10-Q/A 1 q1st2004restatement.txt 1ST QUARTER 2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q/A (Amendment No. 2) (Mark One) |X| Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 28, 2004. |_| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _____________ to _______________. Commission File Number 001-13587 CEC ENTERTAINMENT, INC. (Exact name of registrant as specified in its charter) Kansas 48-0905805 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4441 West Airport Freeway Irving, Texas 75062 (Address of principal executive offices, including zip code) (972) 258-8507 (Registrant's telephone number, including area code) 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [_] At May 5, 2004, an aggregate of 37,353,604 shares of the registrant's Common Stock, par value of $.10 each (being the registrant's only class of common stock), were outstanding. EXPLANATORY NOTE As previously disclosed in a Form 8-K filed on March 2, 2005, following a review of its lease-related accounting policies, CEC Entertainment, Inc. (the "Company") determined that it was appropriate to adjust its prior financial statements (the "Restatement") to correct certain errors in those financial statements relating to the computation of depreciation, lease classification, straight-line rent expense and the related deferred liability. Historically, when accounting for leases, the Company has 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. Following an extensive analysis of its lease and related accounting policies, the Company has now determined to use a consistent lease period (generally, the initial non-cancelable lease term plus renewable 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 will commence 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 cost of leasehold improvements will be recorded as a deferred credit resulting from a lease incentive and amortized over the lease term as a reduction to rent expense. As a result, the accompanying condensed consolidated financial statements have been restated from the amounts previously reported to incorporate the effects of these policies. See Note 2 to the consolidated financial statements. This amendment No. 2 on Form 10-Q/A to the Company's quarterly report on Form 10-Q for the fiscal quarter ended March 28, 2004 ("Original Filing"), initially filed with the Securities and Exchange Commission ("SEC") on May 6, 2004, is being filed to reflect restatements of the Company's consolidated balance sheets at March 28, 2004 and the Company's consolidated statements of earnings, changes in stockholders' equity and consolidated cash flows for the three months ended March 28, 2004 and March 30, 2003 and the notes related thereto. For a more detailed description of these restatements, see Note 2, "Restatement of Financial Statements" to the accompanying condensed consolidated financial statements and the section entitled "Restatement" in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in this Form 10-Q/A. For the convenience of the reader, this Form 10-Q/A includes the Original Filing in its entirety. However, this Form 10-Q/A only amends and restates Items 1, 2 and 4, of Part I of the Original Filing and no other material information in the Original Filing is amended hereby. The foregoing items have not been updated to reflect other events occurring after the Original Filing or to modify or update those disclosures affected by subsequent events. In addition, pursuant to the rules of the SEC, Item 6 of Part II of the Original Filing has been amended to contain currently-dated certifications from our Chief Executive Officer and Chief Financial Officer , as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of our Chief Executive Officer and Chief Financial Officer are attached to this Form 10-Q/A as Exhibits 31.1, 31.2, 32.1 and 32.2, respectively. Except for the foregoing amended information, this Form 10-Q/A continues to describe conditions as of the date of the Original Filing, and does not update disclosures contained herein to reflect events that occurred at a later date. Other events occurring after the filing of the Original Filing or other disclosures necessary to reflect subsequent events have been or will be addressed in our amended Quarterly Reports on Form 10-Q/A for the quarterly periods ended June 27, 2004 and September 26, 2004 which are being filed concurrently with this filing of this Form 10-Q/A and any reports filed with the SEC subsequent to this filing. Concurrently with the filing of this Form 10-Q/A, we are filing an amendment on Form 10-K/A to our Annual Report on Form 10-K for the fiscal year ended December 28, 2003 ("2003 10-K") to provide restatements of the financial statements or financial data as of and for the periods included in the 2003 10-K and amended quarterly reports on Form 10-Q/A for the quarters ended March 28, 2004, June 27, 2004 and September 26, 2004. We have not amended and do not intend to amend our previously filed Annual Reports on Form 10-K other than the 2003 10-K or our Quarterly Reports on Form 10-Q for the periods affected by the Restatement that ended prior to December 28, 2003. For this reason, the consolidated financial statements, auditors' reports and related financial information for all affected periods contained in any other prior reports should no longer be relied upon. CEC ENTERTAINMENT, INC. TABLE OF CONTENTS Page ---- Part I - Financial Information: Item 1. Financial Statements: Condensed Consolidated Balance Sheets.................................. 5 Condensed Consolidated Statements of Earnings and Comprehensive Income. 6 Condensed Consolidated Statement of Shareholders' Equity............... 7 Condensed Consolidated Statements of Cash Flows ....................... 8 Notes to Condensed Consolidated Financial Statements................... 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................. 13 Item 3. Quantitative and Qualitative Disclosures about Market Risk ....... 17 Item 4. Controls and Procedures.......................................... 17 Part II - Other Information: Item 1. Legal Proceedings................................................ 18 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities................................................... 19 Item 6. Exhibits and Reports on Form 8-K................................. 19 Signatures................................................................... 20 Certifications............................................................... 21 PART I - FINANCIAL INFORMATION Item 1. Financial Statements
