills have been introduced in Congress from time to time that would provide for federal regulation of the franchisor-franchisee relationship. The state laws often limit, among other things, the duration and scope of non-competition provisions, the ability of a franchisor to terminate or refuse to renew a franchise and the ability of a franchisor to designate sources of supply. We believe that our franchise disclosure document, together with any applicable state versions or supplements, and franchising procedures, comply in all material respects with both the Federal Trade Commission guidelines and all applicable state laws regulating franchising in those states in which we have offered franchises.
While we endeavor to comply with all applicable laws and regulations, governmental and regulatory bodies may change such laws and regulations in the future, which may require us to incur substantial cost increases. If we fail to comply with applicable laws and regulations, we may be subject to various sanctions, penalties, fines and/or lawsuits, or may be required to cease operations until we achieve compliance, which could have an adverse effect on our business and our consolidated financial results.
We may face litigation risks from customers, employees, franchisees and other third parties in the ordinary course of business, which could adversely affect our business and our consolidated financial results.
Our business is subject to the risk of litigation by customers, current and former employees, franchisees, suppliers, governmental entities, stockholders, or others, through private actions, class actions, administrative proceedings, regulatory actions, or other litigation. The outcome of litigation, particularly class action lawsuits and regulatory actions, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time. The cost to defend future litigation may be significant. There may also be adverse publicity associated with litigation that could decrease customer acceptance of our food or entertainment offerings, regardless of whether the allegations are valid or whether we are ultimately found liable. From time to time, we are also involved in lawsuits with respect to alleged infringement of third party intellectual property rights, as well as challenges to our intellectual property.
We are also subject to risks from litigation and regulatory action regarding advertising to our market of children between the ages of two and 12 years old. In addition, since certain of our venues serve alcoholic beverages, we are subject to “dram shop” statutes. These statutes generally allow a person injured by an intoxicated person to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person. Although we believe we are adequately protected against such losses by insurance, a judgment against us under a “dram shop” statute in excess of the liability covered by insurance could have an adverse effect on our business and our consolidated financial results.
We face potential liability with our gift cards and Play Pass cards under the property laws of some states.
Our gift cards are used in our venues to purchase food, beverages, merchandise, game credits and time blocks, and our Play Pass cards are loaded with game credits purchased by our guests. These cards may be considered stored value cards by certain states in accordance with their abandoned and unclaimed property laws. These laws may require us to remit cash amounts equal to all or a designated portion of the unredeemed balance of stored value cards based on certain criteria and the length of time that the cards are inactive or dormant. Our gift cards and Play Pass cards do not expire and do not incur service fees. We recognize income from unredeemed cards when we determine that the likelihood of the cards being redeemed is remote, and we believe remittance pursuant to abandoned and unclaimed property laws is not required.
The analysis of the potential application of the abandoned and unclaimed property laws to our gift cards and Play Pass cards is complex and involves an analysis of constitutional issues, statutory provisions, case law and factual matters. In the event that one or more states change their existing abandoned and unclaimed property laws or successfully challenges our position on the application of its abandoned and unclaimed property laws or if the estimates that we use in projecting the likelihood of the cards being redeemed prove to be inaccurate, our liabilities for deferred revenue and revenue recognition with respect to unredeemed gift cards and Play Pass cards may materially differ from the amounts reported in our financial statements and our net income could be materially and adversely affected.
Our business may be adversely affected by local conditions, natural disasters, terrorist attacks and other events.
Certain regions in which our facilities (including our support center, venues, and warehouses) are located may be subject to adverse local conditions, natural disasters, terrorist attacks and other events. Severe weather, such as heavy snowfall,
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ice, or extreme temperatures, may discourage or restrict customers in affected regions from traveling to our venues or prevent employees from performing their work in our facilities, which could adversely affect our sales. If severe weather conditions occur during the first quarter of the year, the adverse impact to our sales and profitability could be even greater than at other times during the year because we typically generate our highest sales and profits during the first quarter. Natural disasters including tornadoes, hurricanes, floods and earthquakes may damage our facilities, which may adversely affect our business and our consolidated financial results.
Our business is seasonal, and quarterly results may fluctuate significantly as a result of this seasonality.
We have experienced, and in the future could experience, quarterly variations in our consolidated revenues and profitability as a result of a variety of factors, many of which are outside our control, including the timing of school vacations, holidays, and changing weather conditions. We typically generate our highest sales volumes and earnings in the first quarter of each fiscal year. If there is a material decrease in the customer traffic in our venues during the first quarter of the year due to unusually cold or inclement weather or other circumstances outside of our control, our operating results could be materially, adversely affected for that quarter and further, may have an adverse effect on our consolidated financial results for the fiscal year.
Public health issues could adversely affect our consolidated financial results.
Our business may be impacted by certain public health issues including epidemics, pandemics and the rapid spread of certain illnesses and contagious diseases. To the extent that our customers feel uncomfortable visiting public locations, particularly locations with a large number of children, due to a perceived risk of exposure to a public health issue, we could experience a reduction in customer traffic, which could adversely affect our consolidated financial results.
Our current insurance policies may not provide adequate levels of coverage against all claims, and we could incur losses that are not covered by our insurance, which could adversely affect our business and our consolidated financial results.
We have procured and maintain insurance coverage at levels that we believe are typical for a business of our type and size. However, we could experience a loss that either cannot be insured against or is not commercially reasonable to insure. For example, insurance covering liability for violations of wage and hour laws is generally not available. Under certain circumstances, plaintiffs may file certain types of claims that may not be covered by insurance, or by sufficient insurance to cover the entire amount of a judgment. In some cases, plaintiffs may seek punitive damages, which may also not be covered by insurance. Losses such as these, if they occur, could adversely affect our business and our consolidated financial results.
We may face labor shortages that could slow our growth and adversely impact our ability to operate our venues.
The successful operation of our business depends upon our ability to attract, motivate and retain a sufficient number of qualified executives, managers and skilled employees. From time-to-time, there may be a shortage of skilled labor in certain of the communities in which our venues are located. Shortages of skilled labor may make it increasingly difficult and expensive to attract, train and retain the services of a satisfactory number of qualified employees and could delay the planned openings of new venues or adversely impact our existing venues. Any such delays, material increases in employee turnover rates in existing venues or widespread employee dissatisfaction could have a material adverse effect on our business and results of operations. Competition for qualified employees could require us to pay higher wages, which could result in higher labor costs and could have a material adverse effect on our results of operations.
Immigration reform continues to attract significant attention in the public arena and the United States Congress. If new immigration legislation is enacted, such laws may contain provisions that could increase our costs in recruiting, training and retaining employees. Also, although our hiring practices comply with the requirements of federal law in reviewing employees' citizenship or authority to work in the United States, increased enforcement efforts with respect to existing immigration laws by governmental authorities may disrupt a portion of our workforce or our operations at one or more of our venues, thereby negatively impacting our business.
We are dependent on the service of certain key executives, and the loss of any of these personnel could harm our business.
Our success significantly depends on the continued employment and performance of our key executives. We have employment agreements with certain of our key executives. However, we cannot prevent our key executives from terminating their employment with us. Losing the services of any of our key executives could harm our business until a suitable replacement is hired, and such replacement may not have equal experience or capabilities. Additionally, economic conditions or concerted overtures by competitors may lead to resignations of significant numbers of members of our operations management team, which may also negatively impact our consolidated financial results in the short term.
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Failure to establish and maintain effective internal control over financial reporting could have a material adverse effect on our business and operating results.
Maintaining effective internal control over financial reporting is necessary for us to produce reliable financial reports and is important in helping to prevent mistakes in our financial statements and financial fraud. If we are unable to maintain adequate internal controls, our business and operating results could be harmed. Any failure to remediate deficiencies noted by our management or our independent registered public accounting firm or to implement required new or improved controls or difficulties encountered in their implementation could cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements. Any such failure could result in a loss of investor confidence in the reliability of our financial statements, have a material adverse effect on our business, financial condition and results of operations and the fair value of our common stock.
We may not be able to adequately protect our trademarks or other proprietary rights, which could have an adverse effect on our business and our consolidated financial results.
We own certain common law trademark rights and a number of federal and international trademark and service mark registrations, internet domain name registrations and other proprietary rights relating to our operations. We believe that our trademarks and other proprietary rights are important to our success and our competitive position. We therefore devote appropriate resources to the protection of our trademarks and proprietary rights. However, the protective actions that we take may not be enough to prevent unauthorized usage or imitation by others, which could harm our image, brand, or competitive position, and if we commence litigation to enforce our rights, we may incur significant legal fees.
There can be no assurance that third parties will not claim that our trademarks, menu offerings, or advertising claims infringe upon their proprietary rights or constitute unfair competition. Any such claim, whether or not it has merit, may result in costly litigation, cause delays in introducing new menu items in the future, interfere with our international development agreements, lead to delays or cancellation of pre-paid marketing campaigns, or require us to enter into royalty or licensing agreements. Additionally, we may be subject to infringement claims by purported patent holders that relate to software or systems that are critical to our operations. As a result, any such claim could have an adverse effect on our business and our consolidated financial results.
We are subject to risks in connection with owning and leasing real estate, which could adversely affect our consolidated financial results.
As an owner or lessee of the land and/or buildings for our Company-operated venues, we are subject to all of the risks generally associated with owning and leasing real estate, including changes in the supply and demand for real estate in general and the supply and demand for the use of the venues. We may be compelled to continue to operate a non-profitable venue due to our obligations under lease agreements, or we may close a non-profitable venue and continue making rental payments with respect to the lease, which could adversely affect our consolidated financial results. Furthermore, economic instability may inhibit our landlords from securing financing and maintaining good standing in their existing financing arrangements, which could result in their inability to keep existing tenants or attract new tenants, thereby reducing customer traffic to our venues. The lease terms for our leased facilities vary, and some have only a short term remaining. Most - but not all - of our leased facilities have renewal terms. When a lease term expires, the Company may not be able to renew such lease on reasonable economic and commercial terms, or at all. Such failure to renew leases on reasonable economic and commercial terms could adversely affect our business and consolidated financial results.
We also may not be able to renew real property leases on favorable terms, or at all, which may require us to close a venue or relocate, either of which could have a material adverse effect on our business, results of operations or financial condition. Of the 515 Company-operated Chuck E. Cheese's venues as of December 30, 2018, 506 are leased. All of the 39 Company-operated Peter Piper Pizza venues as of December 30, 2018 are leased premises. The leases typically provide for a base rent and, in some instances additional rent based on a percentage of the revenue generated by the venues on the leased premises once certain thresholds are met. A decision not to renew a lease for a venue could be based on a number of factors, including an assessment of the area in which the venue is located. We may choose not to renew, or may not be able to renew, certain of such existing leases if the capital investment then required to maintain the venues at the leased locations is not justified by the return on the required investment. If we are not able to renew the leases at rents that allow such venues to remain profitable as their terms expire, the number of such venues may decrease, resulting in lower revenue from operations, or we may relocate a venue, which could subject us to construction and other costs and risks, and, in either case, could have a material adverse effect on our business, results of operations or financial condition.
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Fixed rental payments account for a significant portion of our cash operating expenses, which increases our vulnerability to general adverse economic and industry conditions and could limit our operating and financial flexibility.
Payments under our operating leases (excluding rental payments on our sale leaseback properties) account for a significant portion of our operating expenses. For example, total rental payments, including additional rental payments based on sales at some of our venues, under operating leases were approximately $93.9 million, or 10.5% of our Total revenues, in fiscal 2018. In addition, as of December 30, 2018, we were a party to operating leases requiring future minimum lease payments aggregating approximately $183.4 million through the next two years and approximately $718.2 million thereafter. We expect that we will lease any new venues we open under operating leases. Our substantial operating lease obligations could have significant negative consequences, including:
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increasing our vulnerability to general adverse economic and industry conditions;
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limiting our ability to obtain additional financing;
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requiring a substantial portion of our available cash to be applied to pay our rental obligations, thus reducing cash available for other purposes;
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limiting our flexibility in planning for or reacting to changes in our business or the industry in which we compete; and
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placing us at a disadvantage with respect to our competitors.
We depend on cash flow from operations to pay our lease obligations and to fulfill our other cash needs. If our business does not generate sufficient cash flow from operating activities and sufficient funds are not otherwise available to us from borrowings under the CEC revolving credit facility or from other sources, we may not be able to service our operating lease obligations, grow our business, respond to competitive challenges or fund our other liquidity and capital needs, which would have a material adverse effect on us.
We may not be successful in integrating the operations of companies we acquire, which could have an adverse effect on our business and results of operations.
We have engaged in acquisition activity in the past and in the future we may engage in acquisitions or other strategic transactions, such as investments in other entities. Strategic transactions, such as the Peter Piper Pizza acquisition completed in October 2014, involve risks, including those associated with integrating operations or maintaining operations as separate (as applicable); financial reporting; disparate technologies and personnel of acquired companies; the diversion of management's attention from other business concerns; unknown risks; and the potential loss of key employees, customers, and strategic partners of acquired companies or companies in which we may make strategic investments. We may not successfully integrate any businesses or technologies we may acquire or strategically develop in the future and may not achieve anticipated revenue and cost benefits relating to any such strategic transactions. Strategic transactions may be expensive and time consuming, and may strain our resources. Strategic transactions may not be accretive and may negatively impact our results of operations as a result of, among other things, the incurrence of debt, write-offs of goodwill and amortization expenses of other intangible assets.
We are involved in litigation relating to the Merger Agreement that could divert management's attention and harm our business.
As described in Part 1, Item 3 of this report, “Legal Proceedings,” following the January 16, 2014 announcement that we had entered into a merger agreement (the ‘‘Merger Agreement’’), pursuant to which an entity controlled by Apollo Global Management, LLC (“Apollo”) and its subsidiaries merged with and into CEC Entertainment Inc., with CEC Entertainment Inc. surviving the merger (the ‘‘Merger’’), four putative class actions were filed by 29 shareholders in the District Court of Shawnee County, Kansas, on behalf of our purported stockholders, against us, our directors, Apollo, Queso Holdings Inc. (“Parent”) 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 in March 2014. On July 21, 2015, a consolidated class action petition was filed as the operative consolidated complaint, asserting claims against CEC and its former directors, adding The Goldman Sachs Group (‘‘Goldman Sachs’’) as a defendant, and removing all Apollo entities as defendants (‘‘Consolidated Class Action Petition’’). The Consolidated Class Action Petition alleges that our directors breached their fiduciary duties to our stockholders in connection with their consideration and approval of the Merger Agreement by, among other things, conducting a deficient sales process, agreeing to an inadequate tender price, agreeing to certain provisions in the Merger Agreement, and filing materially deficient disclosures regarding the transaction. The Consolidated Class Action Petition also alleges that two members of our board who also served as our senior managers had material conflicts of interest and that Goldman Sachs aided and abetted the board’s breaches as a result of various conflicts of interest facing the bank. The Consolidated Class Action Petition seeks, among other things, to recover damages, attorneys’ fees and costs. On March 23, 2016, the Court conducted a hearing on the defendants’ Motion to Dismiss the Consolidated Class Action Petition and on March 1, 2017, the Special Master appointed
18
by the Court issued a report recommending to the Court that the Consolidated Class Action Petition be dismissed in its entirety. On September 9, 2018, the Plaintiff in the Consolidated Shareholder Litigation filed a notice of appeal of the District Court’s decision. Although CEC Entertainment and its former directors are no longer defendants in the lawsuit, we assumed the defense of the Consolidated Shareholder Litigation on behalf of CEC’s named former directors and Goldman Sachs pursuant to existing indemnity agreements, and continuing to fund Goldman Sach’s defense of this action is expensive and may divert management’s attention and resources, which could adversely affect our business.
Risks Related to Our Capital Structure
Our substantial indebtedness could adversely affect our ability to raise additional capital or to fund our operations, expose us to interest rate risk to the extent of our variable rate debt, limit our ability to react to changes in the economy, and prevent us from making debt service payments.
We are a highly leveraged company. As of December 30, 2018, we had $978.9 million face value of outstanding indebtedness (excluding capital lease and sale leaseback obligations), in addition to $141.0 million available for borrowing under the revolving credit facility at that date. For the fiscal year ended December 30, 2018, we made total debt service payments of $68.0 million (excluding capital leases, sale leaseback, and fees to extend our revolving credit facility).
Our substantial indebtedness could have important consequences for us, including, but not limited to, the following:
•
limit, along with the financial and other restrictive covenants in our indebtedness, among other things, our ability to borrow additional funds or dispose of assets; limit our ability to repurchase shares and pay cash dividends;
•
limit our ability to borrow money for our working capital, capital expenditures, debt service requirements, strategic initiatives or other purposes;
•
make it more difficult for us to satisfy our obligations with respect to our indebtedness, and any failure to comply with the obligations of any of our debt instruments, including restrictive covenants and borrowing conditions, could result in an event of default under the indenture and the agreements governing other indebtedness;
•
require us to dedicate a substantial portion of our cash flow from operations to the repayment of our indebtedness, thereby reducing funds available to us for other purposes;
•
limit our flexibility in planning for, or reacting to, changes in our operations or business;
•
make us more highly leveraged than some of our competitors, which may place us at a competitive disadvantage;
•
impact our rent expense on leased space, which could be significant;
•
make us more vulnerable to downturns in our business or the economy;
•
restrict us from making strategic acquisitions, engaging in development activities, introducing new technologies, or exploiting business opportunities;
•
cause us to make non-strategic divestitures; and
•
expose us to the risk of increased interest rates, as certain of our borrowings are at variable rates of interest.
In addition, our credit agreement contains restrictive covenants that will limit our ability to engage in activities that may be in our long-term best interest. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of substantially all of our indebtedness.
We may be able to incur substantial additional indebtedness in the future, subject to the restrictions contained in our revolving credit facility. If new indebtedness is added to our current debt levels, the related risks described above could intensify.
We may not be able to generate sufficient cash to service all of our indebtedness, and we may be forced to take other actions to satisfy our obligations under our indebtedness that may not be successful.
Our ability to pay principal and interest on our debt obligations will depend upon, among other things, (a) our future financial and operating performance (including the realization of any cost savings described herein), which will be affected by prevailing economic, industry and competitive conditions and financial, business, legislative, regulatory and other factors, many of which are beyond our control; and (b) our future ability to borrow under our revolving credit facility, the availability of which depends on, among other things, our complying with the covenants in the credit agreement governing such facility.
19
We cannot assure you that our business will generate cash flow from operations, or that we will be able to draw under our revolving credit facility or otherwise, in an amount sufficient to fund our liquidity needs, including the payment of principal and interest on our debt. If our cash flows and capital resources are insufficient to service our indebtedness, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital, or restructure or refinance our indebtedness, including the senior notes (as defined in “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition, Liquidity and Capital Resources - Debt Financing”). These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, the terms of existing or future debt agreements may restrict us from adopting some of these alternatives. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. We may not be able to consummate those dispositions for fair market value or at all. Furthermore, any proceeds that we could realize from any such dispositions may not be adequate to meet our debt service obligations then due. Apollo and its affiliates have no future obligation to provide us with debt or equity financing. Our inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our indebtedness on commercially reasonable terms or at all, could have a material adverse effect on our business, results of operations, and financial condition, and could negatively impact our ability to satisfy our debt obligations.
If we cannot make scheduled payments on our indebtedness, we will be in default, and holders of our senior notes could declare all outstanding principal and interest to be due and payable, the lenders under the secured credit facilities could terminate their commitments to loan money, our secured lenders could foreclose against the assets securing their loans, and we could be forced into bankruptcy or liquidation.
ITEM 1B. Unresolved Staff Comments.
None.
ITEM 2. Properties.
Chuck E. Cheese’s and Peter Piper Pizza venues are typically located in densely populated locations and are predominantly situated in shopping centers or in free-standing buildings near shopping centers. On average, Chuck E. Cheese’s
20
existing venues are approximately 12,700 square feet, with table and chair seating generally averaging between 400 to 450 guests per venue, and include approximately 75 games, rides and attractions. On average, Peter Piper Pizza existing venues are approximately 10,100 square feet, with table and chair seating generally averaging between 350 to 400 guests per venue, and include approximately 40 games, rides and attractions.
The following tables summarize information regarding the number and location of venues we and our franchisees operated as of December 30, 2018:
Domestic
Company-operated venues
Franchised venues
Total
Chuck E. Cheese’s
504
26
530
Peter Piper Pizza
39
61
100
Total domestic
543
87
630
International
Chuck E. Cheese’s
11
65
76
Peter Piper Pizza
—
44
44
Total international
11
109
120
Total venues in operation
554
196
750
21
Domestic
Company- Owned venues
Franchised venues
Total
Alabama
8
1
9
Alaska
1
—
1
Arizona
33
15
48
Arkansas
6
—
6
California
81
4
85
Colorado
9
—
9
Connecticut
4
—
4
Delaware
2
—
2
Florida
33
—
33
Georgia
15
—
15
Hawaii
—
3
3
Idaho
1
—
1
Illinois
21
—
21
Indiana
13
—
13
Iowa
4
—
4
Kansas
4
—
4
Kentucky
5
—
5
Louisiana
10
2
12
Maryland
14
—
14
Massachusetts
10
—
10
Michigan
16
—
16
Minnesota
8
—
8
Mississippi
3
2
5
Missouri
8
—
8
Montana
—
1
1
Nebraska
2
—
2
Nevada
8
—
8
New Hampshire
1
—
1
New Jersey
14
—
14
New Mexico
7
3
10
New York
21
—
21
North Carolina
13
2
15
North Dakota
—
1
1
Ohio
19
1
20
Oklahoma
6
—
6
Oregon
1
2
3
Pennsylvania
20
—
20
Rhode Island
1
—
1
South Carolina
7
—
7
South Dakota
2
—
2
Tennessee
12
—
12
Texas
66
46
112
Utah
2
—
2
Virginia
12
3
15
Washington
10
1
11
West Virginia
1
—
1
Wisconsin
9
—
9
Total domestic
543
87
630
22
International
Company- Owned venues
Franchised venues
Total
Canada
11
—
11
Chile
—
7
7
Colombia
—
2
2
Costa Rica
—
1
1
Guam
—
1
1
Guatemala
—
2
2
Honduras
—
2
2
Mexico
—
63
63
Panama
—
2
2
Peru
—
3
3
Puerto Rico
—
3
3
Trinidad
—
2
2
Saudi Arabia
—
18
18
United Arab Emirates
—
3
3
Total international
11
109
120
Total venues in operation
554
196
750
Company-operated Venue Leases
Of the 515 Company-operated Chuck E. Cheese’s venues as of December 30, 2018, nine are owned premises and 506 are leased. All of the 39 Company-operated Peter Piper Pizza venues as of December 30, 2018 are leased premises.
The terms of our venue leases vary in length from lease to lease, although generally a lease provides for an initial primary term of 10 years, with two additional five-year options to renew. As of December 30, 2018, seven of our leases were month-to-month and 37 of our leases were set to expire in 2019. Of those set to expire in 2019, 12 have no available renewal options and the remainder have available renewal options expiring between 2020 and 2039. Our remaining leases are set to expire at various dates through 2037, with available renewal options that expire at various dates through 2054.
These leases generally require us to pay the cost of repairs, other maintenance costs, insurance and real estate taxes and, in some instances, may provide for additional rent equal to the amount by which a percentage of revenues exceed the minimum rent. It is common for us to take possession of leased premises prior to the commencement of rent payments for the purpose of constructing leasehold improvements.
Corporate Offices and Warehouse Facilities
We lease 55,257 square feet of space in an office building in Irving, Texas, which serves as our corporate office and support services center. This lease expires in July 2026 with options to renew through July 2036. Peter Piper Pizza leased a 5,243 square foot office building in Phoenix, Arizona through September 2018, which served primarily as its corporate office. Upon expiration of the lease in September 2018, we relocated our Peter Piper Pizza corporate office to an adjoining office space located at a Peter Piper Pizza venue in Phoenix, Arizona. We also lease a 166,432 square foot warehouse building in Topeka, Kansas, which primarily serves as a storage, distribution and refurbishing facility for our venue fixtures and game equipment. The lease expires in August 2024 with options to renew through August 2034.
ITEM 3. Legal Proceedings.
From time to time, we are involved in various inquiries, investigations, claims, lawsuits and other legal proceedings that are incidental to the conduct of our business. These matters typically involve claims from customers, employees or other third parties involved in operational issues common to the retail, restaurant and entertainment industries. Such matters typically represent actions with respect to contracts, intellectual property, taxation, employment, employee benefits, personal injuries and other matters. A number of such claims may exist at any given time, and there are currently a number of claims and legal proceedings pending against us.
In the opinion of our management, after consultation with legal counsel, the amount of 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, LLC 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”). The Consolidated Class Action Petition alleges that CEC Entertainment’s directors breached their fiduciary duties to CEC Entertainment’s stockholders in connection with their consideration and approval of the Merger Agreement by, among other things, conducting a deficient sales process, agreeing to an inadequate tender price, agreeing to certain provisions in the Merger Agreement, and filing materially deficient disclosures regarding the transaction. The Consolidated Class Action Petition also alleges that two members of CEC Entertainment’s board who also served as the senior managers of CEC Entertainment had material conflicts of interest and that Goldman Sachs aided and abetted the board’s breaches as a result of various conflicts of interest facing the bank. The Consolidated Class Action Petition seeks, among other things, to recover damages, attorneys’ fees and costs. The Company assumed the defense of the Consolidated Shareholder Litigation on behalf of CEC’s named former directors and Goldman Sachs pursuant to existing indemnity agreements. On March 23, 2016, the Court conducted a hearing on the defendants’ Motion to Dismiss the Consolidated Class Action Petition and on March 1, 2017, the Special Master appointed by the Court issued a report recommending to the Court that the Consolidated Class Action Petition be dismissed. On September 9, 2018, the Court accepted the Special Master’s recommendations and dismissed the lawsuit in its entirety. On October 8, 2018, the Plaintiff in the Consolidated Shareholder Litigation filed a notice of appeal of the District Court’s decision. While no assurance can be given as to the ultimate outcome of the consolidated matter, we currently believe that the final resolution of the action will not have a material adverse effect on our results of operations, financial position, liquidity or capital resources.
ITEM 4. Mine Safety Disclosures.
None.
23
PART II
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information and Dividends
As of December 30, 2018, all of our outstanding common stock was privately held and there was no established public trading market for our common stock.
We did not declare any dividends in 2016, 2017, and 2018.
Our ability to pay and declare dividends is restricted by our secured credit facilities and senior notes. See further discussion of the secured credit facilities and senior notes in Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition, Liquidity and Capital Resources - Debt Financing” and Part II, Item 8. “Financial Statements and Supplementary Data - Note 10. Indebtedness and Interest Expense” of this Annual Report on Form 10-K. See Part I, Item 1A. “Risk Factors” for a discussion of factors that might affect our financial performance and compliance with debt covenants, including covenants that affect our ability to pay dividends.
Issuer Purchases of Equity Securities
There were no repurchases of our common stock during Fiscal 2018.
24
ITEM 6. Selected Financial Data.
The following selected financial data presented below should be read in conjunction with Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements included in Part II, Item 8. “Financial Statements and Supplementary Data” (in thousands, except percentages and venue number amounts):
Fiscal Year 2018
Fiscal Year 2017
Fiscal Year 2016
Fiscal Year 2015 (1)
For the 317 Day Period Ended December 28, 2014 (6)
For the 47 Day Period Ended February 14, 2014 (7)
Successor (7)
Successor (7)
Successor (7)
Successor (7)
Successor (7)
Predecessor (7)
(in thousands, except percentages and venue number amounts)
Statements of Earnings Data:
Company venue sales
$
875,334
$
868,888
$
905,314
$
905,110
$
712,098
$
113,556
Total revenues
$
896,066
$
886,771
$
923,653
$
922,589
$
718,581
$
114,243
Operating income (loss)
$
50,801
$
47,890
$
61,452
$
55,131
$
(32,259
)
$
2,873
Interest expense
$
76,283
$
69,115
$
67,745
$
70,582
$
60,952
$
1,151
Income taxes
$
(5,021
)
$
(74,291
)
$
(2,626
)
$
(2,941
)
$
(31,123
)
$
1,018
Net income (loss)
$
(20,461
)
$
53,066
$
(3,667
)
$
(12,510
)
$
(62,088
)
$
704
Statement of Cash Flow Data:
Operating activities
$
86,790
$
104,297
$
118,955
$
100,613
$
48,091
$
22,314
Investing activities
$
(79,284
)
$
(93,712
)
$
(98,439
)
$
(78,191
)
$
(1,124,285
)
$
(9,659
)
Financing activities
$
(11,547
)
$
(5,030
)
$
(10,095
)
$
(81,599
)
$
1,168,448
$
(13,844
)
Non-GAAP Financial Measures:
Adjusted EBITDA (3)
$
175,166
$
180,800
$
207,924
$
220,936
$
170,456
$
24,967
Adjusted EBITDA Margin (4)
19.5
%
20.4
%
22.5
%
23.9
%
23.7
%
21.9
%
Venue-level Data:
Number of venues (end of period):
Company-operated
554
562
559
556
559
NM
Franchised
196
192
188
176
172
NM
750
754
747
732
731
NM
Comparable venues (end of period) (2)
526
531
529
489
485
NM
Comparable venue sales change (2)
(0.0
)%
(4.8
)%
2.8
%
(0.4
)%
NM
NM
As of
As of
As of
As of
As of
As of
December 30, 2018
December 31, 2017
January 1, 2017
December 28, 2015
December 28, 2014
February 14, 2014
Balance Sheet Data:
Total assets
$
1,666,165
$1,695,044
$1,710,112
$1,733,035
$1,836,113
NM
Total debt (5)
982,121
986,419
989,948
994,448
999,783
NM
Stockholders’ equity
242,571
262,148
206,005
208,546
292,586
NM
Dividends declared
—
—
—
70,000
—
—
_______________________
(1)
We operate on a 52 or 53 week fiscal year ending on the Sunday nearest December 31. Fiscal year 2015 was 53 weeks in length, which resulted in our fourth quarter consisting of 14 weeks. All other fiscal years presented were 52 weeks.
25
(2)
We define “comparable venue sales” as sales for our domestic owned company-operated venues that have been open for more than 18 months as of the beginning of each respective fiscal year or for 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-owned 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. We define “comparable venue sales change” as the percentage change in comparable venue sales for each respective period. We believe comparable venue sales change to be a key performance indicator within our industry; it is a critical factor in evaluating our performance, as it is indicative of acceptance of our strategic initiatives and local economic and consumer trends. Our comparable venue sales for Fiscal 2015, and the Successor 2014 period exclude the Peter Piper Pizza venues that were acquired in October 2014 as we had operated them for less than 12 months at the beginning of each respective fiscal year. As a result of the 53 week fiscal year in 2015, our 2016 fiscal year began one calendar week later than our 2015 fiscal year. . The comparable venue sales change in the table above is presented on a calendar week basis, excluding the additional week of operations in 2015. On a fiscal basis, excluding the additional week of operations in 2015, comparable venue sales change would have been 3.0% in 2016.
(3)
For our definition of Adjusted EBITDA, see the “Non-GAAP Financial Measures” section below.
(4)
Adjusted EBITDA Margin is defined by us as Adjusted EBITDA as a percentage of Total revenues.
(5)
Total debt includes our senior notes, our outstanding borrowings under the term loan facility and the revolving credit facility, net of deferred financing costs, capital leases, and the Predecessor Facility.
(6)
Results for the Successor 2014 period include the revenues and expenses for Peter Piper Pizza for the 73 day period from October 17, 2014 through December 28, 2014.
(7)
As a result of the Merger, we applied the acquisition method of accounting and established a new basis of accounting on February 15, 2014. The period presented for the period December 29, 2013 through February 14, 2014 represent the operations of the predecessor company (“Predecessor”) and the periods presented after February 14, 2014 represent the operations of the successor company (“Successor”). The financial results for the period December 29, 2013 through February 14, 2014 represent the 47 day Predecessor period.
Non-GAAP Financial Measures
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, unrealized gains and losses on foreign exchange, and stock based compensation. In addition, Adjusted EBITDA excludes other items we consider unusual or non-recurring and 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 Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - 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 the annualized full year effect of Company-operated and franchised venues that were opened and closed during the year. 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 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.
26
The following table sets forth a reconciliation of net income (loss) to Adjusted EBITDA and Adjusted EBITDA Margin for the periods presented:
Fiscal 2018
Fiscal 2017
Fiscal 2016
Fiscal 2015 (1)
For the 317 Day Period Ended December 28, 2014
For the 47 Day Period Ended February 14, 2014
Successor
Successor
Successor
Successor
Successor
Predecessor
(in thousands, except percentages)
Total revenues
$
896,066
$
886,771
$
923,653
$
922,589
$
718,581
$
114,243
Net income (loss) as reported
$
(20,461
)
$
53,066
$
(3,667
)
$
(12,510
)
$
(62,088
)
$
704
Interest expense
76,283
69,115
67,745
70,582
60,952
1,151
Income tax expense (benefit)
(5,021
)
(74,291
)
(2,626
)
(2,941
)
(31,123
)
1,018
Depreciation and amortization
100,720
109,771
119,569
119,294
118,556
9,883
Non-cash impairments, gain or loss on disposal (2)
10,371
9,241
10,070
8,934
9,841
294
Unrealized gain on foreign exchange (3)
1,255
—
—
—
—
—
Non-cash stock-based compensation (4)
324
606
689
838
703
12,639
Rent expense book to cash (5)
6,982
5,655
7,852
9,100
10,665
(1,190
)
Franchise revenue, net cash received (6)
1,632
—
113
1,217
2,585
—
Impact of purchase accounting (7)
—
817
1,380
995
1,496
—
Venue pre-opening costs (8)
183
904
1,591
792
1,166
131
One-time and unusual items (9)
2,898
5,916
5,146
22,448
55,060
(165
)
Cost savings initiatives (10)
—
—
62
2,187
2,643
502
Adjusted EBITDA (11)
$
175,166
$
180,800
$
207,924
$
220,936
$
170,456
$
24,967
Adjusted EBITDA Margin
19.5
%
20.4
%
22.5
%
23.9
%
23.7
%
21.9
%
__________________
(1)
We operate on a 52 or 53 week fiscal year ending on the Sunday nearest December 31. Fiscal year 2015 was 53 weeks in length, which resulted in our fourth quarter consisting of 14 weeks. All other fiscal years presented were 52 weeks.
(2)
Relates primarily to (i) the impairment of Company-operated venues or impairments of long lived assets; (ii) gains or losses upon disposal of property or equipment; and (iii) inventory obsolescence charges in 2015 outside of the ordinary course of business.
(3)
Relates to unrealized gains on the revaluation of our indebtedness with our Canadian subsidiary. Effective January 1, 2018, we no longer consider undistributed income from our Canadian subsidiary to be permanently invested.
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 landlords incentives and allowances in the period in which it was received.
(6)
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.
(7)
Represents revenue related to unearned gift cards and unearned franchise fees that were removed in purchase accounting, and therefore were not recorded as revenue.
(8)
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.
(9)
Represents non-recurring income and expenses primarily related to (i) accounting, investment banking, legal and other costs incurred in connection with the Merger, the sale leaseback transaction we completed on August 25, 2014 and the acquisition of Peter Piper Pizza (“PPP Acquisition”); (ii) severance expense, executive termination benefits and executive search fees; (iii) one-time integration costs, including consulting fees, accounting service fees, IT system integration costs and travel expenses incurred in connection with the integration of Peter Piper Pizza; (iv) legal fees, claims and settlements related to litigation in respect of the Merger; (v) legal claims and settlements related to employee class action lawsuits and settlements; (vi) one-time costs incurred in connection with the 2015 relocation of our corporate offices; (vii) cash landlord incentives received in 2015 on our new corporate offices; (viii) sales and use tax refunds that relate to prior periods; (ix) professional fees incurred in connection with one-time strategic corporate and tax initiatives, such as accounting and consulting service fees incurred to obtain sale and use tax refunds from prior periods, to enhance transfer pricing and implement Play Pass, initial fees incurred in connection with the overseas outsourcing of our accounts payable and payroll functions, and costs related to the transition in 2015 to new advertising agencies whereby we were under contract for duplicate advertising costs for a period of time; (x) removing the initial recognition of gift card breakage revenue related to prior years on unredeemed Chuck E. Cheese's gift card balances sold by third parties; (xi) removing insurance recoveries relating to prior year business interruption losses at certain v
27
enues, primarily relating to natural disasters, fires and floods; (xii) removing proceeds received related to the early termination of a venue lease by the property landlord pursuant to a decision by the landlord to demolish the shopping mall where the venue was located; (xiii) one-time costs related to the early termination of a supplier contract in connection with the transition to a new supplier; (xiv) one-time training and travel-related costs incurred in connection with training venue employees in connection with the implementation of our Play Pass initiative and the re-imaging effort of the venues in our Chuck E. Cheese portfolio; (xv) one-time marketing expenses related to the grand openings of our re-imaged Chuck E. Cheese venues; and (xv) non-recoverable account balances written off outside of the ordinary course of business.
(10)
Relates to estimated net cost savings primarily from (i) cost savings related to our change from public to private ownership and the elimination of public equity securities upon the closing of the Merger, including reductions in investor relations activities, directors fees, and certain legal and other securities and filing costs; (ii) estimated full-year effect of venue-level cost savings initiatives implemented in 2013, such as the installation of advanced thermostat systems, the replacement of helium-filled balloons with table top balloons, the consolidation of parts suppliers, and the increase in tickets required to redeem prizes; (iii) estimated effect of cost savings following the Merger from participation in Sponsor-leveraged purchasing programs, including various supplies, travel, and communications purchasing categories; (iv) labor cost savings associated with the elimination of certain management positions in connection with the Merger; (v) the full period impact of reduced occupancy costs associated with the relocation of our corporate offices in 2015; (vi) estimated cost savings associated with the integration of Peter Piper Pizza following its acquisition in October 2014, including labor cost savings associated with headcount reductions implemented in 2015; (vii) the full year effect of cost savings associated with upgrades to our telephone communication systems in 2015; and (viii) the estimated incremental costs associated with the new ERP system we implemented at the beginning of Fiscal 2015, net of system optimization costs, and post-Merger insurance arrangements.
(11)
With the continued evolution of our games business from tokens to game play credits and now towards time-based play packages following the implementation of All You Can Play (“AYCP”) in Fiscal 2018, the impact on our financial results of the fluctuation of the deferred revenue liability related to unused credits on Play Pass cards begins to lessen in importance in understanding our Adjusted EBITDA. Customers continue to see the value of time based play and game play credits continue to decline as a percentage of overall game play. As a result, the change in the deferred revenue liability relating to unused Play Pass cards has been removed from Adjusted EBITDA for all periods presented.
28
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
As used in this report, the terms “CEC Entertainment,” “CEC”, 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 our Consolidated Financial Statements and related notes included in Part II, Item 8. “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.
Our MD&A includes the following sub-sections:
•
Presentation of Operating Results;
•
Executive Summary;
•
Key Measures 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;
•
Inflation;
•
Critical Accounting Policies and Estimates; and
•
Recently Issued Accounting Guidance.
Presentation of Operating Results
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. The fiscal years ended December 30, 2018, December 31, 2017 and January 1, 2017 each consisted of 52 weeks. References to 2018, 2017 and 2016 are for the fiscal years ended December 30, 2018, December 31, 2017 and January 1, 2017, respectively.
Executive Summary
General
We develop, operate and franchise family entertainment and dining centers (also referred to as “venues”) under the names “Chuck E. Cheese's” (“Where A Kid Can Be A Kid”) and “Peter Piper Pizza” (“The Solution to the Family Night Out”). 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 new selection of sophisticated options for adults. We operate 554 venues and have an additional 196 venues operating under franchise arrangements across 47 states and 14 foreign countries and territories as of December 30, 2018.
29
The following table summarizes information regarding the number of Company-operated and franchised venues for the periods presented:
Twelve Months Ended
December 30, 2018
December 31, 2017
January 1, 2017
Number of Company-operated venues:
Beginning of period
562
559
556
New
1
6
6
Acquired from franchisee
—
2
—
Closed
(9
)
(5
)
(3
)
End of period
554
562
559
Number of franchised venues:
Beginning of period
192
188
176
New
8
8
16
Acquired from franchisee
—
(2
)
—
Closed
(4
)
(2
)
(4
)
End of period
196
192
188
Total number of venues:
Beginning of period
754
747
732
New
9
14
22
Closed
(13
)
(7
)
(7
)
End of period
750
754
747
__________________
(1)
The number of new and closed Company-operated and Total venues during 2018 included one venue that was relocated.
Our Strategic Plan
Our strategic plan is focused on increasing comparable venue sales, improving profitability and growing new venues domestically and internationally. See discussion of our strategic plan included in Part I, Item 1. “Business - Our Strategic Plan.”
Key Measures 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 for 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. We define “comparable venue sales change” as the percentage change in comparable venue sales for each respective fiscal year. 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.
Average Sales per Comparable Venue. Average sales per comparable venue is calculated based on the average annual sales of our comparable venue base. Average sales per comparable venue cannot be used to compute year-over year comparable venue sales increases or decreases due to the change in the comparable venue base.
Fiscal Year Ended
December 30, 2018
December 31, 2017
January 1, 2017
(in thousands, except venue number amounts)
Average sales per comparable venue
$
1,587
$
1,561
$
1,636
Number of venues included in our comparable venue base
526
531
529
30
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 other adjustments required or permitted in calculating covenant compliance under the indenture governing our senior notes and/or secured credit facilities. 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, game-play credits, unlimited game-play time blocks, 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 revenues from the sale of equipment and other items or services to franchisees. Historically, we recognized development and franchise fees as revenues when the franchise venue had opened and we had substantially completed our obligations to the franchisee relating to the opening of a venue. Effective January 1, 2018, with the adoption of Accounting Standards Update 2016-10 Revenues from Contracts with Customers (Topic 606) (“ASU 606”), 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. In addition, our national advertising fund receipts from members of the Association are now accounted for on a gross basis as revenue from franchisees, when historically they have been netted against advertising expense.
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 prizes provided and merchandise sold to our customers, and the cost of Play Pass and AYCP cards and writsbands, as well as the cost of tickets dispensed to customers;
•
Labor expenses consist of salaries and wages, bonuses, related payroll taxes and benefits for venue personnel;
•
Rent expense includes lease costs for Company-operated venues, excluding common occupancy costs (e.g., common area maintenance (“CAM”) charges and property taxes); and
•
Other venue operating expenses primarily include utilities, repair and maintenance costs, liability and property insurance, CAM charges, property taxes, credit card processing fees, licenses, preopening expenses, venue asset disposal gains and losses and all other costs directly related to the operation of a venue.
“Cost of food and beverage” and “Cost of entertainment and merchandise” mentioned above, as a percentage of company venue sales, are influenced both by the cost of products and the overall mix of our Package Deals and coupon offerings. “Entertainment and merchandise sales” have higher margins than “Food and beverage sales.”
31
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. Historically, prior to the adoption of ASU 606 on January 1, 2018, advertising expense was partially offset by contributions from our franchisees. Contributions from franchisees are now recognized as revenue from franchisees.
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 directly related to our Company-operated venues’ property and equipment, including leasehold improvements, game and ride equipment, furniture, fixtures and other equipment, and depreciation and amortization of corporate assets and intangibles.
Asset impairments. Asset impairments represent non-cash charges to reduce the carrying amount of certain long-lived assets within our venues to their estimated fair value, when a venue’s operation is not expected to generate sufficient projected future cash flows to recover the current net book value of the long-lived assets within the venue. We believe our assumptions in calculating the fair value of our long-lived assets are similar to those used by other marketplace participants.
