FORM 10-K
|X| Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended January 2, 2005.
|_| Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _____ to _____.
Commission File Number 0-15782
CEC ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
Kansas 48-0905805
(State or jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4441 West Airport Freeway
Irving, Texas 75062
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 258-8507
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Common Stock, par value $.10 each
(Title of Class)
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
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 such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) Yes |X| No |_|
At March 7, 2005, an aggregate of 36,398,870 shares of the registrant's
common stock, par value of $.10 each (being the registrant's only class of
common stock), were outstanding.
At June 30, 2004, the aggregate market value of our common stock held by
non-affiliates of the registrant was $1,092,110,507.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement, to be filed
pursuant to Section 14(a) of the Act in connection with the registrant's 2005
annual meeting of shareholders, have been incorporated by reference in Part III
of this report.
P A R T I
Item 1. Business
General
CEC Entertainment, Inc. (the "Company") was incorporated in the state of
Kansas in 1980 and is engaged in the family restaurant/entertainment center
business. The Company considers this to be its sole industry segment. Our
principal executive offices are located at 4441 W. Airport Freeway, Irving,
Texas 75062. The Company maintains a website at www.chuckecheese.com. Documents
available on our website include the Company's (i) Code of Business Conduct and
Ethics, (ii) Code of Ethics for the Chief Executive Officer and Senior Financial
Officers (iii) Corporate Governance Guidelines, and (iv) charters for the Audit,
Compensation, and Nominating/Corporate Governance Committees of the Board. These
documents are also available in print to any stockholder who requests a copy. In
addition, we make available free of charge through our website our annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and amendments to those reports as soon as reasonably practicable after
electronic filing or furnishing of such material with the Securities and
Exchange Commission.
The Company operated, as of January 2, 2005, 449 Chuck E. Cheese's (R)
restaurants. In addition, as of January 2, 2005, franchisees of the Company
operated 46 Chuck E. Cheese's restaurants.
Chuck E. Cheese's Restaurants
Business Development
Chuck E. Cheese's restaurants offer a variety of pizzas, a salad bar,
sandwiches, appetizers and desserts and feature musical and comic entertainment
by robotic and animated characters, family oriented games, rides and
arcade-style activities. The restaurants are intended to appeal to families with
children between the ages of two and 12. The Company opened its first restaurant
in March 1980.
The Company and its franchisees operate in a total of 48 states and five
international countries. The Company owns and operates Chuck E. Cheese's
restaurants in 44 states and Canada. See "Item 2. Properties."
The following table sets forth certain information with respect to the
Chuck E. Cheese's restaurants owned by the Company (excludes franchised
restaurants and one TJ Hartford's Grill and Bar).
2004 2003 2002
---- ---- ----
Average annual revenues
per restaurant (1) $ 1,695,000 $ 1,628,000 $ 1,641,000
Number of restaurants open at end
of period 449 418 384
Percent of total restaurant revenues:
Food and beverage sales 66.1% 66.5% 66.7%
Game sales 31.4% 31.0% 30.8%
Merchandise sales 2.5% 2.5% 2.5%
- -------
(1) In computing these averages, only restaurants that were open for a period
greater than eighteen months at the beginning of each respective year were
included (360, 331 and 300 restaurants in 2004, 2003 and 2002,
respectively). Fiscal year 2004 consisted of 53 weeks while each of fiscal
years 2003 and 2002 consisted of 52 weeks.
The Company's sales volumes fluctuate seasonally and are generally higher
during the first and third quarters of each fiscal year. Holidays, school
operating schedules and severe weather may affect sales volumes seasonally in
some operating regions. Because of the seasonality of the Company's business,
results for any quarter are not necessarily indicative of the results that may
be achieved for the full fiscal year.
Each Chuck E. Cheese's restaurant typically employs a general manager, one
or two managers, an electronic specialist who is responsible for repair and
maintenance of the robotic characters and games, and 45 to 75 food preparation
and service employees, most of whom work part-time.
To maintain a unique and exciting environment in the restaurants, the
Company believes it is essential to reinvest capital through the evolution of
its games, rides and entertainment packages and continuing enhancement of the
facilities.
In 2000, the Company initiated a Phase III upgrade program that generally
includes a new Toddler Zone, skill games and rides, kiddie games and rides,
SkyTubes(R) enhancements, and prize area enhancements with ticket counting
machines. The Company completed Phase III upgrades in 28, 105, 123 and 50
restaurants in 2000, 2001, 2002 and 2003, respectively, and completed this
upgrade program in 2003. In 2003, the Company also initiated a game enhancement
plan. The primary components of this plan are to provide new and transferred
games and rides and, in certain stores, enhancements to the Toddler Zone. The
Company completed the game enhancement initiative in 33 and 81 restaurants in
2003 and 2004, respectively, and plans to complete game enhancements in
approximately 60 additional restaurants in 2005. The Company also began a
program of exterior and interior remodels that include a new exterior identity
including a revised Chuck E. Cheese logo and signage, updating the exterior
design of the buildings and, in some restaurants, colorful new awnings. The
interior component of this remodel includes painting, updating decor, a new menu
board and enhanced lighting. This remodel also includes new games and rides in
conjunction with the transfer of games and rides between stores. In 2004, the
Company completed 15 interior and exterior remodels.
The Company also will complete major remodels in a select number of
restaurants that are believed to have the greatest opportunity to significantly
increase sales and provide an adequate return on investment. A major remodel
includes expansion of the space allocated to the game room and an increase in
the number of games. The Company completed three major remodels in 2003 and 19
in 2004. The Company plans to complete 60 to 70 major remodels in 2005, of which
approximately one quarter will include the new exterior and interior identity
depending on the age and condition of the building exterior, signage and
awnings.
The Company has expanded the customer areas of 93 restaurants since 1995,
including restaurants with increased seating capacity due to an enhanced
showroom package. The Company plans to continue its strategy of expanding the
customer areas and seating capacity of five to seven selected restaurants in
2005. The customer area of expanded restaurants, other than restaurants with
increased seating capacity due to an enhanced showroom package, is typically
increased by an average of 1,000 to 4,000 square feet per store.
The Company has added 35, 35 and 32 Company-operated Chuck E. Cheese's
restaurants in 2002, 2003 and 2004, respectively, including restaurants acquired
from franchisees. The Company anticipates adding approximately 30 to 35 new
restaurants in 2005 through a combination of opening new restaurants and
acquiring existing franchise restaurants. At the beginning of 2005, the Company
had identified development opportunities for approximately 250 restaurants
including those restaurants expected to open in 2005.
The Company periodically reevaluates the site characteristics of its
restaurants. The Company will consider relocating the restaurant to a more
desirable site in the event certain site characteristics considered essential
for the success of a restaurant deteriorate.
The Company believes its ownership of trademarks in the names and character
likenesses featured in the operation of its restaurants are an important
competitive advantage.
Restaurant Design and Entertainment
Chuck E. Cheese's restaurants are typically located in shopping centers or
in free-standing buildings near shopping centers and generally occupy 7,000 to
14,000 square feet in area. Chuck E. Cheese's restaurants are typically divided
into three areas: a kitchen and related areas (cashier and prize area, salad
bar, manager's office, technician's office, restrooms, etc.) occupies
approximately 35% of the space, a dining area occupies approximately 25% of the
space and a playroom area occupies approximately 40% of the space.
The dining area of each Chuck E. Cheese's restaurant features a variety of
comic and musical entertainment by computer-controlled robotic characters,
together with video monitors and animated props, located on various stage type
settings. The dining area typically provides table and chair seating for 250 to
375 customers.
Each Chuck E. Cheese's restaurant typically contains a family oriented
playroom area offering approximately 45 coin and token-operated attractions,
including arcade-style games, kiddie rides, a Toddler Zone(R), video games,
skill oriented games and other similar entertainment. Most games dispense
tickets that can be redeemed by guests for prize merchandise such as toys and
dolls. Also included in the playroom area are tubes and tunnels suspended from
or reaching to the ceiling known as SkyTubes(R) or other free attractions for
young children, with booth and table seating for the entire family. The playroom
area normally occupies approximately 60% of the restaurant's customer area. A
limited number of free tokens are furnished with food orders. Additional tokens
may be purchased. Tokens are used to play the games and rides in the playroom.
Food and Beverage Products
Each Chuck E. Cheese's restaurant offers a variety of pizzas, a salad bar,
sandwiches, appetizers and desserts. Soft drinks, coffee and tea are also
served, along with beer and wine where permitted by local laws. The Company
believes that the quality of its food compares favorably with that of its
competitors.
The majority of food, beverages and other supplies used in the
Company-operated restaurants is currently distributed under a system-wide
agreement with a major food distributor. The Company believes that this
distribution system creates certain cost and operational efficiencies for the
Company.
Marketing
The primary customer base for the Company's restaurants consists of
families having children between the ages of two and 12. The Company conducts
advertising campaigns which are targeted at families with young children that
feature the family entertainment experiences available at Chuck E. Cheese's
restaurants and are primarily aimed at increasing the frequency of customer
visits. The primary advertising medium continues to be television, due to its
broad access to family audiences and its ability to communicate the Chuck E.
Cheese's experience. The television advertising campaigns are supplemented by
promotional offers in newspapers, the Company's website and direct e-mail.
Franchising
The Company began franchising its restaurants in October 1981 and the first
franchised restaurant opened in June 1982. At January 2, 2005, 46 Chuck E.
Cheese's restaurants were operated by a total of 26 different franchisees, as
compared to 48 of such restaurants at December 28, 2003. Currently, franchisees
have expansion rights to open an additional five franchise restaurants. The
Company is not granting additional United States franchises.
The Chuck E. Cheese's standard franchise agreements grant to the franchisee
the right to construct and operate a restaurant and use the associated trade
names, trademarks and service marks within the standards and guidelines
established by the Company. The franchise agreement presently offered by the
Company has an initial term of 15 years and includes a 10-year renewal option.
The standard agreement provides the Company with a right of first refusal should
a franchisee decide to sell a restaurant. The earliest expiration dates of
outstanding Chuck E. Cheese's franchises are in 2005.
The Company and its franchisees created The International Association of
CEC Entertainment, Inc., (the "Association"), to discuss and consider matters of
common interest relating to the operation of corporate and franchised Chuck E.
Cheese's restaurants, to serve as an advisory council to the Company and to plan
and approve contributions to and expenditures from the Advertising Fund, a fund
established and managed by the Association that pays the costs of system-wide
advertising, and the Entertainment Fund, a fund established and managed by the
Association to further develop and improve entertainment attractions. Routine
business matters of the Association are conducted by a Board of Directors of the
Association, composed of five members appointed by the Company and five members
elected by the franchisees.
The franchise agreements governing existing franchised Chuck E. Cheese's
restaurants in the United States currently require each franchisee to pay: (i)
to the Company, in addition to an initial franchise fee of $50,000, a continuing
monthly royalty fee equal to 3.8% of gross sales; (ii) to the Advertising Fund
an amount equal to 2.7% of gross sales; and (iii) to the Entertainment Fund an
amount equal to 0.2% of gross sales. Under the Chuck E. Cheese's franchise
agreements, the Company is required, with respect to Company-operated
restaurants, to spend for local advertising and to contribute to the Advertising
Fund and the Entertainment Fund at the same rates as franchisees. The Company
and its franchisees could be required to make additional contributions to the
Association to fund any cash deficits that may be incurred by the Association.
Competition
The restaurant and entertainment industries are highly competitive, with a
number of major national and regional chains operating in the restaurant or
family entertainment business. Although other restaurant chains presently
utilize the combined family restaurant / entertainment concept, these
competitors primarily operate on a regional, market-by-market basis.
The Company believes that it will continue to encounter competition in the
future. Major national and regional chains, some of which may have capital
resources as great or greater than the Company, are competitors of the Company.
The Company believes that the principal competitive factors affecting Chuck E.
Cheese's restaurants are established brand recognition, the relative quality of
food and service, quality and variety of offered entertainment, and location and
attractiveness of the restaurants as compared to its competitors in the
restaurant or entertainment industries.
TJ Hartford's Grill and Bar
In 2001, the Company opened a full service casual dining restaurant with a
game room area named TJ Hartford's Grill and Bar aimed at a broad demographic
target offering medium priced, high quality food, including alcoholic beverages
in a relaxed entertaining atmosphere.
Trademarks
The Company, through a wholly owned subsidiary, owns various trademarks,
including "Chuck E. Cheese's" and "TJ Hartford's Grill and Bar" that are used in
connection with the restaurants and have been registered with the appropriate
patent and trademark offices. The duration of such trademarks is unlimited,
subject to continued use. The Company believes that it holds the necessary
rights for protection of the marks considered essential to conduct its present
restaurant operations.
Government Regulation
The development and operation of Chuck E. Cheese's restaurants are subject
to various federal, state and local laws and regulations, including but not
limited to those that impose restrictions, levy a fee or tax, or require a
permit or license on the service of alcoholic beverages and the operation of
games and rides. The Company is subject to the Fair Labor Standards Act, the
Americans With Disabilities Act, and Family Medical Leave Act mandates. A
significant portion of the Company's restaurant personnel are paid at rates
related to the minimum wage established by federal and state law. Increases in
such minimum wage result in higher labor costs to the Company, which may be
partially offset by price increases and operational efficiencies.
Working Capital Practices
The Company attempts to maintain only sufficient inventory of supplies in
its restaurants to satisfy current operational needs. The Company's accounts
receivable consist primarily of credit card receivables, tax receivables, vendor
rebates and construction advances.
Employees
The Company's employment varies seasonally, with the greatest number of
people being employed during the summer months. On January 2, 2005, the Company
employed approximately 16,500 employees, including 16,111 in the operation of
Chuck E. Cheese's and TJ Hartford's Grill and Bar restaurants and 389 employed
by the Company in its executive offices. None of the Company's employees are
members of any union or collective bargaining group. The Company considers its
employee relations to be good.
Item 2. Properties
The following table sets forth certain information regarding the Chuck E.
Cheese's restaurants operated by the Company as of January 2, 2005.
Chuck E.
Domestic Cheese's
-------- --------
Alabama 7
Alaska 1
Arizona 1
Arkansas 4
California 64
Colorado 8
Connecticut 6
Delaware 2
Florida 21
Georgia 16
Idaho 1
Illinois 22
Indiana 12
Iowa 5
Kansas 4
Kentucky 3
Louisiana 8
Maryland 14
Maine 1
Massachusetts 10
Michigan 18
Minnesota 5
Mississippi 3
Missouri 8
Nevada 5
Nebraska 2
New Hampshire 2
New Jersey 15
New Mexico 3
New York 19
North Carolina 11
North Dakota 1
Ohio 17
Oklahoma 3
Pennsylvania 21
Rhode Island 1
South Carolina 6
South Dakota 2
Tennessee 11
Texas 54
Virginia 10
Washington 6
West Virginia 1
Wisconsin 9
----
443
International
Canada 6
----
449
====
Of the 449 Chuck E. Cheese's restaurants owned by the Company as of January
2, 2005, 391 occupy leased premises and 58 occupy owned premises. The leases of
these restaurants will expire at various times from 2005 to 2028, as described
in the table below.
Year of Number of Range of Renewal
Expiration Restaurants Options (Years)
2005 34 None to 20
2006 37 None to 20
2007 48 None to 20
2008 53 None to 20
2009 and thereafter 219 None to 25
The leases of Chuck E. Cheese's restaurants contain terms that vary from
lease to lease, although a typical lease provides for a primary term of 10
years, with two additional five-year options to renew, and provides for annual
minimum rent payments of approximately $4.00 to $31.00 per square foot, subject
to periodic adjustment. It is common for the Company to take possession of
leased premises prior to the commencement of rents for the purpose of
constructing leasehold improvements. The restaurant leases require the Company
to pay the cost of repairs, insurance and real estate taxes and, in many
instances, provide for additional rent equal to the amount by which a percentage
(typically 6%) of gross revenues exceeds the minimum rent.
Item 3. Legal Proceedings.
From time to time the Company is involved in litigation, most of which is
incidental to its business. In the Company's opinion, no litigation in which the
Company currently is a party is likely to have a material adverse effect on the
Company's results of operations, financial condition or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth
quarter of 2004.
P A R T I I
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchase of Equity Securities.
As of March 7, 2005, there were an aggregate of 36,398,870 shares of the
Company's common stock outstanding and approximately 2,132 stockholders of
record.
The Company's common stock is listed on the New York Stock Exchange under
the symbol "CEC." The following table sets forth the highest and lowest price
per share of the common stock during each quarterly period within the two most
recent years, as reported on the New York Stock Exchange (adjusted for a three
for two stock split effective on March 15, 2004):
High Low
------ -----
2004
- 1st quarter $ 38.67 $ 30.94
- 2nd quarter 36.55 30.18
- 3rd quarter 36.99 28.93
- 4th quarter 42.25 34.44
2003
- 1st quarter $ 21.11 $ 16.03
- 2nd quarter 24.97 17.40
- 3rd quarter 27.17 22.83
- 4th quarter 34.67 25.99
The Company has not paid any cash dividends on its common stock and has no
present intention of paying cash dividends thereon in the future. The Company
plans to retain any earnings to finance anticipated capital expenditures,
repurchase the Company's common stock and reduce its long-term debt. The future
dividend policy with respect to the common stock will be determined by the Board
of Directors of the Company, taking into consideration factors such as future
earnings, capital requirements, potential loan agreement restrictions and the
financial condition of the Company.
From time to time, the Company repurchases shares of its common stock under
a plan authorized by its Board of Directors. See the section titled Financial
Condition, Liquidity and Capital Resources under Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations. The following
table presents information related to repurchases of common stock the Company
made during the fourth quarter of 2004:
Cummulative Maximum Dollar
Number of Shares Amount that May
Total Number of Average Price Purchased Under Yet be Purchased
Fiscal Period Shares Purchased Paid per Share the Program Under the Program
------------- ---------------- -------------- ---------------- -----------------
Sept 27 - Oct. 24, 2004 - - 754,200 $ 74,080,836
Oct. 25 - Nov. 21, 2004 - - 754,200 $ 74,080,836
Nov. 22 - Jan. 2, 2005 251,400 $ 39.84 1,005,600 $ 64,065,347
--------
Total 251,400 $ 39.84
========
Item 6. Selected Financial Data.
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(Thousands, except per share and store data)
Operating results (1):
Revenues ................................................. $ 728,079 $ 654,598 $ 602,201 $ 562,227 $ 506,111
Costs and expenses........................................ 594,314 544,500 494,629 462,940 421,355
--------- --------- --------- --------- ---------
Income before income taxes................................ 133,765 110,098 107,572 99,287 84,756
Income taxes.............................................. 51,233 42,717 41,772 38,721 33,048
--------- --------- --------- --------- ---------
Net income................................................ $ 82,532 $ 67,381 $ 65,800 $ 60,566 $ 51,708
========= ========= ========= ========= =========
Per share (2)(3):
Basic:
Net income ........................................... $ 2.22 $ 1.70 $ 1.58 $ 1.44 $ 1.27
Weighted average shares outstanding.................... 37,251 39,654 41,511 41,724 40,499
Diluted:
Net income .......................................... $ 2.15 $ 1.66 $ 1.55 $ 1.41 $ 1.23
Weighted average shares outstanding.................. 38,472 40,389 42,263 42,771 41,759
Cash flow data:
Cash provided by operations............................ $ 165,835 $ 158,730 $ 136,395 $ 121,889 $ 97,623
Cash used in investing activities...................... (80,370) (94,226) (112,686) (111,058) (89,363)
Cash used in financing activities...................... (81,734) (68,651) (15,177) (14,449) (3,691)
Balance sheet data:
Total assets........................................... $ 612,017 $ 582,983 $ 537,251 $ 457,430 $ 386,724
Long-term obligations (including current portion
and redeemable preferred stock)...................... 100,808 84,259 77,211 65,445 60,670
Shareholders' equity................................... 360,730 364,323 359,907 316,201 264,846
Number of restaurants at year end:
Company operated..................................... 449 418 384 350 324
Franchise............................................ 46 48 50 52 55
--------- --------- --------- --------- ---------
495 466 434 402 379
========= ========= ========= ========= =========
- ----------------------
(1) Fiscal year 2004 was 53 weeks in length and all other fiscal years presented were 52 weeks in length.
(2) No cash dividends on common stock were paid in any of the years presented.
(3) Share and per share information reflect the effects of a 3 for 2 stock split effected in the form of a special stock dividend
that was effective on March 15, 2004.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
Of Operations.
Results of Operations
A summary of the results of operations of the Company as a percentage of
revenues for the last three fiscal years is shown below.
2004 2003 2002
------- ------- -------
Revenues ...................................... 100.0% 100.0% 100.0%
------ ------ ------
Costs and expenses:
Cost of sales
Food, beverage and related supplies....... 12.3% 12.2% 12.2%
Games and merchandise..................... 4.2% 4.3% 4.2%
Labor..................................... 27.5% 27.8% 27.8%
Selling, general and administrative......... 11.9% 12.7% 12.3%
Depreciation and amortization............... 7.7% 7.6% 7.3%
Interest expense............................ .3% .3% .3%
Other operating expenses.................... 17.8% 18.3% 18.0%
------ ------ ------
81.7% 83.2% 82.1%
------ ------ ------
Income before income taxes..................... 18.3% 16.8% 17.9%
====== ====== ======
Number of Company-owned stores:
Beginning of period......................... 418 384 350
New......................................... 29 32 32
Company purchased franchise stores.......... 3 3 3
Closed...................................... (1) (1) (1)
------ ------ ------
End of period............................... 449 418 384
====== ====== ======
Number of franchise stores:
Beginning of period......................... 48 50 52
New......................................... 1 2 1
Company purchased franchise store........... (3) (3) (3)
Closed...................................... (1)
------ ------ ------
End of period............................... 46 48 50
====== ====== ======
2004 Compared to 2003
Revenues
Revenues increased 11.2% to $728.1 million in 2004 from $654.6 million in
2003 primarily due to an increase in the number of Company-operated restaurants,
an additional week of operation in 2004 and a 2% increase in comparable store
sales. The Company opened 29 new restaurants, acquired three restaurants from
franchisees and closed one restaurant in 2004. Average annual revenues per
restaurant increased to approximately $1,695,000 in 2004 from approximately
$1,628,000 in 2003. Fiscal year 2004 consisted of 53 weeks while fiscal year
2003 consisted of 52 weeks. Menu prices increased approximately 1.8% between the
two years.
Revenues from franchise fees and royalties were $3.2 million in 2004
compared to $3.3 million in 2003. During 2004, one new franchise restaurant
opened and three franchise restaurants were acquired by the Company. Franchise
comparable store sales increased 1.8% in 2004.
Costs and Expenses
Costs and expenses as a percentage of revenues decreased to 81.7% in 2004
from 83.2% in 2003.
Cost of sales as a percentage of revenues decreased to 44.0% in 2004 from
44.3% in 2003. Costs of food, beverage, and related supplies as a percentage of
revenues increased to 12.3% in 2004 from 12.2% in 2003. Food costs were
negatively impacted approximately $3.4 million due to an increase of
approximately 25% in average cheese prices paid in 2004 compared to 2003. This
increase was partially offset by the impact of a 3% increase in menu prices
implemented in June of 2004. Costs of games and merchandise decreased to 4.2% in
2004 from 4.3% in 2003 primarily due to the menu price increase. Restaurant
labor expenses as a percentage of revenues decreased to 27.5% in 2004 from 27.8%
in 2003 primarily due to the increase in comparable store sales.
Selling, general and administrative expenses as a percentage of revenues
decreased to 11.9% in 2004 from 12.7% in 2003 primarily due to a $4.25 million
legal settlement recorded in 2003 and higher revenues in 2004.
Depreciation and amortization expense as a percentage of revenues increased
to 7.7% in 2004 from 7.6% in 2003 primarily due to capital invested in new
restaurants and remodels.
Interest expense as a percentage of revenues remained constant at 0.3% in
both 2004 and 2003.
Other operating expenses decreased as a percentage of revenues to 17.8% in
2004 from 18.3% in 2003 primarily due to the increase in total revenues.
The Company's effective income tax rate decreased to 38.3% in 2004 from
38.8% in 2003 due to lower estimated state tax rates.
Net Income
The Company had net income of $82.5 million in 2004 compared to $67.4
million in 2003 due to the changes in revenues and expenses discussed above. The
Company's diluted earnings per share increased 29.5% to $2.15 per share in 2004
compared to $1.66 per share in 2003 due to the 22.5% increase in net income over
the prior year and a 4.7% decrease in the Company's number of weighted average
shares outstanding. In addition, the Company estimates that the additional week
of operations in 2004 increased diluted earnings per share by approximately
$.11. Weighted average diluted shares outstanding decreased to 38.5 million in
2004 from 40.4 million in 2003 primarily due to the Company's share repurchase
program.
2003 Compared to 2002
Revenues
Revenues increased 8.7% to $654.6 million in 2003 from $602.2 million in
2002 primarily due to an increase in the number of Company-operated restaurants.
The Company opened 32 new restaurants, acquired three restaurants from
franchisees and closed one restaurant in 2003. Comparable store sales decreased
0.3%. Average annual revenues per restaurant declined to approximately
$1,628,000 in 2003 from approximately $1,641,000 in 2002. Menu prices increased
0.8% between the two years.
Revenues from franchise fees and royalties were $3.3 million in 2003
compared to $3.2 million in 2002. During 2003, two new franchise restaurants
opened, three franchise restaurants were acquired by the Company and one
franchise restaurant closed. Franchise comparable store sales increased 1.4% in
2003.
Costs and Expenses
Costs and expenses as a percentage of revenues increased to 83.2% in 2003
from 82.1% in 2002.
Cost of sales as a percentage of revenues increased to 44.3% in 2003 from
44.2% in 2002. Costs of food, beverage, and related supplies as a percentage of
revenues were 12.2% in both 2003 and 2002. Costs of games and merchandise
increased to 4.3% in 2003 from 4.2% in 2002 primarily due to higher prize costs
resulting from a guest value program implemented in the second quarter of 2003.
Restaurant labor expenses as a percentage of revenues remained constant at 27.8%
in both 2003 and 2002.
Selling, general and administrative expenses as a percentage of revenues
increased to 12.7% in 2003 from 12.3% in 2002 primarily due to a $4.25 million
charge in 2003 relating to the settlement of a class action wage and hour
lawsuit filed in the State of California.
Depreciation and amortization expense as a percentage of revenues increased
to 7.6% in 2003 from 7.3% in 2002 primarily due to capital invested in new
restaurants and remodels.
Interest expense as a percentage of revenues was 0.3% in both 2003 and
2002.
Other operating expenses increased as a percentage of revenues to 18.3% in
2003 from 18.0% in 2002 primarily due to losses on the disposal of assets,
repairs and property taxes.
The Company's effective income tax rate was 38.8% in both 2003 and 2002.
Net Income
The Company had net income of $67.4 million in 2003 compared to $65.8
million in 2002 due to the changes in revenues and expenses discussed above. The
Company's diluted earnings per share increased 7.1% to $1.66 per share in 2003
compared to $1.55 per share in 2002 due to the 2.4% increase in net income
discussed above and a 4.4% decrease in the Company's number of weighted average
shares outstanding. Weighted average diluted shares outstanding decreased to
40.4 million in 2003 from 42.32 million in 2002 primarily due to the Company's
share repurchase program.
Critical Accounting Policies and Estimates
The Company's significant accounting policies are disclosed in Note 1 to
the consolidated financial statements. The following discussion addresses the
Company's most critical accounting policies, which are those that require
significant judgment.
Self Insurance
The Company estimates its liability for incurred but unsettled general
liability and workers compensation related claims under its self-insured
retention programs, including reported losses in the process of settlement and
losses incurred but not reported. The estimate is based on loss development
factors determined through actuarial methods using the actual claim loss
experience of the Company subject to adjustment for current trends. Revisions to
the estimated liability resulting from ongoing periodic reviews are recognized
in the period in which the differences are identified. Significant increases in
general liability and workers compensation claims could have a material adverse
impact on future operating results.
Impairment of Long-Lived Assets
The Company periodically reviews the estimated useful lives and
recoverability of its depreciable assets based on factors including historical
experience, the expected beneficial service period of the asset, the quality and
durability of the asset and the Company's maintenance policy including periodic
upgrades. Changes in useful lives are made on a prospective basis, unless
factors indicate the carrying amounts of the assets may not be recoverable from
estimated future cash flows and an impairment write-down is necessary.
Lease Accounting
The Company uses a consistent lease period (generally, the initial
non-cancelable lease term plus renewal option periods provided for in the lease
that can be reasonably assured) when calculating depreciation of leasehold
improvements and in determining straight-line rent expense and classification of
its leases as either an operating lease or a capital lease. The lease term and
straight-line rent expense commences on the date when the Company takes
possession and has the right to control use of the leased premises. Funds
received from the lessor intended to reimburse the Company for the costs of
leasehold improvements is recorded as a deferred credit resulting from a lease
incentive and amortized over the lease term as a reduction to rent expense.
New Accounting Standards
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123 (revised 2004), "Share-Based Payment." SFAS 123(R) is a revision of SFAS No.
123, "Accounting for Stock-Based Compensation" and supersedes APB Opinion No.
25, "Accounting for Stock Issued to Employees." SFAS 123(R) requires all
share-based payments to employees including grants of employee stock options, to
be recognized in the financial statements based on their fair values. SFAS 123
(R) is effective at the beginning of the first interim or annual period
beginning after June 15, 2005. Under APB Opinion No. 25, no stock-based
compensation cost has been reflected in the net income of the Company for grants
of stock options to employees. Beginning in the third quarter of 2005, the
Company will recognize compensation expense in its financial statements based on
the fair value of all share-based payments to employees.
Inflation
The Company's cost of operations, including but not limited to labor,
supplies, utilities, financing and rental costs, are significantly affected by
inflationary factors. The Company pays most of its part-time employees rates
that are related to federal and state mandated minimum wage requirements.
Management anticipates that any increases in federally mandated minimum wage
would result in higher costs to the Company, which the Company expects would be
partially offset by menu price increases and increased efficiencies in
operations.
Financial Condition, Liquidity and Capital Resources
Cash provided by operations increased to $165.8 million in 2004 from $158.7
million in 2003. Cash outflows from investing activities for 2004 were $80.4
million, primarily related to capital expenditures. Net cash outflows from
financing activities for 2004 were $81.7 million, primarily related to the
repurchase of the Company's common stock. The Company's primary requirements for
cash relate to planned capital expenditures, the repurchase of the Company's
common stock and debt service. The Company expects that it will satisfy such
requirements from cash provided by operations and, if necessary, funds available
under its line of credit.
Cash provided by operations is a significant source of liquidity for the
Company. Since substantially all of the Company's sales are for cash and credit
cards, and accounts payable are generally due in five to 30 days, the Company is
able to carry current liabilities in excess of current assets. The net working
capital deficit increased from $16.5 million at December 28, 2003 to $92.2
million at January 2, 2005 due primarily to the reclassification of the
Company's borrowings on its line of credit to current. The Company intends to
extend the maturity date on its line of credit.
The Company has initiated several strategies to increase revenues and
earnings over the long-term that require capital expenditures. These strategies
include: (a) new restaurant development and acquisitions of existing restaurants
from franchisees, (b) a game enhancement initiative that includes new games and
a game rotation plan (c) major remodels, and (d) expansions of the square
footage of existing restaurants.
In 2005, the Company plans to add 30 to 35 restaurants, which includes
opening new restaurants and acquiring existing restaurants from franchisees. The
Company currently anticipates its cost of opening such new restaurants will vary
depending upon many factors including the size of the restaurants, the amount of
any landlord contribution and whether the Company acquires land or the
restaurant is an in-line or freestanding building. The average capital cost of
all new restaurants expected to open in 2005 is approximately $1.8 million per
restaurant. At the beginning of 2005, the Company identified development
opportunities for approximately 250 restaurants including those restaurants
expected to open in 2005.
The game enhancement initiative began in 2003 and has an average capital
cost of approximately $50,000 to $60,000 per restaurant. The primary components
of this plan are to provide new and transferred games and rides and, in certain
stores, enhancements to the Toddler Zone(R). The major remodel initiative
includes expansion of the space allocated to the game room, an increase in the
number of games and in some cases may include a new exterior and interior
identity. A new exterior identity includes a revised Chuck E. Cheese logo and
signage, updating the exterior design of the buildings and, in some restaurants,
colorful new awnings. The interior component includes painting, updating decor,
a new menu board and enhanced lighting. The typical capital cost of the major
remodel initiative will range from $250,000 to $300,000 per restaurant.
Expanding the square footage of existing restaurants can range in cost from
$200,000 to $900,000 per restaurant, but generally have an average capital cost
of approximately $500,000.
The Company expects the aggregate capital costs in 2005 of completing the
game enhancement initiative, major remodels, expanding the square footage of
existing restaurants and the exterior and interior remodels to total
approximately $30 million and impact approximately 160 restaurants.
During 2004, the Company opened 29 new restaurants, acquired three
restaurants from franchisees and impacted a total of 120 existing restaurants
with capital expenditures. The Company currently estimates that capital
expenditures in 2005 will be approximately $100 million, includes the $30
million the Company is expecting to invest to remodel existing stores. The
Company plans to finance its capital expenditures through cash flow from
operations and, if necessary, borrowings under the Company's line of credit.
From time to time, the Company repurchases shares of its common stock under
a plan authorized by its Board of Directors. The plan authorizes repurchases in
the open market or in private transactions. Beginning in 1993 through 2004, the
Company has repurchased approximately 18.4 million shares of the Company's
common stock, retroactively adjusted for all stock splits, at an aggregate
purchase price of approximately $321 million. During 2004, the Company
repurchased 3,168,150 shares at an aggregate purchase price of approximately
$113.9 million. At the end of 2004, approximately $64 million remained available
for share repurchases under a $100 million share repurchase authorization
approved by the Company's Board of Directors in August 2004.
The Company has available borrowings under its line of credit agreement of
$132.5 million that is scheduled to mature in December 2005. Interest under the
line of credit is dependent on earnings and debt levels of the Company and
ranges from prime or, at the Company's option, LIBOR plus 0.75% to 1.50%.
Currently, any borrowings under this line of credit would be at the prime rate
or LIBOR plus 0.75%. As of January 2, 2005, there were $77.8 million in
borrowings under this line of credit and outstanding letters of credit of $7.5
million. The line of credit agreement contains certain restrictions and
conditions as defined in the agreement that require the Company to maintain net
worth of $314 million as of January 2, 2005, a fixed charge coverage ratio at a
minimum of 1.5 to 1.0 and a maximum total debt to earnings before interest,
taxes, depreciation, amortization and rent ratio of 3.25 to 1.0. Borrowings
under the line of credit agreement are unsecured but the Company has agreed to
not pledge any of its existing assets to secure future indebtedness. At January
2, 2005, the Company was in compliance with all of the above debt covenants. The
Company intends to extend the maturity date of its line of credit agreement.
The following are contractual cash obligations of the Company as of January
2, 2004 (thousands):
Cash Obligations Due by Year
----------------------------------------------------------------------------
Total 2005 2006 2007 2008 Thereafter
----- ---- ---- ---- ---- ----------
Operating leases (1)............... $ 753,336 $ 56,026 $ 55,473 $ 53,733 $ 51,999 $ 536,105
Revolving line of credit........... 77,800 77,800
Purchase commitments............... 32,124 4,966 5,116 5,272 5,431 11,339
Capital lease obligations.......... 19,881 1,401 1,401 1,401 1,401 14,277
--------- --------- -------- -------- -------- ---------
$ 883,141 $ 140,193 $ 61,990 $ 60,406 $ 58,831 $ 561,721
========= ========= ======== ======== ======== =========
(1) Includes the initial non-cancelable term plus renewal option periods provided for in the lease that can be
reasonably assured.
In addition to the above, the Company estimates that the accrued
liabilities for group medical, general liability and workers compensation claims
of approximately $20.6 million as of January 2, 2005 will be paid as follows:
approximately $9.8 million to be paid in 2005 and the remainder paid over the
six year period from 2006 to 2011.
Certain statements in this report, other than historical information, may
be considered forward-looking statements within the meaning of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, and are
subject to various risks, uncertainties and assumptions. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may differ from those anticipated, estimated or
expected. Among the key factors that may have a direct bearing on the Company's
operating results, performance or financial condition are its ability to
implement its growth strategies, national, regional and local economic
conditions affecting the restaurant/entertainment industry, competition within
each of the restaurant and entertainment industries, store sales
cannibalization, success of its franchise operations, negative publicity,
fluctuations in quarterly results of operations, including seasonality,
government regulations, weather, school holidays, commodity, insurance and labor
costs.
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
The Company is subject to market risk in the form of interest rate risk and
foreign currency risk. Both interest rate risk and foreign currency risk are
immaterial to the Company.
Item 8. Financial Statements and Supplementary Data
CEC ENTERTAINMENT, INC.
YEARS ENDED JANUARY 2, 2005, DECEMBER 28, 2003
AND DECEMBER 29, 2002
CONTENTS
Page
----
Report of independent registered public accounting firm................... 18
Consolidated financial statements:
Consolidated balance sheets............................................ 19
Consolidated statements of earnings and comprehensive income........... 20
Consolidated statements of shareholders' equity........................ 21
Consolidated statements of cash flows.................................. 22
Notes to consolidated financial statements............................. 23
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
CEC Entertainment, Inc.
Irving, Texas
We have audited the accompanying consolidated balance sheets of CEC
Entertainment, Inc. and subsidiaries (the "Company") as of January 2, 2005 and
December 28, 2003, and the related consolidated statements of earnings and
comprehensive income, shareholders' equity, and cash flows for each of the three
years in the period ended January 2, 2005. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of CEC Entertainment, Inc. and subsidiaries as
of January 2, 2005 and December 28, 2003, and the results of their operations
and their cash flows for each of the three years in the period ended January 2,
2005, in conformity with accounting principles generally accepted in the United
States of America.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of January 2, 2005, based on the
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 18, 2005, expressed an unqualified opinion on management's
assessment of the effectiveness of the Company's internal control over financial
reporting and an adverse opinion on the effectiveness of the Company's internal
control over financial reporting because of a material weakness.
Deloitte & Touche LLP
Dallas, Texas
March 18, 2005
CEC ENTERTAINMENT, INC.
CONSOLIDATED BALANCE SHEETS
(Thousands, except share data)
January 2, December 28,
2005 2003
---------- ------------
ASSETS
Current assets:
Cash and cash equivalents.................................................... $ 11,798 $ 8,067
Accounts receivable, net..................................................... 13,482 13,103
Inventories.................................................................. 12,171 12,491
Prepaid expenses............................................................. 7,444 7,608
Deferred tax asset........................................................... 1,763 1,487
--------- ---------
Total current assets...................................................... 46,658 42,756
--------- ---------
Property and equipment, net..................................................... 563,081 538,756
--------- ---------
Other assets ................................................................... 2,278 1,471
--------- ---------
$ 612,017 $ 582,983
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt............................................ $ 78,279 $ 554
Accounts payable............................................................. 24,294 30,126
Accrued liabilities.......................................................... 36,329 28,610
--------- ---------
Total current liabilities................................................. 138,902 59,290
--------- ---------
Long-term debt, less current portion............................................ 11,673 75,205
--------- ---------
Deferred rent................................................................... 53,427 42,816
--------- ---------
Deferred tax liability.......................................................... 36,429 32,849
--------- ---------
Accrued insurance .............................................................. 10,856 8,500
--------- ---------
Commitments and contingencies (Note 6)
Shareholders' equity:
Common stock, $.10 par value; authorized 100,000,000 shares;
55,556,857 and 54,481,913 shares issued, respectively ..................... 5,556 5,448
Capital in excess of par value............................................... 245,991 219,071
Retained earnings ........................................................... 433,267 350,735
Accumulated other comprehensive income....................................... 1,476 695
Less treasury shares of 19,210,568 and 16,042,418, respectively, at cost..... (325,560) (211,626)
--------- ---------
360,730 364,323
--------- ---------
$ 612,017 $ 582,983
========= =========
See notes to consolidated financial statements.
CEC ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF EARNINGS
AND COMPREHENSIVE INCOME
(Thousands, except per share data)
Fiscal Year
-------------------------------------
2004 2003 2002
------ ------ ------
Food and beverage revenues.................................. $ 479,741 $ 433,952 $ 400,119
Games and merchandise revenues.............................. 245,088 217,261 198,466
Franchise fees and royalties................................ 3,220 3,335 3,188
Interest income, including related party income
of $404 in 2002.......................................... 30 50 428
--------- --------- ---------
728,079 654,598 602,201
--------- --------- ---------
Costs and expenses:
Cost of sales:
Food, beverage and related supplies................... 89,228 79,982 73,690
Games and merchandise ................................ 30,395 28,234 25,490
Labor................................................. 200,554 181,789 167,177
--------- --------- ---------
320,177 290,005 266,357
Selling, general and administrative expenses............. 86,471 83,024 74,143
Depreciation and amortization............................ 55,771 49,502 43,951
Interest expense......................................... 2,486 2,194 1,680
Other operating expenses................................. 129,409 119,775 108,498
--------- --------- ---------
594,314 544,500 494,629
--------- --------- ---------
Income before income taxes.................................. 133,765 110,098 107,572
Income taxes................................................ 51,233 42,717 41,772
--------- --------- ---------
Net income.................................................. 82,532 67,381 65,800
Other comprehensive income, net of tax:
Foreign currency translation............................. 781 786 87
--------- --------- ---------
Comprehensive income........................................ $ 83,313 $ 68,167 $ 65,887
========= ========= =========
Earnings per share:
Basic:
Net income ............................................. $ 2.22 $ 1.70 $ 1.58
========= ========= =========
Weighted average shares outstanding...................... 37,251 39,654 41,511
========= ========= =========
Diluted:
Net income ............................................. $ 2.15 $ 1.66 $ 1.55
========= ========= =========
Weighted average shares outstanding...................... 38,472 40,389 42,263
========= ========= =========
See notes to consolidated financial statements.
CEC ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Thousands, except per share data)
Fiscal Year - Amounts Fiscal Year - Shares
------------------------------------- ---------------------------------
2004 2003 2002 2004 2003 2002
------ ------ ------ ------ ------ ------
Common stock and capital in
excess of par value:
Balance, beginning of year............... $ 224,519 $ 205,503 $ 195,574 54,482 53,505 52,988
Stock options exercised.................. 18,853 14,588 6,367 1,063 960 506
Tax benefit from exercise
of stock options ...................... 7,801 4,072 3,265
Stock issued under 401(k) plan........... 401 356 297 13 17 11
Payment for fractional shares............ (27) (1)
--------- --------- --------- ------- ------- -------
Balance, end of year..................... 251,547 224,519 205,503 55,557 54,482 53,505
--------- --------- --------- ======= ======= =======
Retained earnings:
Balance, beginning of year............... 350,735 283,516 218,035
Net income............................... 82,532 67,381 65,800
Redeemable preferred stock accretion..... (49) (95)
Redeemable preferred stock dividend...... (113) (224)
--------- --------- ---------
Balance, end of year..................... 433,267 350,735 283,516
--------- --------- ---------
Accumulated other comprehensive
income (loss):
Balance, beginning of year............... 695 (91) (178)
Foreign currency translation............. 781 786 87
--------- --------- ---------
Balance, end of year..................... 1,476 695 (91)
--------- --------- ---------
Treasury shares:
Balance, beginning of year............... (211,626) (129,021) (97,230) 16,042 12,614 11,379
Treasury stock acquired.................. (113,934) (82,605) (31,791) 3,169 3,428 1,235
--------- --------- --------- ------- ------- -------
Balance, end of year..................... (325,560) (211,626) (129,021) 19,211 16,042 12,614
--------- --------- --------- ======= ======= =======
Total shareholders' equity.................. $ 360,730 $ 364,323 $ 359,907
========= ========= =========
See notes to consolidated financial statements.
CEC ENTERTAINMENT, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Thousands)
Fiscal Year
-------------------------------------
2004 2003 2002
--------- --------- ---------
Operating activities:
Net income..................................................................... $ 82,532 $ 67,381 $ 65,800
Adjustments to reconcile net income to cash provided by operations:
Depreciation and amortization .............................................. 55,771 49,502 43,951
Deferred income tax expense ................................................ 3,304 10,225 15,884
Tax benefit from exercise of stock options ................................. 7,801 4,072 3,265
Other....................................................................... 4,618 4,247 2,948
Net change in receivables, inventories, prepaids, payables and
accrued liabilities......................................................... 4,242 17,790 1,731
Leasehold reimbursements from lessors.......................................... 7,567 5,513 2,816
--------- --------- ---------
Cash provided by operations................................................. 165,835 158,730 136,395
--------- --------- ---------
Investing activities:
Purchases of property and equipment............................................ (80,131) (93,899) (110,952)
Proceeds from dispositions of property and equipment........................... 791
Payments received on notes receivable.......................................... 2,201
Additions to notes receivable.................................................. (3,971)
Change in other assets......................................................... (1,030) (327) (426)
Sale of assets held for resale................................................. 462
--------- --------- ---------
Cash used in investing activities........................................... (80,370) (94,226) (112,686)
--------- --------- ---------
Financing activities:
Proceeds from debt and line of credit.......................................... 47,000 48,700 52,375
Payments on debt and line of credit............................................ (34,227) (46,818) (42,171)
Redeemable preferred stock dividends........................................... (113) (224)
Acquisition of treasury stock................................................. (113,934) (82,605) (31,791)
Exercise of stock options...................................................... 18,853 14,588 6,367
Redemption of preferred stock.................................................. (2,795)
Other.......................................................................... 574 392 267
--------- --------- ---------
Cash used in financing activities........................................... (81,734) (68,651) (15,177)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents.................................. 3,731 (4,147) 8,532
Cash and cash equivalents, beginning of year...................................... 8,067 12,214 3,682
--------- --------- ---------
Cash and cash equivalents, end of year............................................ $ 11,798 $ 8,067 $ 12,214
========= ========= =========
See notes to consolidated financial statements.
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies:
Operations: CEC Entertainment, Inc. and its subsidiaries (the "Company")
operates and franchises family restaurant/entertainment centers as Chuck E.
Cheese's restaurants.
Fiscal year: The Company's fiscal year is 52 or 53 weeks and ends on the
Sunday nearest December 31. References to 2004, 2003 and 2002 are for the fiscal
years ended January 2, 2005, December 28, 2003, and December 29, 2002,
respectively. Fiscal year 2004 consisted of 53 weeks, and 2003 and 2002 each
consisted of 52 weeks.
Basis of consolidation: The consolidated financial statements include the
accounts of the Company and its subsidiaries. The consolidated financial
statements also include the accounts of the International Association of CEC
Entertainment, Inc. (the "Association"), an entity in which the Company has
variable interests and the Company is considered the primary beneficiary. All
significant intercompany accounts and transactions have been eliminated.
Foreign currency translation: The consolidated financial statements are
presented in U.S. dollars. The assets and liabilities of the Company's Canadian
subsidiary are translated to U.S. dollars at year-end exchange rates, while
revenues and expenses are translated at average exchange rates during the year.
Adjustments that result from translating amounts are reported as a component of
other comprehensive income.
Cash and cash equivalents: Cash and cash equivalents of the Company are
composed of demand deposits with banks and short-term cash investments with
remaining maturities of three months or less from the date of purchase by the
Company.
Inventories: Inventories of food, paper products, merchandise and supplies
are stated at the lower of cost on a first-in, first-out basis or market.
Property and equipment, depreciation and amortization: Property and
equipment are stated at cost, net of accumulated depreciation and amortization.
Depreciation and amortization are provided by charges to operations over the
estimated useful lives of the assets by the straight-line method, generally
ranging from four to 20 years for furniture, fixtures and equipment and 40 years
for buildings. Leasehold improvements are amortized by the straight-line method
over the lesser of the lease term, including renewal option periods provided for
in the lease that are reasonably assured, or the estimated useful lives of the
related assets. The Company uses a consistent lease period (generally, the
initial non-cancelable lease term plus renewal option periods provided for in
the lease that can be reasonably assured ) when calculating depreciation of
leasehold improvements and in determining straight-line rent expense and
classification of its leases as either an operating lease or a capital lease.
All pre-opening costs are expensed as incurred.
The Company evaluates long-lived assets held and used in the business for
impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable. Long-lived assets are
grouped at the lowest level for which identifiable cash flows are largely
independent of the cash flows of other groups of assets and liabilities. The
carrying amount of long-lived assets is not recoverable if it exceeds the sum of
associated undiscounted future cash flows. The amount of any impairment is
measured as the excess of the carrying amount over associated discounted future
operating cash flows. Assets held for sale are reported at the lower of carrying
amount or the fair value less estimated costs to sell.
Deferred Rent: The Company recognizes rent expense by the straight-line
method over the lease term, including lease renewal option periods that can be
reasonably assured at the inception of the lease. The lease term commences on
the date when the Company takes possession and has the right to control use of
the leased premises. Also, funds received from the lessor intended to reimburse
the Company for the cost of leasehold improvements are recorded as a deferred
credit resulting from a lease incentive and amortized over the lease term as a
reduction of rent expense.
Fair Value of Financial Instruments: The Company has certain financial
instruments consisting primarily of cash equivalents, notes receivable and notes
payable. The carrying amount of cash equivalents approximates fair value because
of the short maturity of those instruments. The carrying amount of the Company's
notes receivable and long-term debt approximates fair value based on the
interest rates charged on instruments with similar terms and risks.
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. Summary of significant accounting policies (continued):
Stock-Based Compensation: The Company accounts for its stock-based
compensation under the intrinsic value method of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations ("APB 25"), and has adopted the disclosure-only provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" ("SFAS 123"). Under APB 25, no stock-based compensation cost is
reflected in net income for grants of stock options to employees because the
Company grants stock options with an exercise price equal to the market value of
the stock on the date of grant. Had compensation cost for the Company's stock
option plans been determined based on the fair value method at the grant date
for awards under those plans consistent with the method prescribed by SFAS No.
123, the Company's pro forma net income and earnings per share would have been
as follows (thousands, except per share data):
2004 2003 2002
-------- -------- --------
Net income, as reported .................................... $ 82,532 $ 67,381 $ 65,800
Fair value based compensation expense, net of taxes......... (5,776) (6,507) (6,439)
-------- -------- --------
Pro forma net income........................................ $ 76,756 $ 60,874 $ 59,361
======== ======== ========
Earnings per Share:
Basic:
As reported.............................................. $ 2.22 $ 1.70 $ 1.58
Pro forma................................................ $ 2.06 $ 1.53 $ 1.42
Diluted:
As reported.............................................. $ 2.15 $ 1.66 $ 1.55
Pro forma................................................ $ 2.00 $ 1.50 $ 1.40
For the pro forma calculations above, the estimated fair value of options
granted was $9.93, $6.32 and $9.79 per share in 2004, 2003 and 2002,
respectively. The fair value of each stock option grant is estimated on the date
of grant using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants: risk free interest rate of 3.00%,
3.10% and 4.34% in 2004, 2003 and 2002, respectively; no dividend yield;
expected lives of five years; and expected volatility of 30%.
Franchise fees and royalties: Franchise fees are recognized upon
fulfillment of all significant obligations to the franchisee. At January 2,
2005, 46 Chuck E. Cheese's restaurants were operated by a total of 26 different
franchisees. The standard franchise agreements grant to the franchisee the right
to construct and operate a restaurant and use the associated trade names,
trademarks and service marks within the standards and guidelines established by
the Company. Royalties from franchisees are accrued as earned. Franchise fees
included in revenues were $160,000, $281,000, and $240,000 in 2004, 2003 and
2002, respectively.
Advertising costs: Production costs for commercials are expensed in the
year in which the commercials are initially aired. All other advertising costs
are expensed as incurred. The total amounts charged to advertising expense were
approximately $26.1 million, $24.6 million and $24.4 million in 2004, 2003 and
2002, respectively.
Self-Insurance Accruals: The Company self-insures a significant portion of
expected losses under its workers' compensation, employee medical and general
liability programs. Accrued liabilities have been recorded based on the
Company's estimates of the ultimate costs to settle incurred claims, both
reported and unreported.
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. Summary of significant accounting policies (continued):
Use of estimates and assumptions: The preparation of financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Recent Accounting Pronouncements: In December 2004, the Financial
Accounting Standards Board issued SFAS No. 123 (revised 2004), "Share-Based
Payment." SFAS 123(R) is a revision of SFAS No. 123, "Accounting for Stock-Based
Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to
Employees." SFAS 123(R) requires all share-based payments to employees including
grants of employee stock options, to be recognized in the financial statements
based on their fair values. SFAS 123 (R) is effective at the beginning of the
first interim or annual period beginning after June 15, 2005. Under APB Opinion
No. 25, no stock-based compensation cost has been reflected in the net income of
the Company for grants of stock options to employees. Beginning in the third
quarter of 2005, the Company is required to recognize compensation expense in
its financial statements based on the fair value of all share-based payments to
employees.
Reclassifications: Certain reclassifications of 2003 and 2002 amounts have
been made to conform to the 2004 presentation.
2. Accounts receivable:
2004 2003
-------- --------
(thousands)
Trade...................................... $ 4,645 $ 2,414
Tax receivables............................ 1,873
Vendor rebates............................. 3,096 3,638
Leasehold reimbursements from lessors...... 4,139 3,481
Other...................................... 1,602 1,697
-------- --------
$ 13,482 $ 13,103
======== ========
3. Property and equipment:
2004 2003
--------- ---------
(thousands)
Land............................................................. $ 42,661 $ 40,357
Leasehold improvements........................................... 355,230 317,578
Buildings ....................................................... 52,590 49,305
Game, restaurant and other equipment............................. 357,185 328,369
Property leased under capital leases (Note 6).................... 13,512 12,562
--------- ---------
821,178 748,171
Less accumulated depreciation and amortization................... (276,724) (230,816)
--------- ---------
Net property and equipment in service........................ 544,454 517,355
Construction in progress......................................... 7,992 7,547
Game and restaurant equipment held for future service............ 10,635 13,854
--------- ---------
$ 563,081 $ 538,756
========= =========
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. Accrued liabilities and accrued insurance:
2004 2003
-------- --------
(thousands)
Current:
Salaries and wages.......................... $ 12,680 $ 8,665
Insurance................................... 9,879 7,888
Taxes, other than income.................... 6,453 5,668
Income taxes................................ 2,926 2,804
Other....................................... 4,391 3,585
-------- --------
$ 36,329 $ 28,610
======== ========
Long-term:
Insurance .................................. $ 10,856 $ 8,500
======== ========
Accrued insurance liabilities represent estimated claims incurred but
unpaid under the Company's self-insured retention programs for general
liability, workers compensation, health benefits and certain other insured
risks.
5. Long-term debt:
2004 2003
-------- --------
(thousands)
Revolving bank loan, prime or LIBOR
plus 0.75% to 1.5%, due December 2005 ........... $ 77,800 $ 64,400
Obligations under capital leases (Note 6)............ 12,152 11,359
-------- --------
89,952 75,759
Less current portion................................. (78,279) (554)
-------- --------
$ 11,673 $ 75,205
======== ========
The Company has available borrowings under the line of credit of $132.5
million. Interest under the line of credit is payable at rates which are
dependent on earnings and debt levels of the Company. Currently, any borrowings
under this line of credit would be at prime (5.00% at January 2, 2005) or, at
the Company's option, LIBOR (2.42% at January 2, 2005) plus 0.75%. A 0.2%
commitment fee is payable on any unused credit line. The Company is required to
comply with certain financial ratio tests during the terms of the loan
agreement. The weighted average interest rate on the revolving bank loan was
2.3% and 2.0% in 2004 and 2003, respectively. The Company capitalized interest
costs of $56,000, $77,000 and $176,000 in 2004, 2003 and 2002, respectively
related to the construction of new restaurants. The Company intends to extend
the maturity date of its revolving bank loan.
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. Commitments and contingencies:
The Company leases certain restaurants and related property and equipment
under operating and capital leases. All leases require the Company to pay
property taxes, insurance and maintenance of the leased assets. The leases
generally have initial terms of 10 to 20 years with various renewal options.
Scheduled annual maturities of the obligations for capital and operating
leases as of January 2, 2005, are as follows:
Years Capital Operating
- ----- -------- ---------
(thousands)
2005................................................. $ 1,401 $ 56,026
2006................................................. 1,401 55,473
2007................................................. 1,401 53,733
2008................................................. 1,401 51,999
2009................................................. 1,401 50,611
2010-2028 (aggregate payments)....................... 12,876 485,496
-------- ---------
Minimum future lease payments ....................... 19,881 $ 753,338
=========
Less amounts representing interest................... (7,729)
--------
Present value of future minimum lease payments....... 12,152
Less current portion................................. (479)
--------
Long-term capital lease obligation................... $ 11,673
========
The Company's rent expense, including contingent rent based on a percentage
of sales when applicable, is comprised of the following:
2004 2003 2002
-------- -------- --------
(thousands)
Minimum................................ $ 62,191 $ 56,791 $ 52,096
Contingent............................. 430 291 330
-------- -------- --------
$ 62,621 $ 57,082 $ 52,426
======== ======== ========
From time to time the Company is involved in litigation, most of which is
incidental to its business. In the Company's opinion, no litigation to which the
Company currently is a party is likely to have a material adverse effect on the
Company's results of operations, financial condition or cash flows.
In September 2003, the Company recorded a charge to selling, general and
administrative expense of $4.25 million related to the settlement agreed to on
September 29, 2003, which was subject to court approval, in a class action wage
and hour lawsuit filed in the State of California. The settlement amount has
been paid in full by the Company.
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. Income taxes:
The significant components of income tax expense are as follows:
2004 2003 2002
-------- -------- --------
(thousands)
Current expense:
Federal............................................ $ 33,761 $ 23,430 $ 18,571
State.............................................. 6,167 4,810 3,854
Foreign............................................ 200 180 198
Tax benefit from exercise of stock options ........... 7,801 4,072 3,265
-------- -------- --------
Total current expense.............................. 47,929 32,492 25,888
Deferred expense:
Federal............................................ 3,192 9,497 14,068
State.............................................. 112 728 1,816
-------- -------- --------
Total temporary differences .................... 3,304 10,225 15,884
-------- -------- --------
$ 51,233 $ 42,717 $ 41,772
======== ======== ========
Deferred income tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of assets and liabilities and their respective tax bases. The
income tax effects of temporary differences which give rise to deferred income
tax assets and liabilities are as follows:
2004 2003
-------- --------
(thousands)
Current deferred tax asset:
Accrued vacation................................ $ 973 $ 894
Unearned gift certificates ..................... 695 498
Other........................................... 95 95
-------- --------
$ 1,763 $ 1,487
Non-current deferred tax asset (liability):
Deferred rent................................. $ 20,462 $ 16,607
Unearned franchise fees......................... 153 91
Depreciation.................................... (60,364) (50,120)
Foreign......................................... (760) (479)
Insurance....................................... 3,263
Other........................................... 817 1,052
-------- --------
$(36,429) $(32,849)
======== ========
A reconciliation of the statutory rate to taxes provided is as follows:
2004 2003 2002
------ ------ ------
Federal statutory rate........................ 35.0% 35.0% 35.0%
State income taxes, net of federal benefit.... 3.3% 3.3% 3.9%
Other......................................... .5% (.1)%
----- ----- -----
Effective tax rate............................ 38.3% 38.8% 38.8%
===== ===== =====
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. Earnings per common share:
Basic earnings per common share ("EPS") is computed by dividing earnings
applicable to common shares by the weighted average number of common shares
outstanding. Diluted EPS adjusts for the effect of potential common shares from
dilutive stock options using the treasury stock method. Net income applicable to
common shares has been adjusted for redeemable preferred stock accretion and
dividends for the applicable periods. The redeemable preferred stock was fully
redeemed in 2003. Earnings per common and potential common shares (retroactively
adjusted for a three-for-two stock split effective March 15, 2004) were computed
as follows (thousands, except per share data):
2004 2003 2002
-------- -------- --------
Net income................................................ $ 82,532 $ 67,381 $ 65,800
Accretion of redeemable preferred stock................... (49) (95)
Redeemable preferred stock dividends...................... (113) (224)
-------- -------- --------
Net income applicable to common shares.................... $ 82,532 $ 67,219 $ 65,481
======== ======== ========
Basic:
Weighted average common shares outstanding............. 37,251 39,654 41,511
======== ======== ========
Earnings per common share.............................. $ 2.22 $ 1.70 $ 1.58
======== ======== ========
Diluted:
Weighted average common shares outstanding............. 37,251 39,654 41,511
Potential common shares for stock options.............. 1,221 735 752
-------- -------- --------
Weighted average shares outstanding.................... 38,472 40,389 42,263
======== ======== ========
Earnings per common and potential common shares........ $ 2.15 $ 1.66 $ 1.55
======== ======== ========
Antidilutive stock options to purchase 5,175; 1,143,144; and 1,181,851
common shares were not included in the EPS computations in 2004, 2003 and 2002,
respectively, because the exercise prices of these options were greater than the
average market price of the common shares.
9. Employee benefit plans:
The Company has employee benefit plans that include: a) incentive bonus
compensation plans based on the performance of the Company; b) non-statutory
stock option plans for its employees and non-employee directors, c) restricted
stock plan for employees; and d) a retirement and savings plan.
In 1997, the Company adopted an employee stock option plan under which
10,781,250 shares, as amended in 2004, may be granted before July 31, 2007. The
exercise price for options granted under the plan may not be less than the fair
market value of the Company's common stock at date of grant. Options may not be
exercised until the employee has been continuously employed at least one year
after the date of grant. Options which expire or terminate may be re-granted
under the plan. Options which have been granted under the plan cannot be
re-priced with shareholder approval.
In 1995, the company adopted a stock option plan for its non-employee
directors. Per an amendment to the plan in 2004, the number of shares of the
Company's common stock that may be issued under this plan can not exceed
437,500. The exercise price for options granted under this plan may not be less
than the fair market value of the Company's common stock at the date of grant.
Options which expire or terminate may be regranted under the plan. Each
non-employee director is entitled to an option to purchase 7,500 shares of
common stock in January of each year, and a non-employee director is granted an
option to purchase 15,000 shares of common stock upon becoming a board member.
Options may not be exercised until the non-employee director has served on the
Board of Directors for at least two years after the date of grant.
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Employee benefit plans (continued):
In May 2004, the Company adopted an employee restricted stock plan under
which 500,000 shares may be granted before December 31, 2014. The price of the
shares awarded under the plan shall be equal to the fair market value of such
shares on the date of grant. All shares awarded shall provide for a vesting
period of at least one year and no more than five years. Shares issued under a
restricted stock award are nontransferable and subject to the forfeiture
restrictions. Shares which expire or terminate may be re-granted under the plan.
At January 2, 2005, there were 2,952,683 shares available for future grants
under the employee and non-employee directors stock option plans. Stock option
transactions are summarized as follows for all plans:
Weighted Average
Number of Shares Exercise Price Per Share
---------------------------------------- -------------------------------
2004 2003 2002 2004 2003 2002
---------- ---------- ---------- ------- ------- -------
Options outstanding, beginning of year 5,598,311 4,538,213 3,975,917 $ 21.09 $ 20.42 $ 16.84
Granted ....................... 641,671 2,264,756 1,188,449 31.90 19.98 28.97
Exercised...................... (1,063,029) (959,861) (506,484) 17.74 15.20 12.57
Terminated..................... (89,900) (244,797) (119,669) 25.29 21.53 19.61
---------- ---------- ----------
Options outstanding, end of year 5,087,053 5,598,311 4,538,213 23.08 21.09 20.42
========== ========== ==========
Options outstanding at January 2, 2005:
Options Outstanding Options Exercisable
- ----------------------------------------------------------------------- -------------------------------
Shares Weighted Avg. Weighted Shares Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices as of 1/2/05 Life (Years) Exercise Price as of 1/2/05 Exercise Price
- ----------------- ------------ ------------- -------------- ------------ --------------
$ 9.70 - $ 17.38 633,266 2.0 $ 15.19 558,266 $15.15
$ 18.21 - $ 19.99 1,900,200 5.1 19.98 377,711 19.96
$ 20.83 - $ 24.39 958,049 3.1 22.67 685,714 22.67
$ 25.10 - $ 29.79 972,182 4.1 29.00 445,196 29.01
$ 30.41 - $ 37.07 623,356 6.2 31.92 4,857 33.65
---------- ----------
$ 9.70 - $ 37.07 5,087,053 4.3 23.08 2,071,744 21.53
========== ==========
Stock options expire from five to seven years from the grant date. Stock
options vest over various periods ranging from one to four years. Through March
7, 2005, the Company has granted 896,269 additional options to employees at an
exercise price of $36.66 per share and 52,500 options to its non-employee
directors at exercise prices of $36.66 to $38.86 per share.
The Company has adopted the CEC 401(k) Retirement and Savings Plan, to
which it may at its discretion make an annual contribution out of its current or
accumulated earnings. Contributions by the Company may be made in the form of
its common stock or in cash. At January 2, 2005, 20,662 shares remained
available for grant under the plan. The Company made contributions of
approximately $400,766 and $356,000 in common stock for the 2003 and 2002 plan
years, respectively. The Company accrued $455,000 for contributions for the 2004
plan year which will be paid in common stock in 2005.
CEC ENTERTAINMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. Supplemental cash flow information:
2004 2003 2002
------ ------ ------
(thousands)
Cash paid during the year for:
Interest................................. $ 2,458 $ 2,226 $ 1,695
Income taxes ............................ 40,248 25,773 26,936
11. Quarterly results of operations (unaudited):
The following summarizes the unaudited quarterly results of operations in
2004 and 2003 (thousands, except per share data).
Fiscal year ended January 2, 2005
---------------------------------------------------
March 28 June 27 Sept. 26 Jan. 2
--------- --------- --------- ---------
Revenues....................................... $ 206,948 $ 165,424 $ 183,622 $ 172,085
Income before income taxes..................... 50,945 23,363 34,222 25,235
Net income..................................... 31,433 14,416 21,114 15,569
Earnings Per Share:
Basic ...................................... $ .82 $ .38 $ .57 $ .43
Diluted .................................... .79 .37 .56 .41
Fiscal year ended December 28, 2003
---------------------------------------------------
March 30 June 29 Sept. 28 Dec. 28
--------- --------- --------- ---------
Revenues....................................... $ 184,126 $ 152,885 $ 170,138 $ 147,449
Income before income taxes..................... 43,385 22,726 26,122 17,865
Net income..................................... 26,552 13,908 15,987 10,934
Earnings Per Share:
Basic ...................................... $ .65 $ .34 $ .41 $ .28
Diluted .................................... .64 .34 .40 .28
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None
Item 9A. Controls and Procedures
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND
MANAGEMENT'S EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The Company's Audit Committee of the Board of Directors (the "Audit
Committee) held a telephonic meeting with management on January 31, 2005.
Management reached the conclusion, and the Audit Committee concurred, that the
Company's controls over the selection and monitoring of appropriate assumptions
and factors affecting lease accounting were insufficient, and, as a result, the
Company's computation of depreciation, lease classification, straight-line rent
expense and the related deferred rent liability had been incorrect. Accordingly,
management determined, and the Audit Committee concurred, that the Company
should report on Form 8-K that its historical financial statements should no
longer be relied upon. The Audit Committee also concurred with management's
action plan to complete an extensive analysis of these matters and quantify the
impact of the correction of the lease accounting errors on the Company's
financial statements for each of the prior periods affected. Historically, the
Company had depreciated its leasehold improvements over a period equal to the
lesser of the initial non-cancelable lease term plus periods of expected
renewal, or the useful life of the assets. The periods of expected renewal
included option periods provided for in the lease and any additional periods
that the Company considered reasonably assured of exercising or acquiring. When
determining whether each of its leases was an operating lease or a capital lease
and when calculating straight-line rent expense, the Company used the initial
non-cancelable lease term commencing when the obligation to make current rent
payments began. Funds received from the lessor intended to reimburse the Company
for the cost of leasehold improvements were netted against the amount recorded
for the leasehold improvement.
On March 1, 2005, the Audit Committee held a telephonic meeting with
management and the Company's independent registered public accounting firm.
Management presented the results of its completed analysis of its lease
accounting practices, including the quantification of the impact of the
correction of the lease accounting errors on the Company's financial statements
for each of the prior periods affected. Management affirmed its prior
determination, and the Audit Committee concurred, to restate the Company's
financial statements for the three year periods ended December 28, 2003 and for
the first three quarters of fiscal 2004 to reflect the correction in its lease
accounting practices. Such restatements were completed and amended reports were
filed with the SEC on March 18, 2005.
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rules 13a-15(f)
and 15d-15(f) under the Securities and Exchange Act of 1934. The Company's
internal control over financial reporting is designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles. The Company's internal control over financial
reporting includes those policies and procedures that:
- pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the
assets of the Company;
- provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the company; and
- provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the Company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the Company's
internal control over financial reporting as of January 2, 2005. In making this
assessment, the Company's management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control-Integrated Framework.
Based on the Public Company Accounting Oversight Board's Auditing Standard
No. 2, An Audit of Internal Control Over Financial Reporting Performed in
Conjunction With an Audit of Financial Statements, restatement of financial
statements in prior filings with the Securities and Exchange Commission is a
strong indicator of the existence of a "material weakness" in the design or
operation of internal control over financial reporting. As of January 2, 2005,
the Company has concluded that, because its historical financial statements
required restatement as a result of the lease accounting error described above,
a material weakness existed in the Company's internal control over financial
reporting as of the date of this report and, to this extent, its internal
control over financial reporting was not effective.
The Company's independent registered accounting firm has issued an
attestation report on the Company's assessment of the Company's internal control
over financial reporting. This report appears below.
The Company also performed an evaluation, under the supervision and with
the participation of the Company's management, including the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures as of the end of
the period covered by this report. Based on that evaluation, which included the
matters discussed above, the Company's management, including the Chief Executive
Officer and Chief Financial Officer, concluded that the Company's disclosure
controls and procedures were not effective as of January 2, 2005 in ensuring
that material information relating to the Company, including its consolidated
subsidiaries, required to be disclosed by the Company in reports that it files
or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms.
In connection with correcting its lease accounting methodology, the Company
has instituted the following procedures to remediate this material weakness:
- use of a consistent lease period (generally, the initial
non-cancelable lease term plus option periods provided for in the
lease that can be reasonably assured) when calculating depreciation of
leasehold improvements and in determining straight-line rent expense
and classification of its leases as either an operating lease or a
capital lease;
- commence the lease term and straight-line rent expense on the date
when the Company takes possession and the right to control use of the
leased premises; and
- record funds received from the lessor intended to reimburse the
Company for the cost of leasehold improvements as a deferred credit
resulting from a lease incentive and amortized over the lease term as
a reduction to rent expense.
During the evaluation the Company has identified no change in its internal
control over financial reporting that occurred during the last fiscal quarter
covered by this report that has materially affected, or is reasonably likely to
materially affect, its internal control over financial reporting.
INDEPENDENT AUDITORS' ASSESSSMENT OF MANAGEMENT'S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
Board of Directors and Shareholders
CEC Entertainment, Inc.
Irving, Texas
We have audited management's assessment, included in the accompanying Management
Report on Internal Control over Financial Reporting, that CEC Entertainment,
Inc. and subsidiaries (the "Company") did not maintain effective internal
control over financial reporting as of January 2, 2005, because of the effect of
the Company's insufficient controls over the selection and monitoring of
appropriate assumptions and factors affecting lease accounting based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the "COSO control
criteria"). The Company's management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management's assessment and an opinion on the
effectiveness of the Company's internal control over financial reporting based
on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by,
or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more that a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The following material weakness has been identified and included in
management's assessment: In its assessment as of January 2, 2005, management
identified as a material weakness the Company's insufficient controls over the
selection and monitoring of appropriate assumptions and factors affecting lease
accounting. As a result of this material weakness in internal control, the
Company concluded that its previously reported annual depreciation expense and
rent expense had been understated and that previously issued financial
statements should be restated. This material weakness was considered in
determining the nature, timing, and extent of audit tests applied in our audit
of the 2004 financial statement, and this report does not affect our report on
such financial statements.
In our opinion, management's assessment that the Company did not maintain
effective internal control over financial reporting as of January 2, 2005, is
fairly stated, in all material respects, based on the COSO control criteria.
Also in our opinion, because of the effect of the material weakness described
above on the achievement of the objective of the control criteria, the Company
has not maintained effective internal control over financial reporting as of
January 2, 2005, based on the COSO control criteria.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial
statements as of and for the year ended January 2, 2005 of the Company and our
report dated March 18, 2005 expressed an unqualified opinion on those financial
statements.
DELOITTE & TOUCHE LLP
Dallas, Texas
March 18, 2005
Item 9B. Other Information
None.
P A R T I I I
Item 10. Directors and Executive Officers of the Registrant
The information required by this item regarding the directors and executive
officers of the Company is incorporated by reference to and will be included in
the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A
in connection with the Company's 2005 annual meeting of stockholders. The
Company has adopted a Code of Ethics for the Chief Executive Officer and Senior
Financial Officers (the "Code of Ethics") that applies to the principal
executive officer, principal financial officer and principal accounting officer.
Changes to and waivers granted with respect to the Code of Ethics related to the
above named officers required to be disclosed pursuant to applicable rules and
regulations will also be posted on the Company's website at
www.chuckecheese.com.
Item 11. Executive Compensation
The information required by this item regarding the directors and executive
officers of the Company is incorporated by reference to and will be included in
the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A
in connection with the Company's 2005 annual meeting of stockholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is incorporated by reference to and
will be included in the Company's definitive Proxy Statement to be filed
pursuant to Regulation 14A in connection with Company's 2005 annual meeting of
stockholders.
Item 13. Certain Relationships and Related Transactions
The information required by this Item regarding the directors and executive
officers of the Company is incorporated by reference to and will be included in
the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A
in connection with the Company's 2005 annual meeting of stockholders.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference to and
will be included in the Company's definitive Proxy Statement to be filed
pursuant to Regulation 14A in connection with the Company's 2004 annual meeting
of stockholders.
P A R T I V
Item 15. Exhibits, Financial Statement Schedules.
(a) The following documents are filed as a part of this report:
(1) Financial Statements and Supplementary Data:
Report of independent registered public accounting firm.
CEC Entertainment, Inc. consolidated financial statements:
Consolidated balance sheets as of January 2, 2005 and December
28, 2003.
Consolidated statements of earnings and comprehensive income
for the years ended January 2, 2005, December 28, 2003 and
December 29, 2002.
Consolidated statements of shareholders' equity for the years
ended January 2, 2005, December 28, 2003 and December 29,
2002.
Consolidated statements of cash flows for the years ended
January 2, 2005, December 28, 2003 and December 29, 2002.
Notes to consolidated financial statements.
(2) Exhibits:
Number Description
- ------ -----------
3(a)(1) Amended and Restated Articles of Incorporation of the Company
(filed as Exhibit 3(a) to the Company's Quarterly Report on
Form 10-Q for the quarter ended July 4, 1999, and incorporated
herein by reference).
3(b)(1) Restated Bylaws of the Company, dated August 16, 1994 (filed
as Exhibit 3 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1994, and incorporated
herein by reference).
3(b)(2) Amendment to the Bylaws, dated May 5, 1995 (filed as Exhibit 3
to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1995, and incorporated herein by reference).
4(a) Specimen form of certificate representing $.10 par value
Common Stock (filed as Exhibit 4(a) to the Company's Annual
Report on Form 10-K for the year ended December 28, 1990, and
incorporated herein by reference).
10(a) 2001 Employment Agreement dated November 13, 2000, between the
Company and Richard M. Frank (filed as Exhibit 10(a) to the
Company's Annual Report on Form 10-K for the year ended
December 30, 2000, and incorporated herein by reference).
10(b) Employment Agreement, dated May 8, 2001, between Michael H.
Magusiak and the Company (filed as Exhibit 10(a) to the
Company's Quarterly Report on Form 10-Q for the quarter ended
April 1, 2001, and incorporated herein by reference).
10(c)(1) Credit Agreement, in the stated amount of $100,000,000, dated
December 3, 2002, between Showbiz Merchandising, L.P.,
Company, Bank of America, Bank One, U.S. Bank National
Association, Fleet National Bank, and the other Lenders (filed
as Exhibit 10(c) to the Company's Annual Report on Form 10-K
for the year ended December 29, 2002, and incorporated herein
by reference).
10(c)(2) First Amendment to Credit Agreement, in the stated amount of
$100,000,000, dated February 28, 2003, between Showbiz
Merchandising, L.P., Company, Bank of America, Bank One, U.S.
Bank National Association, Fleet National Bank, and the other
Lenders (filed as Exhibit 10(a) to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 29, 2003, and
incorporated herein by reference).
10(c)(3) Second Amendment to Credit Agreement, in the stated amount of
$100,000,000, dated July 16, 2003, between Showbiz
Merchandising, L.P., Company, Bank of America, Bank One, U.S.
Bank National Association, Fleet National Bank, and the other
Lenders (filed as Exhibit 10(_) to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 29, 2003, and
incorporated herein by reference).
10(c)(4) Third Amendment to Credit Agreement, in the stated amount of
$132,500,000, dated August 27, 2003, between CEC Entertainment
Concepts, L.P. (f/k/a Showbiz Merchandising, L.P.), Company,
Bank of America, Bank One, U.S. Bank National Association,
Fleet National Bank, and the other Lenders.
10(c0(5) Fourth Amendment to Credit Agreement in the stated amount of
$135,000,000, dated August 10, 2004, between Bank of America,
N.A. and the Company (filed as Exhibit 10(a) to the Company's
Quarterly Report of Form 10-Q for the Quarter ended on
September 26, 2004, and incorporated herein by reference).
10(d)(1) 1997 Non-Statutory Stock Option Plan (filed as Exhibit 4.1 to
the Company's Form S-8 (No. 333-41039), and incorporated
herein by reference).
10(d)(2) Specimen form of Contract under the 1997 Non-Statutory Stock
Option Plan of the Company, as amended to date (filed as
Exhibit 10(o)(2) to the Company's Annual Report on Form 10-K
for the year ended January 2, 1998, and incorporated herein
by reference).
10(e)(1) Non-Employee Directors Stock Option Plan (filed as Exhibit B
to the Company's Proxy Statement for Annual Meeting of
Stockholders to be held on June 8, 1995, and incorporated
herein by reference).
10(e)(2) Specimen form of Contract under the Non-Employee Directors
Stock Option Plan of the Company, as amended to date (filed as
Exhibit 10(s)(2) to the Company's Annual Report on Form 10-K
for the year ended December 27, 1996, and incorporated herein
by reference).
10(f)(1) Specimen form of the Company's current Franchise Agreement
(filed as Exhibit 10(a)(1) to the Company's Form 8-K (No.
0000813920-04-000021), and incorporated herein by reference).
10(f)(2) Specimen form of the Company's current Development Agreement
(filed as Exhibit 10(a)(2) to the Company's Form 8-K (No.
0000813920-04-000021), and incorporated herein by reference).
10(g) Rights Agreement, dated as on November 19, 1997, by and
between the Company and the Rights Agent (filed as Exhibit A
to Exhibit 1 of the Company's Registration Statement on Form
8-A (No. 001-13687) and incorporated herein by reference).
10(h) 2004 Restricted Stock Plan (filed as Exhibit 4.1 to the
Company's Form S-8 (No. 333-119232), and incorporated herein
by reference).
23 Consent of Independent Registered Public Accounting Firm.
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a).
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a).
32.1 Certification of the Chief Executive Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to
18 U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
During the fourth quarter and to present, we filed or furnished the following
reports on Form 8-K:
A current report on Form 8-K, dated October 14, 2004, containing a press
release on October 14, 2004.
A current report on Form 8-K, dated February 2, 2005, containing a press
release on February 1, 2005.
A current report on Form 8-K, dated March 2, 2005, containing a press
release on March 2, 2005.
A current report on Form 8-K, dated March 9, 2005, containing a press
release on March 9, 2005.
(c) Exhibits pursuant to Item 601 of Regulation S-K:
Pursuant to Item 601(b)(4) of Regulation S-K, there have been excluded from
the exhibits filed pursuant to this report instruments defining the right of
holders of long-term debt of the Company where the total amount of the
securities authorized under each such instrument does not exceed 10% of the
total assets of the Company. The Company hereby agrees to furnish a copy of any
such instruments to the Commission upon request.
(d) Financial Statements excluded from the annual report to shareholders by Rule
14A - 3(b):
No financial statements are excluded from the annual report to the
Company's shareholders by Rule 14a - 3(b).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: March 18, 2005 CEC Entertainment, Inc.
By: /s/ Richard M. Frank
---------------------------
Richard M. Frank
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Richard M. Frank Chairman of the Board, March 18, 2005
- -------------------------- Chief Executive Officer,
Richard M. Frank and Director (Principal
Executive Officer)
/s/ Christopher D. Morris Senior Vice President, March 18, 2005
- -------------------------- Chief Financial Officer
Christopher D. Morris (Principal Financial Officer)
/s/ James Mabry Vice President, Controller March 18, 2005
- -------------------------- and Treasurer
James Mabry (Principal Accounting Officer)
/s/ Michael H. Magusiak President and Director March 18, 2005
- --------------------------
Michael H. Magusiak
/s/ Richard T. Huston Director March 18, 2005
- --------------------------
Richard T. Huston
/s/ Larry T. McDowell Director March 18, 2005
- --------------------------
Larry T. McDowell
/s/ Tim T. Morris Director March 18, 2005
- --------------------------
Tim T. Morris
/s/ Louis P. Neeb Director March 18, 2005
- --------------------------
Louis P. Neeb
/s/ Cynthia I. Pharr Lee Director March 18, 2005
- --------------------------
Cynthia I. Pharr Lee
/s/ Walter Tyree Director March 18, 2005
- --------------------------
Walter Tyree
/s/ Raymond E. Wooldridge Director March 18, 2005
- --------------------------
Raymond E. Wooldridge
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
23 Independent Registered Public Accounting Firm, Deloitte &
Touche LLP
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a).
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a)
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.