CEC ENTERTAINMENT, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Thousands, except share data) ASSETS March 28, December 28, 2004 2003 ------------- ------------- (as restated) (unaudited) Current assets: Cash and cash equivalents.................................................... $ 12,464 $ 8,067 Accounts receivable.......................................................... 9,919 13,103 Inventories.................................................................. 10,254 12,491 Prepaid expenses............................................................. 8,721 7,608 Deferred tax asset........................................................... 1,487 1,487 --------- --------- Total current assets....................................................... 42,845 42,756 --------- --------- Property and equipment, net..................................................... 542,290 538,756 --------- --------- Other assets.................................................................... 1,338 1,471 --------- --------- $ 586,473 $ 582,983 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt............................................ $ 720 $ 554 Accounts payable............................................................. 24,927 30,126 Accrued liabilities.......................................................... 49,811 28,610 --------- --------- Total current liabilities.................................................. 75,458 59,290 --------- --------- Long-term debt, less current portion............................................ 48,273 75,205 --------- --------- Deferred rent................................................................... 45,483 42,816 --------- --------- Deferred tax liability.......................................................... 37,263 32,849 --------- --------- Accrued insurance............................................................... 8,500 8,500 --------- --------- Shareholders' equity: Common stock, $.10 par value; authorized 100,000,000 shares; 54,697,077 and 54,481,913 shares issued, respectively ............................... 5,470 5,448 Capital in excess of par value............................................... 224,637 219,071 Retained earnings ........................................................... 382,168 350,735 Accumulated other comprehensive income ...................................... 681 695 Less treasury shares of 16,840,268 and 16,042,418, respectively, at cost..... (241,460) (211,626) --------- --------- 371,496 364,323 --------- --------- $ 586,473 $ 582,983 ========= ========= See notes to condensed consolidated financial statements.
CEC ENTERTAINMENT, INC. CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME (Unaudited) (Thousands, except per share data) Three Months Ended --------------------------------- March 28, 2004 March 30, 2003 -------------- -------------- (as restated) (as restated) Food and beverage revenues........................................ $ 136,339 $ 120,844 Games and merchandise revenues.................................... 69,741 62,408 Franchise fees and royalties...................................... 861 865 Interest income .................................................. 7 9 --------- --------- 206,948 184,126 --------- --------- Costs and expenses: Cost of sales: Food, beverage and related supplies.......................... 24,478 21,970 Games and merchandise........................................ 8,643 7,524 Labor........................................................ 53,238 47,934 --------- --------- 86,359 77,428 Selling, general and administrative expenses................... 23,832 21,004 Depreciation and amortization.................................. 13,378 12,004 Interest expense............................................... 483 470 Other operating expenses....................................... 31,951 29,835 --------- --------- 156,003 140,741 --------- --------- Income before income taxes........................................ 50,945 43,385 Income taxes...................................................... 19,512 16,833 --------- --------- Net income ....................................................... 31,433 26,552 Other comprehensive income (loss), net of tax: Foreign currency translation................................... (14) 283 --------- --------- Comprehensive income.............................................. $ 31,419 $ 26,835 ========= ========= Earnings per share: Basic: Net income .................................................. $ .82 $ .65 ========= ========= Weighted average shares outstanding.......................... 38,310 40,853 ========= ========= Diluted: Net income ................................................. $ .79 $ .64 ========= ========= Weighted average shares outstanding.......................... 39,607 41,157 ========= ========= See notes to condensed consolidated financial statements.
CEC ENTERTAINMENT, INC. CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Unaudited) (Thousands) Amounts Shares --------- -------- Common stock and capital in excess of par value: Balance, beginning of year................................... $ 224,519 54,482 Stock options exercised...................................... 3,982 203 Tax benefit from exercise of options ........................ 1,235 Payment for fractional shares................................ (26) Stock issued under 401(k) plan............................... 397 12 --------- ------- Balance, March 28, 2004...................................... 230,107 54,697 --------- ======= Retained earnings (as restated): Balance, beginning of year................................... 350,735 Net income................................................... 31,433 --------- Balance, March 28, 2004 ..................................... 382,168 --------- Accumulated other comprehensive income (loss): Balance, beginning of year................................... 695 Foreign currency translation................................. (14) --------- Balance, March 28, 2004...................................... 681 --------- Treasury shares: Balance, beginning of year................................... (211,626) 16,042 Treasury stock acquired...................................... (29,834) 798 --------- ------- Balance, March 28, 2004...................................... (241,460) 16,840 --------- ======= Total shareholders' equity (as restated)........................ $ 371,496 ========= See notes to condensed consolidated financial statements.
CEC ENTERTAINMENT, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Thousands) Three Months Ended --------------------------------- March 28, 2004 March 30, 2003 -------------- -------------- (as restated) (as restated) Operating activities: Net income ............................................................... $ 31,433 $ 26,552 Adjustments to reconcile net income to cash provided by operations: Depreciation and amortization........................................... 13,378 12,004 Deferred income tax expense............................................. 4,414 3,940 Tax benefit from exercise of stock options.............................. 1,235 44 Other................................................................... 3,111 2,573 Net change in receivables, inventory, prepaids, payables and accrued liabilities................................................... 20,310 16,163 -------- -------- Cash provided by operations.......................................... 73,881 61,276 -------- -------- Investing activities: Purchases of property and equipment....................................... (16,434) (20,464) (Increase) decrease in other assets....................................... 60 (996) -------- -------- Cash used in investing activities....................................... (16,374) (21,460) -------- -------- Financing activities: Payments on debt and line of credit ...................................... (27,552) (31,127) Exercise of stock options ................................................ 3,982 264 Redeemable preferred stock dividends ..................................... (59) Repurchase of common stock ............................................... (29,834) (5,922) Other .................................................................... 294 637 -------- -------- Cash used in financing activities....................................... (53,110) (36,207) -------- -------- Increase in cash and cash equivalents ....................................... 4,397 3,609 Cash and cash equivalents, beginning of period............................... 8,067 12,214 -------- -------- Cash and cash equivalents, end of period..................................... $ 12,464 $ 15,823 ======== ======== See notes to condensed consolidated financial statements.
CEC ENTERTAINMENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Interim financial statements: In the opinion of management, the accompanying condensed financial statements for the periods ended March 28, 2004 and March 30, 2003 reflect all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company's financial condition, results of operations and cash flows in accordance with generally accepted accounting principles. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with generally accepted accounting principles have been omitted. The unaudited condensed consolidated financial statements referred to above should be read in conjunction with the financial statements and notes thereto included in the Company's Form 10-K/A filed with the Securities and Exchange Commission for the year ended December 28, 2003. Results of operations for the periods ended March 28, 2004 and March 30, 2003 are not necessarily indicative of the results for the year. 2. Restatement of Financial Statements: Subsequent to the issuance of the Company's interim condensed consolidated financial statements for the period ended March 28, 2004, and following a review of its lease-related accounting policies, the Company's management has determined that it was appropriate to adjust its prior financial statements to correct certain errors contained in those financial statements relating to the computation of depreciation, lease classification, straight-line rent expense and the related deferred rent liability. Historically, when accounting for leases, the Company has 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. The Company has now determined to use 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 will commence 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 cost of leasehold improvements will be recorded as a deferred credit resulting from a lease incentive and amortized over the lease term as a reduction to rent expense. As a result, the accompanying condensed consolidated financial statements have been restated from the amounts previously reported to incorporate the effects of these policies. CEC ENTERTAINMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. Restatement of Financial Statements (continued): The following is a summary of the impact of the Restatement on the consolidated balance sheets at December 28, 2003 and March 28, 2004 , and the consolidated statements of earnings and consolidated statements of cash flows for the three month periods ended March 28, 2004 and March 30, 2003.
March 28, 2004 -------------------------------------------- As Previously Reported Adjustment As Restated ------------- ---------- ----------- Consolidated Balance Sheet: Property and equipment, net.................... $ 538,129 $ 4,161 $ 542,290 Total assets................................... 582,312 4,161 586,473 Current portion of long-term debt.............. 168 552 720 Long-term debt, less current portion........... 37,141 11,132 48,273 Deferred rent.................................. 5,486 39,997 45,483 Deferred tax liability......................... 55,695 (18,432) 37,263 Retained earnings.............................. 411,256 (29,088) 382,168 Total shareholders' equity..................... 400,584 (29,088) 371,496
Three Months ended March 28, 2004 -------------------------------------------- As Previously Reported Adjustment As Restated ------------- ---------- ----------- Consolidated Statement of Earnings: Depreciation and amortization.................. $ 12,229 $ 1,149 $ 13,378 Interest expense............................... 287 196 483 Other operating expenses....................... 31,817 134 31,951 Total costs and expenses....................... 154,524 1,479 156,003 Income before income taxes..................... 52,424 (1,479) 50,945 Income taxes................................... 20,079 (567) 19,512 Net income..................................... 32,345 (912) 31,433 Basic earnings per share....................... .84 (.02) .82 Diluted earnings per share..................... .82 (.03) .79 Consolidated Statement of Cash Flows: Cash provided by operations.................... $ 71,877 $ 2,004 $ 73,881 Cash used in investing activities.............. (14,482) (1,892) (16,374) Cash used in financing activities.............. (52,998) (112) (53,110)
CEC ENTERTAINMENT, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. Restatement of Financial Statements (continued):
Three Months ended March 30, 2003 -------------------------------------------- As Previously Reported Adjustment As Restated ------------- ---------- ----------- Consolidated Statement of Earnings: Depreciation and amortization.................. $ 10,905 $ 1,099 $ 12,004 Interest expense............................... 283 187 470 Other operating expense........................ 29,724 111 29,835 Total costs and expenses....................... 139,344 1,397 140,741 Income before income taxes..................... 44,782 (1,397) 43,385 Income taxes................................... 17,375 (542) 16,833 Net income..................................... 27,407 (855) 26,552 Basic earnings per share....................... .67 (.02) .65 Diluted earnings per share..................... .66 (.02) .64 Consolidated Statement of Cash Flows: Cash provided by operations.................... $ 59,804 $ 1,472 $ 61,276 Cash used in investing activities.............. (20,082) (1,378) (21,460) Cash used in financing activities.............. (36,113) (94) (36,207)
3. 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. Earnings per common and potential common share were computed as follows (thousands, except per share data):
Three Months Ended ------------------------------- March 28, March 30, 2004 2003 ------------- ------------- (as restated) (as restated) Net income ............................................. $ 31,433 $ 26,552 Accretion of redeemable preferred stock................. (26) Redeemable preferred stock dividends.................... (59) -------- -------- Adjusted income applicable to commons shares............ $ 31,433 $ 26,467 ======== ======== Basic: Weighted average common shares outstanding.......... 38,310 40,853 ======== ======== Earnings per common share .......................... $ .82 $ .65 ======== ======== Diluted: Weighted average common shares outstanding.......... 38,310 40,853 Potential common shares for stock options........... 1,297 304 -------- -------- Weighted average shares outstanding................. 39,607 41,157 ======== ======== Earnings per common and potential common share ................................... $ .79 $ .64 ======== ========
CEC ENTERTAINMENT, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 4. 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 123, the Company's pro-forma net income and earnings per share would have been as follows (thousands, except per share data):
Three Months Ended ----------------------------- March 28, March 30, 2004 2003 ------------- ------------- (as restated) (as restated) Net income, as reported ................................................. $ 31,433 $ 26,552 Fair value based compensation expense, net of taxes...................... (1,436) (1,624) -------- -------- Pro-forma net income .................................................... 29,997 24,928 Accretion and dividends of redeemable preferred stock, as reported....... (85) -------- -------- Pro-forma net income applicable to common shares......................... $ 29,997 $ 24,843 ======== ======== Earnings per Share: Basic: As reported.......................................................... $ .82 $ .65 Pro-forma ........................................................... $ .78 $ .61 Diluted: As reported.......................................................... $ .79 $ .64 Pro-forma............................................................ $ .76 $ .60
4. Stock split: All share and per share information have been retroactively adjusted for the effects of a three for two stock split in the form of a special stock dividend effected and distributed on March 15, 2004. Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Restatement Following a review of its lease-related accounting policies, the Company determined that it was appropriate to adjust its prior financial statements to correct certain errors contained in those financial statements relating to the computation of depreciation, lease classification, straight-line rent expense and the related deferred rent liability. Historically, when accounting for leases, the Company has 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. The Company has now determined to use 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 will commence 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 cost of leasehold improvements will be recorded as a deferred credit resulting from a lease incentive and amortized over the lease term as a reduction to rent expense. As a result, the accompanying condensed consolidated financial statements have been restated from the amounts previously reported to incorporate the effects of these policies. The effects of the restatement adjustments are discussed in Note 2 in the notes to the condensed consolidated financial statements. The following has been updated to give effect to the Restatement. Results of Operations First Quarter 2004 Compared to First Quarter 2003 A summary of the results of operations of the Company as a percentage of revenues for the first quarters of 2004 and 2003 is shown below. Three Months Ended March 28, 2004 March 30, 2003 -------------- -------------- Revenue....................................... 100.0% 100.0% ----- ----- Costs and expenses: Cost of sales: Food, beverage and related supplies..... 11.8 11.9 Games and merchandise................... 4.2 4.1 Labor................................... 25.7 26.0 ----- ----- 41.7 42.0 Selling, general and administrative........ 11.5 11.4 Depreciation and amortization.............. 6.5 6.5 Interest expense........................... .2 .3 Other operating expenses................... 15.4 16.2 ----- ----- 75.3 76.4 ----- ----- Income before income taxes.................... 24.7 23.6 Income tax expense ........................... 9.4 9.2 ----- ----- Net income ................................... 15.3% 14.4% ===== ===== Revenues Revenues increased 12.4% to $206.9 million in the first quarter of 2004 from $184.1 million in the first quarter of 2003 due to an increase in the number of Company-operated restaurants and an increase of 5.0% in comparable store sales. During the full year of 2003, the Company opened 32 new restaurants, acquired three restaurants from franchisees and closed one restaurant. During the first three months of 2004, the Company opened two new restaurants and has 420 Company-operated restaurants at March 28, 2004. Menu prices increased 1.0% between the first quarter of 2003 and the first quarter of 2004. Costs and Expenses Costs and expenses as a percentage of revenues decreased to 75.3% in the first quarter of 2004 from 76.4% in the first quarter of 2003. Cost of sales decreased as a percentage of revenues to 41.7% in the first quarter of 2004 from 42.0% in the comparable period of 2003. Cost of food, beverage, and related supplies as a percentage of revenues decreased to 11.8% in the first quarter of 2004 from 11.9% in the first quarter of 2003. Food costs were negatively impacted by approximately $1.1 million due to a 36% increase in average cheese prices paid in the first quarter of 2004 compared to the first quarter of 2003. However this increase was fully offset by lower beverage costs and the favorable effects of a 1.0% menu price increase implemented in 2003. Cost of games and merchandise as a percentage of revenues increased to 4.2% in the first quarter of 2004 from 4.1% in the first quarter of 2003. Store labor expenses as a percentage of store sales decreased to 25.7% in the first quarter of 2004 from 26.0% in the first quarter of 2003 primarily due to the increase in comparable store sales. Selling, general and administrative expenses as a percentage of revenues increased to 11.5% in the first three months of 2004 from 11.4% in the first three months of 2003. The increase was primarily due to higher bonus expense in the first quarter of 2004 due to strong financial performance. In addition, pre-opening expenses for restaurants opened or under construction were higher in the first quarter of 2004 compared to the first quarter of 2003. Depreciation and amortization expenses as a percentage of revenues were 6.5% in the first quarters of both 2004 and 2003. Interest expense as a percentage of revenues decreased to 0.2% in the first three months of 2004 from 0.3% in the first three months of 2003. Other operating expenses decreased as a percentage of revenues to 15.4% in the first quarter of 2004 from 16.2% in the first quarter of 2003 primarily due to the increase in comparable store sales and the fact that a significant portion of operating costs are fixed. The Company's effective income tax rate was 38.3% in the first quarter of 2004 compared to a rate of 38.8% in the first quarter of 2003 due to a reduction in the Company's effective state tax rate. Net Income The Company had net income of $31.4 million in the first quarter of 2004 compared to $26.6 million in the first quarter of 2003 due to the changes in revenues and expenses discussed above. The Company's diluted earnings per share increased 23.4% to $.79 per share in the first quarter of 2004 from $.64 per share in the first quarter of 2003 due to the 18.4% increase in net income discussed above and a 3.8% decrease in the number of weighted average shares outstanding. Financial Condition, Liquidity and Capital Resources Cash provided by operations increased to $73.9 million in the first three months of 2004 from $61.3 million in the comparable period of 2003. Cash outflows from investing activities for the first three months of 2004 were $16.4 million primarily related to capital expenditures. Cash outflows from financing activities for the first three months of 2004 were $53.1 million primarily related to the repayment of borrowings on the Company's line of credit and 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 $32.6 million at March 28, 2004 due primarily to the timing of payments for accrued income taxes payable. 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 or reconfigurations and d) expansions of the square footage of existing restaurants. In addition, the Company is currently testing revisions to the building exterior along with interior enhancements in conjunction with a game enhancement initiative. The game enhancement initiative began in 2003 and has an average capital cost of approximately $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 area. The major remodel or reconfiguration initiative includes a reallocation of space between the dining and game room areas, expansion of the space allocated to the game room and an increase in the number of games. The typical capital cost of this initiative will range from $225,000 to $400,000 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. In 2004, the Company plans to add 36 to 40 restaurants including new restaurants and acquisitions of 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 2004 is approximately $1.4 million per restaurant. At the beginning of 2004, the Company identified development opportunities for approximately 300 restaurants including those restaurants expected to open in 2004. In 2004, the Company plans to complete the game enhancement initiative in 60 to 80 restaurants. The Company plans to complete a major remodel or reconfiguration 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. The Company has currently identified approximately 20 potential restaurants for a major remodel including the three franchise restaurants acquired in 2003. The Company also plans to expand the square footage of approximately four to five restaurants. In addition, the Company is currently testing revisions to the building exterior along with interior enhancements in conjunction with the game enhancement initiative. The Company expects the aggregate capital costs of completing game enhancement initiatives, major remodels, reconfigurations, expanding the square footage of existing restaurants and testing revisions to the building exterior along with interior enhancements in 2004 to total approximately $16 million and impact 105 to 110 restaurants. During the first quarter of 2004, the Company opened two new restaurants, implemented the game enhancement initiative plan in 43 restaurants, completed major remodels in two restaurants and building exterior and interior enhancements in three restaurants. The Company currently estimates that capital expenditures in 2004 will be $79 million to $85 million. 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 the first quarter of 2004, the Company has repurchased approximately 16.0 million shares of the Company's common stock, retroactively adjusted for a three for two stock split effective on March 15, 2004, at an aggregate purchase price of approximately $237 million. During the first quarter of 2004, the Company repurchased 797,850 shares at an aggregate purchase price of approximately $29.8 million. At the end of the first quarter of 2004, approximately $48.2 million remained available for repurchase under the current $75 million repurchase authorization approved by the Company's Board of Directors in the first quarter of 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 March 28, 2004, there were $37.0 million in borrowings under this line of credit. In addition, the Company had outstanding letters of credit of $7.5 million at March 28, 2004. The line of credit agreement contains certain restrictions and conditions as defined in the agreement that require the Company to maintain net worth of $362.0 million as of March 28, 2004, 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 March 28, 2004, 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. Website Access to Company Reports Our website address is www.chuckecheese.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Forms 3, 4 and 5 filed by our officers, directors and stockholders holding 10% or more of our common stock and all amendments to those reports are available free of charge through our website, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Forward Looking Statements 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 3. Quantitative and Qualitative Disclosures about Market Risk The Company is subject to market risk in the form of interest risk and foreign currency risk. Both interest risk and foreign currency risk are immaterial to the Company. Item 4. Controls and Procedures. 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. The Company 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 March 28, 2004 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: - use of 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; - 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. The Company has not identified any change in its internal control over financial reporting that occurred during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting. PART II - OTHER INFORMATION Item 1. Legal Proceedings. On June 2, 2000, a purported class action lawsuit against the Company, entitled Freddy Gavarrete, et al. v. CEC Entertainment, Inc., dba Chuck E. Cheese's, et. al., Cause No. 00-08132 FMC (RZx), was filed in the Superior Court of the State of California in the County of Los Angeles (the " Court"). The lawsuit was filed by one former restaurant manager purporting to represent restaurant managers of the Company in California from 1996 to the present. The lawsuit alleges violations of the state wage and hour laws involving unpaid overtime wages and seeks an unspecified amount in damages. On September 29, 2003, the Company entered into a settlement agreement with the Plaintiffs, which was subject to approval by the Court, whereby the Company will pay $4.2 million plus up to $50,000 for administrative fees to settle all claims of the Plaintiff. On January 14, 2004 the Court entered an order granting preliminary approval of the settlement agreement. Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. The following table presents information related to repurchases of common stock the Company made during the first fiscal quarter of 2004:
Maximum Dollar Total Number Amount that May Total Number of Average Price Shares Purchased Yet be Purchased Fiscal Period Shares Purchased Paid per Share Under the Program Under the Program Dec. 29 - Jan. 25, 2004 0 0 $ 3,011,808 Jan. 26 - Feb. 22, 2004 86,700 $ 34.70 86,700 $ 3,318 Feb. 23 - Mar. 28, 2004 711,150 (1) $ 37.72 711,150 $ 48,174,745 -------- -------- Total 797,850 $ 37.39 797,850 ======== ======== (1) In February 2004, the Company announced completion of its previously announced program to repurchase up to $50,000,000 of the Company's common stock and the authorization by its Board of Directors of a new program to repurchase up to $75,000,000 of the Company's common stock.
Item 6. Exhibits and Reports on Form 8-K. a) Exhibits 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 first quarter and through the original filing of this report, we filed or furnished the following reports on Form 8-K: A current report on Form 8-K, dated February 18, 2004, announcing fourth quarter 2003 financial results. A current report on Form 8-K, dated March 5, 2004, furnishing specimen forms of the Company's current franchise agreement and development agreement. A current report on Form 8-K, dated April 14, 2004, announcing first quarter 2004 financial results. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CEC ENTERTAINMENT, INC. Dated: March 18, 2005 By: /s/ Richard M. Frank --------------------------- Richard M. Frank Chief Executive Officer (Principal Executive Officer) /s/ Christopher D. Morris --------------------------- Christopher D. Morris Senior Vice President, Chief Financial Officer (Principal Financial Officer) /s/ James Mabry --------------------------- James Mabry Vice President, Controller and Treasurer (Principal Accounting Officer)