UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549 

FORM 10-Q 

(Registrant’s telephone number, including area code)

Not applicable

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

As of May 1,October 31, 2018, an aggregate of 200 shares of the registrant’s common stock, par value $0.01 per share were outstanding.

The accompanying notes are an integral part of these unaudited interim Consolidated Financial Statements.

Description of Business

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

We currently operate and franchise Chuck E. Cheese’s and Peter Piper Pizza family dining and entertainment venues in a total of 47 states and 14 foreign countries and territories. Our venues provide our guests with a variety of family entertainment and dining alternatives. All of our venues utilize a consistent restaurant-entertainment format that features both family dining and entertainment areas with a mix of food, entertainment and merchandise. The economic characteristics, products and services, preparation processes, distribution methods and types of customers are substantially similar for each of our venues. Therefore, we aggregate each venue’s operating performance into one reportable segment for financial reporting purposes.

Basis of Presentation

The Company has a controlling financial interest in International Association of CEC Entertainment, Inc. (the “Association”), a variable interest entity (“VIE”). The Association primarily administers the collection and disbursement of funds (the “Association Funds”) used for advertising, entertainment and media programs that benefit both us and our Chuck E. Cheese’s franchisees. We and our franchisees are required to contribute a percentage of gross sales to these funds and could be required to make additional contributions to fund any deficits that may be incurred by the Association. We include the Association in our Consolidated Financial Statements, as we concluded that we are the primary beneficiary of its variable interests because we (a) have the power to direct the majority of its significant operating activities; (b) provide it unsecured lines of credit; and (c) own the majority of the venues that benefit from the Association’s advertising, entertainment and media expenditures. We eliminate the intercompany portion of transactions with VIE’sVIEs from our financial results. The assets, liabilities and operating results of the Association are not material to our Consolidated Financial Statements.

For further details regarding the impact of thisthese new accounting standardstandards on our Consolidated Statement of Cash Flows,financial statements see “Recently Issued Accounting Guidance” - “Accounting Guidance Adopted” - Accounting Guidance Adopted - (iii) ASU 2016-15, Statementbelow.

The preparation of these unaudited Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of our unaudited Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Interim Financial Statements

The accompanying Consolidated Financial Statements as of and for the three and nine months ended April 1,September 30, 2018 and April 2,October 1, 2017 are unaudited and are presented in accordance with the requirements for quarterly reports on Form 10-Q and, consequently, do not include all of the information and footnote disclosures required by GAAP. In the opinion of management, the Consolidated Financial Statements include all adjustments (consisting solely of normal recurring adjustments) necessary for the fair statement of its consolidated results of operations, financial position and cash flows as of the dates and for the periods presented in accordance with GAAP and the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). All intercompany accounts have been eliminated in consolidation.

Recently Issued Accounting Guidance

Accounting Guidance Adopted:

Effective January 1, 2018, we adopted the following Accounting Standards Updates:

The adoption of these amendments also requires us to reconcile our cash balance on our Consolidated Statements of Cash FlowFlows to the cash balance on our Consolidated Balance Sheets, as well as make disclosures about the nature of restricted cash balances. A reconciliation of “Cash and cash equivalents” and “Restricted cash” as presented in our Consolidated Balance Sheets for the periods presented and “Cash, cash equivalents and restricted cash” as presented in our Consolidated Statements of Cash Flows for the threenine months ended April 1,September 30, 2018 and the three months ended April 2,October 1, 2017 is as follows:

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to change their date of initial application to the beginning of the period of adoption. The new guidance will be effective for us beginning on December 31, 2018. Early adoption will be permitted for all entities. We are currently evaluating the impact of the adoption of this guidance on our Consolidated Financial Statements, but we expect this will have a material effect on our balance sheet since the Company has a significant amount of operating and capital lease arrangements.

Food, beverage and merchandise revenues from company-operated venue activitiesvenues are recognized when sold. OurA portion of our entertainment revenue includes customer purchases of game play credits on Play Pass game cards which allow our customers to play the games in our venues.cards. We recognize a liability for the estimated amount of unused game play credits which we believe our customers will redeem or utilize in the future, based on credits remaining on Play Pass cards and utilization patterns.

We sell gift cards to our customers in our venues and through certain third-party distributors, which do not expire and do not incur a service fee on unused balances. Gift card sales are recorded as deferred revenue when sold and are recognized as revenue when: (a) the gift card is redeemed by the guest or (b) the likelihood of the gift card being redeemed by the guest is remote (“gift card breakage”) and we determine that we do not have a legal obligation to remit the value of the unredeemed gift

card under applicable state unclaimed property escheat statutes. Gift card breakage is determined based upon historical redemption patterns of our gift cards.

This new guidanceASU 2016-10 requires us to recognize initial and renewal franchise and development fees on a straight-line basis over the life of the related franchise agreement or the renewal period. Historically, we have recognized revenue from initial franchise and development fees upon the opening of a franchised restaurant when we have completed all of our material obligations and initial services. Additionally, our national advertising fund receipts from Association members of the Association are now accounted for on a gross basis as “Franchise fees and royalties”,royalties,” when historically they have beenwere netted against “Advertising expense”.expense.” Revenue related to advertising contributions from our franchisees was $1.0$0.8 million and $2.6 million in the three and nine months ended April 1,September 30, 2018, respectively, and is recorded in “Franchise fees and royalties” in our Consolidated Statement of Earnings. Continuing franchise royalties and other miscellaneous sales are recognized in the period earned.

Liabilities relating to our Play Passunused game cards,credits, gift card liabilities and deferred franchise and development fees are included in “Unearned revenues” on our Consolidated Balance Sheets. The following table presents changes in the Company’s Unearned revenue balances during the threenine months ended April 1,September 30, 2018:

The following table presents our indefinite and definite-lived intangible assets at April 1,September 30, 2018:

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Amortization expense related to favorable lease agreements was $0.3 million and $0.4 million for both the three months ended April 1,September 30, 2018 and April 2,October 1, 2017, respectively, and $1.0 million and $1.3 million for the nine months ended September 30, 2018 and October 1, 2017, respectively, and is included in “Rent expense” in our Consolidated Statements of Earnings. Amortization expense related to franchise agreements was $0.5 million for both the three months ended April 1,September 30, 2018 and April 2,October 1, 2017, respectively, and $1.5 million for both the nine months ended September 30, 2018 and October 1, 2017, respectively, and is included in “Depreciation and amortization” in our Consolidated StStatements of Earnings.

 Our long-term debt consisted of the following as of the dates presented:

Our secured credit facilities include (i) a $760.0 million term loan facility with a maturity date of February 14, 2021 (the “term loan facility”) and (ii) a $150.0 million senior secured revolving credit facility with an original maturity date of February 14, 2019, which includes a letter of credit sub-facility and a $30.0 million swingline loan sub-facility (the “revolving credit facility” and together with the term loan facility, the “secured credit facilities”). The secured credit facilities requireterm loan facility requires scheduled quarterly payments on the term loan facility equal to 0.25% of the original principal amount of the term loan facility from July 2014 to December 2020, with the remaining balance paid at maturity, February 14, 2021. AsWe had no borrowings outstanding and $9.0 million and $9.9 million, respectively of April 1,issued but undrawn letters of credit under the revolving credit facility as of September 30, 2018 and December 31, 2017, we had no borrowings outstanding under the revolving credit facility and $9.9 million of letters of credit issued but undrawn under the facility as of April 1, 2018 and December 31, 2017.respectively.

On May 8, 2018 we entered into an incremental assumption agreement with certain of our revolving credit facility lenders to extend the maturity on $95.0 million of the revolving credit facility through November 16, 2020.  In connection with the extension of the maturity date, we agreed to the following covenants for the benefit of the revolving credit facility lenders:  (a) with respect to each fiscal year (commencing with the fiscal year ending December 30, 2018), to the extent we have positive excess cash flow (as defined in the Credit Facilities)secured credit facilities agreement), we willare required to make one or more optional prepayments of term loans to the extent required such that the amount of such optional prepayments, together with thea mandatory excess cash flow prepayment of term loans required under the secured credit facilities in respect of such fiscal year, shallloan principal equal to at least 75% of the Company’s excess cash flow for such fiscal year (subject to step-downs based on our net first lien senior secured leverage ratio, and subject to a certainratio) of the amount of excess cash flow threshold amount)that exceeds $10 million less any optional prepayments of principal that may have occurred during the fiscal year and (b) we shall not incur additional first lien debt in connection with certain acquisitions, mergers or consolidations unless our net first lien senior secured leverage ratio is not greater than 3.65 to 1.00 on a pro forma basis. Other revolving credit facility lenders who have not entered into the incremental assumption agreement have until 5:00 p.m. New York time on May 11, 2018 to elect to extend the maturity of their revolving credit facility c

The term loan was issued net of $3.8 million of original issue discount. We also paid $17.8 million and $3.4$3.8 million in debt financing costs related to the term loan facility and revolving credit facility respectively, which we(inclusive of costs incurred in connection with the May 8, 2018 incremental assumption agreement), respectively. All debt financing costs were capitalized in “Bank indebtedness and other long-term debt, net of deferred financing costs” on our Consolidated Balance Sheets. The original issue discount and deferred financing costs related to the term loan facility are amortized over the liveslife of the facilitiesterm loan facility, and the deferred financing costs related to the revolving credit facility are being amortized through November 16, 2020, and are included in “Interest expense” on our Consolidated Statements of Earnings.

Borrowings under the secured credit facilities bear interest at a rate equal to, at our option, either (a) a London Interbank Offered Rate (“LIBOR”) determined by reference to the costs of funds for Eurodollar deposits for the interest period relevant to such borrowings, adjusted for certain additional costs, subject to a 1.00% floor in the case of term loans or (b) a base rate determined by reference to the highest of (i) the federal funds effective rate plus 0.50%; (ii) the prime rate of Deutsche Bank AG New York Branch; and (iii) the one-month adjusted LIBOR plus 1.00%, in each case plus an applicable margin. The base applicable margin is 3.25% with respect to LIBOR borrowings and 2.25% with respect to base rate borrowings under the

term loan facility and base rate borrowings and swingline borrowings under the revolving credit facility. The applicable margin

for LIBOR borrowings under the term loan facility is subject to one step-down from 3.25% to 3.00% based on our net first lien senior secured leverage ratio and the applicable margin for LIBOR borrowings under the revolving credit facility is subject to two step-downs from 3.25% to 3.00% and 2.75% based on our net first lien senior secured leverage ratio. Effective March 4, 2016,During the applicable margin for both our term loan facility and revolving credit facility stepped down to 3.0%. Effective November 16, 2017,nine

months ended September 30, 2018, the applicable margin for LIBOR borrowings under both the term loan facility and the revolving credit facility returned to their previous level ofwas 3.25%.

In addition to paying interest on outstanding principal under the secured credit facilities, we are required to pay a commitment fee to the lenders under the revolving credit facility with respect to the unutilized commitments thereunder. The base applicable commitment fee rate under the revolving credit facility wasis 0.50% per annum and is subject to one step-down from 0.50% to 0.375% based on our net first lien senior secured leverage ratio. During the nine months ended September 30, 2018 the commitment fee rate was 0.50%. We are also required to pay customary agency fees, as well as letter of credit participation fees computed at a rate per annum equal to the applicable margin for LIBOR rate borrowings on the dollar equivalent of the daily stated amount of outstanding letters of credit, plus such letter of credit issuer’s customary documentary and processing fees and charges and a fronting fee computed at a rate equal to 0.125% per annum on the daily stated amount of such letter of credit.

During the threenine months ended April 1,September 30, 2018, the federal funds rate ranged from 1.34% to 1.68%2.18%, the prime rate ranged from 4.50% to 4.75%5.25% and the one-month LIBOR ranged from 1.55% to 1.89% 2.26%.

The weighted average effective interest rate incurred on our borrowings under our secured credit facilities was 5.5%5.7% and 4.6%4.7% for the threenine months ended April 1,September 30, 2018 and April 2,October 1, 2017, respectively, which includes amortization of deferred financing costs related to our secured credit facilities, amortization of our term loan facility original issue discount and commitment and other fees related to our secured credit facilities.

Obligations under the secured credit facilities are unconditionally guaranteed by Queso Holdings Inc. (“Parent”) on a limited-recourse basis and each of our existing and future direct and indirect material, wholly-owned domestic subsidiaries, subject to certain exceptions. The obligations are secured by a pledge of our capital stock and substantially all of our assets and those of each subsidiary guarantor, including capital stock of the subsidiary guarantors and 65% of the capital stock of the first-tier foreign subsidiaries that are not subsidiary guarantors, in each case subject to exceptions. Such security interests consist of first priority liens with respect to the collateral.

The secured credit facilities also contain customary affirmative and negative covenants, and events of default, which limit our ability to, among other things: incur additional debt or issue certain preferred shares; create liens on certain assets; make certain loans or investments (including acquisitions); pay dividends on or make distributions with respect to our capital stock or make other restricted payments; consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; sell assets; enter into certain transactions with our affiliates; enter into sale-leaseback transactions; change our lines of business; restrict dividends from our subsidiaries or restrict liens; change our fiscal year; and modify the terms of certain debt or organizational agreements..agreements.

Our revolving credit facility includes a springing financial maintenance covenant that requires our net first lien senior secured leverage ratio not to exceed 6.25 to 1.00 (the ratio of consolidated net debt secured by first-priority liens on the collateral to the last twelve months’ EBITDA, as defined in the senior credit facilities). The covenant will be tested quarterly if the revolving credit facility is more than 30% drawn (excluding outstanding letters of credit) and will be a condition to drawings under the revolving credit facility that would result in more than 30% drawn thereunder.

Our senior unsecured debt consists of $255.0 million aggregate principal amount borrowings of 8.000%8.0% Senior Notes due 2022 (the “senior notes”). The senior notes bear interest at a rate of 8.000%8.0% per year payable February 15th and August 15th each year and mature on February 15, 2022. We may redeem some or all of the senior notes at certain redemption prices set forth in the indenture governing the senior notes (the “indenture”).

We paid $6.4 million in debt issuance costs related to the senior notes, which we capitalized in “Bank indebtedness and other long-term debt, net of deferred financing costs” on our Consolidated Balance Sheets. The deferred financing costs are being amortized over the life of the senior notes and are included in “Interest expense” in our Consolidated Statements of Earnings.

Our obligations under the senior notes are fully and unconditionally guaranteed, jointly and severally, by our present and future direct and indirect wholly-owned material domestic subsidiaries that guarantee our secured credit facilities.

The indenture contains restrictive covenants that limit our ability to, among other things: (i) incur additional debt or issue certain preferred shares; (ii) create liens on certain assets; (iii) make certain loans or investments (including acquisitions); (iv) pay dividends on or make distributions in respect of our capital stock or make other restricted payments; (v) consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; (vi) sell assets; (vii) enter into certain transactions with our affiliates; and (viii) restrict dividends from our subsidiaries.

The weighted average effective interest rate incurred on borrowings under our senior notes was 8.2% for both the both threenine months ended April 1,September 30, 2018 and April 2,October 1, 2017, which included amortization of deferred financing costs and other fees related to our senior notes.

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The weighted average effective interest rate incurred on our borrowings under our secured credit facilities and senior notes (including amortized debt issuance costs, amortization of original issue discount, commitment and other fees related to the secured credit facilities and senior notes) was 6.2%6.3% for the threenine months ended April 1,September 30, 2018 and 5.5%5.6% for the threenine months ended April 2,October 1, 2017, respectively.

We were in compliance with the debt covenants in effect as of April 1,September 30, 2018 for both the secured credit facilities and the senior notes.

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During the threenine months ended April 1,September 30, 2018 and April 2,October 1, 2017, there were no significant transfers among Level 1, 2 or 3 fair value determinations.

Our income tax expense consists of the following for the periods presented:

Our effective income tax raterates for the three and nine months ended April 1,September 30, 2018 was 24.3%were 18.9% and 6.8%, respectively, as compared to 37.6%32.0% and 90.2%, respectively, for the three and nine months ended April 2,October 1, 2017. Our effective income tax rate for the three and nine months ended April 1,September 30, 2018 was impacted by the reduction in the U.S. federal statutory corporate income tax rate from 35% to 21% resulting from the the TCJATax Cuts and Jobs Act (TCJA) signed into law on December 22, 2017.2017, return-to-provision adjustments including those related to the true up of provisional estimates provided in 2017 to account for the impact of the TCJA pursuant to SAB118, and the impact of employment-related federal income tax credits, offset by the negative impact of nondeductible litigation costs related to the Merger, nondeductible penalties, a net increase in our liability for uncertain tax positions, and state and foreign taxes. Our effective income tax rate for the threenine months ended April 1,September 30, 2018 differs fromwas further impacted by the statutoryunfavorable results of state tax rate primarily duelegislation enacted during the second quarter that increased the amount of income subject to state income taxes, the favorable impact of employment-related federal income tax credits,taxation and a one-time adjustment to deferred taxes (the tax effect of the cumulative foreign currency translation adjustment existing as of January 1, 2018) resulting from the change in our intent to no longer indefinitely reinvest monies previously loaned to our Canadian subsidiary partially offset byrecorded in the negative impact of nondeductible litigation costs related to the Merger.first quarter. Our effective income tax raterates for the three and nine months ended April 2,October 1, 2017 differed from the statutory rate primarily due to state income taxes and the favorable impact of employment-related federal income tax credits.

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the U.S. corporatenecessary information available, prepared, or analyzed to complete the accounting for certain income tax rate from 35%effects of the TCJA. Pursuant to 21% (effective for Fiscal 2018) and increased allowance for bonus depreciation will have a favorable impact on our future after tax net income and cash flows. WhileSAB118, we were able to makeincluded provisional estimates for the impact of the TJCA in our consolidated financial statements for the fiscal year ended December 31, 2017, noting that actual results may differ from thesethe provisional estimates, due to, among other things, changes in our interpretations and assumptions relating to the changes made by the TCJA and additional guidance that is anticipated to be issued by the U.S. Treasury and Internal Revenue Service includingregarding (i) the newly enacted increase in bonus depreciation for qualifying assets acquired and placed in service after September 27, 2017, (ii) the expansion of the limitation under Section 162(m) relating to the deductibility of executive compensation in excess of $1.0 million, and (iii) the one-time transition tax, net of foreign tax credits and operating losses, on earnings of foreign subsidiaries that were previously deferred from U.S. tax. SAB118 further states that any adjustments made to the provisional amounts under SAB 118 should be recorded as discrete adjustments in the period identified and not to extend beyond the one-year measurement provided in SAB 118. During the nine months ended September 30, 2018, we recognized a $0.5 million return-to-provision adjustment discrete tax benefit relating to the provisional estimates required to account for TCJA that normally would not have impacted our effective tax rate (deductions in 2017’s tax return at 35% with the offset to deferred taxes at 21%). The final adjustments to the provisional estimates will be completed in the fourth quarter of 2018.

due to significant variations in the customary relationship between income tax expense and projected annual pre-tax income or loss which occurs when annual projected pre-tax income or loss nears a relatively small amount in comparison to the differences between income and deductions determined for financial statement purposes versus income tax purposes. Using the discrete method, we have determined our current and deferred income tax expense as if the interim period were an annual period.

Our liability for uncertain tax positions (excluding interest and penalties) was $4.6 million as of September 30, 2018 and $3.9 million as of April 1, 2018 and December 31, 2017 and if recognized would decrease our provision for income taxes by $2.6$3.3 million. Within the next twelve months, we could settle or otherwise conclude certain ongoing income tax audits.audits and resolve uncertain tax positions as a result of expiring statutes of limitations or payment. As such, it is reasonably possible that the liability for uncertain tax positions could decrease by as much as $1.0$3.9 million as a result of settlements with certain taxing authorities and expiring statutes of limitations within the next twelve months.

Total accrued interest and penalties related to unrecognized tax benefits as of April 1,September 30, 2018 and December 31, 2017 was $1.1 million and $1.0 million.million, respectively. On the Consolidated Balance Sheets, we include current interest related to unrecognized tax benefits in “Accrued interest,” current penalties in “Accrued expenses” and noncurrent accrued interest and penalties in “Other noncurrent liabilities.”

The 2014 Equity Incentive Plan provides Parent authority to grant equity incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, stock bonus awards or performance compensation

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The following table summarizes stock-based compensation expense and the associated tax benefit recognized in the Consolidated Financial Statements for the periods presented:

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The following table summarizes the changes in stockholder’s equity during the threenine months ended April 1,September 30, 2018:

 

On February 14, 2014, CEC Entertainment, Inc. (the “Issuer”) merged with and into an entity controlled by Apollo Global Management, LLC and its subsidiaries, which we refer to as the “Merger”.“Merger.” The senior notes issued by the Issuer, in conjunction with the Merger, are our unsecured obligations and are fully and unconditionally, jointly and severally guaranteed by all of our 100% wholly-owned U.S. subsidiaries (the “Guarantors”). Our wholly-owned foreign subsidiaries and our less-than-wholly-owned U.S. subsidiaries are not a party to the guarantees (the “Non-Guarantors”). The following schedules present the condensed consolidating financial statements of the Issuer, Guarantors and Non-Guarantors, as well as consolidated results, for the periods presented: