SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K/A
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 1997.
[ ] 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: 0-21854
DISCOVERY ZONE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 36-3877601
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
565 TAXTER ROAD, FIFTH FLOOR
ELMSFORD, NEW YORK 10523
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (914) 345-4500
Securities registered pursuant to Section 12(b) of the Securities Act of 1933:
None
Securities registered pursuant to Section 12(g) of the Securities Act of 1933:
Common Stock, par value $0.01 per share
13 1/2% Senior Secured Notes due 2002
---------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [ ] No [X]
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. 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. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of June 1, 1998 was estimated to be approximately $21.9
million.
As of June 1, 1998, the number of shares of Common Stock outstanding
was 4,000,000.
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PART I
ITEM 1. BUSINESS
Forward-Looking Statements
This report includes "forward-looking statements," including statements
containing the words "believes," "anticipates," "expects" and words of similar
import. All statements other than statements of historical facts included in
this report including, without limitation, such statements set forth in Items 1
and 7 and located elsewhere herein, regarding the Company or any of the
transactions described herein, including the timing, financing, strategies and
effects of such transactions, are forward-looking statements. Although the
Company believes that the expectations reflected in such forward-looking
statements are reasonable, it can give no assurance that such expectations will
prove to have been correct. Important factors that could cause actual results to
differ materially from expectations are disclosed in this report, including,
without limitation, in conjunction with the forward-looking statements in this
report and/or under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Factors that may Affect
Future Operating Performance." The Company does not intend to update these
forward-looking statements.
Overview
Discovery Zone, Inc. is a Delaware corporation founded in 1989. The
Company and its consolidated subsidiaries are referred to herein as "DZ" or the
"Company." The Company's principal executive offices are located at 565 Taxter
Road, Fifth Floor, Elmsford, New York 10523.
The Company owns and operates pay-for-play children's entertainment
centers in North America, with a national network of 205 FunCenters in 39
states, Canada and Puerto Rico which are targeted to appeal to children ages two
to 12. DZ hosted approximately 18.5 million visits by children and adults in the
205 FunCenters in 1997. The Company also operates two entertainment centers
under the "Block Party" name which are targeted to appeal to adults.
The Company's FunCenters are designed to offer children ages two to 12
years old a unique entertainment experience while meeting their parents' needs
for value and convenience. FunCenters generally are located in strip shopping
centers and, to a lesser extent, in shopping malls. Through December 1997,
FunCenters included: (i) "soft play" zones consisting of a series of tubes,
slides, ball bins, climbing mountains, air trampolines, obstacle courses, ramps
and other devices for crawling, jumping, running, swinging and climbing, all of
which have been designed and constructed with an emphasis on safety; (ii) "game
zones" consisting of games that award tickets redeemable for prizes; (iii) food
and beverage operations; and (iv) party rooms for birthdays and other group
events.
The Company operated under the protection of chapter 11 ("Chapter 11")
of the U.S. Bankruptcy Code from March 25, 1996 through July 29, 1997 (the
"Effective Date"). Throughout 1997, and on an accelerated basis since the
Effective Date, the Company has implemented a new business strategy designed to
revitalize, reposition and restore the Company's core business through (i) a
broad expense reduction program, (ii) new in-store programs that feature added
entertainment activities, and (iii) a refocused marketing strategy.
Since emerging from bankruptcy and through the first quarter of 1998,
the Company completed renovation of approximately 60% of its FunCenters to
expand and update its product offerings to include: (i) themed laser tag, (ii)
arts and crafts, (iii) promotional areas featuring changing events, and (iv) a
stage area which features custom DZ programming and kid Karaoke, and creates a
FunCenter focal point for character appearances and other presentations. The
Company's strategy is to create a changing entertainment environment featuring
cross-promotional activities with major entertainment and consumer product
companies. During this period, the Company also completed the conversion of
approximately 80% of its FunCenters to offer Pizza Hut brand menu items. See "--
Product Improvements" and "--New Marketing Strategies."
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New Ownership and Management
During the Company's reorganization under Chapter 11, an affiliate of
Wellspring Associates L.L.C. ("Wellspring") acquired a controlling interest in
the Company. Wellspring recruited Scott W. Bernstein to assist in developing a
new business strategy for, and to assume the role of Chief Executive Officer of
the Company. Mr. Bernstein previously served as a senior executive at Time
Warner, Inc. and Six Flags Theme Parks, Inc., most recently as President of Six
Flags' Northeast operations, where he led a turnaround of the Six Flags Great
Adventure theme park in New Jersey. Mr. Bernstein was named President and Chief
Executive Officer of the Company in December 1996, and the Company has
subsequently hired several other senior managers with backgrounds in the
entertainment and consumer marketing industries.
Pre-Chapter 11 Reorganization
The Company was founded in 1989 and grew from 28 locations in 1991 to a
peak of 347 locations in 1994, achieving much of its growth through the
acquisition of certain of its franchisees and other businesses. In 1995, the
Company acquired two Block Party Stores and certain related leases from
Blockbuster Entertainment Group ("Blockbuster"). The Company acquired no
businesses during 1996 or 1997.
The Company financed its growth primarily through the issuance of debt
securities. In addition, the Company completed an initial public offering of its
common stock, par value $0.01 per share (the "Old Common Stock") in June 1993.
In a series of transactions, Blockbuster acquired 49.9% of the Old Common Stock.
Blockbuster subsequently merged into Viacom Inc. ("Viacom"), which thereby
succeeded to Blockbuster's ownership interest in the Company.
The Company's rapid expansion resulted in a loss of control over costs
and quality at the store and corporate levels, which diminished customer
service, reduced store operating margins and caused selling, general and
administrative expenses to increase dramatically. This negatively affected the
Company's overall profitability and led to a series of defaults under the
Company's revolving credit facility in late 1995 and early 1996.
On March 25, 1996 (the "Petition Date"), Discovery Zone, Inc. and all
of its domestic subsidiaries (the "Discovery Zone Group") filed voluntary
petitions for relief under Chapter 11 with the U.S. Bankruptcy Court for the
District of Delaware (the "Bankruptcy Court"). After its Chapter 11 filing, the
Company entered into a debtor-in-possession credit facility (as amended and
supplemented, the "DIP Facility") to provide working capital during the
reorganization. Under Bankruptcy Court supervision, the Discovery Zone Group
continued to manage and operate its businesses as debtor in possession and, as
described above, developed a Plan of Reorganization (the "Plan") to restructure
its financial affairs, including assuming or rejecting executory contracts and
leases.
Emergence from Chapter 11, Plan of Reorganization and Exit Financing
In November 1996, the Company and Wellspring filed the Plan with the
Bankruptcy Court. The Plan set forth a plan for repaying or otherwise
compensating the Company's creditors in order of the relative seniority of their
respective claims while seeking to maintain the Company as a going concern. The
Plan provided, among other things, for (i) the payment in full of claims which
arose after the Petition Date, including the DIP Facility, (ii) conversion of
substantially all of the Company's pre-petition liabilities into equity
interests in the Company, and (iii) cancellation of all of the pre-petition
equity interests, including the Old Common Stock, in the Company. On July 18,
1997, the Plan was approved by the requisite percentage of creditors in each
class and confirmed by the Bankruptcy Court. The Plan became effective and the
Company emerged from Chapter 11 on the Effective Date.
Upon emerging from Chapter 11, the Company issued $15.0 million in
convertible preferred stock, par value $0.01 per share (the "Convertible
Preferred Stock") to an affiliate of the Wafra Investment Advisory Group, Inc.
The Company also issued units (the "Units") consisting of $85.0 million
aggregate principal amount of 13 1/2% Senior Secured Notes due 2002 (the
"Private Notes") and warrants (the "Warrants") to purchase shares of the
Company's common stock, par value $0.01 per share (the "Common Stock"), at an
exercise price of $0.01 per share. The Private
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Notes were exchanged for an equal aggregate principal amount of 13 1/2% Senior
Secured Notes due 2002 (the "Exchange Notes" and, together with the Private
Notes, the "Notes") on March 11, 1998. The net proceeds of the offerings of the
Units and Convertible Preferred Stock totaled $93.8 million. Of that amount, the
Company (i) repaid borrowings, claims and expenses incurred while under Chapter
11 of $45.5 million, (ii) purchased an aggregate of $21.6 million of securities,
consisting of U.S. Treasury Securities, that were placed in escrow and pledged
as security for scheduled interest payments on the Notes through August 1, 1999,
and (iii) applied $26.7 million to finance capital expenditures, and provide for
working capital and capital for other general corporate purposes. The Company
also recently entered into a new $10.0 million Senior Secured Credit Facility.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Cost Reduction Program
In connection with the Company's reorganization, the Company has closed
or sold 130 underperforming stores that were largely unprofitable and were
unlikely to contribute to the Company's profitability. Most of these locations
had above-market rents, were in markets that already had one or more profitable
FunCenters or were poorly located.
The Company also implemented several initiatives to reduce annual
selling, general and administrative expenses, including: (i) a substantial
reduction in the Company's corporate and regional management personnel; (ii) a
reduction in expenditures for corporate support functions; and (iii) the
elimination of expenses related to certain discontinued operations. In addition,
the Company further reduced costs through changes in labor planning, food and
beverage operations, a revised birthday party reservation system and
renegotiated store lease terms. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Comparison of Years Ended
December 31, 1997 and 1996."
The Company also established an incentive-based compensation plan tied
to store profitability and service quality measures for its FunCenter and
regional managers in order to create a stronger sense of ownership and
accountability and to build support for the Company's business strategy among
such managers.
Product Improvements
In 1997, the Company began implementing several programs designed to
increase attendance and in-store spending.
During the fourth quarter of 1997, the Company began an extensive
FunCenter renovation program, designed to broaden their entertainment offerings,
upgrade their facilities and give them a "new look" consistent with the
Company's brand repositioning campaign (see below). These renovations typically
include the addition of designated areas for laser tag, arts and crafts, stage
events and promotional activities. During the first phase of this program, the
Company has renovated approximately 60% of its FunCenters through March 1998 and
expects, during the next phase, to complete renovations of an additional 15% of
its FunCenters by the end of 1998.
The Company intends to create a series of regularly changing activities
and events tied in with major entertainment properties and consumer products
that appeal to children using the new venues in the renovated FunCenters ("DZ
Live," "Laser Adventure," the "Art Factory" and the "Cage"), as well as open
space in unrenovated FunCenters. Laser tag is currently themed to "Men in
Black," a hit motion picture and an animated television series. See "-- Current
FunCenter Operations." The Company began 1998 with a hockey skills promotion
with the National Hockey League and CCM, a leading hockey equipment brand. In
April 1998, the promotion theme will change to tie into New Line Cinema's major
motion picture release of "Lost in Space." During the second half of 1998, the
Company expects to begin a series of promotions with Fox Kids Worldwide. See "--
New Marketing Strategy."
In April and June 1997, the Company entered into marketing and product
agreements with Pizza Hut, Inc. ("Pizza Hut") and the Pepsi-Cola Company
("Pepsi"), respectively. These agreements provide for joint promotions and, the
Company believes, increase the appeal and quality of its food service
operations. Through March 1998,
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approximately 80% of the FunCenters have been converted to permit the sale of
Pizza Hut menu items. During 1998, the Company expects to complete conversion of
additional FunCenters to permit the sale of Pizza Hut and/or other branded food
menu items.
The Company has also sought to increase revenue by better utilizing
DZ's existing facilities. To increase weekday visits, the Company developed
interactive parent-child play programs for preschoolers in 1997. These programs
offer tumbling, climbing, exercising and singing and are now being offered under
the "Discovery Zone University" and "DZU" brand names. In September 1997, 25
FunCenters began offering these weekday programs and 27 additional FunCenters
began offering these programs in January 1998. Due to the start-up nature of
these programs, the Company does not currently intend to expand these programs
to additional locations in 1998. In the future, the Company may consider
expanding these programs to additional FunCenters and to include after school
programs for older children.
New Marketing and Entertainment Strategy
Since mid-year 1997, the Company has developed and begun to implement a
new marketing strategy consisting of several components:
o Reposition and relaunch "New DZ" brand -- building on its
revamped product offerings, the Company is reintroducing
itself as the "New DZ." Through a combination of local and
national public relations and a new advertising campaign, the
Company is repositioning itself from a children's indoor
playground venue to a children's entertainment center. The
Company initiated its "relaunch" advertising campaign during
the first quarter of 1998.
o Reorient marketing to regional and local focus -- the Company
has begun to reorient its marketing efforts to focus on local
and regional marketing and advertising programs with a
national "overlay."
o Form strategic marketing partnerships -- the Company is
establishing cross-promotional alliances with local and
regional businesses, such as supermarkets, convenience stores
and malls, as well as national advertisers.
As part of its ongoing marketing efforts, the Company's strategy is to
target two subsegments of the Kids Markets; kids ages six to 12 ("Core Target")
and pre-schoolers ("DZ Jr. Target"). The Core Target will be the primary focus
of in-store entertainment programs. Separately, a specific programming calendar
will be aimed at the younger children, called DZ "Jr." Given the strong interest
and efforts of entertainment companies in both these areas, the Company believes
this strategy will create even broader tie-in opportunities.
Due to its national market presence and the strength of its brand name,
the Company believes that it is well positioned to act as a platform for other
promotional and product "tie-ins" with children's entertainment and consumer
product companies, which should give the Company access to a wide variety of
joint marketing, cross-promotional and in-store entertainment opportunities. In
addition to the Pizza Hut and Pepsi agreements referred to above, during 1997
and the first quarter of 1998, the Company entered into promotional arrangements
with Fox Kids Worldwide, Cartoon Network, Hasbro, Columbia Tri-Star, New Line
Cinema, the National Hockey League, CCM, the Worldwide Wrestling Federation and
the Nabisco Foods Group.
The Company has begun negotiations with a number of other possible
promotional partners in the toy, television, film and consumer product
industries and expects to continue to pursue such arrangements in the future.
The Company believes that such alliances will provide significant marketing
support and theme-based promotions to periodically refresh its product offerings
and to stimulate repeat customer visits on a cost-effective basis.
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Industry Overview
Demographics
There are more than 54 million children under the age of 13, with
approximately 35 million children between the ages of five and 13. "Baby Boomer"
families (parents born between 1946 and 1965) are expected to contribute to an
increase in DZ's target market over the next four years. By the year 2000, there
are expected to be approximately 55 million children under the age of 13,
including approximately 36 million between the age of five and 13 (representing
annualized growth rates for these groups of approximately 0.2% and 0.4%,
respectively).
U.S. POPULATION BY AGE GROUP
(IN THOUSANDS)
UNDER 5 5-13 TOTAL UNDER 13
-------------------- ------------------- -------------------
1995 19,591 34,384 53,975
2000 18,987 36,043 55,030
2005 19,127 35,850 54,977
2010 20,012 35,605 55,617
- ----------
Source: Mid-range of U.S. Bureau of the Census estimates.
Competition
The Company competes against a wide variety of concepts vying for
family leisure time and entertainment spending. These competing concepts
encompass a broad spectrum of entertainment opportunities, including family
entertainment centers, theme parks, movie theaters and other in-home and out of
home entertainment activities. DZ is part of the children's entertainment center
segment of the industry, which includes admissions-based, or pay-for-play,
recreational and soft play centers that target children ages two to 12.
The pay-for-play children's entertainment center industry is highly
fragmented and consists largely of local "mom and pop" stores, small regional
chains and local non-profit organizations that provide pay-for-play indoor soft
play facilities. The Company believes that it pioneered this concept when it
built its first FunCenter in 1989. While several national competitors, such as
Leaps and Bounds, subsequently emerged, the Company purchased many such
competitors in an attempt to consolidate the market. The Company's future
revenues will depend to a significant extent upon its ability to respond to
changes in consumer tastes. The performance of individual FunCenters may be
affected by a variety of local factors such as the location of competing
facilities, labor and employee benefit costs and the availability of experienced
management and hourly employees.
New competitors may include The Walt Disney Company, which has a family
entertainment concept in two locations and has announced plans to open
additional store locations. DZ also competes to some extent against certain
children's themed restaurant chains, which provide ancillary entertainment
offerings and merchandise in addition to food and do not charge admission fees.
Such competitors include ShowBiz Pizza Time, Inc., the operator and franchiser
of approximately 300 "Chuck E. Cheese" restaurants in the United States, and, to
a lesser extent, certain franchisees of McDonald's Corporation that operate
indoor playgrounds at a number of locations. These restaurants differ from DZ in
that they do not charge for admission and are focused on food as their primary
attraction and source of revenue. Certain of these competitors have longer
operating histories, substantially greater name recognition and/or more
extensive financial, technical, marketing, sales and distribution resources.
To a more limited extent, the Company competes against indoor/outdoor
family entertainment centers, including theme parks and other themed restaurant
chains. These destinations offer an entertainment experience
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centered around attractions such as miniature golf, water rides, go-carts and
video arcade games. Theme parks provide a variety of thrill rides, redemption
games and other entertainment attractions. Such facilities generally require
more travel and have higher prices than FunCenters. Themed restaurants have
grown in popularity in recent years and include chains such as Planet Hollywood
and Rainforest Cafe. The generally older and/or broader age group focus of each
of these concepts and the differing nature of their product offerings limit the
extent to which they compete against the Company.
Current FunCenter Operations
The current FunCenters are indoor pay-for-play entertainment centers
for children. Adults are not permitted entry without a child. The Company
encourages the participation of parents and other accompanying adults, and play
equipment is constructed to allow them to play along with their children.
A typical FunCenter is approximately 12,000 to 17,000 square feet and
contains the following special features:
o An indoor playground composed of a series of tubes, slides, ball bins,
climbing mountains, air trampolines, obstacle courses, ramps, stairs
and other devices for crawling, jumping, running, swinging and
climbing.
o A separate area for toddlers but on a smaller scale. In renovated
FunCenters, this area is called the "DZ Jr." play area. Access to this
play area is limited to children under a specified height, which
provides younger children their own, less boisterous play area.
o Food and beverage operations which, in most cases, feature a selection
of Pizza Hut menu items and Pepsi beverage products.
o A game zone, featuring activities and games which children are awarded
tickets for play and, to a more limited extent, video games. Tickets
can be redeemed for a variety of small toys and prizes.
o Three to five party rooms, which can be reserved for birthdays or other
group events. FunCenters offer a variety of packages that combine a
celebration in the party room, including cake and other and beverage
services, with access to the entire FunCenter and tokens for use in the
game zone for each child attending a party.
o A redemption counter where awards for games are redeemed, as well as
Discovery Zone apparel, toys and products are sold.
Renovated FunCenters also contain the following features:
o A laser tag area called "Laser Adventure" which features a maze of
interactive targets which will be themed to major entertainment
properties.
o An arts and craft room called the "Art Factory" featuring regularly
changing arts and crafts projects.
o A 1,000 to 1,400 square foot promotional area called the "Cage,"
featuring a series of changing activities and events.
o A stage area called "DZ Live," featuring custom DZ Video programming
and kid Karaoke. The stage area represents a FunCenter focal point
where the Company can present public relation appearances, costume
characters, storytelling, puppet shows, a talent contest and other
appearances.
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DZ currently targets children 12-years old and younger, with the
highest concentration of visitors being one to eight-years old. With its
revamped product offerings, the Company hopes to attract a larger portion of the
eight-to twelve-year-old market population.
FunCenters are designed and constructed with an emphasis on safety and
security. At each FunCenter, an identification bracelet is attached to each
child and matched at the exit with an identical bracelet given to the
accompanying adult. In addition, the entrance and exit at each FunCenter are
monitored for security purposes. At all FunCenters, play area equipment is
equipped with protective cushions and padding, and "coaches" are available to
assist children through play activities. All FunCenters prohibit smoking and
maintain high cleanliness standards.
FunCenters charge a general admission fee for each child, with prices,
since the Effective Date, ranging from $4.99 to $8.99, depending on age,
location and whether the FunCenter has been renovated. The Company also offers
discounted admission fees for groups and birthday parties. Adults accompanying
children are admitted without charge. Typical hours of operation for FunCenters
extend from 11:00 a.m. to 7:00 p.m., Sunday to Thursday, and 10:00 a.m. to 9:00
p.m. on Friday and Saturday. The Company generates most of its weekly revenue on
weekends.
Intellectual Property
The names "Discovery Zone" and "DZ" and the Company's logo are
registered trademarks and service marks in the United States for a variety of
goods and services offered at the FunCenters. The Company has registered and/or
is in the process of registering its names and/or logo in the following foreign
countries: Australia, Belgium, Brazil, Canada, France, Germany, Hong Kong,
Italy, Japan, Mexico, South Korea, Spain and the United Kingdom. The Company
considers these intellectual property rights material to its business and
actively defends and enforces them.
Insurance
The Company carries customary insurance coverages, including primary
commercial liability insurance with limits of $1 million per occurrence and $2
million in the aggregate, and umbrella and excess policies aggregating $100
million per occurrence and in the aggregate, which policies are available after
the Company has paid or become legally obligated to pay $100,000 or $250,000 per
claim, depending upon the policy year. When the Company's aggregate indemnity
and expense amounts in any policy year exceed an aggregate of $2.5 million, the
Company's trailing self-insured retention is reduced to $10,000 or $25,000 per
occurrence, depending upon the policy year. The Company believes that it carries
adequate insurance coverage for its business activities. However, there can be
no assurance that such coverage will prove to be adequate or will continue to be
available to the Company, and, in the event that such coverage proves to be
inadequate, such event may have a material adverse effect on the financial
condition or results of operations of the Company. Claims paid to date have been
within amounts accrued by the Company using historical data based on prior
experience.
Regulation
The Company is subject to various federal, state and local laws and
regulations affecting operations, including those relating to the use of video
and arcade games, the preparation and sale of food and beverages and those
relating to building and zoning requirements. The Company is also subject to
laws governing its relationship with employees, including minimum wage
requirements, overtime, working and safety conditions and citizenship
requirements. Difficulties or failures in obtaining required licenses or other
regulatory approvals could delay or prevent the opening of a new FunCenter, and
the suspension of, or inability to renew, a license or permit could interrupt
operations at an existing FunCenter.
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Employees
At March 31, 1998, the Company had approximately 5,900 full and
part-time employees, including those employed at its corporate headquarters,
regional offices and Company-owned FunCenters. A typical Discovery Zone
FunCenter has a staff of between 20 and 40 employees, including managers,
counter attendants, coaches and party hosts, most of whom are part-time. The
Company's employees are not represented by any labor union or covered by a
collective bargaining agreement. The Company believes its relationship with its
employees to be good.
ITEM 2. PROPERTIES
The Company currently operates 205 FunCenters in 39 states, Canada and
Puerto Rico. The Company also operates two Block Party stores. Pursuant to the
Plan, the Company terminated the franchise agreements related to seven
franchised FunCenters. These stores continue to operate using the Company's
trademarks pending completion of alternative operating arrangements with the
franchisees. Approximately 80% of the Company's FunCenters are located adjacent
to, or are part of, major shopping centers or strip shopping centers with large
parking capacity. The following chart shows a breakdown of the Company's
FunCenters by location:
Number of Number of
Location Fun Centers Location Fun Centers
- -------- ----------- -------- -----------
Alabama.............................4 New Jersey......................9
Arizona.............................1 New Mexico......................1
California........................ 20 New York.......................16
Colorado............................4 North Carolina..................2
Connecticut.........................2 Ohio...........................10
Delaware............................1 Oklahoma........................3
Florida............................11 Oregon..........................2
Georgia.............................6 Pennsylvania...................10
Hawaii..............................1 Rhode Island....................1
Idaho...............................1 South Carolina..................2
Illinois............................6 Tennessee.......................4
Indiana.............................8 Texas..........................20
Iowa................................1 Utah............................1
Kansas..............................2 Virginia........................8
Kentucky............................2 Washington......................2
Louisiana...........................4 Wisconsin..................... 5
Maryland............................6 --
Massachusetts.......................7 Total United States...........197
Michigan............................5 Canada......................... 5
Minnesota...........................2 Puerto Rico.....................3
Mississippi.........................1
Missouri............................5 Total.........................205
Nevada..............................1 ===
The Block Party Stores are located
in Indiana and New Mexico.
Fourteen of the sites on which the FunCenters operate are owned by the
Company and are subject to mortgages and security interests held by McDonald's
(the McDonald's Rent Deferral Secured Notes and the McDonald's Note
(collectively, the "McDonald's Indebtedness")) which were delivered in
settlement of damages suffered by McDonald's as a result of the rejection, in
Chapter 11, of certain leases. The Company currently leases all but one of the
remaining FunCenter sites. The Company believes that it could find alternative
space at competitive market rates if it were unable
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to renew the lease on any of the Company-owned FunCenter sites. In the future,
the Company may from time to time purchase real estate for sites for the
construction of new FunCenters.
The Company currently holds four parcels of undeveloped land which it
intends to sell, of which three parcels secure the McDonald's Indebtedness. The
proceeds of sales of collateral securing the McDonald's Indebtedness, if any,
will be applied first to interest, then to a reduction of principal on the
McDonald's Notes and then to principal of the McDonald's Rent Deferral Secured
Notes. Future principal payments on the McDonald's Note will be reduced to the
extent of the reduction of the outstanding principal balance (i.e., a 50%
reduction in the outstanding principal balance would reduce future principal
payments by 50%).
During the first quarter of 1998, the Company entered into a contract
for the sale of property in Littleton, Colorado. The Littleton property consists
of two parcels, of which one parcel is improved with a FunCenter and the other
is unimproved land. This contract provides for the sale of such property for
$4.2 million and allows the Company to lease the FunCenter located thereon at an
annual rental of $188,250, plus scheduled escalations, for up to five years.
This $4.2 million will reduce the outstanding principal balance of the
McDonald's Note to approximately $800,000, and reduce the annual debt service on
the McDonald's Note to approximately $130,000 per year. The Littleton sale is
scheduled to close in July 1998. There can be no assurances that this sale will
ultimately close or close on the aforementioned terms or time period.
Through January 31, 1998, the Company subleased approximately 30,000
square feet of office space from Blockbuster (the "Blockbuster Space") at an
annual cost of $600,000. A division of Blockbuster occupied approximately 7,500
square feet of this space, thereby mitigating a portion of the Company's cost.
In 1997, Blockbuster informed the Company that it planned to relocate and would
terminate its lease no later than June 30, 1998. Pursuant to an agreement with
Viacom and Blockbuster, Blockbuster agreed to allow the Company to remain in
such space on a month-to-month basis through June 30, 1998.
The Company entered into a lease, commencing October 1, 1997, for
approximately 10,000 square feet of office space in the Plantation, Florida area
to relocate its finance, purchasing, management information systems and other
administrative functions from the Blockbuster Space. The Company relocated to
this space in January 1998 and terminated its sublease with Blockbuster. On
October 31, 1997, the Company entered into a sublease for approximately 6,500
square feet of office space for its executive offices in Elmsford, New York and
relocated to this space in November 1997.
ITEM 3. LEGAL PROCEEDINGS
On March 25, 1996, Discovery Zone, Inc. and all of its domestic
subsidiaries filed voluntary petitions for relief under Chapter 11 with the
Bankruptcy Court.
In November 1996, the Company filed the Plan with the Bankruptcy Court
and a related disclosure statement. The Plan was confirmed by the Bankruptcy
Court on July 18, 1997 and became effective on July 29, 1997, at which time the
Company emerged from Chapter 11. Substantially all of the claims against the
Company relating to pre-petition causes of action were discharged on the
Effective Date.
The Company is involved in litigation from time to time in the ordinary
course of its business. In the opinion of the Company, any liability that may be
incurred upon the resolution of certain claims and lawsuits in which the Company
is involved at this time will not, in the aggregate, exceed the limits of the
Company's insurance policies or otherwise have a material adverse effect upon
the financial condition or results of operations of the Company.
10
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the Company's security holders during the
fourth quarter of 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
The Company's Old Common Stock began trading on the Nasdaq National
Market on June 4, 1993. Prior to that date, there was no established public
trading market for the Old Common Stock. On May 22, 1996, the Old Common Stock
was delisted from the Nasdaq National Market. The Company did not pay any
dividends on its Old Common Stock in 1996 or in 1997. Pursuant to the Plan, all
of the Company's Old Common Stock was canceled.
In connection with the Company's emergence from Chapter 11, the Company
issued units (the "Equity Units"), each consisting of nine shares of Common
Stock and one warrant to purchase one share of Common Stock at an exercise price
of $17.55 per share (the "Ten Year Warrants"). In offerings closing on or about
the Effective Date, the Company issued the Convertible Preferred Stock and
offered and sold the Units, consisting of the Notes and the Warrants. See
"Business -- Recent Developments."
At December 31, 1997, there were approximately 1,000 record holders of
the Common Stock. As of March 31, 1998, there was no established public trading
market for the Common Stock. The Company did not pay any dividends on its Common
Stock in 1997 and does not expect to pay any dividends on the Common Stock in
1998. The Company's ability to pay dividends is limited under the Indenture (as
defined herein).
11
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
(Successor
(Predecessor Company) Company)
-------------------------------------------------------------- ------------
Seven Months Five Months
Year Ended December 31, Ended Ended
------------------------------------------------ July 31, December 31,
1993 1994 1995 1996 1997 1997
--------- --------- --------- --------- --------- ------------
(Dollars in thousands, except per share and location data)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Total revenue ............................ $ 61,585 $ 180,573 $ 259,490 $ 181,725 $ 82,537 $ 48,485
Cost of goods sold ....................... 15,131 36,858 50,227 34,276 14,136 7,311
Store operating expenses(1)(2) ........... 32,010 97,631 185,587 140,486 60,192 44,189
Selling, general and administrative
expenses(2) ............................ 6,300 36,451 58,201 40,779 10,235 10,244
Depreciation and amortization ............ 4,670 16,183 31,972 21,876 11,920 9,314
Restructuring and other charges .......... -- 14,024 372,160 -- -- --
--------- --------- --------- --------- --------- ---------
Operating income (loss) .................. 3,474 (20,574) (438,657) (55,692) (13,946) (22,573)
Interest expense ......................... (1,667) (5,137) (12,226) (6,277) (3,249) (6,076)
Other income (expense), net .............. 1,499 2,331 476 (580) 159 683
Minority interest ........................ -- 256 5,162 -- -- --
Reorganization items ..................... -- -- -- (21,285) 11,583 --
--------- --------- --------- --------- --------- ---------
Income (loss) before income tax,
extraordinary item and cumulative
effect of change in accounting
method.................................. 3,306 (23,124) (445,245) (83,834) (5,453) (27,966)
Income tax provision (benefit) ........... -- (4,000) 4,000 -- -- --
Extraordinary item-gain on discharge of
debt.................................... -- -- -- -- 332,165
Cumulative effect of change
in accounting method ................... -- 5,773 -- -- -- --
Accretion of Convertible Redeemable
Preferred Stock to redemption value .... -- -- -- -- -- (97)
--------- --------- --------- --------- --------- ---------
Net income (loss) applicable
to common shareholders ................ $ 3,306 $ (24,897) $(449,245) $ (83,834) $ 326,712 $ (28,063)
========= ========= ========= ========= ========= =========
Per common share-- basic and
diluted(3):
Income (loss) before extraordinary
item and cumulative effect of
change in method of accounting ....... $ 0.11 $ (0.45) $ (8.30) $ (1.45) $ (0.09) $ (7.02)
Extraordinary Gain ..................... -- -- -- -- 5.75 --
Cumulative effect of change in
accounting method .................... -- (0.13) -- -- -- --
--------- --------- --------- --------- --------- ---------
Net income (loss) ...................... $ 0.11 $ (0.58) $ (8.30) $ (1.45) $ 5.66 $ (7.02)
========= ========= ========= ========= ========= ---------
Weighted average number of
common shares outstanding .............. 31,054 42,696 54,139 57,691 57,705 4,000
Other Data:
Cash provided by (used in) ............... (22,457)
operations ............................. $ 20,055 $ (4,481) $ (59,103) $ (39,888) $ (10,959)
Cash provided by (used in) investing
activities.............................. (97,641) (121,972) (64,562) 3,805 (468) (10,642)
Cash provided by (used in) financing
activities ............................. 187,218 16,162 121,729 33,460 51,493 (1,686)
--------- --------- --------- --------- --------- ---------
Net cash flows ........................... $ 109,632 $(110,291) $ (1,936) $ (2,623) $ 40,066 $ (34,785)
Capital expenditures ..................... $ 88,336 $ 119,134 $ 51,732 $ 2,672 $ 567 $ 10,642
Store Data:
Company-owned stores at
period-end(4) .......................... 111 318 321 212 210 207
Franchised stores at period-end(5) ....... 57 29 15 7 -- --
--------- --------- --------- --------- --------- ---------
Total stores at period-end ............... 168 347 336 219 210 207
Operating Ratio:
Ratio of earnings to fixed ............... 3 -- -- -- -- --
charges(6)
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
(Successor
(Predecessor Company) Company)
-------------------------------------------------------------- ------------
Year Ended December 31,
-------------------------------------------------------------- As of December 31,
1992 1993 1994 1995 1996(7) 1997
--------- --------- --------- --------- --------- ------------
(Dollars in thousands, except per share and location data)
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Restricted cash and investments .............. $ 437 $ -- $ -- $ -- $ $ 19,017
Total assets ................................. 24,018 252,550 474,686 171,571 125,786 176,591
Total long-term debt,
including current portion .................. 4,827 115,843 139,796 240,663 350,072 88,193
Total stockholders' equity (defcit)........... 10,651 98,091 238,963 (180,173) (263,572) 42,255
<FN>
(1) Excludes depreciation and amortization and certain unallocated expenses.
(2) Net of $13.6 million, $200,000 and $251,000 of capitalized costs related to the Company's
expansion for the years 1995, 1996 and 1997, respectively.
(3) Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share, was adopted by
the Company in 1997. All periods presented have been restated to conform to the provisions of
SFAS No. 128.
(4) Includes the Block Party Stores.
(5) The Company rejected or terminated its arrangements with all franchises on or prior to the
Effective Date. The Company currently receives no royalties from its franchised stores.
(6) For purposes of this item, "fixed charges" represent interest, the interest element of rental
expense, capitalized interest and amortization of debt issuance costs, and "earnings" represent
income (loss) before income taxes, extraordinary items, cumulative effect of change in
accounting method and fixed charges. Earnings were insufficient to cover fixed charges by
$445.4 million, $83.8 million, $5.5 million and $28.0 million, in each of 1995, 1996, the seven
months ended July 31, 1997, and the five months ended December 31, 1997, respectively.
(7) Includes certain claims and other liabilities totaling $344.1 million as of December 31, 1996,
which were restricted or extinguished in connection with the Plan.
</FN>
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
The Company is the leading owner and operator of pay-for-play
children's entertainment centers in North America, with a national network of
205 FunCenters in 39 states, Puerto Rico and Canada targeted at children ages
two to 12 and two Block Party Stores which target adult customers.
The Company generates revenue primarily from the operation of the
FunCenters. FunCenter revenues are derived from: (i) admission charges; (ii)
food and beverage sales; (iii) redemption game and other concession revenue; and
(iv) birthday party fees. The Company's revenues are subject to significant
quarterly variations based upon several factors, including seasonal changes in
weather, holidays and the school calendar. The Company experienced negative
comparable store sales while operating in Chapter 11 and this trend continued
through December 1997. Among other factors, comparable store revenues declined
because the Company (i) shortened FunCenter operating hours by approximately 18%
to curtail operations during unprofitable time periods, (ii) reduced its
marketing expenditures (see below), and (iii) did not update its product
offering while in Chapter 11. The Company also experienced a decline in sales
during the recent renovation of the FunCenters and expects future renovation to
temporarily reduce sales during the renovation period.
The Company has undertaken a series of initiatives to increase
revenues, including offering new products, improving food and beverage offerings
and increasing utilization of FunCenters during weekdays and other off-peak
times. Since initiating new marketing and advertising programs during the first
quarter of 1998, the Company has experienced favorable comparable store sales
compared to the same period in 1997. Further, per customer spending on food has
increased significantly in those FunCenters offering Pizza Hut menu items since
conversion.
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<PAGE>
The Company's operating expenses at the store level consist primarily
of food and beverage costs, the cost of game merchandise, labor costs, occupancy
and maintenance expense. As a substantial portion of store operating expenses,
including occupancy costs, facility maintenance and core staffing requirements
are fixed, the Company has a high degree of operating leverage. The Company has
reduced its rent expense through renegotiation of certain store leases and,
since the Effective Date, has generated additional annual cost savings at the
store level through cost containment measures and improved financial controls.
The Company's selling, general and administrative expenses include
salaries, corporate and regional management expenses and other administrative,
promotional and advertising expenses. Interest expense after the Effective Date
declined substantially from prior years as a result of the discharge or
restructuring of substantially all of the Company's pre-petition indebtedness in
connection with the Plan.
The Company incurred substantial restructuring costs, including the
costs of relocating the Company's headquarters, terminating certain managers and
employees and the rejecting of certain store leases. A portion of these costs
were discharged in connection with the Plan and other amounts were repaid with
the proceeds of the offering of the Units and the Convertible Preferred Stock.
Recent Developments
The Company is currently implementing the Turnaround Plan, which
consists of a number of cost-cutting and revenue enhancing initiatives,
including an extensive FunCenter renovation program, a revamped marketing and
promotional campaign and an enhanced hiring and training program for store
managers. At May 31, 1998, the Company had renovated approximately 60% of the
FunCenters, which enables such stores to offer new products that have been
developed by the Company in conjunction with its entertainment and promotional
partners. The Company has experienced significant delays and cost overruns in
completing its renovation program.
Comparable store revenues during the first quarter of 1998 were up 4%,
as compared to a decline of 22% during the first quarter of 1997. During the
first five months of 1998, comparable store revenues declined 0.7%, compared to
a 16.8% decline in comparable store revenues in the first five months of 1997.
This decline in comparable store revenues for the first five months of 1998
consisted of a 12.7% increase in general admission revenues, offset primarily
by decreases in party and game revenues. During the first five months of 1998,
98 stores (48.5% of total stores) had increased comparable store revenues as
compared to 13 stores (6.4% of total stores) in the 1997 period, and 167 stores
(82.7% of total stores) had increased general admission revenue as compared to
13 stores (6.4% of total stores) in the 1997 period.
In spite of improvements relative to the comparable period of the prior
year, the Company's revenues in the first five months of 1998 were less than
expected due to (i) construction delays in completing its FunCenter renovation
program and related business disruptions, (ii) corresponding delays in launching
certain marketing and promotional programs, (iii) unseasonably warm spring
weather in many parts of the United States, which diminished demand for a
variety of indoor entertainment activities and (iv) transitional staffing and
training expenses associated with the introduction of new entertainment
attractions at FunCenters.
As a result of these factors, the Company expects to report negative
comparable store sales and negative EBITDA (as defined herein) for the second
quarter of 1998. The Company requires additional capital to continue funding its
operations and implementing the Turnaround Plan. See "-- Liquidity and Capital
Resources."
Results of Operations
Comparison of Years Ended December 31, 1997 and 1996
Upon emergence from its Chapter 11 proceeding, the Company adopted
Fresh Start Accounting. See "-- Fresh Start Reporting." Thus the Company's
balance sheets and statements of income and cash flows after the Effective Date
reflect a new reporting Company (the "Successor Company") and are not comparable
to periods prior to the Effective Date (the "Predecessor Company").
The twelve months ended December 31, 1997 include the results of the
Predecessor Company for the seven months ended July 31, 1997 and the Successor
Company for the five months ended December 31, 1997. The principal differences
between these periods relate to reporting changes regarding the Company's
capital structure and indebtedness and the revaluation of the Company's
long-term assets, which primarily affect depreciation and amortization expense
and interest expense in the Company's results of operations.
Revenue. The Company had revenue of $131.0 million in 1997, a decrease
of 28% from $181.7 million in 1996. This decrease resulted primarily from a
decrease in the number of FunCenters in operation and a reduction in average
sales per FunCenter. In connection with the Company's reorganization, the
Company has closed or sold 130 underperforming stores. See "Business -- Cost
Reduction Program." The decrease in same store average sales per FunCenter of
approximately 15% was due primarily to disruptions in the business associated
with the Company's bankruptcy, and a lack of new attractions at the FunCenters.
During the fourth quarter of 1997, revenues were also negatively impacted as the
Company temporarily closed stores and discounted admission prices as part of its
renovation program.
Cost of Goods Sold. Cost of goods sold, which consists primarily of the
cost of food, redemption merchandise and other product sales, was $21.4 million
in 1997 and $34.3 million in 1996. As a percentage of revenue, cost of goods
sold declined from 18.9% in 1996 to 16.3% in 1997. This percentage reduction was
primarily attributable to simplified product offerings, better cost management
and, beginning in the fourth quarter of 1997, lower costs associated with
conversion to a new food and supply vender. The decline in actual dollars also
was due, in part, to a lower number of FunCenters operating in 1997.
Store Operating Expense. Store operating expenses, which consist
primarily of compensation and benefits for FunCenter operating personnel,
occupancy expenses and facility repair and maintenance expenses, were $104.4
million, compared with $140.5 million in 1996. As a percentage of total
revenues, store operating expenses increased from 77% in 1996 to 80% in 1997.
The increase as a percentage of revenue was attributable to the decline in
revenues during 1997. The $36.1 million reduction in store operating expenses is
primarily attributable to the implementation of labor planning, lower rent from
renegotiated leases, reductions in central reservation expenses and other cost
savings
14
<PAGE>
generated through the Company's cost reduction program and store closings.
During the five-months ended December 31, 1997, store operating expenses
included certain non-recurring costs resulting from training and start-up
expenses for new product offerings and renovation program disruptions to
FunCenter operations.
Selling, General and Administrative Expense. Selling, general and
administrative expenses were $20.5 million in 1997, a decrease of 49.8% from
$40.8 million in 1996. As a percentage of revenue, selling, general and
administrative expenses declined from 22% in 1996 to 16% in 1997 despite a 28%
reduction in revenue. This decrease reflected a reduction in corporate staff and
related expenses, and marketing expenses as part of the Company's cost reduction
program, combined with a general reduction in spending due to the lower number
of FunCenters in operation during 1997.
Depreciation and Amortization Expense. Depreciation and amortization
expense was $21.2 million in 1997, a decrease of 3% from $21.9 million in 1996.
The decline resulted primarily from the reduction in the number of FunCenters in
operation, offset by an increase during the five-months ended December 31, 1997
attributable to an increase in the carrying value of the Company's plant and
equipment as a result of adopting Fresh Start Accounting for the Successor
Company.
Interest Expense. Interest expense was $6.1 million during the
five-months ended December 31, 1997 for the Successor Company and $3.2 and $6.3
million, respectively, for the Predecessor Company during the seven-months ended
July 31, 1997 and the year ended December 31, 1996. Reported interest for the
Predecessor Company did not include interest on the pre-petition indebtedness,
which was suspended during the Company's reorganization under Chapter 11. Had
these interest costs been accrued, reported interest expenses would have been
$12.4 and $18.2 million, respectively, for the seven-months ended July 31, 1997
and the year ended December 31, 1996.
Interest Income. The Company reported interest income of $1.1 million
during 1997 and $0 in 1996. The increase was due to investment earnings from the
Interest Escrow Account and short-term investments of the proceeds of the
Company's offering of Units and Convertible Preferred Stock in the exit
financing.
Reorganizing Costs. Reorganization Costs of $11.6 million (increase to
income) and $21.3 million were (decrease to income) incurred by the Company
during its reorganization under Chapter 11 for the years ended December 31, 1997
and 1996, respectively, including $6.2 million and $7.1 million incurred for
professional fees in the 1997 and 1996 periods, respectively. Included in
reorganization items for the year ended 1997 was an increase in net income of
$24,829,000 which resulted from the difference between the Company's reorganized
value and a revaluation of the Company's assets and liabilities. See Note 4 to
the Financial Statements. The remainder was primarily attributable to losses on
asset disposals associated with the closing of FunCenters, the write-off of
deferred financing costs on certain pre-petition indebtedness and expenses
associated with the Plan of Reorganization.
Comparison of Years Ended December 31, 1996 and 1995
Revenue. The Company had revenue of $181.7 million in 1996, a decrease
of 30% from $259.5 million in 1995. This decrease resulted primarily from a
decrease in the number of FunCenters in operation and a reduction in average
sales per FunCenter. The 17% decrease in same store average sales per FunCenter
was due primarily to disruptions in the business associated with the Company's
bankruptcy filing, reduced and ineffective marketing programs in 1996 as
compared to 1995 and a lack of new attractions.
Cost of Goods Sold. Cost of goods sold was $34.3 million in 1996 and
$50.2 million in 1995. Cost of goods sold as a percentage of revenues was 19% in
1996, unchanged from 1995.
Store Operating Expense. Store operating expense was $140.5 million, or
77% of revenue, compared with $185.6 million, or 72% of revenue in 1995. The
increase in store operating expense as a percentage of revenue resulted largely
from an increase in the number of leases requiring above market rental payments
and reduced oversight of store
15
<PAGE>
expenses related to the Company's rapid expansion. In addition, the Company
experienced lower than anticipated revenue in 1996 due to disruptions related to
the Company's Chapter 11 filing.
Selling, General and Administrative Expense. Selling, general and
administrative expenses were $40.8 million in 1996, an increase of 30% from
$58.2 million in 1995. Selling, general and administrative expenses as a
percentage of revenue remained steady in 1996 and 1995 at 22%. The decrease of
30% in the amount of selling, general and administrative expenses in 1996 from
1995 reflects a reduction in corporate staff, the elimination of regional
offices and a decrease in spending due to a reduction in the number of
FunCenters.
Depreciation and Amortization Expense. Depreciation and amortization
expense was $21.9 million in 1996, a decrease of 32% from $32.0 million in
1995. This decrease resulted primarily from a reduction in the number of
Company-owned stores and in the value of property and equipment subject to
depreciation, which resulted from a decrease in the number of FunCenters in
1996. In addition, the Company recorded increased goodwill amortization in 1995
related to the acquisitions of certain businesses in 1994 and 1995. The carrying
value of such goodwill was written off at the end of 1995.
Interest Expense. Interest expense was $6.3 million in 1996, a decrease
of 48% from $12.2 million in 1995. This decrease resulted primarily from a
suspension of interest payments on indebtedness while the Company reorganized
under Chapter 11.
Other Income (Expense), Net. The Company recorded other income
(expense), net, of ($600,000) in 1996 and $500,000 in 1995. The decline in 1996
was primarily attributable to a decrease in interest income associated with a
lower value of funds available for investment.
Restructuring and Other Charges. In 1995, the Company incurred
restructuring and other charges of $372.2 million, resulting primarily from a
write-down of $306.2 million of intangibles, leasehold improvements and
equipment in accordance with the implementation of SFAS No. 121. In 1995, the
Company also recognized charges related to a reduction in the carrying value of
certain assets. Such reductions were not materially different from the charges
that would have resulted from the application of SFAS No. 121. Such charges,
which totaled $44.0 million, resulted primarily from the write-down of certain
entertainment facility equipment and from the write-down of property and
equipment related to a relocation of the Company's headquarters.
Reorganization Costs. Reorganization costs of $21.3 million incurred by
the Company in 1996 resulted from the Company's reorganization under Chapter 11.
These costs included $7.1 million for professional fees and $8.9 million for
losses on asset disposals.
Liquidity and Capital Resources
Because it does not have significant receivables or inventory and
utilizes trade credit in purchasing food products and other supplies, the
Company does not require significant working capital to operate. The Company
requires cash primarily to finance capital expenditures to maintain and upgrade
existing stores and to fund operating losses and debt service. Following the
implementation of its business strategy, the Company will also need cash to
build new stores. Historically, the Company has met these liquidity requirements
primarily through external financings, including through the issuance of debt
and equity securities and borrowings under revolving credit facilities, as well
as through cash flow generated by operating activities.
In connection with the Plan of Reorganization, substantially all of the
Company's pre-petition debt facilities and other obligations to creditors were
restructured, repaid or eliminated including certain pre-petition tax claims,
the McDonald's Note and the McDonald's Rent Deferral Secured Notes. Upon
emerging from Chapter 11, the Company issued (a) Units consisting of $85.0
million aggregate principal amount of Notes and Warrants and (b) $15.0 million
of Convertible Preferred Stock. The net proceeds of the offerings of the Units
and Convertible Preferred Stock totaled $93.8 million. Of that amount, the
Company (i) repaid borrowings, claims and expenses incurred while under Chapter
16
<PAGE>
11 of $45.5 million, (ii) purchased an aggregate of $21.6 million of securities,
consisting of U.S. Treasury Securities, that were placed in escrow and pledged
as security for scheduled interest payments on the Notes through August 1, 1999,
and (iii) applied $26.7 million to finance capital expenditures, and provide for
working capital and capital for other general corporate purposes.
The Company holds for sale certain parcels of undeveloped land which
secure the McDonald's Notes. To the extent such sales occur prior to the due
date for debt services, the net proceeds for such sales would be available to be
applied to such payments.
During 1997 and 1996, the Company used cash of $27.8 million and $36.2
million, respectively, in operations before reorganizations items. These uses
included losses from operations before interest, taxes, depreciation and
amortization of $15.3 million in 1997 and $33.8 million in 1996, net interest
and other expenses of $8.5 million in 1997 and $6.9 million in 1996 (excluding
suspended interest on pre-petition indebtedness during bankruptcy), payment of
$6.5 million in 1997 for plan administrative expenses, and other changes in
working capital including approximately $5 million of payables and accruals in
1997 attributable to the Company's renovation program.
During the fourth quarter of 1997, the Company began an extensive
FunCenter renovation program which, on a per store basis, was much broader in
scope and costlier than originally planned, designed to broaden their
entertainment offerings, upgrade their facilities and give them a "new look."
During the first phase of this program, through March 31, 1998, the Company has
renovated approximately 60% of its FunCenters, and expects, during the next
phase, to complete renovations of an additional 15% of its FunCenters by the end
of 1998. Through March 31, 1998, the Company also completed the conversion of
approximately 80% of its FunCenters to permit the sale of Pizza Hut menu items
and renovated approximately 25% of its locations to offer new weekday programs
under the "DZU" brand name. The estimated costs for these renovations and
advance purchases through March 31, 1998, were approximately $21 million and $3
million, respectively, of which approximately $15 million had been paid or
accrued as of December 31, 1997. These costs exclude approximately $3 million of
excess billings from general contractors which the Company intends to dispute.
See Note 14 to the Consolidated Financial Statements. The Company estimates that
the cost to complete the renovation of an additional 15% of its FunCenters,
excluding advanced purchases referred to above, will be approximately $2
million.
If the Company's renovation program is delayed or costs more than
expected, or if results of operations do not improve sufficiently to generate
positive cash flow from operations, later phases of the Company's renovation
program would be delayed and the Company could require additional financing for
working capital and to complete its renovation program. The cash necessary to
complete the Company's capital expenditure program, fund operating losses, if
any, and working capital has been provided by the Company's financing
activities, including from the proceeds from the sale of Units and Convertible
Preferred Stock, and equipment financing and is now also being provided under
the Company's Senior Facility (as described below). Should operating cash flow
of existing FunCenters increase to a level beyond that which is needed to
maintain its operations, the Company also expects to use such cash to fund
capital expenditures at existing FunCenters and to build new FunCenters. If
operating cash flows do not so increase, or additional capital is not raised, it
is unlikely that additional FunCenters beyond those anticipated to be renovated
in 1998, will be renovated.
If the Company continues to generate negative operating cash flow, less
capital will be available for its renovation program, which may, in turn,
adversely impact implementation of the Company's business strategy and thus,
future operating results. In the event that the results of its business strategy
are not sufficient for the Company to generate positive cash flow from
operations, or take longer than expected to realize, or if the Company's
renovation program is delayed or costs more than expected, the Company is likely
to need additional financing for debt service, working capital and later phases
of the renovation program. See "Risk Factors Affecting Future Operating
Performance -- Successful Execution of Turnaround Plan."
The Company is also permitted under the Indenture to incur up to $5.0
million of new indebtedness under sale and leaseback transactions, capital lease
obligations or purchase money obligations. If the Company were unable to
generate sufficient operating funds to pay the interest on the Exchange Notes
and to fund its other capital requirements,
17
<PAGE>
including current and future operating losses, if any, there can be no assurance
that alternative sources of financing would be available to the Company or, if
available, that such financing would be on commercially reasonable terms. If it
becomes necessary for the Company to raise additional capital, the Company would
be limited by the terms of the indenture with respect to the Exchange Notes to
issuing additional equity. There can be no assurance that capital would be
available from any of the sources permitted under such indenture.
On December 31, 1997, the Company had an unrestricted cash balance of
approximately $8.6 million. The Company also had $19.0 million in cash and
investments in the Escrowed Interest Account as of December 31, 1997, which
amount is dedicated to making scheduled payments of interest on the Exchange
Notes through August 1, 1999. Subject to the Company's ability to generate
positive cash flow from operations, and availability of funds under the
Company's Senior Secured Revolving Credit Facility, the Company believes that
its existing capital resources will provide sufficient funds during 1998 to
finance the Company's operations in the ordinary course and to fund its debt
service requirements and the phases of its renovation program contemplated to be
completed in 1998, and other capital expenditures.
On March 31, 1998, the Company entered into a $10.0 million Senior
Secured Revolving Credit Facility (the "Senior Facility") as permitted under the
Indenture dated July 22, 1997 (the "Indenture"), among the Company, the
guarantors named therein and State Street Bank and Trust Company, trustee. The
Senior Facility bears interest at prime plus 1% plus certain fees and allows the
Company to borrow 133% of the 12-month trailing FunCenter contribution (as
defined therein) for its 100 top performing FunCenters up to a maximum principal
amount of $10.0 million. On April 3, 1998, the Company had the ability to borrow
the full $10.0 million available under this Senior Facility, subject to a $2.0
million reserve for certain contractor disputes. See Note 15 to the Consolidated
Financial Statements.
Seasonality
The Company's FunCenters experience seasonal fluctuations in their
revenues, with higher revenues occurring in the first quarter of the year due to
the fact that many FunCenters are located in cold weather regions where children
are unable to play outside during this time of year. In 1997, the FunCenters
generated 30% of their revenue in the first quarter versus 25%, 24% and 22% in
the second, third and fourth quarters, respectively. These fluctuations in
revenues are primarily related to the school year and the weather.
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("SFAS No.
109"), issued in February 1992. Deferred income tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws in
effect when the differences are expected to reverse. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. A valuation allowance must be
established for deferred tax assets if it is "more likely than not" that all or
a portion of the deferred tax assets will not be realized. At December 31, 1997,
the Company's deferred tax valuation allowance was equal to its net deferred tax
assets because, in management's judgment, it is "more likely than not" that all
of the net deferred tax assets will not be realized.
As a result of its reorganization under Chapter 11, the Company
realized discharge of indebtedness income of $332,165,000. Although this income
is not taxable to the Company for federal or state purposes due to the Company's
insolvency, the Company's net operating loss carryforwards ("NOLs") are reduced
by a corresponding amount. In addition, as a result of the reorganization, the
Company is treated as having experience an "ownership change" under Internal
Revenue Code Section 382. Accordingly, the Company's ability to offset income in
each post-reorganization taxable year by its then remaining NOLs and certain
built-in losses (including depreciation and amortization deductions of any
portion of the Company's basis in assets with built-in-losses) is limited to an
amount not to exceed the aggregate value of the Company's common stock
immediately before the change in control (taking into account the increase in
value resulting from the cancellation of creditors' claims under the Plan of
Reorganization)
18
<PAGE>
multiplied by the long-term tax-exempt rate published monthly by the Internal
Revenue Service. At December 31, 1997, the Company's NOLs were approximately
$178.0 million and the use of approximately $137.0 million of those NOLs was
limited to approximately $4.0 million per year.
Fresh Start Reporting
The effects of the Company's reorganization under Chapter 11 have been
accounted for in the Company's financial statements using the principles
required by the American Institute of Certified Public Accountants' Statement of
Position 90-7, "Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code" ("Fresh Start Accounting"). Pursuant to such principles, the
Company's assets and liabilities have been restated at "reorganization value,"
which is defined as the value of the entity before considering liabilities on a
going-concern basis following the reorganization and approximates the amount a
willing buyer would pay for the assets of the Company immediately after the
reorganization. The reorganization value for the Company has been determined by
reference to liabilities remaining after the Effective Date plus the estimated
value of total stockholders' equity of the outstanding shares of the New Common
Stock. The reorganization value of the Company has been allocated to the assets
of the Company in conformity with the procedures specified by Accounting
Principles Board Opinion No. 16, Business Combinations, for transactions
reported on the basis of the purchase method of accounting.
New Accounting Pronouncements
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share,"
and SFAS No. 129, "Disclosure of Information about Capital Structure," which are
effective for fiscal years ending after December 15, 1997. SFAS No. 128
simplifies the current required calculation of earnings per share ("EPS") under
Accounting Principles Board No. 15, "Earnings Per Share," by replacing the
existing calculation of primary EPS with a basic EPS calculation. It requires a
dual presentation, for complex capital structures, of basic and diluted EPS on
the face of the income statement and requires a reconciliation of basic EPS
factors to diluted EPS factors. SFAS No. 129 requires disclosing information
about an entity's capital structure. The Company adopted SFAS No. 128 in 1997
and experienced no material impact to the Company's EPS calculation or
disclosure information.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which is effective for fiscal years beginning after December 15, 1997.
This statement established standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. The new rule requires that the Company (a) classify items
of other comprehensive income by their nature in a financial statement and (b)
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of the
balance sheet. The Company plans to adopt SFAS No. 130 in 1998 and expects no
material impact to the Company's financial statement presentation.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information," which is effective for
fiscal years beginning after December 15, 1997. This statement requires annual
financial statements to disclose information about products, services and
geographic areas. This statement management approach requires disclosing
financial and descriptive information about an enterprise's reportable operating
segments based on reporting information the way management organizes the
segments for making business decisions and assessing performance. It also
eliminates the requirement to disclose additional information about subsidiaries
that are not consolidated. This statement may result in more information being
disclosed than presently presented and require new interim information not
previously presented. The Company plans to adopt SFAS No. 131 in 1998 and
expects that such adoption will affect only the Company's disclosure information
and not its results of operation.
Impact of Year 2000
The Company's computer programs were written using two digits rather
than four to define the applicable year. As a result, they recognize a date
using"00" as the year 1900 rather than the year 2000. If not changed by January
1, 2000, certain programs may not be able to function or there could be system
failures.
19
<PAGE>
The Company has made a preliminary assessment of this situation and has
concluded that it will have to modify or replace certain portions of its
software so that the Company's computer systems will function properly with
respect to dates in the year 2000 and thereafter. Certain software used by the
Company is licensed from third party vendors who have planned releases to
address this issue. Other software has been internally generated by the Company.
The Company believes that with modifications to existing software and
conversions to new software, the year 2000 issue will not pose significant
operational problems for its computer systems. However, if such modifications
are not made, or are not completed timely, the year 2000 issue may have an
impact on the Company's ability to operate. The Company does not believe that
the costs of addressing this issue will be material to the Company's operations.
RISK FACTORS AFFECTING FUTURE OPERATING PERFORMANCE
Successful Execution of Turnaround Plan
The Company is implementing a new business strategy, which consists of
a number of cost-cutting and revenue enhancing initiatives. The Company is
undertaking a significant renovation program at a majority of its FunCenter
locations. Although the Company has not experienced any material delays to date,
there is a risk that such renovations will not be completed in a timely manner
and that such capital expenditures will exceed expected amounts. The
implementation of the Company's business strategy will require successful
repositioning of the Company's brand image with its target customers, which will
depend in part upon successful marketing and promotional campaigns, as well as
customer acceptance of the product changes. Finally, the success of the
Company's strategy will depend upon its ability to attract and retain qualified
FunCenter managers capable of implementing the Company's revised operating
strategy.
Prior to implementing the Turnaround Plan and commencing renovations,
the Company experienced negative comparable store sales while operating in
Chapter 11. If the Company is not successful in attracting additional customers
and reversing this trend, it will not be able to fully implement its strategy
without additional financing (which may not be available) and the improvement in
the Company's results of operation would not materialize. If such strategy is
not fully implemented, it is less likely that the trends of negative comparable
store sales and/or earnings will be reversed, which in turn would have an
adverse affect on the availability of cash and other financial resources
necessary for the implementation of the Company's business strategy. Further, if
the implementation of such strategy is not successful and the Company is
unable to generate sufficient operating funds to pay the interest on the Notes
and fund its other capital requirements, there can be no assurance that
alternative sources of financing would be available to the Company or, if
available, that such financing would be on commercially reasonable terms. If it
becomes necessary for the Company to raise capital in addition to the amounts
permitted to be raised by the Indenture, the Company would be limited by the
terms of the Indenture to issuing additional equity which may not be available.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Noncomparability of Financial Information
Information reflecting the results of operations and financial
condition of the Company since the Effective Date is not comparable to prior
periods due to: (i) store closings undertaken during the Company's
reorganization; (ii) the replacement of the management team and the
restructuring of the Company's store operations and general and administrative
activities; (iii) the costs and expenses relating to the Company's bankruptcy
case and the impact of the restructuring or extinguishment of certain interests
and liabilities; and (iv) the application of Fresh Start Accounting, pursuant to
which the Company's assets have been stated at "reorganization value," which is
defined as the value of the entity (before considering liabilities) on a
going-concern basis following the reorganization and approximates the amount a
willing buyer would pay for the assets of the Company immediately after the
reorganization. Accordingly, there is only limited financial and operating
history of the Company for a potential investor to evaluate. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
20
<PAGE>
Dependence on Key Personnel
The Company's success is highly dependent upon Scott W. Bernstein, the
President and Chief Executive Officer. The Company's success is also dependent
upon its other senior managers, Robert G. Rooney, Senior Vice President and
Chief Financial and Administrative Officer, and Sharon L. Rothstein, Senior Vice
President, Marketing and Entertainment. Each of Mr. Bernstein, Mr. Rooney and
Ms. Rothstein is subject to an employment agreement; however, the loss of the
services of any such individuals could have a material adverse effect upon the
Company.
Control by Principal Stockholders
The Company's executive officers and directors (and their respective
affiliates) (collectively, the "Principal Stockholders") beneficially own 67.9%
of the Common Stock (after giving effect to Stock Options granted under the
Stock Incentive Plan, the Convertible Preferred Stock and the Ten Year
Warrants). See "Principal Stockholders." The Principal Stockholders, if voting
together, have sufficient voting power to elect a majority of the Company's
directors, exercise control over the business, policies and affairs of the
Company and, in general, determine the outcome of any corporate transaction or
other matters submitted to the stockholders for approval, such as any proposed
amendment to the certificate of incorporation of the Company, the authorization
of additional shares of capital stock, and any merger, consolidation, sale of
all or substantially all of the assets of the Company, and could prevent or
cause a Change of Control of the Company, all of which may adversely affect the
Company.
Seasonality
The Company's FunCenters typically experience seasonal fluctuations in
their revenues, with generally higher revenues occurring in the first quarter of
the year due to the fact that many of the Company's facilities are located in
cold weather regions where children are unable to play outside during this time
of year. In 1997, the Company's FunCenters generated 30% of their revenue in the
first quarter versus 25%, 24% and 22% in the second, third and fourth quarters,
respectively. These fluctuations in revenues are primarily influenced by the
school year and the weather.
Industry Conditions/Competition
The Company competes against a wide variety of concepts vying for
family leisure time and entertainment spending. These competing concepts
encompass a broad spectrum of entertainment opportunities, including family
entertainment centers, theme parks, movie theaters and other in-home and
out-of-home entertainment activities. In particular, the Company competes in the
pay-for-play children's entertainment center industry by targeting its
activities and programming to children ages two to twelve. This industry is
affected by general and local economic conditions, demographic trends and
consumer tastes over which the Company has no control. Consumer tastes, in
particular, are subject to rapid changes which could result in the Company's
activities falling out of favor with its target customers, requiring it to
invest in new equipment for FunCenters. The Company's future revenues will
depend to a significant extent upon its ability to respond to changes in
consumer tastes. The performance of individual FunCenters may be affected by a
variety of factors such as the location of competing facilities, increased labor
and employee benefit costs and the availability of experienced management and
hourly employees.
Competitive market conditions, including the emergence of significant
new competitors, could materially adversely affect the Company's ability to
improve its results of operations. Such new competitors, which may include The
Walt Disney Company (which has a family entertainment concept in two locations
and has announced plans to open additional store locations), and certain
existing competitors have or may have longer operating histories, substantially
greater name recognition and more extensive financial, technical, marketing,
sales and distribution resources. There can be no assurance that the Company
will be able to compete successfully against existing and future competitors or
that competitive pressures faced by the Company will not materially adversely
affect its business, operating results and financial condition.
21
<PAGE>
Limitation on Use of Net Operating Losses and Built-in Losses
The Company was required to reduce its NOLs as a result of the
cancellation of indebtedness pursuant to the confirmation of the Plan.
At December 31, 1997, the Company's NOLs were approximately $178.0
million (after taking into account the reduction due to the cancellation of
indebtedness). As a result of its reorganization under Chapter 11, the Company
is treated as having experienced an ownership change under Internal Revenue Code
Section 382. Thus, the Company's ability to offset income in each
post-reorganization taxable year by its remaining NOLs and built-in losses
(including depreciation and amortization deductions of any portion of the
Company's basis in assets with built-in losses) is limited to an amount not to
exceed the aggregate value of the Company's common stock immediately before such
change in control (taking into account in such calculation, however, any
increase in value resulting from any surrender or cancellation of creditors'
claims in connection with the Plan) multiplied by the long-term tax-exempt rate
published monthly by the Internal Revenue Service. Based on this calculation,
the Company's use of approximately $137.0 million of these NOLs is limited to
approximately $4.0 million per year.
22
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Certified Public Accountants for the years ended
December 31, 1997 and 1996.............................................. 24
Report of Independent Certified Public Accountants for the year ended
December 31, 1995....................................................... 25
Consolidated Statements of Operations for the five month period
ended December 31, 1997, the seven month period
ended July 31, 1997, and the two years in the period
ended December 31, 1996................................................. 26
Consolidated Balance Sheets as of December 31, 1997 and 1996................ 27
Consolidated Statements of Cash Flows for the five month period
ended December 31, 1997, the seven month period
ended July 31, 1997, and the two years in the period
ended December 31, 1996................................................. 28
Consolidated Statements of Equity (Deficit) for the five month period
ended December 31, 1997, the seven month period
ended July 31, 1997, and the two years in the period
ended December 31, 1996................................................. 30
Notes to Consolidated Financial Statements.................................. 31
23
<PAGE>
Report of Independent Certified Public Accountants
Board of Directors and Stockholders
Discovery Zone, Inc.
We have audited the accompanying consolidated balance sheet of Discovery Zone,
Inc. and subsidiaries as of December 31, 1997 (Successor Company) and the
related consolidated statements of operations, equity (deficit), and cash flows
for the seven-month period ended July 31, 1997 (Predecessor Company) and the
five-month period ended December 31, 1997 (Successor Company). We have also
audited the consolidated balance sheet of Discovery Zone, Inc. as of December
31, 1996 and the related consolidated statements of operations, equity
(deficit), and cash flows for the year then ended (Predecessor Company). Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Discovery Zone,
Inc. and subsidiaries at December 31, 1997 (Successor Company) and the
consolidated results of their operations and their cash flows for the
seven-month period ended July 31, 1997 (Predecessor Company) and the five-month
period ended December 31, 1997 (Successor Company) as well as the consolidated
financial position at December 31, 1996 and the consolidated results of their
operations and their cash flows for the year then ended (Predecessor Company),
in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that Discovery Zone, Inc. will continue as a going concern. Since the date of
completion of our audit of the accompanying consolidated financial statements
and initial issuance of our report thereon dated April 3, 1998, the Successor
Company, as discussed in the third paragraph of Note 15, has experienced
continued operating losses and management believes that it will require
additional capital to continue funding operations and meet its obligations as
they come due. These conditions raise substantial doubt about the Successor
Company's ability to continue as a going concern. Management's plans in regard
to these matters are also described in the third paragraph of Note 15. The
consolidated financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from the outcome
of this uncertainty.
/s/ ERNST & YOUNG LLP
West Palm Beach, Florida
April 3, 1998, except for
the third paragraph of Note 15,
as to which the date is June 22, 1998
24
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors and
Shareholders of Discovery Zone, Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the results of
operations and cash flows of Discovery Zone, Inc. and its subsidiaries (the
"Company") for the year ended December 31, 1995 in conformity with generally
accepted accounting principles. 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 audit. We conducted our audit
of these statements in accordance with generally accepted auditing standards
which 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 of
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Notes 10 and 16 (Note
references are to previously issued December 31, 1995 financial statements) to
the financial statements, the Company has suffered increasing operating cash
flow losses, is in default of certain indebtedness and has on March 25, 1995
filed voluntary petitions for relief under Chapter 11 of the United States
Bankruptcy Code. These events and circumstances raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 16 (Note reference is to
previously issued December 31, 1995 financial statements). The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
As discussed in Note 3 to the financial statements, in 1995, the
Company adopted Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of".
PRICE WATERHOUSE LLP
Miami, Florida
April 13, 1996
25
<PAGE>
DISCOVERY ZONE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
---------------------------------------------------------------------
Five Months
Ended Seven Months
December 31, Ended July 31, Year Ended Year Ended
1997 1997 December 31, 1996 December 31, 1995
-------------------------------- ----------------- ------------------
<S> <C> <C> <C> <C>
REVENUE:
Company location sales ....................... $ 48,485 $ 82,537 $ 181,699 $ 257,839
Franchise related revenue .................... -- -- 26 1,651
--------- --------- --------- ---------
Total revenue .............................. 48,485 82,537 181,725 259,490
COST OF GOODS SOLD ............................. 7,311 14,136 34,276 50,227
STORE OPERATING EXPENSE ........................ 44,189 60,192 140,486 185,587
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSE ...................................... 10,244 10,235 40,779 58,201
DEPRECIATION AND AMORTIZATION .................. 9,314 11,920 21,876 31,972
OTHER CHARGES .................................. -- -- -- 360,803
RESTRUCTURING CHARGES .......................... -- -- -- 11,357
--------- --------- --------- ---------
OPERATING LOSS ................................. (22,573) (13,946) (55,692) (438,657)
OTHER INCOME (EXPENSE):
Interest expense (Note 1) .................... (6,076) (3,249) (6,277) (12,226)
Interest income .............................. 1,010 86 -- 323
Minority interest ............................ -- -- -- 5,162
Other, net ................................. (327) 73 (580) 153
--------- --------- --------- ---------
Total other expense, net ................ (5,393) (3,090) (6,857) (6,588)
--------- --------- --------- ---------
LOSS BEFORE REORGANIZATION ITEMS,
INCOME TAX PROVISION, AND
EXTRAORDINARY ITEM ......................... (27,966) (17,036) (62,549) (445,245)
REORGANIZATION ITEMS:
Professional fees .......................... -- (6,164) (7,076) --
Loss on asset disposals .................... -- -- (8,867) --
Unallocated reorganization value ........... -- 24,829 -- --
Other, net ................................. -- (7,082) (5,342) --
--------- --------- --------- ---------
Total reorganization items .............. -- 11,583 (21,285) --
--------- --------- --------- ---------
LOSS BEFORE INCOME TAX PROVISION
AND EXTRAORDINARY ITEM ..................... (27,966) (5,453) (83,834) (445,245)
INCOME TAX PROVISION ........................... -- -- -- 4,000
--------- --------- --------- ---------
LOSS BEFORE EXTRAORDINARY ITEM ................. (27,966) (5,453) (83,834) (449,245)
EXTRAORDINARY ITEM-GAIN ON
DISCHARGE OF DEBT .......................... -- 332,165 -- --
--------- --------- --------- ---------
NET INCOME (LOSS) .............................. (27,966) 326,712 (83,834) (449,245)
ACCRETION OF CONVERTIBLE
REDEEMABLE PREFERRED
STOCK TO REDEMPTION VALUE .................. (97) -- -- --
--------- --------- --------- ---------
NET INCOME (LOSS) APPLICABLE TO
COMMON SHAREHOLDERS ........................ $ (28,063) $ 326,712 $ (83,834) $(449,245)
========= ========= ========= =========
Per common share-- basic and diluted:
Loss before extraordinary item ............. $ (7.02) $ (0.09) $ (1.45) $ (8.30)
Extraordinary item-gain on discharge of debt -- 5.75 -- --
--------- --------- --------- ---------
Net income (loss) .......................... $ (7.02) $ 5.66 $ (1.45) $ (8.30)
========= ========= ========= =========
Weighted average number of common
shares outstanding ......................... 4,000 57,705 57,691 54,139
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
26
<PAGE>
DISCOVERY ZONE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
---------------------- ----------------------
December 31, 1997 December 31, 1996
---------------------- ----------------------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents .................................... $ 8,607 $ 3,326
Restricted cash and investments .............................. 13,036 --
Receivables, net ............................................. 750 1,338
Inventories .................................................. 1,739 2,038
Prepaid expenses ............................................. 2,289 1,085
Current deposits ............................................. 2,804 1,699
--------- ----------
TOTAL CURRENT ASSETS ..................................... 29,225 9,486
RESTRICTED CASH AND INVESTMENTS ................................ 5,981 --
PROPERTY AND EQUIPMENT, net (Note 3) .......................... 131,352 110,381
LAND HELD FOR SALE ............................................. 3,635 3,635
OTHER ASSETS, net .............................................. 6,398 2,284
--------- ----------
TOTAL ASSETS ............................................. $ 176,591 $ 125,786
========= =========
LIABILITIES & EQUITY (DEFICIT)
LIABILITIES NOT SUBJECT TO COMPROMISE:
CURRENT LIABILITIES:
Accounts payable ............................................. $ 13,657 $ 7,518
Accrued liabilities .......................................... 9,049 7,780
Due to affiliate ............................................. -- 903
Accrued interest ............................................. 2,371 637
Current portion of long-term debt ............................ 1,102 --
Debtor-in-possession credit facility ......................... -- 22,448
--------- ----------
TOTAL CURRENT LIABILITIES ................................ 26,179 39,286
LONG-TERM DEBT ............................................... 87,091 4,666
OTHER LONG-TERM LIABILITIES .................................. 7,169 498
LIABILITIES SUBJECT TO COMPROMISE .............................. -- 344,908
SERIES A CONVERTIBLE PREFERRED STOCK-- 1,000 shares
authorized, 1,000 shares issued and outstanding, redemption
value of $15,000 ............................................. 13,897 --
COMMITMENTS AND CONTINGENCIES
NON-REDEEMABLE PREFERRED STOCK, COMMON
STOCK AND OTHER EQUITY (DEFICIT):
Preferred stock (Predecessor Company) -- $.01 par value;
10,000,000 shares authorized, no shares outstanding ...... -- --
Common stock (Predecessor Company)-- $.01 par value; ......... --
100,000,000 shares authorized, 57,705,470 shares issued
57,645,925 shares outstanding at December 31, 1996 ....... -- 577
Common stock (Successor Company)-- $.01 par value;
10,000,000 shares authorized, 4,000,000 shares issued and
outstanding at December 31, 1997 ......................... 40 --
Treasury stock (Predecessor Company)-- 59,545 shares at cost . -- (588)
Additional paid-in capital ................................... 70,063 291,925
Cumulative translation adjustment ............................ 118 62
Accumulated deficit .......................................... (27,966) (555,548)
--------- ----------
TOTAL NON-REDEEMABLE PREFERRED STOCK,
COMMON STOCK AND OTHER EQUITY
(DEFICIT) ............................................. 42,255 (263,572)
--------- ----------
TOTAL LIABILITIES AND EQUITY (DEFICIT) ................... $ 176,591 $ 125,786
========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
27
<PAGE>
DISCOVERY ZONE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
----------------- ------------------------------------------------------
Five Months Seven Months
Ended Ended Year Ended Year Ended
December 31, 1997 July 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- ----------------- ----------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss) .................................... $ (27,966) $ 326,712 $ (83,834) $(449,245)
Adjustments to reconcile net income (loss) to net cash
used in operating activities before reorganization
items:
Reorganization items ............................ -- (11,583) 21,285 --
Plan administrative payments .................... (5,391) (1,109) -- --
Extraordinary item-gain on discharge of debt .... -- (332,165) -- --
Depreciation and amortization ................... 9,314 11,920 21,876 31,972
Amortization of debt discount and other
noncash interest charges ..................... 398 -- 1,383 5,863
Provision for bad debts ......................... -- -- 1,093 2,149
Other charges ................................... -- -- -- 360,803
Restructuring costs ............................. -- -- -- 11,357
Provision for deferred taxes .................... -- -- -- 4,000
Loss on asset disposals ......................... -- 1,010 --
Changes in operating assets and liabilities, net of
effects from purchase transactions:
Receivables ..................................... (42) 630 (831) 6,463
Inventories ..................................... (425) 724 1,998 254
Prepaid expenses and current assets ............. (1,825) (484) (3,757) (3,830)
Accounts payable ................................ 4,779 814 8,792 (17,703)
Accrued liabilities ............................. 812 (3,182) (5,193) (9,954)
Other ........................................... 375 (108) -- (1,232)
--------- --------- --------- ---------
Net cash used in operating activities before
reorganization items ............................... (19,971) (7,831) (36,178) (59,103)
Reorganization items ................................. -- 11,583 (21,285) --
Adjustments to reconcile reorganization items to
cash provided by (used in) reorganization items:
Unallocated reorganization value ................... -- (24,829) -- --
Loss on asset disposals ............................ -- -- 8,867 --
Write-off of deferred debt items ................... -- -- 4,340 --
Accrued reorganization expenses .................... (2,486) 10,118 2,615 --
Proceeds from sale of property and equipment ....... -- -- 1,753 --
--------- --------- --------- ---------
Net cash provided by (used in) reorganization items .. (2,486) (3,128) 3,710 --
--------- --------- --------- ---------
Net cash used in operating activities after
reorganization items ............................... (22,457) (10,959) (39,888) (59,103)
CASH FLOWS FROM INVESTING
ACTIVITIES:
Cash used in acquisitions and investments, net ....... -- -- -- (5,300)
Expenditures for intangible and other assets, net .... -- -- -- (4,344)
Minority interest in subsidiaries .................... -- -- -- (3,186)
Purchases of property and equipment .................. (10,642) (567) (2,672) (51,732)
Proceeds from sale of property and equipment ......... -- 99 6,477 --
--------- --------- --------- ---------
Net cash provided by (used in) investing activities .. (10,642) (468) 3,805 (64,562)
</TABLE>
Continued on next page
28
<PAGE>
DISCOVERY ZONE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In thousands)
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
----------------- --------------------------------------------------------
Five Months Seven Months
Ended Ended Year Ended Year Ended
December 31, 1997 July 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- ----------------- ------------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM FINANCING
ACTIVITIES:
Purchase of treasury stock .................... $ -- $ -- $ -- $ (511)
Proceeds from issuance of long-term obligations -- -- -- 626,200
Repayment of long-term obligations ............ -- -- -- (544,411)
Net proceeds from debtor-in-possession credit
facilities .................................. -- -- 22,448 --
Net repayment of debtor-in-possession credit
facilities .................................. -- (22,448) -- --
Proceeds from Senior Secured Notes
with Warrants ............................... -- 85,000 -- --
Proceeds from Redeemable Convertible
Preferred Stock ............................. -- 15,000 -- --
Payment of financing costs .................... (1,800) (4,569) -- --
Escrow of restricted cash ..................... -- (21,608) -- --
Proceeds from short-term borrowings ........... 276 276 7,500 --
Repayment of short-term borrowings ............ (162) (158) (7,500) --
Advances from Birch Holdings LLC .............. -- 2,500 -- --
Repayment of advances from Birch
Holdings, LLC ............................... -- (2,500) -- --
Advances from affiliate, net .................. -- -- 10,730 11,028
Proceeds from the exercise of options
and warrants ................................ -- -- 282 29,423
--------- --------- --------- ---------
Net cash provided by (used in) financing
activities .................................. (1,686) 51,493 33,460 121,729
--------- --------- --------- ---------
Net increase (decrease) in cash and cash
equivalents ................................. (34,785) 40,066 (2,623) (1,936)
Cash and cash equivalents, beginning of period 43,392 3,326 5,949 7,885
--------- --------- --------- ---------
Cash and cash equivalents, end of period ...... $ 8,607 $ 43,392 $ 3,326 $ 5,949
========= ========= ========= =========
SUPPLEMENTAL CASH FLOW
INFORMATION:
Cash paid for interest ........................ $ 3,194 $ 3,340 $ 844 $ 3,021
========= ========= ========= =========
Cash paid for professional fees in connection
with Chapter 11 Proceedings.................. $ 1,331 $ 3,128 $ 5,461 $ --
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
29
<PAGE>
DISCOVERY ZONE, INC.
CONSOLIDATED STATEMENTS OF EQUITY (DEFICIT)
FOR THE THREE YEARS ENDED DECEMBER 31, 1997
(In thousands, except share data)
<TABLE>
<CAPTION>
Common Treasury
------------------------- ------------------------
Additional
Paid-in
Shares Amount Shares Amount Capital
------ ------ ------ ------ --------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994 ................... 48,723,115 $ 487 (5,058) $ (77) $ 260,282
Stock issued in acquisitions ................... 200,000 2 -- -- 1,311
Stock issued on exercise of nonqualified
stock options ............................ 1,377,855 14 -- -- 3,387
Stock issued on exercise of warrants ......... 7,234,500 72 -- -- 26,566
Treasury shares acquired ..................... -- -- (54,487) (511) --
Cumulative translation adjustment ............ -- -- -- -- --
Net loss ..................................... -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1995 ................... 57,535,470 575 (59,545) (588) 291,546
Stock issued on exercise of nonqualified
stock options ............................. 170,000 2 -- -- 280
Cumulative translation adjustment ............ -- -- -- -- --
Net loss ..................................... -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1996 ................... 57,705,470 577 (59,545) (588) 291,826
Cumulative translation adjustment ............ -- -- -- -- --
Cancellation of old common shares and
elimination of existing stockholders' .... 57,705,470) (577) 59,545 588 (228,716)
equity upon emergence from
bankruptcy
Issuance of new common shares ................ 4,000,000 40 -- -- --
Record value of warrants issued in
connection with exit financing ........... -- -- -- -- 7,050
Net income .................................. -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Balance at July 31, 1997 ....................... 4,000,000 40 -- -- 70,160
Accretion of convertible redeemable preferred -- -- -- -- (97)
stock to redemption value
Cumulative translation adjustment ........... -- -- -- -- --
Net loss .................................... -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1997 ................... 4,000,000 $ 40 -- $ -- $ 70,063
========== ========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Retained Cumulative Total
Earnings Translation Equity
(Accumulated Adjustment (Deficit)
Warrants Deficit)
-------- -------- ------------- ----------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 ............................... $ 715 $ (22,469) $ 25 $ 238,963
Stock issued in acquisitions ............................. -- -- -- 1,313
Stock issued on exercise of nonqualified
stock options ........................................ -- -- -- 3,401
Stock issued on exercise of warrants ..................... (616) -- -- 26,022
Treasury shares acquired ................................. -- -- -- (511)
Cumulative translation adjustment ........................ -- -- (116) (116)
Net loss ................................................. -- (449,245) -- (449,245)
--------- --------- --------- ---------
Balance at December 31, 1995 ............................... 99 (471,714) (91) (180,173)
Stock issued on exercise of nonqualified
stock options ......................................... -- -- -- 282
Cumulative translation adjustment ........................ -- -- 153 153
Net loss ................................................. -- (83,834) -- (83,834)
--------- --------- --------- ---------
Balance at December 31, 1996 ............................... 99 (555,548) 62 (263,572)
Cumulative translation adjustment ........................ -- -- (30) (30)
Cancellation of old common shares and
elimination of existing stockholders' ................ (99) 228,836 (32) --
equity upon emergence from
bankruptcy
Issuance of new common shares ............................ -- -- -- 40
Record value of warrants issued in
connection with exit financing ....................... -- -- -- 7,050
Net income .............................................. -- 326,712 -- 326,712
--------- --------- --------- ---------
Balance at July 31, 1997 ................................... -- -- -- 70,200
Accretion of convertible redeemable preferred ........... -- -- -- (97)
stock to redemption value
Cumulative translation adjustment ....................... -- -- 118 118
Net loss ................................................ -- (27,966) -- (27,966)
--------- --------- --------- ---------
Balance at December 31, 1997 ............................... $ -- $ (27,966) $ 118 $ 42,255
========= ========= ========= =========
</TABLE>
The accompanying notes to consolidated financial statements are an
integral part of these statements.
30
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND BASIS OF PRESENTATION
Discovery Zone, Inc. (the "Company") is the leading owner and operator
of pay-for-play children's entertainment centers ("FunCenters") in North America
with a national network of 205 FunCenters in 39 states, Puerto Rico and Canada.
The Company also operates two entertainment centers targeting adult customers,
under the "Block Party" name. The accompanying financial statements present the
consolidated financial position of the Company and its wholly-owned
subsidiaries. All material intercompany transactions and balances have been
eliminated in consolidation.
Discovery Zone, Inc. and its nineteen domestic subsidiaries
(collectively, the "Group") emerged from bankruptcy on July 29, 1997. The Group
had originally filed voluntary petitions for relief under Chapter 11 of the
United States Bankruptcy Code (the "Bankruptcy Code") in the United States
Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") on March
25, 1996 (the "Petition Date"). While under Chapter 11, certain claims against
the Group at the Petition Date were stayed while the Company continued its
operations as a Debtor-in-Possession. These claims are reflected in the
Company's consolidated balance sheet as Liabilities Subject to Compromise as of
December 31, 1996. On July 18, 1997, the Bankruptcy Court approved the Company's
Joint Plan of Reorganization with Birch Holdings LLC ("Birch"), an affiliate of
Wellspring Associates, LLC ("Wellspring") which became effective on July 29,
1997 (the "Effective Date" or "Emergence Date").
The consolidated financial statements reflect accounting principles and
practices set forth in American Institute of Certified Public Accountants
Statement of Position ("SOP") 90-7, "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code," which provides guidance for financial
reporting by entities that have filed voluntary petitions for relief under, and
have reorganized in accordance with, the Bankruptcy Code.
In accordance with SOP 90-7, the Company did not accrue interest on its
prepetition interest bearing obligations after the Petition Date as it was
unlikely such interest would be paid under the Plan. The amount of such
unaccrued contractual interest during the seven-month period ended July 31, 1997
and the year ended December 31, 1996 was approximately $9,176,000 and
$11,900,000, respectively.
The preparation of consolidated 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 consolidated
financial statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
Certain amounts in the 1995 and 1996 Consolidated Financial Statements
have been reclassified to conform with the 1997 presentation.
(2) JOINT PLAN OF REORGANIZATION, EXIT FINANCING AND NEW BUSINESS STRATEGY
In November 1996, the Company filed with the Bankruptcy Court a Joint
Plan of Reorganization (the "Plan") with Birch which set forth a plan for
repaying or otherwise compensating the Company's creditors in order of relative
seniority of their respective claims while seeking to maintain the Company as a
going concern. On July 18, 1997, the Plan was approved by the requisite number
of creditors and confirmed by the Bankruptcy Court. The Plan became effective on
July 29, 1997 and the Company emerged from bankruptcy as of that date.
The Plan provided for (i) the payment in full of certain administrative
claims against the Company (those claims which arose after the Petition Date),
(ii) conversion of substantially all of the Company's liabilities subject to
compromise (excluding taxes payable, lease assumption payments and certain other
prepetition liabilities permitted under the Plan) to equity interests in the
Company and, (iii) cancellation of all of the prepetition equity interests in
the
31
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(2) JOINT PLAN OF REORGANIZATION AND EXIT FINANCING (Continued)
Company, as more fully described in the Plan. Birch had purchased certain of
these prepetition claims from the original banks providing a credit facility to
the Company, resulting in ownership of 55.7% of the common stock of the
reorganized Company ("Common Stock").
Pursuant to the Plan, substantially all the Company's prepetition
unsecured liabilities were converted to equity in exchange for units consisting
of nine shares of Common Stock and a ten-year warrant to purchase one share of
Common Stock at a price of $17.55 (the "Ten Year Warrants"). Such unsecured
creditors will receive 4,000,000 shares of Common Stock and Ten Year Warrants
exercisable for 444,444 shares of Common Stock. As a result of the transactions
which occurred on the Effective Date, indebtedness of $332,165,000 was
discharged, resulting in a gain, reflected as an extraordinary item in the
accompanying consolidated statements of operations. This gain is not recognized
for tax purposes to the extent the Company was insolvent at the date of
discharge. However, the Company's net operating loss carryforwards were reduced
by the amount of the gain.
In connection with its emergence from bankruptcy, the Company raised
$100 million through the issuance of $15 million of Convertible Redeemable
Preferred Stock ("Preferred Stock") and $85 million of 13.5% Senior Secured
Notes with Warrants, resulting in approximately $93.8 million of net proceeds to
the Company after deducting related offering costs (the "Exit Financing"). The
proceeds were used to repay the Company's debtor-in-possession credit facilities
(See Note 5) and certain bankruptcy administrative claims and reorganization
costs incurred in connection with the Company's emergence from bankruptcy and to
fund the Bond Interest Escrow Account, which is reflected as Restricted Cash and
Investments in the accompanying consolidated financial statements. The Senior
Secured Note holders also received warrants (the "Warrants") to purchase 805,154
shares of Common Stock at an exercise price of $.01 per share exercisable
through August 1, 2007, which represent approximately 12.5% of the fully diluted
shares of Common Stock after giving effect to the exercise of the Warrants and
the Ten Year Warrants and conversion of the Preferred Stock. A portion of the
proceeds from the Senior Secured Notes was allocated to the Warrants. (See Note
6).
The Preferred Stock is convertible at any time into 1,191,626 shares of
Common Stock at an effective conversion price of $12.59 per common share,
representing approximately 18.5% of the fully diluted shares of Common Stock
after giving effect to the exercise of the Warrants and the Ten Year Warrants
and conversion of the Preferred Stock. The terms of the Preferred Stock include
a liquidation preference, the right to receive dividends, if paid, voting
rights, Board of Directors representation and redemption upon (i) the earlier to
occur of a merger, the sale of substantially all the Common Stock or assets of
the Company or other change of control, or (ii) 180 days prior written notice
from any holder at any time 62 months after the Effective Date.
Approximately 3,157,000 shares of Common Stock are reserved for
issuance for the exercise of all warrants, and options and conversion of the
Preferred Stock.
During 1997 the Company implemented a broad cost reduction program and,
since the Effective Date, has begun implementing an extensive store renovation
program and brand repositioning strategy designed to increase attendance and
in-store spending. The Company intends to reposition the Company from an indoor
playground concept to an entertainment venue for children and families that
includes the addition of designated areas for laser tag, arts and crafts, stage
events and promotions with regularly changing activities and events tied in to
major entertainment properties and consumer products.
Subject to the Company's ability to generate positive cash flow from
operations, and availability of funds under the Company's Senior Secured Credit
Facility (See Note 15), the Company believes that its existing capital resources
will provide sufficient funds during 1998 to finance the Company's operations in
the ordinary course and to fund its debt service requirements and the initial
phase of its renovation program and other capital expenditures. However, if the
Company continues to generate negative operating cash flow, less capital will be
available for its renovation program, which may, in turn, adversely impact
implementation of the Company's business strategy and thus, future operating
results. In the event that the results of its business strategy are not
sufficient for the Company to generate positive cash flow from operations, or
take longer than expected to realize, or if the Company's renovation program is
delayed or costs more than expected, the Company is likely to need additional
financing for debt service, working capital and later phases of the renovation
program. (See Note 15)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
The Company considers all highly liquid investments with original
maturities of ninety days or less to be cash and cash equivalents. Such
investments are valued at quoted market prices.
32
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Restricted Cash and Investments
Restricted cash and investments consists of U.S. treasury securities
purchased to fund the Bond Interest Escrow Account (See Note 2). The securities
are stated at cost plus accrued interest which approximates fair value.
Receivables
The Company has recorded a reserve for uncollectible accounts of
approximately $974,000 at December 31, 1996. There is no reserve for
uncollectible accounts at December 31, 1997. The Company believes that the
carrying amount of accounts receivable at December 31, 1997 and 1996
approximates the fair value at such date.
Inventories
Inventories, consisting primarily of facility operating supplies, food
and apparel items, are valued at lower of the cost (first in, first out) or
market.
Property and Equipment
Property and equipment is stated at cost. The Company is in the process
of finalizing the allocation of its reorganization value (see Note 4) to
property and equipment and identifiable intangible assets in accordance with SOP
90-7, which provides for reorganization value to be allocated to the Company's
assets in conformity with the procedures specified by Accounting Principles
Board Opinion No. 16, "Business Combinations," for transactions reported on the
basis of the purchase method. Depreciation and amortization expense is provided
using the straight-line method over the lesser of the estimated useful life of
the related assets or the lease term, excluding renewal options. Property and
equipment at December 31, 1997 and 1996 consists of the following (in
thousands):
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
-------------- -----------------
Life in Years 1997 1996
------------------- -------------- -----------------
<S> <C> <C> <C>
Land.......................................................... -- $ 8,164 $ 8,164
Building and improvements..................................... 20-40 8,811 9,190
Equipment, furniture and fixtures............................. 3-12 51,318 74,533
Leasehold improvements........................................ 1-14 29,563 42,094
Computer equipment and software............................... 3-5 3,778 7,705
Unallocated reorganization value (Note 4)..................... 24,829 --
Construction in progress...................................... 14,203 --
---------------- ----------------
140,666 141,686
Less accumulated depreciation and amortization................ (9,314) (31,305)
--------------- ----------------
Property and equipment, net................................... $ 131,352 $ 110,381
=============== ===============
</TABLE>
Depreciation and amortization expense related to property and equipment
was approximately $9,314,000 for the five months ended December 31, 1997,
$11,920,000 for the seven months ended July 31, 1997, $21,876,000 for the year
ended December 31, 1996 and $28,466,000 for the year ended December 31, 1995.
Additions to property and equipment are capitalized and include cost to design,
acquire and install property and equipment, costs incurred in the
33
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
location, development and construction of new facilities, major improvements to
existing property and direct incremental costs incurred in the development of
management information systems.
In 1995, the Company elected early adoption of Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of
Long-Lived Assets to Be Disposed Of." This statement requires that long-lived
assets and certain identifiable intangibles, to be held and used by an entity,
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. In addition, this
statement requires that long-lived assets and certain identifiable intangibles
to be disposed of be reported at the lower of carrying amount or fair value less
cost to sell. The Company completed its review of property and other assets in
accordance with SFAS No. 121 and adjusted the carrying values of those assets in
the fourth quarter of 1995. No further adjustments were made in 1996 or 1997.
Concurrent with the adoption of SFAS No. 121, the Company changed the
useful lives of its leasehold improvements to the lesser of the useful life or
term of the lease, excluding renewal options, effective in the fourth quarter of
1995. Effective January 1, 1996, the Company reduced the period of depreciation
for certain equipment, furniture and fixtures from its useful life to the lesser
of its useful life or the term of leases for locations at which these items are
placed. This change is an accounting change in the estimate of the useful lives
of property and equipment and is accounted for on a prospective basis beginning
January 1, 1996. The effect of this change was to increase 1996 depreciation
expense by approximately $6,096,000.
Land Held For Sale
The classification of land held for sale at December 31, 1997 and 1996
is based upon management's decision to dispose of certain parcels of undeveloped
land. The land is stated at the lower of historical cost or fair value less
costs to sell.
In February 1998, the Company entered into a contract for the sale of
property in Littleton, Colorado. The Littleton property consists of two parcels,
of which one is improved with a FunCenter and the other is unimproved land. This
contract provides for the sale of such property for $4.2 million and allows the
Company to lease the FunCenter located thereon at an annual rental of $188,250,
plus scheduled escalations, for up to five years. This sale will reduce the
outstanding principal balance of the McDonald's Note to approximately $800,000,
and reduce the annual debt service on the McDonald's Note to approximately
$130,000 per year. The Littleton sale is scheduled to close in July 1998. There
can be no assurances that this sale will ultimately close or close on the
aforementioned terms or time period.
Intangible Assets
Prior to December 31, 1995, intangible assets consisted of the cost of
acquired businesses in excess of the market value of net intangible and
identifiable intangible assets acquired and the cost of territory rights
acquired. Territory rights included amounts paid to former franchises to
reacquire development rights in market areas previously granted to them under
area development agreements. The reacquisition of these territories gave the
Company the exclusive right to develop the markets with Company-owned facilities
or grant development rights to others, at its discretion. The cost in excess of
the market value of net tangible and identifiable intangibles and the cost of
territory rights were being amortized on a straight-line basis over 40 years.
Subsequent to an acquisition, the Company periodically evaluates
whether later events and circumstances have occurred that indicated the
remaining estimated useful life or cost of acquired businesses in excess of the
market value
34
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
of net tangible and identifiable intangible assets acquired may warrant revision
or that the remaining balance of such costs may not be recoverable. The Company
uses an estimate of the Company's undiscounted net income over the remaining
life of the costs of acquired businesses in excess of the market value of net
tangible and identifiable intangible assets acquired in measuring whether the
costs are recoverable. Certain events and circumstances occurred during 1995
that indicated that the carrying amounts of the cost of acquired businesses in
excess of the market value of net tangible and identifiable intangible assets
and the cost of territory rights acquired may not be recoverable. Accordingly,
the remaining carrying amounts relating to all of the Company's intangible
assets were written down to zero during the fourth quarter of 1995.
Amortization expense related to intangible assets was approximately
$3,506,000 in 1995.
Accrued Liabilities
Accrued liabilities included in current liabilities at December 31,
1997 and 1996 consists of the following (in thousands):
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
-------------- ----------------
1997 1996
-------------- ----------------
<S> <C> <C>
Accrued bankruptcy administrative claims and
reorganization costs........................ $ 4,180 $ --
Accrued payroll and employee benefits............ 1,961 851
Other............................................ 2,908 6,929
------------- ----------------
Total............................................ $ 9,049 $ 7,780
=============== ================
</TABLE>
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash equivalents
in banks and credit card receivables from credit card transaction processing
companies. The credit risk associated with cash and cash equivalents is
considered low due to the credit quality of the financial institutions.
Revenue Recognition
Revenue from Company-owned facilities is recognized at the time of
sale. Revenue from franchises is recognized when all material services or
conditions required under the Company's franchise agreement have been performed
by the Company.
Capitalized Interest
Interest costs have been capitalized on facility expenditures during
the construction period in accordance with SFAS No. 34, "Capitalization of
Interest Costs". Interests costs capitalized as an offset to interest expense
were approximately $197,000 in 1995.
35
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings (Loss) Per Common Share
In 1997, the Company adopted SFAS No. 128, "Earnings per Share" (EPS).
EPS amounts for all periods presented have been restated, where appropriate, to
conform to the SFAS No. 128 requirements. Earnings (loss) per common share is
calculated based on the weighted average number of common shares outstanding
during the period. Common equivalents outstanding, common shares issuable upon
assumed conversion of the Preferred Stock and other potentially dilutive
securities have not been included in the computation of diluted earnings (loss)
per share as their effect is antidilutive for all relevant periods presented.
Shares of Common Stock to be issued to unsecured creditors pursuant to the Plan
have been reflected as outstanding as of the Effective Date for purposes of
calculating the weighted average common shares outstanding in the accompanying
consolidated statement of operations for the five-month period ended December
31, 1997.
Recently Issued Accounting Pronouncements
SFAS No. 130, "Reporting Comprehensive Income" is effective in 1998.
SFAS No. 130 establishes standards for reporting and displaying comprehensive
income. The adoption of this statement is not expected to result in a
significant change from the current required disclosures.
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information" is effective in 1998. This statement abandons the "Industry Segment
Approach" in favor of the "Management Approach" for segment disclosure purposes.
Adoption of this statement will only effect the Company's disclosures.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair
value of financial instruments included in the following categories:
Receivables consist primarily of credit card receivables which
are converted to cash within a short time after sales transactions are
completed and therefore are reported at approximate fair value.
Interest rates and terms for the 13.5% Senior Secured Notes,
Secured Rejection Note, and Secured Rent Deferral Notes were recently
negotiated (see Note 6). No significant events have occurred which
would indicate the reported amounts of these debt instruments would
differ from fair value.
Convertible Redeemable Preferred Stock
Convertible Redeemable Preferred Stock (see Note 2) is carried at the
net consideration to the Company at time of issuance (fair value), increased by
periodic accretion to redemption value using the interest method. Redemption
accretion is effected by charges against retained earnings, or, in the absence
of retained earnings, paid-in capital.
Advertising Expense
The Company expenses costs of advertisements at the time the
advertisements are first shown or published. Advertising expense for the years
ended December 31, 1997 and 1996 was approximately $7,116,000 and $18,095,000,
respectively.
36
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(4) FRESH START REPORTING (Continued)
Upon emergence from its Chapter 11 proceedings, the Company adopted
fresh start reporting pursuant to the provisions of SOP 90-7. Although the
Emergence Date was July 29, 1997, the Company has recorded the effects of fresh
start reporting as of July 31, 1997. In accordance with SOP 90-7, assets and
liabilities have been restated as of July 31, 1997 to reflect the reorganization
value of the Company, which approximates their fair value at the Emergence Date.
In addition, the accumulated deficit of the Company through the Emergence Date
has been eliminated and the debt and capital structure of the Company has been
recast pursuant to the provisions of the Plan. Thus, the balance sheet as of
December 31, 1997 reflects a new reporting entity (the "Successor Company") and
is not comparable to prior periods (the "Predecessor Company"). Furthermore, the
accompanying consolidated statements of operations and cash flows of the
Predecessor Company reflect operations prior to the Emergence Date and the
effect of adopting fresh start reporting and are thus not comparable with the
results of operations and cash flows of the Successor Company.
The reorganization value of the Company's common equity of
approximately $70,200,000 was determined by the Company with the assistance of
financial advisors. These advisors (1) reviewed certain historical information
for recent years and interim periods; (2) reviewed certain internal financial
and operating data including financial projections; (3) met with senior
management to discuss operations and future prospects; (4) reviewed publicly
available financial data and considered the market values of public companies
deemed generally comparable to the operating business of the Company; (5)
considered certain economic and industry information relevant to the operating
business; (6) reviewed on five year forecast prepared by the Company; and, (7)
conducted such other analysis as appropriate. Based upon the foregoing, the
financial advisors developed a range of values for the Company as of the
Effective Date. In developing this valuation estimate the advisors, using rates
of 30% to 35%, discounted the Company's five year forecasted free cash flows and
an estimate of sales proceeds assuming the Company would be sold at the end of
the five year period within a range of comparable Company multiples.
The difference between the Company's reorganized value and a
revaluation of the Company's assets and liabilities resulted in a reorganization
item of approximately $24,829,000 which is included as an increase in net income
in the accompanying consolidated statement of operations for the seven month
period ended July 31, 1997 and as an increase in property and equipment in the
balance sheet at July 31, 1997. This reorganization item is included in property
and equipment at December 31, 1997, net of recorded amortization, as unallocated
reorganization value. This reorganization item will be allocated to specific
property and equipment assets and certain intangible assets after the Company
obtains appraisals of certain assets and completes a review of property and
equipment, all of which are currently in process.
The accumulated deficit of the Company at July 31, 1997 of
approximately $243,234,000, which included the effects of the reorganization
items and the extraordinary gain on discharge of debt, was reclassified to
additional paid-in capital.
The effects of the Plan, the Exit Financing, and fresh start reporting
on the Company's condensed consolidated balance sheet at July 31, 1997 are as
follows (in thousands):
37
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(4) FRESH START REPORTING (Continued)
<TABLE>
<CAPTION>
Pre- Discharge Exit Fresh Start Reorganized
Emergence of Financing Adjustments Balance
Balance Sheet Debt (1) (2) (3) Sheet
----------------- ------------- ----------- -------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents..................... $ 2,678 $ (33,811) $ 74,525 $ -- $ 43,392
Restricted cash and investments............... 134 -- 10,414 -- 10,548
Receivables, net.............................. 708 -- -- -- 708
Inventories................................... 1,314 -- -- -- 1,314
Prepaid expenses and other current assets..... 3,140 -- (569) 697 3,268
---------------- ------------- ---------- --------------- --------------
TOTAL CURRENT ASSETS..................... 7,974 (33,811) 84,370 697 59,230
RESTRICTED CASH AND INVESTMENTS................... -- -- 11,060 -- 11,060
PROPERTY AND EQUIPMENT, net....................... 98,929 -- -- 24,829 123,758
LAND HELD FOR SALE................................ 3,635 -- -- -- 3,635
OTHER ASSETS, net................................. 2,468 443 5,000 (1,592) 6,319
----------------- ------------- ----------- --------------- --------------
TOTAL ASSETS............................. $ 113,006 $ (33,368) $100,430 $ 23,934 $ 204,002
================= ============= =========== =============== ==============
LIABILITIES AND EQUITY (DEFICIT)
LIABILITIES NOT SUBJECT TO COMPROMISE:
CURRENT LIABILITIES:
Accounts payable.......................... $ 7,119 $ -- $ -- $ -- $ 7,119
Accrued liabilities....................... 10,506 (925) 1,630 8,341 19,552
Debtor-in-possession credit facility...... 30,895 (30,895) -- -- --
----------------- ------------- ----------- -------------- --------------
TOTAL CURRENT LIABILITIES............ 48,520 (31,820) 1,630 8,341 26,671
LONG-TERM DEBT................................ 4,682 5,000 77,950 -- 87,632
OTHER LONG-TERM LIABILITIES................... (813) -- -- 6,512 5,699
LIABILITIES SUBJECT TO COMPROMISE................. 344,070 (338,713) -- (5,357) --
CONVERTIBLE REDEEMABLE
PREFERRED STOCK............................... -- -- 13,800 -- 13,800
COMMON STOCK AND OTHER EQUITY
(DEFICIT):
Common stock (Predecessor Company)............ 577 -- -- (577) --
Common stock (Successor Company).............. -- -- -- 40 40
Treasury stock (Predecessor Company).......... (588) -- -- 588 --
Additional paid-in capital.................... 291,925 -- 7,050 (228,815) 70,160
Cumulative translation adjustment............. 32 -- -- (32) --
Accumulated deficit........................... (575,399) 332,165 -- 243,234 --
----------------- ------------- ----------- --------------- -------------
TOTAL COMMON STOCK AND OTHER
EQUITY (DEFICIT).............................. (283,453) 332,165 7,050 14,438 70,200
----------------- ------------- ----------- --------------- -------------
TOTAL LIABILITIES AND EQUITY $ 113,006 $ (33,368) $ 100,430 $ 23,934 $ 204,002
(DEFICIT)..................................... ================= ============ ========== =============== ==============
(footnotes on next page)
</TABLE>
38
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(4) FRESH START REPORTING (Continued)
- ----------
(1) To record the discharge or reclassification of prepetition obligations
(liabilities subject to compromise) and debtor-in-possession credit
facilities pursuant to the Plan.
(2) To record the Exit Financing and related issuance costs.
(3) To record assets and liabilities at their fair value pursuant to
fresh start reporting and eliminate the existing accumulated deficit.
(5) DEBTOR-IN-POSSESSION CREDIT FACILITIES
Pursuant to a final Order of the Bankruptcy Court dated May 20, 1996,
the Discovery Zone Group was authorized to enter into a Revolving Credit
Agreement dated April 30, 1996 (the "Revolving Credit Agreement") among
Discovery Zone, Inc., as borrower, the other members of the Group, as
guarantors, and Madeleine LLC ("Madeleine"), as lender. Under the Revolving
Credit Agreement, Madeleine agreed to lend Discovery Zone up to the aggregate
principal amount of $17,000,000, inclusive of a $7,000,000 subfacility for the
issuance of letters of credit. Under the Revolving Credit Agreement, Madeleine
was granted (i) superpriority administrative expense claim status over
administrative expenses of the Group, (ii) first priority liens on and security
interests in all of the Group's owned and subsequently acquired unencumbered
assets, (iii) liens on and security interests senior to any liens on or security
interests in all owned or subsequently acquired unencumbered assets, other than
collateral securing certain permitted liens, and (iv) junior liens on and
security interests in collateral for such permitted liens. The Revolving Credit
Agreement was amended by the First Amendment, dated as of May 28, 1996, which
changed certain of the financial covenants contained in the Revolving Credit
Agreement.
In August 1996, the Group requested that Madeleine make available
additional funds to insure the Group sufficient liquidity to timely satisfy
their postpetition obligations during the months of September and October, 1996.
By motion dated August 16, 1996, the Discovery Zone Group requested authority
from the Bankruptcy Court to enter into a Second Amendment to the Revolving
Credit Agreement (the "Proposed Second Amendment"), which provided for, among
other things, an increase from $17,000,000 to $20,000,000 in the aggregate
principal amount of the loans available under the Revolving Credit Agreement and
an adjustment to certain of the financial covenants therein.
Both prior to and following the filing of the motion requesting
authority to enter into the Proposed Second Amendment, the Group conducted
discussions with other prospective lenders regarding the provision of additional
financing. These negotiations resulted in a commitment from Perry Partners L.P.
("Perry Partners") to provide financing on substantially the same terms as the
Revolving Credit Agreement, as amended by the Proposed Second Amendment, but up
to the aggregate principal amount of $25,000,000. Because of this opportunity to
obtain additional credit, the Group, with consent of Madeleine, withdrew the
motion requesting authority to enter into the Proposed Second Amendment.
By Order dated October 25, 1996, the Group obtained authority from the
Bankruptcy Court to enter into a Replacement Revolving Credit Agreement (the
"Replacement Credit Agreement"), among Discovery Zone Inc., as borrower, the
other members of the Group, as guarantors, and Perry Partners, as lender. Under
the Replacement Credit Agreement, Perry Partners agreed to lend Discovery Zone
up to the aggregate principal amount of $25,000,000, inclusive of a $7,000,000
subfacility for the issuance of letters of credit. Perry Partners was granted
(i) superpriority administrative expense claim status over administrative
expenses of the Group, (ii) first priority liens on and security interests in
all of the Group's owned or subsequently acquired unencumbered assets, (iii)
liens on and security interests
39
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(5) DEBTOR-IN-POSSESSION CREDIT FACILITIES (Continued)
senior to any liens on or security interests in all owned or subsequently
acquired unencumbered assets, other than collateral for certain permitted liens,
and (iv) junior liens on and security interests in collateral for such permitted
liens.
The Replacement Credit Agreement contained covenants similar to those
contained in the Revolving Credit Agreement, as amended by the Proposed Second
Amendment, including, among other things, the maintenance of certain financial
ratios, prohibition against the incurrence of certain additional indebtedness,
and prohibition against dividends. The Group used proceeds made available under
the Replacement Credit Agreement to repay in full all outstanding obligations
under the Revolving Credit Agreement, as amended by the First Amendment, and the
Revolving Credit Agreement, as amended, was terminated. Approximately
$16,250,000 of the $25,000,000 was used to satisfy all obligations under the
Revolving Credit Agreement.
During the fourth quarter of 1996, the Group determined that it would
require an additional $5,000,000 in postpetition financing to satisfy
obligations which would become due and payable during the first quarter of 1997.
By motion dated December 27, 1996, the Group requested authority from the
Bankruptcy Court to enter into a First Amendment to the Replacement Credit
Agreement (the "First Replacement Amendment") pursuant to which the aggregate
principal amount to be advanced to the Group by Perry Partners would be
increased from $25,000,000 to $30,000,000. By interim Order dated December 31,
1996, the amount which the Group was authorized to borrow from Perry Partners
was increased from $25,000,000 to $28,500,000. By final Order dated March 4,
1997, this amount was increased to $30,000,000.
At December 31, 1996, the Company had outstanding borrowings under the
Replacement Credit Facility of $22,448,000, bearing interest at prime plus 3.5%
(11.75% at December 31, 1996) payable monthly. The Replacement Credit Facility
also required payment of certain fees as defined in the agreement plus an amount
to be determined such that Perry Partners earned an internal rate of return,
determined on an annualized basis, of 21% on all borrowings (which return took
into account all interest and fees). This additional interest of approximately
$364,000 over fees and interest accrued at the stated rate was included as a
post petition liability at December 31, 1996, and was due and payable upon
repayment of the loan.
At July 29, 1997, the Company had outstanding borrowings under the
Replacement Credit Facility of $28,395,000. Interest on those borrowings accrued
at prime plus 3.5% (11.75% at July 29, 1997) payable monthly. At the Effective
Date, additional fees and interest of $821,000 over interest accrued at the
stated rate were owed. Outstanding borrowings under the facility were repaid
upon the Company's emergence from bankruptcy with the proceeds of the Exit
Financing (See Note 2) and the facility was eliminated.
In June and July 1997, the Bankruptcy Court issued orders permitting
the Company to borrow $5,000,000 from Birch as permitted under the existing
Replacement Credit Facility. The facility bore interest at prime plus 3.5% and
required the payment of certain additional fees to Birch at such time as the
Company exited bankruptcy protection. The loan was unsecured; however,
borrowings under the loan agreement had superpriority administrative claim
status with respect to payment of administrative expenses under the Plan. The
Company borrowed $2,500,000 under this facility, which was repaid with interest
and fees of approximately $82,000 upon the Company's emergence from bankruptcy
with the proceeds from the Exit Financing and the facility was eliminated.
40
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(6) LONG-TERM DEBT
Long-term debt at December 31, 1997 and 1996 consists of the following
(in thousands):
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
---------------------------
1997 1996
---------------------------
<S> <C> <C>
13.5% Senior Secured Notes due 2002, net of unamortized
discount of $6,652 (1) ........................... $ 78,348 $ --
Secured Rejection Note (2) ............................ 4,416 4,666
Secured Rent Deferral Notes (2) ....................... 429 --
Prepetition tax claims (3) ............................ 5,000 --
-------- --------
88,193 4,666
Less current portion .................................. (1,102) --
-------- --------
Long-term debt ........................................ $ 87,091 $ 4,666
======== ========
</TABLE>
At December 31, 1997, maturities of the Company's long-term debt are as
follows: $1,102,000 in 1998; $1,663,000 in 1999; $1,663,000 in 2000; $1,663,000
in 2001; $86,708,000 in 2002; and $2,046,000 thereafter.
- -----------
(1) In connection with its exit financing to emerge from bankruptcy, the
Company issued $85,000,000 of 13.5% Senior Secured Notes due August 1,
2002 (the "Notes") and the Warrants. A value of $7,050,000 was
allocated to the Warrants based upon their estimated fair value at the
time of the issuance, representing the original issue discount on the
Notes and resulting in an effective interest rate on the Notes of
approximately 15.9%. The Notes are secured by substantially all the
assets of the Company and interest is payable quarterly in arrears
beginning November 1, 1997. A separate interest escrow account was
established with the trustee to fund interest payments on the Notes
through August 1, 1999. The interest escrow account balance totaled
approximately $19,017,000 at December 31, 1997, consisting of treasury
securities and accrued interest thereon, and is reflected as restricted
cash and investments in the Company's Consolidated Balance Sheet.
The Notes contain restrictions on payment of dividends, additional
indebtedness, and cross-default provisions with other obligations of
the Company. Among other things, the Company is permitted to have
outstanding up to $10 million of senior secured indebtedness and up to
$5 million of new indebtedness arising from sale and leaseback
transactions, capital lease obligations, or purchase money obligations.
(2) In connection with the 1994 acquisition of Leaps & Bounds, Inc. ("Leaps
& Bounds") from the McDonald's Corporation ("McDonald's") (see Note 8),
the Company, through a wholly owned subsidiary, received fee simple
ownership of certain parcels of real property. Each parcel of real
property is encumbered by a mortgage or deed of trust in favor of
McDonald's, which serves to secure certain indemnity obligations owed
by the Company to McDonald's.
By Order dated November 16, 1996, the Group was granted authority by
the Bankruptcy Court to enter into, and perform under, a stipulation
with McDonald's (the "McDonald's Stipulation") which provides for a
global resolution of issues relating to, among other things, the
assumption and rejection of leases of property where McDonald's is the
sublessor and Leaps & Bounds is the sublessee (the "L&B" Subleases");
rent deferrals which McDonald's will grant to Leaps & Bounds in respect
of certain assumed L&B Subleases; the treatment of secured claims which
McDonald's holds against the Group arising from the rejection and
assumption of the L&B Subleases, and future rent deferrals to be
granted in respect of certain of the L&B Subleases.
41
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(6) LONG-TERM DEBT (Continued)
The McDonald's Stipulation provided that Leaps & Bounds assume L&B
Subleases with respect to 21 FunCenters (the "Assumption Locations")
and reject the L&B Subleases with respect to 17 FunCenters, which the
Group also requested the Bankruptcy Court's authority to close. The
Group, upon Leaps & Bounds assuming the L&B Subleases for the
Assumption Locations, cured all unpaid rent and other charges under
these subleases pursuant to section 365(b) of the Bankruptcy Code,
which cure payments totaled approximately $528,000. McDonald's
rejection claims related to the 17 closed FunCenters currently totals
$4,416,000, and is evidenced by a six-year note payable requiring
annual principal payments of approximately $736,000 (the "Secured
Rejection Note"). The Secured Rejection Note bears interest at 11%
payable annually and matures in the year 2003.
McDonald's also granted the Company rent deferrals (the "Rent
Deferrals") under the L&B Subleases, which are evidenced by nine notes
due upon the expiration of each initial sublease term (the "Secured
Rent Deferral Notes"). The Rent Deferrals currently total approximately
$398,000 per year and, when combined with the initial Emergence Date
principal balance of approximately $266,000, will total approximately
$2,840,000 over the next seven years. The notes bear interest at 11%
per annum payable at maturity and have maturity dates ranging from
August 31, 2002 to December 31, 2004.
The Secured Rejection Note and the Secured Rent Deferral Notes are
secured by first mortgages or deeds of trust on fourteen properties
owned by the Company, including three undeveloped parcels of land with
a book value of $2,747,000 at December 31, 1997, which are included in
Land Held for Sale in the Company's Consolidated Balance Sheet, one of
which is under contract for sale for $4.2 million (See Note 3). The
notes contain certain cross-default provisions including cross-defaults
among themselves, with the McDonald's subleases and with other
indebtedness of the Company in excess of $2.5 million.
(3) The prepetition tax claims (the "Tax Claims") represent taxes assessed
prior to the Company filing for bankruptcy and have an estimated
aggregate principal amount of $5,000,000. The Tax Claims have
maturities of up to six years from the original date of assessment and
require payment of principal amounts in equal annual installments. The
majority of the Tax Claims accrue simple interest at 10% per annum
payable with each annual principal installment. The remainder accrue
interest at 12% per annum.
(7) LIABILITIES SUBJECT TO COMPROMISE
Under the Bankruptcy Code, certain claims against the Company arising
prior to the Petition Date were stayed. These prepetition claims were
compromised under the Plan (See Note 2). At December 31, 1996, these prepetition
liabilities were separately classified in the consolidated balance sheet as
liabilities subject to compromise and included the following (in thousands):
42
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(7) LIABILITIES SUBJECT TO COMPROMISE (Continued)
Accounts payable..................................... $ 27,213
Accrued liabilities.................................. 27,446
Lease rejection claims............................... 18,767
Note payable to affiliate (See Note 8)............... 13,215
Other amounts payable to affiliate (See Note 9)...... 22,724
Priority tax claims (See Note 6)..................... 5,000
Payable under credit agreement with banks............ 101,900
Subordinated convertible debt........................ 128,643
------------
Total liabilities subject to compromise.............. $ 344,908
============
Accrued liabilities include amounts accrued for claims related
to lawsuits and other legal matters.
In accordance with the Bankruptcy Code, the members of the Group sought
court approval for the rejection of certain prepetition executory contracts and
real property leases. Such lease rejections give rise to prepetition claims for
damages pursuant to the Bankruptcy Code. The Group rejected 91 real property
leases during 1996 and 4 during 1997.
The Company entered into a $175,000,000 credit agreement on December
22, 1994 (the "Credit Facility") with a consortium of banks. On September 15,
1995, the Company became in default under the Credit Facility as a result of the
expiration of an amendment/waiver agreement entered into between the Company and
the lenders on June 30, 1995 which waived until September 15, 1995 certain
financial covenants contained in the credit agreement. As a result of the
expiration of the amendment/waiver agreement on September 15, 1995, the Company
became in default under certain financial covenants contained in the Credit
Facility and such default continued as of December 31, 1995.
Another event of default occurred under the Credit Facility on the
Petition Date when the Group filed voluntary petitions for relief under the
Bankruptcy Code with the Bankruptcy Court. Consequently, all unpaid principal
of, and accrued prepetition interest on, amounts outstanding under the Credit
Facility became immediately due and payable. The payment of such debt and
accrued but unpaid interest thereon was prohibited during the pendency of the
Group's bankruptcy cases other than pursuant to a court order. At the Petition
Date, these amounts totaled $101,900,000 and were classified as liabilities
subject to compromise at December 31, 1996.
In October and November, 1993, the Company issued $293,250,000
aggregate principal amount at maturity of Liquid Yield Option Notes ("LYONs"), a
form of subordinated convertible debt, due October 14, 2013. Net proceeds, after
the underwriting discount, amounted to approximately $111,000,000. No periodic
interest payments were required on the LYONs. Each LYON had an issued price of
$391.06 and had principal amount due at maturity of $1,000 (representing a yield
to maturity of 4.75% per annum computed on a semiannual bond equivalent basis).
Each LYON was convertible into 13,845 shares of Common Stock, at the option of
the holder, at any time on or prior to maturity, was subordinated to all
existing and future Senior Indebtedness (as defined in the LYONs indenture
agreement, "Indenture") of the Company, and was redeemable on or after October
14, 1998, in whole or in part, at the option of the Company, for cash in an
amount equal to the issue price plus accrued original issue discount to the date
of redemption.
43
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(7) LIABILITIES SUBJECT TO COMPROMISE (Continued)
As a result of the Group's bankruptcy filing, the Company defaulted
under the Indenture governing the LYONs. Consequently, the original issue price
of the LYONs plus the accrued original issue discount of the LYONs (the
"Accreted Value") through the Petition Date was immediately payable. As of
December 31, 1996, the Accreted Value was $128,643,000 and at the Petition Date
this obligation became subject to compromise.
(8) BUSINESS COMBINATIONS, SALES AND DISPOSALS
On May 24, 1995, the Company purchased from a subsidiary of Viacom,
Inc. ("Viacom") substantially all assets pertaining to the operation of two
family entertainment centers operating under the name "Block Party". The
purchase price was $13,215,000 and was paid through the issuance of a
subordinated promissory note having a ten-year term (the "BFF Note"). Interest
on such note accrued at the one-month London Interbank Offered Rate ("LIBOR")
plus .75% and was payable quarterly. The principal of the note was payable in
varying annual amounts beginning in the fourth year. Under the purchase
agreement, the Company was assigned certain real and personal property leases
related to the operations of the entertainment facilities and assumed all
liabilities arising thereunder. See Note 9, Related Party Transactions, for a
further discussion of transactions with Viacom.
During the year ended December 31, 1995, the Company also acquired
businesses that own and operate indoor recreational facilities for children for
an aggregate of $5,300,000 in cash and 200,000 shares of common stock. All
businesses acquired during the year ended December 31, 1995 were accounted for
under the purchase method of accounting and are included in the consolidated
financial statements since the dates of acquisition.
On February 8, 1996, the Company sold all issued and outstanding stock
of two wholly-owned subsidiaries, I&S Consultants and VLT, Inc., which together
owned and operated The Enchanted Castle, a family entertainment facility located
in Lombard, Illinois for $2,800,000.
On March 8, 1996, the Company sold all issued and outstanding stock of
its Wright Entertainment Group subsidiary for $2,000,000.
During 1996, the Company closed 101 of its indoor entertainment
facilities resulting in a loss on asset disposals of approximately $8,867,000.
Proceeds from sale of property and equipment at these locations totaled
approximately $1,753,000.
The Company's consolidated results of operations for the year ended
December 31, 1995 prepared on an unaudited pro forma basis assuming businesses
acquired and accounted for as purchases in 1995 had occurred as of January 1,
1995 are as follows:
Revenues as reported.....................................$ 259,490
Revenue of purchased businesses for the period prior to
acquisition, net of eliminations....................... 3,170
------------
Pro forma revenue........................................$ 262,660
============
Net loss as reported..................................... (449,245)
Net loss of purchased businesses for period prior to
acquisition............................................ (238)
Adjustment for interest and goodwill amortization........ (494)
------------
Pro forma loss...........................................$ (449,977)
============
Loss per share as reported-- basic and diluted...........$ (8.30)
Effect of purchased businesses prior to acquisition...... (0.01)
------------
Pro forma loss per share-- basic and diluted.............$ (8.31)
============
44
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(8) BUSINESS COMBINATIONS, SALES AND DISPOSALS (Continued)
Business acquisitions and investments during the year ended December
31, 1995 which included the use of cash were accounted for as follows:
Property and equipment................................ $ 1,276
Intangibles........................................... 31,657
Other assets.......................................... 16
Working capital deficiency, excluding cash acquired... (956)
Long-term obligations................................. (13,215)
Other noncurrent liabilities.......................... (13,478)
-----------
$ 5,300
===========
Business acquisitions during the year ended December 31, 1995 which
involved the issuance of the Company's common stock, $.01 par value were
accounted for as follows:
Intangibles...............................................$ 1,313
===========
Common stock issuance allocated to:
Common stock..............................................$ 2
Additional paid-in capital................................ 1,311
-----------
$ 1,313
============
(9) RELATED PARTY TRANSACTIONS
On September 2, 1994, the Company acquired Blockbuster Children's
Amusement Corporation, Tumble For Fun Limited Partnership and Blockbuster
Children's Amusement Canada Corporation (collectively, the "Blockbuster
Entities") from Blockbuster Fun & Fitness Holding Corporation, an indirect
wholly-owned subsidiary of Blockbuster Entertainment Corporation ("BEC"), prior
to BEC's merger with Viacom. The Company paid to BEC as consideration for the
acquisition 4,624,597 shares of common stock. At the time of acquisition, the
Blockbuster Entities owned 60 franchised Discovery Zone facilities and certain
franchised territories in the United States and Canada. Separately, on September
2, 1994, BEC, through its indirect wholly-owned subsidiary, Blockbuster
Discovery Investment, Inc., exercised its option to purchase from the former
partners of DKB Investments, L.P. (which was at the time the largest stockholder
of the Company, "DKB"), a number of shares of common stock sufficient to
increase BEC's indirect equity ownership in the Company to 49.9%. Pursuant to
the merger of BEC into Viacom, Viacom succeeded to BEC's equity ownership
interest in the Company. At the time of these transactions, Donald F. Flynn, who
was then Chairman of the Board and Chief Executive Officer of the Company, was a
director of BEC, and H. Wayne Huizenga, who was then Chairman of the Board and
Chief Executive Officer of BEC, and John J. Melk, who was then a director of
BEC, were directors of the Company.
On May 24, 1995 (the "MSA Effective Date"), a Management Services
Agreement ("MSA") between the Company and Viacom became effective, providing for
the services of Viacom's division, Blockbuster Entertainment Group
("Blockbuster"), in connection with the overall coordination and supervision of
the business of the Company and the day-to-day operations and business affairs
of the Company. Responsibility for management of the Company beyond the scope of
Viacom's services under the MSA was placed with a Special Committee of the Board
of Directors of the
45
<PAGE>
DISCOVERY ZONE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(9) RELATED PARTY TRANSACTIONS (Continued)
Company (the "Special Committee"), consisting of the independent directors,
Messrs. McGrath and Muething. On the MSA Effective Date, all members of the
Board of Directors except Steven R. Berrard and Donald F. Flynn resigned
(including H. Wayne Huizenga, George D. Johnson, Jr., James R. Jorgensen, John
T. Melk, Peer Pedersen and Gerald F. Seegers). The MSA had an initial term of
five years and thereafter could be extended automatically for one year renewal
periods unless terminated by either party on six months' prior notice. In
payment for the management services to be provided under the MSA, the Company
was required to pay Viacom a quarterly fee equal to the actual costs, fees,
expenses, and reimbursements of the services provided, and a fair and reasonable
allocation of overhead expenses incurred by Viacom in providing such services,
during the preceding calendar quarter. In addition, on the MSA Effective Date,
the Company issued to Viacom 157,821 Series A Warrants, 157,821 Series B
Warrants, and 157,821 Series C Warrants. See Note 13, Warrants and Options, for
further discussion.
Also on the MSA Effective Date, the Company purchased from a subsidiary
of Viacom substantially all assets pertaining to the operation of two family
entertainment centers operating under the name "Block Party". As of December 31,
1995, the Board of Directors of the Company was composed of Steven R. Berrard,
Frank J. Biondi, Jr., Phillippe P. Dauman, Donald F. Flynn, J. Brian McGrath,
John L. Muething and Sumner M. Redstone. Messrs Biondi, Dauman, McGrath,
Muething and Redstone were elected to the Board on May 24, 1995, pursuant to the
MSA. As of December 31, 1995, Messrs. Berrard, Biondi, Dauman and Redstone were
officers and/or directors of Viacom, which owned approximately 49% of the
Company's outstanding common stock, and Messrs. Berrard, Biondi, Dauman,
McGrath, Muething and Redstone were directors of Spelling Entertainment Group
("Spelling"), an affiliate of Viacom. In connection with his resignation as
Chief Executive Officer and a director of Viacom and as a director of Spelling,
Mr. Biondi resigned as a director of the Company on January 17, 1996. Mr. Flynn
resigned as Chairman of the Board of Directors of the Company on February 27,
1996. In connection with his resignation as the Chief Executive Officer of
Blockbuster and as director of Viacom and Spelling, Mr. Berrard resigned as the
Chief Executive Officer and a director of the Company on March 19, 1996. Messrs.
Dauman and Redstone resigned as directors of the Company on March 24, 1996 and
Mr. McGrath resigned as a director and as a member of the Special Committee on
March 27, 1996.
Donna R. Moore, then President and Chief Operating Officer of the
Company and Adam D. Phillips, Senior Vice President and General Counsel of
Blockbuster, were appointed to the Board of Directors of the Company on March
24, 1996. Dr. James M. Rippe was appointed to the Board of Directors of the
Company on June 20, 1996. At March 31, 1997, Donna R. Moore, John Muething, Dr.
James Rippe and Adam Phillips were the Company's directors.
On January 12, 1996, the Company received an interim working capital
loan of up to $10,000,000. This loan was guaranteed by Viacom and matured on
February 6, 1996. On February 6, 1996, the Company did not make its scheduled
repayment of the principal or accrued interest on the loan. The outstanding
principal on the loan was $7,500,000. On February 7, 1996, the principal amount
of $7,500,000 and accrued interest was paid to the lender by Viacom. As result
of its performance as guarantor, Viacom is subrogated to the lender's right to
receive payments of such amounts for the Company.
In summary, at December 31, 1996 the Company had a prepetition amount
due to Blockbuster/Viacom, excluding the principal amount of the BFF Note, for
approximately $22,724,000, relating to $5,662,000 in reimbursements for
construction and other costs of certain subsidiaries of Blockbuster previously
incurred by Blockbuster, $6,998,000 in other operating costs paid by Blockbuster
on behalf of the Company, $7,527,000 in repayment of debt and accrued interest
thereon paid by Viacom on behalf of the Company, accrued interest of $748,000 on
the BFF Note and $1,789,000 due Blockbuster under the MSA. Viacom's ability to
receive such amounts was subject to the Group's bankruptcy proceedings.
Accordingly, these amounts were included in liabilities subject to compromise
and the Company's consolidated balance sheet at December 31, 1996.
46
<PAGE>
DISCOVERY ZONE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(9) RELATED PARTY TRANSACTIONS (Continued)
In 1996, the Company incurred $3,724,000 of other obligations to
Blockbuster under the MSA including obligations to reimburse Blockbuster for
insurance and other costs on behalf of the Company, of which $1,424,000 was
incurred and $521,000 was paid after March 25,1996.
On May 7, 1997, the Bankruptcy Court issued an order providing for the
settlement of all of Viacom's prepetition general unsecured claims against the
Group and all claims which the Group or any holders of claims against the Group
may hold against Viacom. Under the agreement and subsequent Bankruptcy Court
order, Viacom received no property for its prepetition unsecured claims under
the Plan. In exchange for this treatment, the Group agreed to (i) satisfy in
full a claim which Iwerks Studios, Inc. held against the Group, and which was
guaranteed by Blockbuster, in the amount of $61,500, (ii) assume approximately
30 leases of the Group, which were guaranteed by Viacom, and assign them to
Blockbuster and (iii) pay Viacom's postpetition administrative claims for
expenses advanced by Viacom on behalf of the Group of approximately $991,000 and
obligations incurred under the MSA, subject to any setoff paid on behalf of
Viacom. In connection with this settlement, the MSA was terminated.
The Company subleased approximately 30,000 square feet of office space
from Blockbuster at an annual cost of approximately $600,000. A division of
Blockbuster occupied approximately 7,500 square feet of this space thereby
mitigating approximately $128,000 of the Company's cost. The Company terminated
its lease with Blockbuster and vacated the office space February 1, 1998.
The Company and a corporation owned by one of the Company's principal
stockholders were previously parties to a consulting arrangement, pursuant to
which the Company paid approximately $90,000 in 1995 for consulting and related
services. In addition, the Company paid to this corporation approximately
$59,000 in 1995 for the use of its private airplanes. Agreements between the
Company and this corporation for consulting services and use of airplanes were
terminated as of July 1, 1995. This principal stockholder is also a director of
Psychemedics Corporation ("Psychemedics"), a provider of drug testing services.
The Company entered into an agreement with Psychemedics for certain drug testing
services and paid Psychemedics approximately $186,000 and $468,000 during 1996
and 1995, respectively, for such services.
As required under the Plan, the Company reimbursed Birch approximately
$1,078,000 for its out-of-pocket expenses incurred in connection with sponsoring
the Plan.
An officer of Griffin Bacal, Inc. ("Griffin Bacal"), the Company's
advertising agency, serves as a director of the Successor Company. The Company
paid approximately $7,600,000 to Griffin Bacal for creative services and as
agent for the purchase of media from third parties during the year ended
December 31, 1997.
(10) INCOME TAXES
The federal statutory tax rate is reconciled to the Company's effective
tax rate for the noted periods as follows:
47
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED STATEMENTS (Continued)
(10) INCOME TAXES (Continued)
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
------------------- -----------------------------------------------------------
Five Months Seven Months Year Year
Ended Ended Ended Ended
December 31, 1997 July 31, 1997 December 31, 1996 December 31, 1995
------------------- --------------- -------------------- -------------------
<S> <C> <C> <C> <C>
Federal statutory rate (benefit).... (34.0)% (34.0)% (34.0)% (34.0)%
Change in valuation allowance....... 34.0 % 34.0 % 34.0 % 35.0 %
------------------- --------------- -------------------- -------------------
Effective tax rate.................. -- -- -- 1.0 %
=================== =============== ==================== ===================
</TABLE>
Income tax provision for the following periods consists of (in
thousands):
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
------------------- -----------------------------------------------------------
Five Months Seven Months Year Year
Ended Ended Ended Ended
December 31, 1997 July 31, 1997 December 31, 1996 December 31, 1995
------------------- --------------- -------------------- -------------------
<S> <C> <C> <C> <C>
Current............................. $ -- $ -- $ -- $ --
Deferred............................ -- -- -- 4,000
------------------- --------------- -------------------- -------------------
$ -- $ -- $ -- $ 4,000
=================== =============== ==================== ===================
</TABLE>
The primary components that comprise the deferred tax assets and
deferred tax liabilities at December 31, 1997 and 1996 are as follows (in
thousands):
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
1997 1996
--------------- -----------------
<S> <C> <C>
Net operating loss carryforwards....................................... $ 66,000 $ 170,000
Difference between book and tax bases of acquired net assets........... 12,000 18,500
Noncurrent asset reevaluations......................................... 85,000 86,500
Other assets........................................................... 10,000 6,000
Other liabilities...................................................... (16,000) (19,500)
--------------- -----------------
Net deferred tax asset before valuation allowance...................... 157,000 261,500
Valuation allowance.................................................... (157,000) (261,500)
--------------- -----------------
Net deferred tax asset................................................. $ -- $ --
=============== =================
</TABLE>
The valuation allowance totaled approximately $209,000,000 at December
31, 1995. The valuation allowance increased approximately $52,500,000 and
$164,800,000 in 1996 and 1995, respectively, and decreased approximately
$104,500,000 in 1997 due to a reduction in net operating loss carryovers related
to the cancellation of indebtedness of the Company upon emergence from
bankruptcy. The Company has net operating loss carryforwards for federal tax
purposes totaling approximately $178,000,000 which will expire as follows:
$127,000,000 in 2011 and $51,000,000 in 2012. As a result of its reorganization
under Chapter 11, the Company is treated as having experienced an ownership
change under Internal Revenue Code Section 382. Under Section 382, the Company's
ability to offset income in each post-reorganization taxable year by its
remaining NOLs and built-in losses (including depreciation and amortization
48
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED STATEMENTS (Continued)
(10) INCOME TAXES (Continued)
deductions of any portion of the Company's basis in assets with built-in losses)
is limited to an amount not to exceed the aggregate value of the Company's
common stock immediately before such change in control (taking into account in
such calculation, however, any increase in value resulting from any surrender or
cancellation of creditors' claims in connection with the Plan) multiplied by the
long-term tax-exempt rate published monthly by the Internal Revenue Service.
Based on this calculation, the Company's use of approximately $137,000,000 of
NOLs is limited to approximately $4,000,000 per year.
The federal income tax net operating loss carryforwards described above
are not binding on the Internal Revenue Service and may be subject to
adjustments which may be substantial in magnitude. In accordance with SOP 90-7,
any realization of the benefit from tax net operating loss carryforwards
subsequent to the effective date of the Company's Plan of Reorganization will
result in an increase to equity.
(11) OTHER CHARGES
Certain of the Company's FunCenters generated increasing operating cash
flow losses or marginal operating cash flows during 1995 and in the first
quarter of 1996. These circumstances, in addition to the circumstances requiring
the Group to file voluntary petitions for relief under Chapter 11 of the
Bankruptcy Code, indicated that the carrying amounts related to these FunCenters
may not be recoverable. Accordingly, management reviewed the intangibles,
property and equipment related to these FunCenters for recoverability in
accordance with SFAS No. 121 and determined that certain assets were impaired.
For each FunCenter, the Company tested for impairment by computing the sum of
the estimated future operating cash flows (undiscounted and without interest
charges) and comparing that result to its carrying value. If such sum was less
than the carrying value of the FunCenter's assets, an impairment condition was
considered to exist and an impairment loss was recognized. The impairment loss
recognized was measured as the amount by which the carrying amount exceeded the
fair value of the FunCenter's assets.
The estimate of fair value was determined using the present values of
each FunCenter's estimated future operating cash flows. The Company recognized
impairment losses in the fourth quarter of 1995 of approximately $306,212,000
resulting primarily from the write down of intangibles, leasehold improvements,
and equipment. Management's judgment is necessary to estimate future operating
cash flows. Accordingly, actual results could vary from such estimates.
In the second quarter of 1995, the Company recognized other charges
relating to the reduction in carrying values of certain assets that management
believed would not have continuing benefit under its new business plan. Such
reduction would not have been materially different from the charges that would
have resulted from the application of SFAS No. 121. These charges, which totaled
approximately $44,002,000, resulted primarily from the write down of certain
entertainment facility equipment and, to a lesser extent, the write down of
property and equipment related to the relocation of the Company's headquarters.
Additionally, in the second quarter of 1995, the Company recognized
other charges of approximately $10,589,000 related to the provision of
additional lease commitment reserves on certain previously closed entertainment
facilities because of the inability to terminate leases on favorable terms.
(12) RESTRUCTURING COSTS
In connection with the change in management effected by the MSA and the
relocation of its headquarters offices from Chicago, Illinois to Fort
Lauderdale, Florida, the Company recognized certain restructuring costs in the
second quarter of 1995. These restructuring costs consisted of employee
termination benefits of approximately $7,903,000 and
49
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED STATEMENTS (Continued)
(12) RESTRUCTURING COSTS (Continued)
facility lease termination costs of approximately $3,454,000. The Company
expected, and accrued the cost of, the termination of approximately 300
management and administrative employees in this regard. At December 31, 1995,
the majority of such employees had been terminated and costs of approximately
$6,579,000 had been paid and charged against the accrued liability. The Company
completed all material aspects of the aforementioned restructuring by March 31,
1996.
(13) WARRANTS AND OPTIONS
On May 11, 1995, the Company received approximately $26,700,000 from
the Company's former Chairman and certain members of his family in connection
with the exercise of warrants, which were exchanged for an aggregate of
7,234,500 shares of common stock. The Company used the proceeds from the
exercise of these warrants to reduce debt.
On the MSA Effective Date, the Company issued to Viacom 157,821 Series
A Warrants, 157,821 Series B Warrants and 157,821 Series C Warrants. The Series
A, Series B and Series C Warrants were to vest on the first, second and third
anniversaries of the MSA Effective Date, respectively. All such vested warrants
were to become exercisable on or after December 16, 1998, although such
exercisability was to be accelerated in certain circumstances. Each warrant
entitled Viacom to purchase one share of Series A Preferred Stock of the
Company. The exercise prices for the Series A, Series B and Series C Warrants
per share of the common stock into which the Series A Preferred Stock was
convertible were $10.375, $11.931 and $14.317, respectively.
In April 1993, the Company adopted a stock option plan (the "1993
Plan"), whereby up to 6,000,000 shares of common stock may be granted to key
employees, consultants and directors of the Company. In addition, in July 1995,
the Company adopted the 1995 Long-Term Management Incentive Plan (the "1995
Plan") pursuant to which up to 3,000,000 shares of common stock may be granted
to certain key employees and consultants of the Company. Options granted under
the 1993 Plan and the 1995 Plan are nonqualified and were granted at a price
equal to the fair market value at the date of grant. No options were granted
under the 1995 Plan.
In connection with the MSA, all shares available for future grant and
all options granted and outstanding relating to the Company's directors under
the 1993 Plan were canceled if not exercised prior to the MSA Effective Date.
Additionally, the vesting of all non-director employee options outstanding at
the MSA Effective Date was accelerated to a date not later than November 24,
1995.
Pursuant to the Plan all options and warrants and the 1993 Plan and
1995 Plan were canceled as of the Effective Date.
As part of the Plan, a new stock option plan was established. Pursuant
to certain executive employment contracts, options to purchase 536,845 shares of
Common Stock have been granted to senior executives of the Company at an
exerciseable price of $11.88 per share. One third of the options presently
granted vest on each January 1 of 1998, 1999 and 2000. In addition, such options
vest in their entirety upon the incurrence of a "Change in Control" as defined
in the Plan. A total of 715,692 shares of Common Stock have been reserved for
issuance under the Company's new stock option plan.
50
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED STATEMENTS (Continued)
(13) WARRANTS AND OPTIONS (Continued)
The following summarizes stock option activity for the following
periods:
<TABLE>
<CAPTION>
Successor Predecessor
Company Company
------------------- ------------------------------------------------------
Five Months Seven Months Year Year
Ended Ended Ended Ended
December 31, July 31, December 31, December 31,
1997 1997 1996 1995
------------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Options outstanding at beginning of period............ -- 2,754,802 2,924,802 3,805,191
Granted............................................... 536,845 -- -- 794,861
Exercised............................................. -- -- (170,000) (1,377,855)
Canceled.............................................. -- (2,754,802) -- (297,395)
------------------- ---------------- ----------------- ------------------
Options outstanding at end of period.................. 536,845 -- 2,754,802 2,924,802
=================== ================= ================= =================
Weighted average exercise price of options at
beginning of period.............................. -- $ 10.47 $ 7.92
Weighted average exercise price of options exercised.. -- $ 1.66 $ 2.47
Range of exercise prices of options outstanding
at end of period................................. $ 11.88 $ 1.67 to $24.63 $ 1.67 to $24.63
Weighted average exercise price of options
outstanding at end of period..................... $ 11.88 $ 11.01 $ 10.47
Vested options at end of period....................... -- 2,754,802 2,924,802
Options available for future grants at end of period.. 178,847 129,351 129,351
</TABLE>
(14) COMMITMENTS AND CONTINGENCIES
Future minimum lease payments, under noncancelable operating leases as
of December 31, 1997, are as follows (in thousands):
1998...................................................... $25,555
1999...................................................... 24,567
2000...................................................... 23,478
2001...................................................... 22,488
2002...................................................... 21,804
Thereafter................................................ 38,123
-----------------
$ 156,015
=================
The Company is also obligated under a three-year operating lease
agreement to pay a per capita license fee for laser tag equipment. This
agreement requires the Company to pay 20 cents per attendee at its FunCenters
for the first 9 million attendees; 18 cents per attendee for the next 9 million
attendees; and 16 cents for each attendee thereafter. Because the agreement is
based upon attendance, the exact payment in each of the three years cannot be
determined.
Rental expense for operating leases during the years ended December 31,
1997, 1996, and 1995 amounted to approximately $34,455,000, $41,137,000 and
$52,716,000, respectively.
During the fourth quarter of 1997 the Company began an extensive
FunCenter renovation program designed to broaden their entertainment offerings,
upgrade their facilities and give a "new look." During the first phase of this
program, the Company renovated approximately 60% of its FunCenters through March
1998 and expects during the next phase, to complete renovations of an additional
15% of its FunCenters by the end of 1998. Through March 31, 1998,
51
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED STATEMENTS (Continued)
(14) COMMITMENTS AND CONTINGENCIES (Continued)
the Company also completed the conversion of approximately 80% of its FunCenters
to permit the sale of Pizza Hut items and renovated approximately 25% of its
locations to offer new weekday programs under the "DZU" brand name. The
estimated cost for these renovations and advance purchases through March 31,
1998 is approximately $24 million, of which approximately $15 million has been
paid or accrued as of December 31, 1997 and approximately $3 million relates to
advance purchases for future renovation. These costs exclude approximately $3
million of excess billings from general contractors which the Company intends to
dispute.
From time to time, the Company is a party to a number of lawsuits and
other legal matters, including claims relating to injuries which allegedly
occurred at the Company's facilities and to alleged employment discrimination. A
portion of these claims may be covered by insurance. Management has estimated
the potential liabilities resulting from such claims which arose subsequent to
the Petition Date and which are not covered by insurance to be approximately
$3,347,000 at December 31, 1997 and $1,849,000 at December 31, 1996. These
amounts were recorded in accrued liabilities and other long-term liabilities in
the Company's consolidated balance sheets based on management estimates of the
tendering of future payments. Because these amounts represent estimates, it is
reasonably possible that a change in these estimates may occur in the future.
(15) SUBSEQUENT EVENTS
During the first quarter of 1998, the Company substantially completed
Phase One of its capital plan to renovate its FunCenters, add new attractions,
and broaden their entertainment offerings, including the addition of designated
areas for lasertag, arts and crafts, stage events and promotional activities.
Approximately 60% of the Company's FunCenters were renovated pursuant to this
plan. The Company also completed the conversion of its food service operations
to offer Pizza Hut products in approximately 80% of its FunCenters (See Note
14).
On March 31, 1998, the Company entered into a $10 million Senior
Secured Revolving Credit Facility (the "Facility") with Foothill Capital
Corporation, as permitted under the Notes. The Facility bears interest at prime
plus 1% plus certain fees, and allows for the Company to borrow 133% of trailing
twelve month FunCenter contribution (as defined therein) for its top 100
performing FunCenters, up to a maximum loan principal amount of $10 million. The
Facility contains restrictions on additional indebtedness, capital expenditures,
dividends, is secured by substantially all of the Company's assets and has
cross-default provisions with other obligations of the Company. $2.0 million of
the Facility is reserved for resolution of certain disputes in connection with
the Company's renovation program (See Note 14).
Effective July 29, 1997, the Company emerged from bankruptcy with a
brand repositioning, operating and financing strategy. These strategies were
executed and, although they were partially effective, additional steps must be
taken to both eliminate losses from operations and raise additional capital to
ensure the Company continues as a going concern. The Company's new operating
strategy calls for a number of cost-cutting and revenue enhancing initiatives,
including an extensive FunCenter renovation program, a revamped marketing and
promotional campaign, the successful repositioning of the Company's brand image
with its target customers, and an enhanced hiring and training program for store
managers in order to attract and retain qualified people who are capable of
implementing the new operating strategy. The new finance strategy calls for
raising additional capital through a private placement. Management believes
raising this capital is required to fund the next phase of planned FunCenter
renovations as well as to fund the revised operating strategy and meet related
obligations as they come due. The consolidated financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from this uncertainty.
52
<PAGE>
DISCOVERY ZONE, INC.
NOTES TO CONSOLIDATED STATEMENTS (Continued)
(16) SUMMARIZED COMBINED FINANCIAL INFORMATION
The following sets forth summarized combined financial information of
Discovery Zone (Canada) Limited (formerly Discovery Zone Children's Amusement
Canada Corporation) and Discovery Zone (Puerto Rico), Inc., which are subsidiary
guarantors under the Senior Secured Note financing secured by the Company in
connection with its emergence from bankruptcy (See Notes 2 and 6). Separate
financial statements of these subsidiary guarantors are not included as the
subsidiaries guarantee the Senior Secured Notes on a full, unconditional, and
joint and several basis and are wholly-owned subsidiaries of the Company.
Non-guarantor subsidiaries under the financing are inconsequential.
Successor Predecessor
Company Company
-----------------------------------
December 31, December 31,
1997 1996
--------------- ------------------
Current assets.................. $ 233 $ 682
Noncurrent assets............... 3,124 3,925
Current liabilities............. 257 144
Noncurrent liabilities.......... 8,158 9,627
Year ended December 31,
------------------------------------------------
1997 1996 1995
------------------------------------------------
Net revenue................... $ 4,931 $ 6,637 $ 7,991
Operating expenses............ 5,688 7,561 12,018
Net loss...................... (542) (753) (4,001)
53
<PAGE>
DISCOVERY ZONE, INC.
Valuation and Qualifying Accounts
Schedule II
(In thousands)
<TABLE>
<CAPTION>
Balance at Additions Amounts Balance at
Beginning Charged to Written End
of Year Expense Off of Year
Description ---------------------------------------------------------------------------
- ------------------------
<S> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL
ACCOUNTS
1995........................................... $ 36 $ 2,149 $ -- $ 2,185
1996........................................... 2,185 1,093 2,304 974
1997........................................... 974 -- 974 --
RESERVE FOR OBSOLESCENCE
1995........................................... 259 766 -- 1,025
1996........................................... 1,025 -- 1,025 --
1997........................................... -- -- -- --
</TABLE>
54
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS OR
ACCOUNTING AND FINANCIAL DISCLOSURES
Reference is made to the Current Report on Form 8-K dated July 9, 1997,
the Current Report on Form 8-K dated June 10, 1996, the amendment to the Current
Report on Form 8-K dated June 11, 1996 and the Current Report on Form 8-K dated
August 15, 1995.
55
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning the
executive officers and directors of the Company and the positions they hold.
<TABLE>
<CAPTION>
Name Age Position
- ----------------------------------------------- --- ---------------------------------
<S> <C> <C>
Scott W. Bernstein........................... 37 Chief Executive Officer, President and Director
Sharon L. Rothstein.......................... 40 Senior Vice President, Marketing and Entertainment
Robert G. Rooney............................. 40 Senior Vice President, Chief Financial and
Administrative Officer
Andrew M. Smith.............................. 45 Vice President, Real Estate, General Counsel and
Secretary
Leighton J. Weiss............................ 46 Vice President and Controller
Martin S. Davis.............................. 71 Director
Greg S. Feldman.............................. 41 Director
Douglas W. Rotatori.......................... 37 Director
L.G. Schafran................................ 59 Director
Christopher R. Smith......................... 33 Director
Paul D. Kurnit............................... 49 Director
</TABLE>
Background of Directors and Executive Officers
Set forth below is a brief description of the business experience of
the executive officers and directors of the Company.
Mr. Bernstein has been Chief Executive Officer and President of the
Company since December 1996 and was elected as a director in July 1997. Mr.
Bernstein was hired by Wellspring in June of 1996 to assist with formulation of
the Plan of Reorganization and to assume the role of Chief Executive Officer of
the Company. From August 1994 until June 1996, Mr. Bernstein served as President
of the Northeast operations of Six Flags Theme Parks Inc. ("Six Flags"), which
included Six Flags Great Adventure and Six Flags Wild Safari Animal Park. From
April 1992 until August 1994, Mr. Bernstein served in the following roles: (i)
Senior Vice President of Time Warner Enterprises, a strategic business
development unit of Time Warner Inc.; (ii) Senior Vice President and General
Counsel of Six Flags; and (iii) Senior Vice President, chief administrative and
legal officer of Six Flags.
Ms. Rothstein has been Senior Vice President, Marketing and
Entertainment of the Company since March 1997. From April 1996 until March 1997,
she was Vice President -- New Business at Nabisco. From 1987 until April 1996,
she held several positions at Nabisco, including Senior Director -- New
Business, Director -- Business Marketing, Product Manager -- Ritz, Product
Manager -- New Products and Product Manager -- Snack Crackers.
Mr. Rooney has been Senior Vice President, Chief Financial and
Administrative Officer of the Company since February 1997. From March 1994 until
September 1996, Mr. Rooney served as Chief Financial Officer of Forschner
Enterprises, a venture capital group, and from September 1992 to February 1994,
Mr. Rooney served as a director and consultant on behalf of various investors
and investment funds affiliated with Forschner Enterprises. From 1989 through
1992, Mr. Rooney served as Managing Director and Chief Financial Officer of The
Signature Group, a merchant banking group specializing in troubled real estate.
From 1986 through 1989, he served as Senior Vice President, Chief Financial
Officer and Treasurer of Imagine Entertainment, Inc., a publicly held film and
television production company. Mr.
Rooney is a certified public accountant.
56
<PAGE>
Mr. Smith joined the Company as Vice President--Real Estate and General
Counsel in October 1997 and has served as Secretary since November 1997. From
June 1996 to October 1997, Mr. Smith served as a Managing Director of Alpine
Consulting, a real estate consulting firm. From January 1995 to May 1996, he
served as the Vice President--Operations and as a director of Influence, Inc., a
medical device manufacturer. From 1986 to 1994, Mr. Smith was a real estate
partner with Weil, Gotshal & Manges LLP, an international law firm.
Mr. Weiss has been Controller of the Company since 1996 and in 1997 he
was named Vice President of Finance. He joined the Company in July 1995, serving
as Assistant Controller. Mr. Weiss held various positions as a controller or
finance manager within the music division of Blockbuster Entertainment from
January 1994 through June 1995. Prior to that, he served as Controller and
Director of Accounting for Sound Warehouse, Inc. from October 1988 to January
1994. Prior to joining Sound Warehouse, Inc., Mr. Weiss held various positions
for Arthur Andersen LLP, where he achieved the position of manager in the audit
and financial consulting division.
Mr. Davis was elected as a director of the Company in July 1997. Mr.
Davis has been a managing partner of Wellspring Associates L.L.C. since January
1995. Prior to founding Wellspring, Mr. Davis served as Chairman and Chief
Executive Officer of Gulf + Western Industries, Inc. and its successor company,
Paramount Communications, Inc., from 1983 to 1994. Mr. Davis is a member of the
Board of Directors of Lionel L.L.C., National Amusements, Inc., the parent
company of Viacom Inc. and SLM International, Inc.
Mr. Feldman was elected as a director of the Company in July 1997. Mr.
Feldman has been a managing partner of Wellspring since its inception in January
1995. From September 1990 until January 1995, he was a vice president in charge
of acquisitions at Exor America Inc. (formerly IFINT-USA Inc.), the U.S.
investment arm of the Agnelli Group. From September 1988 until September 1990,
Mr. Feldman was vice president and company-founder of Clegg Industries, Inc.,
and investment firm. Mr. Feldman is a member of the Board of Directors of Lionel
L.L.C. and Chartwell Re Corporation.
Mr. Rotatori was elected as a director of the Company in July 1997. Mr.
Rotatori is a partner and has been with Wellspring since September 1995. From
1991 until 1995, Mr. Rotatori was an Associate Director in the investment
banking department of Bear, Stearns & Company, Inc. Mr. Rotatori is a member of
the Board of Directors of SLM International, Inc.
Mr. Schafran was elected as a director of the Company in July 1997. Mr.
Schafran has been a managing general partner of L.G. Schafran & Associates, a
real estate and development firm, since 1984. Mr. Schafran is a member of the
Board of Directors of several companies, including Comsat Corporation, Publicker
Industries, Inc., Capsure Holdings Corporation, Sassco Corp., Leslie Fay Inc.
and Glasstech, Inc., Chairman of the Executive Group of The Dart Group
Corporation, Chairman of the Board of Directors of Delta-Omega Technologies,
Inc. and a trustee of National Income Realty Trust.
Mr. Smith was elected as a director of the Company in July 1997. Mr.
Smith joined Wafra Investment Advisory Group, Inc. ("Wafra") in 1992, where he
is a Vice President. From 1990 until 1992, Mr. Smith served as a Vice President
of Kouri Capital Group, Inc., a merchant bank providing, among other things,
privatization advisory service. Prior to joining Kouri Capital Group, Mr. Smith
served as Assistant Vice President of Direct Equity Investment at Lambert
Brussels Capital Corporation and, prior to that, as a Corporate Loan Officer at
First Union National Bank.
Mr. Kurnit was appointed as director in accordance with the terms of
the Plan as representative of the committee of pre-petition unsecured creditors
of the Company. He will serve for a term of three years through July 2000. Mr.
Kurnit's appointment was approved by the Bankruptcy Court at the confirmation
hearing. Mr. Kurnit has been President of Griffin Bacal Inc. ("Griffin Bacal")
since 1988.
57
<PAGE>
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires the Company's officers and
directors, and persons who own more than ten percent of a registered class of
the Company's equity securities, to file reports of securities ownership and
changes in such ownership with the Commission. Officers, directors and greater
than 10% shareholders also are required by rules promulgated by the Commission
to furnish the Company with copies of all Section 16(a) forms they file.
The Company is currently working with its officers, directors and
greater than 10% shareholders to ensure full current and future compliance with
the reporting requirements of Section 16(a). The Company has recently assisted
each of its officers and directors and Birch Holdings, L.L.C. in the filing of a
delinquent Form 3. In addition, the three executive officers granted stock
options in 1997 did not timely file a Form 5 to report such grants.
ITEM 11. EXECUTIVE COMPENSATION
The following table and discussion summarize the compensation earned by
the two individuals who have served as the Company's Chief Executive Officer
during the year ended December 31, 1997, and the other four most highly
compensated executive officers of the Company who earned more than $100,000 in
salary and bonuses (collectively, the "Named Executive Officers") for services
rendered in all capacities to the Company during the three years ended December
31, 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long-Term
Compensation
Awards
Number of
Annual Compensation Securities
--------------------------------------------------------------------------------------
Other
Annual Underlying All Other
Compensation Options/ Compensation
Name Position Year Salary ($) Bonus ($) (1)$ SARs ($)
- ----------------------- -------------- ---- ---------- --------- ------------ ----------- ---------------
<S> <C> <C> <C> <C> <C>
Scott W. Bernstein(2).. President/CEO 1997 416,667 200,000 37,862 357,845 --
1996 30,204 -- -- -- --
Donna R. Moore.......... President/CEO 1997 115,962 -- 900 -- 300,000
1996 412,500 -- -- -- 2,699(4)
1995 145,594 150,000 -- -- 26,224(4)
Robert G. Rooney(2).... SVP--CFO 1997 185,000 45,000 4,615 89,500 75,000(5)
1996 8,538 -- -- -- --
Sharon L. Rothstein(2). SVP--Marketing 1997 185,000 75,000 4,615 89,500 --
Leighton J. Weiss...... VP--Finance 1997 126,969 12,000 -- -- 50,000(5)
1996 115,987 23,356 -- -- --
1995 41,887 17,756 -- -- --
Stan Gerasimczyk........ VP--Store 1997 147,115 12,500 2,400 -- 30,000(5)
Operations
</TABLE>
- ---------------------------
(1) Represents payments made by the Company for auto allowances and other
perquisites pursuant to employment contracts.
(2) Mr. Bernstein, Mr. Rooney and Ms. Rothstein became executive officers of
the Company in December 1996, February 1997 and April 1997, respectively.
(3) Ms. Moore held a nominal title of President and Chief Executive Officer
through the Confirmation Date in order to avoid the need for Bankruptcy
Court approval in the event the Plan was not approved by the Company's
creditors, in which case Mr. Bernstein would have ceased to serve as
President and Chief Executive Officer of the Company. Ms. Moore was paid
her salary through February 1997 and received severance pay of $300,000
upon the Company's emergence from Chapter 11.
(4) Represents reimbursement for relocation expenses.
58
<PAGE>
(5) Represents a one-time bonus awarded by the Company in recognition of
efforts in connection with the reorganization of the Company and its
successful emergence from Chapter 11.
Option and SAR Grants in Fiscal Year 1997
<TABLE>
<CAPTION>
Potential Realizable
Value-at-Assumed
Annual Rates of Stock
Price Appreciation for
Individual Grants Option Term (2)
----------------------------- -------------------------
Number of % of Total
Securities Options/SARs Exercise or
Underlying Granted to Base-Price
Options/SARs Employees in ($/Sh) Expiration
Name Granted Fiscal Year (1) Date 5%($) 10%($)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Scott W. Bernstein.... 357,845 66.7% 11.88 7/31/07 2,673,556 6,775,315
Robert G. Rooney...... 89,500 16.7% 11.88 7/31/07 668,678 1,694,563
Sharon L. Rothstein... 89,500 16.7% 11.88 7/31/07 668,678 1,694,563
</TABLE>
- ------------------
(1) The exercise price of each of the Company's outstanding stock options
equals the fair market value of the Common Stock on the date of grant,
which the Company reasonably believed to be $11.88, based on the opening
book value of the total equity of the Company on a fully diluted basis as
of July 31, 1997, as determined by Fresh Start Accounting.
(2) Amounts reported in these columns represent amounts that may be realized
upon exercise of the Company's stock options immediately prior to the
expiration of their terms assuming the specified compounded annual rates
of appreciation (5% and 10%) on the Common Stock over the term of the
options. These assumptions are based on rules promulgated by the
Commission and do not reflect the Company's estimate of future stock price
appreciation. Actual gains, if any, on the stock option exercises are
dependent on the timing of such exercise and the future performance of the
underlying Common Stock. There can be no assurance that the rates of
appreciation assumed in this table can be achieved or that the amounts
reflected will be received by the option holder.
Option and SAR Exercises in Fiscal 1997 and Year-End Option and SAR Values
<TABLE>
<CAPTION>
Number of Securities
Underlying
Unexercised Value of Unexercised
Shares Options/SARs In-the-Money Options/SARs
Acquired on Value at FY-End 1997 at FY-End 1997 ($)
Name Exercise Realized Exercisable/Unexercisable Exercisable/Unexercisable(1)
- ------------------------ -------- -------- ------------------------- ----------------------------
<S> <C> <C> <C> <C>
Scott W. Bernstein...... -- 16.7% 0/357,845 7/31/07
Robert G. Rooney........ -- 16.7% 0/89,500 7/31/07
Sharon L. Rothstein.... -- 16.7% 0/89,500 7/31/07
Donna R. Moore.......... -- 16.7% 0/89,500 7/31/07
Leighton J. Weiss....... -- -- -- --
</TABLE>
- -----------------------
(1) The Company's Common Stock was not publicly traded on December 31, 1997.
The Company reasonably believes that the stock options granted to Mr.
Bernstein, Ms. Rothstein and Mr. Rooney in 1997 were not in-the-money at
December 31, 1997.
Committees of the Board of Directors
None.
Compensation of Directors
The Directors do not receive any fee for their services; however, they
are reimbursed for all out-of-pocket expenses incurred in connection with
attending meetings of the Company's Board of Directors.
59
<PAGE>
Employment Agreements
On July 21, 1997, the Company entered into an employment agreement with
Mr. Bernstein providing for his continued employment as Chief Executive Officer,
President and Director. The agreement with Mr. Bernstein expires on January 1,
2001. The agreement provides for an annual base salary of $440,000 per year,
with annual increases of $40,000 beginning January 1, 1998. In addition, the
agreement provides an annual bonus, equal to 2.0% of the Company's earnings
before interest, taxes, depreciation and amortization expenses. The agreement
also provides for the reimbursement of certain other business related expenses.
On August 1, 1997, the Company entered into an employment agreement
with Ms. Rothstein providing for her employment as Senior Vice President,
Marketing and Entertainment. The agreement with Ms. Rothstein expires on
December 31, 2000. The agreement provides for an annual base salary of $185,000
(plus performance bonuses based on the achievement of certain objectives).
On August 1, 1997, the Company entered into an employment agreement
with Mr. Rooney providing for his employment as Senior Vice President, Chief
Financial Officer and Administrative Officer. The agreement with Mr. Rooney
expires on December 31, 2000. The agreement provides for an annual base salary
of $185,000 (plus performance bonuses based on the achievement of certain
objectives).
Committee Interlocks and Insider Participation
The Company's Board of Directors does not currently have a compensation
committee. The Company's Board of Directors determines all executive
compensation matters. Mr. Bernstein serves as a director on the Board of
Directors and as Chief Executive Officer and President of the Company.
Stock Incentive Plan
All of the Company's option plans and equity securities in existence
prior to the Effective Date were canceled pursuant to the Plan. The Company
adopted the 1997 Stock Incentive Plan in connection with the Plan. Pursuant to
their respective employment agreements, the Company granted to Mr. Bernstein,
Ms. Rothstein and Mr. Rooney options to purchase 357,485 shares, 89,500 shares
and 89,500 shares, respectively, of the Company's Common Stock at an exercise
price of $11.88 per share. One-third of such options vested on January 1, 1998.
One-third of such options will vest on January 1, 1999 and the remaining
one-third will vest on January 1, 2000. In addition, such options vest in their
entirety upon the incurrence of a "Change of Control." The Board of Directors of
the Company may amend or modify the Stock Incentive Plan at its discretion in
accordance with the Company's Certificate of Incorporation and By-laws. The
Stock Incentive Plan terminates ten years after the Effective Date. Shares of
Common Stock subject to the Stock Incentive Plan represent up to a maximum of
10% of the outstanding shares of Common Stock after giving effect to the
issuance of the Ten Year Warrants and the Warrants. The Company has reserved
715,692 shares of Common Stock for issuance under this Stock Option Plan. In the
first quarter of 1998, the Company awarded options to purchase approximately
150,000 shares to certain other management employees.
The Stock Incentive Plan is administered by the Board of Directors and
provides for the grants to eligible officers and employees of "Incentive Stock
Options" or "NonQualified Stock Options" (together, the "Stock Options"), or
both, to purchase shares of the Common Stock at no less than its fair market
value at the date of grant, in any such case subject to the discretion of the
Board of Directors. Pursuant to the Stock Incentive Plan, the Board of Directors
may also grant Stock Appreciation Rights (as defined therein). The Board of
Directors will fix the term of each Stock Option. However, no Incentive Stock
Options will be exercisable more than ten years after the date of grant. Stock
Options may be exercised, in whole or in part, at any time during the option
term by giving written notice of exercise to the Company and, for a limited
time, upon the death, disability or retirement of the optionee. No Stock Option
will be transferable by the optionee other than by will, by the laws of descent
and distribution, or, in the case of a NonQualified Stock Option, as permitted
under the applicable option agreement. The Company may repurchase a portion of
the shares of Common Stock upon exercise of the Stock Options. The Stock
Incentive Plan allows an option holder to demand cash for his or her option upon
a Change of Control (as defined therein) of the Company.
60
<PAGE>
The Stock Incentive Plan also provides for grants of Restricted Stock
(as defined therein). The Board of Directors may designate an award of
Restricted Stock (an "Award") which vests upon the attainment of certain
specified performance goals set by the Board of Directors. Prior to the letter
of expiration of the applicable restricted period and attainment of such
performance goals, a participant may not sell, assign, transfer, pledge or
otherwise encumber shares of Restricted Stock other than to pledge the
Restricted Stock as security for a loan to provide funds to pay the exercise
price for the Stock Options. Holders of Restricted Stock will have all of the
rights of a stockholder of the Common Stock. Any Restricted Stock must be
forfeited upon termination of employment.
The Stock Incentive Plan also provides for grants of Performance Units
(as defined therein). The Board of Directors may designate an award of
Performance Units and may condition any settlement thereof upon attainment of
specified performance goals. Performance Units may not be sold, assigned,
transferred, pledged or otherwise encumbered during the award cycle. Upon
achievement of such performance goals, the Board of Directors will deliver to
the participant either shares of Common Stock equal to the number of Performance
Units or cash equal to the fair market value of such number of shares of Common
Stock.
61
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The following tables set forth certain information concerning the
beneficial ownership of shares of Common Stock on March 31, 1998 (the "Table
Date"), by: (i) each stockholder known by the Company to beneficially own more
than 5% of the outstanding Common Stock; (ii) each of the Named Executive
Officers; (iii) each of the Company's directors; and (iv) all directors and
executive officers of the Company as a group.
<TABLE>
<CAPTION>
SHARES OF
BENEFICIALLY PERCENT
OWNED BENEFICIALLY
BENEFICIAL OWNER COMMON STOCK (1) OWNED (1)
- ------------------------------------------------------------------- ----------------------- ------------------------
<S> <C> <C>
Birch Holdings L.L.C. (2)......................................... 2,229,622 55.7%
Martin S. Davis (2)................................................ 2,229,622 55.7
Greg S. Feldman (2)................................................ -- --
Douglas W. Rotatori (2)............................................ -- --
Balfour Investors Incorporated (2)................................. 607,154 13.9
L.G. Schafran (2).................................................. -- --
Wafra Investment Advisory Group, Inc., or its designee (3)......... 1,191,626 23.0
Christopher R. Smith (4)........................................... -- --
Paul D. Kurnit (5)................................................. 48,931 1.2
Scott W. Bernstein (6)............................................. 119,282 2.9
Robert G. Rooney (6)............................................... 29,833 .7
Sharon L. Rothstein (6)............................................ 29,833 .7
Directors and executive officers as a group (2)(4)(5)(6)........... 3,649,129 67.9
</TABLE>
- ----------------
(1) Beneficial ownership is determined in accordance with the rules and
regulations of the Securities and Exchange Commission. In computing the
number of shares beneficially owned by a person and the percentage of
ownership of that person, shares of Common Stock subject to options or
warrants held by that person that are currently exercisable or exercisable
within 60 days of the Table Date are deemed outstanding. Such shares,
however, are not deemed outstanding for the purpose of computing the
percentage ownership of any other person.
(2) Birch Acquisition L.L.C., an affiliate of Wellspring ("Birch Acquisition"),
beneficially owns approximately 98% of the economic interest and has voting
power over 100% of Birch Holdings. The remaining 2% of the economic
interest of Birch Holdings is held by affiliates of Balfour Investors
Incorporated ("Balfour"). A separate affiliate of Balfour beneficially owns
approximately 5% of the Common Stock (the "Balfour Shares"). Birch
Acquisition is company-managed by Mr. Davis and Greg S. Feldman. In his
capacity as the managing member of Birch Acquisition, Mr. Davis exercises
voting and dispositive power over the shares of Common Stock held by Birch
Acquisition. Birch Holdings and Mr. Davis disclaim beneficial ownership of
the Balfour Shares and neither Birch Holdings nor Mr. Davis have
dispositive power over the Balfour Shares. L.G. Schafran, a director of the
Company nominated by Balfour, disclaims voting, dispositive power and
beneficial ownership over the shares of Common Stock beneficially owned by
Balfour, and Mr. Feldman and Douglas W. Rotatori disclaim voting and
dispositive power over the shares of Common Stock beneficially owned by
Birch Acquisition.
(3) Wafra owns the Convertible Preferred Stock which, by its terms, is
immediately convertible into 18.5% of the fully diluted shares of Common
Stock (after giving effect to the issuance of the Warrants and the Ten Year
Warrants, but before giving effect to Stock Options granted under the Stock
Incentive Plan).
(4) Christopher R. Smith, a director of the Company nominated by Wafra,
disclaims voting and dispositive power over the shares of Common Stock
beneficially owned by Wafra.
62
<PAGE>
(5) Paul D. Kurnit is the director of the Company nominated by certain classes
of pre-petition creditors of the Company pursuant to the Plan of
Reorganization, including Griffin Bacal, a pre-petition creditor of the
Company, of which Mr. Kurnit is an officer. Mr. Kurnit, individually, is
the beneficial owner of less than 5.0% of the outstanding Common Stock.
(6) Represents the vested portion of Stock Options granted to Mr. Bernstein,
Mr. Rooney and Ms. Rothstein. The Company's Board of Directors has granted
Stock Options to Mr. Bernstein, Mr. Rooney and Ms. Rothstein with respect
to 357,845, 89,500 and 89,500 shares of Common Stock, respectively,
one-third of which had vested as of January 1, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As required under the Plan, the Company reimbursed Wellspring $1.1
million for out-of-pocket expenses by Wellspring incurred in connection with its
joint sponsorship of the Plan. In addition, an officer of Griffin Bacal, the
Company's advertising agency, serves as a director of the Company. The Company
paid $7.6 million to Griffin Bacal for media purchases on behalf of and creative
services provided to the Company in 1997. Management believes that the terms of
its agreement with Griffin Bacal are on terms at least as favorable to the
Company as the Company could have obtained from an independent third party.
63
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Reference is made in the information set forth in Part II, Item 8
of this Report, which information is incorporated herein by
reference.
(a)(2) Financial Statement Schedules:
Financial Statement Schedule II, Valuation and Qualifying
Accounts, for the years ended December 31, 1997, 1996 and 1995 are
submitted herewith; all other schedules have been omitted because
they are not applicable or are not required.
(a)(3) The exhibits to this Report are listed in the Exhibit Index which
appears elsewhere in this Report and is incorporated herein by
reference.
(b) Reports on Form 8-K: None
64
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the undersigned Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized, in Elmsford, New York on June 30, 1998.
DISCOVERY ZONE, INC.
By: /s/ Scott W. Bernstein
------------------------------------------------------
Name: Scott W. Bernstein
Title: Chief Executive Officer, President and Director
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Scott W. Bernstein and Robert G.
Rooney, and each of them, his true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities to sign any and all amendments to this
report, granting unto said attorneys-in-fact and agents, and each of them, full
power and authority to do and perform each and every act and thing requisite or
necessary to be done in and about the premises, as full to all intents and
purposes as he might or could do in person, hereby ratifying and confirming that
each of said attorneys-in-fact and agents and/or either of them, or his
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this has been signed by the following persons in the capacities
indicated on June 30, 1998.
NAME TITLE
/s/ Scott W. Bernstein Chief Executive Officer,
- ------------------------------------ President and Director
Scott W. Bernstein
/s/ Martin S. Davis Director
- ------------------------------------
Martin S. Davis
/s/ Greg S. Feldman Director
- ------------------------------------
Greg S. Feldman
/s/ Douglas W. Rotatori Director
- ------------------------------------
Douglas W. Rotatori
/s/ L.G. Schafran Director
- ------------------------------------
L.G. Schafran
- ------------------------------------ Director
Christopher R. Smith
/s/ Paul D. Kurnit Director
- ------------------------------------
Paul D. Kurnit
/s/ Robert G. Rooney Senior Vice President, Chief
- ------------------------------------
Robert G. Rooney Financial and Administrative Officer
/s/ Leighton J. Weiss Vice President and Controller
- ------------------------------------
Leighton J. Weiss (Chief Accounting Officer)
65
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number
- --------
+1.1 Purchase Agreement, dated July 15, 1997, between the Registrant
and Jefferies & Company, Inc., as the initial purchaser (the
"Initial Purchaser").
++++2.1 The Third Amended Joint Plan of Reorganization of the
Registrant, dated March 11, 1997.
+2.2 Agreement and Plan of Merger, dated as of July 28, 1997, between
Discovery Zone Children's Amusement Corp. and the subsidiaries
of the Registrant listed therein.
+2.3 Agreement and Plan of Merger, dated as of July 29, 1997, between
the Registrant and Discovery Zone Children's Amusement
Corporation.
+3.1 Amended and Restated Certificate of Incorporation of the
Registrant.
+3.2 Amended and Restated By-laws of the Registrant.
+4.1 Indenture, dated as of July 22, 1997, among Registrant, as
issuer, Discovery Zone Limited, Discovery Zone (Puerto Rico),
Inc. and Discovery Zone Licensing, Inc., as guarantors (the
"Guarantors") and State Street Bank and Trust Company, as
trustee (the "Trustee").
4.2 Form of Exchange Note (included in Exhibit 4.1).
+4.3 Registration Rights Agreement, dated as of July 22, 1997,
between the Registrant and the Initial Purchaser.
+4.4 Warrant Agreement, dated as of July 22, 1997, between the
Registrant and State Street Bank and Trust Company, as warrant
agent.
+4.5 Escrow and Security Agreement, dated as of July 22, 1997, among
the Registrant, as pledgor, the Initial Purchaser, and the
Trustee, as collateral agent.
+4.6 Pledge Agreement, dated as of July 22, 1997, between the
Registrant and the Trustee, as collateral agent.
+4.7 Security Agreement, dated as of July 22, 1997, between the
Registrant and the Trustee, as collateral agent.
+4.8 Subsidiary Pledge Agreement, dated as of July 22, 1997, between
the Guarantors and the Trustee, as collateral agent.
+4.9 Subsidiary Security Agreement, dated as of July 22, 1997,
between the Guarantors and the Trustee, as collateral agent.
+4.10 Collateral Assignment of Patents, Trademarks and Copyrights,
dated as of July 22, 1997, among the Registrant, as assignor,
the Guarantors, as assignors and the Trustee, as assignee.
+4.11 Assignment and License Agreement, dated as of July 29, 1997,
among the Registrant, as assignor, the Guarantors, as assignors,
and DZ Party, Inc., as assignee.
66
<PAGE>
Exhibit
Number
- -------
+++4.12 Form of Intercreditor Agreement, dated as of July 22, 1997,
between a [lender] and the Trustee, as collateral agent.
+4.13 The Mortgage, Assignment of Leases and Rents, Security Agreement
and Fixture Filing, dated as of July 29, 1997, between the
Company, as mortgagor and the Trustee, as mortgagee, related to
property located in Hamilton County, Ohio.
+4.14 The Mortgage, Assignment of Leases and Rents, Security Agreement
and Fixture Filing, dated as of July 29, 1997, between the
Company, as mortgagor and the Trustee, as mortgagee, related to
property located in Cook County, Illinois.
+4.15 The Mortgage, Assignment of Leases and Rents, Security Agreement
and Fixture Filing, dated as of July 29, 1997, between the
Company, as mortgagor and the Trustee, as mortgagee, related to
property located in Cobb County, Georgia.
+4.16 The Mortgage, Assignment of Leases and Rents, Security Agreement
and Fixture Filing, dated as of July 29, 1997, between the
Company, as mortgagor and the Trustee, as mortgagee, related to
property located in Franklin County, Ohio.
+4.17 The Mortgage, Assignment of Leases and Rents, Security Agreement
and Fixture Filing, dated as of July 29, 1997, between the
Company, as mortgagor and the Trustee, as mortgagee, related to
property located in Macomb County, Michigan.
+4.18 The Mortgage, Assignment of Leases and Rents, Security Agreement
and Fixture Filing, dated as of July 29, 1997, between the
Company, as mortgagor and the Trustee, as mortgagee, related to
property located in Anoka County, Minnesota.
+4.19 The Mortgage, Assignment of Leases and Rents, Security Agreement
and Fixture Filing, dated as of July 29, 1997, between the
Company, as mortgagor and the Trustee, as mortgagee, related to
property located in Philadelphia County, Pennsylvania.
+4.20 The Mortgage, Assignment of Leases and Rents, Security Agreement
and Fixture Filing, dated as of July 29, 1997, between the
Company, as mortgagor and the Trustee, as mortgagee, related to
property located in Marion County, Indiana.
+4.21 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among
the Registrant, as grantor, Kenneth W. Pearson, as trustee and
the Trustee, as beneficiary, relating to property located in
Dallas County, Texas.
+4.22 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among
the Registrant, as grantor, Kenneth W. Pearson, as trustee and
the Trustee, as beneficiary, relating to property, located in
Bexar County (San Antonio), Texas.
+4.23 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among
the Registrant, as grantor, Kenneth W. Pearson, as trustee and
the Trustee, as beneficiary, relating to property located in
Tarrant County, Texas.
67
<PAGE>
Exhibit
Number
- -------
+4.24 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among
the Registrant, as grantor, Kenneth W. Pearson, as trustee and
the Trustee, as beneficiary, relating to property located in
Bexar County (Leon Valley), Texas.
+4.25 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among
the Registrant, as grantor, Kenneth W. Pearson, as trustee and
the Trustee, as beneficiary, relating to property located in
Fort Bend County, Texas.
+4.26 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among
the Registrant, as grantor, Chicago Title Insurance Company, as
trustee and the Trustee, as beneficiary, relating to property
located in Clark County, Washington.
+4.27 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among
the Registrant, as grantor, The Public Trustee of Arapahoe
County, Colorado, as trustee and the Trustee, as beneficiary,
relating to property located in Arapahoe County, Colorado.
+4.28 The Deed of Trust, Assignment of Leases and Rents, Security
Agreement and Fixture Filing, dated as of July 29, 1997, among
the Registrant, as grantor, The Public Trustee of Douglas
County, Colorado, as trustee and the Trustee, as beneficiary,
relating to property located in Douglas County, Colorado.
++4.29 Open-end Mortgage, Assignment of Leases and Rents, Security
Agreement and Fixture Filing (Amended and Restated), dated as of
July 29, 1997, between the Registrant, as mortgagor and
McDonald's Corporation, as mortgagee, relating to property
located in Hamilton County, Ohio.
++4.30 Amended and Restated Mortgage, Assignment of Leases and Rents,
Security Agreement and Fixture Filing, dated as of July 29,
1997, between the Registrant, as mortgagor and McDonald's
Corporation, as mortgagee, relating to property located in Cook
County, Illinois.
++4.31 Amended and Restated Deed to Secure Debt and Security Agreement,
dated as of July 29, 1997, between the Registrant, as mortgagor
and McDonald's Corporation, as mortgagee, relating to property
in Cobb County, Georgia.
++4.32 Open-end Mortgage, Assignment of Leases and Rents, Security
Agreement and Fixture Filing (Amended and Restated), dated as of
July 29, 1997, between the Registrant, as mortgagor and
McDonald's Corporation, as mortgagee, relating to property
located in Franklin County, Ohio.
++4.33 Amended and Restated Mortgage, dated as of July 29, 1997,
between the Registrant, as mortgagor and McDonald's Corporation,
as mortgagee, relating to property located in Macomb County,
Michigan.
++4.34 Amended and Restated Mortgage, Assignment of Leases and Rents,
Security Agreement and Fixture Filing, dated as of July 29,
1997, between the Registrant, as mortgagor and McDonald's
Corporation, as mortgagee, relating to property located in Anoka
County, Minnesota.
++4.35 Amended and Restated Open-end Mortgage, Assignment of Leases and
Rents, Security Agreement and Fixture Filing, dated as of July
29, 1997, between the Registrant, as mortgagor and McDonald's
Corporation, as mortgagee, relating to property in Philadelphia
County, Pennsylvania.
68
<PAGE>
Exhibit
Number
- -------
++4.36 Amended and Restated Mortgage, Assignment of Leases and Rents,
Security Agreement and Fixture Filing, dated as of July 29,
1997, between the Registrant, as mortgagor and McDonald's
Corporation, as mortgagee, relating to property in Marion
County, Indiana.
++4.37 Amended and Restated Deed of Trust, Assignment of Leases and
Rents, Security Agreement and Fixture Filing, dated as of July
29, 1997, among the Registrant, as grantor, Kenneth W. Pearson,
as trustee and McDonald's Corporation, as beneficiary, relating
to property located in Bexar County (San Antonio), Texas.
++4.38 Amended and Restated Deed of Trust, Assignment of Leases and
Rents, Security Agreement and Fixture Filing, dated as of July
29, 1997, among the Registrant, as grantor, Kenneth W. Pearson,
as trustee and McDonald's Corporation, as beneficiary, relating
to property located in Tarrant County, Texas.
++4.39 Amended and Restated Deed of Trust, Assignment of Leases and
Rents, Security Agreement and Fixture Filing, dated as of July
29, 1997, among the Registrant, as grantor, Kenneth W. Pearson,
as trustee and McDonald's Corporation, as beneficiary, relating
to property located in Bexar County (Leon Valley), Texas.
++4.40 Amended and Restated Deed of Trust, Assignment of Leases and
Rents, Security Agreement and Fixture Filing, dated as of July
29, 1997, among the Registrant, as grantor (borrower),
McDonald's Corporation, as grantee (lender) and Chicago Title
Insurance Company, as grantee (trustee), relating to property
located in Clark County, Washington.
++4.41 Amended and Restated Deed of Trust, Assignment of Leases and
Rents, Security Agreement and Fixture Filing, dated as of July
29, 1997, among the Registrant, as grantor, The Public Trustee
of Arapahoe County, Colorado, as trustee and McDonald's
Corporation, as beneficiary, relating to property located in
Arapahoe County, Colorado.
++4.42 Amended and Restated Deed of Trust, Assignment of Leases and
Rents, Security Agreement and Fixture Filing, dated as of July
29, 1997, among the Registrant, as grantor, The Public Trustee
of Douglas County, Colorado, as trustee and McDonald's
Corporation, as beneficiary, relating to property located in
Douglas County, Colorado.
++4.43 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Hamilton
County, Ohio.
++4.44 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Cook
County, Illinois.
++4.45 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Cobb
County, Georgia.
++4.46 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Franklin
County, Ohio.
++4.47 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Macomb
County, Michigan.
++4.48 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Anoka
County, Minnesota.
69
<PAGE>
Exhibit
Number
- -------
++4.49 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in
Philadelphia County, Pennsylvania.
++4.50 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Marion
County, Indiana.
++4.51 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Bexar
County (San Antonio), Texas.
++4.52 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Tarrant
County, Texas.
++4.53 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Bexar
County (Leon Valley), Texas.
++4.54 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Clark
County, Washington.
++4.55 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Arapahoe
County, Colorado.
++4.56 Subordination Agreement, dated as of July 29, 1997, among the
Registrant, the Trustee, for itself and as collateral agent, and
McDonald's Corporation, related to property located in Douglas
County, Colorado.
++4.57 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Independence,
Missouri.
++4.58 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Royal Palm,
Florida.
++4.59 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Cincinnati,
Ohio.
++4.60 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Greenfield,
Wisconsin.
++4.61 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Webster, Texas.
++4.62 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Houston, Texas.
++4.63 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Manchester,
Missouri.
++4.64 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Rancho
Cucomonga, California.
70
<PAGE>
Exhibit
Number
- --------
++4.65 Secured Rent Deferral Note of McDonald's Corporation, dated as
of July 29, 1997, related to property located in Amherst, New
York.
++4.66 Secured Rejection Note of McDonald's Corporation, dated as of
July 29, 1997.
+++++4.67 Loan and Security Agreement, dated as of March 31, 1998, between
the Registrant and Foothill Capital Corporation ("Foothill").
+++++4.68 General Continuing Guaranty, dated as of March 31, 1998, among
Discovery Zone (Canada) Limited, Discovery Zone (Puerto Rico),
Inc. and Discovery Zone Licensing, Inc., as guarantors (the
"Guarantors"), in favor of Foothill.
+++++4.69 Security Agreement, dated as of March 31, 1998, between the
Guarantors and Foothill.
+++++4.70 Stock Pledge Agreement, dated as of March 31, 1998, between the
Registrant and Foothill.
+++++4.71 Trademark Security Agreement, dated as of March 31, 1998, among
the Registrant, Discovery Zone Licensing, Inc. and Foothill.
+++++4.72 Intercreditor Agreement, dated as of March 31, 1998, between
Foothill and the Trustee, as collateral agent.
++10.1 Employment Agreement, dated as of July 21, 1997, between the
Registrant and Scott W. Bernstein.
++10.2 Employment Agreement, dated as of August 1, 1997, between the
Registrant and Robert G. Rooney.
++10.3 Employment Agreement, dated as of August 1, 1997, between the
Registrant and Sharon L. Rothstein.
++10.4 1997 Stock Incentive Plan.
12.1 Statements re computation of ratios.
++++++16.1 Letter re change in certifying accountant.
+21.1 List of Subsidiaries of the Registrant.
24.1 Power of Attorney (included on signature page).
27.1 Financial Data Schedule (December 31, 1997).
27.2 Restated Financial Data Schedule (July 31, 1997).
+++++27.3 Restated Financial Data Schedule (1995).
- --------------
+ Incorporated by reference from the Registration Statement on Form S-4
of the Registrant, dated November 19, 1997.
++ Incorporated by reference from Amendment No. 1 to the Registration
Statement on Form S-4 of the Registrant, dated December 9, 1997.
71
<PAGE>
Exhibit
Number
- -------
+++ Incorporated by reference from Amendment No. 3 to the
Registration Statement on Form S-4 of the Registrant, dated
January 28, 1998.
++++ Incorporated by reference from the Current Report on Form 8-K of
the Registrant, dated July 9, 1997.
+++++ Incorporated by reference from the Annual Report on Form 10-K of
the Registrant for the year ended December 31, 1997.
++++++ Incorporated by reference from the Current Report on Form 8-K of
the Registrant, dated June 3, 1996.
72
DISCOVERY ZONE, INC
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN THOUSANDS, EXCEPT RATIOS)
<TABLE>
<CAPTION>
SEVEN MONTHS FIVE MONTHS
ENDED JULY 31 ENDED DECEMBER
1997 31, 1997
------------- --------------
<S> <C> <C>
Pre-tax income (loss) from continuing operations........................ (5,453) (27,966)
Adjustments:
Fixed Charges......................................................... 3,249 6,076
------------- --------------
Earnings before taxes and fixed charges as adjusted..................... (2,204) (21,890)
============= ==============
Fixed Charges:
Interest incurred..................................................... 3,249 6,076
Portion of rent expense which represents interest factor.............. -- --
------------- --------------
Total fixed charges..................................................... 3,249 6,076
============= ==============
Ratio of earnings to fixed charges...................................... -- --
============= ==============
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1995 1996
------------- --------------
<S> <C> <C>
Pre-tax income (loss) from continuing operations........................ (445,245) (83,834)
Adjustments:
Fixed Charges......................................................... 12,226 6,277
------------- --------------
Earnings before taxes and fixed charges as adjusted..................... (433,019) (77,557)
============= ==============
Fixed Charges:
Interest incurred..................................................... 12,226 6,277
Portion of rent expense which represents interest factor.............. -- --
------------- --------------
Total fixed charges..................................................... 12,226 6,277
============= ==============
Ratio of earnings to fixed charges...................................... -- --
============= ==============
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 5-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> AUG-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 8,607
<SECURITIES> 0
<RECEIVABLES> 750
<ALLOWANCES> 0
<INVENTORY> 1,739
<CURRENT-ASSETS> 29,225
<PP&E> 140,666
<DEPRECIATION> 9,314
<TOTAL-ASSETS> 176,591
<CURRENT-LIABILITIES> 26,179
<BONDS> 87,091
13,897
0
<COMMON> 40
<OTHER-SE> 42,215
<TOTAL-LIABILITY-AND-EQUITY> 176,591
<SALES> 0
<TOTAL-REVENUES> 48,485
<CGS> 0
<TOTAL-COSTS> 60,814
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,076
<INCOME-PRETAX> (27,966)
<INCOME-TAX> 0
<INCOME-CONTINUING> (27,966)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (27,966)
<EPS-PRIMARY> (7.02)
<EPS-DILUTED> (7.02)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 7-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUL-31-1997
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 0
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 0
<TOTAL-REVENUES> 82,537
<CGS> 0
<TOTAL-COSTS> 86,248
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,249
<INCOME-PRETAX> (5,453)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,453)
<DISCONTINUED> 0
<EXTRAORDINARY> 332,165
<CHANGES> 0
<NET-INCOME> 326,712
<EPS-PRIMARY> 5.66
<EPS-DILUTED> 5.66
</TABLE>