Results of Operations
The following table summarizes our principal sources of Total company venue sales expressed in dollars and as a percentage of Total company venue sales for the periods presented:
Fiscal Year Ended
December 30, 2018
December 31, 2017
January 1, 2017
(in thousands, except percentages)
Food and beverage sales
$
396,658
45.3
%
$
410,609
47.3
%
$
415,059
45.8
%
Entertainment and merchandise sales
478,676
54.7
%
458,279
52.7
%
490,255
54.2
%
Total company venue sales
$
875,334
100.0
%
$
868,888
100.0
%
$
905,314
100.0
%
32
The following table summarizes our revenues and expenses expressed in dollars and as a percentage of Total revenues (except as otherwise noted) for the periods presented:
Fiscal Year Ended
December 30, 2018
December 31, 2017
January 1, 2017
(in thousands, except percentages)
Total company venue sales
$
875,334
97.7
%
$
868,888
98.0
%
$
905,314
98.0
%
Franchise fees and royalties
20,732
2.3
%
17,883
2.0
%
18,339
2.0
%
Total revenues
896,066
100.0
%
886,771
100.0
%
923,653
100.0
%
Company venue operating costs (excluding Depreciation and amortization):
Cost of food and beverage (1)
94,319
23.8
%
97,570
23.8
%
104,315
25.1
%
Cost of entertainment and merchandise (2)
36,650
7.7
%
29,948
6.5
%
32,014
6.5
%
Total cost of food, beverage, entertainment and merchandise (3)
130,969
15.0
%
127,518
14.7
%
136,329
15.1
%
Labor expenses (3)
256,327
29.3
%
248,061
28.5
%
251,426
27.8
%
Rent expense (3)
96,484
11.0
%
95,917
11.0
%
96,006
10.6
%
Other venue operating expenses (3)
150,255
17.2
%
149,462
17.2
%
148,869
16.4
%
Total Company venue operating costs (3)
634,035
72.4
%
620,958
71.5
%
632,630
69.9
%
Other costs and expenses:
Advertising expense
48,198
5.4
%
48,379
5.5
%
46,142
5.0
%
General and administrative expenses
54,850
6.1
%
56,482
6.4
%
61,011
6.6
%
Depreciation and amortization
100,720
11.2
%
109,771
12.4
%
119,569
12.9
%
Transaction, severance and related litigation costs
527
0.1
%
1,448
0.2
%
1,299
0.1
%
Asset impairments
6,935
0.8
%
1,843
0.2
%
1,550
0.2
%
Total operating costs and expenses
845,265
94.3
%
838,881
94.6
%
862,201
93.3
%
Operating income
50,801
5.7
%
47,890
5.4
%
61,452
6.7
%
Interest expense
76,283
8.5
%
69,115
7.8
%
67,745
7.3
%
Loss before income taxes
$
(25,482
)
(2.8
)%
$
(21,225
)
(2.4
)%
$
(6,293
)
(0.7
)%
__________________
(1)
Percent amount expressed as a percentage of Food and beverage sales.
(2)
Percent amount expressed as a percentage of Entertainment and merchandise sales.
(3)
Percent amount expressed as a percentage of Company 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.
33
Fiscal 2018 Compared to Fiscal 2017
Revenues
Company venue sales were $875.3 million and $868.9 million for Fiscal 2018 and Fiscal 2017, respectively. The increase in Company venue sales was primarily attributable to the favorable impact of approximately $6.6 million in net breakage related to Play Pass for Fiscal 2018 compared to $2.2 million of net deferral for Fiscal 2017. The favorable impact of the reduction in deferred revenue related to Play Pass was partially offset by a $3.6 million decrease in revenue due to temporary venue closures, and a $2.6 million net decrease in revenue from venues closed in Fiscal 2018 and 2017.
Franchise fees and royalties increased from $17.9 million to $20.7 million primarily due to the impact of new revenue recognition guidance in 2018 which resulted in $3.5 million of national advertising fund contributions from franchisees being recorded as revenue, rather than netted against advertising expense (see “Advertising Expense” below), partially offset by a $0.3 million decrease in revenue recognized from franchise and development fee agreements which as a result of the new revenue recognition guidance are now recognized on a straight-line basis over the life of the related franchise agreement beginning at the time a new franchised location is opened. Historically we recognized revenue from initial franchise and development fees upon the opening of a franchised location. Additionally, Franchise fees and royalties were impacted by a $0.3 million reduction in revenue from the shipment of games to franchisees.
Company Venue Operating Costs
The cost of food, beverage, entertainment and merchandise, as a percentage of Total company venue sales, was 15.0% and 14.7% for Fiscal 2018 and Fiscal 2017, respectively, as a sales shift towards higher margin entertainment and merchandise sales from food and beverage sales was offset by an increase in redemptions for merchandise, primarily related to the impact of More Tickets, one of the new initiatives launched by the Company in 2018.
The cost of food and beverage as a percentage of food and beverage sales, was 23.8% for both Fiscal 2018 and Fiscal 2017, as a change in sales mix and increased beverage costs in 2018 offset favorability in commodity prices and volume, primarily related to cheese and pepperoni compared to 2017.
The cost of entertainment and merchandise, as a percentage of Entertainment and merchandise sales, was 7.7% and 6.5% for Fiscal 2018 and Fiscal 2017, respectively. The cost of entertainment and merchandise, as a percentage of Entertainment and merchandise in 2018 compared to 2017 primarily reflects a combination of the impact of AYCP and More Tickets which were launched nationally during the third quarter of 2018. Also impacting the cost of entertainment and merchandise, as a percentage of Entertainment and merchandise sales, was an increase in Play Pass related supplies such as cards and wristbands, as a result of Play Pass being deployed to all of our Company-operated venues in 2018 compared to 268 at the beginning of 2017.
Labor expenses, as a percentage of Total company venue sales, were 29.3% and 28.5% for Fiscal 2018 and Fiscal 2017, respectively. Increased minimum wage rates in several states fully offset a decrease in labor hours in Fiscal 2018 compared to Fiscal 2017. Our sales per man hour improved approximately 1.7% in Fiscal 2018 from Fiscal 2017.
Other venue operating expenses, as a percentage of Total company venue sales, were flat at 17.2% for both Fiscal 2018 and Fiscal 2017. Fiscal 2018 reflects higher property taxes and common area and utility costs, as well as expenses related to the production and deployment of new menu boards and panels in connection with the launch of AYCP. Fiscal 2017 reflects losses incurred in connection with Hurricanes Harvey and Irma, as well as higher IT and technology support costs related primarily to the completion in 2017 of the deployment of Play Pass in all of our domestic Company-owned venues.
Advertising Expense
Advertising expense was $48.2 million and $48.4 million for Fiscal 2018 and Fiscal 2017, respectively. Advertising expense for Fiscal 2018 was impacted by the adoption of a new revenue recognition standard effective January 1, 2018 that requires us to account for our national advertising fund contributions as revenues, rather than netted against Advertising expense. Including the impact of netting national advertising fund revenues against Advertising expense, Advertising expense for Fiscal 2018 would have been $45.0 million (see “Revenues” above). Advertising expense for Fiscal 2018 reflects a decrease in national media costs and local venue marketing, as well as a decrease in advertising for our Peter Piper Pizza venues as we shifted away from television and print advertising to digital advertising.
34
General and Administrative Expenses
General and administrative expenses were $54.9 million and $56.5 million for Fiscal 2018 and Fiscal 2017, respectively. The decrease in General and administrative expenses is primarily due to cost savings initiatives implemented in 2018 and a decrease in labor related litigation, partially offset by an increase in incentive compensation as a result of improved operating results in the latter part of the year.
Depreciation and Amortization
Depreciation and amortization was $100.7 million and $109.8 million for Fiscal 2018 and Fiscal 2017, respectively. The decrease in depreciation and amortization is primarily due to the impact of certain property plant and equipment having reached the end of their depreciable lives, and impairments recorded on certain venues.
Transaction, Severance and Related Litigation Costs
Transaction, severance and related litigation costs were $0.5 million and $1.4 million for Fiscal 2018 and Fiscal 2017, respectively. The Transaction, severance and related litigation costs for Fiscal 2018 and Fiscal 2017 relate primarily to $0.3 million and $1.0 million, respectively, in legal fees and settlements incurred in connection with Merger related litigation, and severance payments of $0.2 million and $0.5 million, respectively.
Asset Impairments
In Fiscal 2018, we recognized an asset impairment charge of $6.9 million primarily related to eight venues. In Fiscal 2017 we recognized an asset impairment charge of $1.8 million primarily related to five venues, of which two were previously impaired. We continue to operate all but two of these venues. The impairment charges were based on the determination that the financial performance of these venues was adversely impacted by various competitive and economic factors in the market in which the venues are located.
Interest Expense
Interest expense was $76.3 million and $69.1 million for Fiscal 2018 and Fiscal 2017, respectively. Our weighted average effective interest rate 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 6.4% and 5.6% for Fiscal 2018 and Fiscal 2017, respectively.
Income Taxes
Our effective income tax rates for Fiscal 2018 and Fiscal 2017 were 16.9% and 36.0%, respectively (excluding the adjustment to our deferred tax liability resulting from the decrease in the federal income tax rate from 35% to 21% enacted on December 22, 2017, as part of the Tax Cuts and Jobs Act (the “TCJA”)). Our effective income tax rate for Fiscal 2018 was favorably impacted by employment-related federal income tax credits and 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 previously loaned to our Canadian subsidiary recorded in the first quarter, offset by:
(i) nondeductible litigation costs related to the Merger;
(ii) nondeductible penalties;
(iii) an increase in our state income tax expense for the year which in large part was caused by state tax legislation enacted during the second quarter that increased the amount of income subject to state taxation;
(iv) foreign income taxes withheld (not offset by foreign tax credits due to the foreign tax credit limitation);
(v) an increase in the reserve for uncertain tax positions, and
(vi) 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 Canadian operations that could expire before they are utilized.
Our effective income tax rate for Fiscal 2018 was also favorably impacted by adjustments to the provisional estimates provided in Fiscal 2017 to account for the impact of the TCJA pursuant to Staff Accounting Bulletin No. 118 (“SAB 118”). Under SAB 118, we included a provisional estimate of $66.6 million tax benefit in our consolidated financial statements for the fiscal year ended December 31, 2017, relating to the enactment of TJCA, which primarily related to the re-measurement of our
35
deferred tax liability. In the second quarter of Fiscal 2018, we recorded an adjustment to the provisional estimate of $0.2 million tax benefit, and in the third quarter of Fiscal 2018, we recorded an incremental adjustment to the provisional estimate of $0.5 million tax benefit. The measurement period relating to the enactment of the TCJA ended during our fourth quarter, and the tax effects thereof have been completed as of the end of Fiscal 2018.
Fiscal 2017 Compared to Fiscal 2016
Revenues
Company venue sales were $868.9 million and $905.3 million for Fiscal 2017 and Fiscal 2016, respectively, the decrease was primarily attributable to a 4.8% decrease in comparable venue sales, offset partially by revenue from new venue openings. Company venue sales for Fiscal 2017 were also negatively impacted by an increase of approximately $2.2 million in Play Pass related deferred revenue compared to Fiscal 2016.
Franchise fees and royalties decreased from $18.3 million to $17.9 million due to a reduction in shipping revenue from the shipment of games to franchisees as a result of fewer unit openings in Fiscal 2017 compared to Fiscal 2016, offset partially by an increase in sales at our franchised units, and additional revenue from new franchise units opened in 2017, net of franchise units closed.
Company Venue Operating Costs
The cost of food, beverage, entertainment and merchandise, as a percentage of Total company venue sales, was 14.7% and 15.1% for Fiscal 2017 and Fiscal 2016, respectively, as food and beverage costs benefited from the implementation of our new inventory management system offset by higher Entertainment and merchandise costs related to an increase in Play Pass related supplies.
The cost of food and beverage as a percentage of Food and beverage sales, was 23.8% and 25.1% for Fiscal 2017 and Fiscal 2016, respectively. The decrease in the cost of food and beverage on a percentage basis in Fiscal 2017 was driven by benefits realized from the implementation of our inventory management system late in the third quarter of 2016, as well as price increases taken in our food and beverage menu in the fourth quarter of 2016, partially offset by an increase in our commodity prices, primarily cheese, pepperoni and chicken wings.
The cost of entertainment and merchandise, as a percentage of Entertainment and merchandise sales, was 6.5% for both Fiscal 2017 and Fiscal 2016. The cost of entertainment and merchandise, as a percentage of Entertainment and merchandise sales reflects an increase in Play Pass related supplies in 2017 as a result of Play Pass being deployed to more venues compared to 2016, and an increase in the amount of revenue deferred in connection with the implementation of our Play Pass card system. The cost of Entertainment and merchandise sales, excluding the impact of supplies and deferred revenue related to Play Pass, was 5.7% for Fiscal 2017 compared to 6.2% for Fiscal 2016.
Labor expenses were $248.1 million and $251.4 million for Fiscal 2017 and Fiscal 2016, respectively. A decease in labor hours as a result of lower sales volumes in Fiscal 2017 compared to Fiscal 2016 mostly offset increased minimum wage rates in several states.
Other venue operating expenses were $149.5 million and $148.9 million for Fiscal 2017 and Fiscal 2016, respectively, the increase was primarily due to losses incurred in connection with Hurricanes Harvey and Irma, and an increase in IT and technology support costs related primarily to the completion in 2017 of the deployment of Play Pass in all of our domestic Company-owned venues, partially offset by a decrease in start up and marketing costs related to new venue openings.
Advertising Expenses
Advertising expenses were $48.4 million and $46.1 million for Fiscal 2017 and Fiscal 2016, respectively. As a percentage of Total revenues, advertising expenses were 5.5% and 5.0%, respectively, for Fiscal 2017 and Fiscal 2016. Fiscal 2017 reflects an increase in radio advertising and digital and social media costs.
General and Administrative Expenses
General and administrative expenses were $56.5 million and $61.0 million for Fiscal 2017 and Fiscal 2016, respectively. General and administrative expenses in Fiscal 2017 reflect a decrease in incentive compensation as a result of lower sales and operating performance and a decrease in labor related litigation costs, partially offset by an increase in subscription service fees related to corporate IT initiatives.
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Depreciation and Amortization
Depreciation and amortization was $109.8 million and $119.6 million for Fiscal 2017 and Fiscal 2016, respectively. The decrease in depreciation and amortization is primarily due to the impact of certain property plant and equipment having reached the end of their depreciable lives.
Transaction, Severance and Related Litigation Costs
Transaction, severance and related litigation costs were $1.4 million and $1.3 million for Fiscal 2017 and Fiscal 2016, respectively. The Transaction, severance and related litigation costs for Fiscal 2017 and Fiscal 2016 relate primarily to $1.0 million and $1.2 million, respectively, in legal fees and settlements incurred in connection with Merger related litigation, and severance payments of $0.5 million and $0.1 million, respectively.
Interest Expense
Interest expense was $69.1 million and $67.7 million for Fiscal 2017 and Fiscal 2016, respectively. Our weighted average effective interest rate 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 5.6% and 5.5% for Fiscal 2017 and Fiscal 2016, respectively.
Income Taxes
Our effective income tax rate for Fiscal 2017, excluding the adjustment to our deferred taxes resulting from the enactment of the TCJA, was 36.0% as compared to 41.7% for Fiscal 2016. Our effective income tax rate for Fiscal 2017 differs from the statutory tax rate primarily due to the favorable impact of employment-related federal income tax credits which were partially offset by the true-up of the prior year’s estimate of employment-related tax credits versus actuals. Our effective income tax rate for Fiscal 2017 was negatively impacted by non-deductible litigation costs related to the Merger, non-deductible Canadian interest expense, and adjustments recorded in Fiscal 2017 to state tax credit carryforwards that we estimate will expire. In addition, our Fiscal 2017 effective income tax rate was favorably impacted by a reorganization of our Canadian structure, partially offset by the impact of a valuation allowance recorded in connection with our Canadian subsidiary.
The reduction in the federal corporate tax rate resulting from the TCJA significantly impacted our Fiscal 2017 income taxes. U.S. GAAP requires deferred tax assets and liabilities to be measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled, and further requires the effect of a change in tax law to be recorded discretely as a component of the income tax provision related to continuing operations in the period of enactment. This accounting requirement resulted in a $66.6 million nonrecurring reduction of our net deferred tax liability and a corresponding $66.6 million benefit to deferred federal income taxes.
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 becomes due;
•
frequent inventory turnover and the use of fresh ingredients results in a limited investment required in inventories; and
•
our accounts payable are generally due within five to 30 days.
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.
The following tables present summarized consolidated financial information that we believe is helpful in evaluating our liquidity and capital resources as of the periods presented:
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Fiscal Year Ended
December 30, 2018
December 31, 2017
January 1, 2017
(in thousands)
Net cash provided by operating activities
$
86,790
$
104,297
$
118,955
Net cash used in investing activities
(79,284
)
(93,712
)
(98,439
)
Net cash used in financing activities
(11,547
)
(5,030
)
(10,095
)
Effect of foreign exchange rate changes on cash
50
466
216
Change in cash and cash equivalents
$
(3,991
)
$
6,021
$
10,637
Cash paid for interest
$
72,966
$
64,675
$
64,614
Cash paid for income taxes, net
$
1,054
$
7,136
$
10,728
December 30, 2018
December 31, 2017
(in thousands)
Cash and cash equivalents
$
63,170
$
67,200
Restricted cash
$
151
$
112
Term loan facility
$
723,900
$
731,500
Senior notes
$
255,000
$
255,000
Net availability on undrawn revolving credit facility
$
141,000
$
140,100
Funds generated by our operating activities and available cash and cash equivalents continue to be our primary sources of liquidity. We believe these sources of liquidity will be sufficient to finance our strategic plan and capital initiatives for the next twelve months. However, in the event of a material decline in our sales trends or operating margins, there can be no assurance that we will generate sufficient cash flows at or above our current levels. Our revolving credit facility is also available for additional working capital needs and investment opportunities. Our ability to access our revolving credit facility is subject to our compliance with the terms and conditions of the credit agreement governing such facility, including our compliance with certain prescribed covenants, as more fully described below.
As of December 30, 2018, we had no borrowings outstanding and a $9.0 million of letter of credit issued but undrawn under the revolving credit facility, leaving $141.0 million in borrowing capacity under the revolving credit facility as of December 30, 2018. As of December 31, 2017, we had no borrowings outstanding and $9.9 million of letters of credit issued but undrawn under the revolving credit facility. On May 8, 2018 we extended the maturity on $95.0 million of the revolving credit facility through November 16, 2020 from February 14, 2019, whereas. The remaining $55 million matured on February 14, 2019.
Our primary uses for cash provided by operating activities relate to funding our ongoing business activities, planned capital expenditures, servicing our debt, and the payment of income taxes.
Our strategic plan does not require that we enter into any material development or contractual purchase obligations. Therefore, we have the flexibility necessary to manage our liquidity by promptly deferring or curtailing any planned capital spending.
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 elect to repurchase our outstanding debt, including repurchases of our senior notes, for cash through open market repurchases or privately negotiated transactions with certain of our debtholders, although there is no assurance we will do so.
Sources and Uses of Cash - Fiscal 2018 Compared to Fiscal 2017
Net cash provided by operating activities was $86.8 million in Fiscal 2018 and $104.3 million in Fiscal 2017. The decrease in net cash provided by operating activities is primarily due to a decrease an increase in our net loss, excluding the adjustment to our deferred taxes resulting from the enactment of the TCJA in Fiscal 2017, and fluctuations in working capital, partially offset by a reduction in income taxes receivable.
Net cash used in investing activities was $79.3 million in Fiscal 2018 and $93.7 million in Fiscal 2017. Net cash used in investing activities in Fiscal 2018 and Fiscal 2017 relates primarily to capital expenditures.
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Net cash used in financing activities was $11.5 million in Fiscal 2018 and primarily related to principal payments on our term loan and lease related obligations. Net cash used in financing activities of $5.0 million in Fiscal 2017 related primarily to principal payments on our term loan and lease related obligations, partially offset by sale leaseback proceeds of $4.1 million and a $1.4 million return of capital.
Sources and Uses of Cash - Fiscal 2017 Compared to Fiscal 2016
Net cash provided by operating activities was $104.3 million in Fiscal 2017 and $119.0 million in Fiscal 2016. The decrease in net cash provided by operating activities is primarily due to a decrease in net income, excluding the adjustment to our deferred taxes resulting from the enactment of the TCJA, and fluctuations in working capital.
Net cash used in investing activities was $93.7 million in Fiscal 2017 and $98.4 million in Fiscal 2016. Net cash used in investing activities in Fiscal 2017 and Fiscal 2016 relates primarily to capital expenditures.
Net cash used in financing activities was $5.0 million in Fiscal 2017 and related primarily to principal payments on our term loan and lease related obligations, partially offset by sale leaseback proceeds of $4.1 million and a $1.4 million return of capital. Net cash used in financing activities was $10.1 million in Fiscal 2016 and related primarily to principal payments on our term loan and lease related obligations.
Debt Financing
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”). 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 facility lenders: (a) with respect to each fiscal year (commencing with the fiscal year ending December 30, 2018), we are required to make a mandatory prepayment of term loan principal to the extent that 75% of our excess cash flow (as defined in the secured credit facilities agreement and subject to step-downs based on our net first lien senior secured leverage ratio) exceeds $10 million and any such required mandatory payment shall be reduced by any optional prepayments of principal that may have occurred during the fiscal year, and (b) we shall not incur additional first lien senior secured 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. All borrowings under our revolving credit facility are subject to the satisfaction of customary conditions, including the absence of a default and the accuracy of representations and warranties.
We may request one or more incremental term loan facilities and/or increase commitments under our revolving credit facility in an aggregate amount of up to the sum of (a) $200.0 million plus (b) such additional amount so long as, (i) in the case of loans under additional credit facilities that rank equally and without preference with the liens on the collateral securing the secured credit facilities, our consolidated net first lien senior secured leverage ratio would be no greater than 4.25 to 1.00 and (ii) in the case of loans under additional credit facilities that rank junior to the liens on the collateral securing the secured credit facilities, our consolidated total net secured leverage ratio would be no greater than 5.25 to 1.00, subject to certain conditions, and receipt of commitments by existing or additional lenders.
The secured credit facilities require scheduled quarterly payments on the term loan facility equal to 0.25% of the original principal amount of the term loan facility from July 2014 to December 2020, with the balance paid at maturity, February 14, 2021. We may voluntarily repay outstanding loans under the secured credit facilities at any time, without prepayment premium or penalty, except in connection with a repricing event subject to customary “breakage” costs with respect to London Interbank Offered Rate (“LIBOR”) loans.
As of December 30, 2018, we had no borrowings outstanding and $9.0 million of letter of credit issued but undrawn under the revolving credit facility leaving $141.0 million in borrowing capacity under the revolving credit facility as of December 30, 2018. As of December 31, 2017, we had no borrowings outstanding and $9.9 million of letter of credit issued but undrawn under the revolving credit facility.
Borrowings under the secured credit facilities bear interest at a rate equal to, at our option, either (a) 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%
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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. 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 Fiscal 2018, the applicable margin for LIBOR borrowings under both the term loan facility and revolving credit facility was 3.25% and during Fiscal 2017 the applicable margin was 3.00% under both the term loan facility and the revolving facility until November 16, 2017, when the applicable margin returned to its current rate of 3.25% for both the term loan facility and revolving credit facility. During Fiscal 2018, the federal funds rate ranged from 1.34% to 2.40%, the prime rate ranged from 4.50% to 5.50% and the one-month LIBOR ranged from 1.55% to 2.52%.
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 under the revolving credit facility was 0.5% per annum and was subject to one step-down from 0.5% to 0.375% based on our net first lien senior secured leverage ratio. During Fiscal 2018, the commitment fee rate was 0.5% and for Fiscal 2017, the commitment fee rate was 0.375% until November 16, 2017, when it returned to its current rate of 0.5%. 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 processing and fronting fees computed at a rate equal to 0.125% per annum on the daily stated amount of each letter of credit.
The weighted average effective interest rate incurred on our borrowings under our secured credit facilities was 5.8% for the 2018 fiscal year, 4.7% for the 2017 fiscal year and 4.6% for the 2016 fiscal year, which includes amortization of debt issuance 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 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 65.0% 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 a first-priority lien with respect to the collateral. The secured credit facilities also contain customary covenants and events of default. The covenants 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;
(viii) enter into sale-leaseback transactions;
(ix) change our lines of business;
(x) restrict dividends from our subsidiaries or restrict liens;
(xi) change our fiscal year; and
(xii) 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 last twelve month’s EBITDA, as defined in the Senior Credit Facilities). The covenant will be tested quarterly when the revolving credit facility is more than 30.0% drawn (excluding outstanding letters of credit) and will be a condition to drawings under the revolving credit facility that would result in more than 30.0% drawn thereunder.
Senior Unsecured Notes
Our senior unsecured notes consist of $255.0 million aggregate principal amount borrowings of 8.000% Senior Notes due 2022 (the “senior notes”) and mature on February 15, 2022. The senior notes are registered under the Securities Act, do not
40
bear legends restricting their transfer and are not entitled to registration rights under our registration rights agreement. As of February 15, 2017, 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”).
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.
The weighted average effective interest rate incurred on borrowings under our senior notes was 8.2% for the 2018, 2017 and 2016 fiscal years, which includes amortization of debt issuance costs and other fees related to our senior notes.
Capital Expenditures
We intend to continue to focus our future capital expenditures on reinvestment into our existing Company-operated Chuck E. Cheese’s and PPP venues through various planned capital initiatives and the development or acquisition of additional Company-operated venues. During Fiscal 2018, we completed 268 game enhancements and 31 major remodels, of which 25 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 2018 totaled approximately $79.8 million.
The following table reconciles the approximate total capital spend by initiative to our Consolidated Statements of Cash Flows for the periods presented:
Fiscal Year Ended
December 30, 2018
December 31, 2017
January 1, 2017
Growth capital spend (1)
$
31,269
$
51,079
$
55,200
Maintenance capital spend (2)
44,656
35,678
33,838
IT capital spend
3,919
7,309
10,058
Total Capital Spend
$
79,844
$
94,066
$
99,096
__________________
(1)
Growth capital spend includes our Play Pass initiative, major remodels, venue expansions, major attractions and 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.
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Off-Balance Sheet Arrangements and Contractual Obligations
As of December 30, 2018, we had no off-balance sheet financing arrangements as described in Regulation S-K Item 303(a)(4)(ii).
The following table summarizes our contractual obligations as of December 30, 2018: